Surveillance: 2023 Market Outlook

us on this Tuesday morning. Matt, thank you so much for being here. First things first, fish fan, yes, no, uh, fish fan, but I will I will not be attending any of the concerts here this year. I'm afraid I won't be able to make it down. Let's say, okay, well, the attendance that matters is your attendance here on Surveillance this morning. So let's get to the actual pertinent market conversation we talked about. Matt was talking about how four

thousand became the consensus. We may or may not actually reached that level this year, but obviously that was after expectations had to be dramatically reduced from what they were at the start of two what we expected this year would bring. Does that mean that expectations for three are also perhaps overly optimistic. Well, I mean, it's funny because one of the things is that that we have heard a lot of bearishness around the street in the last last couple of weeks, which is uh uh, you know,

the sentiments She's changed dramatically. But you're right, even though people have become much more bearished, they're talking about things dipping further. They think, well, don't worry, by the end of the year, it'll be fine. Um, I'm a little concerned about that. I mean, I do think the worst, I mean, what won't happen by the end of the year.

I have somewhere in the middle of the year. But the biggest problem I think that we face is that when whenever the market gets to an extremely overvalued level, like it did at the end of two thousand twenty one this time last year, the uh, the bear market always lasts longer than just a year or so. It's usually last eighteen months or even a little bit longer. That's number one. Number two is that the the evaluation levels. I mean again, when you get to extreme valuation levels,

that we what we have. It takes a lot bigger decline for the market to get back in line with what what what would be a natural level of evaluations? Okay, and so much to reach the bottom. But I don't think that's the case. Yet. Give us a number, what is fair value in a world of now four and a half percent interest rates instead of zero? Well, that's the thing. I mean, we have, uh, well to give you a number at least thirty five d And that's

a suming we don't have a recession. That's a suthing we don't get a decline uh and and and earnings in two thousand twenty two, and every bear markets and every recession since World War two has has given I'm sorry, every recession, not every bear market, but every recession since World War two has given a decline in earning. So if we have a decline in earnings that next year, that takes us again something below thirty I mean, people

have to forget that. People have to remember I'm sorry that you that when you don't have zero interest rates and you don't have qu e uh, you don't have eighteen to twenty times forward earnings, you have something more like fifteen and sixteen times four durnings. That's the fair value. So do we need then to come down? I'm interested really in the in the uh, the pees, the valuations,

because it's something I actually understand. So, um, you look at forward pees right and we're trading at seventeen three right now? Do we need to come down to fifteen before this bear market can end? Is that also something we've seen in every bear market exactly every single bear market since since basically since World War Two. It certainly over the last forty years you've seen at least fifteen times forward earnings, if not lower. I mean, but that's

the very best we've note as fifteen times earnings. And again the the the But when you get to all these all time valuation levels, we certainly had it, uh you know, stream valuations in two thousand seven and in two thousand at the very beginning of two thousand. The problem is you get all this addition of level reach and so when the de risking process and the de leveraging process takes longer than just one year, and people

like well Jesus come down so much, that's enough. It's like, actually, not until we get those valuation levels, because the the the the leverage gets so far to one side, it has to swing to the other one as people de leverage, and they have to I hate to say it, but they get forced selling. They sell even though they've reached fairly value. They sell because even when they don't have to, because they're getting margin calls and such. And that's why

the market swings to the other action. It's not just a thing. There's a ra actual reason why we get a swing to the other extreme. And so we'll probably get something below fifteen times there before we actually bottom. So how long will it take? I always think of the age of de leveraging by Gary Shilling, which was a financial crisis thing right, took us a decade to get through that. Um, are we looking at that kind of leverage again or is it not nearly as serious?

So we could be done with it in three the de leveraging that is well, I mean, it certainly could happen a bottom out in two twenty three, but I just think it happens at a lower level. I mean, what I guess the question is how much does does does the FED willing to to to let it the leveraging take place? I mean, when I always put back point back to its two thousand and eighteen you know, everybody says, well Jesus, stock markets started to crumble so bad that the FED was forced to pivot, But wasn't

the stock market. They actually in the middle of December that year, right in the middle, they said, hey, the markets get down a lot, We don't care. We're gonna keep keep tightening. Then two to three weeks later, the fixed income market, the jump farm market, just imploded, and that's when they pivoted. So they're much more concerned that what's what's going on in the fixed income market. And right now, even though it's down quite a bit, it's

still running fine. So we may get a pivot later on this year from the from the from the from the Federal Reserve where they actually start cutting rates. But that's gonna be happened when something, when the situation is gonna become much more dire than it is now. If we just have this slow grind lower, the Fed's gonna keep interest rates at high levels, even if they stopped cutting i'm sorry, stopped races in any kind of any

kind of way. Not finally, well, none of us probably could have seen what the FED did this year coming at the start of it, we couldn't have seen the war in Ukraine, so many things. I think also many of us weren't anticipating that in two we would see essentially the full reopening of the Chinese economy. Many of us thought it was just something that was going to

take much longer. If you have unleashing of commodity demand from China, how does that fuel back into those prices, and frankly the energy sector, which has already run so far this year, how much more upside could there be? Well? I think that can it can be more upside. I mean, as you say, with what China reopen, you see the commodities bouncing back, and that could continue, especially if the

dollar continues to move lower. If there's one thing that we've been a good uh correlation or inverse correlation has been the dollar and over time has been the dollar and commodity prices, especially with oil and gold for that matter.

But the thing is, though, is that you know, if you look at the way the valuations are are trading for the energy sector, it's still trading for for oil, trading out like sixties sixty five dollars UH, and it seems like, oh, pick wants to keep it at seventy dollars are higher, and now with the reopening of China, you know we could get you know, pushed back towards the hundred dollar level. That's gonna be bullish for these equities.

They still have, believe it or not, they still have ways to go to play catch up to the price of oil, even though it's rallied, even though they've rallied so much this year. So I still I still remain bullish on the energy sector throughout most most of this year. All Right, Matt, thanks so much for joining us. Matt Mailli there of Miller tay Back, he has been bullish

on the energy detector. And if you ever decide to cash out of some of those deals, we can buy some nosebleed seats at Madison Square Gardens and will stub down to the floor for the fifth show this New Year's even Let's get over to Julia Coronado. She is president at Macro Policy Perspectives, joining us from a very chili Austin, Texas this morning. Juliet, great to see you. We were speaking with Steve Sasnake of Interactive Brokers at the top of the hour and he was talking about

markets now that are still fighting the Fed. How hard is the Fed going to have to fight back in the new year. Well, the Fed has sort of shifted its strategy. It's sort of signaled both hawkish stance at the December meeting in the sense that the consensus on the committee is higher race than the market is currently pricing.

But they also sort of signaled a down shift in the pace, another down shift to twenty five basis points per meeting, and that allows them, i think, to both proceed with caution and feel their way to what is the right sort of restrictive degree of restriction to put in place, and also hold the threat of rate hikes

over the market for longer. Share Powell has been frustrated by some of these rallies in the market, these undesirable rallies that ease financial conditions, when they're trying to slow the economy down by by holding a longer string of rate hikes over the market. I think that they hope to kind of prevent that relief rally that you're sort of alluding to, Uh, that that they can hold markets in check for a little bit longer and make sure that the economy really does cool down enough to cool

those underlying inflation pressures. Well, on that note, Julie, if it really all is going to come down to the trajectory of inflation. I love the way that our team at Bloombrick Economics put it when they release their inflation outlook for three uh this morning, saying, the story of two was how fast inflation rose. The story of three will be how fast it falls. What is your expectation

on that speed? Yeah, so I think it's going to really gather steam in the latter part of the year, and we sort of all know that there's these leading indicators of housing of rental inflation that have really rolled over, but we know it's a lag from the time that happens to when it feeds into the official inflation metrics that the FED is targeting, and that leg should should be kicking in sort of towards the latter part of three.

In the first half of the year, they're going to be dealing with stickiness, those second round effects from higher wages and higher prices and the pipeline that sometimes ripple through into services. So they've kind of broken inflation into three buckets. The goods inflation that was disrupted by the pandemic. Rental housing inflation the single biggest component of core inflation,

and then sort of all other services inflation. And that's really where they're taking the temperature of the labor market, of consumer price sensitivity. Uh, that really hasn't it's sort of stabilized at a high rate. Uh. They'd like to see that come down, and that that probably is going to take some time. Isn't the third bucket the hardest, Julie.

I mean, from my understanding, services is the hardest uh, piece of inflation for the FED to effect because you know, with goods um certainly with something like you know, car sales or home sales, they can easily raise rates and limit the number of buyers who can afford to come in. In terms of services, do they have to just cause real economic pain to bring those prices down? Do they have to you know, knock mom and dad out of work today to put people on the unemployment line in

order to get services inflation down? You know that there that's one possible outcome. We don't really know for sure, but I will say this, the pandemic disrupted services inflation as well as goods inflation. Think about hotel rates, airfares. They've done a lot of busting and booming through the various opening closing waves um and we've seen that. Actually, one of the key tests here is that when will consumers become more price sensitive like they were before the pandemic.

For the pandemic, it was notorious that there was no pricing power. Consumers were budget conscious, they wanted deals, and then that all went away when all they could buy was good in the in the lockdowns during the pandemic. Now and then reopening, there was this sort of revenge travel idea. Uh, now we're sort of settling into a more normal consumer. I think we saw that this holiday season. Consumers do want deals. They are aware of the limitations of this boom that we've been in in the last

year and a half. They're more aware that there are clouds on the economic horizon, and they're responding accordingly with being price sensitive. And that's really key to cooling inflation without a deep recession, is that consumers start demanding deals again and that companies are going to have to you know,

meet them in the middle. But they haven't had to think about these passed through of of of car costs that you just mentioned unimaginable a couple of years that consumers would simply accept a fifty percent increase and used car prices. Uh So. But consumers now they've got a broader basket of goods and services they can spend on. We saw that with air affairs, Matt. We saw that somewhere around the fall, consumers started canceling trips if they

couldn't find the right airfairs. They were deal hunting, uh and airlines had to respond accordingly. So I think we're getting back into a more normal zone of consumer price sensitivity, and that's that's really key because that would allow the Fed to cool that services inflation without a very deep recession.

What about people waiting because consumers go back to their old bargain hunting ways, Julia, You know a lot of people in the housing market currently are on the sidelines because they're looking at six seven percent, eight percent mortgages. Maybe a lot of people, you know, I want to buy um this year. Next year, I want to buy the last Dodge Challenger Hellcat. They'll never make one again, I think the fifteenth year then building that gigantic muscle

car and they'll never build one again. But Chrysler right now is offering me seven point to nine percent. I'm not going to finance at that rate if I wait till the end of three. Are those borrowing costs gonna come back down by the end of twenty three? But remember we have to go through the soft pat or

recession first before we get to that relief. The rates are high right now to cause the pain that you're describing, to cause the reaction of you know what, I'm not going to buy this car because rates are too high. I'm not going to buy this house because rates are too high. That is the demand cooling the FED is

looking for, and we are seeing it. We have seen, despite better production of new cars, more better availability, car sales have been kind of languishing still because the right rates of financing a car loan have shot up oh much. Consumers are looking at a big jump in payments uh for for a new car or or any car, and

so they're responding accordingly. We're seeing used car prices fall pretty consistently in the last few months after soaring in the last couple of years, and we first saw some softness in new car pricing in the last inflation report. We would expect that to follow through into the first half of the year. Some actual discounts on M S R P imagine that if you will, all right, Julia Coronado of Macro Policy Perspectives, thank you so much for

joining us. Let's bring in Dr Bakti Hansatti. She's Associate professor of Emergency Medicine at Johns Hopkins. Great to see you. It has been a while since we've spoken. If we could just think about China in particular in terms of the remaining COVID story, What is your expectation for what is going to happen there given the vaccination rates that they have, even now that there's been practically an entire removal of restrictions, When could China reach a peak in cases?

I think it's really hard to say onto your question when can they reach a peak? Because we just don't have accurate reporting data from the National Health Commission UM side is trying to stop reporting cases. We're relied on the China CDC, who traditionally does monthly reporting um and we have not seen numbers coming out of China. So when can they heat get a peak? I honestly don't know, but what we're seeing is that it's been a rapid surge similar to the delta and the omicron waves in

most countries. When we went through delta and omicron, we sort of peak at six weeks. So I'm praying for them that this is fast and rapid and resolve soon. We also do know that China has high vaccination rates, so over ninety two of individuals fully vaccinated, and we have also heard that Chinese have access to all anti

virals that will decrease hospitalizations and depths. So you know, they are similar to the US in that there is innate immune protection available to individuals, and that we know that they're likely sick with the newer variants which have a much much more much more transmissible and so much more likely to peak early. So this newer variant, it's not delta, it's not O macron. Do we have a new name for it? And what else do we know about it? Besides the transmissibility. We have lumbas and lettas,

so we have moved away from names. We have be A one point one, B A five b A five point one is cute, so we know in trans and transmissive, I know, right, but we run out of names A long time ago. So we know that in terms of transmissibility, within two to three days of individuals come in contact on this COVID positive that they'll be symptomatic. We know that at five days, individuals will get sicker, requiring hospitalization

and needing therapeutic treatment. We know that as quickly as it comes on, it goes off, So individuals are most likely to be symptom free within ten days. I don't want to wear a mask. Do we have to wear masks again? I don't think I'm going to. It defends

who you are, right, I don't know you. But if I did know you, and I knew you were immun compromise, Oh you had a disease that made you vulnerable to getting really really sick from COVID, or you're an individual in whom the oral anti virals were unavailable, I would say where a mosque um. I will say, though wearing a mosque is tough, we are exhausted as a nation. M that you need to assess your own risk, and

every American has agency to make those decisions. I was speaking with Matt earlier about how so many people I know are sick right now. Some of them are COVID positive. It seems like I know more COVID positive people than I have in probably a year. But there are also a number of people who are just ill, whether that's the flu or sinus infections. I myself feel like I have been getting sick way more often than I ever

did pre pandemic. I'm just wondering, like long term health ramifications, if people are getting more sick, whether because that we've suppressed our immune systems by wearing masks and not interacting with people and we're getting just are we going to be more sick more often, especially now that COVID is probably going to be circulating in the population some time to come as a seasonal virus. Maybe Doc, you can solve something that an argument that we have at the

Miller household. My wife wears masks all the time and constantly, uh what do you call this? No? Not what She's using hand sanitizer all the time right, like it's an addiction. I never use it and don't wear masks. I never get sick, and she constantly does. Have have people who are overprotective of their immune systems allowed them to weaken so that they get sick so much? Or is this just coincidence and coincidence in my anecdotal um home life.

So again the easy clounces here and I in my house, so we joke I've had more viruses and pumpkin spice lattees. But I'm the mom with young kids. I have a five year old and a two year old, right, and they're bringing stuff from home. So I think what's really going on here is, yes, we have not been as exposed in the last two years um as we should have been to common household colds two different entraviruses, coronaviruses

and colds. Also, however, if you look at the current strains of RSP and flu, they are more virulent than they have been previously. This happens with the flu. Every five to seven years, you get a flu variant that is more aggressive than previous. So I think it's a combination of two. Right, last year we weren't exposed. We don't have any animate community. On top of that, we have a flu in an RSB season that is also hitting us really hard. Are we about to become a

nation that's constantly sick? I don't think so. Um, does your wife of a week immune system compared to you probably not. She's probably just exposed. Maybe she's at home looking after kids. Maybe she's out there doing things in the community, see going grocery shopping. Um, and you are in the studio and you're more protected. I think it all depends on what our lives look like and what our exposures are and thus what we are likely to be inflicted with. All right, Doc, thanks so much for

joining us. Pleasure talking to you again, although hopefully it's not too often, right because um, when we're all healthier, we see we see you less often. Dr Vaki Hans Hottie there of Johns Hopkins talking to us about this wave that we're seeing, and it's I don't think it's anecdotal, right, We have the data to backup that we really do see it coming back in a pretty serious way, and hopefully it's just more transmissible and not as that as fatal.

Let's talk about what to expect in terms of policy in this divided Congress that we will see sworn to kick off three. Isaac Boltanski joins US policy research director at b T I G. And Isaac, you've looked deeply into what's happening in terms of the legislative agenda for next year, even before we're finished with the legislative agenda for two Do we finish everything here? Does the Congress just call it quits and start afresh? Um, what are

you concerned about business that hasn't been done yet? Well, this was actually a very busy Congress, and despite all of the headline volatility that all of us had to live through, they actually accomplished a fair amount, from the infrastructure bill to the i r A to this massive one point seven trillion dollars spending bill that just came through. And look, we're still coming through that document. And it reminds me Matt of old saying that Campbell is just

a horse that's gone through the legislative process. There are lots of things that are crammed in there that we're still figure ring out. But that is the last and final part of business of this Congress, and they get to start again next year, and it's gonna be materially different next year given the composition, which is what I think we're all now focused on. So next year, I mean, there are a number of smaller issues. I'm focused on.

What's going to happen with cannabis and the safe Banking Act, maybe bigger for a lot of people in this state. What's going to happen with the state and local tax deduction? Will we get that back at any point? But there's also the crypto regulation we have to look forward to, other financial industry regulation, energy policy that we have to focus on. Are we going to be able to drill more? Is this administration will be more friendly to that sector

as we need more stock? What are you most focused on, Isaac fore? Yeah, Look, I think with a divided government, we're not going to have these big, massive legislative vehicles that we've seen over the past two years. So it is going to be the equivalent of a legislative grab that what can be attached to the Appropriations bill in the fall on page nine hundred, right, And so here's how I think about it. On the energy side, we are still optimistic that we will get some degree of

permitting reform in the first quarter UM. It remains to be seen exactly what shape that legislation takes, but there is clearly enough political will for that, and that's something that I'm optimistic about. I also think that we should expect some crypto legislation now here. I don't think you're

going to get the massive comprehensive bill that some want. Instead, I think it's going to be more narrowly targeted to stable coins because that's something that Congress understands, kind of like a money market fund, kind of like a deposit account. They can get their arms around that. Beyond that, I think I'm mostly going to be focused on how does Congress interact with, you know, the regulatory state here in d C and the We have some acronyms that I think are going to play a big role in such

as FTC, cfpb UM. A lot of these regulatory entities are going to get far more active, which is going to have real repercussions for the market. Okay, so those are a lot of very specific policy areas, Isaac. If we can talk about just macro economic policy for a second. Matt and I were talking about the dynamics between monetary and fiscal policy, how both were so common in data,

there was so much stimulus a few years ago. Obviously this is a very different story now, and when you have a Republican House, the likelihood of getting any further fiscal spending through is probably pretty small. So if we do indeed get a US recession next year, what would you expect the reaction from Washington, d C to look like? I think I think it's gonna sound like crickets, Gaily, I really do. I think you know. I'm I'm a fan of that saying that history doesn't repeat itself, but

it often rhymes. And the last time that we had a Republican House and a Democrat in the White House was then time period. And during that time period, we had legislative law jam, fiscal brakesmanship, fights over the debt ceiling, and what passed for fiscal austerity here in d C was something called the Budget Control Act, which had mandatory sequestration.

And so look, just as we have talked about the FED put disappearing, I firmly believe that the Fiscal Congressional put expires the minute the new Congress is sworn in

in a couple of days. Well, speaking of who's getting sworn in in a couple of days, I do want to get your take, Isaac on one of those elected congressman, in particular George Santos, the Republican here in New York who has now admitted essentially to embellishing his resume, about his college degree, about working at two major Wall Street first left something out as well, right, there were many based and he was previously married. There's just a lot

of different points of contention here. Yet he says he still plans to take the oath of office on January three. I'm just wondering what your reaction to these revelations is it shot being It's disappointing, and it's not at all surprising. I think as we've wintled away what what the truth is when it comes to our political discourse, these things are going to continue to happen. I'd be interested to see if he actually makes it um. I think that part of the strategy now is to just hope that

the story dies down over the next few days. I struggled to see that happening. But once he gets into Congress, I would tell you I think that it's gonna be very difficult for him to actually legislate effectively because he will carry a degree of toxicity with him from these stories. But this is, in a lot of ways the new normal, given where our political discourse is. He uttered the words I am not a criminal in an interview with The Post. Those are never good words to have to say, Isaac,

thanks so much for joining us. Isaac Boltanski B T I G. Talking to us about what to expect for three out of Washington, d C. Thanks very much. This is the Bloomberg Surveillance Podcast. Thanks for listening. Join us live weekdays from seven to ten a m. He's Stern on Bloomberg Radio and on Bloomberg Television each day from six to nine am for insight from the best in economics, finance, investment,

and international relations. And subscribe to the Surveillance podcast on Apple podcast, SoundCloud, Bloomberg dot com, and of course on the terminal. I'm Tom Keene and this is Bloomberg