EA Goes Private for $55B in Biggest LBO Ever, U.S. TikTok Valued at $14B & GDP Revised Upward

Ed Elson unpacks the deal to take Electronic Arts private and shares what he thinks the investors see in the company. Wedbush’s Michael Pachter also joins producer Claire Miller to break down why Saudi Arabia’s public investment fund is so interested in the company. Then, Ed and Scott dive into the pricing of the TikTok deal and explain why it appears to be illegal. Finally, Ed is joined by Mark Zandi, Chief Economist at Moody’s Analytics, to break down the latest revision to second-quarter GDP and what’s really fueling economic growth. Vote for Prof G Markets at the Signal Awards Check out our latest Prof G Markets newsletter Order "The Algebra of Wealth" out now Subscribe to No Mercy / No Malice Follow Prof G Markets on Instagram Follow Ed on Instagram and X Follow Scott on Instagram Learn more about your ad choices. Visit podcastchoices.com/adchoices

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• 1:29Ed Elson?

  Today's number two. That's how many people were sent to the emergency room last week by a squirrel in San Francisco. The squirrel has reportedly attacked more than five people so far. Local officials have not yet determined a motive, but they believe that the squirrel may have gone nuts.

• 1:51Speaker 05

  Money markets mad. If money is evil, then that building is hell.

• 2:01Ed Elson?

  Welcome to Prof G Markets. I'm Ed Elson. It is September 30th. Let's check in on yesterday's market vitals. The major indices all rose to start the week. Meanwhile, Treasury yields fell in anticipation of the jobs report due Friday. The price of gold breached $3,800 for the first time ever on the pending threat of a government shutdown. And finally, Etsy's stock popped 16% after OpenAI announced instant checkout, a feature for shopping within ChatGPT. OpenAI is piloting this feature with Etsy, but more than 1 million Shopify merchants will soon be available. OpenAI will collect a transaction fee from every purchase made within ChatGPT.

• 2:46Ed Elson?

  Okay, what else is happening? Video game maker Electronic Arts is set to go private in the largest leveraged buyout ever, valued at $55 billion. The investor group includes Saudi Arabia's Sovereign Wealth Fund, Jared Kushner's investment firm, and also private equity firm Silver Lake. The deal still requires approval from the Committee on Foreign Investment in the US, which evaluates foreign transactions for national security risk. The stock soared 15% to a record high last week, and shares climbed another 5% yesterday after it was confirmed. So EA Electronic Arts is being taken private for $55 billion, the largest leveraged buyout ever.

• 3:28Ed Elson?

  This is the company behind all of your favorite video games, Madden, The Sims, FIFA, which is my favorite game of all time. To be clear, this isn't the largest acquisition ever. We have seen larger, but it is the largest LBO ever. So a quick reminder, what is an LBO? What is the difference between that and just a regular acquisition? Well, the difference lies in how the deal is financed. With leveraged buyouts, the financing is mostly provided by leverage, i.e. debt. So that's what's happening here. JP Morgan is providing the debt to the investor group, and the investor group will then use that debt financing to take the company private. So the other question is, why are they doing this? What do these investors see in EA? I mean, yes, it is a great business.

• 4:13Ed Elson?

  They're doing around $7 billion in revenue. On the other hand, though, it is also a business that isn't really growing. In fact, revenue was flat this year and that's been a theme not just for EA, but also for the video game industry at large. I mean, ever since COVID, you had this explosion in the video game industry and then revenue started to fall back down, started to flatline. And since 2021, video game spending has fallen 12%. Video game stocks have been underperforming and that also includes EA, Electronic Arts. So to help us understand this take private deal, why did they pay $55 billion for EA? Our producer Claire Miller spoke with Michael Pachter.

• 4:55Ed Elson?

  He is the Managing Director of Equity Research at Wedbush Securities.

• 5:00Speaker 06

  The Saudis have been pretty vocal that they want to be in the game space for a long time and while they've made some meaningful deals, they haven't really gotten into anything other than mobile so far. So they made a tiny esports acquisition and then two big mobile acquisitions that have worked really well. But their stated goal from the beginning was that they wanted to create jobs in Saudi Arabia. And I think that's generational. I don't think they're looking to fire several thousand people and move them to Saudi Arabia. But they're hoping in the next 20 years that as these companies grow, they can replace workers and build out an economy in Saudi Arabia. And that's noble. They should be doing that for their people.

• 5:41Speaker 06

  It is the public investment fund, so nominally that money belongs to people of Saudi Arabia. And I think that this is a good step to making that happen. So the deal from their perspective makes sense because if you're going to get involved, get involved in a big way, pick off the biggest remaining guy that's available. I mean, 10 cents bigger, but not available. I think EA, from their perspective, it makes a lot of sense to sell while they can. Andrew Wilson got there and the stock was in the teens. It was up to the 170s before this deal, now over 200. Shareholders are getting rewarded, he's getting rewarded. And to be fair, EA had kind of stopped innovating. They had stopped really growing their core business.

• 6:27Speaker 06

  The Saudis, I think, can fix the business quickly by exploiting mobile, which they're great at with Scopely and Niantic, and by taking some of the core EA properties and making them free to play globally, like EA Sports Football Club Ultimate Team. If they do those two things, they pay for the deal. And those are two things EA wasn't going to execute properly. So I think the Saudis actually add value here.

• 6:53Claire?

  Why are the Saudis interested in the gaming space specifically? Why is that part of their long-term investment strategy?

• 6:59Speaker 06

  I wish I could give you insight into their minds. I mean, I think that the prince is a gamer. You know, he's the right generation. And I think that, you know, they have a very young population. And shockingly, Middle East and North Africa are the biggest, it's the biggest growth area for games. So I think it's something that resonates with the public. They haven't yet institutionalized that where they have a lot of people in degree programs making games. But I think they see that as an emerging, you know, economy and emerging opportunity. Everybody on the planet likes entertainment, you know? And it's a, you know, you're seeing like Arizona with opportunity zones for film. You're seeing everybody trying to get a piece of entertainment.

• 7:42Speaker 06

  Games is kind of the last bastion, last untouched area that, you know, people make games essentially at home. I mean, they don't, you don't have to have a core, you know, group of people in a particular location. So I think that the Saudis look at this as a growth opportunity. The aging population is going to buy more and more games in the next 100 years. And I think they just see it as a growth, you know, opportunity they can participate in.

• 8:08Claire?

  They're paying a 25% premium to the closing price from before the deal. What do you make of that premium? Is it warranted?

• 8:16Speaker 06

  It's enough to hold off anybody else. So the answer is nobody else is going to bid. Warranted, you know, EA probably generates around $2 billion of free cash flow. So they're paying 26 times free cash flow. The, the, the simple math for your listeners is, you know, divide one by 26. You know, so it's a 4% free cash flow yield. You'd be better off investing in treasury bonds, you know, so so clearly this is not a financial transaction. But if the Saudis can monetize by expanding EA into mobile, because EA sucks at mobile, you know, so if they're able to take these properties like like soccer and football and

• 8:57Speaker 06

  Star Wars and Battlefield and The Sims and make mobile games that work, they'll double that cash flow. If they take Ultimate Team, which is the free to play part of the sports, and take it from behind a paywall to free, I think you double that. So I could see these guys getting to six, seven billion in free cash flow by running the business more aggressively than EA has been running it, and that would pay for the deal.

• 9:20Claire?

  I'd like to get your thoughts on the video game space more generally. The industry is bigger than the music and movie industries combined, and Gen Z spends more time playing video games than they do on social media. So you would think that video game stocks would be ripping, but over the past five years, they've actually lagged the S and P 500. So before the deal was announced, EA's stock was up 27% in that timeframe. You compare that to the S and P at nearly 100%. Why do you think gaming has lagged the market?

• 9:51Speaker 06

  Because the public companies aren't really pure play for participating in game growth. The the game opportunity, simply stated, the $200 billion global games market that's bigger than movies and music, that's about 150 billion mobile. And then the remaining 50 billion is about 30 billion of free to play on PC and console and 20 billion of game sales. The EA's of the world, most of their revenue comes from game sales. You know, they're probably 60% from game sales and 40% from other. So you really weren't participating in that mobile business at all, and that's really where the growth is, or in that free to play market, just a little bit, and that's where the growth has been.

• 10:35Speaker 06

  Console and PC buying games, that's yesterday's business. Your kids aren't going to ever buy a game. Your kids are going to play free to play all the way, and they're not going to ever own a console. They're going to play on a connected TV. So the opportunity in gaming isn't EA. The opportunity in gaming is, you know, Microsoft and Amazon and Google with cloud and Nvidia with cloud chips and anybody else who creates the cloud infrastructure to make that happen. So AI and tools, Roblox. Roblox is the one that actually will participate in that because they have that the they're essentially the YouTube of game creation. So they'll participate, but it's hard to buy the rest of these guys.

• 11:19Speaker 06

  So look at Roblox stock. That's outpaced the S and P by a lot because the market gets that. EA is lagged because they weren't participating in the areas that are growing.

• 11:29Claire?

  I found it interesting that the candidate for the largest LBO in history was a gaming company. Was that surprising to you at all? And if not, do you think this will be kind of a starting gun for VCs to re-enter the gaming space?

• 11:45Speaker 06

  I don't think that being the largest makes any difference at all. Like I, I can't remember the name of the book, but I read a book and they made a movie out of the RJR LBO, which I think-

• 11:56Claire?

  Barbarians at the Gate.

• 11:57Speaker 06

  Yeah, there you go. That was it. It was like 20 billion or something. And, you know, that's back when we all valued consumer packaged goods. So now all this is really telling you is that people are looking for IP as a, as a play. But, you know, ultimately, no, they'll be a bigger deal. You know, there, there are plenty of companies that are worth a lot more. I mean, Microsoft is worth a lot more. Amazon's worth a lot more. Not that anybody's going to buy them, but Tesla's battery business is worth more. You know, so Tesla's self-driving car business is worth more. So no, I, I'm, I'm surprised it took this long to buy a game company.

• 12:37Speaker 06

  EA was for sale back in 2000 and again in like seven and again in 15 and again in 19. You know, they've, they've constantly been for sale. The problem is that they didn't have a buyer. It was always, oh, the big media companies. Comcast has its own problems. They're not buying anybody. You know, Warner Brothers has its own problems. I mean, look what's going on with Paramount and with Warner Brothers now. It's like Larry Ellison, the knight on the white horse is coming in to save, you know, traditional media. So I think it really is just that it takes somebody weird and thinking different like the Saudis. By weird, I mean their motive is not to make money. Their motive is to drive, you know, business to Saudi Arabia.

• 13:21Speaker 06

  And that's different and that's they can afford to pull this off. They will, in fact, make money because I think they will do things EA was really afraid to do. Like make FIFA Ultimate Team, EA Sports Football Club Ultimate Team free to play. So, yeah, I guess I was surprised, but it's not surprising.

• 13:40Claire?

  Got it. It's very interesting. Thank you, Michael. I appreciate you joining us.

• 13:44Speaker 06

  It's my pleasure. Say hi to Professor G, my idol.

• 13:46Claire?

  I will. Thank you. Take care.

• 13:49Ed Elson?

  That was Michael Pachter, Managing Director of Equity Research at Wedbush Securities. Ultimately, what this really comes down to is attention. I mean, the truth about the video game industry is that it is one of the most powerful attention arbiters in the world. Young people spend a quarter of their entertainment time playing video games. Gamers play an average of fifteen hours per week, which is roughly the same amount that Americans spend eating, caring for their children and socializing combined. So these are total attention merchants. They are absolutely crushing it in terms of locking in our attention. What these companies lack, however, is an ability to monetize that attention,

• 14:34Ed Elson?

  or at least an ability to monetize it as effectively as companies like Meta and Google and ByteDance. In fact, despite the amount of attention they receive, video games account for only three percent of global advertising spend. You compare that to television, which commands roughly twenty-three percent of global ad spend. In addition, there was this other study. It found that brands spend less than five percent of their marketing budgets on video games. So what you have here is a surplus of attention that is not really being monetized all that well. I mean, if attention is the new oil, then this is basically an oil field that has been identified. It's been surveyed. It's been tapped. It's been drilled.

• 15:18Ed Elson?

  The only thing left to do now is to sell that oil. That's what they need to do now. And perhaps that is what makes EA such a great target for an LBO, for a leveraged buyout. And that is, the hard part here has already been done.

• 15:35Ed Elson?

  These tech companies, these video game companies, they have gotten the attention. They've already done that part. And now it's time for the private equity guys to step in and do what they do best. And that is monetizing, taking the asset and figuring out how to squeeze as much cash as possible out of that asset. And by the way, private equity is incredible at this. They did it with healthcare, they did it with industrials and retail. And so now, now it's perhaps time to do it with video games. This is the perfect opportunity in a lot of ways because ultimately there's a lot still left to be squeezed out of the video game industry. Now, does that mean that EA games are going to get better? Probably not. This probably isn't great news for gamers.

• 16:20Ed Elson?

  And as Michael said, EA will move towards the mobile and free to play markets. In other words, more banner ads are on the way. But it does mean that EA games are about to get a lot more profitable. And that is the opportunity here. That's why they paid $55 billion, a 25% premium, the largest LBO in history. But in our view, that was worth every penny.

• 16:49Ed Elson?

  The White House revealed that the TikTok deal will value the US version of the company at $14 billion. That announcement came after President Trump signed an executive order approving the proposal, which will keep TikTok operating in the US. ByteDance, however, has not confirmed any agreement. So a couple of weeks ago, we asked this question. What will the pricing of the TikTok deal look like? And what will that pricing tell us about the nature of this deal? Well, we now have our answer. It is $14 billion. That values the new entity at roughly one time sales. That's about the same multiple as General Mills. And for comparison, Meta trades at roughly 11 times sales. So 11 times sales versus one time sales.

• 17:34Ed Elson?

  And this is for a company that is actually growing faster than Meta. It's the fastest growing social media platform in the world. It's the platform from which 40% of young Americans get their news. Supposedly, that company is worth $14 billion. Supposedly, it is actually less valuable than Domino's Pizza. So, right off the bat, the deal looks ripped. And if this were a company that were trading on the open market, if this were a free auction, if this were going public, for example, you'd probably be looking at a valuation above $50 billion, maybe closer to $100 billion. And even that, depending on your perspective, even that might be cheap. This is $14 billion.

• 18:19Ed Elson?

  Now, there are some caveats. Supposedly, ByteDance is going to charge a licensing fee, and apparently that will translate to roughly 20% of the company's revenue. So that partially explains how cheap the pricing is here, but it certainly does not explain all of it. How did they land on $14 billion for the US version of TikTok? I don't know, but something certainly seems off here. Let's bring in Scott Galloway. Let's see what he makes of this new detail.

• 18:53Ed Elson?

  Scott, good to see you.

• 18:55Scott Galloway?

  Good to be seeing my brother Eduardo Edgimonte, Edwino.

• 19:00Ed Elson?

  This is good.

• 19:01Scott Galloway?

  Yeah, this is good.

• 19:02Ed Elson?

  Nice, nice new nicknames.

• 19:03Scott Galloway?

  Yeah.

• 19:03Ed Elson?

  We want to get your reaction to the TikTok news. TikTok, we finally have a valuation. We have a price on the deal. $14 billion for TikTok US. Your thoughts on the valuation?

• 19:17Scott Galloway?

  Well, depending on who you talk to, whether it's that guy Ashwan, who's the tech analyst, or other analysts who tried to put a fair value on it, or just looking at multiples on other companies, it's going for somewhere between 70 and 90% off of retail, off of what it would get if this was a true deal and people were allowed to bid on it. As a matter of fact, I think earlier in the year, I forget his name, the guy who owned the Dodgers at one point, put together an investor group and offered, I think, 50% more. And my understanding is that the deal includes sort of a tail or a claim on up to forty or fifty percent of the profits back to ByteDance. But even if you doubled the valuation to twenty eight billion,

• 20:02Scott Galloway?

  it's still basically a massive discount to its free market value.

• 20:07Ed Elson?

  Well, I was interested to hear some of those valuation numbers there. I saw reports that or estimates that this company, this US company should be worth around fifty billion dollars, which I also thought that was low. I mean, TikTok US compared to, let's look at Reddit, for example, forty, around forty five billion dollars or Twitter, which was in the same ballpark, forty to forty five billion dollars. And this is fourteen.

• 20:32Scott Galloway?

  So if we're going to play the valuation game, I think they'll do somewhere around fifteen billion this year, or somewhere between twenty and fifteen billion, just in the US. If it got the same valuation as Meta, and I don't see why it wouldn't, ten times revenues, you're looking at one hundred and fifty billion. If these guys, if this deal actually goes through, and I'm still suspect the deal is going to close, you're looking at an IPO, the value is the same, probably at one hundred and fifty billion to a quarter of a trillion dollars, which will be a ten X markup for basically either investing in one of Trump's shitcoins or investing in his campaign. So if you're an ally of the president's, you get an investment that will likely be marked up ten X on billions of dollars of deployed capital within the next twenty four months. That's a straight oligarchy,

• 21:18Scott Galloway?

  socialism deciding who gets, who gets, you know, deciding, picking winners and losers amongst your friends. It's a cross between corruption, socialism and oligarchy. And my disappointment is that there are more Democrats kind of raising their hand and saying, yo, Ellison and Susquehanna, this is an illegal deal. You are engaging in illegal business activity. And as soon as there's a real attorney general in office, and the next three and a quarter years will go fast, we're going to unwind this fucking Frankenstein of a deal. It's just, I find it very frustrating that the rule of law and the basics. You know, I met somebody who's who's participating in this deal and all of these guys are just,

• 22:00Scott Galloway?

  they are such quote unquote free marketer warriors. They talk about the markets and competition. And then when they get a chance to participate in what is corrupt oligarchy, they're they're all for it. You know, Sequoia, General Atlantic, all of these guys know this is total bullshit. You know, something tells me the Soros funds weren't invited to bid on this deal. Right? Something tells me even a guy like Ken Griffin, who's a moderate, unless you've already given to the Trump campaign and you're hardcore on his side, no matter what he does, you do not get to participate in what has traditionally been a free market around this. So.

• 22:40Ed Elson?

  Your friend who got in on the deal, do you know how he or she got the call?

• 22:48Scott Galloway?

  Yeah, he's giving a shit ton of money to Trump.

• 22:53Scott Galloway?

  And by the way, it's not my friend.

• 22:54Ed Elson?

  Which, okay, your acquaintance.

• 22:57Scott Galloway?

  It's somebody I know and I know it is it is going to get to participate in the deal.

• 23:01Ed Elson?

  Got it.

• 23:02Scott Galloway?

  But and has been.

• 23:03Ed Elson?

  Which seems to be a very key detail. I mean, the thing that we're describing here, the thing that you're describing is illegal is the nature by which this deal was finalized. I mean, the idea that only a select set of people are getting access to this deal that prices the company at what I believe and what it sounds like you believe is a ridiculously cheap valuation. This is a question that we asked several weeks ago. It was, we'll know if this deal stinks because we'll look at the price of the company. And if it's a joke of a price, which in my view, fourteen billion dollars is, then we know this was a setup. And the people who got in on the setup were friends of the president and you have firsthand evidence right here.

• 23:46Scott Galloway?

  Name a Democrat in this deal. I mean, here here's, okay, so first off, it's probably a violation of all sorts of intra, you know, international trade agreements. We're not supposed to do this. Having said this, China pulls this kind of shit all the time. So let's. Let's walk past the back. Let's give the president some credit and say this thing is a threat to the US and I have figured out a way to capture some economic value while reducing the risk of the the the defense threat of a propaganda machine affecting our use. Okay. And he wants Americans to, because they've created the value by spending so much money on this thing, they want Americans to capture it. All right. That violates all sorts of international trade treaties, but okay, fine. Then the way you would do this

• 24:29Scott Galloway?

  is you would, you would say, okay, here's the company. It will be owned by something called TikTok US Co. Now it's an auction. Who's going to pay the most for it? And, and then those people pay a market price. And by the way, the existing investors either get cashed out, or they can roll their stake, or they can bid on new TikTok US Co. But to, to price it at an incredibly low price and then hand it out like a birthday cake to your donors is flat out corruption. So, okay, I'll tell you what. Ed and Scott will bid fourteen billion and one dollars. I'm not exaggerating, Ed.

• 25:08Ed Elson?

  We could raise it in a second. If they said yes, we'd go out and raise it. Easy.

• 25:11Scott Galloway?

  If all of a sudden, we had a tangible chance of getting TikTok, the rights to US TikTok, you and I could raise that money in about seventy-two hours.

• 25:23Ed Elson?

  You know, I think we should try to do it. I think that's what we need to do.

• 25:27Scott Galloway?

  Well, here's the thing. If there's a case, I mean, if you really, and I'm, and I'm down for this kind of stuff, put together an LLC, bid fifteen billion, and then when you don't get it, which you won't, you, you basically have a suit, in my opinion. You have a very tangible legal case against the government for, for not, you know, for, for not going to the highest bidder. That is what you are supposed to do. If they're closing DMVs, or they're closing Veterans Affairs buildings, right? They take that real estate. There are emoluments clauses, or I don't know what the term is, where when you sell that real estate, you're not allowed

• 26:09Scott Galloway?

  Westwood Park or in Westwood, the VA has some of the most prime real estate, Veterans Affairs Building. I don't know if they're closing that building or not, but that real estate is probably worth three or 400 million bucks. There are all sorts of laws saying you have to sell it to the highest bidder because US citizens own that land. And if you just carve it up and give it to the most right wing LA real estate developer who happens to support Trump at a below market price, you are cheating US taxpayers out of money. And that's the same thing as here. They are taking somewhere between 30 and 60 billion dollars

• 26:49Scott Galloway?

  of gains from US citizens and investors that should have the opportunity to buy this thing and bid it up.

• 26:57Ed Elson?

  Uh huh. Well, you recently predicted that this wouldn't go through. This is the update we have right now is that this is still a framework. We still don't have any signed terms. We don't have any, I mean, we don't really have anything. The White House has said that Xi Jinping has signed off, but the Chinese government has not approved of the deal, or at least they haven't said anything publicly. So it appears maybe this is going through, still not totally clear, but let's just get an update on your prediction. Do you think a deal is going to go through? Last time we spoke, you said, no, it's not going to happen. Do you think it, do you think it might?

• 27:34Scott Galloway?

  Look, there's no doubt about it. The likelihood it's going to close has gone up.

• 27:38Ed Elson?

  Yep.

• 27:38Scott Galloway?

  And I don't, I don't, you're going to find this hard to believe, Ed, but occasionally I'm wrong. I know, I know it doesn't seem that way. But, but yeah, maybe it closes. I guess my question is, one, does it get overturned in some sort of court? Two, is Xi Jinping just playing, you know, slow ball with a president that has the attention span of a cat on meth? I mean, so what, you know, I don't know, but I would put it at, you know, it's now, I would say kind of 50 50, maybe 60 40 that the deal closes. And this is, um, I don't know. What was the term I used? Bullshit. This is bullshit, Ed.

• 28:23Ed Elson?

  Well, Galloway and Alison Coe will be putting in a bid for $50 million.

• 28:26Scott Galloway?

  GE.

• 28:27Ed Elson?

  So stay tuned.

• 28:27Scott Galloway?

  GE. It makes a comeback. That's right. You're the Jack Welch of podcast co-hosts. There you go.

• 28:36Ed Elson?

  That's pretty good.

• 28:37Scott Galloway?

  By the way, I'm in my gym just because I'm shocked you even recognize me. I just worked out, I'm so jacked. And I'm trying to, I'm trying to up our female, our female base here. Hello, ladies. Hello. That's right. You come, you come for the young and the handsome. You stay for the old and sort of rich.

• 28:58Scott Galloway?

  All right, Ed.

• 28:59Ed Elson?

  All right. Kick him out, quiet.

• 29:03Scott Galloway?

  See you, guys.

• 29:05Ed Elson?

  Thank you.

• 29:07Ed Elson?

  After the break, a look at the revised GDP data. If you're enjoying the show, give Prof G Markets a follow and vote for us at the Signal Awards. We will put a link in the description for you. Thank you and stay with us.

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• 30:59Ed Elson?

  We're back with Profi Markets. New GDP revision data recently came in and the results were promising. Second quarter GDP was revised upward to an annualized rate of 3.8%. That is well above the second estimate of 3.3% and well above the first estimate of 3%. The boost came from stronger than expected consumer spending data. And looking ahead, the Atlanta Fed projects third quarter GDP to come in at 3.3%. So the economy looks stronger on paper and it is the consumer that is keeping it going. Personal consumption expenditures rose 0.6% in August. Spending was especially strong for physical items with a 0.8% rise in both durable and non-durable goods.

• 31:42Ed Elson?

  However, the question that we have raised before and which we must again raise here is how much does this actually tell us about America overall versus rich America? I mean, as we've discussed before, there's this groundbreaking data from Mark Zandi, which found that the top 10% of Americans are accounting for half of all consumer spending right now, the highest share in American history. We are obsessed with this number and rightly so because it appears maybe if GDP growth is growing because of the consumer spending here, could it be that that is what is driving the GDP growth? Could it be that rich people are driving the real economy? Or?

• 32:26Ed Elson?

  Is it that America is overall doing very well right now? Well, to answer this question, we are speaking again with Mark Zandi, Chief Economist of Moody's Analytics. Mark, thank you for joining us once again on Prof G Markets.

• 32:40Mark Zandi?

  Thanks, Ed. It's good to be with you.

• 32:42Ed Elson?

  So GDP has been revised up to 3.8%. People are feeling pretty good about it. The White House is feeling pretty good about it. But I just want to point our audience to something you wrote today. You wrote, quote, "Recession risks appear to have receded with the revised GDP numbers, but they remain uncomfortably high." Could you elaborate on what you meant by that?

• 33:07Mark Zandi?

  Yeah, sure. Well, the upward revisions are good. I'll take them, particularly to consumer spending. It looked like the American consumer was going to take a hike here, but back in the game. So that's really good. But even with the better numbers, the economy is growing below its potential, which means it's not creating any kind of jobs that will keep unemployment. Low unemployment is, it's low, but it's on the rise. So the economy is, I would characterize it as struggling. And that's most evident, again, in the job market. We're just not seeing any job creation. What job creation we are seeing is just concentrated in a couple of industries. So, yeah, the economy is, is growing. It's not recession. That's, that's really, really good.

• 33:52Mark Zandi?

  But the coast is not clear. You know, we're still growing well below where we should be, and we're very vulnerable to anything else that could go wrong.

• 33:59Ed Elson?

  You mentioned consumer spending there. The big revision was consumer spending, which was originally reported to have grown 1.6% from the previous year. It's now been revised to 2.5% annual growth, which is strong. But this does bring us back to your data once again, specifically the fact that, as we've discussed on the, on the show many times now, the top 10% are making up half of all consumer spending in the US. So there is this question we have to kind of ask again. If it was consumer spending that drove up that GDP number and rich people are making

• 34:40Ed Elson?

  up half of consumer spending, does this not just tell us the same story again that the real story isn't that the economy is growing, but actually that it's growing specifically for rich people?

• 34:52Mark Zandi?

  Well, I mean, it is growing for rich people. I mean, and I do think, you know, what probably happened here was, you know, the more stock market rallied big time, you know, in late April through May and June. And of course, high income, high net worth households are focused on their stock portfolios. If they see green on the screen, they feel a lot better. They go out and they spend more aggressively and, you know, with less caution. And I think that's what we saw here. I think and that's what we're seeing coming into the third quarter as well, that so-called wealth effect. But as you point out, it does mean that the economy is very dependent on these high income, high net worth households,

• 35:36Mark Zandi?

  the wealth do, and thus very dependent on the stock market. And that's just not a very comfortable place to be. Thus, you know, my comment that the recession risks are still uncomfortably high because if anything goes off in the equity market, and there's lots of things to be nervous about there, we can talk about it. Now, that will weigh heavily on that group and by extension, the broader economy.

• 35:57Ed Elson?

  Let's talk about it. I mean, what I wanted to talk about it, you mentioned, I saw you on Twitter today, you were pointing out your favorite measure of the stock market, which is the Wilshire 5000 to the after-tax corporate profits ratio, sort of like a basically a P E ratio, ratios currently at 20. Last time it was that high was, wait for it, the dot com bubble.

• 36:22Mark Zandi?

  Right.

• 36:23Ed Elson?

  Which doesn't paint a particularly comforting picture of what's happening in the economy right now. Your thoughts on what is going on in the equity markets and perhaps what it might say about the recession risk going forward?

• 36:36Mark Zandi?

  Well, you know, I don't want to draw too strong a parallel back to Y2K and the internet bubble.

• 36:42Ed Elson?

  Yeah.

• 36:43Mark Zandi?

  I do think the companies that are driving the stock market higher today. Our real companies are obviously juggernauts, you know, making lots of money and they have a very important technology that's going to advance the ball here and drive a lot of growth. So they, you know, think are on solid ground. But even saying that, prices are up an awful lot. Investors are expecting an awful lot from these companies. You can see the capex they're doing and compare that to just even the revenues that they're generating. They're rising very rapidly, but it's hard to square the circle and make the economics of all this work. So valuations are high. And again, you know, I point out, this is

• 37:25Mark Zandi?

  not atypical when you get into periods like this. Investors take something and to the to the nth power, to the extreme, they go, this is great. And then they drive stock prices up, anticipating even greater greatness. So it feels like it's getting ahead of itself. And that's the point of that ratio of the Wilshire 5000 after tax corporate earnings. It's like an economy wide P ratio price earnings multiple, and it is awfully high and headed straight north. So, you know, it gives you another reason to be nervous about what's going on, that the, you know, if the stock market, if these companies stumble in any little way, it can be simply, and I'm making this up, they're not growing 100%, they're

• 38:06Mark Zandi?

  growing 93%. You know, that might be enough to send the stock market from green to red. And that would be enough to upend kind of the spending by the high income group and thus the economy is vulnerable to that and those recession risks.

• 38:21Ed Elson?

  Just to spell out what you're kind of describing here. Basically, you've got, so you've got GDP growing at a pretty high clip. So you've got strong economic growth, but then you dig into it and you realize why is it growing? Or what is the reason behind this big revision? It's because of the consumer spending. That's what's really driving the growth. And you think, okay, why is the consumer spending up? As you've said, half of that is being driven by the top 10% of Americans, 25% is being driven by the top 3% of Americans. So it's rich people that are really driving that growth in the real economy. And then it's, okay, why are rich people spending so much? Why are we seeing that growth? Because

• 39:03Ed Elson?

  the stock market is so high. And so they have that, as you say, that wealth effect. They feel rich right now, especially rich today, hence why they're spending like this. And so what we have, if I were to sort of Simplify things is you've got the stock market, which is almost driving the real economy. And I think that's interesting because I think the way we often think about it in economics is that it's the real economy that drives the stock market. If things are growing, then investors sort of see what's happening. They process that and they lift up valuations. It seems to me that the dynamic has switched, that actually now it's valuations that are driving economic growth.

• 39:47Ed Elson?

  And therefore, if valuations, for whatever reason, come down, there's some snap in the narrative, then actually you're not just going to see a stock market crash, you're also going to see a real crash in the real economy, too.

• 39:59Mark Zandi?

  Yeah, I mean, you laid that out very nicely. Just two things that I just put more color around. First, where you began, the economy's growing quickly. No, I mean, in the second quarter, it grew quickly, but in the first quarter, it actually declined. Right? So

• 40:14Ed Elson?

  Yes.

• 40:14Mark Zandi?

  And that's because of the ups and downs and all arounds related to the tariffs. So if you kind of look at the underlying growth rate in the economy, I'd say it's still pretty punk. I mean, as I said, it's below the economy's potential, which means it's not growing fast enough to absorb even the weakened labor force. And we're seeing unemployment continue to rise. So the economy isn't growing strongly. It's growing, you know, it's not in recession, but it's not growing all that well.

• 40:39Ed Elson?

  Yep.

• 40:40Mark Zandi?

  And then I just reinforce something you said about the stock market and causality. You know, obviously, the causality works in both directions. You know, the stock market impacts the economy, economy impacts the stock market. Most times, the direction of travel here is the economy is driving the equity market. But at times, you know, in times of euphoria, like the ones we're in now, the causality shifts and the stock market drives economic activity. And that's, that's the environment we're now in. And historically, when you're in that kind of environment, it doesn't generally end well. You know, generally. Uh, the stock market takes things too far. You know, there's real reasons why the stock market are up. It should be up, but it's it's up a lot and getting ahead of itself

• 41:24Mark Zandi?

  and it's getting over its skis and it doesn't take a whole lot of something not sticking to script in the stock market, you know, goes down and then the the positive of from this equity market to the economy turns into a negative from the from the stock market to the economy. So you did a really great job. It's those two things I would just hone a little bit.

• 41:47Ed Elson?

  Yeah.

• 41:47Mark Zandi?

  Just in case you decide you want to explain that to somebody else.

• 41:50Ed Elson?

  Yeah, yes. Thank you, sir. Uh, one final narrative violation is what I would call it that I'd like to get your reaction to.

• 41:58Mark Zandi?

  Yeah.

• 41:58Ed Elson?

  We see consumer spending is up. Um, that's, that's again what drove this revision, but we also have consumer sentiment, the consumer sentiment index from the University of Michigan, which actually fell another 5% this month. It's down more than 20% from a year ago, which does not seem to fit with the consumer spending narrative. To me, it seems to reinforce your

• 42:22Mark Zandi?

  Yeah.

• 42:22Ed Elson?

  point about this is really the rich people economy. I just want to get your reactions to that consumer sentiment index, the fact that it is down 20%. Is that something that we should be taking seriously?

• 42:32Mark Zandi?

  Yeah, I mean, I think it goes to the to the point, the broader point that, look, you know, the folks in the part, top part of the distribution of income and wealth, let's say the top 10, 20% of the population, they're fine, no problem. They're feeling good. In fact, they're feeling great now with the stock market up. Uh, but

• 42:47Ed Elson?

  Yeah.

• 42:48Mark Zandi?

  the rest of the population, the 80%, not so much. I mean, they don't own much in the way of stock, if any. Many of those folks don't even own their own home. And unlike the folks in the top part of the distribution, they owe money, right? It's not like they own a lot of stuff, but they owe money. They own credit card, on credit cards, on auto loans, student loans, you know, if they're lucky, they own a home or mortgage. So they're in a very different spot. And now they're seeing inflation on the rise because of tariffs and immigration policy and their incomes are not rising any faster than the rate of inflation. So you add that all up, doesn't make for the kind of environment where you feel really good about the economy. And that that explains this this seeming disconnect

• 43:30Mark Zandi?

  between the top line numbers and what most Americans think about the economy.

• 43:35Ed Elson?

  All right. Mark Zandi, as always, we really appreciate your time. Thank you.

• 43:39Mark Zandi?

  Yeah, anytime, Ed. I appreciate the opportunity.

• 43:43Ed Elson?

  That was Mark Zandi, chief economist of Moody's Analytics. So yes, GDP is growing, yes, consumer spending is rising. But again, we go back to this question, this point that we keep on running into. It's not happening across the economy. It is happening specifically among the rich affluent households at the top. And what does that really mean? Well, as Mark pointed out, it basically tells us that this consumer story is really more of a stock market story. Wealthy households are spending a lot. Why are they spending a lot? Because the stock market is booming, which essentially tells us that the US economy

• 44:23Ed Elson?

  is more dependent now on the stock market than it has been ever before.

• 44:33Ed Elson?

  Okay, that's it for today. This episode was produced by Claire Miller, edited by Joel Patson and engineered by Benjamin Spencer. Our associate producer is Alison Weiss. Our research team is Dan Shalan, Isabella Kinsel, Kristin O'Donoghue and Mia Silverio. And our technical director is Drew Barris. Thank you for listening to Prof G Markets from Prof G Media. If you liked what you heard, give us a follow. I'm Ed Elson. I'll see you tomorrow.

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