You got, you got, you got your trade. You bet, you bet, you bet, you bet your money just got made convex. Welcome to U Got Options, an exciting series right here on Top Traders Unplugged, hosted by none other than Cem Karsan, one of the sharpest minds when it comes to understanding what's really driving market moves beneath the surface.
In this series, Jem brings his deep expertise and unique perspective, honed from years years of experience on the trading floor to candid conversations with some of the brightest minds in the industry. Together they unpack the shifting tides and underlying forces that move markets and the opportunities they create. A quick reminder before we dive in, U Got Options is for informational and educational purposes only.
None of the discussions you're about to hear should be considered investment advice. As always, please do your own research and consult with a professional advisor before making any investment decisions. Now, what makes this series truly special is that it's recorded right for from the heart of the action on the trading floor of the cbo. That means you might catch a little background buzz. Phones ringing, traders shouting as Cem and his guests unpack real world insights in real time.
We wouldn't have it any other way because this is as authentic as it gets. And with that, it's time to hear from those who live and breathe this complex corner of the markets. Here is your host, Cem Karsan. Welcome back to another episode of U Got Options from the CBOE Floor, brought to you by Kai wealth and Top Traders Unplugged. Today we talk to Jim Bianco of Bianco Research, one of the most well respected independent voices in macro research.
Surely is a macro driven time and we get some real deep dives. We start with Mayday and the origin of populism right here in Chicago. And then we get to the next 10 years and tariffs and populism. What's that? What that's doing for markets? How do you bet it? How do you play on it? I hope you enjoy the episode. Hello. Welcome back to you Got Options. It's our second episode and I can't think of a better person for our second episode than Jim Bianco.
Thanks for joining us, Jim. Thanks for having me. Looking forward to the conversation. Jim's an old Chicago person. So wonderful to have him here on the floor. We were talking a little bit about some old Chicago stories. It's almost Mayday, May 1, and he was giving me a little bit of background. You mind sharing that story to start here? Yeah. So May Day is the big holiday in the communist countries around the world. It's workers rights, where they celebrate the. The rise of the worker.
Where did that come from? It came from a park about a mile west of where we are, called Haymarket Square in 1886. There was a demonstration then to invent this thing called unions. And a lot of the workers in, or a lot of the business owners in Chicago, the Marshall Fields of the world, those are the names, were against it. And a bomb went off, killed a bunch of workers. Turned out that the Chicago Police Department planted the bomb on behalf of the business owners in Chicago.
And that was the catalyst for the entire labor movement throughout the late 19th and earliest 20th century. That brought us the eight hour workday, five day work week, which is celebrated on May 1st in communist countries around the world. So the next time you think about what communist countries are for and what they stand for, it all began in Chicago. And if, you know, Chicago politics seems. Kind of appropriate echoes of the past into the future.
That's kind of an interesting kind of point to start this conversation, which I think will be a wide ranging kind of conversation about macro, where we are at this critical time. But before we dive in, I want to get a little bit of your background too. You know, tell me about your early Chicago days and how you got to this point. Grew up in Chicago. Grew up in the western suburbs of Chicago called Hinsdale. Went to school, Marquette University in Milwaukee, Wisconsin.
Graduated in 1984. You go back into my age. It's old. 84. That means what were you doing in 87? 87. I was working on Wall Street. Oh, wow. So it's gotta be a good story there. Yeah, there is. So I was working at Shearson, Lehman Brothers, that was their name before they became Lehman Brothers, in the 101st story floor of the South Tower, by the way, which was Canter Fitzgerald's offices some 16 or 17 years later.
Wow. I accepted a job with a firm called First Boston, which became Credit Suisse, which is now UBS, on October 16, 1987, in the equity research department, working for the technical analyst Joe Generalis. The next Monday was the crash. And I called him up after the end of the crash, that Monday, and I said, do I still have a job? And he said, at this point, I don't know if I still have a job. And it turned out I did have a job. I was the last person hired.
And when I got there, my nickname was Lifo, Left last in, first out. So they always used to call me Lifo in all the staff meetings. And the director of research, Al Jackson, Heard them calling me Lifo one day, and he starts off the meeting going, I think, that's great. That's funny that you call him Lifo. It's fantastic. He goes, but just remember. And he points at me, he goes, t doesn't cost me any money. You do? Yeah. Sometimes it's first in, first out, right? A lot of times, yeah. Amazing.
And then that's a crazy way to start. That must have given you a pretty wild perspective on the financial industry. How to go from there. Where did you go from? Yes, I worked there for a couple of years, shifted with followed Joe to UBS securities. This was all New York City, by the way. One of my clients back then was a firm called Arbor Trading Group, which is a bond brokerage firm that's headquartered here in Chicago. I wanted to get back to Chicago.
They hired me in 1990 as the director of research for Fixed Income. Of course, I was the only person in the whole department. So I gave myself the title Director of Research, and I worked there for eight years. And in 1998, I spun myself off through them as Bianco Research. Bianco Research has been around for 28 years. Arbor Research is now their name. They used to be. Arbor Trading Group is still my partner to this day and is a shareholder in my company, and I'm still a shareholder in Arbor.
So I've been with them now for 35 years. I almost have as much gray hair as you do. I started in 98. And you have, you know, 14 years on me. So I'm sure I can learn a few things from you, as can our. Listeners today, how to properly wear suspenders, because I was in the 80s when we used to wear suspenders. But I want to lead today off by really taking a big picture kind of view. Backing up a little bit here.
You know, you let off with that Mayday story, which is really about labor rights and populism, right? Yep. And I think, again, echoes of the future here. Here we are amidst a tariff war and protectionism that I've been talking about for some time. And I know you have in your own way about, you know, where that's come from and where that's going.
So I'd love to kind of give you a little free rein to kind of start out and kind of paint the story as you see the big picture and where we are kind of from 30,000ft. Well, I think, you know, I'll start off by saying that I think Trump's got the right idea and I think it's all about the execution, which we could really start to question. What's the right idea?
If you look at the state of the US Economy, where it is right now, its fiscal position, its debt position, its deficit position and the like, you could, you know, channel like the Muhammad El Erians and the Ray Dalios that have said it's unsustainable and that something has to change. And I think that Trump and Scott Fessant and Howard Lutnick and Steven Mirren, who's his Council of Economic Advisors, would all agree with that. We could not continue with the status quo.
So they've enacted a bunch of policies to try and change the status quo. Now, we can argue whether or not those are the right policies. But really, what was the driver of the status quo being fractured is the inequality at the top line. You could argue for the last 40 years that globalization has been a net benefit to the US Economy. I completely agree it has been. But along the way, there's been losers, and those losers have been the working class. And that's Trump space.
And if you go back to 2016, when Obama said, what are you going to do? Wave A1, those jobs aren't going to come back? And then Trump says, no, I got a plan to make those jobs come back. I think the working class said, at least he's going to try. And that's where tariffs come in, and that's where this disruption comes in that he's trying to do. Now, is it the way he's doing it? Is it the best, most optimal way?
I'd probably say no. But what I'm trying to push on the idea is, would Trump just stop, just call it off, just say, I give. Let's just go back to the way it was. We can't. I don't think we're going to go back to the status quo. So if you don't like this radical policy that he's been promoting, give me another radical policy to promote. So that's really where we have to go forward and we can't go backwards.
And that, that's the thing I try to emphasize is the criticism seems to me to sound like let's go backwards and we can't. I think we agree on one thing. It's an intractable situation. It's a situation that if we don't deal with it now, it's only going to get worse. I disagree with some of the details in terms of. And by the way, you have a lot of good company that agree with you. Like the Dalios of the world or the drunken Millers.
But I tend to really disagree that the, that the debt is the problem. The debt here in the us, much like Japan, monetized all of its external debt. I mean, you could talk about its 250, 275% debt, but it's all owned by its central bank. Its effective debt is now zero. It has monetized all of its debt, and it could do that because it had the support of the US and the west broadly. And so not only did its currency not collapse, its currency became much stronger in that period.
So I would argue that the US could solve the debt problem on its own after a minor kind of fear and crisis or whatever it is. We've already done that, by the way. That's what 1971, Nixon taking us off the gold standard was. That was a debt jubilee, essentially. And what came of that, eventually, a stronger currency again. And so I don't think that's the core problem, but you did touch on something that's, I think, the core critical issue, which is inequality.
At the end of the day, if you think about why we are where we are, if you, if you push, you know, constantly money to the top of the distribution, to corporations, to wealthy individuals, it's the natural system. You know, it's a, it's a winner take all survival, the fittest system. And the biggest, most powerful get stronger and stronger and stronger. You know, in the Mesozoic era, a bunch of oxygen out of the system, what happened?
You got a certain group of dinosaurs or predators, it just became really big, right? And, and at the end of the day, you know, that works, but it works for the whole system at large. It doesn't work for everybody. And we are not all cogs in a system. They're human beings in the system. And the distribution of income, the inequality has grown dramatically in the last 40 years through supply side monetary policy. We took interest rates from 20% 1982 to 0.3%, the tenured.
And that's wonderful because that drives zero inflation, actually. Deflation drives globalization, technological development, great growth. You mentioned this was good for everybody, right? The problem was it was not good for everybody. The same amount, dramatically, dramatically better for the top of the distribution and for lowest cost labor. And who sits in the middle? Who got decimated? Trump's base? Yep, that's everybody. It's the middle class.
We have completely hollowed out the middle class in the US and that is an intractable problem because at some point people vote Some point, people say this system's not fair. And that's what's happening here. It's a populist move. Echoes your Mayday. This happened in the 1880s. It happened in the 1930s, you know, happened in the 70s. Here we are again. This is not a new story.
The difference is the extent to which has happened where we are as a, as an empire and where their debt is, where all these things are combined. And how difficult that makes that situation. Yeah. So a couple of things you're right about, you know, the debt, the deficit situation. Let me put this in starker terms. The US US federal budget is about $7 trillion. About 5 of that's covered by taxes. The other two we borrow to make up the difference. So taxes cover roughly 75 or 80% of what we spend.
We borrow the other 20 to 25%. We're not going to balance the budget by trying to find more taxes out of everybody else. But that's essentially. It's a spending problem. I don't know that we need to balance the budget. Right. Well, we may have. I mean, people would argue that you could just. The Federal Reserve. I know it seems irresponsible. The reserve is not a human being. It does not have the same. It prints its own currency, which is the reserve currency of the world. Again, Japan did this.
This is not something that's new. Like, if we really wanted to, we could internalize and buy all of our external debt. And by the way, I think there will be an effort to do that in the next five to 10 years. I think that's the only way out, right? Yeah, it's the only way out. And it will be assisted by our allies if we don't alienate them. Well, that's exactly right. One of the things that Trump has been pushing on with our allies, and again, his motivations, his ideas are right.
Implementation matters. I'll give you a couple statistics. Since 1960, the U.S. has spent $22 trillion on defense. Since 1960, NATO has spent seven and a half trillion dollars on defense. Well, the U.S. has been the leader in fighting communism, fighting terrorism, any kind of conflict throughout the world. We take a lead role. Europe has taken less and less of a role to fast forward today, we are now fighting the Houthis in Yemen to reopen the Red Sea.
Even the New York Times has admitted Europe can't do that. That the Houthis are too much for Europe right now. That's how bad their. Or how much their military offense capabilities have retarded relative to the U.S. they've admitted it, too, that Europe has said, you're right, we need to spend more on defense. We're willing to spend $3 trillion more. Trump, you got to win. You know, you said that we need, they need to spend more. They agreed. And you keep kicking teeth. No, I completely agree.
And. And the reality is it's about power. It always has been, it always will be. And you have a China, U.S. kind of problem here. Right. And the U.S. the old empire, Right. Or whatever, you know, is at a point where it is still meaningfully more powerful economically, militarily, in other ways, you can argue, but particularly so with its allies. And I think the problem with the approach, yes, I agree with you about spending whatever.
But if they do start to fall in line, the last thing you want to do in terms of real politic, right. Is, is alienate and push your allies away in terms of implementation. That, that's the reality. But we can get away from politics and policy and more to kind of economics.
You know, the reality of the situation is, if we choose to prioritize as a society, median outcomes instead of mean outcomes, instead of maximizing gdp, but maximizing the median person, the average person's outcome, which is what we're essentially talking about when we talk. And they're not the same thing. They're not. They sound very similar. They're actually dramatically different.
And this, given how unequal, you know, this is at the last year, just to give you a statistic, the top 19 families in America, just 19 families, increase their wealth by $1 trillion. $1 trillion. I mean, think about that. Think about where this has gotten. That's enough. That's the same as about the 40, the bottom 40% of America. We're talking about 19 families. It's an incredible 120 million people versus 19.
I'll give you another statistic along those same lines about the concentration of wealth, actually to 400 for the top 400 taxpayers in New York City pay nearly half the taxes in New York City. Trump used to be one of them. And Trump famously said, you know, you're treating me poorly. This is well before he was going to run for election and I'm going to leave and go to Florida. And Bloomberg was the mayor.
And when Trump said, I'm going to leave and go to Florida, basically everybody's attitude was, don't let the, you know, what hit you on the way out. We kind of did that to Ken Griffin here in Chicago when he Left as well. And Bloomberg said, look, you can't lose these guys. You know, you lose two, three, four of them, you're going to have a financial crisis in your city or in your state. David Tepper, left, left New Jersey to move to Florida. He owns the. But it didn't used to be that way.
And it doesn't have to be that way. By the way. By the way, the other statistic, just to give you an idea, writing it bigger, just is for the uber wealthy, currently all retail sales in the United states, the top 10% of income is now 50% of retail sales. That is the most concentrated it has ever been. So that when we talk about how retail sales are doing, you're basically asking how the wealthy are doing. And this is not the bottom half. There's a critical point. You're bringing up the top 10%.
The, the, the spending and the economic output. Of that top 10% is at a record relative to the economy. You were telling me a stat earlier. What's the actual stat? The top 10% is 50% of the. Of retail sales. Of retail sales. Wow. Yeah. Yeah. I mean, that's an incredible statistic. If you think about it. And at the, at the end of the day, the problem is if you start taking from that 10% to give back to the people on the bottom, those 10% don't spend all the money they make.
They invest the majority of what they make. So an incremental dollar to that cohort is not the same as an incremental dollar to the person at the very bottom of the distribution. And if we're going to start creating jobs here in the US which are at the bottom of that distribution, bring them back from China, bring them back from India, bring them back from the rest of the world, you may actually get unemployment growth. You may get a better median outcome for, for the majority of people.
But if you're starting to pull from that 50% of retail sales, from that top 10%, you could actually have a situation where GDP declines and employment hangs in. Because we're getting the distribution. Actually, I think that's probably where we're going. Not today, not tomorrow, not in the next month, but in the next couple years, you're going to start seeing a very stagflationary picture. And that's what that essentially.
And I think that's what the markets are starting to play out and starting to sniff out as well. But to your point, another set of statistics kind of put this into perspective about 1/3 of the American public, 35% to be exact, has a college degree, 30, 65% don't.
So if you don't have a college degree and you want to make a decent living so you can raise a family of two in a decent house, have a, you know, have a decent two cars, have a decent vacation and stuff, what are your job opportunities without a high school, without, without a college degree? It's usually working with your hands. It's usually heavy manufacturing or it's in construction or it's in repair or something along those lines.
And if those are the jobs that we're trying to bring back, that is what the majority of the country is looking for. You know, we've tried. Going to college is kind of a, it's a cultural thing. It's not good enough for us to say go to college, learn to code that, that the people that don't go to college, it's not because they don't lack the intelligence to go to college. It's not part of their culture, it's not part of the way that they grew up to do it, do something like that.
So that's why those loss of jobs in that middle class, that working class that got sent overseas because of globalization. Yes, at the GDP maximization it was a win, but at the median there was a price to be paid by the by globalization. And I want to walk through this for like listeners here. Like, you know, we did what's essentially supply side economics for from 1982 to 2021. And what do I mean by that? If you lower interest rates from 20% to zero when it got to 0.3 the 10 year did.
That every time there's a crisis, you lower it, you're stimulating, you're sending money to corporations. Why is that to corporations when you lower interest rates? Because the majority of money that is borrowed is borrowed by wealthy individuals, corporations and investors. And at the end of the day, that money and the benefits from it flow to the top. QE also directly into asset prices. Which is also owned by all the wealthy. So Federal Reserve policy is monetary policy.
That monetary policy is supply side economics. If you do that for 40 years, you keep sending money to the top. You don't get inflation because those people don't spend, you get asset inflation. People invest. But you don't get goods inflation. And at the end of the day that's great, you can have growth without inflation. But it creates this inequality we've talked about. And at some point People say enough is enough.
Not just that doesn't only create inequality because the money's going to the top. What does a corporation do? There are knock on effects. A corporation maximizes profits, so it has to try and find the lowest means of production. Well, guess what? That leads to globalization. You think it's a coincidence that the growth of China lines up with 1982 to 2021? No, it's not a coincidence. You get technological development. We've been in a massive technological boom. You take interest rates to 0.
Semi to corporations, they're incentivized to create new goods and new, new who's it's and what's it's. And, and so now importantly, and I wanted to bring this part in, there's a generational component. Because if you were born in 1980 or 81 or 82, at the top of that cycle, you're now 43, 44, 45. And all you've ever known is increasing inequality, increasing technological development, increasing globalization.
And your parents and your parents, parents have lost their jobs and you've lost status. That's what this is about. And that's why it mattered in terms of time. This really started with Occupy Wall street and, and the Tea Party in 2010. But that generation was 25. Or 30. They didn't have the power. And the demographic bubble, I.e. millennials was still at the mercy of the last demographic bubble, which was baby boomers.
This is not just about inequality, like vertical, this is inequality, horizontal, generational. Because when you leave high school or college, you are labor and when you retire you are capital. You know, so it's the passing of. A baton really generationally. And this is what I said at the top. Trump's got the right idea. This is a problem what we're discussing. And that's why I'd like to really emphasize.
All right, maybe the way he's going about doing the tariffs isn't the best or in the most efficient way. I get that. I agree with that to some degree. But what is the alternative? And the alternative isn't stop and go back. We have to deal with this intractable problem. And that's really where why the markets, I think, are reacting the way that they're reacting. Because if they just thought this was Trump storing out tariffs, he's kind of a transactional kind of guy.
If we, if we slap him down enough, he'll call off the tariffs and then it'll all go away. No, they're not going to all go away. Because we'll still be left with this problem if he was to call it off. That we have to deal with. Trump is a vehicle. And by the way, this, like I said, it started in 2010. You know, it was before Biden is before Trump. The first, you know, version started with Hope and Obama. But they weren't at the political dominance to get to where they are.
And Trump came with a populist message. First time the right in a long time has moved left in terms of economics, right towards that populism. He took the right kicking and screaming. That move, though, is in line with the left also going left. And we could talk about Bernie Sanders and aoc. People think they're dramatically different. If you go look at the policies, they're the same general policies, right? Not exactly, but definitely not on social policies, but definitely on economics.
You're right. Just like in geology. You know, every couple of million years, there's a, there's a pole shift between the north and south pole. We've seen that with, with our politics right now. You know, what is the, what did the Republicans have been crowing about that the, the party of the working class. They used to be the Democratic Party. What is the Democrat Party? At least what I see them talking about. They're talking about forever wars.
They're very worried that billionaires are losing money in Wall street and they're all into free trade and against tariffs. That's the Democrat Party. It's amazing. You know, so we've kind of polar shifted both parties. Right. The truth is they're both, you know, trying to be further left from another, from one another, just like slightly varying ways. Right.
But I think it really goes to a larger issue that they're, that they're recognizing that we're seeing in our politics that something's out of balance and that the status quo cannot stay. And that's really what we've been really seeing in our politics and in what Trump's policies are and what the market response is. Something's going to have to change. And we're, we're in the process of trying to make that change effective now.
What it's going to be, how it's going to unfold, that's what the next couple of years. What does this mean about mar. Mean for markets? That means a period of, I think, more volatility for markets. I've actually argued, I've used a spiffy little line if you want me to talk about big markets, that we're going to be in the 4, 5, 6 markets for the next several years, cash will return you 4%, bonds will return you 5 and stocks will return you 6. Now how did I arrive at that?
I think that we're in a period of more inflation. Yeah. So we're not in a period of sub 2% inflation. We're in a period of closer to 3% inflation. Not to get too wonky, but the Fed likes to take, you know, what's the long run inflation rate and then they add a little premium on it called our star. So that means 3% inflation plus another 1% for our star, 4% cash. So money market T bills will return you 4% bonds.
If you look at things like the Bloomberg aggregate index and the like, the average yield on the bond market is about 490. That's all mortgages, Treasuries, mortgages, corporates, investment grade agencies, it's about 490. Let's round that to five. So over the next several years, if you bought into a big bond fund, you'll get about 5%. Some years you'll get a capital appreciation because yields will go down, prices go up, you'll get eight or nine.
Other years like last year, yields go up, you'll get 3, you'll average 5 stock. Going into this year the valuations in stocks were so high, if you take like the Shiller PE ratio, the CAPE ratio was 37. Now people will say valuation is not a timing tool. I agree, it's an expectations tool. What is it that you need if you're going to buy a Shiller PE of 33 or you're going to buy a forward 12 month PE of 23 to 24. What is it you need? You need everything to go right.
Well, we're talking about an out of balance economy. The status quo can't hold. We're trying to affect change. Everything's not going to go right now, it's not going to go bad. But at those valuations, what the Shiller measures tell you is that you should expect the stock market over the next several years to return you about 1% more than the bond market. 4, 5, 6, maybe 2, somewhere in 7. Let me restate that.
Cash money market fund will give you half to two thirds of what the stock market will give you. With a $1 Navy every single day, no volatility, you'll get half to two thirds of the stock market. For some people that's fantastic. Bonds will give you somewhere around 66 to 80% of the stock market's return with a Little more volatility, especially if you have longer durations at the longer end of the curve. Stocks, they're going to return you six or seven. Now, people complain about that to me.
Oh, but they return 20. They're supposed to return 20 all the time. Well, that's where I think there's going to be a big shift in the way that we invest. And the last thought I'd give you on that is active management's gonna return. You know, and the reason I use the metaphor of sailing, I'm not a sailor. But if last year the stock market, the S and p, returned 25%, if I'm in a sailboat and there's a 25 knot wind, I just can't get my sail in the air just by the index. And I'm going forward now.
You're gonna slow it down, the six knot wind. Well, if I can tack and I can trim and I've got some skill, I can move my bow forward. That's active management. Last year when I would talk to my active management clients, they would make the case to me, like, here's a case for financials or for small cap or for health care or for international stocks versus domestic stocks or small cap versus large cap. And then they largely conclude I'm kind of generalizing all of them.
No one gives a shit because the stock market's going up 25%. Well, if it's going up 6 now, they'll give a shit. This is the passive active thing. I just want to hit this real quick. And we, and we had Mike Green on here last time. I know Mike Green. He disagrees. He and I debate this all the time. But I think it's so important. Passive investing did not exist until the 1980s. Why? They paint it like a technological innovation, like it's a revolution in finance.
No indexing has existed for 200 years. It's not an innovation. The reason that it didn't. People didn't do it until 19, the 1980s, is because it didn't work. It didn't work for 20, 30, 40 years before that. Why didn't it work? Because 1968 to 1982, interest rates went from 3% to 20%. And guess what? The stock market went nowhere for 14 years. Yeah, the Dow went from 1,000 to. 1,000, but it lost 70%. In real terms, all the numbers that you just gave in terms of returns were nominal.
What about the inflation part? Right. And we'll get to that in a second. But the point is, in real terms, I think at this point, given the populist trends and the rebalancing and everything we've seen, we've seen this happen before and forward during these periods, right. You get negative real returns for long periods of time. And passive investing is the absolute worst place to be in a regime change. What matters is the types of things.
Last thing I want to say about Shiller, like fundamentals and you said a lot of fundamental kind of metrics and why you think we're heading. I don't think fundamentals, like you said, the CAPE ratio are not predictive in the short term, but what they are, are great risk management tools. I've used this metaphor before, but it's like an airplane. If an airplane's got liquidity, if it's engines going, it's got gas, how far off the ground it is doesn't matter.
It's how many buyers and sellers, how much lift there is, you know, to the, to the airplane. But what happens when that, that engine goes put, put, put, put, put and the liquidity dries up and that's what inflation is, that's what long term bonds going higher is. It's liquidity coming off the table. And when liquidity comes off the table, what, what happens all of a sudden nobody's looked at that elevation thing for a long time, right. All that matters is how far off the ground you are.
And that's, those are the periods where all of a sudden we get massive corrections and fundamentals. And that's when Warren Buffett guess when he got his start. 60s and 70s, right. That's when value investing works. That's when active management works. So yeah, it hasn't mattered. Passive investing works great if you're just liquidity, liquidity, liquidity if we have unlimited fuel, where the plan will just keep going up. Absolutely.
From 66, 82, as I mentioned, the Dow went from a thousand to a thousand. Does that mean no one made money? No, there was, there was the go go area in the late 60s, there's nifty 50 in the early 70s. There was the energy boom. There was, you know, the metals boom. There was, you know, there was, there were big themes that would go up 2,300% over several years and then bust out. And another theme would come in and that was the way that we all invested.
But you're right, when we got to the 80s and 90s, when we got to the Fed lowering interest rates and then eventually printing money, it was just get your sale in the air by the Fed put right Right. That's the liquidity we've been talking about. That is this. Whenever something goes wrong, the Fed would stimulate, do supply side economics and juice equity markets. That's the liquidity. And guess what? That just creates an ever ongoing upward going plane. Now why wouldn't the Fed do that again?
Well, the Fed's kind of stuck now, right? I think they're stuck for two reasons. One, I think they, they got to the, they got to the end, end game of it right in the late 2020s or late 2010s because we not only got the, you know, the Fed to zero and printing money, we got Europe to negative interest rates, we got Japan to negative interest rates. By the way, Richard Sala and Sidney Homer wrote a book called A History of interest rates. 700 pages of tables showing interest rates back to 3000 BC.
The last time that book was updated was 2005. There is now one syllable in that book about negative interest rates. That is a new phenomenon that we learned in the last 10 years which largely didn't work as far as being a stimulative to the economy. So one, they hit their logical limit. Second of all, what was coincidental with that from 20% to zero, falling inflation.
Well, if the inflation cycle has bottomed and turned with COVID and I've often said that whenever you have a financial crisis or you have a recession, we had both in 2020, the economy changes. Now change. I always like to warn, I'm not saying it got worse, I'm not saying it's dystopian, saying it's different. The economy changed in 2020. If you want one example. Remote Work is a big example. Completely changed the nature of the labor market. With that change we've got higher levels of inflation.
The Fed cannot cut and print in an inflationary environment. And one example I'll give you is last year, September of last year, the Fed got worried about the labor market because we got that QEW, that revision of minus 818,000 jobs in early September we had the SOM rule that 1 of the unemployment rate went to 4.3% and that was supposed to trigger a recession. The Fed panicked. They cut rates 50 basis points in September. What happened right after that? 10 year yields went up 100 basis points.
Correct. If you're not interested in fighting inflation, I'm not interested in owning your bonds. What could the Fed do right now to destroy the bond market? Cut rates. Yeah. And that's why they're not cutting rates. Right, Right. I think this is maybe the most critical point of all. What we learned very recently is when the market goes down.
And it's worried we could do to tariffs and populism and where we're going that the Federal Reserve likely won't come to the rescue anymore because they can't, because they're stuck in a box dealing with inflation on one hand. And on the other hand trying to support the economy. And the inflationary problem is the secular problem. That, that is really the big story here.
Yeah. And just to give you an example of that, the day we're recording, I put out a tweet thread or I guess an ex post thread now that you kind of call it correctly. And what I said was poly market, the big betting market, has a market that you could bet on whether or not there's going to be recession in 2025. It hit 70% this morning. Now, all that is just as a quick aside, why I cite that. It's like looking at the point spread in a football game.
Just because one team is a three point favorite over the other team doesn't mean they're going to win by three points. But it tells you where, how people are thinking as opposed to if they're 15 point you know, favorite in the game. Well, 70% tells you how people are thinking. And that, I think is an accurate representation of how they're thinking. It doesn't mean they're going to be right, but they're thinking that way.
Now, I look over at the Fed fund futures, I see a 9% chance that the Fed's going to cut rates at the May 7 meeting. I see a 59% chance they're going to cut rates at the June meeting. Wait a minute, 70% chance of a recession? Shouldn't we be talking about a rate cut this afternoon? Why are we not talking about a rate cut for the next 90 days? Because of inflation. I think recession, that word is there's so much packed into recession. Like there can be all kinds of different kinds of recessions.
And I think this one in particular, we've only seen the same kind for 40 years. But, but this kind of recession, what we're talking about is really taking from that top 10% as we talked about, and giving to that bottom 40%. And if we're going to do that, that means employment on the bottom will actually be quite strong, which is. Is. Which means demand will be quite strong. And by the way, the reason we had inflation in the 60s and 70s is because we had an incredibly Strong economy.
We talked about how poor equity returns were and long bond returns right to the 60s and 70s. What is going to be confusing people is is to learn that GDP growth in real terms was significantly stronger from 68 to 82 than it's been in the last 40 years. People think the stock market returns are a function of GDP and economic growth. Economic growth was way stronger during that time and we lost 70% real time real terms in the equity market. Right.
Stocks are not a function of how strong the economy is. They're a function first and foremost of the discount rate. What is the. This is why Cape and Shiller looks at it relative to interest rates. Guess what. 1968 was a 24 PE. And record profit margins. Guess what? In 1982 it was a four and a half PE. What do they have in common? Well, the 20 year bond was 20% in 1982. That means a 21 22% earnings yield for the S&P in 1968, 24 meant okay, foreign. Guess what? The interest rate was 4 in 1968.
The discount rate. That long term bond inflation is what determines the outcome first and foremost for equities. You know, and what's important to note about that is a lot of people will say, Besson said that the focus of the administration is the ten year note. And then you'll hear people say, well, the Fed needs to cut rates because we've got too much interest costs. They need interest rates down. And I'll go back to that famous Jim carville line from 30 years ago. When I get reincarnated.
I want to come back as the bond market because you can intimidate anybody. The bond market will do whatever the hell it wants to do regardless of Besson or Trump or Powell want it to do. And to that point, if the economic growth is strong and if inflation is sticky, it's going up in yield. And they can do all they want to try and stop it. They won't be able to stop it. It will go up that they will. Make it worse if they stimulate cyclically, as you mentioned.
I'll give you a quick example about making it worse. In 2022 we hit 9% inflation. The Fed was raising rates 75 basis points. A meeting there for a while. What was the highest 10 year note the entire calendar year of 2022 it was 4.22%. We're at 4.22% right now. Why is it that we never got much beyond 4.22%? Because if you're hiking at 75ameeting. You're on the inflation train. And I can relax. When you back off is when I get worried.
And by the way, let's kind of Ghost of Christmas future here think about this. Right? We know that one of the problems of inflation during the Nixon era was Arthur Burns being brought into the administration and them stimul forcing monetary policy. That's what took inflation sky high. They're already the structural secular forces driven by Great Society program, Vietnam War, right. OPEC crisis, all the things we know about.
But it was really when Arthur Burns and federal monetary policy started stimulating en masse that things went crazy. What is Trump talking about? He's beating up Powell, trying to get that you know best and him are trying to get supply side economics and Federal Reserve into the game so they can support the markets and they can pull off their policy. That's going to make the long term bond. I agree with you. Go dramatically higher and inflation skyrocketed.
Yeah. And that's, and that's the fear that they've, they've got, you know that what is it that, what is it that the market is worried about? It's worried about prices right now. What is it that the Fed is? What's holding the Fed back is prices. What is the Fed most concerned about right now? And I call this the Main Street Wall street divide. Whenever I watch financial television, I see Wall Streeters on. They'll say growth is going down. There's a high percentage of inflation of a recession.
So the Fed's got a cut. That's the prescription the last 40 years. But why isn't that the Fed's cutting? Because there's this inflation problem, Main Street. When you ask a Wall Streeter what's happening with the economy, they say growth. This week the Fed's got a cut. When you ask somebody on Main street, the 65% that never went to college, what are you worried about? These tariffs are going to mean higher prices and that, that means inflation. And the Fed is siding on that side.
That's exactly what the Fed did in 2022. The first quarter 2022 was negative GDP. The first quarter 2025 is negative GDP. What did the Fed do after the first quarter 2022? Hike, hike, hike, hike, hike because of inflation. And they kept long rates lower because remember they never got higher than 422. If they were to do, if they were to acquiesce to Trump, invest it and cut rates, I think you'd see the 10 year skyrocket.
So I think the big difference between 22 and now is we're getting to the five year anniversary of the low in interest rates and there is a massive lag to interest rates. Right. You have to understand like it's not like interest long, long bonds go higher. And you know, and then you start to get a slowdown. The effect is when people, you know the difference between debt and cash, they're both money is one has an expiration date. Well guess what?
The expiration date of all that debt, all that mal investment, everything that happened in 2021, remember SPACs, right. All of that 2021 period is, is now coming, beginning to come to, just starting to. So in terms of, never mind predicting out to the future, but supply and demand along the curve. There's a massive amount of refinancing and supply coming on, on the table. And right as that's happening by the way, we have this, guess who the buyers of that debt are, right?
Japan, China, Federal Reserve. All of a sudden the buyers are being either alienated or can't step into the, to the picture. And so for the next year, well this is a very short time. We've been talking decade, right. For the next year there is a supply and demand imbalance that's massive. On the back end of the curve there's a supply demand balance for equity and venture. As well. That's why you're seeing max7 suffering the most or tech in general and growth.
These are the core problems underneath the market. And so what do you do about that? We've also by the way during this time this was a problem before we started the terraform. Right now we've injected all this uncertainty and volatility into the bond market. Swaps have blown out. We were talking about this before like the basis trade gone, has gone negative. Like those are problems for liquidity even in a balanced scenario.
So I think there's a real like one year again there's a reason they're trying to get the 10 year lower. It's not working actually there and we saw this when the market declined. What do we see? We saw the 10 years start to break out, right? That's a canary in the coal mine. So to give a perspective on about the 10 year, September 18th of last year when the Fed cut 50 basis points, the 10 year yield was 360. It's 420 right now. It's been 450 in the last three weeks.
We're at 70% chance of recession. I'm going to Repeat myself here. Worried, you know, we're all worried that the economy is going to go down, everybody's going to lose their job. Why are we at 340? Why are we at 3% right now? If we were at 360 last September and we're 420 right now. So obviously the bond market is worried about something. I think it's prices that it's really was inflation of prices was worried about.
And to come in like a little zoom in a little bit closer than a year, we're in a month here, that's incredibly important. Today after the close two of the mag seven report on the first on Mayday, you know, Mayday, Mayday, there's, there's two other, you know, back seven reporting. Then May 2nd we get unemployment. And May 13th we get inflation. Now these numbers keep coming, but this one is more important than any other number because it's the first one that's going to start to.
You're going to start to hear about the effects of those tariffs. Exactly. And really what you're starting to see is an unusual economy that I don't think I've ever seen. And that is the consensus opinion right now is today the end of April, the economy is okay. We've got growth, we've got jobs, we've got retail sales.
But within 90 days there's this big wall we're going to hit when tariffs kick in and kick prices higher and we're going to slam into that wall and we're going to see job losses, we're going to see economic contraction. I've never seen it where everybody said we're okay now. But shortly, like in a period of weeks or a month or two, things are going to go bad or sideways or pear shaped real fast. Now whether they do or don't is a different issue, but I've never seen it quite that way.
And that's also part of the uncertainty. Is that a liberation day? So when people online, maybe up to online will say to me, I'll say, look, I'm worried about inflation, they'll say here's the inflation data. And I say, look, nothing that happened before April 2nd matters.
That's why you were saying when we get these numbers with the, with the reporting, what's most interesting about the economic reporting, you know, just to kind of nuance into the earnings numbers is not what the reporting for the first quarter because that ended two days before Liberation Day, it's their outlook.
And exactly what you're seeing on Wall street is second quarter earnings are going, estimates are going straight down because all these companies are either not giving you an outlook or giving you a dire outlook. And so they're all worried. So it's almost like when people cite me statistics, I always like to say anything you cite me. Well, look at what happened with today. The day we're recording, the core PCE came out. So what? That's a March number. That's two days before Liberation.
Liberation Day. It's. What is it going to look like in April? What's it going to look like May in June when those tariffs kick in? That's what everybody's worried. So since Liberation Day, which it was. August 2nd, 2nd or okay, April 2nd, and you know why it was the 2nd? Because he knew he didn't want to do it on April 4. But it takes 30 days for a shipping boat to go From China to LA. Takes 45 days for by train that's left to reach Chicago. And Texas. Takes 60 days for it to get to New York.
So there is a one month to two month lag. And here we are, you know, two days begin before we begin to start to see the actual. And the beginning of it. And that's what everybody's worried about. That in the pipeline, what is coming is all the prices are going to go way up and that unit sales are going to go down because 65% of the country, you know, doesn't have excess. No, excuse me, a different statistic now.
Bankrate does a statistic every year asking the public, can you come up with $1,000 in an emergency, your car breaks down, you need a new roof, medical emergency and half the country says no, they'd either have to borrow from somebody or put it on a credit card. So if those prices are going to go up, they're buying less units is what they're going to buy. This is what everybody's afraid of. This is why we see this volatility in the markets.
And this is why citing statistics up until the day we're recording doesn't matter because they're all pre labor, they're all pre Liberation day statistics. And now full circle to populism and politics. What happens when all of a sudden you start to see these slowdowns and you know, the people start to get worried. I mean, Trump's first hundred days, the approval rating is the lowest we've seen since World War II. For the first hundred days.
The angry hordes, which are already angry, that's kind of what brought kind of Trump to power. And it's the populism that, you know, for change. What happens now when we're in recession? Well, guess what? They're already starting to talk about, whether it's Bannon or Trump himself, now starting to talk about changing the tax cuts to be more heavy, not just to the wealthy, but to individuals. Well, what happens with fiscal, heavier fiscal spending? That's inflationary as well. Yeah, exactly.
Right. So we're on this flywheel that once it gets started, you know, every time you get a slowdown due to the issues we're having, then you stimulate, not monetarily, which is what we used to do, but you stimulate fiscally because that's what people are demanding. So your, your statements are true. And they beg a question. Why is Trump doing this?
And he said it the day before, we're recording, when he was interviewed in Michigan, is he talked about, well, prices are going to go up because there's going to be, you know, all these tariffs. And he said, no, that's not true. You watch. I'm paraphrasing what he said. China's going to eat most of those tariffs. They're going to pay most of those tariffs so that prices in the United States won't go up as much. Unpopular opinion.
Whenever you get to being an aging empire like we are now, there's two ways you fix an aging empire. Way one is you plunder your neighbors. And way too is you create either a slave class or an indentured servants class. But we seem to be doing both. Trump is talking about plundering our neighbors. Now, he's not talking about raising an army, invading them, but he's talking about Canada being the 51st state, taking over Panama.
He wants Greenland back, you know, making, you know, and China will eat those costs on tariffs. Plunder our neighbors. The left, the Democrat Party, is talking about an indentured service class. We need, we need migrants. We need people to do the jobs that people won't want to do at low wages and stuff like that to bring them in as well. So really, what we're hoping or what Trump is hoping for is that those tariffs at 145% on Chinese goods is going to be borne more by China.
Remember what I said earlier? $5 trillion of taxes, $7 trillion of spending. We can't really take our tax base from 5 to 7. Historically, what economists have found is we, Historically, for the last 80 years, our tax rate has been about 18% of GDP. When it gets much above 20, the economy really starts to sputter. When it gets much below about 16, you really start to see overheating. Well, we need about 23% of taxes to GDP if we want to maintain the spending. When are we going to get it?
We're going to get it from them. We're going to get it from China. That's where we're going to get it from. I don't think the, the balancing the budget and spending. I don't think that rhetoric is as important as I mentioned or as you make it to be. I don't think it's inevitable also that an empire is in decline. I do think short termism and the short political cycle and entities continuously doing what's good short term and not doing what they need to do to maintain power.
Look, at the end of the day, absolute power corrupts absolutely and power can maintain power forever. Like Rome was in decline for 250 years. Oh yeah, if I said that the US is an empire in decline. Yeah, I'm talking about decades. Yeah, I'm talking about decades is maybe a century. I'm not, I'm, I'm talking, I'm not saying that we're in decline and we're going to be in the soup by the end of the year or in two years, something like that.
But you could argue that doesn't have to be in decline even. I know, I don't agree with Ray Dalio's necessarily like the, the end of the empire. Because the reality is you, if you are still by far the most powerful country in the world, right, there are forces that are, that are pulling you down, but you have the tools, if you're able to get the correct leadership, right, to reverse those things.
But what it involves is stopping the inertia, taking your short term pain in order to fix the long term problems. And I think that's in a way what we're trying to do. The question is, are we going to be able to attain it and are we willing to take the pain? By the way, the pain can be a decade, 15 years of real pain and rebuilding. And that's the question.
And the problem is, and you asked about Trump, why is he doing like at the end of the day, politicians and the current system demands they get reelected so they cannot take 20 year bets without addressing the four year cycle. And that's really at the core of the problem here, you know, and why is Trump, by the way, Trump came in with Elon Musk and Besant as this supply side, Republican, big, you know, side and simultaneously this lutnick like a side of the party.
And what's happened, you know, as his approval ratings gone down. As the realities politically have come to the table, Elon's been pushed out. And the angry hordes have come for eat the rich, who is the wealthiest man in the world much more than they've come for Trump. But I think what the angry hearts have to realize is that if you think the answer is, you know, the, the definition of insanity is doing the same thing over and over again, expecting a different result.
If you think the answer is tax the rich, tax the rich, tax the rich. We've tried that for 50 years and it doesn't work. So really, ultimately, what Trump is trying to say is there's somebody rich, there's somebody that's got even more money than the rich, and that's foreigners, and we want to try and take it from that. Right. And you can exert that power. As a, you know, but ideally, you don't alienate your allies.
Otherwise you may be, you know, and ideally do it sooner rather than later because if you do it in 10 years, you may not have that power and it may be too late. And that is exactly what will accelerate the timeline from, maybe it's not 200 years, maybe it's 20, 30 years. Right. So, but, but I, I agree that this is a critical time. We're talking big picture cycle things here. And so what's the trade?
Let's, let's, you know, as we get to the end and work our way to the exit here, how do you, how are we going to make the most amount of money, you know, and benefit from this scenario? So higher volatility environment is what we're in right now, because there is going to be no going back. It's going to be, when I say higher volatility environment, I mean, we're going to go, you know, from big swings to big swings. I said maybe that the stock market returns 6%.
That doesn't mean that you can't have down 21 year, up 30 to next year, you know, when you average out to six or something along those lines. So I think that that's going to be the environment. I also think the next environment, too is that if we're in a lower absolute return environment, you know, I know that on the C boat where we're recording, there's a heavy concentration of the volume is in the max seven stocks. There's 2,000 others out there.
And as we start to unfold in this period, you might want to start thinking about those other 1993 stocks. We've been in a world, right, essentially where it's all linear, everything goes up together. The Federal Reserve liquidity is what drives everything. You mentioned active management. It's also becoming increasingly non linear. Right. And that's why part of why like volume on options is through the roof these days. Right.
It's because it allows you to take bets based on outcomes with much less risk, with much more convexity. And when you're in a regime change and you're in a big environment change, you can make those bets much more directly. With options and different parts of the distribution. You can also do it in the bond market. I think the CBO has, you know, bond indexes and options on these products as well.
So I think there's an incredible opportunity to, to really use some of these products to risk manage to make convex bets on really convex. And you've got, you've got from zero dte all the way out to leaps. So you've got a whole maturity spectrum that you can, you could go with. But that is the environment. Because actually for an institution like the cbo, I would argue this is a better environment. Because what was the last environment? It was three instruments. It was just by. By spiders in.
By spiders and by spiders because they always go up. Nothing could beat them. And it was a one decision era. Non correlated. Investments. And what are essentially at the end of the day, if you're playing different parts of the distribution, different products, right. In nonlinear ways, that is a way. To get, to get non correlated.
And I also think that the expectation too, because as a macro guy, the question I get most often, if I could summarize it, is some big multi trillion dollar asset class is going up 25% this year. Which one is it? And it's like, okay, I get why you ask the question. Because most of the time in the past it's always been some big multi trillion dollar asset class is going up. And I mean something bigger than gold. And maybe now is the era where we don't have that. So how do I get those big returns?
You have to start, you know, you have to start decentralizing your thinking instead of centralizing your thinking into the big indexes and start thinking that way now. The problem everybody faces is a lot of people go, yeah, yeah, yeah, that makes sense. That makes sense. You've never had to do it before. Well, the inertia, right? Yeah. You don't want to be the last one out the door, I'll tell you. But 60, 40 just being long stocks and long long term bonds, how'd that work out?
68 to 82 or you know, how'd that work out? You know, all these other times? It worked great from 2009 to 2022. Right. If not there anymore. Yeah, but yeah, right. From 68, 82, that was a disaster. Type of. So there's two ways to solve that. One is to take down your stock and bond exposure and go into non correlated investments. Or the other one is to hedge out your exposure. To the long term bond and inflation. And drive nonlinear outcomes against to offset that exposure.
But either way you need non correlated or inversely correlated kind of. Right. And the thing is, we're talking about the markets are in a state of flux right now because we're shifting from one regime to another regime and that's the volatility we're seeing. And like I argued, we can't go back. So we're going to continue to go into this type of environment.
Now with that said, if you don't like the volatility, you could also look at very safe investments like cash or you could look at very safe investments like bonds that could give you most of the riskier market returns with less volatility. Which bonds though? If you go to long bond, you know, interest rates go up 3, 4%. You're going to lose 80% of, you know, 70, 60, 70, 80% of your money. And if you go too much into credit, you're going to wind up losing.
If we have a, which is correlated with a long, credit is very cyclical. Because credit will wind up being very poor investment when the economy turns down. If we have a 70% chance of a recession, then a lot of these companies are going to have to restructure their credit, which means you lose, you know, on a restructuring. So yeah, I think investment grade bonds. But mainly, you know, the benefit you have in the bond market right now is the yield curve is still very flat.
So you could be in very short term maturities, very low duration and get about the same yield as you would get in long term maturities. The thing of that, you know, you'd want to be in long term maturities historically was, well, if we're going to go into recession, it'll be a big bond rally. There isn't one now and that's the equity market. All assets are now correlated to the long term bond.
I've actually argued that if you look at the last couple of months and it's been a bit of a an outside the box thinking. Everybody thinks that the whole world turns on tweets and tariff talk and to some extent it does. But really what I also think is another constant is what are yields doing? When yields go up, the stock market struggles and when yields go down, the stock market does better.
Why are we've been recovering for the last couple of weeks, we've gone from 458 in the 10 year note to 420 on the 10 year note. And so what the market really wants is cheap money. It always wants cheap money. Problem is with inflation you can't keep that unnaturally low, right? Or you drive more inflation. Right? That's no inflation. In 2010-2022 you could go to zero and print money. You could get away with it. But with inflation, as we said with September, you want to get the long bond.
You want to get the long bond above 6. You want to get the 10 year above 6. Do what Trump is asked. Cut rates. Start talking about cutting rates. Talk about printing money. The long bond will go vertical in yield if you do it in this environment right now. Completely agree. Mayday. Exactly. Wonderful having you here. Great Jim, thanks for joining me. Incredible conversation and look forward to staying in touch. Thank you, thank you. Thanks for listening to Top Traders Unplugged.
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