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Today’s Points:

• The S&P 500 set an all-time high, again.
• Gold also set an all-time high, again — people want inflation hedges. 
• The Fed’s minutes suggest the doves have the upper hand.
• Lisa Cook looks like she’s keeping her job (and the Fed’s keeping its independence).
• AND: It’s Kool to celebrate.

The Links in an Age of Extremes

The US stock market closed Wednesday at an all-time high. Gold has also never been more expensive, and for the first time costs more than $4,000 per ounce. Meanwhile, both the excitement and the apprehension over the vast sums companies are investing in artificial intelligence intensifies; those big investments seem ever more circular, as the AI giants pour money into each other.

These things are related. Beyond their causal links, they also help explain each other. The rally in gold — which gains when people are pessimistic — casts a different light on stocks, the choice of optimists. Denominate US stocks in gold rather than the dollar, and they have been in decline ever since the dot-com bubble burst 25 years ago. Stocks everywhere else have done far worse:

Precious metals are an inflation hedge. Yet the most direct market inflation forecasts, from swaps and from bond breakevens, agree that inflation will stay within the ranges of most of the last two decades:

Metals suggest something different. Precious metals (including palladium, platinum and silver) have outstripped industrial metals to a record extent in Bloomberg’s indexes. They’ve only previously rallied like this during extreme alarms over the economy, such as the pandemic and the Global Financial Crisis:

How do we justify buying stocks when gold signals alarm? Michael Wilson, equity strategist at Morgan Stanley, set out a fascinating bull case for stocks this week that sadly also reads like a bear case for society. He starts with the point that both stocks and gold are hedges against inflation, which is likely to increase as the Fed seems to be locked into dovishness (as evidenced by the minutes of the latest Federal Open Market Committee meeting) and that stocks now appear to be far cheaper. He draws this comparison with the peak for the S&P 500 in gold terms back in 2000:

This was a time of real wage growth, high productivity, balanced budgets and a better affordability backdrop for everyday needs like housing, health care, education, food and energy — largely the opposite of the past 15-20 years. Today, the ratio is almost 70% below the peak from 25 years ago. Stocks were much more expensive in 1999-2000 than they are today… because they were pricing in much stronger real growth that proved to be unachievable.

There are many measures on which stocks look almost as expensive as in 2000, but Wilson offers counterintuitive signs that they offer value. Taking the median stock (not the average for the overall index), S&P 500 stocks’ free cash flow yield is nearly treble that of 2000:

Free cash flow involves subtracting capital expenditures from overall cash flow, so it’s encouraging that massive AI spending hasn’t dented it for the average company. For the overall index, dominated by the companies splurging on AI, it’s a different story. Its FCF yield is also back to the 2000 level. Other stock markets offer far better value:

This neatly illustrates that the capex boom makes it hard to call stocks cheap. It’s also necessary to be forgiving about the record US profit margins. Over time, they tend to mean-revert, rising when capital has the upper hand, and falling when labor is ascendant. Of late, they just rise. While prospective earnings multiples are roughly back where they were in 2000, margins are much higher:

If those margins are now sustainable, then it’s much easier to justify a higher multiple of earnings. Wilson provides a measure of the S&P 500’s forward p/e divided by the profit margin. On that basis, stocks are much cheaper than 25 years ago.

The other way to look at this is that if profit margins were to revert to their long-term average of a little over 7%, then this measure would be right back where it was in the run-up to the millennium. Wilson suggests that margins will be helped by operational leverage as companies that have slimmed down their workforce take in more revenue. Higher margins, all else equal, tend to mean higher prices, and they would be aided by inflation, which is correlated with sales and gives firms greater cover to raise prices:

This analysis isn’t reassuring. If 2000 was about a surfeit of optimism, this is almost exactly the opposite. Optimism now is predicated on rising inflation. That’s not what people want. Last year’s US election swung more than anything else on price rises; the Biden administration was not forgiven for losing control. Trump 2.0 has taken dramatic action on many fronts, but not against inflation. Indeed, tariffs and pressure for lower rates are more or less the exact prescription to make inflation rise. The latest CBS News poll suggests that people have noticed: 

To be clear, it’s still the economy, stupid. Immigration and crime, justifications for sending troops onto the streets, are dwarfed in importance by jobs and inflation: 

The bull thesis might well be right. But if companies enjoy a circular boom in AI spending, and keep their wide profit margins, while inflation buoys their pricing power and revenues while giving investors little choice but to buy into them, the chances are that the electorate won’t be happy. The bullish narrative sounds a lot like an intensification of all the trends of the last few decades that left people so angry in the first place. 

Trump v. Cook

The Supreme Court is in session hearing disputes on emotive social issues. Its most financially consequential intervention came in a two-sentence ruling last Friday: The administration can’t fire Lisa Cook from her Federal Reserve governorship until the justices have ruled, and they won’t hear the case until January. It’s highly unlikely there will be a decision until next summer.

That’s critical, as engineering a reliable Trump majority on the FOMC requires Cook to be fired and replaced in time to vote on nominees for the Fed’s regional presidencies at the end of February. Those presidents will then serve for five years, making February the only chance to overhaul the FOMC in the Trump term.  

Polymarket gives an overwhelming chance that Cook stays in place:

This garnered little attention, possibly because it came after revelations first published by Reuters that showed the case against Cook was far weaker than its original presentation. She is alleged to have claimed two separate homes as her primary residence in mortgage documents — but forms show that she described the second as a vacation home. Bloomberg found that Treasury Secretary Scott Bessent once made the same error of describing different houses as his primary residence in mortgage applications. Initially about whether Cook should even have her “day in court” before getting sacked, the issue is now that she might well win in court. Media interest has almost disappeared:

Beyond the legalities of Cook’s case, the question of whether the president has the power to fire her remains. An amicus brief signed by economists from across the political spectrum, including all the living former Fed chairs, argues that he doesn’t, and shouldn’t be given it.

For a summary, try this blistering post by David Kotok of Cumberland Investors. He points out that the Federal Reserve Act of 1913 , which created the central bank, and the Banking Act of 1935 that amended it, both said that the president could only fire Fed board members “for cause.” Fed board members at the time insisted that this language was kept to avoid “political control.” With the intent of the legislation so clear, it’s hard to see how the justices would allow a Cook firing to continue. 

The Fed’s structure is totally anachronistic. There are two regional Feds in Missouri and only one on the entire West Coast. Its structure hasn’t changed in 90 years, and its mandate was last revised half a century ago. There’s a pressing need for reform and improvement. But that requires a national debate, and majorities in Congress. Two sentences from the Supreme Court may have finally allowed that to happen.  

The African Sun Shines on Emerging Debt 

The Fed’s pivot to lowering rates and the weak dollar are rekindling investor appetite for emerging market debt, particularly in markets once shut out. African sovereigns are tiptoeing back into global capital markets. Oil-rich Angola has become the latest to join the comeback, raising $1.75 billion in a fresh bond sale.

Yields on its dollar debt have eased from record highs, signaling the most favorable borrowing conditions since the pandemic and opening a window to refinance obligations coming due next month. Sharply narrowing spreads have prompted 14 sovereign issuances across eight African countries, raising about $15.7 billion in debt, up 25% from last year:

With Nigeria, Africa’s largest oil producer, also weighing a $2.3 billion bond sale this year, African issuance is rebounding. According to IC Asset Managers’ Churchill Ogutu, this reflects a pent-up need to refinance shorter-tenor notes. Societe Generale’s Phoenix Kalen expects flows to strengthen as investors position for softer growth in the developed world and central bank easing. That implies a weaker dollar, a welcome tailwind for EM currencies. The Ghanaian cedi and Zambian kwacha, both countries that recently underwent debt restructurings after default, rank among the year’s best performers against the dollar:

Investors have piled into local-currency bonds as developed-market yield curves steepen. Bloomberg Intelligence shows that local EM debt is up 14.7% this year as carry, currency, and duration combine to drive its best start since 2017:

The Fed easing puts this rally under threat. It gives EM central banks room to cut, which markets have started to price in. But their growth outlook remains fragile, underscoring the need to continue trimming rates. TS Lombard’s Jon Harrison shows EM debt performance moves in tandem with rate expectations:

Until recently, EM ex-China local debt had kept pace with equities on a risk-adjusted basis; it has lagged in the past few weeks. China’s is likely to fall behind as stimulus lifts yields from record lows.

Oxford Economics’ Joshua Fisher argues that concerns about fiscal risk are limited to a small number of countries — but developed markets still get the benefit of the doubt “thanks to stronger confidence in their institutions.” Ultimately, debt-stabilizing policy settings hinge on three key levers: debt levels, interest rates, and economic growth. When debt is already high, fiscal restraint becomes essential. For now, countries who’ve got their houses in order are benefiting. 

—Richard Abbey

Survival Tips

While writing this, YouTube decided I would like to listen to Massive Attack’s Teardrop. If you don’t know it, it’s a wonderful song. Listen to it. And if you prefer more upbeat fare, Bruno Mars (of Uptown Funk fame) turns 40 today, while Kool of Kool & the Gang is 75. Time for a celebration, and to give thanks for some great cheerful music. 

More From Bloomberg Opinion

• Jonathan Levin: Gold Isn’t the Warning Ken Griffin Worries About
• Justin Fox: The AI Spending Boom Is Massive But Not Unprecedented
• Mark Gongloff: A Chart Climate Denialists Can’t Ignore

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