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Hello and welcome to another episode of the aud Thoughts podcast. I'm Tracy Alloway and I'm Joe.
Isn't thal Joe.
We always start these the same with someone saying, it's that time of year, and.
It's the most wonderful time of the year.
That's right, never changed.
Forecast season, it's.
The outlook season. It is the moment when every investment bank on Wall Street releases they're forecasts for next year.
Yeah, it is a great time, you know.
We make New Year's resolutions.
The time of year, we go back, we make our list of top ten things that happened, predictions, as we're supposed to. News gets a little quiet often around the holidays, so we make up for it by just looking back and looking forward.
And then a year later we completely forget what everyone says about the current year and we just move on and do the next year. That's right, always forward looking. Although I do think, you know, twenty twenty six shaping up to be an interesting year for a variety of reasons. We just had a CPI number that came out surprisingly softer than a lot of people expected. Some people say, unrealistically softer with zero percent shelter costs increase, So that
was interesting. We're going to have a new FED chairman. Yeah, there's still a question mark over the impact of tariffs, whether we're waiting to see those show up, and what's going to happen with unemployment as well, that's been ticking up.
And then it's been this really incredible year obviously in the stock market. The US stock market just continues year after year, with a few exceptions here and there, but not many putting up massive numbers. And so the question is like how long is this realistic, especially given you know, all the concerns about concentration and a handful of names, some of which haven't really been doing so well lately, and so so many on both the real economy and the stock mark.
Yeah, there's definitely been some dispersion creeping into some of the big AI names or the tech names. All right, well, I'm happy to say we do, in fact have the perfect guests plural. We've got two. So we're going to be speaking with Jan Hatzias. He's the chief economist and head of research at Goldman Sachs. He's been on the show a number of times before and we like talking to him at least once a year. And Ben Snyder, he is the chief US equity strategist, replacing David Costen.
So thank you both for coming on all thoughts.
Thanks so much for having us.
Great to be here.
Is research outlook time? Is that actually a quiet time for you guys?
It's not a quiet time normally. We actually do it about six weeks earlier. Yeah, because actually November tends to be a little bit better than December. But because of the shutdown and the dearth of data, we decided to push it back. It's completely under all control when we do it, and why do it at a time when you actually have much less information normal? So we pushed out a number of reports yesterday, including the global economic and market's outlook.
Can you talk to two of you maybe again? So obviously different roles, but on the same team. And obviously the stock market US secrety market is different from the economy, and you can have years where the economies find stocks are bad and vice versa. All different permutations and combinations. But how do you think about being in alignment cross team and so that roughly you're sort of working under a similar set of assumption.
Yeah, I can talk about that, and not just with respect to the US or global economic outlook versus stock market outlook. But of course there's currencies, there's em economies, there's commodities. Certainly on the macro side, I would say we're on the coordinated side of the spectrum. Nobody is at one extreme or the other extreme. You can't have people that just work alongside one another without ever talking
to one another. But you also shouldn't have just a machine where everything is exactly aligned and there's zero room for individual initiative. So we're towards the coordinator side for sure.
Well, you mentioned yesterday a good time to note to listeners we are recording this December nineteenth, twenty twenty five. Ben, how do you think about sort of working with aligning your views of where markets are going or what the meaning of the rally has with the sort of with the macro thinking.
There are a number of frameworks to think about the equity market, but a pretty common one and one we rely on a lot, is to think of the market like a stock, as a discounted stream of future cash flows. And from that perspective, the most important driver of stocks is that stream of cash flows is earnings, and if you break those apart, the most important driver of those cash flows is usually the US economy. So we rely very heavily on Yon's forecasts.
So in terms of Yan's forecast, I noticed your forecasting strong growth as in GDP, but also rising unemployed. How do you square those two things.
We have flat unemployment at four and a half percent, but it's not going down as you might think when you're printing let's say two point six percent for real GDP in two thousand and twenty six. And a small part of the answer is that that two point six probably overstates the underlying trend a bit because we had the shutdown that the pressed Q four it's going to add to Q one. But the more important part of the answer is accelerating productivity growth, and we've seen that
over the last five years. The five years since the pandemic have shown about two percent underlying trend productivity growth. The prior cycle was at about one and a half percent. And I think there's reason to believe that that acceleration is still ongoing because it probably doesn't have a lot
of AI in it. We expect more of a boost from AI going going forward in the next five years, then in the last five years, and I think that's got important implications for the relationship between GDP and unemployment.
So obviously, like the distribution of growth matters. It seems to particularly matter when we're talking about the stock market, because you can have sectors that are like very quiet, but then you have these gigantic companies that make a ton of money and capture a lot of the growth that their stock's do incredibly well, maybe it would be helpful even before we get to the twenty six outlook for the economy, ben like what happened in twenty twenty five,
What were the underlying conditions that allowed for such like another monster year, especially for the Nasdaq and a lot of big tech names.
So to bring it back to earning, Yeah, one thing that happened was really strong earnings growth. And I think among all the discussions of bubbles, what's underappreciated is just how strong corporate earnings growth has been.
Yeah.
Just wrapped up the third quarter season a few weeks ago, and S and P five hundred companies in aggregate reported earnings growth of twelve percent. Even if we strip out the megacaps, the median S and P stock reported earning's growth of about ten percent. That's very solid.
This seems to be like an underappreciated point, which is that, look, the AI driven market, the tech heavy market, it is not just that, is it.
We'll take an extension for this. We spend a lot of time, understandably talking about the largest stocks in the market. The top ten stocks are over forty percent of market cap. We should spend a lot of time talking about them.
But if you look at the S.
And P four hundred and ninety or four hundred ninety three, that market or that group of stocks has returned about fifteen percent this year. They were turned about fifteen percent last year. They were turned about fifteen percent the year prior. And so I understand why we're talking about the large stocks, but really the broad US equity market has performed quite well.
Well.
How do you account for I guess the weakness that we've seen in some of the mega tech stocks in recent weeks. What's going on there?
For three years we've been obsessed with AI as a market, and for three years, really the story has been increased capex, extraordinarily growth in AI investment spending. And although we're discussing a lot the eventual productivity benefits. As Yon mentioned, really the trade in the equity market has been the companies
with earnings that are benefiting from those capex dollars. And what's happened this year, especially in the last several months, is it's become increasingly clear that A probably that growth will decelerate next year, and b to continue that growth, it's going to require more debt, and both of those factors have made investors understandably uncomfortable.
Yeah.
One of the sort of the viral charts of the year various estimates of like how much the AI build out specifically is a driver of US economic growth? And twenty five and beyond, like how much you know, when you look at the GDP in twenty twenty five, how much of the growth can you attribute to what benj just talked about.
Actually pretty close to zero.
Really, this is because very different.
This is a zero I love for two reasons. Number one, the goods that are being invested in in the AI sector are largely imported, so you can look at the contribution of investment spending to GDP growth, But if you don't net that out against the imports, then you're going to get the wrong answer.
That's one reason.
Second reason is that semiconductors are generally treated as intermediate inputs, not as investment, so they don't actually show up in the investment numbers. And so when we look at the impact of AI investment on measured GDP growth on the numbers that are actually being printed, we're getting only about twenty basis points of contribution over the last three or four years, and pretty close.
To zero over the last year.
So it struck to me is such an important point because you know, you have other people estimating how fifty percent of growth this year is related to the AI build up? Are you just always like banging your head against the wall because you must see these headlines every day like the rest of us.
I do a bit because oftentimes it's just based on looking at some portion of investment spending. Sometimes there are also other things included in those calculations that aren't necessarily AI related. But the big point is that you really need to look at the imports as well.
Ben I should just ask before we go any further, what actually is your twenty twenty six target for the S and P five hundred, Because we haven't seen the official outlook yet.
We've published seventy six hundred seventy six ORed.
Okay, so one thing I did want to ask this was in Yan's Economic outlook. But you talk about potentially credit underperforming, which seems a little bit strange if interest rates are going lower and you know, equities are doing pretty good. What's going on there?
I mean, it's mainly really that the valuations are very high. The credit fundamentals we think are still pretty good, but the market is priced to i mean, not perfection perhaps, but.
To a very politive scenario.
And so in that kind of situation, my instinct would always be to build in a little bit of mean reversion and that would give you a modest amount of underperformance. But I wouldn't say that that's a major part of our overall views for the next year.
I have a question, and it's one of these things.
Maybe it doesn't fit right into this moment in the conversation, but I'm so worried that I'm going to forget it that I'm going to ask it now. So we are recording this December nineteenth. We got that CPI report yesterday came in two point six on Core. This is year over year because we didn't have October data, And then there were people like, wait, they imputed a zero present zero rent growth 's zero shelter inflation for October when
they didn't collect the data, et cetera. But then I'm like, Okay, that doesn't sound particularly accurate or that doesn't sound like that sounds a little risky. But on the other hand, we're talking about a year over year number, so I'm not even sure why October really affects that. Can you, just before we go in further explain how I should understand yesterday's CPI report.
Yeah, I mean they use a six month growth rate for rents, and they did assume a zero sequentially for October, and that does take away from the year on year growth rate as of the November number as well. So we do think that shelter inflation in yesterday's numbers was understated, and the numbers are not quite as good as the eight basis points for core CPI on average for October and November.
Capture would suggest.
So capturing rent is not like measuring bananas, where I could say, here's the price of a banana in November twenty twenty five, here's the price of a banana November twenty twenty four. Therefore, you could just do a year over year thing.
You can't do that because they don't. They don't do it that way. They don't look at just one month.
And it's also owners equivalent, right, Well.
That's that's a separate point because this distortion affects both actual rent and own as a close brand.
So it wasn't as good.
And there probably also were some other distortions stemming from the fact that prices were collected in the second half of November pretty close to Thanksgiving, pretty close to the Black Friday deals that may have understated prices in the goods sector. But I think if you step back and look at the inflation news more big picture, it's pretty encouraging. We've seen twenty twenty five a meaningful amount of pass through from tariffs. We think about fifty basis points of
contribution to core PC inflation. Core PC inflation in that environment has been going sideways. So if you take out the fifty basis points, if you think that that's really a price level effect, that's more like a value added tax increase and is going to come out of the numbers in twenty twenty six. Then we've seen ongoing disinflation to an underlying rate that's no longer that far away from two percent, and that's pretty good news.
Can we talk about prices and tariffs? And I'm very curious casting your mind back to April this year, April second, when all the tariff announcements came out, what was your base case for the impact on inflation, because there seemed to be two schools of thought. There are people who think companies are going to use tariffs as an excuse to raise their prices, and then there are people who think that tariffs end up being disinflationary because they basically take money out of consumers pockets.
Like attacks, we had probably more like one hundred basis points of pass through, and we ended up, I mean.
So far, I think with about fifty basis points.
And there's still a question of how much of this reflects just a smaller pact, greater absorption maybe by the business sector and perhaps to a small degree by foreign producers, although I actually think that number is relatively small versus just a different time profile and a longer lag. We don't know that yet, but it's probably some combination of the two the one thing that I think has been consistent in terms of how we think about it is
that this is more of a price level effect. And I've seen a lot of VAT increases in European economies where vit rates often move usually upwards rather than downwards. And we've got many precedents that have shown, you know, a twelve month increase in inflation on the back of one of these tax increases, and then a decline when that gets cycled out.
Ben let's talk about tariffs on the stock market, because if the stock games had just been driven by a bunch of big tech companies, we say, oh, of course the teriffs didn't matter, because you know, they're not as tariff sensitive, et cetera. But when we're talking about the fact that the S and P four ninety three also did very well, it's not intuitive to me. I would I guess crymp margins, I would I guess lower sales, all kinds of things. How did it all shake out?
From the equity perspective, the impact of tariffs?
This was our concern too. Most of earnings variability is driven by margin variability. When you have years with very large earnings growth or very poor earnings growth, it's usually because of margins, and earlier this year we were concerned that, in part because of tariffs, margins would get squeezed and that would weigh on earnings.
Wasn't just you who is concerned.
And it really didn't materialize. Now, thank Part of what we have to keep in mind is the counterfactual. Right, So, for the last couple quarters, SMB five hundred profit margins have basically been flat well in an environment of pretty healthy nominal GDP growth, Normally you would expect some operating leverage that would cause margins to expand, and so I think part of the story here is you didn't get
that counterfactual. But we seen consistently over the last few quarters companies across earnings calls really point to three levers they've been pulling to offset these pressures. One is, of course, as Yihon mentioned, pushing through some in the form of prices. Second is both pushing back on suppliers to absorb some
of the costs and restructuring supply chains were necessary. And the third is cutting costs improving efficiency within companies, and that ties back to the slightly better productivity story we've seen.
So we talked about rising productivity early, and you think that the main boost from it is yet to come. Who actually captures that productivity acceleration when it comes to the equity market, Like you know, the big tech guys, they've risen quite a lot, and now we're seeing some of the non tech companies start to catch up. Who's going to benefit the most?
This is, I guess to call it a trillion dollar question is to understate the value of this question. I think the general consensus, certainly that we have and that most of our clients have, is that AI eventually will create a very large productivity boost to the economy that will create value for someone. Who that someone is is hard to answer. And as I mentioned earlier, what the market has been doing given that uncertainty over the last couple of years is really focusing on near term earnings.
It's been the semiconductors, obviously, It's been the hyperscalers to some extent, power companies, etc. I think that is actually one of the key differences between this market and what happened twenty five years ago during the dot com bubble, where we saw valuations expand quite dramatically as investors tried to look forward and guess at the productivity gains and the economic benefits. Today investors are saying, we saw what
happened that time. It's too hard, and so what we're really going to focus on is the earnings today.
This is really important. So your view is that, at least from the behavior of public equity investors, you do not see any particular element of people letting their imaginations run wild.
Of course, there are exceptions at the stock level, sure, and to some extent, if a stock trades hand in hand with earnings that are growing dramatically because of AI capex investment, the implicit assumption is the earnings from that investment are sustained over a long period of time. So maybe one could argue, actually the prices should go up by less than earnings. So I won't say there's no opti in the market with valuations at the current level.
There's clearly optimism, but it's a very different kind of optimism from frankly, what I expected a few years ago, which is, to tracy your question, investors will be asking who are the long term winners and trying to pay for those immediately. That has really not been the story.
I would actually say That's the key pivot that's happened in our conversations with clients over the last few months, which is as this anxiety has built up about the AI infrastructure trade and as for the first time we've seen some public companies discreetly quantify the earnings boost of AI. The narrative is shifted from how much will the semiconductors and other infrastructure companies make next year? Two? How can we identify long term productivity winners?
What would make you nervous when it comes to valuations in general? This maybe like indiscriminate investment in anything that has the word AI in it.
That would do it? Yeah, okay, I think if you look historically, you know it's hard to quantify speculative activity or over EXUBERANTCE. But we try, and so a few months ago we actually built something we call it Speculative Activity Trade Indicator. It looks at trading volumes, for example, in stocks with no profits, trading volumes in stocks with
extraordinarily high valuation multiples. As you might expect, that has risen this year, but it is comforting to me that is still well below levels that we saw twenty five years ago and even five years ago in the twenty twenty one experience.
Yeah, there's a question. It's I had not even really a twenty twenty six question. But you know, one of the reasons we've always loved talking to you is beyond just the forecast, et cetera. Consider you gould be sort of a deep macro thinker with a rooted in academic ideas. Economists seem, you know, fairly strict on the idea that like, yes, new technologies could put some people out of work, and that's obviously painful, but in the aggregate, tech doesn't destroy jobs.
Is there any reason to think that AI would be any different? I mean, this is what scares people, right, that there's going to be ten people who have all the money and the rest of us are going to be living and universal basic income. AI may very well be a good podcast host at some time, and maybe podcasts will go away, But like in the broad thinking, is there any reason to think that somehow this time it's different with the relationship between tech and labor.
I mean, history certainly doesn't support it. From the perspective of the long term outcomes. If you look at kind of intervals of you know, ten twenty years, you cannot find an adverse relationship between more productivity growth, even if it's more labor productivity growth that at the industry level puts people out of work and aggregate unemployment. What you can find is increases in frictional unemployment. When you see
productivity acceleration. It takes a while for the new jobs to be created in other industries to compensate for the jobs that are being lost in the affected industries, and we do build in some of that into our forecast, and then it really becomes a question of how quickly
the adoption really occurs. If it happens over say a decade, if you look at the entire economy, and you know, people think that's way too slow, But I actually don't think it's a crazy idea to think that this takes a while to diffuse through the economy, not just the most innovative companies, but all companies and at all levels. I do think it's going to take a number of years that would probably give the economy time to adapt
and create jobs in other areas. But if it's much faster, then I'd be more worried about short term increases in frictional unemployment. So it's important to keep an open mind, even though I would say my underlying view is on the optimistic side that we will be able to cope with this structural change the way that the US and world economy has coped with technological advancement in the past.
Can you talk a little bit about what's been going on with consumer spending because unemployment, you know, getting a little bit softer, but we haven't really seen a significant hit to consumer spending. And yet if you look at the sentiment surveys, everyone is miserable at the moment, but they keep buying stuff. What is going on there?
I think the sentiment surveys have been getting less and less useful for predicting activity, and that's true for the consumer sentiment surveys, and the University of Michigan in particular has been quite far out of line with what we've seen. But it's actually true more broadly if you think back to ten years ago, twenty years ago, just the importance of the ism print for markets and the importance now it's just nowhere close.
We still look at.
The business service and the consumer surveys because they have interesting detail, they're very up to date, but they just don't work as well as the US, or certainly we're believed to. So I would really focus more on the heart data. The heart data would say that the consumer is doing okay. Consumer spending is certainly not super rapid. Maybe we'll get to two percent or so next year, but I think consumer spending in real charms is likely
to lag the overall economy. There are obviously differences between the top end. I mean the levels obviously, but also the growth rates towards the top end versus the bottom end. That's a little bit hard to really assess in real time because the official consumer spending numbers are not broken down and at a very high frequency in the very up to date numbers. But it is a mixed picture out there. But I would expect under our forecast for the economy, I would expect the consumer to hang in there.
What would be your desert island economic indicator for next year? You're stuck on an island. You can only look at one thing to gauge the direction of.
The always be hard to beat the unemployment rate.
Okay, So on the unemployment rate, we should talk about the FED right because this time next year we're going to have a new FED chair and almost like a year of performance already. When does he actually come in like April or something may Okay, well, a significant amount of performance in the role already. How much of a change is a new FED chair when it comes to your economic forecast.
I mean it's probably not a lot. We're very unlikely to make a forecast change on the back of an appointment, and I don't know who it's going to be. It's a committee, so there is more continuity in the system than I think people sometimes believe when they talk about the different potential candidates. So at least in the say, six, twelve, eighteen month forward horizon, I wouldn't really expect a major change in terms.
Of the policy outcomes.
Obviously, the further out you goal, the more room there is for people to turn over on the committee, that's through on the Board of Governors. That's true among the Federal Reserve Bank presidents, and that could have more of an impact. But in the NIA charm I would not expect a massively different outcome because there's a new chair.
Then, on this note, talk to us about multiples, and obviously you talk about the importance of earnings obviously, and then how frequently margin expansion is important, But then there's also the multiples question. Where are we now in terms of how you thinking about multiples, and then when you think where we're going and how much is that going to be tied sort of implicitly to perceptions of policy trajectory.
Multiples high. There's no debating that, certainly, if you're comparing with history, is high in the last few decades. We've really only seen how higher multiple very briefly during the post COVID period, the reopening and of course in the late nineteen nineties.
Done in that the post COVID is because no one had made any money for like two quarters.
Well, I think that's a key point, which is one of the things that drives the multiple is expectations of accelerating or improving earnings. And from that perspective, if I listened to Yon's forecast for a healthy economy that's improving, it's not necessarily so strange to me that the multiple
is pretty elevated. The other thing I'd point out is if we sat here a year ago, or frankly, if we sat here at the beginning of nineteen ninety nine, weren't many podcasts back then, but we'll use our imagination, the multiple was exactly where it is today, and that didn't really tell you anything about what to do with the market over the short term. So I view valuations through a physics lens as a measure of potential energy.
They tell you a lot about how much the market can move if there's a catalyst, but they're not the catalyst themselves.
I know you talked earlier about how you're not seeing people invest in the AI productivity story indiscriminately. But when it comes to an expected productivity boost from this new technology, what concrete evidence are you saying that this is actually happening versus people talking their books.
Well, about sixty percent of S and B companies say AI every quarter on their earnings, true, and you can probably count on one hand how many are actually quantifying it. So I don't think you should expect to really see it in the numbers today. Actually, for the first time, we are modeling an AI productivity boost in our S and P five hundred earnings forecast for next year, and the magnitude of that boost is under half a percent, so we still think even next year it'll be quite small.
But the important thing is it is growing over time.
But that's the users of AI rather than the investment.
Correct when you're spending hundreds of billions of dollars in capex, the AI boost in terms of those dollars has clearly been large for the last couple of years.
So you're talking about the concentration of equities within the S and P five hundred, very top heavy. How does that compare with the concentration of earnings within the S and P five hundred.
That is a key point that is I think often underappreciated, which is five years ago the top ten stocks in the market accounted for a third of market cap. This was a record at the time, although we look back and think wasn't so bad, and fast forward now they are a third of earnings. So one way to conceptualize this is the market was correctly looking forward back then
and saying earnings are going to grow. And so today, if the top ten companies are forty percent of market cap and a third of earnings, the question is will they continue to outperform on an earnings basis over the next few years. Well, given the current run rate of earnings growth, it looks very likely that the answer will be yes, law perform although on our forecasts that gap will shrink a little.
Bit and then markets might look forward further than that, and that I mean, that's been part of the issue for some of them.
More recently, and that's how you create valuation problems.
Tracy.
When I hear that big tech companies only have about a third of the earnings of the S and P five hundred, my thought is, well, that's seventy percent of all corporate earnings that they have.
Yet to swallow.
Right, think of all of these earnings that are accruing to non tech companies. All of that is going to be Amazon's, Amazon and Alphabet's income in the future world. They're still upside Yeah, there's still seventy percent. They're still the majority of money is not being made by tech companies.
Okay, wait, I got to ask though, Yes, tech companies have seen you very dominant in recent years, But what would it take to make you a little bit nervous about the outlook for next year, the broad market outlook, Like what would you need to see to think like, oh, wait a second, we're kind of getting ahead of ourselves, or I think maybe my target is a little more optimistic than I had expected.
First I think an investors should always be a little nervous. That's the reflection of equity risk premium, which is how the market generates return over time, or at least part of how the market generates return over time. Well, first, you know Jan mentioned his Desert Island indicator being the unemployment rate. For me, every Thursday morning, I wake up excited to see jobless claims.
This is I've said it many times. I'm a claims guy. When it comes to my Desert Island.
We're on the same page of Bros. So you know, if a few thursdays in a row we start to see claims rise, I'll become a lot more nervous. If Yon walks down the hall one day and says, you know, we think the Fed's going to hike at the next meeting, I'll be nervous about that too. One consistent pattern at the top of almost every equity bull market in the past has been tightening FED policy instead of easing policy
that we have today. And then, of course the third is you know, this is a very small and maybe silly example, but a couple of years ago, I remember when the gop one drugs were being rolled out, there was a very brief window where investors were talking about buying the airline stocks on the basis that fuel costs would be lower.
Right.
Yeah, When this narrative, this type of narrative starts to emerge in my conversations, that's the kind of time where I think you will be seeing prices run ahead of earnings, which, as I mentioned, has really not been the case. I'll be a lot more nervous.
Then. That's interesting.
So when you just start to see investors start to justify things on various bank shots, the narratives, Yeah, and that's just sort of like it's like a behavioral sign that maybe people are starting to get over their skates a bit.
I think this has been one of the least enthusiastic markets that is often described as a bubble in recent history.
You know what happened to housing? And when I say that, I mean I feel that we could go a whole conversation talking about the economy these days without talking about how a mediocre the housing market is doing, whether we're talking about prices, whether it starts basically every measure of
housing not very good. And yet by and large, in conversations about the economy, you know, we used to there used to be the housing cycle is the business cycle, even setting aside the crisis of two thousand and eight two thousand and nine, housing is linked to the economy has always or for a long time, felt very robust.
Has that changed?
It's amazing how if I look back to well, certainly run up to eight and the couple of years after, how we rolled, I don't know, thirty percent, forty percent, fifty percent of what we were putting out on housing, and the spillovers from housing and mortgage equity withdrawal and leveraged losses because of mortgage credit exposures on bank balance sheets, and how it is now such a small part of the discussion because it's been kind of a tug of war, I think between you know, on the one hand, low
vacancy rates and therefore a supportive supply picture for housing activity and house prices, and at the same time already high price levels, bad affordability, still reasonably high mortgage rates, and it just hasn't really moved very much now. Of course, we've also seen demographic changes that just result in less housing turnover, but it is not a major feature of
our outlook for twenty twenty six. We have housing go you know, more or less sideways from here, low positive number for price appreciation, and you know, I think the action is really really elsewhere, more on the investment side, and obviously a lot of the technology issues that we've been discussing.
We would be remiss if we didn't talk about the world's second biggest economy, which is China. So in your outlook, you say you expect China to hold up well, and I think this would be surprising to a lot of people who look out at I guess the global trading sphere, and it looks like everyone is a raid against China in various ways. The US has imposed tariffs, Europe seems to want to do something and possibly you know, form
a coherent block I guess against China. Why haven't we seen more of a growth hit to China?
The manufacturing sector and Chinese exports have just held up incredibly well despite a at times punitive level of tariffs from the US side. Exports to the US came down substantially in a twenty five thirty percent on a year on year basis, but exports to other places have held up very well.
Overall, exports are still up five to ten percent.
They're a little bit noisy, but very healthy growth rates, and our expectation is that that's going to continue, mainly because China keeps getting better and better at producing better and better goods at cheaper and cheaper prices, and it's going to be pretty difficult to really stem that for other economies. And they also control the supply of rare earths. They controlled about seventy percent of the mining, ninety percent
of the refining. That's a pretty good way to deter trade action and tariffs, and I think we saw that in the negotiations with the US, but that could be relevant for other economies that try to impose tariffs on China. So I think the goods producing sector is still going to be strong. Now. The flip side is that the domestic economy is very weak, and that's a country where
the housing story is much more central. Housing starts and sales are still going down, even though they're already down sixty to eighty percent, but they're still going down steeply. Prices are still falling steeply. Our China team estimates that if you take the direct and indirect effects of property on GDP growth, it's subtracted about two percentage points in twenty twenty five, and while the worst is probably behind us, they still have a one and a half percentage point
drag next year. So in that sort of environment, you know, we think China will hold up okay, you know, slower growth over time, but probably still closer to five percent than to four percent.
Then going back to US, doc I sort of joked that, you know, there's seventy percent of earnings out there that have yet to be captured by big tech companies. But I actually kind of don't really think that's a joke in the sense that that does seem to be the trend.
There are a handful of companies that are cruing a lot of value when you think about the earnings growth that the big tech companies have, the realized earnings growth, and you gave the example about how the market sort of was correct five years ago that they would come to represent thirty percent of earnings. Is there any historical precedent for the largest companies in the world to be growing like this year after year, because I used to
think mature companies don't grow like small companies do. Is this sort of like a novel phenomenon. When you think about the history of markets.
Part of what's fun about markets is they're always changing. This seems to be one of those examples. You know, we did a study last year. We looked at one hundred years of market concentration in the US, and at least over the last century, we didn't find anything that quite matches up to today.
Wow, what do you.
Think would actually like put an end to that market dominance? I guess stronger antitrust laws or what.
Yeah.
I keep coming back to earnings, and one way that earning's dominance could end, of course, is regulatory policy. I think the top of mind question for investors is whether this revolutionary shift resulting from AI technology is going to change where the earnings end up accruing. But I think almost certainly when one day we look back. If one day we look back and they're no longer is dominant from a market cap perspective, it's going to be because their earnings aren't as dominant either.
You know, we started this conversation talking about the CPI number that came out, and I would be curious to hear just how unusual this year has been in terms of tracking some of the data and dealing with, you know, things that you probably haven't had to deal with as an economist before, like tariffs on you know, some tiny Pacific island or something like that.
I would echo what benj just said, this is what makes markets and economic forecasting fund that there's always something new. And of course the extent of the tariff increases that we saw on an around Liberation Day is if not unprecedented, then at least we haven't seen it in many, many decades. So that's a new set of challenges in terms of figuring out what the impacts are going to be. It's not as extreme as what we've seen at times in the prior twenty years or so, certainly compared with COVID.
I mean, that's where you could effectively throw out a lot of the government data and had to look for other indicators like cell phone locations to figure out what was going on that if not that day, then at least that week, and you know, not a month, a month earlier.
So that's been a challenge.
The government shutdown, I would say, has been more challenging than past shutdowns.
Will actually have holds.
In the economic data that will probably be there for ever and you know, you look at some of the labor market numbers. We've had a consistent series for the US unemployment rate on a monthly basis since nineteen forty eight except for October two thousand and twenty five, and that's going to look pretty weird.
That's kind of crazy.
What is your outlook for twenty twenty six in terms of FED policy? Where do you see this rate cut cycle going and how deep.
We still have a forecast that we've had for the last six months, which is after the seventy five bases points of insurance cuts in twenty twenty five, two more into twenty twenty six, that bring you down to what we think is roughly their neutral estimate three to three and a quarter percent. We're penciling that in for March and June. At the moment, haven't changed that. I would say there's a pretty sizable amount of uncertainty around that.
It's certainly possible that if GDP growth does as well as we think and that actually gives a bit more of a lift to the labor market, that they would wait longer and push that perhaps into the second half. But I'm also pretty focused on January ninth, when we get the next employment report, because if that shows another increase in the unemployment rate, then I think it might
be hard not to cut at the January meeting. We don't have that in the forecast at the moment, but I think it's a very real possibility.
Something to look forward to after we come back for your holidays.
Currently, I think according to work it's just a less than twenty percent chance of a cut in January, but it sounds and I know you don't expect one, but I guess it sounds like there's a condition in which that could jump.
Yes, I think so.
Yeah, and Ben, thank you so much for coming on all thoughts, and I guess we'll have you back on next year.
Yeah, make an anual tradition.
Yeah, check your forecast against reality.
So thanks, thank you so much, Thank you so much, Joe, that's always fun.
I love that.
I do think the point about, you know, whether or not we're in a bubble. The one thing that like does give me some caution is this idea that like, actually everyone's kind of worried about it at the moment, and people are talking about the down potential downsides. But that said, I also think back to the Internet bubble, the dot com bubble, and I mean people were so worried about it. They were writing books about a dot com bubble, right so at the time before it actually bursts.
So I don't you know, we've had bubbles before where people have been worried and they're still bubbles.
Yeah, merely observing them does not obviate the existence of one. That's right, a couple things. So I love the Yan pushback on this very almost consensus meme that AI expenditure has been a huge driver of GDP expansion this year, and when you talk about I think, you know, it's interesting to hear him push back so hard on that, given how much of what gets put into the ground comes out on the other side via imports. I also, you know, look, I'm I love Ben's point about you
say whatever you will about the big tech companies. They deliver monster earnings every year, and it's very interesting to hear how like over the last five years, you know, look at this crazy concentration and then they catch up there to earnings and it turns that the market was right again right.
And it's also true, as he pointed out, that some non tech companies are seeing earnings growth too, so it's not even a market that's as dominated by big tech as it was just like two weeks ago.
I'm sure that I have contributed it at various times to the sort of meme that it's just a tech driven you know, like we say that, right, this tech driven rally in twenty twenty five, And obviously, look, the NASDAK has outperformed the S and P five hundred this year, so we know that, like, yes, tech has outperformed, but you know, financials have done very well. I hadn't appreciated how consistently strong the earnings growth of the S and P four ninety three had been over the last three years.
I also think this idea of productivity keeping on importsloyment stuck at like four point five percent is an interesting one. People I think tend to think of higher productivity as a good thing. Yeah, obvious reasons, but you know, there's so much political nervousness at the moment about jobs and economic security. If we have a massive productivity boost that ends with people not having as many good jobs, that'll be interesting.
I mean, I still think it's a huge question mark obviously, like what AI ultimately means for the labor market. But this idea that like it could raise the frictional unemployment so not necessarily sustained change the number of people who have jobs, but the time it takes don't find a job in various other things because it's just so economy wide. Is like, maybe that's a useful I think that's a useful way to think about the question, at least in the short and medium term.
Yeah, all right, shall we leave it there.
Let's leave it there.
This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.
And I'm Joe Wisenthal. You can follow me at the Stalwart. Follow our producers Carmen Rodriguez at Carmen armand Dashil Bennett a Dashbot and kill.
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