Follow the equity risk premium

 

There should be an equity risk premium over bonds. Equity is riskier than bonds, yet the current market does not suggest this. The bond market has disconnected from equities. One can always say that bondholders are pessimists relative to equity optimists, yet there is more going on than just behavior. 

Bonds are pricing stagflation, while equities, through cap-weighted indices, are pricing an AI productivity revolution. Perhaps both can be right, but that does not bode well for holding equity in traditional companies. 

The politics of the Fed run through Congress

 

This is an interesting chart on the politics of the Fed. Clearly, Powell is a political animal. There is nothing wrong with being political. It is important to maintain good communication with politicians to ensure they understand the Fed's role and mission. One of the key Fed battles has always been the level of oversight from Congress. (I was involved in that fight in the 1980's when consulting for the GAO on primary dealer oversight. Getting data from the Fed was an ordeal.)

Powell needs to limit interference from the executive branch and ensure there is limited oversight from Congress. Independence takes work. 

So bonds are not the solution?

The chart from Nicolas Rabener of Finominal compares the drawdown from bonds versus managed futures. If you ask most investors, they would say that a managed futures fund is riskier, yet when you look at the long history of bonds, it does not look attractive. There can be drawdowns for decades. It is unlikely the 10-year will get out of this drawdown in time in the near future. Of course, it is critical to think about upside and what a bond drawdown means. 

Edmund Phelps - more than a macroeconomist

Edmund Phelps died this week. Unfortunately, many may not remember his path-breaking work in macroeconomics, which opened the door to neo-Keynesian models. His most important macro work examined the inflation-growth trade-off through the lens of inflation expectations and addressed the natural rate of employment. First, if inflation expectations rose, there would be a corresponding impact on wages, leading to a wage-price spiral. Second, if central banks attempt to maintian emeplyent above the natural rate (the equilibrium rate) there will be a surge in inflaiton. 

While he was viewed early on as an important macroeconomist, he provided significant insights into innovation and creativity as drivers of economic dynamism. Few economists have had many important pieces of research across fields. 

He could not be placed in any school of thinking and should be viewed as one of the few truly independent thinkers on a range of topics.