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Inflation: The Fed 'doesn't have the guts' to raise interest rates by 6 to 7%, strategist says

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Smead Capital Management CIO Bill Smead joins Yahoo Finance Live to discuss the Fed's fight against inflation and why he doesn't think interest rates will get too high.

Video Transcript

- But now we have Smead Capital Management CIO Bill Smead. He joins us now with his thoughts on inflation and recession concerns. Always great to see you here. And what are you thinking about here with respect to inflation?

BILL SMEAD: Well, we think it's going to be a problem for quite a long time. And I don't think people have the respect for the circumstances that are set up here. If you look from a historical standpoint, when you have massive federal government expenditures to fight a war, and then you throw a much larger adult population group into the household formation years, and then you have an oil debacle at the same time, that's called the 1970s. And that's what we've got. And inflation was a problem off and on for 10 or 12 years. So we think that's very likely.

- Bill, I bet you never imagined going viral when talking about inflation, but that's what happened. And maybe it was because a misinterpreted headline, but millennials caused inflation seemed to be a headline that lit the internet up. Although listening to your point, I thought it was actually an excellent one. Do you care to explain the misconception or the misinterpretation of what happened with that one.

BILL SMEAD: Sure. We're very bullish about the economic benefits of having a large population of people between 25 and 42. That's a terrific thing. We're positive about the economy going forward. But those millennials didn't ask us to have a pandemic. They didn't ask us to spend $6 or $7 trillion at the federal government level to fight the pandemic. They didn't ask the OPEC countries to chop US oil producers off at the knees in the spring of 2020. They had nothing to do with those three factors.

And you take those three factors and put them with 42% who are 27 to 42-year-olds that we had, and you get too many people with too much money chasing too few goods. And what set that whole thing off is they said I blame them. No, I'm very positive, we're very positive as a company about the economy. But because we're positive about the economy, we're positive about millennial economic activity, we believe there's going to be a lot more demand than there is supply. And all that money is going to find a home at higher prices.

- Can millennials stave off, then, a recession by continuing to spend in the face of it?

BILL SMEAD: Well, that's kind of what the market's been hoping the last-- this last week. That's why the market's been a little better, every time that they're hoping that the economy will scare the Fed into backing off. But what you have to understand is this same set of circumstances happened in the '70s. Inflation ripped after the first Arab oil embargo in 1973. Then the Fed tightened credit to try to slow inflation down. Then they got it down to, say, four, and then the economy got better, and it moved up to six or seven.

And then they tightened credit and brought it down to five, and then the economy picked up and it went up to eight. And they did that all through the 1970s, they fought that, and the inflation didn't die until you took short-term interest rates dramatically above the inflation rate. Well, let's say the inflation rate average is five. That means you've got to go to 6% or 7% Treasury interest rates to kill this inflation. I don't see our Federal Reserve having the guts to do that over the next couple of years.

- Bill, I want to ask you about the housing market. Obviously, that's usually where we see the first impact in terms of mortgage rates. As you look at the generations, who's buying the most? And then some of the data that you're seeing in terms of slower confidence, we're seeing lower confidence, slower starts, what are you keeping an eye on in the housing market as it relates to the broader economy?

BILL SMEAD: That's a wonderful question. I'd like to take you on the road and ask that question when I do my CFA talks and so forth. We think that homebuilding is going to very good the next 10 years. We think that we weren't smart enough to sell them at the beginning of this year and buy them back at the low this year or whatever. We think it could be difficult for the next 12 months, but these companies have the best balance sheets, the largest market share, the best possible setup to have to sit through a contraction.

What I like to say to people, I say, you know, if your spouse loved you 3% less in an affection recession next year, would you divorce them? Well, that's what people do, is the economy contracts 3% for a year, and they sell all their stocks. So we think the homebuilders have an extremely bright 10-year future. And they're trading so cheap and have such good balance sheets that we're sticking with them and think there's a very bright end to that tunnel.

- Bill, the markets are betting my wife is going to love me 10% less. I'll take that 3 and I'll double down on that. But lastly, I want to ask you about big tech and these growth stocks that largely drove the markets throughout the week, and then social media got hammered today. Is there some room to run with big tech?

BILL SMEAD: We did a study about six months ago, we went back and looked at what the 10 largest cap companies were in the world at the end of 1980, 1990, 2000, 2010, and 2020. What we learned about those four prior sets of 10 stocks was they underperformed the S&P all four times, and two of those four times, they lost money compounded over a 10-year time frame.

So who were the largest 10 in '20? Apple, Microsoft, Amazon, Google, Facebook, Alibaba, Tencent. You get the idea. So statistically, there's almost no chance that group of stocks will beat the S&P 500, and 50% of the time after getting that popular, they lose money over the following decade.

- Excellent stuff. Bill Smead, really appreciate it, my friend. Have a good weekend.