State of Play: Inflation, Recession Signals, and the Housing Market — with Mark Zandi - The Prof G Pod

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Kara Swisher: Hello, I'm Kara Swisher. Happy New Year. It's 2023, but the gifts of the holiday season continue. Fresh Pivot episodes resume on Friday, and today we bring you more quality programming from the Pivot Cinematic Universe with this episode of the Prof G Pod with Scott Galloway. If you're not already a subscriber to Scott's other podcasts, you'll want to be after you hear this. Enjoy.

Scott Galloway: Episode 218. 218 is the area covered in northern Minnesota. In 2018, Pete Davidson and Ariana Grande got engaged and disengaged, and Miley Cyrus and Liam Hemsworth tied the knot. True story, my girlfriend looks a little bit like Ariana Grande and a lot like Patrick Ewing. That means I'm single again. Oh, behave. Go, go, go. Welcome to the 218th episode of the Prof G-Pod. In today's episode, we speak with Mark Zandi, the chief economist of Moody's Analytics. True story, I met Mark back in 2008, although as you'll hear in our conversation, he doesn't remember me. So I hate Mark. I hate him. I think he's lying. I think he wants to be my friend, and he's pretending not to know me. Anyways, we discussed with Mark the state of the economy, including geopolitical uncertainty, the housing market, and why he's not all that concerned about a possible recession.

Scott Galloway: Okay, what's happening? The nationwide protests against strict pandemic protocols in China have actually had some successful results. Several Chinese cities, including Shenzhen and Shanghai, have eased up on restrictions, including eliminating PCR testing requirements before riding public transportation, and some apartment complexes in Beijing are being more lenient with respect to where residents are required to quarantine. China has yet to announce any plans to end the zero COVID policy, and for good reason. This country is nowhere near the immunity it should be by now. Health experts and economists believe it will be mid-2023 and potentially 2024 before vaccination rates are high enough and hospitals are prepared to handle a possible surge of infections.

Scott Galloway: There's sort of been a nice power to the people over the last week. Some of the protests in Iran, you would have to argue, have led to the regime announcing they're going to ban or discontinue the morality police. Think about how ridiculous that is, the morality police. Ian Bremmer would argue it's mostly symbolic, but still symbolism is important. And these protests in China, can you imagine they are still about a quarter of the population in China is still under some sort of partial or full lockdown. I mean, can you imagine how pissed off they are? I mean, in Florida, we couldn't handle it for five days. They've been dealing with it for about two and a half years.

Scott Galloway: Anyways, the CCP has to be responsive to the middle class or somewhat responsive because if they vote the party in power, out of power, that's called revolution. When you don't have a two-party system, there is no peaceful transfer of power, so to speak. So they have to be somewhat responsive. And I think this is at least a nod to that. At the same time, the CCP is really worried about COVID because they have, I think, approximately one-third the number of ICU beds per capita as the U.S., and one-fifth the nurses. And what you could effectively have here is just a, simply put, a fucking disaster.

Scott Galloway: They estimate that if COVID had kind of followed the same pattern as the West, and it didn't, their zero COVID policy was effective, they would lose three to five million Chinese people, which is obviously a huge loss of human life, but also would just be bad, I don't know, also just bad. Three to five million people dying would be very bad. But there is some question around whether a kind of total lockdown, zero COVID policy is the correct one. Because early in the pandemic, when the virus was more lethal and less contagious, total lockdown makes sense. Now that it's more contagious and less lethal, there's some question whether or not this makes sense.

Scott Galloway: But I get the sense this is a kind of thing where to a certain extent, it needs to get through a community. I mean, I guess if you could purely isolate a community, it would make sense. But effectively, why we had so much mortality in nursing homes and in prisons was none of these individuals or few of these individuals had had any exposure to novel coronaviruses. They're not hanging out with snotty-nosed kids. And it just ripped through these facilities. And I wonder if China is about to finally get their turn at the woodshed here. Anyways, it is an interesting week. These protests appear to be getting purchased, and we'll absolutely see what happens. But there is something good and nice about protests and people taking to the streets and seeing some results here.

Scott Galloway: U.S.-listed Chinese stocks did, in fact, rise on Monday due to the easing of COVID restrictions. Bloomberg reported that the NASDAQ Golden Dragon China Index closed up 2.8 percent, compared with a loss of 1.5 percent in the S&P. The e-commerce firm, Pinduoduo, I think I'm saying that right, registered the greatest gains at 13%. I think that company deserves to get much lower stock returns just because of that name. That's an awful name. CNN said that Morgan Stanley improved its view of the future performance of Chinese equities for the first time in nearly two years. Morgan Stanley believes that the MSCI China, an index tracking major Chinese stocks, will hit the 70 level by the end of 2023, which would be a 14% increase from its current level.

Scott Galloway: My colleague Aswath Damodaran mentioned the other week that he's wary of investing in China companies because they will always be tied to the Chinese government. I actually find the Chinese stocks, every year I do predictions. I do a predictions deck and I say, based on what I'm saying and looking at some data, I'm going to make predictions about the upcoming year. Last year, I predicted that Twitter would be acquired, the fundamentals and valuations would reunite, got those very right. And I also predicted that I thought OpenSea's valuation would double and it's an NFT marketplace. I got that one wrong. But last year was my best year in terms of the ones we got right and it's better to be lucky than good. Predictions are a shitty business because if you say Twitter will be acquired all the events leading up to Musk acquiring Twitter seem logical now or illogical and it doesn't seem like that bold a prediction but if you got it wrong everyone's like oh yeah and like comes on Twitter and reminds you for the next three millennium that you got it wrong but anyways I can't resist and also you should not predict stock prices but again see above I can't resist.

Scott Galloway: I think on a risk-adjusted basis the best buy right now would be a basket of Chinese internet stocks. If you look at these stocks as a multiple of EBITDA relative to their competitive position in the marketplace, basically what you're getting with these stocks is American internet companies, but at a third of the valuation. And sometimes they're growing faster. Alibaba is a formidable competitor or formidable analog to Amazon, and it's trading at a fraction of the valuation on any reasonable metric. So to Aswath's point, the existential threat here and the reason these things have gotten the shit kicked out of them. I mean, if the Dow had followed the Hang Seng, the Dow would be at like, I don't know, 12 or 15,000 right now. We're all bitching when it goes down 4 or 5%. Anyways, Chinese internet stocks have just gotten the crap kicked out of them. And it's because the government, the CCP, has gone from being the wind at their back to the monkey on their back.

Scott Galloway: And that is the government used to be seen as kind of blocking and tackling for its great internet heroes, its great corporate titans that were helping create the prosperity and economic value to bring tens of millions of people out of poverty. By the way, the most impressive feat of the last 50 years or one of them, you'd have to argue, is China bringing a half a billion people out of poverty. And whenever we wave our finger at them for various reasons, some of them very warranted, we just have to acknowledge what they've accomplished is incredible. By the way, at that same period, we've actually lost people in the American middle class. Anyway, anyway, I think these companies, the question is, will the government continue to kneecap these companies? The government has looked at America and said, okay, individuals that think they're more powerful than the government, privacy, violation, weaponization of elections, although they don't have elections. And they're like, you know, not here, girlfriend. No, thanks. Imagine if you want to talk about a distinction, a difference in systems. Imagine if Jeff Bezos was shitposting the Biden administration and then just disappeared for several weeks. That is what the CCP is. That is what it means to live in China. So for all of you that are bitching about America, and I'm one of them, I'm a glass half empty kind of guy, where would you rather be? Where would you rather be? Would you rather be in Europe, which is a lovely quality of life and a center, kind of the epicenter for, I think, culture and great food and beautiful fashion? But guess what? The economies there have basically gone sideways for about the last three or four decades. Would you rather be in China, that economic juggernaut, by the way, that their stock market is down 50, 60, and 250 million people are under lockdown and two of millionaires have either left or want to leave. Would you want to be in China? Would you want to be in Where would you rather be? Where would you rather be on a risk-adjusted basis in terms of freedoms, economic prosperity? Our last quarter here in the United States, inflation came down, and we're growing. We had the Goldilocks economic report this last quarter. Where would you want to be economically from a civil liberties standpoint, from a freedom standpoint, from an opportunity standpoint, than here in the lower 50. So we call it the lower 50. Anyways, God bless America. Out of the U.S. World Cup, but go England versus France. That's going to be a great game. Saka is my favorite player. He plays, I think, right wing for Arsenal. And also you're going to get to watch Kylian Mbappe, who arguably is the best player in the history of football right now. You heard it here. He rivals Pele. We're a little bit nostalgic for Pele, but I think right now, if he maintains this form, you're going to see Killian kind of crowned as the best football player in history at this point, or at least in the best form. What does that have to do with China and internet stocks? Almost nothing. But it's called the Prop G pod for a reason. Go, England! We'll be right back for our conversation with Mark Zandi.

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Scott Galloway: Welcome back. Here's our conversation with Mark Zandy, the chief economist of Moody's Analytics. Mark, where does this podcast find you?

Mark Zandi: I'm in suburban Philly. This is where I grew up. Nice.

Scott Galloway: So let's bust right into it. You're a bit of a contrarian here. You recently wrote an op-ed in the Inquirer where you stated that a recession is far from a done deal and that forecasts regarding a recession have been overly glum. Say more?

Mark Zandi: Yeah, well, obviously, recession risks are high. Inflation is a problem and the Fed's on high alert. And in that kind of environment, we're vulnerable to anything else that goes wrong. But I've just been struck by how pessimistic the collective psyche is, you know, from the CEO, Jamie Dimon's a hurricane coming to, you know, really my literally my next-door neighbor who thinks we're going into recession are already there. So I've been a professional economist for over 30 years. I've never seen such deep pessimism around the economic outlook. And I think we, despite the risk, have a fighting chance to get through this without recession for a bunch of reasons. But I'll just name one. And that's the American consumer. They're the firewall between an economy that continues to grow and one that goes into recession. And the consumer is in pretty good shape. Lots of jobs, low unemployment, lots of excess cash built up during the pandemic. We're starting, you know, low-income households are starting to blow through that because of the high inflation. But still a lot of cash. Leverage is low. Despite the decline in the stock market and housing values rolling over, people are still a lot wealthier than they were before the pandemic hit. So just adding it all up, it feels like the consumer can hang in tough, do their part. Nothing extravagant, just continue to do their thing. If they do, then we'll avoid recession. So, yeah, I think we have a fighting chance to get through this without going into a downturn.

Scott Galloway: Do you think the Fed has been overly aggressive in terms of how quickly they've raised interest rates?

Mark Zandi: No. I mean, I think they were slow to start raising interest rates back at the start of the year. I mean, it's hard to imagine, but at the start of the year, we were at zero, the zero lower bound on the federal funds rate. So that doesn't make a lot of sense when the economy is as strong as it is and inflation is as high as it is. So, no, I think they've been playing some catch up. I do think, though, you know, at this point, given where interest rates are, they do now start to need to think about tapering the rate increases and thinking about ending the rate hikes and seeing what kind of impact that has on the economy. But at least up to this point in time, I think they've been playing catch up and appropriately so.

Scott Galloway: Don't we need a recession? I mean, I feel as if a recession is a natural part of the economic cycle and kind of cleans out some stuff and sort of a reset. And Jamie Dimon, I like what Jamie Dimon said, when defining a recession, he said something that happens every seven years. It's been 13 years. Yeah. Would a reset or a decline in asset values be somewhat healthy? I don't, no, I don't think we're in that kind of situation. I mean, I think the fundamentals of the economy, which is what you're pointing to, are good. You know, typically before recession, households have too much debt. They're over levered. That's not the case today. Typically before recession, businesses have over borrowed, taken on too much leverage and debt. And of course, I'm paying with a broad brush here and there's exceptions, but generally that's not the case. Typically before recessions, the financial system has extended out way too much credit. Underwriting has been too easy. People who shouldn't have gotten loans got them. That is definitely not the case. The banking system is on as solid financial ground as it's ever been. Typically before recessions, the real estate markets are vastly overbuilt like they were before the financial crisis. And that's just the opposite today. In the housing market, we're significantly underbuilt. But typically before recession, state and local governments are struggling with trying to maintain their rainy day funds and revenue. There's cash everywhere. The only thing that feels a little off is our high debt load, federal debt load, government debt load. But that's understandable given all the support that was provided during the pandemic and going back to the financial crisis. And that's a problem for another day, I think. But no, I don't think – and I agree with the statement that recessions are a natural part of the business cycle in a market economy. Things tend to get overdone. People take too much risk, get overextended, borrow too much money, but banks lend out too much credit. But that's just not the case today. So I don't think it's necessary to, as you say, clean out the system at this point.

Scott Galloway: Inflation. We're food independent. We're energy independent. Oil prices coming down. I look at everything, and I can't understand why inflation wouldn't come down as fast as it went up in 2023 in terms of everything on their credit cards, their mortgage payment, their car payment. Everything has gotten more expensive, which should, in my opinion, dampen spending. We're likely going to see energy prices come down. Supply chain gunk will get ungunked. It strikes me that every moon is lining up for a massive decrease in inflation. Where do I have that wrong?

Mark Zandi: You don't. I think inflation, it will slow very sharply here going forward, assuming oil prices don't go back up. I mean, if oil prices, gas prices, diesel prices stay roughly where they are, which I think is the most likely outlook, although there's a lot of risk around that given everything that's going on overseas. If that's the case, then yeah, you will see inflation come in pretty quickly. And other prices for other goods, they're already starting to roll over given the improvement in supply chains. And, you know, of course, a key part of inflation is the cost of housing, and that goes back to rents. And there too, some good news, rent growth has really come to a halt for lots of different reasons. And that should show up in the inflation statistics by this time next year. The thing that, you know, will take a bit more time to write and get back in is around wage costs and, you know, the impact that has on the prices for various kinds of services, particularly health care. That's, you know, very labor intensive and wages have risen very sharply there. And that's going to translate through for a while. But assuming that the economy continues to moderate, job growth slows, unemployment starts to notch a little bit higher and wage growth starts to come in, I think inflation will be back close to the Fed's target by early 2024, something like that. So it will come in. But everything I just said is based on a boatload of assumptions around oil prices and OPEC and the EU sanctions on Russian oil and how that implemented It goes back to the pandemic what going on in China If they shut down again that will disrupt supply chains create shortages and more price pressures. So there's a lot of ifs, ands, and all kinds of assumptions being made here. But I think under the most reasonable assumptions, you're right. Inflation is going to come in. We're not going to get back. We're at 7.7% on the consumer price index. So that's a long way from 2%, 2.5% where the Fed wants it. So it's going to take some time to get there. But I do think we're headed in that direction and will get there by early 2024.

Scott Galloway: How does a three or four decade historic strength in the dollar impact all of this?

Mark Zandi: Well, the dollar's strength is more of a reflection of this relative strength of the U.S. economy, right? I mean, we're just doing better. And so we've normalized more quickly. Our interest rates have risen more quickly. and we still are the AAA credit, you know, when there's a problem anywhere on the planet, including here at home, you know, money comes flowing here. So, you know, given all the geopolitical uncertainty and given our relative strength and how well we've done during the pandemic compared to everywhere else, you know, money has come in. So it's a, you know, it's a result of our relative performance. You know, it does make it more difficult to trade. I mean, it's going to, it has, you know, one constraint on our economy's growth rate has been a widening trade deficit. And that goes back to our relative strength of the economy, but also to the relative strength of the currency, the strong dollar. But in the grand scheme of things, that's pretty small. I mean, we're a big economy that does a lot of trade with the rest of the world. But we're still, compared to other economies, very domestically oriented. Going back to my point about the American consumer, the consumer still drives the train. The economic train. So the strong dollar does matter, but it's small in the grand scheme of things. Our economy still depends most significantly on what's happening here domestically and particularly what the American consumer is doing.

Scott Galloway: Try and overlay this all on the markets. When you look at economic activity, the fact that we may not go into a recession, and you look at the performance of the markets or specific sectors, any thoughts or hypothesis regarding market performance in 2023?

Mark Zandi: Well, I think the stock market, let's take that, that's down 20% from the peak at the start of the year. I think that largely reflects higher interest rates. I mean, so when you think about stock prices, it's equal to expectations around the earnings of companies and then the multiple, you know, what investors were willing to pay for those earnings, the so-called PE multiple. and the price earnings multiple, what they're willing to pay, investors are willing to pay is very closely tied to interest rates. We can talk about why, but with the rise in interest rates this year, that means price earnings multiples have come in, which is a good thing going back to, that was one place at the start of the year where you could say, oh, it feels like the market's overvalued and we need some cleaning out there. We need some moderation and people's thinking about, you know, what appropriate multiples are. And they've come in and that's very consistent with the higher interest rates. I don't think down 20%, that's really multiples coming in because of the higher rates. It's not, has anything to do with expectations around corporate earnings. In fact, American businesses are doing really pretty amazingly well. I mean, profit growth has been very good. It's moderating, but it's very, very good. Profit margins, they're down from their peaks, but they're pretty close to record highs. I mean, going back to World War II. Similarly, going to the bond market, you don't see recession signals. I mean, you know, one of the tried and true measures there is the corporate bond spread. You look at the yield on corporate bonds compared to risk-free treasuries. And that difference, that spread reflects the risk that that corporation may not pay you back because of a bad economy. You know, their business is bad, the default. And that spread is incredibly – it's risen a little bit maybe, but it's very consistent with long-run historical averages. So not at all consistent with the idea that bond investors are pricing in some kind of recession. Yeah, a weaker economy, a slowing economy. I mean, by definition, that's going to happen, but not a recessionary one. So the markets in my view, the financial markets in my view, are not signaling at this point that we're going into a downturn.

Scott Galloway: So fairly or unfairly, I think of you as the housing guy. I always go to AdMarkZandy on Twitter when I'm looking for information on housing. I'd love just the cliff notes, if you will, or the voiceover on the U.S. housing market right now.

Mark Zandi: Yeah, that's in recession. So, you know, the U.S. economy is slowing. It will slow further going into next year. And as I said, recession risks are going to be high. My sense is the economy essentially goes sideways, you know, flat in terms of GDP and jobs and everything we take a look at. But if that's the case, then that means big parts of the economy are going to be in recession. They are going to be shrinking, contracting. And those most likely would be the most interest rate sensitive sectors of the economy. And there's no more rate sensitive sector of the economy than single family housing. Right. I mean, if you go want to go buy a home, you got to get a mortgage. You've got to get a mortgage. You know, that's right tied to the interest rate. And it's getting nailed in significant part because of the surge in house prices during the pandemic. So if you go back February of 2020, a month before the pandemic hit, go to the peak in-house prices in June or July of this year, nationwide, they were up over 40%. Nationwide. So in Phoenix and Boise and Tampa and Austin, Texas, they were up 60%, 70%, 80%. That's crazy increase in price. Obviously, going back to the record low interest rates at the time, remote work dynamics, those kinds of things. But now with interest rates up, you mix those higher rates with these higher house prices, people just can't afford it. I mean, I'll give you a statistic. The typical American household going out to buy the typical American home, median price, prevailing interest rates, now has to pay over $1,000 more a month for that home than they did back a year ago. $1,000 a month. I mean, you know, for most potential first-time homebuyers, that's just, you know, forget about it. And even trade-up buyers, I mean, they're not going to do it because they, everyone's refied. If you owed a home and a mortgage, you've refied down in the last five, 10 years, and you probably have a mortgage at three and a half percent. When the mortgage rate's now sitting at six and a half to seven, you're just not going to move because you have to get a new mortgage at this higher interest rate. It's just not affordable. So affordability has been hammered. And so this demand has been crushed, meaning home sales have fallen way off. and, you know, that is now starting to show up in weakening house prices. So the housing market, house prices are now declining in a pretty consistent way. They're probably down, I'd say probably about 2, 3, 4% from their peak. This is, again, nationwide. And I suspect, you know, if my worldview comes to pass and we don't go into recession, given everything else we know about interest rates, we'll see probably a 10% decline in price, you know, from that peak to the bottom. couldn't you just go through the housing markets that have gone up the most and say those are the ones that are the most vulnerable yeah that's exactly right so uh the the areas that got most juiced uh you know when uh the prices went stratospheric are in those mountain west and southern um metropolitan areas and that goes to uh you know the pandemic to a large degree you know remote work. You saw a lot of folks during the teeth of the pandemic leave these big urban areas, you know, people from, you know, New York, Philly, you know, where I'm from, moving into, you know, the South, into Raleigh, into Atlanta, into Charleston, into Jacksonville, Florida, Tampa, Orlando, over Austin, by the way, Austin is the most used market. It's got people coming in from the Northeast Corridor and California at the same time. So that's the one market that's gotten people from both coasts coming in. All the Californians, they kind of, Bay Area, a lot of tech folks moved over into Vegas and Denver, into Phoenix. And, you know, so you saw these massive flows of people, which by the way, they're unwinding. They're still very elevated. If you look at the migration patterns, there's still a lot more people leaving those big urban areas for those other areas, but less so than was the case at the peak back in the summer of 2021. So when you look at everything, the pendulum was rarely at the bottom, right? Things either people get overexcited or people unfairly punish asset classes. Is there a sector across everything you look at where you think this feels like on a risk-adjusted basis there's opportunity that it's been unfairly punished?

Mark Zandi: No, not yet. I mean, I think all asset prices got juiced when interest rates were very low, you know, going back to those P multiples, I mean, valuations got very high for housing, for stocks, for crypto, for bonds. You could make the case if interest rates stayed where they were, that those valuations were fine. But again, reversion of the mean, if interest rates just simply normalized, you know, those prices were, those asset prices were just overvalued and they were going to come in And what we been experiencing you know this so far this year with the run in rates is just kind of a normalization in price So if you look around you know the spectrum of assets out there they all feel like they kind of coming back close to where they should be long run, reversion to the mean. I don't get the sense yet that we've gotten to a place where there's screaming value out there.

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Scott Galloway: So quick lightning round to wrap up here quick crisp answer last piece of media you binged 1975 I just discovered 1975 believe it or not you know the group 1975 I don't oh okay highly well I don't know if you like my I'm a kind of a sad to say I'm a little poppy in my sound in my music because I like it when I run or I you know at the gym or something best piece of advice you've suit? Well, this goes to my dad. You know, he always said, I don't care what you do, just be, try to be the best at whatever it is that you do do. And, you know, I think that's true. I mean, if you're excited about what you're doing, you try to be the best at it. You know, you need to be lucky. Everyone needs a little bit of luck, but generally people gravitate to that because they If you're excited, they get excited, right? So you've got to find the thing that really is exciting and decide that I'm going to be the best I can possibly be. And, you know, if you're doing that, then people really, I think, gravitate to that. So I think that's a very, that to me was a very key piece of advice. Lowest professional moment? um you know the lowest professional moment for me was when I started my company and I was about six nine months in and it was hard uh you know i didn't have any cash and my first born was coming and i actually got sued by the company the another company for and i won by the way so i did win but they sued because they were, you know, I think, you know, competition. I didn't think I was going to make it through. I was young. I was 30 years old. So, you know, I, you know, it's a failure is fine. I mean, I would be fine, but I didn't want to fail. It's capital F when you got a kid coming though. I went through the same thing. And my wife's saying, well, what are you doing exactly? Yeah. How are we going to pay for preschool? Or just simply, you know, the, the medicine they need. Right. I mean, how are you going to do that? because medical care, right? I mean, so that, I can remember, I remember one day I was having a hard time breathing, literally a hard time breathing. I'm going, you know, I'm in good shape. I'm a young guy. Why can't I breathe? Why can't I breathe? And it dawned on me, it was, I was under so, I was just tense. I was so, so much pressure. And once I got to that realization, I could start to breathe again, right? Because I didn't understand what was going on And then I understood and I go, okay, everything will be fine. We'll figure it out. It's not like