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This is the Bloomberg Surveillance Podcast. I'm Jonathan Ferrow, along with Lisa Bromwitz and Amrie Hordern. Join us each day for insight from the best in markets, economics, and geopolitics from our global headquarters in New York City. We are live on Bloomberg Television weekday mornings from six to nine am Eastern. Subscribe to the podcast on Apple, Spotify or anywhere else you listen, and as always on the Bloomberg
Terminal and the Bloomberg Business app. Thel Orlando Federated writing this, we're not buyers of the SPX whole hog here, however, we still expect the rully in stocks will broaden out from mag seventh Centric to include domestic large camp value, small cap growth and international film. Pleased to say it's with us now for more, Phil, Let's go straight to it. The data of yesterday. How much weight would you put on that manufacturing reed?
John? Good morning, Thank you again very much for me back on. I think yesterday's data was very significant that the ism, as you guys pointed out, was back above the fifty level, the contraction line of demarcation if you will, for the first time in sixteen months. And as Lisa pointed out, the number that was stunning was the prices paid component. So you've got a situation where the economy
is strengthening, yet inflation is sticky, perhaps even accelerating. Now pair that with the LI data we saw last week. Leading economic indicators went back positive for the first time in twenty two months. And you sit down and talk to our bond people and they look at these inverted deal curves that we've been watching for the last two years, funds to tends, twoes to tens, three months to tens. They're flattening out. Our bond guys think that those may
become positively sloped again. So the risk of recession or lower risk of a modest soft landing is starting to shift to a stronger period of economic growth. But the inflation question, I think is the more important one. Look at last week's PCEE print core two point eight percent for the month of February. Now what really caught our
attention was the changes in the SVP. At the Fed's last meeting, they're going to increase their core PC forecast to two point six percent for next year and kept their two percent target in place for calendar twenty six. So the FED is telling us that inflation is still a problem. It's going to be a problem as the economy comes back, And what all of that means is that it's going to be less rate cuts relative to what the market was expecting just a couple of months ago.
So, Phil, given everything you've said, every item on that list in the last couple of minutes, is that good or bad for stocks? Let's make it really simple, good or bad for stocks?
So SMP five hundred up ten percent here in the first three months of the year, up twenty eight percent since October. In our view, stocks are ahead of themselves, but we expect sort of a rolling correction, if you will. The MAG seven in the last fifteen months is up ninety nine percent. The Forgotten four ninety three is up
twenty two percent. Our view has been that this rally was broaden out, that we would see some profit taking in the MAG seven and the domestic large cap value stocks, the small cap GIRLD stocks, the international stocks which were largely left for dead over the course of the last year or so, they would find some love and we'd start to see some improvement in the share prices of those categories.
But phil how much do higher rates really challenge the idea of broadening out, particularly to small caps, considering that these companies usually are more leveraged and are more vulnerable to higher rates.
Fair point, But remember that the US economy is doing relatively better than a lot of our trading partners Japan, Germany, UK, all in recession. The reality is that small cap companies here in the United States do eighty percent of their business right here at home, and from an economic standpoint, we're doing better here in terms of underlying fundamentals. The sectors within the small cap market, Biotechnology, for example, is
our favorite, is really well positioned. Biotech stocks have very strong pipelines, the valuations have probably never been cheaper, and with interest rates down at the margin, the prospect of M and A activity is enhanced today versus where they were a year or so ago. We do like small cap here.
What about oil?
How much is oil? The new mag seven at this point where people are talking about the fact that suddenly there is the reality check of supply and demand, to the fact that this economy isn't rolling over the way so many people thought.
Music to our ears Lisa, that we were very lonely at the beginning of the year talking about oil WTI in the mid sixties, thinking that we could see eighty to ninety dollars a barrel by the end of the year. We're now sitting in the mid eighties three months into the year, so this has happened a lot quicker than we thought. But the combination of increased geopolitical risks in combination with the fact that we don't have a lot
of levers here. In the past we might have utilized the Strategic Petroleum Reserve to perhaps adjust the price of oil. We took the SPR down three hundred and fifty million barrels a couple of years ago and didn't replace it. So at this point we are sort of at the mercy of the vicissitudes of what's going on globally. Crude oil last September was at ninety five dollars a barrel.
What we could see the crude oil market retest that gasoline prices at three point fifty or so a gallon now could be at four dollars over the course of the next couple of quarters. So this move and energy for us is real and energy has been one of our favorite categories on the domestic large cap value side.
Well, Phil, with Brent already trading within your reign range of eighty nine dollars a barrow, what do you see for your end.
Higher We think that the TI could could trade up another ten dollars, and Brent, you know, maintaining that spread, could probably approach one hundred dollars a barrow.
So when we were talking to Nowt in November and you were talking about double digit rallies on a sm P five hundred, did you ever expect things to go as far as they have in the Stone market.
Not as quickly as as it has that We've got a six thousand target on the S and P fully discounting calendar twenty twenty five earnings, the market seems to be focusing on that number. We didn't think that we would get up, you know, the fifty two to fifty three hundred level in the first quarter of this year. So the rally, this twenty eight percent rally we've seen over the last five months, has been much faster than we had expected last fall.
So much faster. Great to catch up, Phil, Thank you, sir Filowlando, Thanks for that federates at times. Troygeski of FS Investments saying the performance of the US economy is an opportunity for a spring cleaning of portfolios, writing this cash has been a great place to hang out for quite some time and still offers a positive real rate
of return. But gradually deploying those massive cash hoards into a select group of alternative strategies can substantially increase return potential without having to take on uncomfortable levels of risk. Try and police to say, is with us now for more?
Try?
I want to reflect on the data we've had so far this week, going into a week full of economic data really concluding with payrolls on Friday morning, would you see that data that strength as a good thing or a bad thing for risk assets?
Well, for risk assets it still continues to be a good thing over the medium term, in that stronger economic growth leads to more revenue, leads to lower default rates and credit. We're getting to that inflection point though, where you had a violent enough curve move yesterday that equity
markets finally paid attention. Right if you think a Q one, you know you had another quarter where fixed income was down, you know, like a broken record, like we joke around about, but equity is able to power ahead because not only did you have very strong earnings, but obviously the economic growth surprises relative to robust and Powell started to job own about someone's say, premature cuts.
So you know, we're at a.
More dangerous level in terms of valuations, but generally that rebounded manufacturing should be looked at it as a positive outcome and a positive driver.
Atroy you said the equity markets started to wake up. I mean, I've got a question that we were down point two percent yesterday on the SMP with down point two percent this morning. I think the equity market is still snoozing, isn't it.
Yeah, well, compared to previous higher rate driven dislocations, I mean the most recent one, of course, was August to October last year, where you got a material curve move in.
You know, point two percent. Point two percent is kind of a rounding error, but you know, at twenty one times for earnings, you just have to ask yourself, how much more upside do you have when so much the good news is priced in and to the points you've been making already, there's a material risk of substantially higher rates at the back end of the curve, we still are fairly inverted. The curve has obviously been gradually pricing
out cuts this year. But bottom line is, to Lisa's point, in this scenario where there are no cuts, you have to think the back end of the curve is going higher, and we could retest the five percent level at some point given the substantial supply that's coming on and obviously a technical picture that's not terribly supportive.
That's five percent this year, we have thought and.
We still think that's definitely possible. I mean, look the way, when you think of the FOD reaction function for the FED, right, we've always said that this cutting cycle is going to be the mirror image of the fifteen to eighteen or sorry, this hiking cycle is going to be in the mirror image of the fifteen to eighteen cutting cycle, very slow and steady, and there's a reasonable probability that the FED first starts to cut, you know, the back end sells
off as inflation expectations get anchored higher. In the event that they don't cut at all and they continue to pursue QT, which they still are as you know, there's certainly a risk that we make higher, highest as cycle, and that's one of the risks that markets have priced out, we think far too fast, particularly late last year and early this year. So yeah, it's not that fixed incomes is tragic like it was in twenty twenty, early twenty one,
or late twenty one as well. It's just that the risk reward still isn't fantastic like many people have been articulating it is.
I love the idea of fixed income as tragic, Troy. There is this question though, about what assets get hit hardest. If a ten year yield does climb back up to five percenta starts to retest some of these levels. Is it just public equity markets or is it also some of the private markets that have seen incredible amounts of cash flow in that are kind of peg to floating rate types of instruments.
Yeah, so I think when you start with private credit is one example, which has been an area of tremendous growth and really very attractive positive returns, not only in twenty one and twenty three, but also in twenty twenty two, where the index is up roughly six to seven percent in a very tough year. You know, so when you're always rooting for higher front end rates for longer with the lowest probability of those that tighter FED policy creating.
The economy right.
And that's why when we first came up with the scenario last year we called the dare To Dream scenario, because you know, from a probability standpoint, it was almost too good to be true. But of course that is now the base case, where the FED is typed a lot, They're keeping rates higher for longer and the economy continues
to be incredibly robust. However, to your point, if you get a high enough back end in financial conditions tighten enough, that could lead to slightly higher defaults over time, so you give back some of that excess income in the
form of defaults. But so far we're seeing it is very low default rates, the ability for companies to restructure with strong handed growth private equity and public equity partners, and that means less income being returned through defaults, which is really as good of a scenario as you can hope for in private credit markets.
I get the sense, and it's not just from you, Troy, but a lot of investment managers who come on say, you know, cash, you're running out of time. You got to deploy it, whether it's alternatives, whether it's into other parts of the equity market, the you know forgotten four hundred and ninety three. As we heard earlier, is there
really a sort of pressure for time for cash? And no, I'm not just talking my own book, but there is this question of if the Fed's going to hold rates higher for longer, and it doesn't seem like this is that restrictive. Why couldn't you clip five percent on a money market fund for the foreseeable future?
Oh yeah, Look, we've argued for the last two years, right that what you want to focus on is northwest quadron strategy strategies that have higher returns with lower risk, and cash actually is one of those alternatives to traditional fixed income and all also equities. However, when you look at where you are today, you know, really five and quarters five and a half's the peak, right. The probability of the FED hiking from here has always been non existent.
It still is non existent. So you only have one way to go, and that's lower. Now, as we've discussed, it's going to be very slow, very plotting cutting cycles, so you'll still have incomes. But the question is, when you think of you know whether you're looking at actuarial
studies or what folks need to retire comfortably. Typically you're in that high single digit to low teen drains, and the question now is should you at least gradually think about deploying you know that extra two and a half trillion in money markets at extra four trillion commercial bank deposits into strategies where you're not taking uncomfortable levels of risk.
You're not going to walk into a potential ten or fifteen percent draw down, or if you're in inequities, or you're reaching for duration right now, as many have done the past two years, much to their chagrin, and you take a five to seven percent duration related draw down where you have certainly your conceding liquidity, you're going to have marginally more risk, but you're boosting your return potential
to high smolel digits the low teens. And you know, one of the unique things about private credit now, which is really fascinating, is that you actually have potentially higher returns in the debt part of the capital structure than the equity part of the capital structure, right because that extra debt service payments that go to the lenders comes at the expense of free cash flow for a lot of big cap LBO firms, so the equity for the terms there will be lower to the benefit of the
debt holder. So it's an unusual period of market industry, for sure.
I love how Lisa tolking around book is standing cash if a lot of people as single names, right, you know, But for Bramo is standing cash.
I'm just look, I'm not, you know, swing my head too much.
I actually carry on.
We don't have to continue.
I want to squeaze this in. Actually it's a random question, so forgive me for this. The Ft had a strange front page yesterday and I'd love your thoughts on it. It was about the record supply, the bond issuance we had in the corporate debt market, and this really odd link about the election in the back end of this year. And I have to say, I haven't even thought of that. We linking the boom and supply in the first quarter of twenty four to the prospect of the market closing up in four q this year.
You know, I think that's a bridge too far. I think what's really happened here again, you know, in our investment committee meeting we discussed that a lot of the explanatory variables for what's going on in terms of market price action as well as in terms of risk appetite gets back to those huge cash boards that the FED created during the pandemic and still lurk with us today.
So what we've seen across the board, whether it's middle market corporate lending, whether it's senior serit of commercial real estate lending, whether it's HYO bonds or IG and even agency pastors which really have horrific technicals, is a gradual, steady, relentless tightening. And obviously issuers are taking advantage of that, and you're looking at the past two years and they're thinking the next six to nine months forward. This is probably one of the better points to issue new debt
and lock in new financing. Just as critically, if you have a roll day coming, whether it's floating rate, dead or fixed, you know this is the window you're getting. And if you have turbulences at the back half of the year, you're probably getting better pricing now than you know perhaps in Q four. But I think that's a stretch.
Very diplomatic even calling a stretch. Troy, Thank you, Troy, ESCI of FS Investments. Joining us now to discuss is Stephen Cook of the Council on Foreign Relations. Stephen waterfore to get your insight, your valuable insight on this program this morning, Could you talk us to us about possible consequences from that striking Damascus.
Yeah, this is a significant escalation and the risk of the Iranians responding in any number of ways is very very high. The Iranians have attacked American forces and American forces are in Iraq and Iran, which are obviouss we've seen that happen over the course of the conflict that began on October seventh. There is also the very real possibility that whatever restraints the Iranians have placed on Lebanon's his Belah may start to loosen. There's already a very
significant conflict between Israel and His Belah. The two have been trading fire since October seventh, and strikes against each other's countries have been getting bolder and deeper in recent weeks and months. So this is a very big step for the Israelis, who quite rightly point out that the multi front conflict that they are fighting is a consequence of the Iranian sponsorship of the Axis of Resistance in the North obviously in Gaza, as well as the Huti's
unrelenting fire on Israel from Yemen. So the Israelis clearly want to go after what they consider to be the head of the snake.
Ironian forign Minister amid Lyon in the early hours this morning said that he summoned the Switzerland envoy to give a message to United States. Potentially this is also going on with maybe back channels in Oman. What kind of back channel do you see potentially between Washington and Tehran to try to take the temperature down.
There is and has long been a robust communication between Tehran and Washington through the Swiss embassy. The United States communicated to the Iranians at the outset of the conflict, communicated to the Iranians after the incident in Tower twenty two when three American soldiers were killed, that the Iranians needed to back off otherwise there would be very significant
consequences for them. I imagine the Iranians are using that in reverse, communicating to the United States that unless Washington brings the Israelis to heal, the Iranians have the capability of raising a storm of violence in the region.
How close are the Americans to bringing the Israelis to heal given the fact that they had this call yesterday, a strategic call, and then potentially we are going to see Israeli officials in Washington next week.
I think that the American influence on the Israelis at this point is rather limited. The Israelis frame their conflict with Hamas and in fact there are a conflict on multiple fronts, as an existential threat under those circumstances. Although the United States is obviously an important strategic partner of the Israelis, advice given is not always advice taken. We
have seen this throughout the conflict. President Biden believed that his bear hug of the Israeli government would give him the leverage with the Israelis to shape their military operations in the Gaza Strip. That has not happened. So the conversations between Washington and Jerusalem yesterday virtually in next week's meetings are about Israeli planned military operations in Rufa. Prime Minister Nataniello said those plans have been approved and the
idea of is ready to execute them. It's unclear whether these talks will bear fruit for the United States and shaping the way the Israelis undertake this operation.
Steven, there are a lot of moving pieces here, and you honed in on the northern border of Israel, the border with Lebanon, the Hesblah conflict that has been ongoing for a long time, the tit for tat and not being the true source of an escalation that could draw in a larger swath of the region and potentially disrupt things like oil markets. I'm wondering how close you think
we are to that. If you could quantify how much closer we are now after these assassinations than we were before them, it would be really important, because this is really what a lot of strategists are honing in them this morning.
Well, it's hard to put numbers on it, especially for historically minded political scientists like myself, but I would say that it is a strong likelihood that we will see a significant conflict between Israel and Hesbelah in the north. The constraints on both parties have been loosening in recent weeks and months. The strike in ask Us yesterday that killed two IRGC generals something that the Iranians are going
to be unable to not respond to. I think the only thing really holding the Israels back right now is, in an odd and twisted way, is concreditional dysfunction. The Israels need that security assistance that has been locked in Congress in order to acquire the kind of precision munitions they would like to use in a conflict with his Belah. But I think in the next four six months we're likely to see a major escalation in the North.
Was to stop that from percolating out into a broader region that really does disrupt broader trade markets in the way that a lot of people have suspected was the worst case scenario.
Yeah, I think the major factor here is that the Israelis and has ball getting involved in a major conflict that the Iranians and the Huthis continue to interfere with global shipping and meaning also for the oil markets. Neither Israel nor Lebanon are major players in the energy markets, so there's a lot of gas off booth their coach.
But the knock on effects in which Iran and its access of resistance can disrupt the global economy as they've done or tried to do in the Red Sea is something that I think everybody needs to be well aware.
Of Steven, appreciate your time this morning. Thanks very insight so Stephen Cook there of CFR. This is the Bloomberg Surveillance Podcast, bringing you the best in markets, economics, angiopolitics. You can watch the show live on Bloomberg TV weekday mornings from six am to nine am Eastern. Subscribe to the podcast on Apple, Spotify or anywhere else you listen, and as always, on the Bloomberg Terminal and the Bloomberg Business app.