Jim Paulsen, The Leuthold Group - The Wildcard Is Inflation and Whether It’s Truly Transitory | #356

Episode Summary

Executive Summary: Jim Paulsen argued that the pandemic created a historic bust-to-boom whiplash, pushing companies and consumers into extreme caution before unleashing a powerful recovery. He expects above-trend growth, modestly higher but not runaway inflation, tapering to be mostly priced in, and defense/bonds/gold to struggle as growth and risk appetite improve.

Main Topics: Pandemic-driven bust-to-boom whiplash (Priority: 5/5): Paulsen said COVID created an unusually sharp economic collapse followed by an equally unusual rebound, forcing firms to operate at minimum cost and then producing an extraordinary profit cycle. Running the economy hot vs. cold (Priority: 5/5): He contrasted the current policy stance of allowing nominal growth to exceed the cost of capital with the post-1980 tendency to run the economy cold, arguing the long-term outcome could resemble either the 1950-65 boom or the inflationary 1965-80 period. Growth outlook and structural tailwinds (Priority: 5/5): He sees several years of stronger-than-normal growth driven by pent-up demand, delayed labor-force reentry, household formation, new business creation, and higher productivity after the tech cycle. Inflation and the transitory debate (Priority: 4/5): Paulsen believes current inflation is largely a bust-to-boom supply shock that should ease, though he expects inflation may settle above the prior 2% norm due to persistent structural changes. Tapering and monetary policy normalization (Priority: 4/5): He argued tapering has already had major market effects because QE and M2 growth have slowed for months, so by the time official tapering begins much of the impact may already be reflected. Asset allocation: defense, bonds, and gold (Priority: 4/5): He expressed skepticism about defensive stocks, high-quality bonds, and gold as attractive havens in a still-strong growth regime, while noting they can work during sharp corrections. Valuation, sentiment, and consensus risk (Priority: 4/5): He said valuations are elevated versus pre-1990 history but more normal in the post-1990 regime, and emphasized that understanding consensus positioning is more important than any single indicator.

Key Arguments: The pandemic produced a near-record economic contraction and rebound, which forced firms to slash costs and then created an unusually strong profit cycle once demand returned. Policy makers chose to "run it hot," meaning nominal growth above the cost of capital, which can support strong markets and productivity but risks more inflation if it persists too long. Growth could remain around 3.25%-3.5% in real terms, materially above the 2.25%-2.5% pace of the prior recovery, thanks to pent-up demand and delayed labor supply. Inflation is likely to remain somewhat higher than the last decade's average, but structural disinflation forces such as globalization, demographics, and technology should prevent runaway inflation. Tapering is already well underway in practice through slower QE and M2 growth, so the market impact has mostly occurred before the formal policy announcement. Defensive assets usually outperform in weak-growth or recessionary environments, but with above-trend growth they may underperform even during corrections. Long-duration high-quality bonds look unattractive because yields are low relative to likely growth and inflation, and may be near a "non-viable" level for many investors. Gold remains elevated relative to commodities but lacks a strong catalyst when real growth, profits, and risk appetite are improving. The most useful analytical framework is not one indicator but tracking the consensus view and identifying where beliefs are most vulnerable to change.

Data Points: U.S. real GDP decline in 2020: down about 10%+ year on year - Paulsen cited the pandemic collapse as the biggest drop in real GDP in postwar U.S. history. U.S. real GDP rebound: back up over 12% year on year - He described the recovery as one of the fastest postwar growth rates. Average growth outlook: 3.25% to 3.5% - His estimate for sustainable real GDP growth during the recovery. Prior recovery growth pace: 2.25% to 2.5% - He contrasted the expected new recovery pace with the post-2009 trend. Long-run inflation target drift: from about 2% to about 3% - He suggested inflation may settle modestly higher than the prior norm. Unemployment rate: about 5.2% - He said headline unemployment is still above the true effective slack in the labor market. Effective unemployment rate: closer to 7.5% - His estimate after accounting for labor-force participation shortfall. Cash balances in money market funds: $4.5 trillion - He used this as evidence of still-elevated caution among investors. Deposits available: $17 to $18 trillion - He cited large excess liquidity sitting in the banking system. QE annual growth rate peak: 80% YoY - He said quantitative easing growth peaked in February before slowing sharply. QE annual growth rate current: under 20% YoY - Used to argue tapering is already meaningfully underway. M2 money supply peak growth: 27% YoY - He cited M2 as another measure that peaked before tapering fears became a major market theme. M2 money supply current growth: 12% YoY - Used to show monetary growth is already decelerating. High-beta vs low-volatility investing: near lowest levels since 1990 - Evidence that investors remain defensive and cautious. Household debt-to-income: lowest since 1990 - He argued household balance sheets are unusually healthy. Debt service burden: lower than prior cycles - He attributed this to very low interest rates. Schiller CAPE regime: above the 80th percentile three-quarters of the time over the last 30 years - He said valuations have lived in a higher range since 1990. Trailing P/E: around 26x now, potentially near 20x next year - He argued valuation is less extreme than many think given the post-1990 regime. Bond yields: 10-year yield below median CPI inflation about 75% of the time since 2012 - He used this to argue low yields are not merely a pandemic anomaly.

Pivotal Quotes: "we went from a depressionary bust to a post-war boom" — Jim Paulsen: Describing the unprecedented economic whiplash caused by the pandemic and policy response. "we've been doing this forever, quick to tighten, quick to worry about inflation, ever since the 1970s. It just isn't working. Growth is slowing. Equality is spreading. And so they decide to run it hot." — Jim Paulsen: His explanation of the policy shift toward allowing the economy to run above trend. "by the time we officially start tapering, most of the actual tapering, I think, is already behind us" — Jim Paulsen: His view that markets have already absorbed much of the tapering impact.

Implications: Listeners should expect a still-supportive macro backdrop for risk assets, but with more volatility as policy normalizes. Paulsen favors watching consensus shifts, not headlines, and thinks defensive havens may lag if growth stays above trend.