Cash And De-Risking Look Good As We Enter Late Cycle: Kennedy

the US. Certainly US tenure treasuries were fields that have remained in the narrowest range in more than a year. But the year ahead, the next six months, the next four months could be a little bit more interesting. Joining us now is Tom Kennedy had a fixed income strategy at JP Morgan at private bank, overseeing about five six billion dollars of assets, I believe based in New York. Tom, thank you so much for being with us so looking

out you. You said something in the report that I thought was interesting, which is we were entering a later stage of the credit cycle and you need to dust off your playbooks for this time. What does a playbook for late cycle investing in the debt markets? Look like? At having me so really it's talking talking late cycle is something we haven't had to even discuss for the

last ten years. It's something new, it's something it's something different. Uh, and even candidly, when I look around the floor, there's lots of young people on the floor that don't even know what late cycle looks like. Um. But late cycle is a couple of three, three or four pillars. I think we need to talk about its duration. We've been underweight duration across the wealth management platform for for many years. So it's full disclosure, it's a measure. It's sort of

how closely tied. Uh. You know your investments are to hire yields or yields going up, absolutely so, so we there's a if you're underweight duration, you're fearing that interest rates will go higher. So we're you've talked about the interest rate on tenure treasury is being quite low. I'm not so sure it's gonna go much higher. And hopefully we can talk about that in the time I'm here. But you want to start to slowly dial your way into duration. Another one we were talking about in the

break is about credit. You for years, you have been incentivized to reach for yields, so Let's say that's a traditional investment grade investor that's gonna say yields and an investment grade are not high enough. I'm gonna reach to high yield, but maybe not so comfortable with those risks. As interest rates by the FED start to rise, those credits should be challenged and we should see a readjustment there. Um. Those are two two key pillars that we're focused on.

And then, finally, for the first time in a long time, cash actually has a position in a portfolio. Um. Again, a challenging discussion to have because you haven't had it for so long, but cash is actually yielding you T bills are over two percent. That's that's an interesting risk reward proposition to discussing portfolios. How do you discuss that? When people don't want to talk about relative return and they say, you know what, we can't really live on

two percent tax? Do you send them to the municipal market. I think the municipal market is is actually looking quite attractive at this point. What's actually interesting about the municipal market is in the front end we actually see relative value as not especially in your favor, but further out in the in the municipal curve. There's actually a steepness

in that curve. The in in the media outlets, Bloomberg is constantly talking about the shape of the treasury Oeld curve being very flat, but the Muniol curve is actually quite steep. So if you move further out to say, ten year MUNI bonds, you can actually pick up a hundred basis points and spread relative to short data munies. I want to go back to the idea that we're in a late stage. Does that mean that you expect a recession or downturn in the imminent future in the

next three months, six months? What does that mean to you? So late cycle? I think it's importantly to say late cycle is not end cycle. Late cycle means we are closer to the end than the beginning. But I actually believe this economy has a good bit of runway to go in it um the key indicator to look at, I mean, if you only had one, would be to got the spread between treasure yields two years versus ten years.

It's flattening, but historically an inverted Yel curve is the key measure that I'm looking So you still buy this whole thing as an indicator so some people try to say this time is different. You're not one of those people. Um, the this time is different theory suggest I think when I've tried to unearth when people say this time is different, to me, they're suggesting that monetary policy is keeping rates in the long end much lower than they they fundamentally

should be. I really don't find that argument compelling, really for two reasons. When you look back of what's happened over the last ten years, fundamentals in this in the United States have changed dramatically. Demographics, it's an aging demographic by the Census Bureau is telling us roughly of the U S population will be sixty five and older. That's relative to seven percent pre crisis. So aging, there are less people working. Employment to population ratio is coming down.

And then importantly, and it's not discussed nearly enough, is central bank credibility. We the FED is telling us what they're gonna do, and we believe them, We trust them. So your term premium that the risk you should be the compensation you demand for risk is much lower. So all in all, that back end I don't think has

to reprice very much. When I when I modelowed interest rates to actually think they're a little bit rich to fair value right now, but not substantially, and just trying to understand from an investor point of view that has followed what the Federal Reserves said to do, which is basically go further out on the risk curve and reach for yield. As you described earlier, have they bought products that they really don't understand from people who are no

longer in the business of selling those products. That sounds an awful lot like what we went through in two thousand and eight. So now you're talking about the next piece of this argument, which is the FED has displaced natural investors, and that's in the treasury market, in the NBS market. I think that has happened quite substantially. But the balance sheets size of the FED, the new operating framework that they've implemented post crisis, demands that their balance

sheet be much bigger. So when I look at the underlying trends in the balance sheet, I don't see the balance sheet for the FED contracting very much more. I'm talking about when I start to model out where the Fed's balance sheet is gonna go, it's about four point two trillion today. I think it's going to intersect it's natural level around year and twenty nineteen at about three

and a half trillion. It's a little bit higher than what markets are talking about, but it suggests that this monetary policy displacement that's happened for so long isn't likely to reverse very much. It's important to sort of put into context here your background, because you worked at the New York FED and you helped draft the program UH that will unwind the balance sheet? Am I correct that the Fed is following the FEDS playbook has been out for quite some time. When I was there, we we

put that thing together, all right. So UM, it's wonderful then to get your insights on later this year because there is some concern among fixed income analysts that there will be a choppy sort of stoppage of refinancing some

of the Fed's UH treasury holdings. In other words, as say forty billion dollars of longer term treasuries come do or three year tenure, whatever it is, they will let it roll off instead of repurchasing those treasuries, and it could cause some kind of hiccup in the bond market. Do you buy these arguments? I really don't you can think about a flow versus a stock concept. And really, what I'm trying to say is, as an investor, I should be responding to known quantity information. The FED has

put out its its planned we all know it. We can all look at what treasury reinvestments look like, and we should be able to tell right now, this per this piece of the treasury roll off will be reinvested in, this piece won't. So in a sense, when we have known information, we should be able to price that into markets. And I think that's effectively been done. The FED has slowly every quarter been stepping up the amount of treasuries and mbs that it allows to roll off its balance.

It hasn't had a substantial impact in my opinion. Um, now that's you can see. I'm a big believer in this stock argument. Being on the investing side of the business, I can I understand the flow dynamic, but I just think it's a marginal contributor to two rates relative to the stock impact. Thank you so much for being with us.

Really really illuminating. Tom Kennedy had a fixed income strategy at JP Morgan, a private bank overseeing more than five hundred billion dollars based in New York really him important inside, especially considering Tom's experience at the New York Federal Reserve. At a time when a lot of people say we're not paying enough attention to the roll off of the balance sheat Evidently we have less than a trillion more

to go for that balance sheet to roll off. The value of goal it has dropped consistently over the last couple of months. It currently trades below twelve drear an ounce atars on the Comax. Here to help us understand what is going on with the precious metal is Ben Hunt. He is the co founder and chief investment officer for Second Foundation Partners. He is also the creator and the author for Epsilon Theory. They're based in Reading, Connecticut. Ben Hunt,

thank you very much for being here. You've got a lot of people who are interested in what you've got to say about the value of precious metal, specifically gold. Do you believe that it is linked to what the Federal Reserve is doing with interest rates? Hey, great to be on Tim, Thanks thanks for having me in. And the short answer is yes, it is absolutely linked to what the FAT is doing. And and frankly, that's the only thing I think that really drives the price of

gold as it's being traded. So this is nothing new. I mean, we haven't had gold responding to i'll call it a geopolitical crisis for a long time, a decade or more. It looks if you're a businessman in Istanbul or Kara today, you know, you're you're you're delighted to have gold. It's very it's worth a lot to you because you can't access your your dollar denominated bank account. But for all the rest of US, I suspect, you know,

ninety nine people listening to this radio broadcast. The meaning of gold, the the the factor that gold trades on is well, what what's the FED doing? What are central banks doing? It's an insurance policy against central bank error. That's the way I think you should really think about gold in its price. Okay, So before we get to the central bank era part, which I want to tease out and understand exactly why gold would be a hedge against that, I want to just talk about the idea

that gold used to be a store value. It used to be a haven investment. Are you saying it is no longer a haven investment in anyway? Uh? In any way? Is a is a is a tough you know, tough kind of additional clause to put on there, but basically, yes, look, you know JP Morgan, the original JP Morgan, you know Jupiter, Jupiter Morgan. He had a great quote and his quote

was gold is money, everything else is credit. And look that was right, that was right back when you know JP Morgan, the man was you know what was walking the earth. But it's but it's not true anymore. It's not it's not what gold means to investors anymore, and that it really it's not just gold. When people talk about whether it's bitcoin or they talk about gold is being a store of value, I think they're really missing

what that phrase means. Okay, well, uh, and perhaps it's not entirely a coincidence that we're seeing a dramatic so often cryptocurrencies in tandem with gold, although that's probably another story. But I do want to get to your point of why this could be a hedge, my gold could be a hedge against such a bank. Eric, Can you just sort of explain that? Sure? Sure, what I'm trying to describe as is what well, they back up A second one I'm always interested in is not what what you know,

we the words we have for things. But what actually is and what you actually see in the price of gold, what you actually see in the price of of any precious commodity, is that it goes up or down depending on confidence in central bankers, right because because that's that that's really what gold is there to be. That's that's the insurance policy that I'm talking about if things get really awful, right, if central makers make some gruesome policy

mistake that results in infation or deflation. It can work either way, right, But it's it's that sort of mistake that gold has meaning for today. It It doesn't have meaning as an alternative currency, it does any Look, if we get to the point where we need gold to buy something at the store, yeah, you're better off owning

ammunition and seeds rather than gold. My point is that as a security, as an investment, what gold goes up and down on is the degree of confidence we have the central bankers are large and in charge, and right now there's a lot of confidence in that, and so that's why the price of gold is down ben just quickly. Because Doug Cass of Seabreeze Partners, he enjoys listening to you, and he wants to know your thoughts about the VIX because it rose to fifteen from ten yesterday on less

than a one percent drop in the SMPI index. Your thoughts give you about twenty seconds. Sure, well, we'll look like the VIX is another one of these um constructed entities. I mean it's it's it's essentially the short to medium term volatility in the SMP five hundred. But what it also is is a trading instrument, so in exactly the same way that gold now means something I think very different from what it meant for JP Morgan back in

the early nineteen hundreds. So do I think the VIX as a trading instrument means something very different than we when it started. And so you can see these outsized movements for things other than just the mechanistic impact of a change in the SMP five. Ben Hunt, thank you so much. As always, it feels like two little time. We'll have to have you back. Pen Hunt, co founder and chief investment officer of Second Foundation Partners and publisher

of Epsilon Theory. Earlier today, Home Depot came out with their earnings beating expectations. In response, shares up less than one percentage point. Not much here to talk about what the Staples, the retail Staples world brings or should bring in the next few months. Is Scott Mushkin, Managing director and senior Staples retail analyst for Wolf Research in New York. Scott, thank you so much for being with us so we did get those positive results from Home Depot. I want

to look ahead. We're gonna get Walmart after the bell. What's the biggest concern of analysts on the street, the wild card, given how positive the backdrop of the American economy is right now. Thanks for having me by the way, And I think if you're looking at Home Depot and you just said it, stocks barely off even though they absolutely just crushed expectations. Um, I think you know, when

people look at housing, uh, there's concern. Uh, there's concern that we're going to We've been a you know, a bullish housing market for a long time. Interest rates are coming up. Certain housing markets have been so so hot, unfortunately not in Connecticut where I live, but in places like Seattle, Portland's, Denver, or even Boston. Uh, these markets have been so hot and they're cooling off very quickly. And I think you know, we all have memories of

the last financial crisis and what happened to housing. So I think people are growing a little concerned with with the housing market. That's what kind of holding back the Home Depot stock right now. But you know, Home Deepot is one of the best companies out there, and so you know, we take the opportunity to buy it to you know, buy it today with such great numbers. Hey, as Scott Mushkin, what about the increases in the cost of fuel transportation as well as input costs for things

such as imported lumber. Yeah, I mean so, I mean that's definitely an issue. Right we were seeing some inflation creep in. Um. Some of that it's unforced because we're putting some tarrass on and we're getting some retaliatory terrorists. But right now, you know, the home Depot and the home improvement sectors managing through that. Okay. Uh. We saw appliances actually do okay at Home Depot, even though we've

seen prices come up quite a bit. So it's something you know, we're watching, it's something the company is watching. But at this stage, it really isn't enough to uh, to kind of derail the very strong sales that the company seeing and the strong earnings, because of course that's causing some cost pressures. But Home Depot is a master of being efficient in increasing their productivity and we definitely

saw that this quarter. Okay, So you were saying that you are viewing this as an opportunity to buy Home Depot. I'm looking at shares right now of the company two hundred dollars and seventy two cents. Where do you see them going by the end of the year. Now we have a two fifteen price target. Uh. Is kind of where we you know, where our heads are still. And um, you know, it's one of the few companies as this market is really rat I look at a lot of my companies. I know you guys want to talk about

Walmart and and some of the other names. Um, but the house some of these housing stocks lately have been left behind Home Deep belows and so it's one of the few places where my DCF is actually this kind of cash flow analysis is actually nicely above that one. Um. And so you know we do like Home DEEPO. Still okay,

but but I want to go to that point. I mean, you're saying that homebuilders and housing stores or housing related stores have done poorly recently, and I'm just wondering, I mean, why, what makes you confident that people are wrong about the cooling housing market waying on these companies. So, you know, always you don't always don't want to be overconfident in your analysis. But one of the things I think it's

under uh, I guess underplayed a little bit. It's just the strong supply and demand aspects of what's going on and in housing, particularly for home DEEPO and lows, where the aging of the housing stock, the fact that we haven't built in a bid to enough houses, the fact if you look at housing spending or spending into the home improvement area, it actually peaks between sixty and seventy four, So it's baby boomers are still playing a big role and spending on their house. Uh. The other thing that's

interesting is the millennials. The millennials are you know, we've seen homeownership rates rise a little bit. The crest of the millennials is now, so they're really starting to get into that area of they're going to buy their first home. Uh. We've seen household formations pick up. So there are definitely besides the macrocyclical aspects. There are definitely things going on and housing, particularly for home DEEPO and lows that are

more more bullish than I think is being recognized. Scott Mushkin give you about twenty seconds here just to comment on the comps that Home Depot is going to have to deal with in the second half of the year because of that six hundred million in hurricane related sales that have to compare against. Yeah, I mean it's about a one headwind, so it's definitely there, you know, you know, thankfully knocking on wood there. Thankfully we haven't had any

hurricanes yet, so that's a good thing. Um. But it's you know, it's a little bit of a head wind, but certainly it's not such a big headwind that there. You know, their sales will be you know, we were still expecting five five is typed cops into the back after the year. All right, Thanks very much for being with us, Scott Mushkin. Of course, he's an expert when it comes to all things really related to the world of retail, in this case Walmart, Target and the Home

Depot in China. Spending on fixed assets such as factory machinery and public works projects it is at its lowest point in nearly twenty years. To tell us more about the Chinese economy and the potential for continued trade conflagration with the United States States is Christopher Balding. He is a Bloomberg opinion columnist. He is also the author of Sovereign Wealth Funds, The New Intersection of Money and Power. He is the former Associate Professor of Business and Economics

at the HSBC School Business School, and he joins us now. Christopher, thank you very much for being with us. Can you just describe the state of the Chinese economy for those that made me think it's monolithic? I think what we're seeing right now is is some real weakening. What we saw in late two thousand and seventeen and really through let's say up through about May this year, was a real credit tightening, and so this is this has been

passing through into real activity. And in China, we're typically looking at about a six to nine month lag from the time credit starts tightening until the time it hits activity, and so we're really starting to see the effects of all that credit tightening that began in say November December trickled down right now UM. I do think what you're seeing though, is some conflicting signals. And what I mean by that is, UM a lot of fixed asset investment is is it a decade decade lows? But there are

other signs that are actually incredibly robust. Uh. Land sales and construction starts are up that in the mid teams for the most part. UH. So it really depends on

what you're looking at. And if you look at the credit cycle and where we are with the economy, it's not unrealistic to believe that all of those new construction starts and land sales are going to filter through into let's say, not a boom, but let's say a pick up in the second half of this year, in the latter second half of this year or the early first half of next year. Christopher, there's a story in the latest edition of The Economist. The headline is China losing

the trade war against Aren't that? What do you make that? Do you think that it is? Um? It's it's it's tough to say who's who's losing it because in in the grand scheme of things, for let's say a fifteen nearly fifteen trillion dollar economy, UM fifty fifty billion dollars in tariffs is effectively zero. UM. But what there is prompting in a lot of China is a is a lot of concern about One of the things you've seen in political circles is UM, did China try to get

too big too fast to stand up to the United States? UM. I also think it's very fair to say that there is that that this discussion over the trade war that you're seeing in China UM is is kind of a proxy for two specific discussions that people don't want to have in public, and that is, first of all, UH, the political crackdown led by Chairman she UM really reversing a lot of the liberal reforms over the past say twenty years UH. And then furthermore, whether or not China

should open its market. There's been very little discussion in China about that. So this handringing about is China losing the trade war? UM? There is some very valid questions about that, but I think it's there there's other factors going on. UM. And the other thing is is that this is this is likely to have a bigger impact on China UM. Even though we always think of China as this trading nation that is running these large current

accounts surpluses. Actually so far UM the current account in China this year is is effectively zero UM, and so any impact on trade is going to have a very significant pass through effect to other aspects of the economy, much more than it will in the United States. Christopher, I'm glad that you broke you brought in this sort of crackdown on liberal orders of things in China because it kind of leads me to ask you about why

you decided to leave. I know that you opted to leave HSBC Business School, and you uh left China after I think after almost a decade, right, what made you decide to do that? So I I was informed last year that that my contract would not be renewed, and I actually debated where, you know, if I wanted to stay in China, and actually interviewed with some Western universities in China. UM, and I opted to leave because UM I started there were stories. You could sense the crackdown.

But at the same time as I was talking to people not even mentioning my situation, you started hearing more and more stories about even innocent issues being grounds for dismissal UM or worse, UM and quite honestly, you know it did it. It felt that just remaining in China was simply going to up that risk uh continually where

I felt it was just better for me to leave China. Christopher, based on your experience, do you see Chinese individuals who have the wherewithal to move money out of China continuing to do so? Um? I think there is absolutely, uh every interest in doing so. UM people with means um that that you meet in China, Everyone that I ever met absolutely has some type of let's say, fallback position.

They have hedged their their bets in some way. UM. At the same time, right now, I think China has cracked down very very hard on capital in in capital controls and made it much much more difficult to get money out. That doesn't mean that it's not still happening, um, but the the levels that we're seeing are much much smaller because it is so much harder to get money out um in different ways. UM. But there is absolutely a continued interest among people with that have money to

get money out of China. Christopher. I want to go back to something that you were saying, which is, you know, is there a risk that China just expanded too quickly and perhaps without the necessary infrastructure to really compete with the US. Right now, what do you think, just to sort of tie this all together, what do you think it's a likely outcome for the Chinese economy going forward? Here? Are we going to have a higher risk of a

hard landing? UM? I've I've always been a believer that a hard life, let's say, a crisis of of what we would think of as a crisis, maybe something akin to what we're seeing in Turkey right now, is decidedly unlikely UM. And the primary reason is is that UM. Beijing is acutely aware of what happens if there is a financial crisis. UM. If there is a financial crisis in China, UM, it is that once a century event. And so they will not allow a crisis UM except

as an absolute laughed outcome. That doesn't mean that there won't be pain, UM, and that they won't be willing to impose pain. And so this leads us to, you know, for instance, the trade war. I think there there needs to be a very clear understanding that with regards to China, they will be very, very willing to accept a lot of pain going forward in a trade war or bailing out firms as long as it avoids a type of financial crisis. Christopher Balding, thank you so much for joining us.

Welcome back to the States, if only temporarily. Christopher Balding was an Associate professor of Business Economists at HSBC Business School in China and is continues to be a Bloomberg opinion columnist. I recommend you read his columns. They are very, very good. 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.