00:00Nominal GDP is really, if I'm talking to my accountant, he sees only nominal dollars, right?
00:06We all get paid in nominal dollars, right?
00:08So what we observe in the world is a nominal world.
00:11We don't observe, like we don't get paid in real dollars.
00:14So, you know, the fact that nominal GDP first quarter of this year was running at 6%,
00:19which is significantly above the average over the last, you know, many years, which was closer to 4%.
00:25And in the second quarter, nominal GDP, if you look at the GDP deflator, nominal GDP was running closer to
00:337.9%.
00:34If you use PCE as your inflation measure, it's closer to 6.5%.
00:39But the point here, Tom, is that if you're in a higher nominal GDP world, you tend to get higher
00:45earnings.
00:45No surprise there.
00:47We can take a look and see what's going on with second quarter earnings and even with first quarter earnings.
00:52And that's the kind of connection that we should draw.
00:54So when I talk about higher nominal GDP, think about that as higher equity earnings and earnings per growth and
01:01earnings per share growth.
01:03So, Jim, how does our Federal Reserve adapt to this type of economic environment and growth environment?
01:10Well, I mean, you know, part of this is the inflation element to it, right?
01:15You know, so nominal GDP is real growth plus the inflation.
01:19So, you know, what's driving the higher nominal GDP is that we are living in a higher inflation world, somewhere
01:25around 2.5%, 3%, let's say.
01:27Well, I guess we'll find out more on Wednesday.
01:30So, you know, the question is, is inflation accelerating higher?
01:35Can we sustain a 2.5% inflation to 3% for the time being until it settles back down?
01:42Yes.
01:43I don't think that that is going to be overly corrosive, you know, for the Fed, as long as they
01:49believe that inflation and inflation expectations are not becoming ingrained where it becomes, you know, something that, you know, becomes
01:57more destructive going forward.
01:59But so at this point right now, I think it's sustainable.
02:03But, you know, I guess we'll find out more on Wednesday with CPI.
02:07How do you expect here just kind of interest rates in general?
02:12It just feels like we're higher for longer here, Jim.
02:14Is that the world you think we're in or are we going to see some moderation?
02:18Yeah, I do think that we're in a higher for longer environment.
02:22So, you know, one of the correlations that you can draw and you can go back over a long period
02:26of time is nominal GDP versus the 10-year yield.
02:30Those two usually sit pretty close to each other.
02:34And I'm not calling for 10-year yields to go up, you know, significantly.
02:36I think that we're primarily in a range and we're going to go pretty much sideways into the end of
02:41the year.
02:41But, you know, the ability for rates to move down sharply right now, particularly at the back end, outside of
02:48having a recession or some really sharp slowdown in the economy, I think is somewhat limited.
02:53Because, you know, in the environment that we're in, you know, at the current moment, it just seems that nominal
02:59growth is going to be higher, which means that it just alleviates the risk of yields moving down sharply.
03:06So, Jim, the gloom crew is going to step in and say, OK, there's all this fancy Jim Caron talk.
03:12But the question is the fiscal state we're in.
03:16How do you pull in our debt and our deficit into that ancient worry, oops, price down, yields up bigly?
03:27So this is a great question, Tom.
03:29So let's connect the dots on this.
03:31So the idea is that if you have higher nominal growth, which we do, that's what pays down your deficit,
03:38right?
03:38That is the number one thing that pays down your deficit.
03:40So you're absolutely right.
03:41The deficit is too high.
03:43It's around 6% of GDP.
03:44It's been coming down.
03:45By some measures, it's slightly under 6%.
03:49I'm sorry.
03:49That's the fiscal deficit, not debt to GDP.
03:51Debt to GDP is, you know, is still a little bit high, depending on what metric you're using, around 120%.
03:57Now, that's likely to come down as long as you have higher nominal growth.
04:03That's what brings that down the fastest.
04:05That's what we did after World War II, right?
04:07We had yield curve control.
04:09We capped, you know, 10-year yields at 2.5%.
04:11And we allowed nominal GDP to get above 6%.
04:14And that's what paid down the deficit after World War II.
04:17So in some ways, we're doing something similar to that right now with higher nominal growth.
04:23Jim, how is this kind of world of higher economic growth?
04:27Has that changed your asset allocation at all?
04:31Yeah, absolutely.
04:32So basically, if you're at a higher nominal world, you're likely going to favor more equities over fixed income.
04:39So when you think of 60-40, I would say, you know, 60% equity, 40% fixed income as
04:45a traditional balanced portfolio.
04:46I would say that the 40% in fixed income becomes somewhat challenged right now, just because you don't have
04:53the ability to generate high levels of return without rates moving down very sharply.
04:59So the equity markets tend to have higher valuations when you have inflation somewhere around 2.5% to 3
05:05.5%, which is where it is today.
05:08Valuations tend to be higher and sustainably higher.
05:11Companies have margins.
05:12They have pricing power.
05:13They generate higher earnings.
05:16So equities tend to be the asset class that is in favor in a higher nominal growth world.
05:22So it tilts me more towards the equity spectrum and a little bit away from fixed income.
05:27So do you look in terms of use of cash?
05:30Is dividend growth and share buyback to be a constructive yield equivalent forward three or five years?
05:40Yeah, yes, you know, absolutely.
05:43Because, look, you know, dividend yields are real yields, right?
05:46You know, that's the yield you get after all the expenses and inflation is a cost, right?
05:51That's what you get back from the, you know, the, you know, the stock that you bought.
05:54So what you want to have are higher real returning assets, real yields.
06:00And as I always like to say that, you know, equities are a nominal asset with real returns.
06:08Because with equities, you get the return after all the expenses, inflation being one of those expenses.
06:14So whether it's dividends or if it's buybacks or whatever the case may be, that's where you're likely to see
06:21the appreciation.
06:22The most appreciation in your investment is likely to come from the equity side of the level.
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