The weakening of the dollar leads to a grim 2030’s

Barry Bannister, Stifel head of institutional equity strategy, joins Yahoo Finance to discuss outlooks for the S&P 500 and the potential impacts of reflation.

Video Transcript

MYLES UDLAND: All right, let's stay on the markets here, talk a bit about everything that's been happening, and we'll use a nice big word-- convexity. Barry Bannister joins us now. He's Stifel's Head of Institutional Equity Strategy.

Barry, really appreciate you joining the show today. Love that note right at the top of your latest deck that you sent over, the convexity problem that we have for some of the major growth stocks. Walk us through the thinking there for-- for maybe more of a lay audience and how you're thinking about the setup here, I guess, for markets broadly.

BARRY BANNISTER: Well, yeah, I mean, convexity is-- is difficult to explain. But just in simple terms, there's not a linear relationship between the price-to-earnings ratio of the stock market, any index, and the real yield, the yield on the 10-year Treasury minus inflation. So what are you getting for a 10-year yield on the Treasury above the inflation rate or below it?

Now as you recall, Fed Chairman Powell pivoted on-- around the 1st of January, 2019. And he had been very tight in the fourth quarter of 2018. We had a nearly 20% drop in the fourth quarter of '18. The Fed went too far. President Trump was right at the time. The Fed was-- called it the "loco" Fed.

The Fed was too tight, and we showed it quantitatively a number of ways that-- and the Fed noticed it, and they saw the research. And they did pivot. They-- after a 20% drop in the market in the fourth quarter of '18, December was the worst month since 1932 for December, the Fed pivoted. And the real yield, the yield after inflation of the 10-year, went from plus 1.1 then to minus 1.1 a couple of years later.

And when it did that, imagine that There Is No Alternative, TINA. You have no alternative to buy stocks when your real risk-free return after inflation from bonds is minus 1. So what happened is the price-to-earnings ratio shot up. The relationship between the real yield and the price-to-earnings is not a straight line. It's not a diagonal line. It's a curved line, meaning at very low real yields, the PE goes parabolic, goes straight up. And that's what happened.

A lot of these growth stocks companies with no earnings or very little earnings, they went to very high multiples of earnings. And as soon as the real yield started to rise again on stronger economic activity from all the successive fiscal that we're doing, fiscal policy, spending, government spending, as soon as that real yield started to rise, the price-to-earnings multiple fell down that curve. It's like falling down the steep part of a slide, and the price-to-earnings multiple for the growth stocks fell. And that was our call, and it worked. We have preferred value stocks on the reopening trade and on the excessive fiscal stimulus trade, because we're going to see a pretty big surge in activity as soon as that multi-trillion dollar package is spent.

BRIAN SOZZI: Barry, what are the best stocks to own ahead of that $1.9 trillion stimulus plan?

BARRY BANNISTER: Well, value stocks, which are overweighted in financials, expecting a yield curve steepening, which is to say that the longer-term yields, let's say 10, 15, 20-year yields, are way above short-term yields. That would be Treasury bills, one year, three year, and so on. The Fed is on hold at the short end of the yield curve, meaning they're going to keep short rates down for a while. And as the activity picks up, inflation expectations, real growth potential which is reflected in that real yield after inflation, the curve will steepen, and that's good for financials, you know, the large banks and the small banks, depending on who has the most leverage to the curve, and cost of funds, and net interest margins.

The other is energy. Over time when the rest of the world gets in gear and the Fed is liquefying the world, and the US Treasury is liquefying the world, and US demand helps the world that over time, I would expect the energy to boost as the dollar falls. It's not a bad dollar fall, in a sense, it's just a sign that the rest of the world's recovering.

And the third is industrials and basic materials, miners as well as industrials, like my old coverage. I covered Caterpillar and Deere. I covered engineering companies for about 25 years. You know, they-- they've gotten a really big lift. And that's because global economic activity, particularly on the construction and infrastructure side and energy side, should pick up.

JULIE HYMAN: And they may continue to get a lift from infrastructure. But I want to fast-forward a little bit, Barry, because something that you wrote to us, or that you sent to us in your note, really stood out to me, strong language here, "the utter obliteration of US living standards by the late 2020s and well into the 2030s." And you're talking about reflationary, monetary, and fiscal policy.

That's a strong statement, I would say. What gets us to that point? And-- and one would think the Fed is going to raise before then. Is it going to be too late to stem that kind of a tide?

BARRY BANNISTER: Yeah, look, I mean, the biggest gains you're going to make in the market are off the lows, right. If I buy a stock at $1 and take it to $10, I get a 10-fold return. If I buy something with momentum at $5 and take it to $10, I got a lousy double, right. So I'd rather make 10-fold than a double.

So the best investors tend to be unemotional. And I'm not emotional about this. This is not an agenda. But you know, as the US tilts towards ever bigger government and more dependency on government and bigger debt what you find historically is that we get less nominal GDP, that's real plus inflation, less GDP for every dollar of debt added to the economy.

We used to get-- 50 years ago, Kennedy administration, early Johnson, we used to get almost a dollar of GDP for a dollar of debt. Now we get about $0.30 of GDP for a dollar of debt. So as government becomes bigger and we spend these incredible deficits, we're essentially doing backdoor universal basic income and financing it through the front door with something called MMT, or Modern Monetary Theory, which is just the monetization directly of deficits by the Fed. The Fed buys the debt. The debt is stored on the Fed's balance sheet.

Paying people not to work and to be dependent is not going to grow the economy. And so the ever larger, now 25% of GDP in 12 months, stimulus is going to generate less long-term growth. It's going to weaken the dollar, which will weaken American living standards. A weak currency never increased national wealth. Look at Zimbabwe and Venezuela.

So as you look at the future, the direction is actually quite concerning. And as a consequence of that, we will see rising costs, a falling dollar, weaker living standards, and it will end not now-- it takes 15 years, like it did in the mid-60s to the late '70s or other decades in the past, not now-- but we will end with high inflation, diminished living standards, and stagflation. So the 2030s are looking very bad to me right now.

The 2020s are a transition to that, much like the late 1960s, guns and butter, we fought the Cold War then, the Vietnam War. Now we're fighting a war on a virus with war-level spending, and we've got the war on the climate change thing. These are excuses for much bigger government roles. And I think it will obliterate US living standards over time. You can hedge that in the stock market by buying these inflation/value trades, and that's where we're overweight.

MYLES UDLAND: Barry, do you think some of these trends you're talking about is what's inspiring people to think about things like cryptocurrencies?

BARRY BANNISTER: Well, you know, I've never been a huge fan of the ESG movement. I mean, I just think our job as investors is to make money for people so that they can hit their financial retirement goals, because nothing stinks more than retiring and not having any money. But when you look at ESG, I mean, they don't like power consumption. If you look at crypto, they-- they consume an enormous amount of power.

Right now Bitcoin is using more power than the entire country of Pakistan just to produce additional coins. Eventually, and not very long off, we'll be using more power than the nation of Japan. So when you look at the coal-fired power-- more than 2/3 of crypto Bitcoin comes out of China. They use coal-fired power for almost 3/4 of their power grid. They're burning a lot of coal to create bitcoins, and I don't know how that ever fits into a ESG model.

So I'm not overly fond of Bitcoin and crypto, but I understand where they're coming from. It's a rebellion against this Fiat money that government wants to create in infinite amounts and store on the Federal Reserve balance sheet in this sort of populist environment that we're in where they're trying to make everybody rich, but the value of money depends on its scarcity. If money is not scarce, it has no value. And as the dollar falls, living standards fall. So there's some very bad policies going on, and we can monetize those. We can make some money off of those, and that's the direction we're heading.

MYLES UDLAND: All right, Barry Bannister, Head of Institutional Equity Strategy at Stifel. Barry, really appreciate you taking some time to talk with us this morning. I know we'll talk soon.

BARRY BANNISTER: Take care.