Market Conditions Are Ripe for Long-Term Investment — Jefferies Chief Market Strategist

Episode Summary

The U.S. economy is delivering what may be once-in-a-generation investment opportunities, says Jefferies Chief Market Strategist David Zervos in this edition of The Informed Board podcast, hosted by Skadden M&A partner Ann Beth Stebbins.

Zervos points to accelerating productivity, a growing capital share of GDP, a favorable regulatory environment and strong demographic tailwinds as converging forces that make this an extraordinary time to invest and deepen both human and physical capital.

Zervos argues that the U.S. economy has demonstrated extraordinary resilience this year, absorbing a 50% spike in oil prices and adjusting for the elimination of expected Fed rate cuts. Notwithstanding these short-term shocks, the S&P 500 has risen by more than 8% since late February. He links this strength to a productivity surge that began during the COVID reopening and has accelerated through investment in AI, robotics and supply chain modernization.

Looking ahead, the midterm elections will be the most significant near-term risk for capital markets, he says, with outcomes potentially triggering either a positive tailwind or a sharp negative market reaction.

Zervos also unpacks what the installation of Kevin Warsh as chairman of the Federal Reserve could mean. He expects Warsh to try to reduce the Fed’s balance sheet, which Zervos says could allow the Fed to lower interest rates, a move that Zervos argues would better serve Main Street and ease the generational economic tension created by high interest rates and AI-driven labor disruption.

Jay Powell’s decision to remain on the Fed board could prevent a sharp change in Fed policies, Zervos says.

Voiceover (00:00):
From Skadden, you’re listening to The Informed Board, a podcast for directors facing the rapidly evolving challenges of a global market. A compliment to our newsletter for directors, our aim with this podcast is to help flag potential problems that may not be fully appreciated, explain trends, share our observations, and give directors practical guidance without a lot of legal jargon. Join Skadden partners who draw on years of frontline experience inside boardrooms to explore the complex issues facing directors today.

Ann Beth Stebbins (00:33):
How should boards think about the macroeconomic environment when making decisions? How do boards make long-term strategic decisions in times when we seem to be experiencing more frequent short-term shocks? And what factors should a board be focused on?

I’m Ann Beth Stebbins, a partner at Skadden and host of The Informed Board. Here to discuss these topics with me today is my guest, David Zervos, chief market strategist at Jefferies.

(00:58):
David, thanks for joining me today.

David Zervos (01:00):
Thanks for having me, Ann Beth.

Ann Beth Stebbins (01:02):
David, how should boards view the current macroeconomic environment? Is it a good time for business?

David Zervos (01:08):
I actually think it’s one of the most incredible times in recent history and, maybe even longer than that, modern history to be a capital holder. I think capital is getting rewarded in this U.S. economy in particular at an incredible rate, and that rate is growing. We’re seeing the capital share of income in GDP increase relative to the labor share of income. We’re seeing productivity as measured by the national income and product accounts start to accelerate quite rapidly. I would argue that it’s being underappreciated and I think, even with that under appreciation, it’s still coming out as an incredible storyline for capital.

(01:51):
So, in many ways, I think this is the time to invest. This is the time to think about leveraging both human and physical capital and taking that to the next level. Because of the overall economic outlook, the technological landscape, but also the regulatory landscape, the ease-of-doing-business landscape that we have, what the administration is bringing to the table in particular. And I think the financial environment, it’s just a time demographically where people are looking to hold capital in investment accounts and build those investment accounts. So you have a tailwind to folks who are looking to continue to increase their access to capital markets.

Ann Beth Stebbins (02:31):
Well, that’s all really good news for directors, right? They’re making strategic decisions. They’re making long-term bets. And they have these tailwinds you described. But what about headwinds? I mean, if I’m a director, am I worried about the war in Iran? Am I worried about energy prices? Am I worried about any other potential short-term shocks? How should I be thinking about that as a director?

David Zervos (02:52):
There’s always going to be reasons to stress out. I actually think we’ve learned an incredible amount about this economy and its resilience in the face of what’s happened since February 27th. It’s been a shock that we can really measure and look at and then ask questions about how did that feed back into financial markets.

(03:16):
The shock was a 50% increase in oil prices, maybe a little more, maybe a little less, but that’s a sizable short-term shock in energy prices. Importantly, on that date in late February, we were pricing in over two Fed rate cuts this year and another Fed rate cut next year, which have been completely priced out of the market. What’s happened in the last couple months is we’ve taken out the stimulus that was expected from lower interest rates at the short end, and we’ve introduced a headwind in terms of an input price shock to the system based on energy.

(03:54):
And what has the market done since February 27th? Well, what it’s done is it’s rallied 8%. The total return on the S&P since the end of February is close to 8%. That’s a startling statement to many.

Ann Beth Stebbins (04:08):
Does that surprise you? I mean, it surprises me.

David Zervos (04:11):

I think it surprises everybody, but it is incredibly informative more than it is surprising. This economy has looked through two incredibly large punches in the gut. And these are punches in the gut. What is that telling us? Well, I think what it tells you is the underlying strength of this economy is incredibly strong, and the resilience of this economy is incredibly strong.

Ann Beth Stebbins (04:38):
What does this mean for boards making decisions about capital deployment?

David Zervos (04:42):
So as we started out talking about, is this a good time to be an investor, is this a good time to lever up a business, is this a good time to engage in capital deepening both physical and human capital — whether it’s hiring better or more workers, or whether it’s investing in the infrastructure around them — I think the upshot of that answer to that question is absolutely, and it’s even better than you might’ve thought two months ago. That’s how I’m coming at it.

(05:11):
Now, we could step away now and think about, well, why did that happen? And there, you’re going to get into a big debate. You’re going to have a cohort of people that say, “Well, we found out that AI is just much greater than oil price shocks or politically motivated wars, so the AI is even stronger than we thought.” Maybe that’s true. Maybe that’s part of it.

(05:33):
There’s going to be a cohort that’s probably more sympathetic to the idea that the tax changes, the deregulation, the momentum that was behind the economy, maybe from the One Big Beautiful Bill and other actions, allowed that resilience to be strengthened in this year, particular as we have tax refunds, as we have a lot of the fiscal policy changes that have come into play for 2026. You’re going to have those on one side of the political spectrum saying this is because of MAGA-style policies. And then you’re going to have another that says it’s despite MAGA-style policies.

The reality is there is this resilience. It’s an incredible resilience. That’s what the takeaway is from the last two months, that we just have a storyline and a narrative here, particularly in the U.S. economy, that is incredibly strong.

(06:25):
I’m very focused on that as a theme and have been now since our recovery out of the COVID era took place. I’ve seen this productivity story developing for many years now. It has not been something that just magically appeared in the last six months or two months, or even last year. It’s been with us really since COVID began, since we reopened. If you go back, and you look at how we reopened, real GDP, the level of real GDP, got back to its pre-COVID levels a year after the COVID crisis. That productivity shock was unbelievable. And I think that was the beginning of more investment in supply chains, more investment in AI, more investment in robotics, more investment in things that allow people to have —

Ann Beth Stebbins (07:13):
And the things that make us resilient.

David Zervos (07:14):
Yes. And then it just became almost a self-fulfilling prophecy that a lot of this started to work. And we were on the brink of many great technological advances that were propelled by the need for those technological advances, a need for many businesses to adapt to a world where maybe we weren’t going to be able to have as much labor input. It was almost a defensive practice by many businesses and boards, obviously, to what had happened. And the ones that embraced a technological advance that allowed more adaptability on the labor front, they were the ones that prospered, and they invested in more. I think that’s where it began.

Ann Beth Stebbins (07:53):
Technological advances are driving GDP in the U.S. And for many businesses, this may reduce the need for labor. What’s the downside here if we have a large group of consumers that are negatively impacted by a shrinking job market?

David Zervos (08:06):
So, that’s the kind of the demand side, consumer demand side, of an economy that isn’t producing jobs at a rate that maybe we’re used to or more comfortable with, and we need to be watching for that very carefully.

Ann Beth Stebbins (08:20):
Do you see that continuing? Or do you see a retooling? What’s your expectation?

David Zervos (08:25):
I think the most important and deepest question that economists are going to grapple with over the next five to 10 years is, what is the repositioning of this labor force as we see these technological advances in a variety of industries and how those industries and the workers that are within those industries, more importantly, how they adapt to that?

(08:46):
The history books are pretty kind to the idea that people figure this out, whether it’s the mechanization of farming, whether it’s the railroads getting rid of the buggies and the horses and carriages that were moving goods and services across the country. We move forward, and people adapt. The speed with which we move is the important thing. And if the speed is too quickly, and that creative destruction is fast enough, you can create very disruptive political forces.

(09:12):
How do we make this transition to a place where productivity is skyrocketing, and the need to hire is not what it once was? How do we reset that job market without creating a lot of angst? It’s a tough question. I think it’ll be a question politicians need to answer. And the ones that get it right are the ones that are going to win. And winning may be the existential question on how our markets perform because, if winning means sort of a redistribution of wealth away from capital holders and back to those that are starting out in their life cycles, it’s going to probably take away from the overall growth rate of the economy. And if there is a way to kind of create apprenticeship programs and really find ways for businesses to bring along those that are affected the most by that disruption, it could be incredibly powerful for growth in the economy.

Ann Beth Stebbins (10:09):
I mean, could the midterms be the next gut punch? You talked about the two gut punches since February. And is there potential for a gut punch that could derail this momentum come November?

David Zervos (10:22):
For sure. I think that stands out to me as the biggest risk as we go into the second half of the year, both on the upside and the downside. I think the markets are already pricing in some retrenching and some pullback from the, let’s call it, the business-friendly policies that are in place today. To the extent that there is relief that that’s going to stay, which would probably be Senate staying in control of the Republicans, and the Trump administration-type policies continuing through that with only a minor disruption because of what changes in the House, I think you could have a positive tailwind. To the extent that there’s a larger repudiation of the policies that have been put in place, you’re going to see capital markets react pretty violently to that, I would imagine. So I think that’s the biggest risk.

Ann Beth Stebbins (11:11):
|Do you think that the political risks this year are greater than in other midterm cycles?

David Zervos (11:16):
I think so because the extremes are more.

Ann Beth Stebbins (11:18):
What changes do you foresee in a Warsh-led Fed?

David Zervos (11:22):
Let me discuss that in the context of Jay deciding he’s going to stay because I think that changes a lot of the dynamic.

Ann Beth Stebbins (11:29):
And how does that change the dynamic? He’s one of many governors now.

David Zervos (11:34):
His vote is an important vote. Most every committee requires the board to be involved in some way, shape, or form if there’s a major change in deregulation, if there’s a major change in financial stability, if there’s a major change in how policy operates with the balance sheet. Those seven members together have a huge amount of control. Right now, you have Miki Bowman as the vice chair, Chris Waller as a governor, and, if Kevin as the chair, having a fourth seat would give you four out of seven board seats. That fourth seat is incredibly powerful.

(12:09):
So, I think Jay’s decision to stay is much less about him trying to guide policy from the inside and stay as a force for the debate, but really as a fulcrum away from giving four out of seven seats to an agenda that may be, in his view, politically leaning toward this president’s agenda.

Ann Beth Stebbins (12:29):

But I never really thought about the Fed that way, maybe because I’ve never thought about the political composition of the Fed governors the same way we typically think about the Supreme Court.

David Zervos (12:39):
Well, it’s very important. The biggest story, I think, for your clients to think about with Kevin is his desire to reduce the size of the balance sheet, which would be a reduction in the liquidity in the economy and a tightening of monetary policy, and offsetting that tightening with a lowering of rates.

You have two policy tools and levers now in the post-crisis era. You have rates, and you have balance sheet. We’ve been using interest rates to calibrate monetary policy for centuries. We’ve been using balance sheets for 15 years. They have a lot of history with balance sheets that have been misused in places like Zimbabwe, in places like Turkey, Argentina, Brazil. We know what happens when you go too big on the balance sheet. It’s an overindulgence in monetary stimulus that turns into a very ugly scenario if you abuse it.

(13:30):
I think Kevin’s idea is, let’s get rid of this unconventional stuff, make it a little smaller, and that opens up a window to get the rate structure a little lower. And running a higher rate structure as a kind of basic monetary policy structure has distributional effects.

Big balance sheets tend to increase liquidity and stimulus going to big banks. But when you put that stimulus in via the balance sheet, it gets stuck in the banking system. It doesn’t always get to Main Street. It’s a nice elixir for Wall Street, but it doesn’t always get out of the banking system the way a lowering of rates does. A lowering of rates forces banks to compete in a different way and then allows that stimulus that the Fed is trying to get to the entire economy to be more evenly distributed. That’s a contestable statement. There will be many that might not agree with that, but I do think Kevin agrees with that, and I think that’ll be the direction he takes the board.

(14:26):
I think there’s the idea that if you can get these balance sheets a little lower, put a little less net interest margin into the pockets of the bigger banks, and trade that off for lower mortgage rates, lower loan rates in general, student loans and credit card loans, anything else, that that’s probably a good trade-off for monetary policy more generally in this economy.

Ann Beth Stebbins (14:47):
And is shrinking the balance sheet decision, that would be less politicized at the Fed? Is that a way for Kevin Warsh to build consensus that might not be as controversial as interest rate cuts?

David Zervos (15:01):
It’s hard to say. I think, look, the banking lobby has pushed very hard against shrinking the balance sheet significantly. They’ve done a great job of convincing the Fed, particularly through the New York Fed, that big balance sheets are needed, big balance sheets are good. We have lots of need for high-quality liquid assets in the post-Dodd-Frank world. We never sold any assets. We just bought them and then let them run off very slowly. And then we have these big, big stimulative balance sheets that have been with us for a decade plus. And it got in the way of thinking about what the real transmission mechanism is for monetary policy.

(15:36):
The bottom line is I think you’re going to have a pretty cogent way for Kevin to argue for a lower equilibrium rate structure at the expense of a balance sheet that comes down. And I think that’ll be an important recalibration of monetary policy that’s a little better for Main Street, not as stimulative, but still stimulative for Wall Street, and I think gives you a sort of interest rate tailwind to this economic storyline.

(16:05):
And I think it answers your other question, Ann Beth, which is, how do we get maybe some stimulus to the most disaffected parts of the economy from the AI disruption? And I think lower rates do that. I think people seeing their mortgage rates go down, or their ability to access a lower mortgage rate increase, people seeing their student loan and their credit card debt coming down ... If you think about how the structure of this economy is set up right now, boomers and late Gen-Xers like myself that have built up wealth and built up 401ks and own a house and have a pretty ensconced job, they’re not new to the labor market, things are pretty good. We got high rates. We can access those and lend our money and our capital at a higher rate. We’re not in a zero-rate environment or a negative real rate environment. Our assets are performing really well. Our job prospects are okay.

(16:56):
You start to look at youth, I mean, they’re the ones, when they have a high interest rate structure, that are the most troubled by that because they want to borrow on their future. Their future is theoretically very bright. We’re making it very expensive for them to borrow on the future, and we’re making their job prospects look about as troubling as they’ve looked in a generation because of the AI-like disruption. So this is really a generational conflict, and I think interest rates could be a fulcrum that brings the heat down in that debate and that asymmetry that sits in our capital markets and our economy today.

Ann Beth Stebbins (17:31):
David, how long will these good times last? Is this a cycle where there’s an end in sight? And when is that end?

David Zervos (17:39):
My profession is known as the doom profession. That’s economists. I tend to be the more optimistic soul in that world, but we always have some music that stops and less chairs to sit in, and people need to figure out when those are going to happen. I think at the end of the day, we do have a lot of tools on the policy side to deal with whatever shocks hit our system, whether it’s something in private credit, whether it’s something in geopolitics, or whether it’s something like what happened with COVID that just comes out of the blue. I feel pretty good that our policymakers have a toolkit that they’ve responded to with great force when those shocks hit.

(18:15):
So I’m optimistic that we can handle what the world throws at us. I’m also kind of going back to what we opened the discussion with — the two shocks that hit us, taking out these rate cuts that were priced in, oil prices up 50%, and here we sit with the market up 8% since all that began. That’s pretty resilient.

I’m comfortable that we’ve got a good road ahead of us. I think there are political risks around the corner that we need to hedge and think about. But all in, I don’t see those derailing us. I still think this is the place, being the U.S., is the place where capital gets treated the best in the world. That’s our exceptionalism. There’s nothing about this American exceptionalism to me other than we are the place that treats capital better than anywhere else, both human and physical capital.

(19:03):
And as long as that stays on a relative basis true, we’re going to prosper. We’re going to attract the best minds. We’re going to attract the most money. We’re going to be the innovators in almost every vertical, and we’re going to lead growth. And we’re going to lead returns on capital profits and earnings.

(19:45):
I’m not looking for any major pullback. I think we have hedges if there is something I’m missing. I just remain incredibly optimistic on the outlook for capital. I really do. I think it’s just an incredible time to be a capital holder.

Ann Beth Stebbins (19:56):
That’s a great way to end this podcast, David, on that optimistic note. And thank you for being with us today.

David Zervos (20:04):
My pleasure, Ann Beth. Take care.

Voiceover (20:06):
Thank you for joining us for today’s episode of The Informed Board. If you like what you’re hearing, be sure to subscribe in your favorite podcast app so you don’t miss any future conversations.

(20:16):
Additional information about Skadden can be found at skadden.com. The Informed Board is a podcast by Skadden, Arps, Slate, Meagher & Flom LLP and Affiliates. This podcast is provided for educational and informational purposes only and is not intended and should not be construed as legal advice. This podcast is considered advertising under applicable state laws.