A Big Market Bull Just Turned Cautious | Ed Yardeni

Thoughtful Money with Adam Taggart

Wall Street strategist Ed Yardeni discusses his recent shift from an aggressive bullish stance to a more cautious outlook for the S&P 500's

Key takeaways

• Ed Yardeni has moved his S&P 500 year-end target from the end of this year to mid-next year due to intensifying short-term issues.
• The unwinding of the yen carry trade, triggered by Bank of Japan rate hikes, is a significant driver behind rising global bond yields.
• Yardenist views 4% to 5% bond yields as the 'new normal' following the era of zero interest rates.
• The 'G-shaped economy' describes a landscape where seniors with high net worth drive consumption while younger generations face affordability crises.
• AI capital expenditure is acting as a massive, ongoing stimulus program for the broader economy through heavy borrowing and infrastructure build-out.

Main topics

• S&P 500 Market Forecasts
• Bank of Japan and Yen Carry Trade
• AI and Technological Revolution

Notable quotes

We're moving the 8400 for the S & P 500 at the end of this year into the middle of next year.

Conclusion

The episode provides a nuanced view of market volatility, suggesting t

Transcript preview

Speaker 2 (0:00) We're moving the 8400 for the S &P 500 at the end of this year into the middle of next year. Just think it's going to take us a bit longer here. There are kind of more short-term issues that have been out there that are just becoming a little bit more intense that lead me to be somewhat more cautious. Speaker 1 (0:28) Welcome to Thoughtful Money. I'm Thoughtful Money founder and your host, Adam Taggart. Welcome you here for a discussion with Ed Yardeni. Ed is known as being one of the more bullish guys on Wall Street. He is starting to, and forgive me for using this terminology, Ed, but slow his roll a little bit. Some of your recent writings have suggested, not that you're becoming bearish, but that you're becoming maybe just a little bit less bullish. And I believe you have walked down a little bit. your end of year target for the S &P. So if all that is true, I'd love to hear the reasons why. Speaker 2 (1:03) Yeah, it's all true. The way I would frame it is we're moving the 8,400 for the S &P 500 at the end of this year into the middle of next year. Just think it's going to take us a bit longer here. There are kind of more short-term issues that have been out there that are just becoming a little bit more intense. that lead me to be somewhat more cautious and think that while the market will continue to be driven by what I call FIMO, fabulous earnings momentum, that FOMO, namely the PE, might shrink a little bit more, which is what's been going on all year. We've had tremendous growth in earnings, and yet the valuation multiple has actually declined. We'd be a lot higher if it wasn't for that. But what that shows is that analysts remain very optimistic, exuberant about earnings, but investors, not so much. They say, well, those are great numbers, but they're unbelievably strong. And we don't know that we want to pay what we had been paying in multiples. So that's where we've been at. And I think on the near term basis. My main concern has been the geopolitical front. We've seen the re-escalation of the war in the Middle East. I think we're going to be in this for a while, and I think that'll continue to create problems in the oil market. So I'm looking at higher for longer oil prices as a result of that. And that in turn means that inflationary pressures from the oil market will have more time to seep into the inflation rate, excluding energy. You know, like diesel prices as energy, but that gets into transportation costs and gets into agricultural costs and so on. That's the way it is working in woodwork. And that in turn has caused the Fed to go... and into a tightening cycle. I think everybody has concluded it's not going to be one and done, but there could be two more rate hikes this year. And then last but not least, the Bank of Japan has been the focus of our work. You know, Japan... had these amazingly abnormal interest rates, zero negative interest rates for many, many years. Hedges, hedge funds played the yen carry trade game. They went and borrowed in Japan, converted the yens into other currencies, and then bought bonds and other kind of assets all around the world. Great trade. But it really requires that the Japanese rates stay near zero, which they're not. The Bank of Japan has already raised rates to 1 % in terms of their official rate. And they're on the verge, as we're speaking. Speaker 2 (4:11) they will be raising the rate by at least a quarter point. The yen also needs to be weak for the yen carry trade to be working. And it looks as though the yen may be actually bottoming out. I would say that one of the best explanations for why bond yields have gone up around the world in the past couple of years is because the yen carry trade has been unwinding as the Bank of Japan has been moving towards raising rates. and as the yen has basically, in a volatile fashion, formed a bottom. Speaker 1 (4:46) All right. Ed, that was just a fantastic kickoff to this. You answered most of the questions that I had for you, so this may not be that long. It's been Speaker 2 (4:56) fun. Thanks very much. Speaker 1 (4:57) It may be a very quick interview here. But I actually would love to dive into a number of these, if that's okay with you. Speaker 2 (5:03) Yeah, yeah. Speaker 1 (5:04) And again, just want to, at a very high level, say you're not expressing a truckload of worry or concerns, you still feel like we're in the roaring 2020s. All you're doing is just shifting what was a fairly aggressive target for the end of the year just to the middle of next year. Speaker 2 (5:25) Yeah, that's all. Speaker 1 (5:26) Okay. All right. So when you talked about your main concerns being geopolitical, which largely leads you to a conclusion that we'll have higher for longer oil prices. maybe higher for longer inflationary pressures. The Fed continued to hike more from here. I presume you also lump higher for longer bond yields into that discussion, correct? Speaker 2 (5:54) Yes. I have not been totally freaking out over the bond deal the way others have been. To me, 4 % to 5 % is the old normal range. That's where we were before the... great financial crisis through the great virus crisis when the Fed and other central banks rigged their bond markets and tried to keep interest rates as close to zero as possible. Well, that abnormal period is over. Bonds around the world have been freer to express an opinion, if you will. My friends, the bond vigilantes is another way to express it. And I've been thinking 45 % is where we'll be for a while. Now we're right smack dab on top of that 5 % level. And the suspense is killing me. You know, I hope 5 % holds, but it certainly might not, especially if we find that if the Bank of Japan continues. to tighten, that that continues to create upward pressure on bond yields around the world, including here. I will say that the U.S. economy is less interest rate sensitive than it was in the past. I mean, housing still is interest rate sensitive and autos are, but they're not as big in the economy anymore. And the consumers, many consumers are retiring. The baby boomers, about a third. of households are in america are headed by somebody now 65 years or and older there's a lot of seniors a lot of baby boomers that they're increasingly retiring and uh you know they they couldn't care less what's going on in the labor market they're they're retired uh and uh and that those five Speaker 1 (7:37) percent interest rates are wonderful if they own bonds right Speaker 2 (7:41) yes yeah as a matter of fact uh you know for my experience as a investment strategist talking to uh portfolio managers who manage money for rich people, a lot of these people are very nervous. They made a lot of money in the stock market and they're very worried about things like the deficit and geopolitics. And they keep telling the wealth managers, you know what, maybe we should, you know, raise some money here. And so I said, well, what are they really worried about? I said, they're most worried about the government deficit being out of control. So I said, all right, so what do they want you to do? I'm talking now to the portfolio managers. Speaker 1 (8:16) So Speaker 2 (8:16) what do they want you to do if you sell their equities? they say they want to put the money in 10-year treasuries. So I said, how does that make any sense? Here they're worrying about the deficit. And on the other hand, you know, when they get spooked and scared, they want to be in 10-year treasuries. So there's a lot of those kind of interesting developments out there in conversations I have with people. But yeah, I think the baby boomers are going to remain resilient. A lot of them figure, you know, why help the kids when we're dead with an inheritance? Why not help them now? So I think there's a lot of that going on. In other words, I don't really believe in the K economy. The rich are getting richer, the poor are getting poorer. I believe in the G-shaped economy, which is the young people have an affordability crisis. Seniors don't have an affordability crisis. And they're helping their kids. And so I think that's why the consumer is resilient. And then capital spending, as we know, has been on a tear. And I'm not quite sure what level of bond yields it would take to shut off the AI boom. It looks as though these companies are just committed to borrowing money in the bond market and building data centers. Speaker 1 (9:34) Okay. Great points and lots to dig into there. So first off, it's fair to say, is it fair to say you thought that historically 4 % to 5 % was the old normal for bond yields? And is it fair to say that you now think the old normal is now the new normal again? Speaker 2 (9:53) I'm still counting on 4 % to 5 % to hang in there. I think 5 % is a very attractive yield. And we saw that happen in 2023. We went from 4 % to 5 % in three months, and it's 5%. There's no shortage of buyers that brought the yield right back down. Speaker 1 (10:10) Okay. Now, you actually think that what's been driving bond yields, at least a very important driver of higher bond yields, has been the... breakdown in the carry trade or at least the weakening of the carry trade? Speaker 2 (10:23) It's a theory. I mean, it's really hard to, I don't have really data. I can't put it in the chart, but I do see a coincidence with the Bank of Japan raising rates and their bond yield just absolutely soaring and the spread of kind of that. the tightening of financial conditions in their bottom market spreading to the rest of the world because of this carry trade idea. Speaker 1 (10:51) Okay. Let me just ask you about the carry trade. So let's assume the yen is bottoming. It does strengthen. Let's say the carry trade goes away. How seismic would that be? Have we already felt the majority of what we're going to feel? What's your sense of if it went away, how important that would be? Speaker 2 (11:12) Well, my sense is that some of it, maybe a significant part of it, has already gone away. I mean, hedge funds are not, you know, are not clueless. They know what they're doing and they know what kind of risk they have. They know that the short-term borrowing rate in Japan has gone up for about two years now. So that shouldn't be a surprise. But it still has been... very low compared to borrowing rates elsewhere and it's been very low relative to the yield you can get in bonds in other parts parts of the world what's changed is the bonds Japanese investors now can get a pretty decent bond yield over in Japan because their yields have gone up so much. Look, Adam, I'll put it to you this way. It's one of the reasons that I'm somewhat more cautious about the short term because the honest answer is I don't know, but we're probably about to find out. And we'll see how the bond markets react if the perception is that the Bank of Japan is committed to raising rates. And by the way, Treasury Secretary Scott Besant has been leaning on the Japanese to raise their rates because he's concerned that he wants to see the yen firm. And otherwise, if the yen gets weak, he's concerned that the Japanese will have to intervene in the yen market by selling U.S. treasuries. Speaker 1 (12:34) But Speaker 2 (12:35) the solution he's proposing doesn't necessarily make this problem go away because... If they convince everybody that they are tightening and that they intend to support the yen, then you could see U.S. bond yields and other bond yields go up because of the further unwinding of the carry trade. Speaker 2 (13:01) So I think we just have to kind of watch how the bond markets around the world trade relative to what the Bank of Japan is doing now and will be doing over the next few weeks. Speaker 1 (13:14) Okay. You made a comment that the U.S. economy isn't as interest rate sensitive as it was in previous decades, we'll say. Speaker 1 (13:24) Square that conclusion for me with the fact that we just have a tremendous amount more debt than we did back then. And we're still doing a ton of deficit spending. Speaker 2 (13:38) That's a very good question. I guess I was kind of referring to the old business cycle model where monetary policy raised interest rates, lowered interest rates would have a pretty significant impact on the overall economy. uh now if you raise interest rates you don't seem to really clobber consumer spending um uh in any significant way they keep spending uh capital spending looks like it's uh also gonna hold up but you make a an excellent point and that is uh what about the compounding of the interest cost uh of the debt we're up over a trillion dollars we're spending more on a 12-month basis we're spending more on interest expense than on uh Speaker 2 (14:22) defense and it creates another you know it's you know another issue on what I call my worry list Adam as you know I tend to be an optimist but to kind of discipline myself we've taken to updating on a monthly basis a worry list just so you know we keep ourselves focused on what could go wrong and I think we are getting to the point where the bond market is starting to care about the compounding effect of interest costs on the debt, because a lot of debt is going to be refinanced and it's going to be refinanced now at higher rates. And the question is, when will the bond market care? Another way to put it, I've been doing this for, what, 45 years. And on my shelves back there, I've got books from the 80s. called Living Beyond Our Means, the debt bomb. And so I've gotten a little bit jaded about the imminent debt crisis, quite honestly. It's not a good thing to get. It's not good to be jaded in this business because you got to stay nimble on the top of it. But I'll admit to you, it's, you know, this debt crisis has been a long time. long time and some pretty smart people over the past couple of years like Jamie Dimon and Ray Dalio has basically said it's kind of imminent that we're going to have a debt crisis. And, you know, I keep