First Trust ROI Podcast
On the ROI podcast, we discuss some of the most important questions facing investment professionals today, ranging from macroeconomic views, to perspectives on the equity and fixed income markets, to insights on practice management. We aim to cut through the noise, examine the data, and provide fresh insights to investment professionals as they help their clients find better ways to invest…seeking to generate attractive returns on their investments.
First Trust ROI Podcast
Ep 54 | Brian Wesbury | It’s a Topsy-Turvy World | ROI Podcast
Brian Wesbury discusses Fed independence, inflationary fears, the growth of government, and whether the broader economic benefits of AI adoption will materialize.
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Hi, welcome to the First Trust ROI podcast. I'm Ryan Esekainen, etf strategist at First Trust. Today I'm joined by Brian Westbury, chief Economist at First Trust. We are going to discuss the Fed and its independence. We're going to talk about the US economy, maybe, where the equity markets are headed between now and the end of the year. Thanks for joining us.
Ryan:Well, we're finishing up the summer here, heading into the fall. There's been a lot that has gone on this year. It feels like you know, we've had a compressed amount of activity, everything from markets diving because of uncertainty related to tariffs to the potential for an outbreak of war, to questions about what the Fed's going to do Fed independence, fed policy there's a lot of ground to cover today, so I'm glad you're able to join me. Maybe we can start out here. I don't want to spend all our time focused on government policy, but it seems like it's kind of unavoidable in the economy because it has such a big impact, especially this year, and some of the things I like, some of the things I don't like. But one of the things that kind of keeps on striking me is sort of echoes of what Ronald Reagan said once upon a time with the nine most terrifying words in the English language. You know, I'm here from the, I'm from the government and I'm here to help.
Ryan:Yeah, yeah, I don't know if that's all the but, but and you know, I guess I want to start there what's your take on all of the intervention that the government has had this year, and is that going to be good or bad for the long-term health of the economy?
Brian:Yeah, I mean I kind of try to step back from all of this. Our government is massive and the federal budget is $7 trillion a year. If you include everything, including defense, all of that stuff, it's 24% of GDP, almost like it's a quarter of our GDP. And that's just the federal government. State and local is another 20%. And then if you include the cost of regulation, which eats up about 7% of our resources, just complying with taxes and compliance and all of that stuff, that's 51% of everything that we do.
Brian:No matter how much I hate talking about government, because I don't think that's what creates wealth, it's half of everything of a daily life and as a result, everything's become political, and so I would put the blame on that, on just the size of government. And then you get in a new election, a new president comes in that sort of wants to, at least on the surface, tear that down, kind of like Ronald Reagan, when Ronald Reagan beat Jimmy Carter and then now Trump beats Biden-Harris. It's sort of small government versus big government in the philosophy, but Trump is doing a lot of things that kind of sort of go against the grain of free markets.
Brian:And that is, you know, tariffs are a tax and taking 10% of Intel if you give them money you know, 15% of the sales, of any revenue that comes to NVIDIA from Chinese chip sales things like that, and so people have gone sort of I think a little bit nuts about that, because I actually think some of those things are still the jury's still out whether we're going to do those. I've heard that the Trump team is debating this 10% ownership. They fully realize that's not really a free market thing to do. We have to realize is that at the same time they're doing that and people focus on it, and I just read a piece, uh, not long in the wall street journal, not long ago, that this is the chinaization of it's the state capitalism. Uh, and and trump's bringing it in.
Brian:I'm like that's. I mean, this is forgetting history, because back in the 30s we paid farmers not to grow stuff. In the 30s we paid farmers not to grow stuff. In the 70s we had wage and price controls and we set different price increases for Chrysler versus Ford versus ag versus steel. Like we have played around with state capitalism for decades and decades and decades and at the same time, trump has done some of these things. You know what he's attempting to do is bring manufacturing, especially chips, back to the US. So that's an admirable goal.
Brian:And him getting involved in that is a little state capitalistic, you know, china-isty. But on the other side we've taken away regulations on light bulbs, stoves, ovens, dishwashers, you know. Gas mileage requirements have been watered down. We're not going to subsidize electric cars as much anymore. So it's really kind of fascinating because there's two sides to this and I think if you put it all together, especially now that we've furloughed or laid off about 300,000 government workers, I'd say the net effect of Trump's policies isn't state capitalism, it's literally a smaller government. But we're going to have to get to this budget process this fall September and October before we find out what Congress does, because they're the ones that have to pass a budget and then fund the 13 separate 12, 13 separate agencies of the government. And if they are able to cut that spending, then we have a little bit of a repeat of Ronald Reagan and that would be real positive. Are you hopeful that they'll come up with a little bit of a repeat of Ronald Reagan, and that would be real positive.
Ryan:Are you hopeful that they'll come up with a budget, because, if I'm not mistaken, that hasn't happened for decades, 30 years maybe.
Brian:Yeah, I mean, I'm hopeful.
Ryan:You're an optimist.
Brian:naturally I'm an optimist, but I've been an optimist a number of times, and Republicans are in control. They're the ones that have complained about this the most. You would think that they would be able to pull it together and actually pass a true budget in what we call regular order, like the parliamentary order of the business, of government. But man, maybe they forgot how. I'm starting to think 30, 35 years without a true budget. Maybe they did forget how, but I would argue that the net effect of all of this.
Brian:So we extended the tax cuts, which is a positive, but at the same time, I think we offset that by taxing through tariffs, and so the net tax burden on Americans hasn't well. First of all, extending the tax cut is not a tax cut like at all, it's just keeping them the same, and so that's a positive, because now we know that that's permanent. That's the positive part, not a tax cut. And then we've raised tariffs and I think we still haven't seen the negative effects of that. Canada is slowing down, europe is slowing down. I'm certain China is slowing down, although it's hard to get data that you trust out of them and I suspect that that slowdown is going to show up here as well, and it really is coming from that tax hike, which is a tariff.
Ryan:So let's talk a little bit more about tariffs, because I know there's been some legal challenges and we're recording this on September 3rd, so who knows what happens in the courts. But I think most recently what I read was that some of those tariffs were ruled to be illegal and now it might go to the Supreme Court or something like that. But it makes me think you know, there's corporations that have already paid those tariffs. Oh yeah, so what happens, does the? Treasury have to send them a check back and refund that.
Brian:One of the things that's unbelievable about President Trump is how twisted he makes people's brains, but what we're going to end up with is Democrats cheering a tax cut if tariffs are ruled illegal, and then actually cheering the fact that we're going to pay US companies back money, and so that to me is like it's just what a topsy-turvy world.
Brian:So that to me is like it's just a what a topsy-turvy world. Yeah, but to just, I'm not a lawyer, I'm not a constitutional scholar, but I do understand some things about the tariff issue, and one of them is that we need an emergency and that's why, early on, it was fentanyl and immigration, and so he was especially going after canada and mexico and those are emergencies and so in a way that's a declaration of war, like you could.
Brian:You know, that's kind of the these are the, the area of law that that goes in. But then he just called the trade deficit emergency so so and the loss of jobs in America. And that's where the courts are going to have a really difficult time, because the president isn't allowed to just change tax rates on his or her own, and that's why you really need a legal reason, and it's not clear that he has one, when unemployment is as low as it is currently, to blame the trade deficit and taking away jobs or something.
Ryan:I'm not sure that that is the best argument to make.
Brian:Yeah, exactly.
Ryan:It doesn't ring too, true so the other thing that I was then thinking about if these are ruled illegal and the Supreme Court, let's say, says, okay, they are illegal, I suspect that the Trump administration would try to push Congress to pass some legislation for tariffs, codify it into law, and that could get really messy.
Brian:It could, and I'm not even sure whether they would need a supermajor majority to get that done. You know, tax hikes, I think you need a super majority, but since it doesn't increase the deficit, maybe it falls under the Byrd rule, which says we can do it with a simple majority. But I'm not sure Congress wants to vote on that Because that's raising taxes on corporations in their districts, and so I mean it's a question whether any of this would get done. So obviously there is so much uncertainty because President Trump is pushing the limits of a lot of things really, of executive power, like how much power does the president really have?
Brian:And the reason I think that we're here I think that's important for us to think about is because Congress it's failed at its job. I mean, it hasn't balanced the budget, it hasn't passed a budget. Spending just keeps going up and up and up and up and up, and Congress hasn't been able to stop that. And I mean we could debate why Do we need term limits or how do you put an end to it, but that's why Trump is doing this. And we've talked about this before. But just real, quickly, the whole idea of Keynesianism is that you tax people with a high marginal propensity to save and you give it to people with a high marginal propensity to consume, because Keynesians believe that demand, consumption is what drives growth, not entrepreneurship and innovation and invention, but demand and people spending money, and it's worked.
Brian:It hasn't worked to lift growth but it has worked, because consumption is way up and production is not up and so we're importing more to support that consumption that all this redistribution of money. I mean think about COVID we handed out almost $5 trillion for people to sit at home. So we weren't producing but we were consuming, so no wonder the trade dev. I mean that's an extreme example, but we've been doing this in the US for 40 years and so if you're trying to fix it, one way to do it is tariffs, although I would argue that's not the best way. The best way is to cut tax rates, cut government spending, stop taxing people and handing it out to others to spend, and then cut regulation and let people actually produce here, because we make it really hard to produce in the United States with all the tort law and all the ways you can get regulated and fined and taxed if you produce.
Ryan:At least in the news cycle, there hasn't been much talk about the cutting of regulations. I think that's kind of early on. There was that there was going to be big regulatory cuts, but I haven't seen a ton of news articles that talk about how regulations have been cut. So do you think that that is just something that's being overlooked?
Brian:Yeah, it's being totally overlooked. It's way more. I think news is turned into big time clickbait and it's also turned into politically driven. So you don't want to highlight deregulation. I mean, I'm sure there are people out there that are highlighting it, but it's not as exciting to write about deregulation as it is to write about the war in Ukraine or Israel, or tariffs, and a fight with China and NVIDIA and owning 10% of this.
Brian:So that's where we see the news. There is a lot of deregulation going on. I mean, I mentioned a couple of them and there's a line, but we're not subsidizing electric vehicles. Soon that will run out. We lowered gas mileage. The CAFE rules, cafe requirements yeah, rules. We reduced them, which means now you can, you know if you're ford, you don't have to produce electric cars, you can make more f-150s and you know this is the way the us wants to go. Anyway. People like the demand for electric cars is not huge and it's a lot driven by tax uh reduction. Um, like I said, stoves, dishwashers, light bulbs, all of those things. And then I think this is happening in a lot of other areas and we just don't see it, at least it's not reported on very clearly. But yeah, they're deregulating right now and it's getting easier to do business in the United States and that's a real positive.
Ryan:Yeah.
Brian:So I guess, to summarize from an economic point of view and how this is affecting the economy, there's some good things going on and there's some what I would I'm not going to say negative, but things that might slow the economy. They're good intentioned, if you will, but a tariff is a tax and so, if you try to put these on, one of the things that makes economic forecasting hard is that we don't have a period in time in history where we can look at what happens. When you do this, there's no test. We do know the direction. This deregulation is positive, where we can look at what happens when you do this. There's no test. We do know the direction. This deregulation is positive. The tax hikes from tariffs are negative, but is the negative outweigh?
Brian:the positive, or is the positive outweigh the negative? We don't know. And that's why, when I fall back on looking at the money supply, I think tariffs are taxes and taxes aren't good. So I would argue that, yeah, we're benefiting from some of this stuff, but the costs may keep those benefits at bay. And then you come back to the fundamentals and the money supply is flat for the last three years. We're cutting the deficit, believe it or not. It's not by a massive amount, but it's not going to be growing. And when you have a flat money supply and deficits going down, all that short-term stimulus that we got used to, the era of easy everything, is over, and that means for me, a slowdown in the economy.
Ryan:So then we should talk a little bit about the Fed, because that is kind of related to at least the excuse for not cutting rates is the uncertainty related to tariffs and whether or not that's going to cause some level of prices to go up or inflation. I think there's some pretty wide disagreement about the inflationary effects of tariffs, but there's certainly the uncertainty there, and you've, I think, argued in the past that the Fed can cut a couple times and still be in neutral, and I think maybe the Fed is coming around to that opinion. It seems like they're probably going to cut in September. Is that your expectation? What do you think happens from there?
Brian:Yeah, I think the Jackson Hole speech by Jerome Powell was pretty clear.
Ryan:Yeah.
Brian:I mean I don't care how he said it, I mean I could tell you how he said it. He said, well, inflation's still a worry, but employment's slowing down. And so I mean, basically he was given an excuse to cut, slowing down. And so I mean, basically it was given an excuse to cut and the market's pricing in a quarter point cut September 17. So it's only two weeks from now, and I think that's exactly what we're going to get.
Brian:Inflation right now. Look at all the measures running about two and a half percent. So with the 1% real yield, that's three and a half. One and a half percent real yield, that's four. I would take four as being a good neutral rate, and the Fed could cut twice. They probably should cut by two, by 50 basis points in September, but I think they're only going to do one. And so the now you know, and Trump's leaning on them. One of the things Trump has said, if I'm not mistaken, is he wants interest rates 300 basis points lower. So which would put him at one and a half percent. Yeah, that's below inflation. That's too low and, by the way, that's why the gold market is going crazy. We're over $3,500 an ounce. It's silver's over $40 an ounce. The precious metals are taking off and they're worried that a Fed under Trump will follow a policy that'll create more inflation than they think. I don't think the market should be as worried as it is.
Brian:The money supply is flat and interest rates themselves just by themselves. They don't have as much impact on inflation as people think they do. I mean, bernanke held the federal funds rate at zero for seven years. We didn't get inflation. And then Powell held it for two years and we did get inflation. And then Powell held it for two years and we did get inflation. So wait, if seven years didn't cause inflation but two years did, what was going on? And I think the answer is really easy. Look at a growth rate chart of M2. It's like M2 didn't accelerate under Bernanke. It boomed. It grew 40% under Powell. That's why we had inflation. It was M2, not because of the low interest rates themselves. So we'll have to watch the money supply and right now it's growing less than GDP. So I don't think it's inflationary.
Ryan:So there's been a lot of concerns expressed about the independence of the Fed.
Brian:you know a lot of news articles and by the very same people who wanted to fire members of the Supreme Court. By the way, yes. By the way, yes.
Ryan:So is that something people should be concerned about? Independence of the Fed. And you know, kind of as a second part of that question, any favorites for who might succeed Powell? If you know, assume he's not going to be reappointed.
Brian:Yeah, he will not be reappointed as chairman. He, by the way, he still has some term left. So, like, the chairman is a member of the board and those are 14-year terms, and then their appointed chairman within that term, and so if the term runs out before their four-year chairman term runs out, then they got to be reappointed to keep their presidency, or their, their chairmanship, um and so so his, but his 14 year year term is not over in may he'll, and he will no longer be chairman. But he could, could stay on the Fed as a vote.
Brian:And then now Trump is trying to figure out whether it's constitutional to fire these people or not for a cause or whatever, and so we know all that's going.
Brian:The Fed should be independent, but it's not. It's never been really truly independent, but especially in 2008, that when the Fed started quantitative easing, they tied themselves at the hip to politicians, because what they did is they bought the quantitative easing means. I print money to buy government bonds. They funded the government during TARP and President Obama's shovel ready project programs. They funded all the bonds that were used to pay for COVID and like like five. That's that's what quantitative easing was.
Brian:So the Fed is the one that I think they violated independence from that side. They should have never been financing governments borrowing and spending and they made it a lot easier for the government to borrow and spend. And I don't think that it wasn't a war. I think we overreacted, the Fed overreacted, and if you're going to fight a war, you ought to borrow the money. That's what we used to do.
Brian:I mean England. You know, before the Revolutionary War, england had defeated France, defeated Spain, sun never set on the English Empire, all that stuff. And every year their interest on their debt was 50% of all the tax revenues that they collected. And the way they got in that much debt is they borrowed all the money. So they didn't have a central bank back then to do quantitative easing and they had to work their way out of it and they taxed their colonies, they put tariffs in, they did all kinds of things to get out of that debt. But that's the way we should have financed COVID. If you want to pay people to stay at home, you ought to ask the bond market to pay for it and not have the Fed pay for it.
Brian:So I think the Fed violated independence by doing quantitative easing in the first place. That's number one. Number two the Federal Reserve. It became highly political because it got involved in climate change, community activism, environmentalism, dei. The Fed is one of the most progressive institutions in government and I know this by for a fact. The institution itself is not independent. It's very political and and therefore Trump attacking it, if you will, by going after Cook or Powell yeah, he wants lower interest rates.
Brian:That makes him he's a developer which you know, a developer who doesn't want low interest rates, and so I get all of that. But the Fed is the one that overstepped bounds and it's not talked about enough. And it should be talked about and I'm willing to talk about it because I don't want to be on the Fed, and so I have no desire to be on the Fed. But most economists I know want to be on the Fed, but they're the ones that violated this independence, not Trump. And having said that, I believe in an independent Fed and I think the president's not. With Lisa Cook, if she lied on her mortgage applications, I think that is a fireable offense, although we did have a treasury secretary who didn't pay his taxes like still got through confirmation. So I mean, maybe our standards have fallen in America, but he is not trying to threaten their independence, in my opinion, because they don't have any left. They've already given up their independence.
Ryan:So, with the mission creep that they've had and they're already doing things that are political, you think that it's just a response to that politicization? Yeah, whatever that you think it's a response. It's not actually Trump being the. I think it's a little bit of both but they have earned the response.
Brian:Let's put it that way the Fed and the Treasury should be separate in a way. They have to work together because you know the value of the dollar, the way the trade works, the way money flows. They have to work together. But they have now. For example, the Treasury now has an account at the Fed with hundreds of billions of dollars in it and, according to stuff that I've read, they believe that account ought to have $850 billion in it and they hold that at the Fed. And, by the way, so when they raise taxes you write a check to pay your taxes they put it at the Fed. It comes out of them too, so it's actually become part of monetary policy. And if you dig kind of deep enough in the dirt a little bit and look at this the way these two institutions are working together it looks a lot like modern monetary theory, and this is why gold and silver are going nuts right now, because they're scared to death that we're going to use the Treasury and the Fed to finance spending that we shouldn't be, and I mean that's the way I read this that we'll end up with more inflation, and all I'm saying about Fed independence is that they gave it up just as much as politicians tried to take it, and that's what happened.
Brian:My biggest concern about our world going forward is just the sheer size of our government, because what happens when government gets so big? Not only is it involved in every walk of life, everything you do you can't turn around without having government involved in some way but it also encourages institutions to become political and to try to win favor with this group or stop stymie that group, and I think the Fed has gone that direction much more than anybody is willing to talk about. I also am completely against what the Fed has done with quantitative easing. We're paying private banks right now, private banks $200 billion a year to hold the reserves that the Federal Reserve created to buy the government debt. But we just do it a roundabout way. The banks hold the reserves, the cash, the Fed owns the bonds and we pay the banks so that the Fed can own the bonds. And the net result of all this is government spending went through the roof and if the Fed had not have done that, the markets would have revolted a long time ago.
Brian:And the end result of this for our sake, for what really matters to us here is that the Fed's about to cut. We know this. Well, guess what? The 10-year treasury yield has gone up since we found out that the Fed was going to cut. And so why is that? Well, it's because maybe they shouldn't be, or at least that's what the market might be saying. And the reason that's important to me is the 10-year yield is what goes in our stock market model, and if you put a four and a quarter 10-year yield in with current earnings, we're overvalued by a significant amount, like somewhere around 40%. And so if interest rates don't come down, and there's no guarantee that Fed's going to cut short-term rates, does that mean long rates come down? Well, not, if we're running $2 trillion annual deficits and not doing QE anymore. So what's fascinating is, I think this could undermine the stock market too.
Ryan:So a 10-year yield is basically a combination of all those short-term yields between now and the next 10 years. So what it implies is that we're going to have higher short-term rates in the future, maybe because inflation comes back at some point down the road. Yeah, that's exactly what it is, or just people have less confidence in US treasuries, or something like that.
Brian:Right. So I mean, if you think of a 10-year yield as 10 one-year bonds, right, yeah. So right now, the one-year well I don't know it's 4%. Let's say the 10-year is 4.25%. So you can figure out the math. I mean, you can use your Bloomberg, you can use an Excel spreadsheet to figure out the math. But like we go from 4 to 3.75 to 3.5 to you know, but then the 10-year is saying oh no, it's not going to stay down there, it's going to go back up three, seven, five, four, four and a quarter, four and a half five, and then the average will be four and a quarter over 10 years.
Brian:So what it's saying is you may cut rates in the short term, but we don't think you can hold them there for very long right, okay, so we came into this year and your team put out a price target, I think, of $5,200 for the S&P 500.
Ryan:It sounds like you're pretty confident. You want to keep that for the rest of the year.
Brian:Yeah, I mean two things are important. We're not momentum-based at all, we're fundamental-based. So we run a capitalized profits model. It's a simple approach profits discounted by the 10-year treasury compared to the S&P average over 70 years. Boom. It's a simple mathematical, factual model. All right, not trying to guess momentum, not trying to guess whether NVIDIA has competition or anything like that, just looking at the valuation of markets. So momentum doesn't play a part in it. And the second thing is is I believe in fundamentals? I think we I'm not a mean reversion guy in life you think of, of human life. What's the mean mode of transportation? Probably the horse Like. Maybe it's walking.
Ryan:I don't know.
Brian:Yeah, but maybe it's two feet without moccasins, I don't know. But I mean it depends on how many thousand years ago you go back. Go back, but let's just say it's the horse. Well, we're not going back to the horse like I don't. I mean, I guess you could dream up a scenario, if you're a prepper, that we do, but but you get my point, so so I'm not a mean reversion on everything.
Brian:There are things that they get better. It could change over time and permanently, but one of them is not valuations. When you have to pay 40 times earnings a dollar of earnings, $40 to buy $1 of earnings for one company and you only have to pay $8 for a dollar of earnings for another company and they're both great companies which one's more likely to have higher returns over time. And if you just look at P-E ratios, or price to sales ratios, and then returns over the next 10, 15, 20 years, it is clear the higher the PE ratio is, the lower the returns are in the future. And so I think the market's overvalued Again.
Brian:I'm not a momentum trader, so when the model signals overvalued, it doesn't mean the market's overvalued Again. I'm not a momentum trader, so when the model signals overvalued. It doesn't mean the market's turning down, and so the reason I bring all of this up is that I'm sticking with 5,200. Does that mean I expected to be there on December 31st of this year, because that's technically what we're saying end of the year target, and that'd be about a 20% drop.
Brian:Yeah, it would be about a 20% drop and I think, by the way, if the market falls 20%, the 10-year yield is probably going to come down too. So every time the 10-year falls, that means we're worth a little bit more in our model. So that's why I'm not going all the way. If you really run the model, it's 40% overvalued, but I think interest rates are a little bit higher than they should be today and people are Inflation's a concern over time, but I think the market's overly worried about it today. But having said that, I can't stop the market from worrying or being euphoric. Having said that, I can't stop the market from worrying or being euphoric.
Brian:So we got this YOLO trade.
Brian:You know you only live once Like buy it, like hold it, hoddle, like all these, Like I mean people are trading daily options, like it's huge and I mean, as an investor, this, I mean this drives me crazy. I would, you know, thank goodness my kids aren't doing it At least I don't think they are or my brothers or, you know, my family but be an investor and so I still have $5,200. If you really like push me and said, is that your, you are guaranteeing we're going to finish the year there?
Brian:No, I'm not Well, okay, so over or under on that Today, if I had to say probably a little over, but that's only because I'm looking at people just buying, no matter what happens, and there's not that much time between now and then. Yeah, and it's only three months, but do I think we're going to hit 5,200?
Ryan:We already did it once this year we did yeah.
Brian:And so do. I think we're going to do it again, yeah, yeah, and we might even go a little bit lower. But in the next three months do we hit it? Probably not. But having said all of that, there's still sectors and industries and companies in the S&P 500, in the market as a whole, that are cheap relative to these MAG 10 or 7 or whatever they are. I mean, the top 10 stocks make up almost well last I looked, 39.5% of the S&P 500. And they're expensive. And there are places. I mean you can go to Europe, you can go overseas. International stocks are still they've underperformed for 15 years. And I mean you can go to Europe, you can go overseas. International stocks are still they've underperformed for 15 years. And I mean there's value in the market. And so I'm not telling people to get out of the market, I'm just telling them to broaden out, diversify, and I think that's going to pay, no pun intended, dividends in the future.
Ryan:So I'm hearing you say I'll paraphrase what I'm hearing you say so maybe it's more important now, because valuations are elevated, to make sure that you're picking the right parts of the market. Maybe individual stock picking is going to be more important in this environment than just buying a market cap weighted S&P 500.
Brian:Right.
Ryan:And certain sectors maybe have better value certain parts of the world, and that seems rational.
Brian:Yeah, a fundamentally weighted index. Heck, I mean equal weight. Pe is a lot lower than the market cap weighted and same with market price to sales. I mean price to sales ratios today 3.2%. The 25-year average 1.7 on the S&P 500. I mean, it doesn't matter what value.
Brian:Even the Wall Street Journal wrote basically a front page story online that said the market's more overvalued since the dot-com era. And I've used the dot-com era as a comparison. But I always want people to realize that history rhymes, it doesn't repeat. So we are not in 1999. Back then we had companies that didn't make any money soaring. Today these companies are making a lot of money. We were overvalued by 62% At most. Today we're overvalued by 40% at most and I believe it's really more like 20-ish percent. So nowhere near 1999.
Brian:What's similar is kind of the blind optimism or, as Greenspan said, a rational exuberance, and people were saying things in 1999 like we would never have a recession again. And you know, others are saying you know well, PE ratios are permanently higher, like NVIDIA is no one's ever, ever going to catch up to them, et cetera, et cetera. And spending $200 billion on AI chip data centers is going to be the biggest return that any. One of my worries is I think we're just cannibalizing existing stuff. So Google is investing, or Alphabet, I guess, is investing um you know, 50, 80, 100 I don't even know how much billion in ai every year, right?
Brian:now yeah, and then they're using that to make their search engine better. Well, it's. Are more people going to search because it's AI? I mean, is it driving? Yes, they don't need as many coders because AI can write code.
Ryan:Yeah.
Brian:So I guess they're saving on employment costs and the cost of production somewhat, but are they really driving revenue higher like I? Like I are people doing more searches because they're ai searches now instead of the old google kind?
Brian:yeah and because they use sort of an ai. Before it was more rudimentary, now it's more official, I guess. But that's what I worry is that a lot of this is just cannibalism. It's not really creating something new, whereas you go back to 1999, we were inventing, I mean, remember, the Palm Pilot you could write on it. The one had an antenna you could connect to the internet. It was the iPhone before the iPhone, and it didn't do everything. I'm not trying to equate them, but that company, 3com, went out of business and so history rhymes. It doesn't repeat. But I'm worried that we're overestimating the benefits of AI. I'm not saying it's not a huge deal, that it's going to change a lot of careers and a lot of things, but I haven't seen at least back then we were inventing a new thing, a phone, you know. Now we're just finding a way to run all these things more efficiently.
Ryan:So I think in your example of the smartphone, maybe what these companies are thinking is there was really just a narrow number of winners. I mean, the iPhone was the winner, and so they just don't want to be the loser. Google has to make these investments almost as a defensive move, because if they don't, they recognize that all these other companies, the hyperscalers, will. So they have to also have AI, or someone's just going to go on Grok or they're going to go on one of the other chat, gpt or something like that.
Ryan:So it seems like they feel as though they have to make these hundreds of billions of dollars of CapEx.
Brian:Yeah, and what.
Brian:I wonder? I don't know the answer. I'm not trying to say I know it's truly unbelievable technology. What I wonder? I just don't know the answer. I'm not trying to say I know I'm not trying to. It's truly unbelievable technology. Nvidia is an unbelievable. Apple, google, all these companies we've never seen anything like them. They've done unbelievable things in the history of corporate management, of financial markets. I mean, they're amazing. So I'm not trying to beat them up or find a reason to sell them.
Brian:From an economist point of view, is this actually going to raise productivity and profits in the long run? And what I wonder sometimes is are they just cannibalizing their own business? And let me use a quick example. So back in the late 90s again, history rhymes, it doesn't repeat Ford made a big deal splash, press releases, all kinds of stuff. We are going to move our supply chain management online. So that was the big thing to do back then. This is going to drive a billion dollars to our bottom line. So what Ford was saying is clearly that we're going to make a billion dollars more in profit because we're going to become so much more efficient with our supply chain.
Brian:Well, here's the thing Chrysler, gm, mercedes, porsche, volkswagen, toyota they all put their supply chains online, so they all drove a billion dollars to the bottom line, whatever their number was. Who benefited? Was it the shareholders or was it the customers? And I would argue it was the customers, because then they compete. So if I get a billion dollars going to my bottom line, that lets me lower the price to try to pick up my market share, which is what I really. I want to be the number one car seller in the world. I do want to be the most profitable one, but I'm not going to sell many cars if everybody else is cutting by 10% or adding additional things to it whether it's electronics in the car or whatever, whatever heated seats and air-conditioned seats and all the things they do.
Brian:So maybe they actually didn't cut price, but they improved the quality of the product, and what happened is that supply chain savings got eaten up in the process of competition, and so AI might make you more efficient, but you're going to end up having to cut costs because everybody's using it. As you said, it's a race, it's a space race. It's like everybody's investing $50, $80, $100 billion here, there, everywhere, because they have to compete. Well, guess what? The consumer ends up being the benefactor of that, not the shareholder. Really, when it's a broad technology, it's kind of like inventing the tractor. So the price of crops, the price of food, came down because we were more efficient. The farmer didn't keep all the profits, the consumer got them, and that's.
Ryan:That's the way free market capitalism works like the miracle of free market capitalism.
Brian:It is at work that's what it is, and and so yes there. If you're the first mover you can make the profits, but eventually everybody moves, every farmer gets a tractor and the price of corn comes down.
Ryan:That's what prices do, right? Yes, exactly.
Brian:And over history. That's happened for everything, so I think the jury is still out on whether AI is a true moneymaker for all these companies. They're investing hundreds of billions, moneymaker for all these companies.
Ryan:They're investing hundreds of billions and the question is will they actually reap a reward from that? Okay, All right, Brian, let's end on a optimistic note. As you kind of look in your crystal ball, there's a lot going on that makes me scratch my head. We've talked about a lot of those things. As you kind of look out the next couple of years, is there anything that makes you optimistic about just what will happen, what's coming down the road?
Brian:Yeah, I think. I mean I don't want to make this too political, I don't want to make this too political, but I think there's been a big shift, especially in America. Now it needs to carry on to the rest of the world, away from government management of everything. And a lot of that was around climate change, covid and these kind of draconian government policies, all based on the fact that you were going to die or the world was going to end if government didn't do this stuff.
Brian:And I think we're questioning that today and I think somehow that has to be, you know, cemented into the system. And so the midterm elections are going to be really important. If, if, if, um, if this is, if these are truly 70, 30, 80, 20, 90, 10 issues, like, for example, like the president trump cracking down on crime in dc it's a apparently that's a 90 10 issue, and there are his opponents are kind of taking the wrong side of that and and if that, if that keeps happening, you know, I think republicans will have a much better chance, and then you have a chance, at least I hope, of kind of shifting. See, ronald reagan people don't remember it because it was 44, 45 years ago completely shifted the direction of this country.
Brian:I mean, we went from stagflation, big government, oil price caps like regulation, like we were worried about running out of oil back then, and he completely changed the conversation to smaller government, lower taxes, less regulation. And today it's way more complicated because everything gets identity, politics and personal and I'm trying not to offend anybody almost in this answer, but really what I'm getting to is that we want less government involvement in lives and I think there's a lot that seems to be a majority point of view and Trump seems to be pretty good at picking these 70, 30, 80, 20 battles, and so maybe we're seeing that kind of change. Reagan was really good at it and I know everybody gets upset.
Ryan:Now Somebody's watching this, getting mad at me, but that's what I hope is really what really happens so it seems like most of the people on the right side of the political spectrum would be more for small government yeah um and less government power, at least the federal level especially, uh. But now that trump is in office, people on the left don't want the, the, you know at least the executive branch right now to have a lot of power. So maybe that pushes uh some you know right, yeah, small government left side of the political spectrum it may like.
Brian:You know we're, we're, we're clearly in a I mean it's, it's an amazing I've. You know, I've been reading a lot about the revolutionary war and you go back to the Civil War. I've read a ton on that. The divisiveness in this country and you know, at that time both of those times was massive. I think it was still it's still greater than it is today. But boy do people get worked up about stuff today. And my real focus is economics, and I know I started talking more about politics for a while there. But it's to allow more free market competition and we've drifted away from that. The bigger the government gets, the smaller markets are, and then what happens is houses become unaffordable, cars become unaffordable, people have a tough time making ends meet, and it's all because government is too big. And that's where I hope we're going.
Ryan:All right. Well, that's a good place to finish things up. Thanks again for coming on the podcast. We'll hopefully have you on sometime very soon, Absolutely as your schedule allows. But thank you for joining us and thanks to all of you for joining us on this episode of the First Trust ROI Podcast. We'll see you next time.
