Bond Market To ‘Revolt’ As Fiscal Disaster Nears (Uncut) 04-19-2025

Bond Market To ‘Revolt’ As Fiscal Disaster Nears | Doug Ramsey

Look at the S&P 500 versus gold. I mean, we’re very close to having gold and the S&P 500 up by like amounts from the absolute low of the COVID bottom on March 23rd of 2020. I mean, that’s remarkable.

It really says that a lot of this gain in asset prices has just been from the decline in the currency, right? I’m joined today by Doug Ramsey. He’s the CIO of Lethal Group, and we’ll be getting his outlook on the markets and where we are in the current economic cycle. Doug, welcome to the show.

Good to see you. Thanks for being here. Thank you, David.

Good to be with you. Let’s just start with a question that perhaps is on everybody’s mind right now. Is this massive correction that we’ve witnessed? Is this the end? Are we at the bottom now, you think? Time for recovery? No, I don’t.

I don’t. I think we may be at the end of the economic expansion, but I think what we’ve seen is the first leg or two down of a cyclical bear market rather than a buyable correction. I mean, the problem is people have been taught to buy the dip for a long time.

So, we’re going to see some fierce rallies as people enact what they’ve learned over the last 15, 16 years. When you say cyclical bear market, what does that mean? Does that mean that even without the trade war going on right now, we would still be in this downturn? Yeah, I think that’s likely. I mean, the economy by many measures has been growing at rates and exhibiting characteristics that for a we have called pre-recessionary.

I mean, one example is the slowdown in jobs growth. And again, the focus is always on like the monthly beat or the miss on non-farm payrolls. I mean, that’s the big number.

But the year over year growth rate in non-farm payroll employment has slowed to 1.2%. We have never sustained an economic expansion for more than six to eight months when you’ve dropped to a job growth rate that low. I mean, historically, we’ve just called a level of 1.4% the stall speed. You know, that would just be one example where despite, you know, periodically we have good monthly numbers, year over year rate is slowing down.

And there’s a raft of examples in terms of personal income growth, things of that nature that have really slowed to dangerous levels, notwithstanding pretty good headline numbers on real GDP. And then you take an external shock like, you know, this draconian tariff program, and it just it couldn’t be timed any worse. I mean, I think it will probably bring about the economic downturn quicker than might have otherwise been the case.

But I think we were headed that way to begin with. Yes. This is an interesting chart that you have here.

Let me just share my screen. S&P 500 annualized total returns by unemployment date. So you’ve got this data going all the way back to 1960.

Right. On the x-axis, you’ve got the unemployment rate, and then the y-axis, you’ve got the return in that bucket of unemployment rate. So we’re at around 4.2% right now.

So we’re in the 4% to 5% category. Yeah, we’d be in that in that bottom, the bottom quintile. I mean, as a matter of fact, I mean, the key point associated with this chart is the entire bull market dating back to October of 2022 through and I think the ending was February 19th of this year, the entire bull market took place in that lowest unemployment bucket.

Very unusual. I mean, the entire bull market itself was pretty darn unusual from the perspective that it did start at full employment. There’s only been one other cycle like that, that we’ve seen historically, it was an also very brief and not very powerful in terms of the total magnitude bull market 1966 to 68.

I think that was, it was like 2526 months, only went up about 50%. The bull market and it’s not officially over, right. But if it is, we had a 28 month upswing that took us up 72%.

I mean, 72% gain in the S&P is nothing to sneeze at. But, you know, the key point is, given the initial conditions, when the bull started in late 2022, it was not destined for a long life, because it started with the economy already in pretty good shape. And what this chart illustrates is that, well, the best returns from the stock market, generally come after stocks and the economy have been pretty well liquidated, right.

And you’ve elevated that unemployment rate. There’s a lot of slack in the economy, allowing the Fed to drop interest rates and pump the money supply. This bull market started under totally different conditions that faded it to be a pretty short one.

And we think it’s, you know, turned out to be a pretty short one. Another way to, I’m interpreting this chart and correct me if I’m wrong, is that people are concerned about the labor market worsening, which is a concern that’s shared by not just the regular person, but also the Federal Reserve as well. But if we were to have an improvement in the labor market, which is to say the unemployment rate dropping, well, this chart shows that even if it goes down to 3%, it doesn’t necessarily mean that the stock market returns on an annualized basis, it’s going to be higher.

In fact, it went down. Yeah, you know, I think there’s some logic to that. I mean, if we do see a strengthening of the labor market from here, I mean, from almost full employment, I think we’re going to continue to have wage and price pressures.

And that combined with what still looks like it’s going to be a massive amount of deficit spending. I mean, and don’t be fooled by all the headlines grabbed by Doge during the first six weeks of the administration. Very little meaningful has been cut.

As a matter of fact, year-on-year federal spending, if you track it, you can actually track it daily if you have the appetite for this sort of thing. I don’t, but it’s tracking ahead of 2024 spending rates year-on-year. So nothing meaningful has been cut.

So the idea of shrinking the unemployment rate from here and having deficit spending to the of 7% of GDP, that would be inflationary, stagflationary to use the word of the day. That’s not our outlook, but I think that would be the case if we were somehow to strengthen the labor market from here. Before we continue with the video, let me tell you about the importance of protecting your personal data privacy.

Your personal data is constantly being collected, sold, and exposed online from big breaches to shady data brokers sites. Your private information like your name, address, birthday, phone number, it’s all out there. And it’s easier to find than you actually think.

That’s why I recommend today’s sponsor, Delete.me. I use it to remove my personal details from hundreds of data broker websites. It’s quick to set up, easy to use, and it actually works. Once you submit your info, you’ll get a privacy report in about a week showing exactly where your data was found and removed.

And it doesn’t stop there. Delete.me keeps monitoring these sites year round to make sure your data doesn’t pop back up. Go to join delete.me.com slash David Lin and use the promo code David Lin to get 20% off at checkout.

Link down below or scan the QR code here. Take back your privacy today. What is your outlook? Is it deflationary? Are we getting a recession? I do think we’re heading into recession.

And again, that would have been our base case prior to the tariff plans that have been unfolded. But you still have the lagged effects of the tightening cycle that we went through from 2022-2023. I know the last three moves have been to drop rates.

But you know, look at the interest rate sensitive sectors. Housing is still flat on its back. Manufacturing has been in, you know, a shallow recession now for about two and a half years.

And there are signs that that is deepening. Now I’m always careful to extrapolate from the regional manufacturing surveys, right? There’s the the National Purchasing Managers, or I should say Institute for Supply Management, ISM survey that comes out in the first of every month. But there are various regional manufacturing surveys.

Well, one came out just this morning here. We’re talking on the morning of April 17th, the Philadelphia Fed’s Business Outlooks survey completely cratered. The new orders index dropped to a level close to the lowest print we saw during the entire 07-09 economic downturn.

And at the same time, you saw the price index go up. I mean, that’s, we talked about stagflation earlier. That’s it.

Actually, it’s something worse. I mean, that would suggest a contraction is deepening in the manufacturing sector. But yeah, I think an economic downturn may already be underway.

And David, you know, one point we’ve emphasized, and it’s in my chart deck, there were a lot of preconditions, as I mentioned, pre-recessionary growth rates in a number of economic variables throughout 2024. But one thing that was, you know, are you talking about the term inoculate? Let’s, why don’t we go to slide real 12-month performance of the S&P leading up to- Right. Yeah, there’s a lot going on in this chart here.

What we’re tracking here is the performance of the S&P 500 minus inflation. So the real action in stock prices in the 12 months leading up to each of the last 12 business cycle peaks. And the interesting thing is that on average, by the time the economy is in its final month of expansion, on average, the stock market is down by about 7 or 8% in real terms.

In other words, there’s some real wealth loss that has been suffered by the time the expansion is stalling out. And we would argue, well, that’s sort of the final straw that tips the economy into a recession. And although we were getting, again, the pre-recessionary readings on a lot of things in 2024, we argued, well, look, that may be the case that we’re growing at a dangerously slow rate, but the stock market is not sniffing out an economic expansion.

And the peak, sort of in terms of the wealth effect, that we saw was in October of last year. The stock market was up year over year, deducting about 3 percentage points of inflation. It was up 36% year over year.

In effect, inoculating the economy from sliding into recession because of the power of that wealth effect. Well, what’s happened now, just in the last couple months, is not only has this wealth effect stalled out, it’s actually been jammed into reverse. So we’ve had a negative wealth shock.

And it’s always been true that asset prices have played a role, not just in anticipating the direction of the economy, but they also play a role in the economic outcomes. And there’s a great line from George Soros that I’ve been sharing lately, because I think this dynamic is in play. But this was back in 2011.

Soros said, financial markets have a very safe way of predicting the future. They cause it. And I think that’s what’s happening here, is we’ve had this negative wealth shock.

We’ve taken, in the US, we’ve taken the stock market from a little over two times the size of the economy. It was 206% of GDP at the top just two months ago. It went down to 165% in a little over a month.

So that is one heck of, you know, it was an 18.9% correction in the S&P 500. But because the stock market peaked at such an enormous percentage of GDP, that 18.9% correction is far more destructive in terms of the wealth loss to US investors. As it often is, that wealth shock is the final thing that tips the economy into recession.

Yeah, I think that’s what this chart shows, the valuation decline on a PE basis. Okay, but if the Fed also recognizes this, I think people have been saying that the third unofficial mandate of the Federal Reserve is to watch for financial markets. Presumably they’re looking at what’s going on right now.

Yeah. And risk assets and wondering what to do next, right? Do you think they’ll respond then to financial asset moves like what we had? I think they probably will. You know, the issue is they’ve just done it so frequently and to such excess.

And let’s not just talk about dropping interest rates. You know, the Fed was complicit in the CARES Act, you know, which was $5 trillion of federal spending that was underwritten by really a like expansion in the Fed’s balance sheet. I mean, the COVID fiscal stimulus could not have happened without the Fed’s enabling of it.

And, you know, I’m not blaming them here, but I’m just arguing that the reason the bond market is starting to shutter now is because how excessive past bailout activity has been. And, you know, I don’t want to just single out COVID. I mean, they certainly prevented what could have been the second coming of the Great Depression.

I wouldn’t dispute that, but you really have to look at the entire 12 years preceding the COVID bailout. Remember, QE 1.0 was launched in late 2008. Well, the crisis was pretty well over by the end of 09.

You could even argue, well, if you look at the housing market, maybe there was still a crisis until 2011. But certainly from 2012 onward, there was no good argument to keep rates at zero and policy overall at emergency levels. And the fact that we did so for the rest of the decade, more or less, and then had an historic bailout on top of that in 2020, just leaves us in an incredibly tenable fiscal position so that if rates were to drop here, the bond market could revolt.

And we’re starting to see a little bit of that. A lot of people think this sell-off in bonds is because of the tariff policy. I really think it’s because of the lack of any meaningful spending cuts to have come about from the doge.

Yeah, let’s talk about this bond market revolt. So you’re saying it’s responding to a lack of fiscal discipline, at least what’s been promised. What does this look like? How does this bond market revolt play out, Doug? I just don’t know.

I mean, people have been worried about something like this happening for, I mean, certainly in the last 20 years. I mean, you could argue, from my understanding, I wasn’t, I was around, but I wasn’t focused on things at the time. 40 years ago, there was reluctance on the part of a lot of Republicans to implement the Reagan tax cuts, because they thought it would spike interest rates and crowd out private investment.

I mean, that was 40 years ago, when we were running a deficit of 3% of GDP. It went up under Reagan with all the defense spending from there on. But it does finally seem that we reached a tipping point to be running a 7% deficit as a percentage of GDP when you’re still around full employment.

Given the stock market boom we’ve had in the last couple years, I certainly would have expected that, and capital gains taxes are like, they’re a big swing factor. You know, the receipts should have been growing a lot more rapidly than they have been recently. So we at least should have seen that deficit get down to 5% on a temporary basis.

Is there any noticeable impact of the deficit on the markets? You could argue it has played a role, all of that deficit spending played a role in prolonging the expansion in 2023 and 2024. Yeah, that’s a lot of leading indicators. So why do we want the deficit closed? We want more, we as investors want more liquidity, right? We want more spending.

You know, looking at the expansion from the last couple of years, you could argue that, but it’s certainly come at a cost. I mean, if you look at, I mean, just the performance of gold, look at the S&P 500 versus gold. I mean, we’re very close to having gold and the S&P 500 up by like amounts from the absolute low of the COVID bottom on March 23rd of 2020.

I mean, that’s remarkable. It really says that a lot of this gain in asset prices has just been from the decline in the currency, right? Well, let’s talk about the decline in this currency. So the dollar has been going down, the DXY has been falling.

This is a statement from the Minneapolis Fed Governor Kashkari. He said that normally when you see big tariff increases, I would have expected the dollar to go up. The fact that dollar is going down at the same time, I think lends some credibility to the story of investor preferences shifting.

I think he was talking about people shifting away from the U.S. I keep seeing these dollar is coming to an end headlines all over the media, on social media. First of all, so let’s break it down into two parts. Why is the dollar collapsing? We’re not collapsing, I shouldn’t use that word.

Why is the dollar falling? And second, is it true what Kashkari is implying, which is that investors are pulling money out of the U.S.? The second part, it’s hard to see that in the flows and the numbers we get are a little bit delayed. I think the weakness in the dollar is simply the fact that investors are sniffing out that rates are going to have to be cut here despite the escalating deficit spending. That’s my best guess on the dollar’s weakness here.

Let’s just take a look at what the 10-year yield has been doing the last couple days. As you know, huge uptick when Trump announced reciprocal tariffs. However, it’s been stalling.

It went from $3.89, $3.9 all the way up to almost $4.5, and now we’re down to $4.3. What was this move pricing in, higher inflation or something else? I think it’s the fiscal situation. Last week, both Congress and the Senate rolled out their tax plans. They add about another 1.5% to the deficit on a 12-month basis, looking out five years.

Again, the bond market, I think, is looking at 7% and saying that’s not sustainable. Remember, under Besson’s plan, the goal is to get the deficit as a percentage of GDP down to 3%, which I do think would be sustainable. There’s just nothing coming out of Congress that suggests they’re taking that seriously.

Pass the allocation then for this year, given our macro outlook. What would you prefer? We’re pretty defensively. We’re not maximum defensive position, but David, the way that we move our asset allocation around is we run a quantitative long equity strategy that’s focused on quantitative industry group and thematic analysis.

That remains in place, and we don’t try to pick industries and themes based on what we think is going to happen to the economy in the near term. They tend to be longer-term secular plays. When we affect asset allocation changes, it’s via a hedging vehicle that we also manage in-house.

It’s a short-selling strategy, the Luthold-Grizzly Fund. We don’t actually buy that fund in our strategies, but we put on the same short positions. We are now at about 42% net equity exposure in our tactical asset allocation strategies, and we can shift between 30% and 70%.

It’s a very wide range. We’re closer to the minimum by far than to the max. Pretty defensive here.

We’re a multi-cap equity investor. I do think the broad list of equities in terms of valuations looks a heck of a lot more attractive than the S&P 500 does. In fact, our broad list, the Luthold 3000, which is what we form our industry groups with that universe, so a multi-cap universe, the median stock in that 3000 stock universe is borderline undervalued.

It’s in our initial undervaluation zone. At the same time, you still have the S&P 500 trading at 19 times forward earnings. In a typical recessionary bear market, you’d expect to see the S&P 500 bottom at maybe 14 times forward earnings.

That would take it down to a little bit below 4000. I don’t think that’s an unreasonable target for just a garden variety cyclical bear market. When I use the word cyclical, David, you asked about that earlier.

That’s just to distinguish it from a secular bear market. Secular being 1966 to 82, where stocks went nowhere for 16 years during the high inflation and interest rate era. Just something associated with the business cycle.

That’s why I would call it cyclical. One more chart here. This is interesting.

S&P cyclical over defensive total return ratio, and then here it says major recession warning. How is that a recession warning, Doug? This is part of just a simple two-factor model that we built about a year ago. The treasury yield curve had been an excellent recession warning when it inverts.

It had been 8 for 8 and calling economic downturns. The yield curve inverted two and a half years ago in November of 2022, and still no recession. What we said here is, the inverted yield curve is a sign of tight monetary policy, but its lead time is so long and variable that you need a more timely market signal to enact that recession.

To act on that recession warning is what I should say. This is what we came up with. It’s a ratio of the cyclical sectors in the S&P 500, consumer discretionary, industrials, and materials.

It’s a ratio of those three to healthcare, utilities, and consumer staples, which are classic places to which you want to run during a recession if you need to stay fully invested. When that thing breaks to a 52-week low after an inverted yield curve, that’s a recession signal. This is a volatile chart.

You’ll get those 52-week highs and lows in this ratio all the time. It only matters after you’ve had the requisite monetary tightening. We’ve had that, and we got the signal.

Perfect. Doug, where can we learn more from you and follow your work? TheLutholGroup.com. We sell our research to institutional investors and manage primarily tactical asset allocation strategies. We do have a long equity strategy.

As I mentioned, The Luthol Grizzly Fund is what we use to hedge in our own tactical strategies. There are certainly managers that run high beta equity strategies that like that grizzly just as a permanent, small portfolio hedge. We’ll put the link down below.

Make sure to follow The Luthol Group there. Thank you very much, Doug. We’ll speak again next time.

Appreciate your time. Great to join you. Thanks a lot, David.

Thank you for watching. Don’t forget to like and subscribe.