Bond Market Implies U.S. Recession in Late 2018, 2019: Sri Kumar

legislation that we have seen in decades. Here to talk about what the economic implications are. As Street Kumar, President and founder of three Kumar Global Strategies. He is also a Bloomberg prophet and is based in Santa Monica, California, but he joins us here in our cold ear than Santa Monica, but lovely eleven three our studios three. Thank you so much for joining us. I want to start.

I want to start with all of these stories and analyzes that are reading about the implications of this tax plan. Has anyone read it? I doubt it when you consider that in the last couple of hours as they were negotiating and talking, Lisai the more most important thing was as a Republican, they all had to go ahead and vote for this bill because they wanted a legislative victory before the end of the calendar year. So they got it.

And I think that you hear that parts of it were handwritten, and you have seen that on TV, saying that they didn't even have time to to type it. All of this leads me to believe that people voted for a tax bill they had not fully read. All right, that said, is there a way to assess in a preliminary fashion what the implications are based on sort of

bare bones assumptions of what is in the bill? Bare bones assumption And again, as you will know, there is a difference between the Senate approach and the House approach, which needs to be reconciled. But that being set aside, it doesn't look like it is going to have much of an economic impact at all in terms of stimulus. I'm not one who believes that just because you have a tax cut of some kind it is automatically stimulative. It depends on what the tax cuts are, what it

is oriented to words. For example, you need employment tax credit to hire to give stimulus to hiring, and the other hand, you cannot do things which are which appeared to be done to meet some few powerful interest groups, and that's not the way you're going to get the benefit out of this tree. Let's talk about an interest group that we're fond of. Investors, what investments do you believe will prosper as a result of the bill as you know it, and what investments would you stay away from?

I think clearly, overall, PIM, you're seeing that the risk on investments are benefiting today, and you are taking more of a risk. I think the market is assuming that in addition to the yell And put and the Bernankey put that they have had in the past, they are going to have some form of a Trump put as well from the fiscal side, and so they are going

to have more of speculation building up. So how it ends, it's hard to say and when it will end, but I think overall, all kinds of risk on strategies are going to benefit for a while from both monetary and fiscal policy. Suggesting that they are concerned about the stock market, the President himself has said several times that the stock market going up is a sign of the success of his policies, so he's going to do everything he can

to keep pushing up the equities as well. So to you and Grace Sory about the consensus that seems to be uh coming together about no recession until late early do you agree with that I have actually pulled forward my expectation for a recession, Lisa. I used to be thinking that you had a late twenty nineteen, but I wouldn't be surprised to pull it forward by close to a year to late twenty eighteen or early twenty nine.

Where am I getting my information from? Just to be clear that a recession would start the recession to date, and here is where I would mention that the two to ten year treasury spread is a very important indicator to me. And look at what has happened today, with all the euphoria in the equity market, the bond market has hardly budged. The two to ten years spread remains at fifty eight and a half basis points and below seventy five basis points. The curve typically inverts about a

year later. It is going down. It is narrowing at a significant rate. From about September we have narrowed quite a bit and you if you go back to Christmas, you had a hundred and thirty five basis points spread between two and ten in about twenty twenty one December last year, So you've had a significant narrowing. And I wouldn't be surprised to see if in two or three months that goes down to a very low of state twenty or thirty basis points, down from fifty eight and

a half. Then you're talking about recession being a year away. So let's say maybe not twenty late twenty eighteen, but early twenty nine. Is what the bond market is telling me. Right now, what is the higher bond market telling you? The high bond markets shows me that it has stabilized. We had the spread increase in late October early November. We went up, went up from about three hundred and

seventy basis points close to four hundred basis points. There was a lot of worry, and my reaction then was this is not yet time to worry or to panic about the high held bond market. The bubble will indeed get bigger. You can play the bubble for a longer period of time. And we have then since stabilized and we have gone back to seventy and the reason for that is the high held market, I believe also looks at the two to tents spread on the treasuries and

says that recession is not imminent. Defaults are not going to surge right away, so we have some time to enjoy the high returns from high yield. Thank you very much for repeating with us. There's pleasure. You're very welcome. You don't just just quickly. Do you think there's gonna be really any big change in the Tacks overhaul bill between the Reconciliation Senate House. I don't believe that it's

going to be much of a change, Pim. I think the Republicans are very happy at the Senate victory they had early Saturday morning, and I think this is going to be a signific week in legislative victory and the only legislative victory in the first year of the presidential administration. So I think the House, led by Speaker Paul Ryan, he's going to essentially sign off and make sure anything gets approved. So I think it's going to happen. Thank you very much. Kamar Shri Kamar. He is the president

and founder of Shri Kamar Global strategies. He is also a Bloomberg prophet and he is based in Santa Monica and you can follow him on Twitter at shri k Global. Well, the pharmacy chained CVS Health we know has agreed to buy the health insured ETNA price tag about sixty billion dollars in cash and stock. It will retain its current management. This will bring together one of the largest providers of

pharmacy services with the number three US health ensure. Here to help us understand this deal more is Tara La Chapelle, our deals columnist for Bloomberg Gadfly. You can follow Tara on Twitter at Tara l a c H and also with us. Michael Ray, founder, Chief Executive RX Saving Solutions, based in Overland Park, Kansas. Michael, I just want to begin with you. Does this deal give the combined entity

more power over hospitals and drug makers? Absolutely? I mean the bargaining power of this company is going to be tremendous. When you look at the setup of the new arrangement, you know, CBS goes from owning providers to owning the PBM, to the pharmacy and now the payer. So it's a tremendous bargaining ship for them Tara. A lot of people are talking about this as though it's a done deal. It makes a lot of sense with respect to competing

against Amazon dot Com. You think, perhaps it's going to take a really long time, and maybe that's not the worst Thingsolutely and the companies are definitely anticipating this. If you look at their press release this morning, they really played up the consumer aspect that this is going to be great for consumers, great for patients and people that have end insurance UM. So they're anticipating a long fight

I think with the government over this. I mean, this is the second extremely large vertical merger we're seeing this year. UM A T and T. Time Warner of course is now UM in a lawsuit against the d o j UM trying to get their own deal through, and it's very similar. Even though they're different industries, it's similar in their respect that they are expanding into a different line of business and they're going to consolidate a lot of power.

But I don't think that this regulatory process is necessarily a bad thing, because CBS needs some time to figure out how they're going to get their finances in order to pay for this right. So before we get into the financing, Michael, I just want to get your take on something Terris said, which is, the companies are painting this as a consumer positive of a fair Do you agree that necessarily it is? Uh, that's to be determined.

I mean, I think that the opportunity for them to put tremendous efficiency measures in place and save the system a tremendous amount of money is there. Uh. That said, these are public companies trying to maximize profit, and this type of arrangement also provides them an opportunity to extract enormous profit. So I think that, you know, the talking points in the action will be something that will be

really important to follow over time. Well, Michael, in that in that same context, if the combination goes through and they have more power over hospitals and drug makers, where they're going to get the savings from themselves in terms of their own efficiencies, or more likely perhaps from the very hospitals and the very drug makers which now really don't have I mean, it's just one big entity and they're not going to have a competitor to play them

off against or Am I wrong? Right? I think that that's what you see as you'll see, just a more powerful uh, a more powerful entity from a bargaining standpoint, you gotta play ball with them. Um. So if you're if you're a hospital or if you're a drug drug maker, UM, you know you can't. You can't neglect them or or stiff farm them. They're so big that you have to you have to try to do something. So that's that's

where they could extract, you know, deeper discounts. Um. Also a place where they've got kind of a captive audience where they own the whole paradigm from point of prescribing to point of fulfilling a prescription and everything in between. Uh, that's where it could be very costly for the consumer

and the and the companies. At the end of the day, Tara, let's get back since we're talking about how expensive it could be potentially for consumers, are just at least the hospitals up might end up getting stiffed a little bit. Um let's talk about paying for this deal you so that it might be challenging. Why so, CVS is about a seventies six billion dollar company, I think at least

before today's drop on the deal news. Um, so they didn't really have that much cash to be paying for this deal and their offer for at and I believe forty seven billion dollars of it is in cash, and a majority of that most of that is going to be through new debt that they're taking on. So at the end of the day, they're going to have almost quadruple the amount of debt that they have in combined Ebada profits from these two businesses, So it's going to

be very burdensome on their balance sheet. And CBS has been a great dealmaker. They bought care Mark about a decade ago, and that was another out of the box deal that people didn't really completely buy into when it was announced. So this could be another case where they prove us wrong. But I mean, the numbers involved in here are just starring and I'm really interested to see how they're going to make it work. The math is very tricky here, and they haven't really explained that part

of it yet. Michael, as the founder and the chief executive our X Savings Solutions, maybe just tell us how your company would respond to this situation and how that will affect your business. Yeah, So, I mean I think that you know, we we just completed an eighteen million dollar fundraised last week. I think that the the the focused on you know, businesses like ours to add transparency continues to grow. Um. It also gives you know, the the employers that we sell to another kind of viewpoint

of someone that's that's working on their behalf. So I think that anytime there's this combination of power, there's a question of you know, okay, the efficiency could save me money, but is that what they'll really do? And I think that what we see it as is a tremendous opportunity uh to work with the market, to to try to make sure people know what their choices are from a theraceutic standpoint, and then how they can save money and

where they shop and buy. That is what that pure market is what will really drive change and savings in prescription drugs. That that has to happen, in my opinion, whether it's us for the next guy Sarah pact just real quick, why can't they just incurl out of debt? Everybody else is doing it, right, I mean, I guess that's what they can point to. Everyone's doing that. But I mean, I think we're getting to a point where it needs a question is are are these decisions. How

healthy are these mergers going to create value? If this deal is going to make them that much more profitable and they can pay this down quickly, fine, But I think by looking at CVS bond prices today, I mean, people are a little bit um bothered by it and want to see more language out of the company about how this is going to work out. I mean, everyone seems to think the strategic rationale makes sense, that they're buying into it, but the numbers need to work. So

I'm still a little bit gubious. The numbers need to work. That's a new one. Tara Lesha Fell, thank you so much for joining us. Sara Lasha Pell, deals columnist for Bloomberg gad Flight. Also Michael Read, thank you so much for joining us. He is founder and chief executive officer of RX Savings Solutions, which is based in Overland Park, Kansas. Uh. Definitely interesting to see whether this deal goes through and if it doesn't, what Amazon dot Com will do to

this entire industry. Now we turn our attention to the future of finance, the future of technology, Wall Street, who will be the Titan of Wall Street in ten years? How good can artificial intelligence get We've got a two week series on the future of investing by Bloomberg News reporters. Today's feature looks at how long until black Rock and Vanguard reached ten trillion dollars in assets? Here to help us answer that question is Rachel Evans, our corporate finance

reporter for Bloomberg. Rachel, thank you very much for being here. So how long how long does it take for this do wopoly to end up with ten trillion dollars of assets under management? And that's ten trillly in a piece. Remember, so we're looking at twenty trillion overall. So the moment, we've got black Rock, which has six trillion of assets under management. They're on path to to get to ten

trillion by about twenty five. Vanguard, while smaller at the moment, could actually get their quicker there on four point seven trillion at the moment. They could be there by twenty three if their current growth rates are maintained. Why why the discrepancy do you believe? I think it has to do with kind of how they're the currently position. So black Rock already has one point six trillion under management within exchange traded funds. Vangard is a little bit smaller.

They were a little like to the party when it came to exchange traded funds coming out after black Rocks b D. I um, So when we see kind of the growth going forward, I think Vanguard is going to continue on that trajectory. Their growth rate has just been faster in the last few years. Rachel. Before we get into exactly the assumptions that you made in coming up with this projection, I want to just zoom out and talk about the implications of two asset managers overseeing twenty

trillion dollars of assets. I mean, on one hand, this seems like it could be problematic, and the other a lot of this money is going to passive strategies with the index is being crafted by other firms. Do people talk about this as a potential sort of structural risk. So there's two areas that people tend to discuss when when worrying about kind of the impact of these you know,

titans for asset management. The first is kind of a market efficiency and the argument there goes, you know, if you have so much money impassive strategies, does that warp the way in which price discovery happens within the market. Now,

the evidence on this is still very nascent. I mean, if you think about the proportion of passive as part of the overall market when you look at active sorry, when you look at kind of equity funds in the US, about thirty seven percent is passively managed at the moment, but that drops to about if you look globally and at all different asset classes. So we're still relatively small part of the market as as passive goes. So it's

hard to kind of drawing conclusions there. However, when you start looking at the corporate governance implications, I think that's a little bit clear at the moment. Jack Bogel himself, the founder of Vanguard, actually called Vanguard, black Rock, and State Street oligopoly last week, and he was referring really to the size of Steak, that these are three asset managers, but particularly black Rock and Banguard hold within America's largest companies.

Are there to be reconciled some problems for small and MidCap companies that can't get into an index that are then not part of this wave of E t F love that we seem to have because we've got more exchange traded funds than we have stocks at the moment, right, So, the growth of indexing has been incredible like that, the number of indexes has really proliferated. A lot of that has been driven by exchange traded funds, which typically track

and index um. So yeah, for for the smaller and MidCap companies out there that maybe don't qualify for an index because they're too small or they're not liquid enough, that can be a real issue. And actually we've seen some people suggest that that's one of the reasons we're perhaps seeing fewer initial public offerings at the moment. So, Rachel, let's get back to the assumptions that you made in order to sort of project out the twenty trillion dollar

number for both black Rock and van Guard. What is that based on. So this looks at the annual growth rate in assets of those firms and then averages it over five years, so that the methodology behind it is relatively simplistic, But what it does is it tries to give you a sense of kind of how, based on our immediate past, the growth that we've been seeing and that the recent recent past, how that is going to

translate when we look into the future. And if you look at kind of the components of of where a lot of that growth has been coming from. It really has been from this passive side. It's been from exchange trade of funds, it's been from passive index funds are really helping to boost assets of black Rock and Banguard. Is there a possibility that this will kind of be a dog chasing its own tail because you get people who say, all right, indexing makes sense, it's low cost,

let's get rid of as many people as possible. And then of course that just builds on it on itself, and it really has nothing to do with the value of the underlying companies in the index. So that's definitely one of the critiques of passive investing, the sense that because everybody kind of piles into, you know, a relatively small number of index funds, but that kind of feeds on itself, and you have a certain level of momentum that kind of comes from from people putting their capital

into it. The question really have really kind of sort stems from what happens when that reverses. If you start to see people putting money out of these funds, how then do they behave and are there enough active managers in the markets give you decent price Discovery. Well, we will be counting on your reporting to answer those questions. Rachel Evans, thank you so much for joining us. Rachel

Evans as a corporate dance reporter for Bloomberg News. And how long Black Rocket Vantguard will take to reach ten trillion dollars in assets? This is going to be a series that we rolled out over the months to come. Let's talk taxes right now. Jeremy Swan joins us. He is managing principle for financial sponsors and financial services industry

for Cone Resnick in New York City. He just pulled his head out of the hundreds of pages of the tax plan that the Senate Republicans passed early on Saturday, including some of the handwritten notes. He's a little bit cross side, but he is here. Nonetheless, Jeremy, what does this bill mean for your clients? We're talking about the

private equity firms and others like them that you cater to. Sure, so if you look at the M and A markets, you look at the private equity markets, you look at the firms and how they're going to be impacted, they're really a handful of key areas within the tax policies of tax bills that are out there, and you look at interest deductibility, that can certainly put a damper on the ability to leverage up the businesses. The require you can look at carry interest in extending the epic ability

of that loophole, so to speak, for three years. Um, you know, in terms of the broader markets, it's gonna challenge for the private equity firms to continue as usual. Um, you know, give the challenges the m and A market already. So I have a question because that was my assumption. But then I looked at KKR shares, Blackstone Shares, Apollo, they're all up absolutely. So when you look at the broader financial services businesses, so KKR, Apollo, Blackstone, they're really

more than just private equity. If you look at the pure play private equity firms, they make their money investing in businesses, and with valuations where they are today, the only way you can get the returns is be able to have access to the to the debt markets, be able to provide debt to these businesses to get to that purchase price. The pure player is gonna have a challenge the broader firms. Like you mentioned, there's there's more to it and in terms of the benefits that they're

gonna get from the overall rate reduction. You look at what could happen with you know, cash, this sitting overseas. There are a lot of different aspects to it. Well, Gereman, when you get a call from a client or even a potential client, and they ask you, do I need to change the way I do business because of this overhaul, do you just say, well, we don't know yet. Well,

part of the problem is we don't know yet. When you look at the differences between the House and the Senate bills, you know, even if you're just looking at interest deductibility, you know, and the House bill you have of EVA diving, the Senate ability of event the appreciation

annorization can be a significant number. And when you do, you still don't know what the over Olympic is going to be because you know, now we have the President coming out over the weekend saying well, you know, percents not necessarily where I'm gonna draw the line of sand. Maybe we know what's that impact going to have In terms of the impact on the portfolio companies of these private equity firms, when you look at the after tax return that the private equity firms would expect to see.

You know, these changes could have a significant negative impact on the pure play private equity firms at the end of the day. So when the clients are asking me, you know, does this change the way we need to look at the answers, Possibly we had a wait. Hopefully it looks like we'll have an answer before Christmas. But it may change the way they need to structure deals. May it may have a significant impact in terms of

how they finance all of these deals. Just to be clear, to sort of drill into the specifics of the tax plan, the provision at question here is really the one of how to determine how much companies can deduct from their taxes with respect to their interest payments on their debts.

Of the words, private equity firms usually acquire companies by levering them up doing leverage buyouts UH, and they put a lot of debt on these companies, and under current tax policies, those companies don't have to pay that many taxes because they can deduct the interest payments that they make on their debt from their taxes. Under the Senate proposal, UH, they would have they would only be allowed to deduct a much smaller proportion of that interest from their taxes.

Is that correct. That's correct, and it's and part of it is obviously, you know, when you look at the private equity market, you look at how they finance deals, debt can tend to be a significant portion of it. You look at the broader M and A market, So if you look at the middle market over the past year, we're at higher debt ibadah levels than you know, going back to two thousand six, you're at almost six times

on every deal. And when you look at so that that's obviously gonna have an impact on the private equity deals. But when you look at the broader M and A market, you know, debt is an instrument to finance a lot of these deals, private equity or not. And if you're looking at the changes to how that interest expense can be deducted from a tax perspective, that's gonna impact the bottom line of a lot of businesses, not just the private equity backed ones. Well. One of the other businesses

that may be affected as the housing industry. Because I believe that the Senator Susan Collins of Maine is on board with the overhaul bill because of concessions that would continue to allow taxpayers to write off a ten dollar limit of property taxes. So that is part of that compromise that you were just describing. Yeah, this has been a or these have been at least the two bills we've seen. It's compromise left and right. And I think where we've ended up is you look at the impact

of just retaining the corporate a MT. Tell people what

that's about. How it works. So if you look at if you look at the tax bill and you look at just the federal tax plan and in itself, you have your calculator, your tax rate, you look at the deductions, you come out to your you know, call it the blended tax rate or the effective tax rate that you're gonna hit with, and then that you have to look at that in the parallel system, the a m T. So with a new a m T where it's they're saying, but they're reducing the corporate tax rate and some of

the deductions or credits that you typically would be able to apply. You know, let's look at the research and development tax credit. That's the one that everyone has picked up on. So you can't apply that against the a m T. So you have these businesses and this has been the Research and development tax credit is there to spur innovation in these businesses. Whether you are a clothing designer, whether you're a manufacturer, you're incentivized to be innovative through

the R and D tax credit. Now, with the AMT at the same tax rate as the corporate tax rate, the R and D tax credit is virtually useless the way it's the way the tax bill is currently structured, Jeremy, Real quick, when you tell your clients the news that they may have a really hard time under this, or a much harder time, do they immediately ask you for the names of lobbyists they can call to go and make it all go away? Unfortunately? Not? Okay, yeah, yeah,

really you you summed it up well. Thank you. Jeremy Swan is managing Principal Financial Sponsors and Financial Services Industry for a Cone Residing. Much appreciated. Thanks for listening to the Bloomberg P and L podcast. You can subscribe and listen to interviews at Apple Podcasts, SoundCloud, or whatever podcast platform you prefer. I'm pim Fox. I'm on Twitter at pim Fox. I'm on Twitter at Lisa Abramo. It's one before the podcast. You can always catch us worldwide on Bloomberg Radio