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Sema Shah Prince Blast Management, writing this, the potential for further equity gains may be somewhat limited from here. With valuations so stretched, a soft economic landing is a necessary backdrop to support further gains.
Sema joins us now, Seema, good.
Morning, Welcome, good morning, great to be here, Great to have you. When you talk about stretched valuations, are you talking about the overall market or are you talking about in video.
I'm talking about Nvidia.
Okay, case if you look across a broad market actually doesn't look that stretch.
We're really thinking about the pockets.
It's difficult at this point though, to look across and say we need to have a broadening in the rally, but that broading in the rally can only take place if there's still a sturdy economic backdrop.
Now we are generally.
Quite positive on it, but we are hearing more and more clients actually really worried about the economic backdrop, real concerns. I need to creep into the point that actually, when we think about risks, or we're hearing about risks, we're hearing more about what's going to happen with a hard landing than with an acceleration. And that is a very very clear shift that we've noticed in the past few weeks.
And that's something that a lot of people are talking about.
Morgan Stanley came out over the weekend Mike Wilson, and he said he put their three scenarios that really counter this risk. One of them is overheating. Nobody thinks that's really good to happen. One is potential liquidity risk, and he talked about treasury auctions and some of the politics of the moment.
He said that the base case in terms of what potentially.
Disrupts this is to your point that hard landing scenario. How important is what we get on Friday in terms of personal income, personal spending core PCE to really inform how whether that's a more realistic base case.
So it's definitely important because obviously we know the consumer has been the key driver for the US economy. But you said the buzzword before, which is bifurcation. Right, So you've got the really high income households which are essentially carrying the US economy. You've got the lower income households which are maybe seeing a couple of strains, but because the job market is still very strong, there's no major
job losses that they can almost continue going. And as higher income households can carry the US economy, it's really to me it's about the labor market because if you start to see those job as claims increasing, if you start to sit translating to job losses, well, then the lower income consumers can no longer I should said, the high income consumers are no longer able to sustain the US economy.
And we talk a lot about what the landing will look like, we rarely talk about what the lift off after that landing looks like. So for in this environment we get this soft landing, how important is it that growth is an anemic, that it can take off again for a more stained in longer term rally.
So it is really important. But going to say it' something slightly different.
So when I think about the landing, we think the fun you can get a soft landing up to Q one and Q two next year. But to the point that the FED starts to cut the people who are waiting on the sideline to buy a property, and if you don't have job losses, I worry about how, you know, how does the economy react to that? You could see
another takeoff and then another acceleration. So actually, I think, to me, although I know that's not what people are necessarily talking about, although the acceleration is not key at the moment, maybe as you look to twenty twenty five, that is a theme that starts to return to the market.
Now, I think that's such an excellent point, Semer, because it raises this question, is is the FED going to have the opposite intended fact when they start to cut that everyone rushes to the market and all of a sudden, housing prices go up. In how policy is usually transmissioned, isn't transmission.
The way it is?
So does that mean If the FED starts cutting, they need to start cutting aggressively in order to make sure that it is not a housing market that takes off like crazy, that there's some incentive for supply to come back in.
I think they just actually be really careful how they cut.
I mean, I do believe that they need to have all of the evidence in hand before they start those rate cuts. They need to be very clear that there is the softening in the economy. They need to see that the labor market is maybe not showing clear cracks, but there is a rebalancing taking place.
Otherwise they risk almost of disrupting.
The economy again, and then we've been back to the same place as we were a few years ago in about twelve months or time.
When it comes to the housing markets, are potentially those individuals that maybe they've wanted to upgrade to more space, but they're sitting on a three percent mortgage.
What if all those people.
Come into the market and then actually you have so much supply that it dilutes pricing power.
Wouldn't there be almost of goldilarks for the Fed?
It would be But actually, I think although the supply has increased, the amount of people who are waiting those islens, as you said, have been enjoying those three percent mortgage rates, but scared to go to buy a new property once they come flooding into the market. I actually don't think that the supply is sufficient to stop the housing market
from taking off again. So I think that that is one thing that the FED really needs to keep a very close eye in order to avoid this second wave of inflation, which you look at the moment there is absolutely really no sign of. But I think it is a risk that the Fed is very aware of, which is one of the reasons why they are so careful about the timing of those cuts.
You talk about history suggest that long fed passes are good for stocks, But when you look back at history and in your research, has it always been this concentrated?
I mean, I look at.
Peter Cheer's note today, which is kind of how you started the show. Fragility in a one stock is a stark market.
It's all about Navidia. Have we ever seen anything like that?
I don't think we've seen anything quite like this in a way that the tech gains are quite fundamental. I mean, there's something fundamentally driving I wouldn't compare it to the dot com but also when I look across at tech, I think think that somewhat macroagnostic. I don't think theyn necessarily relying on what's happening in the macrospace. I don't think they necessarily reliant on the FED space. I think they actually create their own demand. At some point that
party will stop. It doesn't look like it's anytime soon, but at some point it will stop. That I think is a very hard part to predict.
So you sound kind of bearish, What are you doing?
If I sound very probably, I don't need you. I think that we should actually be slightly risk on, but not as risk on as we were about six months ago. So we do have a slight overweight to equities, but that has been pulled back a little bit because, as I said, we think that the equity gain is quite
limited from here. When you start to see that slight softening and the economic baddrop, and when there is so much concentration, that sentiment is starting to get a little bit impacted, where people are getting a bit worried about how much exposure they have to these very very these high stocks within fixed income, we actually think should be back to neutral investment grade is probably the area that you want to be focused on with slightly high quality.
But duration doesn't look very attractive to us.
So four twenty five, especially as you was talking before about the fiscal deficit, I don't see yields coming back down too far because that term primer is going to keep thinking about the deficit.
So are you just hoovering up French bonds because there's extra premium there?
I hear French bonds really scare me. And the reason is this, So there is a genuine reason I think investors should be concerned about it. The discussions that are going on could really change the deficit narrative over there, fiscal discipline out the window potentially. But also, if we're a US investor, you've been looking Europe in the last couple of months saying, wow, is this real?
Can this really be sustained?
This political disaster at the moment, which is starting to unfold, is going to scare investors again. It's going to be like, oh where are you again? European political basket case once more. And I think that is a concern.
It's like that just leaves us back with the US, that is that all this is is this just American exceptionalism two point zero when you buy just not America just because it's good, but because Europe is scary.
I think the use exception is very very key here. There are pockets around the world, So it's not like it's just US market. There's Sally as an overweight. Where are we going to be focused on? It is certainly the US.
That's sort of the reason why as much as people want to complain about OI the actions and OI the deficit, you can't really do that because it's OI Europe. Sema Shah, thank you so much for being with us Shaw principle as the management.
Joining US now, I'm.
So pleased to say, is Tamashad, CEO of a Kbwstfel Company.
Tom. A lot of people have been raising.
This issue about whether we're fighting the wrong war and whether maybe some of what the regulators are targeting with banks is counterproductive for the current cycle.
Do you think that that's going to be in focus later this week?
Well, I think first of all, with the stress test, the first thing you're going to see is that the banks are in very very good shape. Remember the stress tests were set up to look at an adverse scenario to show the marketplace that they have plenty of capital to withstand that. And we think that the conversation is going to move away from that to individual company analysis quickly, which is actually a really positive statement about how the
industry has been continuing to build capital. The other thing is the industry has not only been building capital for the stress test, but the industry's been building capital get ready or basle three endgame. So that's been the big story. So I think the first box to check is that the industry is going to come out it's being very well capitalized, and then they're going to be individual companies that are pivoting in one direction or another.
So there's a lot to unpack.
There's a question about which banks, let's start here, are really strong and resilient, right. I mean, it's one thing to say JP Morgan and Bank of American City Group pre are going to fail. I don't think anyone is saying that they're at risk of any kind of real potential turmoil.
It's really the regionals.
At what point do we get to the confidence there?
So there are twenty three banks in this test that's coming on Wednesday, so they start to go down into the super regional category. I think for all twenty three banks, the market's going to say they have plenty of capital.
I think for the regional banks, the regional banks are still in pretty good shape, except for the ones where there might be more concern around real estate exposure for example, and you're seeing a downturn in some of their results, but large and again, I think it's very narrow as to where the concern is. Just in preparation for coming today, I was interested about dividends. I went back and looked at that there are seventy four banks that are in
the KEEF Bank Index or Regional Bank index. If you look at since the beginning of last year, five of them cut or eliminated their dividend. Meanwhile, fifty four of them raised their dividends over that period. The industry is actually in really, I think, pretty good shape for the challenges that we've had, and I think that the areas of concern are generally more narrow than you would think.
And then remember last year's bank failure moment was really around a liquidity crisis, and what we realized is that some banks had gotten off sides in terms of their concentrations and their deposits. I don't think that that was a broad based.
Trend even so.
I mean every now and again you hear of another bank that maybe isn't hedged to interest rates. The latest one was a large bank out of Japan, I think their largest agricultural bank, who was basically position for rates coming lower. Obviously that hasn't happened yet. When you hear these incidents of pockets of stress, do you think that these are still the rare bank that have been hedged against the current rate environment, or if it's higher for longer, do we hear more of this?
So?
I think with the focus for this conversation right now being in the US, I'll go to our Bank America upgrade, which we did recently. We have earnings models by quarter for net interest income. I think just about all of the two hundred and twenty banks we follow, nearly all are going to hit a bottom on a quarterly basis, either last quarter or this quarter. That's the reason why we upgraded Bank America is the second quarter is the inflection point, and it gets better from here. So it's
all a question of timing. Let me there's another point. The five month five year, three month, five year, you'll curve spread is the most important for banks. I know that that plenty of tensions on two tens, that's not the key for the banks. It's been sixty two years since we've seen the length of time for the inversion that we've had, so all things really kind of need to do is get a little bit less bad for
these banks to do a little bit better. And I think that pivot is right here right now, and these banks have a lot of bad news in them. As long as we don't get a hard landing, I think you're going to see a continuing quarterly improvement over the next four or five quarters. And also too, there are specific types of banks like more than others. But this is a great opportunity if you can look longer term.
We think, I know you want to stay in the US, but I have to take you to Europe, especially given we're going to get one of the first rounds of French voting on the thirtieth. You've had the likes of JP Morgan really be courted by mccraulan saying come move to Paris in a post Brexit world. And you've seen other US banks do something similar really building up operations and talent bases in Paris. If there is political volatility, what happens.
So I think it's really the big picture of what's happening with the economy. One thing I would note is over the last twelve months, banks have been the leading group in Europe. Again, there was so much bad news in these stocks, and really what you need in Europe is he needed some improvement in the rates. Negative interest
rates were certainly adversely affecting the banks. Our sense, as it all comes down to what the economy is doing, we still think there's upside for the banks because the banks have done a lot to stabilize themselves over the last several years, and many of those stocks still trade at sixty percent of book value. So we think that the bigger banks are stable in Europe, and it's a question now of what's happening in the economy.
Does it consider we heard last week from the FED in terms of living wills of some of the US biggest banks finding some shortcomings when it comes to likes of Bank of America City.
You know, you remember that teacher in college who was always a hard greater, who never really gave out the oh this is perfect. You're all done. You don't have to do anymore. I will imagine for the rest of my career, every year there will be more work to do on a living will. Okay, And if you look at the living wills, JP Morgan had work to do, City Group had work to do. Really, these living wills
were evolving with the risks of the moment. And also I would say, given last year's bank failures, the FDIC has probably sharpened their pencil on these living wills, so I would view it as as a living, breathing thing. I didn't see our view on it is the banks are going to spend more money at preparing for them, but that there was nothing devastating or really significant in what we read in the results.
To say, the reason why I started by asking you are we looking at the wrong risks is because in the past couple of years, first of all, the risks that I hear about what profitability opportunities do some of these smaller banks have when they're facing off with the rush of money into private capital.
That's a big question at this point.
Oh, there are some tectonic plates that are moving that if you want, you got to if you want to take a step back and not look at the snapshot and look at the movie. Yes, and really what it comes down to was funding and liquidity and deposits. Banks don't fail because of capital. Banks fail because there's a bank run, and there have been very few of them in the United States. So the capital's fine, but really,
what's happening in the deposit base. I think the greatest missed opportunity from last year is there's not been FDIC deposit insurance reform because it puts too much pressure on the small banks and it's encouraging market share to move up gap to the banks that have proven that they're too big to fail.
And it also yeah, so that's the biggest.
And then number two is when it comes to stock selection. The way that regional banks, smaller community banks earn money in the biggest banks is very different. The smaller banks have more real estate and more spread income, they are going to be slower to rebound the bigger banks have. Bank America, amongst the biggest banks, has some of the
least amount of commercial real estate exposure. These bigger banks have already made the shift away from that, and that's why we are leaning in heavier on these bigger banks for the stock ideas, we think it's going to take a little bit more time for the regional banks to turn There might be.
Safety and even profitability in some of the bigger banks. There isn't so much of the classic market making. And this is the other risk that people talk about liquidity risk on another level, that they're not going to be able to shepherd this amount of bond auctions into the market and allow the trading to commence with the same kind of stability that has in the past.
Does that keep you.
Up at night?
Now you're talking about the treasury market and.
The treasury of particular, given the fact that the market has swollen to such a huge part, but it's also the credit market. I hear about this with public credit as well well.
What I take out of that is passive investing is at the highest degree of our lifetime and growing more and in many ways it's changing the investment business.
So there are so.
Many of these indices and index driven funds that so much of that, and it's impacted the liquidity of a lot of the smaller company. So if you look at a typical mid cap stock, it may have thirty five forty percent of their shares owned by passive investors. And it's happening in the credit markets as well, so when you get to individual credits, so that's pushing more of the trading into private markets away from some of the public markets, and so I think that is going to
have an impact. So the way in which companies raise capital is all still evolving because there's this big private market that's grown a lot in the last four or five years.
Tamashad awesome to hear from you. Thank you so much for being with us.
Yes, thanks, Tavi Should of KBW.
Just to get a sense of how to frame the week ahead and the path of rates going forward.
Joining us Stephanie.
Ross of a Wolf Research, Morgan Stanley's Vishi Cheer but Tour.
Stephanie, I want to start with you.
We've been talking about the auctions, we've been talking about concerns about higher rates, but you think that actually rates are expected to go somewhat lower over the next couple of weeks.
Why.
Yeah, So we're looking for the tenure rate to fall towards four percent and then it can trend again higher. When we start talking talking about the election and concerns around the desicits. But in the next couple of weeks we could start to see just a continuation of the softer economic momentum. We've seen that for in the past couple of prints, and that has brought ten year rates back down to four twenty six, which is certainly lower
than many folks were expecting. Many folks we're expecting rates to get to five percent before they come back down. But we've just seen that softening an economic momentum, partially because there is actually a genuine deceleration in the economy. Also, seasonals tend to put downward pressure on both inflation and growth in the summer months, and we d we expect that to be the case in the next couple of prints, which will bring certainly growth expectations back down a little bit,
and then inflation should continue to miss. So yeah, core PC should come in something around point one five percent in the next print. We expect that for the next couple FRIENDSHI should go outside of the build cut in September.
And then after that there could be something of a sell off, a slight one at that, but still some.
Modulation there from there.
Visually, What about you do you agree with that that basically the data is cooperating with the bond market, cooperating with the auction schedule. Do you allow yields to continue the decline?
I think the broad conturs of what we expected are very much in line with the it's definitely on there. I think the economy is clearly showing signs of dissolution, which we had expected, and you know it's it's disilleration,
but not falling off the cliff. And we also, as we might talk about, we expect the core PC will not be a big surprises on Friday, and we expect to see a month or month ten based points in the core PC numbers, all of that pointing to a distilleration in growth, a distilleration in the pace of location, setting the stage for a September cut.
So how much confidence did you have issue? It sounds like a lot, but just chuck me here. If it's true that we've seen the peak and yields.
I think in the near term, I think we have fairly confident on the trajectory of the path of inflation or the next call it, you know, the rest of obvious year, the next three to six months. We have very high degree of confidence that information will continue to decentrate and we probably have seen the fights in rates, and I would a slight difference of view from the speaker is that we think that we've been in a fairly you know and arrange that we are really are
the tight end of the range. So that tactically at this point we have neutral opending how the debate and the follow from the debate will turn out. So, but what a longer time frame, our expectation in the rates will be lower or lower. Our ten year expectation is that will be ten year treasury by second quarter of next year. We expect to see two three seventy five.
Well, disagreements is what makes a market luckily. Stephanie, First of all, I have to give you immense credit for this wonderful pun now oer never, which is excellent. So you actually expect from the oer to come down finally, I mean we've been waiting for this forever, the lag that feels like it's never showed up. So you think that will finally show up in June?
Why?
Yes, June print is the time we're actually expecting it. We haven't been calling it for any particular month until this one. So this isn't necessarily a boy who cried wolf situation. So the reasons for this is twofold one. The seasonals go the other way very much so in the first half, and then June it flips, so we should have seasonal downward pressure on OER by a number
of basis points. And then on top of that, there was a funky surge in the New York region which contributed about twelve basis points to overall OER, which is about ten basis points more than normal. So that should also put down with pressure because that's likely to go in reverse. BLS had put out some comments that it was driven by some noise within the region.
So we're talking about the next couple of weeks, the next couple of months, because that's all that we can talk about.
Beyond that, it starts to get very difficult to really have any visibility.
And it raises this question, like we were talking about earlier with Semashov principle, that if you do get a FED rate cut, that could potentially reignite inflation, particularly in the housing market.
Sephanie, I want to get your thought on that.
First, you believe that based on how much pent up demand there is and the likelihood of any increase in affordability will unleash a flood of interest.
Yeah, I mean this time, there's an argument to be made that it could actually be disinflationary. That's not necessarily our caller base case is that it'll probably be more neutral for housing prices generally than many expect. The reason because all of a sudden, you're going to unleash a.
Lot of supply.
So, yeah, the demand is still there, but now you're gonna get a lot of supply of existing, existing sales because rates are coming down, and now it's a little bit more attractive than certainly it was when mortgage rates were above seven percent. So you actually might get a more normalization in the supply demand imbalance that could actually keep prices somewhat stape.
I mean, this is an argument that we've heard, right, which is it just inflationary inflationary? And everyone seems to disagree, And I guess that this is the reason why it's hard to eve engauge.
What's the bigger risk right now?
Is it a potential reinflation of the FED cuts or is it a potential hard landing recession. I don't have a clear answer, and Frankly, it seems like every investor who's come on this show has a.
Completely different take on this. So where'd we stand on this? I mean, which is a bigger, more compelling risk.
I think the you know, there is a whole host of uncertainties ahead of us. So we have a pretty clear part for the next next six months or so that the shelter in vision that Stephanie was talking about will continue to dissolve it biil we get to the same answer as definitely does perhaps in a different different approach. We look at all the leading indicators and the rent index at the Cleveland Feds rend, your vent index, and there is a clear lag and that will begin to
hit for the next few months. So, you know, I think a lot really depends on what happens after. I don't think a FED cutting in September will unleash enormous amount of supply into the market. We expect to do some supply. So we think that the pace of home price appreciation will slow from about seven percent. Bare we are now to the end of the year. Our base is about two percent. It is still positive, you know,
home prize appreciation, but that pace will slow. But you know, we should we should not forget that there is a huge range of uncertainty of outcomes of elections, and a larger range of uncertainty of the outcomes of the elections. So all of that is very much a front and center. So I think whatever, there's a lot of noise, and it's tough to decipher signal from noise. But or what we do clearly see is over the next three to six months, this inflation is clearly on it dislidate anymore.
We're going to hear a lot of political noise this week, especially when you have this debate on Thursday.
Stephanie, you write your note.
The first year of a Biden VERUS Trump administration may look more similar than many expect.
Why so two things.
People are worried about Trump cutting off immigration, and he will very likely cut off immigration flows, especially humanitarian prole which is adding about seventy five thousand per month. The thing is, the labor market might be in much better balance by the time we get to the beginning of next year that we don't actually need all of all of those people that actually that might risk putting upward pressure on the unemployment rate. Uh So it might not
actually be that as inflationary as many folks expect. And then the second is of course on tariffs, and it our base cases that the tariffs wouldn't go into effect until late twenty twenty five, maybe early twenty twenty six, So the c the the the inflationary forces of the difference in administrations might actually not pan out next year
t come twenty twenty six. Of course, if we get tariffs, that would be uh a dramatic game changer between administrations and and and for sure, But for the first year, it's actually likely the the the economy might look fairly similar under both administrations.
The economy might look similar, but the rhetoric will certainly look different. Uh Vishi, How are you looking at the election and how the impact could be for markets? You know, Stepanie brings up two good points, immigration and tariffs, and what happens with those we might not actually see till twenty twenty six, so.
We might not really know what the how to think about elections much after that. What I would like to think about really is what are the products within especially in the fixed income space, we will perform in either case that puts us in the range of spread products broadly, So by spread products, I mean public credit, private credit,
securitized credit, mortgage backed securities. We see as long as you take out that the next move by the FED is not a hike, as long as we are clear about that in the time the arrival of timing of cards arrival, how many cuts will get when they arrive, and the future course of the of the various policy options probably matter a little bit less to the spread product ingers. So that's where we think that the best Opert study lies.
So just real quick, VISI, what do you think will be the low that we'll see in the next six months for the tenure.
Until we'll get too close to four percent?
So you guys both are on the same page about four percent, all right, Stephanie rothavelf Research, Morgan Stanley's Visita Turbature.
Thank you both so much for being with us.
This is the Bloomberg Surveillance podcast, bringing you the best in markets, economics, and geopolitics. 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 out