The number one risk to the market is growth, says 3Fourteen's Warren Pies

Stocks rallying today led by high growth areas like discretionary and tech. But our next guest warns many including key Fed members are overlooking one big risk to markets this year. 314 Research co-founder Warren Pice joins me now to talk it through. Warren great to see you. It's interesting you know for as steady as the broad U.S. economy has been in its performance the last year or two years we keep alternating between a growth scare and inflation panic. It feels like economic volatility as far as the market's concerned risk getting out of control. What are we in for as we as we get into 2025. Yeah. Thanks for having me in. Happy New Year. What you're describing is kind of what we've talked about before which is this is the soft landing path. It's just this oscillation between growth and inflation fears. My view is that our view at 314 is that is that we are kind of moving into this next phase of the economy where she's 2025 is going to be a year where we all kind of collectively try to discover what is the true nature of this economy. If you put this in economist lingo you'd say where is the neutral rate of interest. Neutral rate of interest is basically the interest rate the Fed where where where inflation and growth is perfectly balanced inflation and in job losses. And so basically I think that the Fed and their most recent SEP and most market participants are misinterpreting bond market signals and basically have gone too far into this inflation concerns. My view is inflation is going to fall pretty hard this year and that really the number one risk to the market is growth. And so neutral is going to we're going to get to the end of this year. The bottom line in my view is we can get to the end of this year. And I think collectively everyone's going to be wondering if neutral has even changed that much post pandemic. It's going to be much lower than what people expect. Interesting. So you say the Fed seems to be misinterpreting bond market signals. So I guess by that you mean that the fact that Treasury yields have gone up a fair bit since the September initial cut and then even further after the December Fed meeting that Fed officials see that as the market bracing for more inflation. And you say it's maybe not that. Yeah I mean I think that's a very common misperception that I'm seeing on the market right now is that you know we had like you said 100 basis point rise in the 10 year after the September cut. And the the I think one really predominant narrative out there is the Fed made a policy mistake by cutting rates. And I just think that ignores initial conditions. If you going into that first rate cut the Fed funds rate was well ahead. It was inverted with the two year yield and the 10 year yield. We've never had that kind of an inversion at the start of a cut cycle. And I think that was the bond markets way of telling the Fed that there was a real concern around growth and that there was a recession priced in to the bond market at that point. So the Fed came in and they basically reassured the bond market and that's the rise in rates as the recession got priced out of the bond market. And I'd say that was stage one of the bond sell off. And then of course Trump was elected and that introduced some policy uncertainty and ultimately was reflected in the December SEP by the Fed. And so that was stage two of this bond sell off. And so here we are at four point six percent on the 10 year seven plus percent on 30 year mortgage rate. And you have to ask ourselves when it comes to that neutral discussion I talked about can the U.S. economy handle a seven percent plus mortgage rate. And I think that the evidence is going to really become clear as we move through Q1 of this year and into Q2 that the real estate market in particular in the U.S. economy broadly can't handle this level of interest rates. And so it's going to force the Fed to cut. It just depends on the real question for us all is what kind of pain we're going to experience along that path. Yeah. I mean because you really could look at the December market activity and say this is essentially what the market was suggesting. Right. So as yields went up obviously housing related stocks went down but so did other cyclicals. I mean banks had a big reset lower you had industrials as well. So I guess the point is that you kind of alluded to it. What do we have to go through before we get to a point where either the Fed sort of capitulates to this view or you have you know I guess stock prices discounted in advance and then can recover. You have a seven and a half percent peak to trough correction on equal weight in the month of equal weight S&P 500 in the month of December. So that's I think a little taste of what we have in store for us. It depends on how hawkish the Fed wants to be. This was our view is that we're bullish on the market this year. We think the soft landings intact but ultimately Fed's going to have to cut. We have 100 basis point of Fed cuts in our base case projection. And I think that our view is that they're going to be a 10 or greater than 10 percent correction in the first half of this year. And it's going to relate back to this growth scare. So I do think it's going to be one of those things we have to keep our eyes out and wait to see when that that that growth scare starts to capture the market's attention. Our view our framework is going to be looking at the housing market and watching those home builders in particular you're seeing a stale inventory completed inventory at the largest builders like D.R. Horton has backed up inventory that's been on the market for more than six months is at a multi year high. I think that you're going to start seeing starts come down there and that's going to be the very first domino fall in this growth scare. So that's we're watching. I still think a few months before it starts. But yeah it'll be some pain.