Three Reasons Why U.S. Stocks Are Going Up: Orlando (Podcast)

We are very lucky to say Phil Orlando, chief Equity Market Strategistic Federated Investors here in the studio. Um, Phil, so can you give us a sense? Let's start with the yields, the rising US yields and how much that will just sort of de facto put a halt to the rally in stocks. How worried are you? Have we reached the tipping point? Well, I don't think we've reached the tipping point now. Our target for benchmark ten year treasury yields at the end of this year was three

and a quarter percent. We're there, so we're not the least bit concerned about that. What does concern us is the rapidity of the move. We've gone from three oh five to three and a quarter in what a week? So I think the markets looking at that and freaking out and saying, Okay, if we went up, you know, twenty bases points in a week, what are we going to do over the course of the next month or the next quarter. We're looking at you know, five percent

treasury yields by the end of the year. Okay, fair enough, But what is the tipping point? Is there sort of a number with the ten year treasure yield at which the equity markets just cannot rally anymore? Well, in our view, that number historically has been five percent, and five percent is the point at which you begin to see massive disinter mediation from the risky asset stocks into the risk

free asset bonds because the yield is attractive. And then as as yields continue to rise six percent seven percent, pe s actually contract up until five pace historically expand so why is that? Well, as as as economy has come out of recession, as economic growth perks up, as inflation starts to perk up, as the Fed is tightening policy, is yields arising, all of that is good for corporate

earnings because it means that the economy is strong. The five percent level historically has been the tipping point because you've got the risky versus you know, risk free inflection point that starts to take money away from from the equity market. Now that there are some who argue, well, okay, this time is different. Five percent won't be the inflection point. Maybe it's four percent, maybe it's three and a half percent. And I'm sensitive to the fact that people think that

the lower numbers right this cycle. But let me point out that the foremost dangerous words in the English language, this time it's different. Phil Orlando Jamie Diamond, chief of JP Morgan Chase, says that people should prepare for US yields of five percentage you just described, and he believes that the yield on the benchmark tenure Treasury could reach four percent this year and perhaps even five or higher next year. He says, you better be prepared to deal

with these rates. Are clients and customers prepared? Um? Certainly not. Our clients are customers because our forecast is not Jamie's forecast. We thought that treasury yields would get to three and a quarter percent this year they have. We think they'll get to three and a half percent next year. Uh. You know, Jamie thinks probably will get there by Thanksgiving

this year. Uh. And then our expectation is that as the bond vigilantes begin to look out into the back half of or the early part of one and see some seeds of slowing economic growth, we actually might see a rally in bonds from three and a half percent,

taking yields back down. So if Mr Diamond things that we're looking at a five percent treasury over the next couple of years, he's got to believe that there's much stronger economic growth, much greater inflationary pressures in the pipeline that will emanate over the course of the next couple of years. All Right, So you sound like you are bullish.

You are sounding like you don't see treasure yields rising to the point of stimming the rally and equities, So are you out there buying the dips at this point? We will. We're monitoring that there are a couple of things that we look at. There's an interesting confluence of three indicators that are looking interesting. UH stocks oversold, bonds overbought, and UH bonds over sold and and uh, and the vics over bought. Uh. And those things are are are shaping up right now. So I don't know if today

is the day or if tomorrow is the day. But as I look out at the market, over the course of the next month or so, there are several positive catalysts that I think will rever this recent weakness. Uh. You've got corporate earnings starting later this week, including Mr Diamond's firm. I'm expecting his company is going to produce some pretty good numbers along with others. We're thinking that corporate earnings are going to plus for the large gaps

this quarter. Uh. We've got the flash report from the Commerce Department on third quarter g d P, which will be out. I believe October. We've got three point four percent is our number. It federated. I think the Atlanta Fed, for example, I might have a four handle on their number. Uh. And then we've the midterms are going to be over in a month and and all of this noise and nonsense will be behind us. There will be some certainty. R. Really, we're gonna quote you on on that one. I want

to ask him more a more everyday question. Shot. So far this month, the SMP five hundred is down a little bit more than one. What is the number based on your experience where the customer and the client starts calling, well, uh, you know that becomes more of a technical question or anything else. So so typically him the third quarter of a midterm election year, a year like this tends to

be a really sloppy quarter. Well, the month of September. Uh, we're up seven percent or something in the month of September. It was the best month we've seen in like five years or something like that, or numbers have been strong. Um. I like to look at more at peaks to troughs, and and this little correction that we're seeing in the large cap market right now is about three or four percent, in the small cap market is about seven or eight percent.

These are healthy corrections, and what I'd like to see is some pull back to some longer term support levels in conjunction with continued solid fundamentals. We talked about a couple of things GDP growth, corporate earnings growth that become sort of buy signals for us. So I'm not ready to pull the trigger right this second. But I'm not getting panicked by this at all. I'm more inclined to be buying at the margin than selling, depending upon how

events play out over the next few weeks. So which sectors are you looking to potentially buy when you get that valuation that looks attractive? There are two areas that just look extraordinarily interesting to us. UH domestic large cap value has underperformed growth by something like thirty percentage points over the last two years. Financials, industrials, and energy at the top of that list. And then small cap stocks as I said of pulled back seven or eight percent

here over the last month or so. For a number of reasons. We think that the small cap rally we've seen earlier this year has legs. UH and UM I think small caps are are are oversold at this point and and will rally, will resume their rally later this year. Where's the money going to come from? It to come out of bonds? Because if Jamie Diamonds right and treasury yields go to five percent, we're sitting at three and a quarter right now. I don't know why you'd want

to be long a treasury in this environment. Okay, but if Phil Orlando is correct, you won't have been in bonds. You will have been in stocks. Where's the new money going to come from? Well, I still think we still have a significant underweight in fixed income. We are five

percent overweight equities, five percent underweight cash. And if if an investor is really interested at the three and a quarter percent Treasury yield because they need the money, I can show them our strategic value fund that's giving them a five percent dividend yield right now. So so if if money, if income is what they want, you can do that in the stock market. You don't need bonds to do that. And the risk of of of a capital loss. All right, So what's the biggest risk to

your outlook right now? What could potentially happen that would make you be wrong? Well, there's you know, I've got a list of nine things to keep me awake at night. I mean, I'm I'm I'm here talking my book and sounding bullish, but that that doesn't mean there's nothing that's going wrong in the world. And at the top of the list is is the Federal Reserve gonna make a policy here in the out years? I mean that concerns me trade and tariffs that seems to be falling into place.

China is sort of the last man standing here. But you know, are we're gonna be able to pull off the last trick here and and get the trade and tariff situation in good shape? The blue wave, I think we're gonna end up with the split election. I think the House probably flips, the Senate probably stays in Republican control.

But suppose the d's are on the table. Suppose we spend the next two years going through impeachment proceedings, and and that takes the focus away from you know, fiscal policy and strong economic growth and strong corporate earnings growth. So there's any number of things that can go wrong. Um, and so you just, you know, you just have to evaluate what's going on and try to get the best

information you can to your clients. So does all of this day the same if oil remains that let's say seventy four seventy five dollars a barrel for West Texas Intermediate or eight plus when it comes to brand. Thank you, I'll give your twenty dollars later. Excellent question. You know, you pick up any newspaper in America and uh, you know, headline writers or crewed gone back to the north of a hundred dollars a barrel, and that just isn't happening.

The supply and demand in balance right now. Uh, we're past the peak driving season. Uh, we're fracking to beat the band. The Saudis and the Russians are continuing to pump. Okay. I think they're going to offset the diminution of crude that that we may lose that of Iran if if these nuclear sanctions are reimposed. There is concern in the Gulf right now with Hurricane Michael. Does that take any

refining capacity out? I understand all the near term noise, but but our view is that the move up from forty dollars a year and a half ago would sort of settled into sixty five to seventy five barrel range. We're at the top end of that range now, so I'm I'm fine with with crude at seventy five, staying within that sixty to seventy five. I don't think that the newspapers are doing a good job getting everyone all worked up with with hundred dollar plus crude. I don't

think crewdes going on a hundred dollars. It's not just the headline writers though there's some pretty big analysts on Wall Street Corp predicting a hundred dollars or more pre barrel of oil, and the i A has come out and said, you know, yeah, please pump morps so that we can get the prices down. So it's not just headline writers. There seems to be an increasing risk of that. I'm just wroking that out there, and and that's fine.

Given the fact that the three largest producers in the world at ten to eleven million barrels a day, of the United States, the Russians and the Saudis, I think will continue to pump when push comes to shove. We're at a point in the cycle where the demand starts to diminish. Obviously, we've got to watch the hurricane activity. Obviously we've got to watch what's happening and rand. But I think that this balances itself out and we'll be okay.

And I thought you were just going to tell us that Jerry Jones and the Dallas Cowboys he wants to buy more more assets in the in the shail play with his comstock resources. I didn't hear that, so I don't have any I don't have any knowledge about what Mr Jones is doing. Are well done, Thanks very much for sharing your knowledge with us. Phil Orlando is the chief equity market strategist for Federated Investors and Lisa, I think we can just call him a bull right now,

fish for now. Thanks for having me on, guys, it is It is a treat to come out of this show. You guys are terrific. Thank you. All right, we'll give you the twenty dollars back, Thanks very much, Phil Orlando of Federated Investors. Our guest is Carl Weinberg. He is the chief economist for High Frequency Economics and you can

follow Carl on Twitter at c B Weinberg. Carl, can you speak a little bit about fatigue when it comes to global growth and particularly in the context of the meetings that are scheduled to take place in Bali for the International Monetary Fund? Yeah, Hi, Pam, good morning. So you know, the i m F has been talking this story for some time now. They're byline that their last set of meetings was you know, is this as good

as it gets in the world economy? This time around, they translated that into some numbers in their world economic outlook, shaving down their growth rate. They still have a pretty cheeky growth rate of three point seven percent for the world economy, and they're the same for this year as last year. But most importantly of all, the i m F has a lousy record of predicting turning points in the world economy. So this document is kind of provocative

and that it gives people something to think about. But the IMF has missed every economic downturn over the last twenty years in its world economic outlook. There should be nothing new for investors in what came out of the i m F today. All right, but Dr Weinberg, do you agree with anything that they put out there, putting aside their track recording. Yeah, I mean, I think that the broad story is that there are risks of the

world economy coming from trade. There are I think bigger risks out there that the fund mentions a little bit deeper into the document. Higher US interest rates or a drain on growth potential and disposable income for countries that have a high foreign currency debts denominated in dollars. The stronger dollar is also a drain. Higher oil prices are

also a drain. So we have clouds forming off of the world economy, and we're starting to see that in things like the industrial production number for Germany that came out on Monday. We're starting to see it in slowing GDP growth in places like Japan, uh and uh So. Overall, I think the Fund's message is right on, but I think that there's still probably more optimistic, and of history is any guide. They are too optimistic about how this

is going evolve over the next year or two. Carl, do you believe that the Chinese will be able to outweight the United States when it comes to trade negotiations. Yeah, I certainly think they will. I certainly think they have to.

The prize in all of this is China's industrial development policy, the so called Made in China, and that's a program in China to acquire the technology to produce seventy of the stuff that goes into what they assemble and re export, rather than thet that they currently produce at this time. So that difference of the value of exports is a trillion dollar a year prize that comes to China, and

that's what's really at stake. The US Trade Representative mentions this program explicitly in its statements about the US tariffs UM and China is never going to give that up. So I think the Chinese have a big prize, a big pay day at the end of the day for sitting out the tariffs. I believe they will. Dr Carl Weinberg, thank you so much for taking the time with us.

Dr Carl Weinberger's chief economist at High Frequency Economics. Talking about the I m f S stellar track record, he actually it doesn't put a whole lot of credis in that, but it's definitely looking at the potential for slowing global growth. Joining us now, Mark Lynde Bloom, portfolio manager for Western Asset Management. Mark, thank you so much for being with us. Can I just ask do you find treasuries attractive here given how quickly yields have risen to seven year highs?

Good morning, Thanks for having me on The answer to your question, as we do. We have for most of the year had two reasons that we are favoring US treasuries. First is that we thought the economic growth this year next year would be a bit more moderate, and I have to say we've been wrong on that given the

fiscal impulse that we've seen. Nonetheless, our economists here are looking for somewhat slower growth versus what we've seen in the middle part of this year, but most importantly from a bond point of view, that inflation is going to remain around two. The second reason I would say, though, is it as important, and that is as part of a fix income portfolio, we do want to have a risk mitigator and insurance policy, if you will, just in case we did start to see you slowdown or financial

conditions did start to pinch economies around the globe. Both of those reasons, we are favoring favoring treasuries here a little bit more even around across the curve than we have in the past where we have focused on the long end mark. Is that also the two reasons why you're choosing now to issue and launch the first fixed income exchange traded fund UH from Western Asset Management, the

Western Asset Total Return ets somewhat coincidental there. What we've been here from the field UM and from those who know Western well over the last four decades is they've been looking for an additional vehicle besides the separately managed portfolio or a mutual fund or a commingled vehicle, and specifically an e t F. So from our point of view, it's a it's a great question that it is a different rapper, if you will, but it will be managed pretty much the same as all the other vehicles with

all the same Western themes as part of the E t F. All right, are you at all concerned about revealing your secret sauce since you have to actually disclose the holdings in real time basis of the E t F Really not mean. We've been always very open about what we are doing on a daily basis, so to the extent that this is a little different and and a from a formal point of view, it's uh, it does not bother us in the least in terms of

letting letting that information out there. So can you give me a sense here of what you would have done or what you did do in the past week given the sell off in in treasuries that we've seen, but also the sell off an investment great debt in particular that really has been quite quite significant. Yes, it has been quite significant to your first part of your question.

As I mentioned a little bit earlier, in the last several years, our clients have benefited from our dedication and some would say stubbornness wanting to own the longest part of the U S treasury curve, and that was based upon our view that the said would very slowly increase rates. In fact, they have done that, as we all know.

The expectation is they'll continue to do that, and we are moving some of that contribution, if you will, or that duration down into the short and intermediate part of the YOK curve, just thinking it's their better value there or fully reflect expectations on the part of the Fed as we go into two thousand and nineteen, and as we all know, there are now actually real yields. They're they're they're quite attractive and our opinions, so that has

been a change. And then one of the things that we've been doing over over the last week or so, as as the as the market has been backing up quite substantially on the non treasury sectors to your to your question, we've been growing increasingly cautious, particularly towards the corporate sectors, and particularly to the below investment grade corporate sectors, where we've been taking our allocation to high yield and

bank loans lower investment grade corporates. We've been more neutral, but our investment grade corporate team has been concentrating on those sectors that we feel most good about it in the late late stages of this economic cycle. The one thing I'll add to that is that the one area we do have higher conviction on is emerging markets, while all the others we don't have that same high conviction, or to put differently, we just don't think we're being

paid for the risk. When you mentioned emerging markets, do you mean dollar denominated emerging market debt or local currency debt? A little bit of both, quite selective, like we are in every credit sector on those countries or those corporations within those countries that we're choosing. But as you look at our portfolios today, right across the board, were approximately half the dollar the external debt, and we are approximately half in some of the local bonds and local currencies.

There is an increasing sort of din out there that the Federal Reserve is on the brink of a policy error as it increases the pace of raising rates. Do you do you agree with that? I mean, do you think that that risk is growing stronger? I think we'd have to acknowledge over the cycles that we've all lived through. When you look at business slowdowns and actual recessions, there are common themes as to why they come about in terms of the FED being on the move, perhaps commodity

prices increasing, uh, some misallocation of capital, inventories, etcetera. So we are not about to dismiss what's happening now in terms of the FED being on the move uh and planning to raise interest rates to neutral or beyond as they've been saying recently. The thing that we all just don't know how to weigh is this experiment we've been

conducting for now ten years. As we unwind that, and if the speed limited growth around the world and particularly in the United States, is lower, we would believe then that smaller incremental increases in the FED funds rate and market interest rates will start to impact the economy sooner. So we are not about to ignore those signs at all, and are growing a little bit more cautious towards particularly the non treasury sectors. In recent months, we're speaking with

Mark Lynd Bloom. He is portfolio manager for Western Asset Management Company. We're speaking about the firm's first fixed income et F. It's called the Western Asset Total Return et F, and as part of the mandate, you've put a cap on the amount of assets that can be put towards junior loans that instruments that are either unsecured and subordinated. Could you speak a little bit about that and particularly

about the market for junior loans. Sure, this is consistent with how we view here at Western Asset the core or a core plus bond fund in that the buyers of these these funds, usually which are measured against an aggregate indexes as you know, are are meant to be an anchor to windward sort of vehicle. UH. Core plus does offer some flexibility in terms of the blow investment

grade sectors to gain some yield and return advantage. Certainly were advocates of that, but to your to your point about limitations that we want to be very careful that the purpose and the objective of a core plus fund is to provide higher returns versus and aggregate index over time,

but without substantially higher volatility. So our intent is through the guidelines, the guard rails, if you will, that we do limit some of those UH, some of those sectors as part of the asset allocation on constraint funds for example that didn't have a benchmark and I had a

lot more flexibility. Certainly, would have a greater greater room to add those on your question, your second part of your question, you know, what do you think, as I suggested a little bit earlier, when we look at many of the sectors below investment grade across corporates are even structure most recently and buy instructure, I mean cnbs and residential loans. We are not at all pounding the table and saying we're about to go into a slowdown our recession.

There are a lot of folks out there with that prediction of two thousand twenty. That isn't our call. But the key is the valuations just aren't there to benefit our investors currently. Thank you so much for being with us. Mark Lynn Bloom, portfolio manager at Western Asset Management Company, which over sees four hundred and twenty billion dollars. They did just launch a new actively managed e t F, the Western Asset Total Return e t F, which uses the same strategy in the broader non e t F

fund UH in real time. Right now, we're looking at emerging market currencies that are just a slight bit if you look at the m s c I index, but certainly they're stable as compared to the plunge that we saw earlier. The question is this just a relative bit of calm before the storm continues? Joining us now, Dr Win Thin, global head of Emerging Markets for the FX markets at Brown Brothers Harriman, coming to us from New York. Dr Winton, thank you so much for being with us.

So let's talk about that. I mean, the I m F came out with this report downgrading their expectations for some major emerging market economies, including China and Brazil. Do you think that what we're seeing right now is the calm before the storm? Well, I say, personal, thanks for having me. It's always a pleasure. Uh. Well, look we have we haven't exactly had um much calm this whole year, So I would say this is within a greater bear trend. I mean, as you mentioned, there's a global backdrop for

EM remains UM, very difficult global growth forecast lower. Uh. I'm your postal worked down trade flow forecast, you know, reflecting the trade tensions. Um, we gonna hire U S interest rates and moving higher, so the backdrop EM remains negative. Um. You know, I think this is sort of a little bit of a pause. Um, but I think it's very way too early to say, hey, this is a good

time to buy EM. If you look at the ms c I um E Mergant Market Index, we're breaking down making new loads off of this move um this yesterday, and I think that's you know, so the negative sense it remains in place. Do you believe that dollar strength continues? I do, yes, Uh no, I think you know, as you know, the the U S bond mark was closed yesterday, so we've ended last week on a very um uh sort of strong in terms of the yields we had.

We had US tenure yield poking up around I think the markets started this week worried that we didn't get further push up, but for now we know we haven't really pushed that Keith twenty five area, and so I think as part of the calm is that we haven't seen another leg up in US rates, which of course, as we mentioned, is very negative for EM very positive dollars. So you know, we've got the p p I tomorrow and cp I the day after here in the US.

I think those were very key given that the focus on on yields and rates here in the US, I think it's still the primary driver for global markets. Not just rates markets. You probably know, the equily markets started to really feel that the heat. Um. You know, part of that is the fact that a lot of these UH stock valuations were made under the assumption of low

interest rates, and that's that's being readdressed. Now. I want to turn the focus a bit to China, because China eased Paul to see further this week, and they're trying to ignite some growth or at least cushion the slowdown

and growth that we've seen. And I guess I am really struck by the reaction of markets, with the equity market in China falling after that announcement, basically saying it's not enough, and it seems like you're a little bit desperate, the Chinese leader of the PBOC to try to gain some control over this. How concerning is that? Well, I think China is always sort of a simmering concern. Um. You know, many analysts called for some sort of big

disaster there. You know, they've been calling us the last ten years. You know, it's clear that they're slowing, and you know we always had a discussion, well, how how do you trust the Chinese umbers? Well you can't really, But what you can trust is the sort of the official actions and the fact that this I think the fourth reserve requirement cut this year, the West, some other directed lending. It's clear they were concerned about a slowdown.

Um we are seeing UM, I would assume I think it's slower than expect to slow down given the policy reaction. Bottom line, though, I do think China kind of muddles through. It's uh. I think the trade tension of the U S makes things obviously much more difficult. And that's you had another ball at the juggling um. And so am I a little bit worried about China? Yeah? I am. I'm probably a little more worre than usual, but I'm not in the sort of we're we're heading for disaster

camp at this point. Can you tell us your outlook for currencies that are tied to commodities such as the Canadian looney and the Australian dollar. Sure, Um, well, you know Canada, it's two separate sets because if you think about the commodities, well, Australia is linked usually to iron ore and China. Um. So from as a result, the Australian dollars and has not been doing well recently on the flip side, Uh, the looney is is more linked towards oil, and of course oil is on a tear um.

You know, at some point, though too much of a good thing is uh is too much? You know, at some point high oil prices are become negative for the world economy. I mean, you're sure it's great for the producing countries, but if you're an all consuming country, like most most industrializations are, uh, that really starts to take a toll, whether it's at the pocketbook, at the at the pump, or even at the firm wide level. Uh two,

high prices are not good. Um. So you know, I'm hoping that OPEC realized this and then they sort of uh take some stronger actions. Even at this point a little bit blase about, but I think that the growing concern given all the other headwinds on the global economy. When you said that you do expect the ongoing deterioration in emerging markets currency valuations to continue versus hard currencies.

But is there anywhe where you see uh sort of potential opportunities or do you think that everything's gonna get sort of caught up on the and the FED tightening and sort of the the QT that's taking over the world. Well, you know, one night one e M, I would say I'm very negative going into year end, and probably i'd

say the first half of next year. But uh, you know, I think we're sorting halfway do the sell off, maybe maybe a little bit more, but I do think there's ways to go still before we sort of get to an equilibrium. Now um with a they e M though, you know, I should say that there are opportunities. You know, for instance, the Mexican pace was actually up this year, up three, so there's a real differentiation. You know, you've got the five so really worst currencies Argentina, Turkey, South

Africa and now Brazil and India swap places. Brazil is rallied on the election, so it's actually gotten pushed up to only sixth worst. Uh and you've got Indian Russia from rounding up there the worst five. You know, you've got the e M weakness concentrated in a handful, whether it's five, six, seven countries with adosyncratic risk, other countries currencies and countries holding up better thaybot come and taste in Malaysian ring get um Mexico. As I mentioned, earlier,

So there's definitely a differentiation. I think markets in a in a tighter global equity story, marks that are punishing the sort of the deader countries, those that have high current account or budget deficits, and there there's not I would say the rewarding, but there's sort of leaving alone the country that the surplus countries, and many of those are in Asia. So again let you look look under the hood. You can't you can't sell em on mask. But in channel I do think the asselete classes is

going to remain under pressure. Now we always talk about countries when they are under pressure. For example Argentina. Any update on the Argentine Paso and the efforts of the Argentine government to contain inflation and produce a credible budget, well, I'll say we're we're I look at that glass of half full. Um, they've taken all the right steps. They've tighten montars policy several times, numerous times, UM, tighten fiscal policy, gone to the IMF. In fact, it just increased the

IMF program um by request. Uh so they've done all the right things. That's finally, UM, I think the pacers finally starting to get some traction um. So you know, I think clearly, uh, you know, the movement forward might have been in a bit of an overshoot, but within the e m bearing mark, I don't think Argentina Payco can be recovered too much in absolute terms. I'd say the same thing in Brazil. You know, we've had a great sort of pre election and post election, but we're

in the ear mark. I don't I don't think there's much more room for for absolute gains now in on a relater basis. You know, I think those two because they've been hammered so badly this year, I could start could do a little bit more outperforming with an e m UM, But you know, absolute terms, I'm pretty negative. I want to thank you very much for joining us and giving us your thought a doctor when Finn is a global head of Emerging Markets f X at Brown

Brothers Harriman. 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.