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Sebastian Reidler of marilynch writing this, we remain negative on European equities and underway France on expectations of weakening growth. The further acceleration in Euro Area growth could easily offset the drag from a more fraud political environment, Sebastin joins us.
Now, Sebastian, which is it?
And this is actually, frankly a confusion that we've been having all week that some people, Sebastian are saying, yeah, we could get that weakness if some of this political uncertainty continues, or if it does transpire in a way that's market unfriendly. But otherwise Europe is the place to go, especially next to an expensive look in the US.
Absolutely, and we see that a lot in our client conversation. People highlight the data weakness in the US we've already seen and you discussed this earlier, But in Europe the macrodata until today was holding up. So people are saying this is a safe port in the storm, and we simply disagree.
We think growth mentum will weaken in.
The US in the your area because in very simple terms, monetary tightening works with the lack and the lacks are now to hit both economies. So we think growth is going to disappoint, is going to weaken, and it's going to disappoint the expectations of Europe being a safe haven.
So when you talk about European equities possibly being at risk of further losses, are you saying that the US is preferable or are you saying that all regions, particularly equity markets that have gotten a boost from recent optimism, are subject to potential risk on that kind of weakening growth outlook you're suggesting might be understated.
Yeah, I think that's a very good summary.
And if you give give me that option, which of these two statements, I would make both statements. I think all equity markets are at a risk simply because you at the point where the unemployment rate in the US is very low, is starting to pick up, the savings ratio is very low, is starting to pick up. We're starting to see the weakness in the consumer. We're seeing consumer confidence really declining very sharply in the US, and the US so far has held up.
The global growth story.
So if global growth weekends on the back of a weakenings weeken Europe, that's negative for risk assets across the board. But we think European equities are particularly vulnerable because they're more cyclical and they have more value names, which would underperform if the weakness in economic activity, together with fading inflation, also leads to declining bonniards.
So Sebastian, what can I buy then?
So there are amazing opportunities in the beaten up defensive sectors that you've got in Europe. Take a sector like food and beverages, add a twelve year low relative to the market, cheapest sector in the market. It's the most defensive and it's gotten clobbled by the compression and risk
premium global risk PREMIU effectively at all time lows. If this combination of macro factors we've just discussed leads macro risk premier to rise, that is a fantastic catalyst for outperformance for the defensive sectors and in particular the beaten up food and beverage sector.
But overall, besides maybe the defensive sector. On European equities, you remain negative at the moment for now. So what happens after the election potential when we get some more clarity.
To be honest, you were talking about economic downside as a function of the election. I would really think about them as separate. So there's political risk and there's economic risk. We think that and an investors have to decide always which in this kind of priority list, which is the thing really to focus on. We think the economic risk
is by far the most important point. When the labor market starts to inflect negatively, that typically heralds bad things happening for risk assets, bad things happening for risk premium. We think that will be the dominant dynamic overcoming months. So if growth we can not because of the election, but because of the normal functioning of the macrocycle. That means equity is lower cyclicts underperforming defensives, but then a
lot of scope for bonds to rally. And that's obviously my colleague Michael Hartnett has the exact same view, and for beaten up defensive sectors to outperform outside.
Of Europe and the United States, there's a lot of also talk about expansion and getting this potential exposure to places like Japan.
Does that still make sense?
So I'm, of course a European equity strategist, so I don't focus.
Mainly on Japan.
That said, we run our models in the background, and Japan, like Europe, is a value trade. So it has benefited from the spike in boniards because it got a lot of value sectors, and it has benefited from the weakening in the end, now the yen is a very defensive currency at would strengthen if you get a weakening of global growth. Plus if Boniard's declined, then value sectors and
value assets underperformers we've just discussed. So therefore Japan had a good run, but the macro environment I'm describing is not one in which Japanese equities will continue to do well.
Sebastian the picture that your painting goes to question that we've been asking pretty consistently for the past couple of months.
Weakening but not weak.
That has been the hope, the white hope for a lot of different markets, particularly the US, this whole idea of goldilocks. How do we know that threshold between weakening and weak when it is a good thing and when it is a bad thing. What data are you watching to see when we've gotten to that tipping point.
I completely agree with you, that's the number one question.
Is a little bit of data we need is good because it removes that overheating fear that the market has been grappling with. And for now, bad data has been good data. Though you could argue this morning in Europe, on the back of this very week PMI, that is starting to change, and in very simple terms, you will
start to see bad data being bad data. If you get clear cracks in the labor market that means payrolls are potentially rising by less than one hundred thousand per months or going to zero or going negative, a more clear cut increase in the unemployment rate, and also very importantly, if you look at the Atlanta Fed GDP track and the best current estimate of.
Where the run rate of growth is in the U.
If that goes close to zero below as it did during the recession fear in twenty twenty two, then there's a lot of scope for risk premium rise from their current low levels.
Yeah, that landed GDP track are still something like three percent even with the most risks of data, so still holding up.
You talked about the weak pmis in Europe.
Can I push back on one thing, Sebastian, You can tell me why I'm wrong.
You say investors.
Need to recognize political risk and economic risk, and the two are separate things, would in today's data argue that they're becoming the same thing. That if you have businesses holding back on their spending plans and decision making, that the political risk is turning into an economic one.
I think it's a very fair point. That clearly is an inter section. And if you look at the country breakdown, you've got Germany down two points, arguably very little to do with the political situation in France, but France down four points, and I agree with you there will be some spillover, but of course they are well understood. The drivers of the macrocycle that have nothing to do with politics. That's the inventory cycle that gave a boost to Europe,
but it's now rolling over. It's the lack of impact of monetary tightening. It's the very negative fiscal impulse that you have in the UN and they would be sufficient to weaken the macro picture even if nothing was going on on the political front.
Sebastian, wonderful to hear from you. Thank you so much for being with us. Don't be a stranger. Sebastian Radler of Merrill Lynch Treasury is looking to erase this year's losses as investors ramp up their rate cut bests. Katie Kaminsky of Alpha Simplex, writing this, fixed income short signals begin to dissipate as yields moved lower on a better than expected CPI print and hopes for a rate cut.
Katie joins us.
Now, Katie, someone who is incredibly brave to go short. Vond's when everybody else was going long, who talked about the potential of ten year yields getting to six percent just simply on trend following, you've noticed a shift of late and treasuries hinting at more of a long position. Can you tell us what that shift is and how much conviction you.
Have around it.
Well, something is very different this month, Lisa, and what we've seen, as you pointed out, weaker economic data.
Secondly, we're starting to hear some murmurs of demand destruction. What does that mean?
From a technical perspective, it means that we've seen synchronous cell us in the cross asset space, So that's in the agriculturals, also in the metals, but particularly rallying in yields I mean sorry, rallying in bond's and really really a big adjustment in the yield space. We've seen risk off behavior which we hadn't seen most of this year, and so if you think about.
That, it really feels like the other.
Asset classes are telling us something about the economic picture that we're still not seeing in the equity markets. So for us, this means that signals and fixed income have really started to dissipate for the first time since the beginning of this year. To me, this looks a lot like an inflection point and a pivot where we might be looking at some sort of sea change for markets that we hadn't seen before.
Katie, this is fascinating at a time where a lot of people are wondering that difference between weakening and weak. You're saying the signal from a lot of acid class and he points to commodities in addition to some of the individual corporate moves that pointing to some kind of weakening that was unexpected or week.
Not just weakening.
What does this do in terms of your conviction to say go long bonds pull out of a lot of different equities, particularly those that have been the highest flyers.
Well, I think the big challenges seeing risk off type of behavior in the market is an indication that for the first time this year, the market is starting to get nervous about the potential or higher probability of some sort of harder landing.
And that wasn't in the data before.
So when we saw weaker data, it usually meant relief. It meant that we might have cuts and that we could get a soft type landing that we wanted.
Right now, what you're.
Seeing is this type of flea to bonds is leading to change signals and fixed income and causing people to be more likely to be long to kind of hedge the potential risk that we might have a correction, particularly if you think about the equity markets where there's such a biifurcation in the sense that valuations are very high even though we're starting to see stabilization of a lot
of economic data. So that's something that we haven't seen stabilized and nobody would like to stabilize, but multiples remain high as data starts to get back to normal.
It's also been interesting to look this flee from bonds as you talk about of who's been fleeing to bonds. Just looking at the ETF flows, we're on track for TLT, that's the black Rock long bond ETF to put on its best month in terms of flows so.
Far this year.
So you do have households buying bonds, you have hedge funds buying bonds. So it's clear with all this discussion of who's going to buy all the bonds out there, people are, but the type of people who are buying it are price sensitive buyers. What does that do to the volatility of this bond market when those are the types of folks who now are the majority owners of this market.
This is a good point because we have really seen bond volatility remain elevated since COVID or particularly once we start to see higher rates and you see in a slightly higher inflation environment, there's a lot more bifurcation of.
Buyers and sellers.
And before it was much more focused on rate cuts, but now it seems that people are also embedding some sentiment in their flows, meaning that as they get concerned about the high evaluations and equities, you start to see that risk off pattern where people think about bonds again as a safety trait, something to lock in if rates go up or if something goes wrong, and we end up in a situation where, like Lisa said, week is actually weak means weak economic data.
What does that do to an automated strategy like your own, Because you can see a clear trend perhaps of people going out buying bonds bonds rally, but it's more volatile, it's not as state as the market once was.
This is this is definitely an issue.
When you have higher vaults, it means that you have less conviction in general and signals, and we've seen that
in fixed income. Fixed income volatility doubled in twenty twenty two and it's still up at elevated levels, which means that the overall direction of fixed income has been difficult to follow, and you can see that by looking at the graph this year, being short was the right call until recently, and now it looks like the trajectory of bonds is actually lower yields, and that suggests that technical strategies, they're just picking up on price behavior and where markets
are moving at the moment, and markets are definitely moving somewhat towards this risk off hedging bets against equity potential weakness.
Katie, you have some research on potentially how the markets could trade with the upcoming election. A third of CFOs in a survey yesterday we learned see the elections impacting investments Given the fact that we're on the edge of waiting for potential cut from the Fed and we still don't know the outcome of this election, how do you position for this?
So positioning elections from a technical perspective is actually quite tricky, but it's really about following whatever the prevailing price trends are, and they usually tend to be pretty strong around volatile environments.
So I think this fall what's going to be interesting is going to be.
To see how does the market, how do people react to how the election unfolds, and what potential trends might emerge. And it really feels right now because of the uncertainty around this, that there's a wide range of outcomes, which means that there could be very interesting trends in the fall.
Could it be long bonds. Maybe.
Right now it's starting to hint that that could be the case and that there could be much lower yields.
But of course we've got to wait and see.
From the data if we actually see that pivot in fixed income positioning completely to long and.
When it comes to the election, as Greg Valley told us earlier, potentially this is going to be dragged out for weeks and potentially not knowing the actual makeup of what Washington is going to look at. Bank of America today has a note talking about the zeitgeist, and it's if there's a clean sweep, there's this potential concern about a Liz Trust moment. But whether we get Trump or Biden, how much are you starting to take into account the concerns about the US fiscal deficit.
Well, this is a great question this week because, as you know, sort of numbers came out this week in the bond market and people have been watching it because with deficits up, there's definitely concern about valuation and fixed income, so people definitely have their eyes on fixed income markets. So I think there's going to be a lot of focus on auctions and there's also going to be a lot of questions about how does that impact the overall valuations of.
US fixed income.
So again that goes back to the point things are very volatile for fixed income. It is not an easy trade like it used to be a simple risk off asset. In a world of inflation with high deficits, bonds are just not as.
Easy to call.
I think that goes to the volatility point, plus correlations being positive this year so far with stocks.
Katie, just to put a bow on it, Earlier this year, you had pretty high conviction to be short bonds based on the trend following. Now you're seeing a pivot point.
Where is your conviction level?
Can you have conviction in the near term to be long bonds.
I think in the near term it's definitely very mixed. But you have seen a pivot.
We have seen more long signals in the European in European debt and international debt, so that to me is sort of ahead of the curve in the sense you've seen the cutting cutting in the ECB, you've seen other central bankers cutting, which has definitely pivoted those particular markets to long I think the US curve, especially with the cautious FED, still remains a short view in the short term, but if we continue to see evidence of risk off behavior, you're going to see that pivot as well.
Katie Kaminsky of Alpha Simplex, thank you so much. Right now joining our city groups, Veronica Clark and Daneer Peterson of the Conference BOARDIC, I want.
To start with you.
It seems like the world is shifting your way in terms of looking for more economic weakness and not necessarily celebrating the resilience in the same kind of way. Do you think that maybe there is this tipping point in the economy that's becoming more clear or do you think that people are just realizing that maybe they got over their skis with betting on the soft landing.
Yeah.
Yeah, it was only a couple months ago where we were, you know, the narrative was reacceleration even but I think the data now have more clearly slowed and I don't
have trouble convincing people that the economy is slowing. I get it a couple months ago, but yeah, it does feel like us to us that this has been a very gradual slowing house cycles usually begin, and we might now be at that tipping point where you enter this nonlinear weakening, where you really do get layoffs that build on each other, and that would be obviously a much worse economic backdrop.
Dana, do you see this tipping point from your vantage point as well? Well?
For a long time we have been predicting a slowing in the economy. In fact, we had a recession call for a long time. Now we think that the second and third quarters are going to be weak growth, probably between zero and one percent. Consumers leading that decline. But the thing is that consumer spending could even be wiped out, but not really have a recession because or even a bad recession, because most consumers are working. The labor market
is doing quite well. Wages are elevated, and businesses, according to our CEO Confidence survey, are not looking to let go of workers. That is a key factor that's going to keep the unemployment rate low even if we do see some layoffs on the margins.
Okay, well, this looks like an area that perhaps danding you and Veronica disagree, So let me press you on this. Dana says that you could start to see what we typically see in a cycle, that some layoffs turn nonlinear and it picks up with some speed.
Why would this time be different, Well.
This time is different because of labor shortages. And the reason why we have labor shortages is because of demographics. It's never been the case that we've had ten thousand people retiring per day. Those are the baby boomers, and so that's why businesses are saying, even though they expect, even though for at least a year and a half they're expecting a recession to happen, they were not interested
in letting go of their employees for two reasons. Yes, of course labor shortages and people were retiring, but also because they had the sting during the pandemic of trying to find qualified workers and raising wages to do that. So you don't want to repeat that even if you think there's going to be a slowdown and this is a structural change in the economy that we have not seen.
Not to do this to you, Veronica, but why could data be wrong?
Yeah?
No, I mean I don't disagree that.
You know, we have experienced labor shortages over the last couple of years that might be leading to employers holding on to workers for longer. You don't want to lay people off and have to hire them back at a higher rate. But that is I think still a precarious position. If you've been holding on for workers for too long and then all of a sudden you do have to let people go, that could mean you're letting even more people go. I don't think that necessarily prevents the layoffs.
Dana.
Also, I have a question about what is going on in a labor market because we had Barkley's command with a report and they were talking about how pretty much we've had this insane surge of immigration that we're seeing so many jobs being filled by.
So where exactly is the shortage.
Well, when you think about immigration, a lot of it's catch up. So remember during the pandemic, we had travel bands and so that meant also if you were an immigrant or you know, whether you're an H one B person, you could not enter. So a lot of it was just getting back to the levels that we saw in terms of immigration right before the pandemic. But the shortages are definitely happening, especially in leisure and hospitality, healthcare and
social as systemce not residential construction, and also government. And if you notice, many of these jobs you have to physically show up for work, and so companies that we speak to CEOs of the Fortune five hundred firms in the US have been saying, look, we can't find qualified workers for these jobs that are necessarily dirty or uncomfortably you have to deal with a public or there's no flexibility in terms of hybrid work.
Veronica.
When it comes to immigration, how do you view it as basically putting a cap on inflation? We've reached the point where pretty much that story is over and starting to normalize.
Yeah, I mean, I definitely think you know, it's been helping to loosen the supply side of the labor market. Of course, you know, more and more workers, so it is helpful for inflation on that front. But immigration is a boost to both supply and demand. I mean, those are people who are gonna you know, buy goods and need housing. So it's not so clear what that does to inflation. It is probably overall a disinflationary force, but not necessarily a big one.
Let's dig into this. And I'm glad that Emory that you brought up the Marchiano one report from Barclays. He was talking about how honestly it's counted accounted for about three quarters of all job creation so far in recent years.
The immigration flows to me this sort of shocking and I love both of your takes, ronic I want to start with you this idea of is this the right kind of job creation that's going to really create a sustainably and stronger economy versus filling in gaps and doing it on the cheap in a way that maybe makes people understand why even though we have a good labor market on the surface, people seem so dissatisfied.
Yeah, I mean, I don't think the immigration story is necessarily one that's going to last with the strength that we've experienced the last couple of years. I don't think we're going to have such strong immigration maybe five years from now. And it's not so clear. You know that these workers have been hired at lower wages. We still see avagell earning something like four percent year on ear
so there hasn't been this big disinflation in wages. But yeah, it is probably you know partly adding tonnet well.
But this also, Dana is something we were talking about with Marchianoni of Barclays, This idea of how much can we really understand the numbers that we're seeing for the labor market as being strong if they are very different than what they've been in the past, if the jobs being added are new people coming to the country and don't account for job mobility, also don't account for how much this economy has grown and how many more people
are in the labor force. When you start to talk about just absolute numbers, how much is the view that we have of the labor market overly rosy based on just historical comps that are no longer valid.
Well, laborers are laborers. It doesn't matter if they're far and born or they're domestically born. The point is that we don't have enough people in the labor market right now. Look at the labor force participation rate overall, it is not returned to the pre pandemic level. Why is that, Well, if you break it out looking at people who are prime age sixteen to sixty four, yes that participation rate has recovered, but people sixty five and older has not.
They're people exiting the labor market. So immigration certainly is going to be continues to be in will be an important solution to addressing the fact that we're losing workers hand over foot to retirement, but it's also getting those
domestic workers out. And certainly when you look at the wages, the wage games that we're seeing, they're in goods, so those are the types of jobs where many people who are immigrants might gravitate to, and those wages are still rising very aggressively, and even among services wages growth has slowed, but it's still particularly elevated and relative to the range that we saw pre pandemic. So I don't see an issue with the types of jobs that people are taking,
whether if foreign born or domestically born. The point is that they're working, their wages are elevated, they're getting income, and as Veronica said, these people are going to be consuming and spending. They're desiring the same things that domestic workers are.
And it's a structural thing you're talking about, Dana, and you said that they're still aren't enough people to fill all of the jobs. So when we're talking about this world of trying to bring inflation down, waiting to see if there are cracks in the labor market, isn't waiting for Goodough? Do we need to get used to something a little bit more uncomfortable because there are still persistent supply issues.
Well, really, when I look at the drivers of inflation, it's certainly labor supply, and that's beating up wages, and that's flowing through to services excluding housing and certainly excluding insurance premiums. But the thing is that that's probably not going to weigh. That's something that the FED is going to have very difficult time resisting because again, it's a
supply issue, and the FED is good at addressing demand issues. Now, where we're going to get a lot of traction on inflation coming down over the next twelve months is from housing. And if you look at the CASHITDAL Home price index and you lag that by about eighteen months, that'll tell you exactly where OER is going. So the other thing that's going to be bidding up inflation is insurance. So certainly insurance costs for autos and also for housing very
different reasons. But the thing is that we don't know when those rises are going to end. So the FED is still going to be challenged in terms of getting inflation back to the two percent targets sustainably.
Dana Peterson and Veronica Clark with us as we look back on some of the data that we've gotten recently coming up, and I'm glad that data you brought up home sales and home values in terms of just the inflation that we expect to see. We do get existing home sales later today, next week, we do get the latest read on core Logic home prices.
Veronica, how much do you.
Believe what we've been hearing from the likes of Jonathan Miller and others who say, at this point, if the FED cuts race, that's going to only reignite a housing market that's just waiting for any catalyst for people to have a more affordable entry point.
Yeah, it's definitely something we're watching, certainly anecdotally. It feels like maybe you could get.
Some buyers coming back.
But we did see, you know, with mortgage rates, you know, above seven percent last year, there was this surprising resilient demand for housing. In twenty twenty three, there was resilient demand for everything, but people couldn't buy homes because you know, people were.
Not willing to sell.
But We've actually in the last six or seven months seen listings of homes come up. They are above you know, levels of the last two years, and there's not demand now. So it does feel like, you know, that resilient consumer is waning everywhere.
I also think this question of prices that Jonathan Miller also talked about is fasting. Not just do people come back, but what happens to pricing of homes. Could we be in a scenario that he thinks will happen that kind of ironically, the FED cuts, but instead housing prices go up because demand comes back.
Yeah, it's not so clear.
I mean, we have seen softer demand in the last six months or so, and that has been accompanied with softer prices. We've not seen the very strong, you know, exceptionally strong prices of the last couple of years in the last six months. So I think in the near term, at least, you know, this is still a soft demand story and so there's not quite that word pressure on prices. But longer term, you know, we are somewhat structurally short housing.
Obviously construction new construction will be pulling back. You're gonna stay short housing. Yeah, that could put longer term pressure on prices, Dana.
When it comes to the American consumer, you talk about how they're also trading down in types of services they purchase. What kind of cracks are you seeing in the US consumer?
Sure, absolutely, Well, let's just start with the fundamentals. While most consumers are working, that excess savings from the stimulus is gone. Also, many consumers are financing their expenditures with debt and so all that's really coming home to roosts. And so what consumers are doing is they are not buying goods. We saw that good spending slowed at the end of last year, it was negative and GDP growth.
And also when we look at retail sales so far in the second quarter, they're signaling another downswing in terms of good spending. When it comes to services, consumers are still interested in going on vacation. However, they are trading down in the types of services. So for example, instead of going to the movies, which might cost them one hundred dollars for a family of four, they're going to
stay home and stream. And also consumers are looking at spending on things services that are necessities, for example healthcare and insurance premiums for your cars. But certainly not those highly discretionary types of services.
Dana, Just to put this all together, what are you looking for to understand whether this is sort of a welcome softening and disinflation versus something that does have more pernicious legs.
Well, this is all part of the Fed's plan, right, This is basic economic monetary economic theory. You slow demand, which helps reduce inflation. That's what the Fed's doing. The challenge is that the FED has all these other supply side elements that are leaning against what they want to do. Again, going back to labor shortages, which is a supply issue, raising wages. But this is all part of the program
making sure that consumers pull back on spending. That also includes home purchases, and certainly if you're not buying a house, you're not buying all the items that would go along with it. So this is good. And the thing is that the FED is probably pleased with what's happening because at the same time, most people are working, you don't have a massive layoffs. Indeed, we do think the unemployment rate's going to tick up, but maybe we'll land at
four point two percent. That's well below the natural rate of unemployment and that's still a really low unemployment rate. So if we have this perfect scenario of weaker consumer demand, weaker demand for housing, but also most people working and inflation slowing, that suggests that the FED can go ahead and start cutting interest rates, probably by the end of this year.
Dania Peterson, Roonic Clark, both of you, thank you so much for being with us.
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