Big Short Investor's Warning About Interest Rates in 2024

I think the expectation that the FED will cut rates three times from where I'm sitting is wrong. It's just everybody's coming to the year so bullish. If there are any disappointments, you know what's going to hold the market up after two years of rate hikes and the subsequent cooling of inflation. Jerome Powell and the Federal Reserve indicated in December that they would keep interest rates steady, a decision that they've held now for three consecutive meetings. But beyond this news, investors cheered at the Fed's outlook for 2024 that they would likely cut interest rates three times across the year.

The Federal Reserve opted to leave interest rates unchanged for a third straight time. We're seeing inflation making real progress. These are the things we've been wanting to see. Rate hikes appear to be over, instead raising the number of rate cuts. US stock futures are on the rise, with cuts indeed in the cards, perhaps as many as three rate cuts next year. The outlook going into 2024 is a lot more positive than it was coming into 2023. This news sent the stock market into a frenzy, with the S&P 500 rising a massive 133% in a two-month period after the Fed's November meeting.

But are investors now getting a little bit too excited with the US needing to raise a ton of debt in the next few years? The potential for reduced demand for US Treasuries and also the annoying fact that core inflation is remaining stubbornly elevated—is it possible that investors have put the blinders on and got a little bit too excited? Steve Eisman is definitely of that opinion, echoing the thoughts of people like Ray Dalio, Howard Marks, and Jamie Dimon. Steve, who found his success by being one of the few people to accurately predict the housing crisis of 2008, recently sat down with CNBC to discuss exactly how he sees interest rates playing out in 2024 and his opinion that investors are a little bit too bullish for the situation at hand.

He said, "If we were here a year ago, most of your guests would have come in and said the earnings of the S&P are going to be down, the market's going to be down, the economy is going to go into a recession in about 15 seconds, and none of that happened. So the market climbed the wall of worry the whole year. Now here we are a year later and everybody is, including me, has a pretty benign view of the economy. The only thing that bothers me is just that everybody's coming to the year so bullish that if there are any disappointments, you know what's going to hold the market up. But I think long-term, I'm still very bullish, but near-term I just worry that everybody's coming to the year feeling too good."

Eisman obviously has a very strong record of snuffing out over-excitement in financial markets, but instead of greed in the real estate sector this time around, he cautions investors against putting all their chips on the idea that the Federal Reserve will start lowering interest rates in 2024. "We've seen rallies in the end of the year as that consensus has taken hold that Fed will cut rates about three times. I think the expectation that the FED will cut rates three times, from where I'm sitting, I think is wrong, okay, or is too aggressive at this point."

He continued, "What is right in your view? Because the market believes that there's going to be probably at least two and maybe three. At this point, I think the best, if you had to lay your life on the line, I'd say one. Unless there's a recession, if there's no recession, I don't see any reason why the FED needs to be aggressive at cutting rates."

Steve raises a strong point here, going back to the basics of central banking. In a high interest rate environment, debts are more expensive, people have less free cash to spend to contribute to economic growth, but it's harder for inflation to persist in a low interest rate environment. It's easier for companies to expand and hire. It also gives more cash back to citizens by the fact that their mortgages aren't as expensive to service. But the downside is it creates a more inflationary environment.

So Steve's point is quite simply—why would the Federal Reserve rush to lower rates now when, generally speaking, citizens are holding up all right? Unemployment remains extremely low, which is unusual for a rising interest rate environment. But one risk factor does remain, and that is that inflation isn't 100% under control just yet. Jerome Powell and the Federal Reserve have stated countless times that the one thing that they are acutely aware of is the possibility that easing monetary policy could spark a second wave of inflation, and it is their top priority to avoid that from happening.

As we look ahead to next year, I want to assure the American people that we're fully committed to returning inflation to our 2% goal. Inflation has eased from its highs, and this has come without a significant increase in unemployment. That's very good news, but inflation is still too high. Ongoing progress in bringing it down is not assured, and the path forward is uncertain. So it makes sense that with inflation still a bit high, particularly core inflation, but most citizens doing okay and being employed, the Federal Reserve will probably err on the side of not lowering interest rates. As Steve says, there's no immediate pressure to do so, and doing so might actually cause problems.

"I'm actually of the view," Steve states, "the market seems to think the Fed's going to cut rates at least three times this year. I at this point don't have that view. I think the FED is still petrified of making the mistake that Volcker made in the early 80s where he stopped raising rates and inflation got out of control again. So I'm not that bullish on the FED cutting rates."

The 1970s was a particularly painful decade for America because of the mismanagement of their monetary policy. If we overlay the charts of inflation and then what happened in terms of interest rates, you can see exactly the problem. In 1967, inflation rose up to roughly 6%. Now to combat this, the FED funds rate was raised to 9%, which cooled inflation back down to around 3% in 1972. Now that's where we find ourselves today.

But then what happened? The FED took its foot off the pedal. It lowered rates back down to 3% and immediately inflation spiked straight back up, this time to 11% in 1974. The FED then had to raise interest rates to 13% to get things back under control. In 1976, inflation had cooled but only to 5.7%. The FED lowered rates back down to around 5%, but then in doing so again allowed inflation to spike right back up. Inflation got to 13.5% in 1980, and they called in a stern man called Paul Volcker who raised interest rates to a crushing 19%, and it was only then that inflation started to get under control, falling to 3% in 1983.

The short of it—three enormous spikes of inflation and three times the American people had to sit through periods of high interest rates, all because they didn't deal with inflation correctly the first time. That is what's currently sitting in the back of the mind of Jerome Powell, and that's why Steve Eisman doesn't believe the FED will jump at the opportunity to lower rates. "I think even if inflation does come in, if I'm the Fed and I'm looking at the Volcker lesson, I say to myself, what's my rush? Inflation has come in. If I don't, if I'm not aggressive in cutting, I could always cut rates tomorrow if things get weak. But if the economy is still flying and inflation has come in, why don't I keep rates here? I'm in Powell's seat. I pat myself on the back and say job well done, and the real risk is that I cut rates and inflation resurges, and then I have a real problem."

The more you think about it, what Steve noted here is the biggest risk for the Federal Reserve across 2024—the risk that they lower rates too soon, inflation picks back up, and they have to start all over again. So what would Steve do if he were in the position of the Federal Reserve? "If I don't cut rates, or if I maybe only cut once and I just sit there and wait, I can wait. I'll see how the data goes. That's what I would do if I were in their shoes."

You know what they'll do? Who knows? So it makes sense that the Federal Reserve will, at least for now, err on the side of not lowering rates. But keeping rates high does have big implications for the US government. The US national debt currently sits at $34 trillion, and because the US runs a deficit, it means that they need to take on more and more debt at current interest rates every year.

But also, when old debts come due, they need to refinance at higher rates. Now both of these factors mean that the US has to spend an increasing amount just on interest payments to bondholders, which takes away the money that they can use elsewhere. The other option is to simply take on larger chunks of debt to pay for this factor, but then you get into a scenario where the debt load can snowball and lead to a debt crisis.

So is the US in any immediate danger of something like that happening? US debt just went over 34 trillion today. Is there a scenario where there's a debt concern, a debt problem in 2024, or some sort of credit crisis that you're looking at? "100% no. 100% no. No. You know, in our business, we like to say being too early is the equivalent of being wrong, and there have been plenty of times in my career where I've been too early. But I'm not 40 years too early."

"You know, the people who are making this argument about US debt have literally been making this argument for the last 30 to 40 years, and they're still making it, and they're telling you to buy Bitcoin because of it. And you know, my attitude is when you're 40 years too early, have a little freaking humility and keep your mouth shut. So there's absolutely no evidence whatsoever that the dollar is going to lose its reserve currency status. People still want to buy US debt; they're not replacing it with Chinese debt. So, you know, until there's a real problem in the US bond market, I think we're just fine."

This is an interesting take because it seems to fly in the face of the opinion of someone like Ray Dalio. Steve Eisman is seeing no threat to the immediate demand of US Treasuries and no threat of the dollar losing its reserve currency status. However, Ray Dalio is very much concerned about the demand for US debt. Then there's the big question of the supply-demand for bonds. The government produces a certain amount of bonds that is equivalent to roughly the size of the deficit. That means they're going to have to sell a lot of bonds, and then we look at who are the buyers of those bonds and do they have an adequate appetite?

And that's a big risk because many who own those bonds have had losses. And that's not just banks; that is central banks, that is Japanese investors, and so on. And there's a supply-demand issue, so we're seeing the need for the rise in real interest rates so that the creditor gets an adequate return at the same time as we have a supply-demand balance. So that's how it looks to me.

So the question is, who the hell do you believe? Well, I actually think they're both right; they're just looking at a difference in terms of time frames. I do think Steve is correct that the US will not come into any sort of debt problem in 2024. The Federal Reserve itself notes that treasury bond auctions continue to be well-subscribed, AKA there are still lots of buyers of US debt out there, which protects its position as the reserve status.

However, Ray Dalio also has a point that over the long term, the trend isn't looking that great. Just looking at the most recent table for holders of US Treasuries, we can see that Japan's holdings are flat and China has reduced their holdings across the year leading up to October 2023. The Treasury Department themselves even note that while they did see a turnaround in foreign interest in bonds in 2023, they do believe there are longer-term structural headwinds as time goes on. Foreign buyers are absorbing less and less of the new debt issuance.

So long story short, I think both can be right here, and I think both would agree that the US needs to wake up and fix its deficit; otherwise, it's only a matter of time before they get pummeled with a debt crisis. But what does it all mean for investors heading into 2024? The debt situation is questionable; interest rates are likely going to stay higher for longer. But the market has gone on an absolute tear thanks to two things—the Fed's prediction of rate cuts in 2024 and also the insane hype around artificial intelligence and its impact on the big tech stocks.

Well, this was something that Steve was asked about. With the seven big technology stocks accounting for 60% of the S&P 500's rise in 2023, will this AI trend actually be backed by any meaningful earnings in 2024? "The stock market has realized a lot of the enthusiasm about this technology; again, being 40 years early. This is going to be something that dominates for decades. What do you expect it to do in 2024 for actual earnings, not just in the Magnificent 7 but across other industries?"

"You know, other than Nvidia and maybe AMD, and maybe some Microsoft, I don't think you're going to see that much of an impact on earnings in tech yet. It's going to be still very story-driven. You know, what I'm most curious about is other than the very, very large tech companies, nobody really yet has a real AI story to tell, and the question is, is anybody going to emerge? And it's only day one of the year. So I mean the best part of it being day one of the year, I haven't made many mistakes yet."

And that's what we largely saw happen in 2023. AI integration is obviously very early; it was really only kicked off when ChatGPT surged in popularity after its release at the end of 2022. I tend to agree with Steve that while 2024 might be a very important year for the world's major companies to integrate AI into their processes and their products, it doesn't look like there will be a big increase in earnings just based on advancements in AI.

A lot of the upcoming AI integrations and products from the world's biggest tech companies will still only be in development in 2024. The classic example is Tesla's full self-driving; they've been working on that for over a decade, and they're still not recognizing substantial revenues from it. Even ChatGPT, which was the first to release, is still very much in its infancy in terms of revenue generation. But that's not to say that AI won't power some businesses' earnings in 2024, as Steve raises a good point that one category of businesses that we shouldn't forget are those that work on the hardware side of AI—the NVIDIAs, the AMDs, the TSMCs.

While major tech companies may still be working on the software, they do need to purchase the hardware to power these experiments. And that's exactly why you saw the earnings of Nvidia absolutely skyrocket last year. In Nvidia's most recent filing, their revenue shot up to $18.12 billion, up 206% year-over-year. Their net income came in at $9.2 billion, a staggering 1,259% increase year-over-year, and it's all thanks to increasing sales in their AI hardware. Overall, Nvidia ended 2023 up 239%, making it the best-performing stock in the S&P 500.

So while we're very early in terms of AI integration into the products and services of those big seven technology stocks, there are still some big winners, but it's all in the hardware. So with that said, what does Steve think investors should do when it comes to these Magnificent Seven tech stocks? Nvidia is hardware-focused, but the rest are largely software-focused. What does he think of these companies in 2024?

"How do you feel about the backdrop of the economy with the Magnificent 7?" He says, "I don’t focus on that that much. I still think you have to have at least a significant percentage of your assets in the Magnificent 7. I think there are a lot of good things going forward in the market. Just, you know, just start the year, psychologically everybody is just a little too freaking happy."

So long story short, yes, there are reasons to be excited around AI and even the reasonably overvalued Magnificent 7. But in Steve's eyes, we need to be careful not to get too carried away. Just recognize that the FED has good reason to keep interest rates elevated this year, and until the average consumer starts getting a lot weaker, or unemployment starts rising, we probably won't see too many rate cuts.

Also, if you do want to learn how to analyze companies like Nvidia, Microsoft, Tesla, and so on, including reading financial statements and three valuation methods, definitely check out Introduction to Stock Analysis. It's a six-hour video course which takes you step by step through the full process of analyzing a company. That link can be found down in the description. But guys, apart from that, thank you very much for watching. Leave a like on the video, and that'll do us for today. I'll see you guys in the next one.