PETER BOOCKVAR: 10 out of last 13 rate hikes cycle since World War II put us into recession. So, it pays to flatten the curve when the Fed is raising interest rates. And it worked.
DANIEL ALPERT: What we are confronting here is the same thing we've been confronting for years now, which is a global environment in which there's an enormous exportation exporting of disinflation.
PETER BOOCKVAR: If Europe grows 2%, that's a victory. Japan was a perfect example of how not to run monetary policy over 30 years, and Draghi decided to do the same exact thing. And Bernanke and Yellen by keeping rates at zero for seven years, decided to do the same thing. I'd argue over the next 10 years, emerging Asian markets are going to do better than US markets.
ED HARRISON: Dan, you agree with you that?
DANIEL ALPERT: Totally.
ED HARRISON: I'm Ed Harrison for Real Vision. And I'm sitting here, about to have a conversation with Peter Boockvar of Bleakley Advisors and Dan Alpert, who is at Westwood Capital. And we're going to be talking about the global economy, especially in the wake of the pivot that the Fed has done. Not just a pivot, but a whole 180-degree turn. And we were talking about this a little bit before. The preconditions for the Fed's pivot was that the United States was outperforming both on an economic basis and also throughout on a market basis. The equity market in the United States is outperforming the rest of the world.
The real question is A, why did the Fed make the pivot that it did? And B, given that the pivot actually happened, is that outperformance going to last? Let me turn it over to you. Why don't you start with that? And you guys talk amongst each other? To tell us what's going to happen here?
PETER BOOCKVAR: Well, we determined that the strike price of the Powell put was down 20%. So, that scared him when he saw the market reaction, because it came on top of worries about the US and China trade deal going awry. It was also that the Saturday before New Year's, when everyone's on vacation, not just here, but everywhere, Trump tweets the negotiations with China going really well. Of course, there was no discussions there. But he also saw the stock market falling. He panicked, particularly on the fall on Christmas Eve, and pulled back that worry, combined with Powell in early January pulling it back, because we can debate whether he made a mistake and he make a mistake. The Fed funds rate is still only two and a quarter, two and a half. So, it's not like we have this really tight money.
Now, relative to the context of the debt that we have and the yield curve and relative to interest rates around the world. Well, yeah, we can be considered tight, but it's a sad state when two and a quarter two and a half in Fed funds rate is considered tight.
DANIEL ALPERT: Yeah, I think that the dynamics of what was going on in the capital markets is very clear. I'm looking at it more from the debt capital market side than from the equity capital markets. But as a practical matter, we've gone through a period of time where the Fed was trying to move the policy rate up consistently. It thought that it would get some movement in the long end of the curve, it did not. The curve flattened out. Obviously, a lot of people took that as a potential portent of a future recession. But nevertheless, regardless of whether that's true or not, the action that they were trying to achieve was to damp down some of the assets bubble that's happened, including in the equity market, but certainly in real estate and other areas.
And so, they didn't achieve that, in fact, what they achieved is slowing of the economy. And at that point, the Fed took a look at it. And also, I think, quite frankly, reflected back on what they were trying to protect against. If you don't have significant price bubbles in price inflation, you don't have significant wage inflation. And all you really have is asset inflation, what they were doing, the exercise that they were trying to go through, really was not likely to be successful with that rise in the long end. So, they reversed course as the environment change and it became more risky for them to continue with tighter money.
PETER BOOCKVAR: And also, the Fed was double tightening with the balance sheet and the Fed funds rate. So, it wasn't your ordinary tightening cycle. And I don't think that they appreciated the impact of the shrinking of the balance sheet, which they should have, considering that enlarging the balance sheet was meant to raise asset prices, they try to sneak in the back door that shrinkage of the balance sheet by calling it watching paint dry. And then all of a sudden, you reached a pressure point when the tightening reached a point where they had to say, okay, let's stop one, we'll continue the other but scale that back as well.
DANIEL ALPERT: Yeah, I'm not sure that- the problem is, is that the long end really didn't respond, right? You would think that if they were shrinking the balance sheet and they had built up quite a bit of longer duration paper, admittedly, that had shrunk down because time has passed. But you would have thought that the long end would have been more responsive in that type of environment, it really wasn't. And the reason is, is that we still have globally, a shortage of sovereign debt relative to the demand for it. I'm talking about high quality sovereign debt, countries that are borrowing their own currency. And so, you have global interest rates that are very low.
The only thing I would argue that was pushing up US interest rates was policy rate action itself. And you look at the delta between US interest rates on a real basis relative to the real interest rate elsewhere, our debt is cheap. And the only thing that was creating that situation was a belief that the policy route would continue to move up. Now, we're on a cuspy situation, we don't really actually have a consensus as to where the policy rate is going forward. There's an acknowledgement that it's not going up anymore. But there are those of us, including myself, who believe that probably around September, we're going to see a policy rate cut. And that's going to change the dynamic all across the board.
ED HARRISON: Are you buying that view? Do you think that we're going to see a policy rate cut this year?
PETER BOOCKVAR: I do. But I also think the long end, it was a reverse when the Fed initiated QE. Look, they did that to suppress long-term interest rates, but long-term interest rates went up when they did it because people thought they're inflating. So, historically, when the Fed raise interest rates-
DANIEL ALPERT: But that was just a very short time than it turn out-
PETER BOOCKVAR: Well, rates went up after QE1. Rates went up after QE2, when the Fed starts a rate hike cycle, because their track record with achieving a soft landing is so poor, it pays to flatten the curve. So, when they were double barreling in terms of their tightening, it pays to flatten the curve, because people know where this typically ends up. 10 out of last 13 rate hikes cycle since World War II put us into recession. So, it pays to flatten the curve when the Fed is raising interest rates. And it worked, because look, we saw the economic slowdown. And we're seeing a pull that lot more likely to have a two-handle the share in GDP than a three like we did last year. And it can get worse if this trade deal gets out of control, which lead eventually to that rate hike. I'm sorry, that rate cut.
ED HARRISON: Well, just backing up for a second, let me ask both of you, because you both mentioned asset prices, asset prices in America, especially in the equity side, they've gone way up. The US has outperformed. What's the cost of that outperformance? Everyone's been easy. And arguably, the Fed has been tighter than the rest. So, where's the outperformance coming from? Where had it come from? That's the question.
PETER BOOCKVAR: Well, if you compare the US markets versus Europe, we have a bigger concentration of technology. And that's been the leader of this bull market. So, if you don't have a big constituency of tech stocks in your industry, well, you're going to underperform. And that's why I think the US market has been so extraordinary because of obviously all the Fang stocks and you throwing semis and software and all this and that up until obviously recently, but that is what separates our market from others.
But you look at China's market, least the H shares with Tencent and Baidu and Alibaba, they've been able to at least that particular index, not the Shanghai Composite, was able to keep up a little bit. But that's why we've left Europe in the dust because they don't have those technology contributions that we have.
DANIEL ALPERT: I'll beg to differ from one respect, we have a rallying secondary market, right? People are moving into our trading and in the shares of companies that are not doing a lot in the form of capital investment. And so, they're not really growing the economy on the ground. What's happening, in my view, is that you don't have a good base of earning capability in the fixed income market. And so, therefore, people are looking for returns elsewhere. And that's always the case, return of investment is always driving equity rallies.
And so, you have people going in trading amongst themselves and shares and bidding the price up as a result. It doesn't really indicate what's going on on the ground. You even look at the increase in capital investment, as a result of the Tax Act of the end of 2017. That capital investment, first of all, was very short- lived, it's over now. And it was all pretty much in two sectors, it was in intellectual property and computer equipment, basically. People took advantage of the rapid depreciation or the expensing of equipment to be able to upgrade whatever they were looking to upgrade.
This was not plants and equipment, this is not job creating stuff. So, you have an environment in which the things that would normally give you good investment returns, both in the fixed income and in equity are rather lackluster. They're just not happening. What is happening is there's a lot of excess cash lying around that's looking to make money. And of course, momentum is king at that point. And that's what really drives up markets. That and the fact that you can borrow cheap.
And we look at fixed assets, real estate and things like that, it becomes a huge driver. If you look at what was going on when the Fed tried to start to push the curve up, right, real estate went into a stall, the housing sector went into an absolute stall and that was frightening the hell out of the Fed.
ED HARRISON: So, going forward, you guys, it sounds like you're on the same page and where things are headed. Tell me where are they headed now that the Fed has made the pivot? We know why the Fed made the pivot. They were scared. But what's going to happen as a result of that pivot to the US economy, and how does the US do relative to the rest of the world?
PETER BOOCKVAR: Well, as a few weekends ago, the Fed is now background noise. And it's only about obviously a trade deal with China or not. Because the US- well, the global economy. If you look at the global PMIs, which are basically hovering around flatline on the manufacturing side, you see the trajectory of growth, you see this collapse in global sovereign bond yields with of course, the Spanish tenure the other day, closing at an all- time record low. And that's telling you that the global economy is slowing. You see it in all the statistics and the day, this airing, of the taping, South Korea reported for the first 20 days of May almost 12% decline in exports driven by a decline in exports of China and also semiconductors.
So, we are at a like brass knuckles point with this trade deal. And it is either going to push us into a global recession, I believe, or we can at least pull back and catch a breath. So, the Fed, they're just going to be reactive at this point. And their reaction function will be okay, let's cut rates. That's what every central bank's reaction function is. I think we're at the point now, and this will separate this economic downturn from previous ones is central banks are not going to be able to save us. That there's not going to be any incremental economic activity that's going to happen if they lower interest rates, because the cost of money is not a binding constraint really on anything.
The Reserve Bank of Australia is basically telling their markets they'll likely cut rates in a couple weeks. Well, their rate is already at a record low 1.5%. Do they really think by cutting to one 1.25%, they're going to be able to tweak the inflation rate to such an extent and lead to a pickup in growth when what their economy is suffering is actually a housing bubble that is now unwinding and consumer debt levels that are way too high? It's a sense of hubris. But then we're going to try, and I think will, we're going to reach a point where there's going to be monetary impotence, we're not going to respond to that so-called medicine. And I'll take it one step further, I argue that monetary policy in Japan, and in Europe is actually restrictive, because they're damaging the profitability of their banking system via negative interest rates and zero yield curve.
So, if you kill the banks, well, how are you going to get growth? So, we have to be careful with our words of a common data versus tight. Because again, I argue that the Bank of Japan and the ECB are actually tight.
ED HARRISON: Interesting.
DANIEL ALPERT: Yeah. That's an interesting view. Look, I think, to a certain extent, the trade negotiations and the tariff concerns are an overblown sideshow. What we are confronting here is the same thing we've been confronting for years now, which is a global environment in which there's an enormous exportation, exporting of disinflation from the developing emerging world to into the advanced nations. That disinflation was something that seemed to have subsided for a period of time a couple of years ago, suddenly, we were coming to the other end of the Fed's famous transience, right? But the transience now seems to have resumed. And I put those in scare quotes, because it was in transient, and it was on quoting.
This is a persistent phenomenon. It's going to continue for the really for the foreseeable future. We have massive oversupply in terms of a huge excess population that is producing goods, dedicating their labor. That is associated with the post socialist countries that emerged beginning of the 1990s. And those countries are going to continue to export deflation effectively abroad. That is going to be offset in places like the United States by those things that are not in the tradable sector, right?
And clearly, the biggest one is housing. And if you look at inflation during 2018 and during 2017, almost all of it. Never before in history, have we seen a sustained period, where 80% to 85% of inflation, when you actually break it all down, is from rent of primary residence and owners' equivalent rent on primary residence, those two categories. And that's all the inflation we really had. You take that out of the story of inflation in the United States, it's less than half a percent.
And so, when you when you look at the world that way, and you say, well, gee, if there's this massive excess of production capacity of labor, relative to aggregate demand, how are we going to bridge that gap? Right? And what are we going to do while we wait for that gap to be bridged? That's really the question going forward. We've tried everything else. And unfortunately, we're still right back in that same situation.
ED HARRISON: So, what's going to happen to inflation over this coming year, and what impact is it going to have in terms of the trajectory of the United States?
PETER BOOCKVAR: Well, I'm sure we'll continue to see this good deflation, but we'll have to see with the tariffs. Goldman Sachs had an interesting chart out a few weeks ago, where they isolated the goods impact from tariffs. And so, the sectors that are directly impacted by the tariffs, and those prices went up, and prices of everything not impacted went down. So, if you throw in the 10% to 25%, on the 200 billion, and then you add in another 300 billion plus, well, you're going to start to see goods inflation. Now, whether that can be offset by the Chinese absorbing it, or companies absorbing it or not filtering through to the consumer. Either way, it's a tax, and there's going to be inflation in the system where someone's going to eat it, whether it's via profit margin, or it's the consumer paying more at a toy store or whatever it is. So, I know there's a debate whether tariffs are deflationary or inflationary, but it is inflationary. It just depends on where in the product cycle it gets eaten.
ED HARRISON: Let me pivot on based on that, because the one missing link in everything that we've been talking about, since the beginning of this is Europe. Because when we talk about the rest of the world, whether the US is outperforming or not, really from an investor perspective, you're thinking Europe. Because nothing that either of you've said sounds positive in terms of the impact that it's going to have on Europe. Where is Europe going to be given these forces that are bearing down on us?
DANIEL ALPERT: If you don't mind, Europe is a very, very strange case right now, right? Because we tend to treat Europe as Europe, right?
ED HARRISON: Right, as a monolith.
DANIEL ALPERT: As a monolith. And we then tend to treat the eurozone as one statistical reporting entity, right? The problem is, is that it's really not, right? It's a bunch of countries agglomerated together, sharing a common currency, and giving up all of their sovereign right to devalue their mode of exchange. So, you look at what's going on in Italy right now. I would say, 50-50, they're going to have a leader at some point. If Italy undergoes additional strain, they're going to have to leave the zone. But regardless of whether or not that happens, there's one country in Europe that is different from all the rest. It's one of these things that's not like the other, it's Germany, right?
So, Germany has tied itself to a currency that benefits it.