J.P. Morgan's Dr. David Kelly on Why He Believes Foreign Stocks Are Attractive, Inflation Will Subside, & The Debt Ceiling is a "Doomsday Machine" | #463

Episode Summary

Executive Summary: Dr. David Kelly argues the macro backdrop is improving: inflation should keep fading, growth is likely slow but not yet recessionary, and valuations—especially outside the U.S.—are more attractive than they’ve been in years. He is upbeat on international equities, cautious on bonds, and worried that weak demographics, limited fiscal support, and the debt ceiling could create policy and market risks.

Main Topics: Inflation is peaking and should keep declining (Priority: 5/5): Kelly says the post-pandemic inflation surge was driven mainly by supply constraints plus excessive fiscal stimulus, then extended by the Ukraine energy shock. He expects inflation to continue falling toward the Fed’s target over 2023-24. International equities look unusually attractive (Priority: 5/5): He makes a strong case for foreign stocks on valuation grounds, noting international P/Es are about 30% below U.S. levels and dividend yields are nearly twice as high. He thinks a falling dollar could be the catalyst for sustained outperformance. The U.S. economy is slowing but not clearly in recession (Priority: 4/5): Kelly emphasizes that recession is possible but not inevitable. He points to still-strong job creation, high job openings, and limited overbuilding as reasons the economy may avoid a formal downturn, even if growth stays weak. China, Europe, and global growth trends are shifting (Priority: 4/5): He expects China to rebound after abandoning strict COVID controls, while Europe may avoid a major energy-driven slump. He sees the rest of the world improving later in 2023 relative to the U.S. Fiscal policy is constrained; debt ceiling is a major risk (Priority: 5/5): With divided government, he believes new fiscal stimulus is effectively off the table. He warns the debt ceiling is a 'doomsday machine' that could trigger recession or broader financial stress if mishandled. Structural reforms: immigration, education, and healthcare (Priority: 4/5): Kelly argues that better immigration policy could offset weak demographics and lift growth, while education choice and healthier incentives are needed to reduce inequality and improve long-run economic outcomes. Consumer balance sheets are weakening (Priority: 4/5): He says households used pandemic stimulus to raise living standards, but with savings rates falling and credit usage rising, consumer spending is likely to slow materially over the next year or two.

Key Arguments: Inflation was caused primarily by pandemic supply constraints plus fiscal transfers that put too much cash in consumers’ pockets, not by a simple money-supply story. Ukraine extended the inflation cycle through energy and food price spikes, but barring another shock, inflation should trend lower. International stocks are cheap relative to U.S. stocks, with lower P/E multiples and higher dividend yields, making them more compelling for long-term investors. A weaker U.S. dollar could be the practical catalyst that finally gets U.S. investors to embrace international equities. The U.S. may avoid recession because labor demand remains strong and the economy lacks obvious signs of severe overbuilding. Fiscal stimulus is politically dead for now, so if growth deteriorates, the Fed may be forced to do more of the work. The debt ceiling creates unnecessary tail risk and should be eliminated because it does not actually control debt growth. Immigration reform is the most powerful near-term policy lever to offset demographic weakness and improve growth. Education choice, healthier incentives, and a better approach to gambling and healthcare could help address inequality. Consumer spending is likely to slow because households have exhausted pandemic-era excess savings and are now relying on borrowing and withdrawals. Investing should be judged over long horizons; short-term sentiment and performance-driven narratives can mislead investors. Consumer sentiment is a useful contrarian indicator: extreme pessimism has historically preceded strong forward returns.

Data Points: Inflation outlook: ~3.x% by end-2023; around 2% or below by end-2024 - Kelly’s base case for continued disinflation absent another major shock U.S. 10-year Treasury yield: 3.6% - Referenced as current nominal yield when discussing bond attractiveness and real returns High-yield bond yield: 9% - Used to illustrate that bond yields are materially better than in prior years 30-year bond yield: over 4% - Presented as part of improved fixed-income valuation setup International equity valuation gap: about 30% lower P/E than U.S. - Relative valuation measure supporting foreign stocks International dividend yield: almost twice U.S. - Additional valuation/income argument for non-U.S. equities U.S. share of world stock market value: 60% - Kelly notes the U.S. dominates global equity market capitalization U.S. share of global stock ownership: at least 60% - Used to explain investor bias toward domestic equities Personal saving rate: 2.4% - Current consumer saving rate cited as evidence households are running out of cushion Pre-pandemic saving rate average: about 7% - Five-year average before COVID, used as a comparison Unemployment rate: 3.5% - Starting point for 2023, indicating a very tight labor market Job openings: more than 10 million - Evidence of continued labor demand and support for payroll growth Budget deficit: about 5% of GDP - Kelly argues this is too high in a full-employment economy Annual deficit: about $1 trillion - Adds to debt and heightens fiscal concern Debt ceiling headroom: over $500 billion - Remaining Treasury cash and debt-room buffer at the time of the interview Potential debt ceiling timing: July or August 2023 - Estimated period when the U.S. could hit the debt ceiling U.S. stock market share of world stocks: 60% - Reiterated to emphasize domestic concentration among investors Targeted inflation by mid-decade: below 2% - Kelly says inflation could undershoot the Fed target by the middle of the decade

Pivotal Quotes: "not the best of times, not the worst of times" — Dr. David Kelly: His overall macro view: mixed but investable, with better valuations and slowing inflation "the debt ceiling is a doomsday machine" — Dr. David Kelly: Strong warning that the debt ceiling creates avoidable recession and crisis risk "if people would just commit to getting rich slowly rather than pretend they're going to get rich quickly, they'd do much better" — Dr. David Kelly: His advice on investing behavior, diversification, and avoiding speculative shortcuts

Implications: Listeners should expect lower inflation, modest growth, and a more favorable setup for international stocks than U.S. mega-cap concentration. The biggest risks are policy missteps, weak demographics, and debt-ceiling brinkmanship.