The Fed Is Guessing As it Plays With Fire: David Kotok

FEDS balance sheet roll off really affect markets? And frankly, there are people lined up on all sides of the issue, debating fiercely and away. In here is David Kotalk. I'm very pleased to say, joining us at ourteractive broker Studios, Chairman and chief investment officer of Cumberland Advisers. David, you spared yourself beautiful weather in Sarah Soda to come here in frigid at New York City. Thank you for joining us here. So what's your take on this? How important

has the Fed's balance sheet rolloff been so far? Well, very important. Pleasure to be with you. I'm leaving tomorrow morning and going back from the five degree in New York weather as fast as I can. So this is the perhaps the most profound debate monetary policy. Never before have we seen a major central bank change an interest rate and shrink its balance sheet simultaneously. So we're in an experiment. Nobody's been here before, and we're doing it in very large sums. So you've got to look at

the balance sheet. And as you know, you've got two sides of a balance sheet. Have the asset side in this case, it's now got long term and intermediate term and mortgages all federal credit. But that's the asset side, and the asset side of this balance sheet for fifty years never looked like this until the financial crisis. It's the liability side where the debate needs to be held.

And the liability side of that balance sheet bank reserves excess bank reserves four five hundred billion to operate the Treasury of the United States a few small items. Currency in circulation will be two trillion by the end of next year. And what do you do about the alternative

to bank reserves REPO? And that is a debate. So the bottom line of that complex to is you can get a range of three and a half trillion high to two and a half trillion low as to the proper size of the balance sheet, and debate all sides of it. How do you think the FED has done in terms of managing the wind down of the balance sheet? And then if you have an opinion, where do you think they should go? Well, showed is always a difficult word.

How have they done? They attempted to communicate what they're gonna do. They published the schedule and and said, here's how we're gonna do it. Here's the amount, here's the time table. We're going to scale it up slowly. So the FED tried to communicate that. What they didn't communicate and haven't clearly is here's the end game, here's what it has to look like when we're done, and here

are the metrics which will cause us to change. So you have this divided opinion within the FED communicated therefore in a confusing way. And I think that's what's needed. I hope Pal tomorrow is questioned and question and question on these metrics so he explains them, and he may have a divided house which will make it very difficult for So David, I'm looking right now by the numbers the fed's balance sheet had a high of four point

five trillion dollars nearly that in April. It's currently a little bit more than four trillion dollars, so a little bit less than five billion dollar reduction in the balance sheet over those early two years. Now, you make a really important point that the balance sheet kind of cannot shrink below two and a half trillion dollars based on just the currency that we have out standing in circulation right now, as well as some of these other obligations.

How much of an effect would it be if the FED stopted at three and a half or two and a half trillion? Is that sort of a seismic difference? I think so? So I think one the FED doesn't know how the market expectation is changing because of the size of the balance sheets. Guessing too, what's the hurry. Why are you in such a rush to take the balance sheet down only to have to start to take it out up in the future. As Bernanke pointed out, it naturally will grow at the rate of two billion

a year. So if we go down, we're gonna be going up soon. What's the big deal? Slow it down, take your time. You're in an experiment, and you're playing with fire because you're playing with the credit markets to the world in the US economy. What's your hurry. How much do you think that the FED right now is is focusing on our weighing the geopolitical issues in China and Europe and Brexit and how that impacts their policy,

or they really just focused on more more internal data. Well, they always have to put the US economy first, But how do you possibly set policy in this list that you just articulated. It's so difficult to do. Imagine that meeting when you're gonna go round that table twice. The first round is going to report on all the influences of the world. You're gonna see them in Beijing book reports,

you're gonna see them in data. You're going to be in the midst of shutdown issues, trade ward tissues issues, tariffs all at once, and you've got to go around the room twice, and you've got two three four minutes each for people sitting around the table who then have to conclude a policy statement, and in between they've been negotiating in between meetings to get to it. It's incredible.

And now they all bring in a hundred staffers from twelve reserve banks plus the board of Governors, and they have diverse models and opinions, and none of them work. That's where we are. That's where we are. None of them work. David Kotak David's chairman, chief investment officer from Cumberland Advisors based in Sarasota, Florida, where he is very much looking forward to returning to tomorrow as we look to enter in to the polar vortex here in New York. Up. So, David,

we're about maybe a third a halfway through earnings. Is what are some of the themes that you've taken out of here as you think about your portfolio, any themes that have been kind of causing you maybe to rethink a little bit where your positioned. Well, we're we're an ETF shop, not a single stock shop, but we look at weights within the E t F space. For example, this week xl E has the largest percentage component reporting

the n G sector. So you look at it the d S because you look at the contents earnings cross currents. Shutdown anticipation is shutdown tariff. You saw it with Harley. You see this constant flow of this crazy narrative world. We live in, impacting with surprises in all directions, and you say, what is normal? Where is a trend? How

do we stabilize the earnings? I think if we can get to the second quarter of this year and we don't have another shutdown, and we make a trade deal of some type or the trade truce continues, we will begin again to see the earnings power of American companies in a more stable environment. And without that, we're guessing. So I'm not surprised by the volatility of the reporting.

I'll give you our numbers. We see about a hundred and seventy or so for this year for the SMP index, but there's a band around that and we see a higher number. We don't see a recession, and that's how we're basing a market overviews level. So I guess that. Then I was gonna ask you or stock investors too optimistic or too pessimistic right now about the US economy? Yes, yes, right, I mean I think that you answered it with a sense of we're just guessing. So then why shouldn't investors

just sit on their hands? If you think interest rates are going to go substantially higher from here, then you might say, wait a minute, my cash is going to earn more. I'm worried about valuation mechanics. I'm going to have to value against a four percent treasury instead of a three percent treasury or whatever. I don't see it, and I don't see the forces that make that happen.

They may make it happen five years from now. We have a large deficit that's going to compound, but for the next two or three or four years, it's not a shock. So without a shock, you say, what are the shocks? Trade ward is the biggest shock. The two giant economies of the world, China in the US are embroiled in a breujaha. Let's get it over. Let's have the truth's extend. Both sides want to make that happen.

If that happens, business gets better, sentiment improves, we all will like it, and stock market will go higher and reflect it. So what do you think I mean if you just put December versus January, and you know just the volatility of December in particular on the downside, and I know you your experience, you've experienced volatile markets before.

Do you think the market just overshot itself on the downside in December, and you know, the five or six percent increase we're seen in the SMP this year is just trying to get us back to a new normal, because if you think about that, the late November December period, it was the volatility was just breathtaking, I would think. So, you know, the Christmas Eve massacre was the bottom? Was it the bottom? It certainly was a climactic bottom, and

we have recovered from it more or less. So now we're back, and you take the v out of the bottom and say, let's look at where we are. We look like we're on trend for around a hundred and seventy dollar earnings. That's a guestimate, but a close one that seems to be on track. How would you value the SMP five index if it's got a hundred and

seventy bucks is earnings, that's cheap, it's not expensive. So the idea of US equities rallying is that predicated on the idea that US bond yields stay low and stay around where they are right now, stay close to where they are right now. If you think that the the thirty year Treasury bund is going to be four and a half instead of three. You don't want to own the stock market. If you think cash is going to earn three or three and a half, you don't want

to own the stock market. What's the threshold? Was the tipping point? Well, I don't know. Three is sort of a magic kind of number that everybody kicks around and we kick it around to When we get there, we'll find out. Do you think the FED has Do you think the FED has the capability to kind of engineer soft ish landing in a two and a half percent range which will support a lot of the forecasts and earnings estimates that that are out there. Oh my gosh,

everybody's that's the question. Can they do it? The record of the FED is mixed at best poor under certain circumstances. And when they try to do two things at once, which is what they've been doing, balance shrink, raise interest rates simultaneously. They're trying to do two things. They can't get one right, let alone too. If the FED stops raising rates, and if the trade war is sort of eased, how much longer does this credit cycle have before? We

could have years. We could have years at least we don't have high inflation upward pressures. As long as we have low end for AH and low rate gradual recovery two hundred thousand kind of job number, unemployment rate low below what we used to think about. These kinds of this cycle could go on for years. It would be the Fed overshoot that could kill it, or ratcheting up tariffs and full blown trade war could kill it. Those are the two killers in my view. David ko talk,

wonderful having you on. Thank you so much for being here, Thank you for warming up my day. Good luck getting back to the warm haven of of of sunshine in Sarasota, Florida, which is very appealing to me right now considering what the temperature is in New York City. David Kotalk, Chairman and Chief Investment Officer of Cumberland Advisors. And certainly the

optimism it's being felt in up markets today. A sort of risk on day for sure, at least in the down not so much the NASDAC ahead of those earnings down four tenths of one per cent, So again all eyes on Apple and on the big tech giants. Another day, another most important vote ever for Brexit joining US now raise at Raphael. I am very glad to say, Bloomberg

Opinion editor, coming to us from London. Raise, there is a vote in Parliament today and you had some scathing words for it in your recent column that was titled had enough of Brexit? How about ten more years? So Raise, what are you expecting? What's at sake today? And how much should we pay attention to this vote? Well, yet again we're all sort of at the edges of our

seat waiting to see what Parliament decides to do. And yet again, what comes out of this vote doesn't tell us very much about what kind of Brexit we're going to get, when we're going to get Brexit, or very

much of anything else. So basically, the primary sister has now thrown her weight behind one of the seven amendments that Parliament would be voting on, and uh she has she has indicated that she would like parliament support to go back to Brussels and reopen the deal that she's previously said cannot be reopened and that took nearly two

years to negotiate. So what's really happening here? Um, this is the government trying to reduce the size of the division within its own party and within Parliament in an attempt to go back to Brussels and say, okay, right, you've been asking us what do we really really want, and now we're telling you. What we really really want is a change to this Irish backstop, this provision that keeps the border open but ties the UK into a

long term custom junion, potentially with the EU. And so Teresa May, having you know, been roundly defeated in her deal, is now trying to get some kind of um unity, or at least to reduce the size of disunity in Parliament so she can try to put more pressure on the EU. But we're what we're not going to get from tonight's vote is a clear sign of what Parliament wants. We may see none of these amendments passed, and I don't think we're going to get anywhere close to a

sort of conclusion to this brexit Sanga. We're going to have to come much closer to the March twenty nine exit date before we get any more clarity. So Terres, you know, it's I keep thinking about the European Union and I'm not sure if it's rhetoric or negotiating tactic or whether they're really serious, but they have been adamant that they are not going to renegotiate this deal. How do you view their rhetoric? Is that in fact should we take that at face value? Or do you think

that is more of a negotiating tactic. Well, you know, I think the it's it's serious on a number of levels. The Irish border issue is one that the EU takes extremely seriously, and it's one that Ireland takes extremely seriously. And for all the argument that you get from the UK, particularly from brexitters, to say, look, this is really a non issue. If they really want to, they can just you know, they can scratch it out, put it in the future political declaration, you do not hear that in

the EU. You do not hear that in Ireland. Today I was speaking to the CEO of Enterprise Ireland, which looks after Irish exporters, and you know, I asked her, well, look, if push comes to slot to shove, won't these won't the CEOs of these exporting companies say please please get rid of that backstop so that we can get a deal. And she said that she had not heard from a single one of them anything close to that, that they

all understand the backstops important that ended. Uh that that that is there to support the Good Friday Agreement, which was agreement that ended a quarter century of of violence and conflict in Northern Ireland. And nobody wants to experiment with what happens if you start putting border infrastructure back.

So I think the EU has room to maneuver. I'm not saying that there's nothing that the EU can give, but it's not going to be a wholesale plucking out of that that controversial Backstop putting it in the trash can and saying, okay, guys, you know, we understand this is hard for you. We'll give you what you wanted.

It's not going to go that far. Tores. I think a lot of investors and analysts would agree with you that one thing is certain with Brexit, and that is that it will be a big muddle for a long time and that we're not going to get resolution anytime soon. What does that do to any leader Theresa May, Theresa May, uh, you know, her successor, etcetera, trying to sort of herd cats here get some sort of agreement. What does that

do to their negotiating power with the European Union. Given the fact that everybody knows it's just going to be an ongoing muddle for a long time. Yeah. I mean think that that's the key question here. That's what we all miss when we get caught up in the sort of drama of you know, the vote. It does two things. First of all, the the the European Union knows that

this is not the last negotiation. It knows that it's going to be entering into a series of negotiations over everything from you know, financial services to UH certification, non barriers, goods, you name it. The whole panoply of of trade relations, UH, security relations, all of that is going to be negotiated for years to come. The EU is not going to want to just roll over on a key red line

right now, knowing that that could set a precedent. UH. The other thing that this UH signals is that Britain is is you know, the whole world knows right now is incredibly divided on this issue. The two main parties are divided on this issue. And because we're going to now have negotiation after negotiation after negotiation, no matter what Brexit outcome we get, UH, this signals that that that a lot of this is going to play out in

the public. It's going to play out in the very robust British media and that is going to most likely weaken the hand of any leader who's going to get criticism from all sides. So the EU understands that it will want to try to ease the path here so it's not blamed. At the same time, uh, it needs it needs to uh to stand firm because there are

more negotiations to come. So to what I'm not hearing in the rhetoric over the past a couple of days, and I didn't hear it in some of the opening statements today in Parliament is the second referendum that seems to have lost a lot of momentum. Where do you think that is as an option? Yeah, well observed. So the second referendum was all the rage a few weeks ago. It has really died down as something people are talking about and talking up. I don't think it's gone away.

I think if, uh, if, if other pathways fail, that it's still there. The one of the amendments sponsored by Evett Cooper seeks to force Parliament to extend Article fifty with a view to putting it to a people's vote as as proponents of a second referenum call it. I think, you know, the Prime Minister really doesn't want that, the Labor Party leader really doesn't want that, and it's very hard to see it happening when the heads of the two major parties you know, quite clearly don't want it

to happen. Y is just real quick here, how much more time does Prime Minister Theresa may have? Probably till mid February. That's I think that's the uh sort of end of what the hard line in her own party will give her. And then she's got to come back and say what she wants to do, and then we'll start to see some some votes that will probably matter

a lot more than tonight's. And just quickly trays the note no brexit that does seem to be off the tables that you read as well, Uh, no brexit at all is not off the table yet, neither was no deal. You know, sorry to disappoint, but all options are still there. If it goes to a second referendum, which we've as we've just said it might people could vote to remain. Very good Tres Rafael Bloomberg, opinion editor covering European politics

and economics. For Bloomber calling in from the London bureau giving us some great color on what is a very you know, fluid story. It's a long playing story. It's a mess. Thank you. Just looking at our monitor here of our members of parliament kind of going back and forth and how long they've been uh doing that, and it just you know, Tres says, it's you know, even if you get something, you got another ten years or of just kind of negotiating all types of side deals here.

So you know, we'll stay on top of it as we always do. Also focused in Washington, d C. We're expecting trade talks at this point at some point between the US and China, but a US court has gone after Huawei to accuse them criminally of some of their actions. Joining us down to talk about this is and Stevenson Yang, co founder and research director at Jay Capital Research, also a Bloomberg opinion contributor, and thank you so much for

being with us. This seems like a very big deal because it seems like the US is going after on a criminal level the biggest or one of the biggest China technology companies. Can you give us a sense of what the charges are and whether they are politically motivated, you know, they're they're two different. Um, there there are two different sets of charges. One has to do with Huawei's evasion of US sanctions on Iran and other countries, and the other one is an indictment in Washington State

for Huawei's attempts to steal technology from T Mobile. And I would say that the latter, which has gotten less attention, is kind of more and is not related to the case of of Mong One Joe, who is being held in Canada. UM I would say that one is more interesting.

And if you read the indictment, it's really damning. I mean, you know, Huawei actually giving bonuses to employees to incentivize them to steal technology from American companies, Huawei guaranteeing employees in writing that they wouldn't be punished if they if they broke US laws. I mean, it's pretty it's pretty damning.

So is it politically motivated? I mean you do have to say that there's been a sea change in h in the political view of China and in companies like Huawei in Washington and probably in other capitals as well. But you know, is this are these indictments justified by

the law absolutely, so they're justified by the law. But from the Chinese perspective, I mean, what is your sense as to how this particular issue, the Huawei issue, and the press that that's receiving, to what extent do you think that will in fact impact the trade talks between

the U S and China. Well, one of the interesting things about all of this is how how China has gone absolutely ballistic on this UM and how they've um, you know, detained three Canadians because Canada, you know, trying to pressure Canada not to act stradite mung Wan Joe, who is the of a CFO of of Huawei and the daughter of the Hawawi founder UM and uh, you know, including it in the trade talks, and how all that the Chinese public commentary is all like, oh, the U

S and Canada are just trying to crush China and put us down. So any pretenses of having this be a be called a private company have just been dropped. So what does that say about just sort of the broader fight for tech dominance between the US and China. You know, what does it say that China seems to be doubling down on its support of Huawei and making this more political while not really necessarily addressing the main complaints.

And what does it say about the US that they're continuing to go after this even while they try to come to some kind of trade resolution. Well, you know, I think that that's actually the appropriate path for the U. S UM. I think what's not appropriate is this big focus on the trade deficit UM, which actually, you know, ironically, during all of this UH discussion and these trade talks has been rising sharply, And the biggest trade deficit for for the US with China in history was last year. UM.

So I think that part is misguided. But the focus on technology and evading US law I think is really quite overdue. Um As for technology competition, you know, I've never really seen that argument. The problem with with Chinese tech companies is is precisely the problem that that is kind of um evinced by by this UH, this this Huawei indictment UH over the Team Mobile case, which is that if you put all of your energy and focus

into stealing technology, you don't develop new stuff yourself. And you know, Huawei has some of the most talented engineers in the country. They have a culture of really really hard work, they get really highly educated people, they incentivize them, and then they just like steel technology. And Stevenson Yang, thank you so much for that insight on what is a you know, a very complex issue, UH made even more complex with some of the legal issues that Hahwei

is facing here in the US. That was and Stevenson Yang co founder, research director J Capital Research and is also a Bloomberg Opinion contributor UH and and it's based in Washington, D C. And Hong Kong. So we'll have to see. UM. I think what we're gonna find is that these negotiations are going to, UH I think be very very difficult. I think there is in fact going to be a political uh tinge to them. That's kind of at least what we're seeing in some of these

recent events. Well, Apple reports earnings after the Clothes eagerly awaited, but let's face it, the text earning season has not started off very well. Both Intel and Nvidio reported disappointing results. A more importantly, their outlook was not much better. So let's let's kind of dive into it a little bit. We're fortunate to have once again our good friends Shire over Day UH Technology columnists for Bloomberg Opinion here with Lisa,

myself and a Bloomberg Interactive Broker studio. So shure this is as it is every quarter of Apples earnings. You know, I think very much anticipated, in large part because people are trying to get a sense of boy, where is what's that next step? For Apple? They pre announced earnings weak earnings for the first time and forever, Uh, what do you expect to hear from the company this afternoon? So I think there there are two things that I'm

going to pay attention to. One is the forecast. Apple doesn't forecast for the full year, but they'll give a forecast for the March quarter. And I think that's really going to set the tone not only for Apple this year, but for the rest of the technology industry, because the forecast will give us a little bit of insight into

what is really happening. Is is there, as I believe, a kind of secure alert change in the smartphone market where all the growth is gone and Apple is just going to have to contend with you know, two thirds of their revenue is coming from a secularly declining industry, or is there something else that Apple thinks is going on?

Temporary weakness in China or other places. And the other thing is will Apple say anything substantive about what they're doing to offset some of these revenue weaknesses in iPhones? So I guess one one question that I have is how much is Apple representative of the broader smartphone industry

of big tech? And how much is Apple really an idiosyncratic story that has to do with where they price their iPhone ten, that has to do with their appeal for luxury consumers and kind of their their missteps in China. I'm gonna cheat and say that Apple is both. They

are representative. I'm sorry, they are representative of the smartphone industry again, because you have this phenomenon where a majority of people in the world now have a smartphone, and they're replacing them less often, and so that affects new device sales. And that's happening not only for Apple, but for every other smartphone manufacturer out there, particularly those like Apple that are focused on, you know, relatively affluent consumers

in the developed world. So um, So there is both a kind of smartphone industry read on Apple as well as a kind of Apples specific given the corner of the market where they concentrate. So one question that people have started to ask them is doesn't make sense for Apple to do something unusual for the company, and that's starts to lower their prices in order to get into markets like India, for example, which has been a high growth smartphone market, one of the few pockets of growth

in the smartphone industry. But their Apple's iPhones are not competitively priced in India, and the same is true in China. And so will Apple be more aggressive with prices and they really haven't shown that in the past a willingness at all like China is probably a great example. So in terms of we but if you think about the Indian market, where they are essentially nowhere, have they ever talked about all right, we are going to strategically make a change and bring in a mid priced or low

priced phone. Not really. I mean, if you recall a couple of years ago, a few years ago, Apple released the iPhone SC, which was more of a mid market price phone, and that has been a device that they've pushed in places like India, although even the iPhone SC is still too expensive for India. And and look, I will say that I think it's debatable whether Apple needs to compete on price. They have done some select price

cuts kind of under the covers in in China, for example. Um, but Apple has never been a company that has tried to get all the market share in the world. Right. They've been content selling a relatively relatively small fraction of the world's personal computers, for example. But they still have a majority of the share of revenue in the personal computer industry because the max they sell our high prices.

So if Apple is content to do that in smartphones, maybe it should set that out as a strategy instead of letting people guess what the heck Apple is trying to do. All Right, so we have Apple sort of setting the tone for the media intensive tech side big tech. Later today, we have already gotten the data from Intel and Nvidia, and I'm wondering, what's your big takeaway other than bad? I think bad is my big takeaway? UM,

I think I think it remains to be seen. You pointed out that Apple is a little bit of an idiostocratic company at least as we think about the rest

of big tech. Right, So my question for UM that came from Intel and Nvidia is one reason that those companies gave for relatively weak financial results was their biggest customers um for computer server chips, which are you know, the kind of high end um superpowered computers that are used by the big Internet companies like Google and Amazon and so on, those come those customers are taking a bit of a pause in buying chips for their data centers.

And the question is is that a temporary pause because they pre bought a whole bunch of computer chips and are now kind of working through that, or do those companies see there's some growth hiccups on the horizon, maybe we should pair back our supplies or purchases of the

raw materials for our internetwork networks. And so that's something that I'm going to be listening for from Amazon and Google and Facebook for the rest of this year, is are they seeing signs of weakness in their growth and that's being reflected in their orders to companies like in Video and Intel. Yeah, that's I I think that's a critical issue that you share. Wrote an article a column two days ago about you know, the Canary and coal mind these these chip makers and what does that mean

for the big text story? You know, I think my question is, you know, and when we think about the Some of the biggest growth areas uh in heck, over the last five six years has been the cloud. And the question that I'm wondering is if have we seen peak cloud um or or is again is it is that something structural or is it something that's just temperate. And I'll tell you if if it is structural, that

is a seismic shift for the entire tech ecosystem. Are you are you hearing any of that or seeing any event? I'm not. I'm not. I think from all that we've seen there there's an imperative for companies to continue to spend on um on pushing more of their digital information into these cloud computing services. I still wonder what happens if we get um a global recession or a recession

in in some parts of the world. UM. I think there's a belief that the cloud is not going to be affected by that because there are financial imperatives, some financial savings removing to things to the cloud. I just don't know if companies are gonna be willing to do those kinds of information technology projects if we do see signs of economic hiccups, and so I think that is

a big question of the peak cloud question. And there's also of course the question of carmakers, right will they simply cut costs by not investing as much in the sort of tech side of the chips and buying as much of those types of issues. So really, um, a lot of in an intersection of a lot of different industries kind of coming together that we're going to find out, uh, some insight into after the bell today, tomorrow and in the upcoming days. Shara Overday, thank you so much for

being with us. As always, Shara Oviday is a Bloomberg opinion columnist covering all things tech. Thanks for listening to the Bloomberg P and L podcast. You can subscribe and listen to interviews at Apple Podcasts or whatever podcast platform you prefer. Paul Sweeney, I'm on Twitter at pt Sweeney. I'm Lisa Abram Woids I'm on Twitter at Lisa A. Bram Woyds one. Before the podcast, you can always catch us worldwide on Bloomberg Radio.