What A Growth Scare Means For The Fed & Markets | Warren Pies

Episode Summary

Executive Summary: Warren Pius argued 2025 is a year of “discovering neutral,” with restrictive rates still slowing the economy despite recent hawkish Fed messaging. He expects a first-half growth scare led by housing weakness and residential construction layoffs, disinflation from shelter to continue, the Fed to cut more than markets expect, bonds to rally later, and large-cap growth/quality to outperform small caps and cyclicals.

Main Topics: 2025 macro theme: discovering neutral (Priority: 5/5): Pius framed the year as a process of uncovering the economy’s true post-pandemic neutral rate after unusual fiscal, inflation, and supply-side distortions. Rates, bond yields, and Fed policy (Priority: 5/5): He argued the Fed is still restrictive, long yields transmit policy with a lag, and the market has been repricing cuts based on the September and December Fed meetings. Housing as the leading indicator (Priority: 5/5): Housing and residential construction are his key recession tell: normalization of inventory, shorter build times, and elevated mortgage rates point to layoffs and slowing starts. Inflation outlook and shelter disinflation (Priority: 4/5): He expects CPI to trend lower as shelter inflation converges with new rents, while oil and labor are unlikely to create sustained inflation pressure. Equity valuations and market composition (Priority: 4/5): Despite high headline multiples, he argued the S&P 500 is not in a bubble because of its modern composition—higher-quality, margin-rich mega-cap tech and staples. Asset allocation: bonds, gold, and relative equity views (Priority: 4/5): He is constructive on long bonds after recent yield backup, bullish gold toward $3,000, and prefers large-cap growth/quality over small caps, value, and cyclicals.

Key Arguments: The economy is still in a post-pandemic discovery phase where neutral rates are not directly observable and must be inferred from market and real-economy behavior. The September 50 bp Fed cut triggered a two-stage bond selloff: first the market repriced recession risk out, then the December SEP and Trump-related expectations reduced projected cuts further. A 4% terminal funds rate is still restrictive; if the 10-year settles around 5.25%, mortgage rates near 7.5%-7.75% would strain housing and the broader economy. Housing is the most useful recession barometer because residential construction payrolls historically roll over before broader labor-market deterioration. New-home resilience during the pandemic came from extreme inventory tightness, long build times, and large backlogs; those supports are now gone. Homebuilder behavior, especially at D.R. Horton, suggests starts will be pulled back as completed unsold inventory rises. The Fed’s December SEP implied a hawkish shift: with 4.3% unemployment and 2.5% core PCE, markets should have expected more than 50 bp of cuts, not fewer. Shelter inflation should fall materially as new-rent measures (like CoreLogic) converge with the larger stock of existing rents, likely by Q1/Q2. Oil is unlikely to be a sustained inflation driver absent an extreme sanctions-driven shock; demand indicators like crack spreads do not support a strong rally. The S&P 500’s high valuation is partly justified by a radically different composition: much more tech, higher ROIC, and structurally higher margins than prior cycles. Small caps remain unattractive because they are more vulnerable to elevated borrowing costs and a growth scare; large-cap growth/quality is preferred. Bonds become attractive again if yields overshoot; he expects rates to fall later in 2025 as growth slows and more Fed cuts are priced back in. Gold remains a favored hedge and secular bull market trade, supported by strength despite higher real yields and a stronger dollar.

Data Points: Fed cuts expected by year-end: 3-4 cuts (75-100 bps) - Pius’ base case for the Fed by end of 2025 after a first-half growth scare 10-year Treasury expected average: 4.0% - His year-ahead bond outlook 10-year yield fair value after Fed cuts: ~5.25% - He said a 4% terminal funds rate with no further cuts implies the 10-year could move to about 5.25% 10-year / Fed funds spread in cut cycles: ~60 bps - Historical spread when the market knows the next Fed move is a cut 10-year / Fed funds spread in hike cycles: ~170 bps - Historical spread when the next Fed move is expected to be a hike Mortgage rate level deemed unsustainable: 7%+ - He argued the housing market cannot handle mortgage rates at or above 7% Mortgage rate implied by a 4% terminal rate: 7.5%-7.75% - Based on his assumed spread from Fed funds to mortgage rates Residential construction jobs in model: ~1 million - Estimated size of the residential construction job sliver he focuses on Drawdown in residential construction payrolls before recessions: 8%-10% - Historical pattern preceding modern U.S. recessions Jobs excess in residential construction: ~75,000 - His model says there are roughly 75k too many jobs in that segment Single-family completion time: ~7 months historically - Normal time to complete a single-family home before pandemic distortions Single-family completion time during pandemic: ~12 months - Pandemic-era supply-chain stretch Multifamily completion time: ~21 months historically; 30+ months during pandemic - He cited normalized versus pandemic build times National housing inventory completed unsold share: Single digits during pandemic; normalized now - Used to show the market moved from extreme tightness to normalization D.R. Horton unsold completed inventory: ~40% - He cited a high completed-inventory share as a warning sign for future starts Core PCE forecast by Fed for 2025: 2.5% - Updated SEP projection Unemployment forecast by Fed: 4.3% for the next three years - SEP projection he used to assess the reaction function Fed cut forecast in SEP: 50 bps - He argued this was hawkish relative to the macro assumptions Expected cuts implied by his SEP reaction-function model: 75-95 bps - What he thought would be consistent with 4.3% unemployment and 2.5% core PCE CPI weight for shelter: 42% - He cited shelter as a major CPI component driving disinflation prospects CoreLogic single-family rents YoY: 1.7% (October) - Used as evidence of new-rent inflation cooling to cycle lows S&P 500 profit margins: +14% - Scenario used in his valuation work when considering the index’s current composition S&P 500 price-to-sales current level: ~3.0x - He said this still looks rich, but less so after accounting for current composition and margins Adjusted fair value price-to-sales: ~2.6x-2.7x - Historical margin-adjusted fair value estimate Possible price-to-sales with current composition: up to ~3.5x - If applying today’s composition and margin profile ROIC of >20% companies in S&P 500: 100+ stocks - Evidence that the index has much higher quality than past cycles Cap-weighted S&P 500 ROIC: ~23% vs ~12% in 2005-06 - Support for his not-a-bubble argument Gold target: $3,000/oz - His year-end gold outlook 10-year yield level that changes asset-allocation behavior: 5% - At this level, he said pension funds begin rotating toward bonds

Pivotal Quotes: "2025 was going to be a year where the theme was discovering neutral." — Warren Pius: Opening macro framework for the year ahead "I don't think the Fed made a mistake by cutting 50 basis points." — Warren Pius: His view that the September cut was appropriate and the bond selloff was market-driven "The housing market and thus the economy cannot handle that high of a mortgage rate." — Warren Pius: Explaining why a 4% terminal funds rate and ~7.5% mortgages would remain restrictive

Implications: Listeners should expect more volatility in rates and growth data, with housing and shelter inflation as key tells. If his view is right, bonds and gold strengthen later in 2025, while large-cap growth/quality beats small caps, value, and cyclicals.