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I'm Tom Keene, along with Jonathan Farrell and Lisa Abramowitz. Join us each day for insight from the best and economics, geopolitics, finance and investment. Subscribe to Bloomberg Surveillance on demand on Apple, Spotify and anywhere you get your podcasts, and always on Bloomberg dot Com, the Bloomberg Terminal and the Bloomberg Business App.
Laurie Cavasena joins us now at a US equity strategy at RBC Capital Markets. Lurie, wonderful to start the week with. You were just reading a note from Barclay's and they said this, we don't see the tech centric rally broadening to the rest of the s and P five hundred. We've got bank earnings on Friday. Do you see that rally broadening out?
Well, thanks for having me as always, and look, I think this market wants to broaden out. We've seen the small cap part of the market make several attempts to fight back.
We have looked at.
Financials earning provisions as well, in particular, and we're seeing that they're generally negative. Carecord been getting a little bit less negative, same thing on energy.
When we look across the S and P, most sectors.
Are in recovery mode in terms of earning sentiment, which means their rate of upward revisions has either flipped from negative to positive or they are starting to get less negative.
So I think this is a market that has really done.
Well in the backs of the tech sector of kind of the broader timt face so far this year for good reasons. But I do think that, especially from the earning's perspective, there are some healthy undercurrents going on in other parts of the market as well.
Laurie, I'm looking over the weekend.
I thought there's a lot of really good equity zeitgeist as we get ready for the Roulette Wheels starting Friday with JP Morgan. And the answer I see is a massive strategy strategist bet that's pretty darn negative. Is that what you observe out there? There's a pretty gloomy strategist tone forward.
I think so, And you know we've talked about this before. My target is forty two to fifty on the S and P. I've pointed to potential to upside the forty four hundred and forty six hundred three of our models are verret three of our models are bullets. The forty two to fifty is is splitting the difference. But even in that context, Tom and I tell people, you know, I personally feel pretty neutral. I don't feel like the
market's been crazy. I do see the potential for someome upside, but this is a December thirty first game, so any incremental upside you might get some.
Profit taking all of that.
Tom, people keep telling me I'm one of the big bulls out there on the street, and I just kind of laugh. But I think the reality is that there's been this view that the earnings expectations are too.
High, need to calm down the comble markets. I don't you know. We could walk through that later.
But I think that you know interprets how stock prices, discounts, stuff like that in advance, and did it last year. But I also think that this is a unique moment in history, and so if we do have a recession, I think we were all talking about it last year. Is technical in nature. I do think the market has the ability to focus on the bigger picture and might not be as damaged by that as some assume.
Give us two attributes when you screen for quality in mid cap small cap I get it. I can screen for quality in the world of Apple, But how do you screen for quality in mid caps?
I think it gets supper when you get down into the small MidCap space. One thing we talked to a lot of clients about is healthcare and technology.
That's where a lot of your.
Loss makers are sitting in the rustle two thousands. So if you were to screen in small caps, say on positive negative earners, things like that, are we especially on about positive negative earners, You're going to come away with the idea that technology is a low quality sector, that healthcare is a low quality sector. Sometimes, you know, we see that. Investors are like, Okay, fine, that's just what the data is. We like these factors over time, let's
just let that work in the filter. But right now, there's a more nuanced discussion happening in the small cap space, which is that if we're going to have sort of a subpar economic recovery next year, the DDP stats and even for twenty twenty five are both comfortably below two percent, which is the long term trend and a subpar economic backdrop,
you want to buy growth stocks. So people are having to look at things like tech and biotech and healthcare and say, okay, our losses is that necessarily low quality? Not necessarily You really have to do it more from an art than science perspective, take into account the data, but also taken to the long term, long term growth dynamics, Lori out of management team.
It's something else you have to look at in small cap as well.
Laurie, how much do you push back against people who say that stocks are just ignoring this feeling in bonds that perhaps we're underpricing the risk. The fit has to go a lot further, that the real neutral rate is significantly higher, and as you can see the real yield go higher, you're not seeing that commensurate sell off even in small pats. How do you rebut that?
So it's interesting, Lisa, and sort of my late June early July conversations with US based investors, they keep asking me about balance sheets, and I think that's really where the interest rate discussion intersects with the ability of companies.
To manage through this higher rate environment.
And we talk to people about how I think only two percent of SMP companies have an effected or have an average weighted maturity of under two years and the rustle two thousand even it's less than ten percent. So we have a lot of other metrics we take people through. Right, so, long term debt has risen, short term debt has come down.
What does six versus variable look like? And what we come away with is the idea that a higher interest rate isn't as damaging to companies and their balance sheets and their ability to manage their cash flows now.
As it was in the past.
And I think that investors and portfolio managers who are really deep in the weed are trying to wrap their head around that issue. This seems to me, this higher straight environment like another one of these like five or six things since twenty eighteen, that's you know, a hurdle. It's a challenge, but it's something that companies seem like they're able to manage through so far. And that's giving at least some of the investors I speak with some comfort.
Does that mean, Laurie that right now FED policy is not as restrictive as people think, and that in order to bring inflation lower to truly their goal, they have to go significantly higher because those higher rates aren't as damaging to some of these companies.
I think that higher for longer is still what I hear.
I will tell you pre SBB, I have evaluation model replug in interest rates GDP, tenure yields that sort of stuff inflation rates as well. Pre SVB, everyone wanted me to run that model at six and seven percent and see what kind of pestimate was spit out. I don't get those requests anymore. We've got I think five three five baked in the model right now, and people are pretty content to sort of use that as a general kind of rough bogie for the end of this year.
We've got some cuts baked in for the end of next year. People seem pretty sanguine about that. I think in general, investors want the inflation fight.
To be one and if you go back to the debt ceilingly sign Awa've it.
Talked about this in quite a bit, but I think one of the reasons why the market didn't collapse around that is I do think the equity market was on McCarthy's side and wanted spending to be ranked in so ultimately infreation could be brought back down to more reasonable kind of levels. I think that calculus at least on
the equity side of the business. I can't really speak so much for fixed income investors, but I think a lot of the equity pms I talked to they want that inflation fight to be one so they're willing to tolerate no another hiker two higher for longer.
Lorie, just the thirty second tis if you can. I've got an article set to one side for reading later this evening. It's Embarren's over the weekend. I saw the headlines your name, and it said something like, it's kind of like the nineteen forties. What's the takeaway?
So, in nineteen forty five we had a recession that the stock market completely ignored. It was a technical recession that occurred because of a transition from a wartime economy to a peacetime economy. Underline economy was still okay, but you had a massive withdrawal of government support back then in terms of fiscal very very analogous for what we're going through today, and a lot of the rhetoric we've
heard about recession over the past year. I think that's one of the reasons why equity markets have been so resilient. This underlying economy is still in pretty good shape and people really understand.
What's happening here.
Looking forward to wadding the article a little bit later, Laurie, thanks for famin us to kick off the training week. LORI canvasiting there of RBC on the week ahead.
Bruce Casman, first in his class on reflation at Columbia a few years ago, joins us. Right now, Bruce, is a question out of the time of green Span, but here we are. People will go OMG China deflation. Can we import deflation? Can we import deflation from China? Or on a global slowdown basis?
I think we can definitely import deflation and goods pricing, and I think there is definitely a force at work which is related to China downshifting the wand going down and perhaps more powerfully simply the unwind of goods price pressures in a world in which manufacturing has been contracting. So I think goods pricing is not going to deflate,
but there's a deflationary impulse. I think the problem is that other things are going to be blunting that downward movement and keeping core inflation on an underlying basis probably around three percent, perhaps a little higher in the US and globally as well.
Are we beyond the pandemic.
I think we are hopefully by on the pandemic from the point of view of its impact on behavior, But there is reverberations from this which are powerful and profound. I think what you're seeing in the US, for example, right now, is in the employment report a moderation in some of the post pandemic recovery sectors, leisure and hospitality perhaps being the most notable. But I don't think that transition and that decline and growth of jobs is a
sign of shifting from strength to weakness. I think it's a sign of shifting from strength to more normalization. I think it'd be a mistake to use the normal business cycle dynamics in try to attribute that to the move towards an early start of a US recession.
One consistent aspect of both the ADP and the Jobs report was the strength in the wage figure that was far beyond what the FED would like to see. And this comes in the heels of people worried not about the year over year comps so to do see coming down because of rents and because of used cars and things of that nature, but because there is this wage pressure underlying some of this strength and some of this
ongoing inflation. How much are you factoring that into how high real rates neutral rates truly are.
So I would be a little bit hesitant to put a lot of weight on the swings at average hourly earnings, which went down sharply earlier this year and have bounced back up. But I do think wage inflation in the US is running above four percent on an annualized basis. That's too high to be consistent with getting inflation down into the mid twies. I would not argue that wage inflation is the primary driver of US inflation, though I
think there's an issue here of tight labor markets. There's an issue here of psychology having shifted, and I think the interaction of those things, in the absence of a slide into recession or something like that, is just going to blunt some of these unwines that are happening here, and we shouldn't ignore that as well. Running inflation at the core five percent this year, I think we're going to slide below four, but I don't think we're going to slide on a sustained basis below three.
How long is it going to take to get there? Below three.
I think it's going to take a recession to get there. I think you have to hit pricing power pretty hard. I think it's a mistake to think that the primary thing you need to do is create unemployment. What you need to do is hit pricing power. Unfortunately, when you do that, you change labor market behavior and the unemployment rate will go up alongside it.
A rates restrictive enough right now where they are to induce some sort of recession.
I don't know, it might be. I don't think the Fed's going to wait around, though, and I think in our forecast of the Fed boiling the frog, they don't wait. They continue leaning against this. They tighten again in July and possibly more later this year, and by time they're done, rates will be high enough with a lag to create a recession, probably sometime in twenty four.
Is your study, doctor Casmin that the modern FED will react to higher interest rates?
Do they?
Actually?
You know, if we breach through and we start talking a six percent level for early ages, whatever it is, if we get a higher interrast rate structure, does a central bank respond well?
I think when you look at the move up in ten year olds we've been seeing in the last month or eight weeks. I think some of that is a tightening in financial conditions as we reprice the FED, but some of it is also taking out recession risk, and you can see more broadly financial conditions moving up, and I think in that environment it's very hard for the FED to look at that and say, Okay, this is lags in the monetary transmission mechanism and we can be
patient against that backdrop. So I think the FED is, as you can see, struggling to figure out where is the right degree of restrictiveness in this economy. It's probably going to be moving too much, at least in the context of trying to preserve an expansion because of the inflation news, and that's eventually going to take us down. I think it's just really hard right now to get the timing and to be too cute about the level of race that's going to end this cycle that's dead on.
And I thought about this over the weekend, Bruce, Are we asking too much of our central banks? By definition they don't get the timing right. I think this is this absurdity that they're going to nail. Plus our mind has fourteen days a turn in the macro climate is absurd.
Well, I think we're in a really difficult macro environment in terms of getting right the inflation dynamics, the appropriate level of what rates are. But I think the fundamentals here are relatively straightforward. This economy is resilient, it has elevated inflation, and I think the chances of delivering a soft landing here are pretty small. So there's every reason for the FED to try to calibrate and try to
deliver that kind of outcome. But ultimately I don't think it's going to be successful, And ultimately I do think we're going to need a recession. It's a question of getting the timing right, getting the rate path right, which I think everybody should realize is hard. People are put forecasting recessions starting this quarter. People have been very confident about forecasting recession. Forecasting a break in the economy like
that is just not that easy to do. There's also a question to understand that.
There's also a question, Bruce, about what the trigger could be of some sort of recession. And I was thinking a lot about geopolitics over the weekend with Yellen in China. How closely are you watching the price of rare metals of some of these sort of tit for tat focused areas of chips and the instruments the commodity is required to supply said chips.
I think it's very unlikely that that dynamics specifically will be the catalyst for recession. But I think your point is really important, which is, recessions are about the FED. Recessions are about the vulnerabilities of the US private sector, and recessions are about shocks. Oftentimes those shocks are in the commodity space and energy specifically, And I think it's quite reasonable to say that the next session will not only be about the FED hiking rates, but it'll be
about some shock that hits us Again. Shocks are not easy to anticipate, both in terms of when they hit and exactly where they hit.
How do you measure the vulnerability then of a financial system to a potential shock, because that really is the key to how deep the recession may be.
So I think vulnerability is broad. It's vulnerability in the financial sector, and as we well know, we've got banking sector stress and credit tightening that's going on. We're not seeing that spill over to the broader financial space and I think that's important. But vulnerability is also about where the private sector is, and this is one of the reverberations of the pandemic is how healthy the US and global private sector is, both on the household and business
sector side. That doesn't mean they're going to be a strong engine for growth, but I think they're going to be our buffers against the potential for a break, at least for the near term.
Bruce Love catching up with you, sir. Good to hear from you as always, Broce Casman of JP Morgan now Alifia Dorojuana the manage director Rock Creek Groof and if you're wonderful to catch up with you. Big rally year. Today, we've talked to a couple of people about whether they think it continues, can it broaden out? I was looking at your notes and you are saying remain overweight US, underweight em short term positive view on Europe. Let's start
with the US and break it down that way. Why remain overweight the US after big games already this year?
Yeah, Look, I think investors have been investing, as you mentioned, in a new regime from the last ten years. Right, we're in the higher rates, higher inflation, for longer. But if you look at equity markets, while we're cautious on equities in general after a very strong first half, what's going to break the equity markets? You know? I think consumer spending is something that we're looking at very closely to see if that's what break equity breaks equity markets.
But I think we also have to remember that within the equity markets, the bull market this year has been driven by eight mega cap stocks. It's more than seventy percent greater cumulative return in the top eight stocks versus the rest of the Russell two thousand year to date seems immune to that action.
When does the party stop?
Alifia, I want you to take a long term view.
Let's be honest.
If your leader, Miss Beschloss went to Marrakesh in the IMF meeting, people would just simply stop to know her opinion on the linkage of the global economy and hydrocarbons. When you guys look out to a three to five year look, do you have the gloom of the IMF? Do you share their view of tepid global growth?
I think growth is going to happen in particular niche sectors and areas, So we are investing quite a bit right now. In alternatives, it continues to be very interesting. Investors can take advantage of those secular long term trends US Europe emerging markets. You see tailwinds from the IRA and climate infrastructure projects. You see huge innovation in AI.
You see things happening in agriculture, technology, healthcare, data centers, as you mentioned, companies producing renewable fuels for rails, terminals, livestock. There are so many interesting investment opportunities today, but they are not going to necessarily make you money in the next three months.
How do you sort of navigate the idea of being less positive over the next three months, but very positive, particularly about the US over the longer term. How do you tell and communicate that message to investors who are not looking to day trade.
You know, we manage very institutional portfolios for endowments and foundations, and they are long term investors. They want their endowment to be there for the next fifty hundred years so they can continue doing the good work that they do, and so diversification in an institutional portfolio is key, especially in this type of uncertain environment. Think about it, just
in the public equities market. If you had taken a very singular view of small cap stocks, you would be missing out entirely on the first half of this year's rally. So you have to be diversified, we think, but you also have to look long term and start to plant the seeds now for those areas that are going to really be your biggest return drivers in ten years.
It feels like diversification is changing the meaning of it, and the people who we talk to used to be in stocks and bonds, and now it means private credit, private debt, some other private equity, other aspects real estate that really are coming to the fore becoming more mainstream and have been over the past couple of decades. But from your vantage point, how has the idea of diversification shifted?
You know, that's a great question. And again the flip side is that there's a lot of money chasing some of those opportunities that you set as well, right, So you know, I wouldn't say that we want to just run into diversification for the sake of diversification, but it has changed because in any particular period of time over the last ten, fifteen, twenty years, you've seen one of those asset classes really be able to drive returns in
your portfolio even today fixed income, right, there's a spread between shorter term and longer term bonds about one to one and a half percent. Maybe you can do something there eke out a little return and fixed income even today. So diversification means something different today because I think that if you don't have allocations cross different asset classes, you will end up getting in a hole in a certain period of time during the market, and then it's very
difficult to climb back out. And again we're looking longer term. We want our endowments to be there in ten, fifteen, twenty years.
Well, let's talk about something longer term. Just finally, the geographic diversification Japan. Japan's getting it done yet today tough week, more recently over the last five sessions or so. But Ifia, where are you on that country? We're hearing a lot of people say they're starting to get interested.
You know. Japan's funny. I think over the last twenty years that we've been investing, there's been fits and starts in Japan, And the question is can Japan really start to change their economy, change the demographics, and really get out of the disinflationary environment that they have had over the last ten years. If they can do all of that, then there's a chance for Japan to continue on this path. But I think it remains to be on you know, it remains I think a question on whether they can
actually get those things done. And in the meantime, it is a stock pickers market, probably more so in Japan than in the US emerging markets today. If you look at the dispersion, for example, in the US equity markets, there's more dispersion on a single stock level in the Japanese market today. So from a stock piggers market, it's great right now. I think longer term we're going to have to see whether there's some fundamental changes in the economy.
Nick Kay, Yeah, today of twenty three percent, it's not bad of Reck Craik.
The calendar of the xaxis and what we're going to do about it. Seriously about price of bonds. Gnnededi Goldberg joins head of US rights Strategy at TED Securities. Gonnedy I want to go to the outcome of this, which is TED Securities reaffirms with a vengeance curve inversion, and we could even get out to a steeper curve in version down the road. What is the process that gets us to a deeper inversion?
Thanks for having me well, I do think that front end rates remaining quite elevated for a while is what's going to get us there. I wouldn't be surprised to see it. It's been one of the most painful trades this year. I can't tell you the number of clients who have tried to enter a curve steepeners here and actually haven't been able to hold onto that trade just
because they're very expensive. From a carrion role perspective. What you can see is the front end of the curve continuing to actually move a little bit higher as the market has capitulated to the FEDS view of slightly higher for slightly longer. And that's very painful for the two to five year part of the curve. That's going to keep pushing up two to five year rates and in my mind, could keep the curve actually very very deeply
inverted for at least the next couple of months. And I can tell you know, the steepening typically starts about three to six months before the first cut, at least that's what our research shows market right now is pricing in a cut. Actually, even after US we've got ours our first cut penciled in for March of twenty twenty four, the markets all the way in May of twenty twenty four, they're not looking for a cut anytime soon.
Gnati, is that including some sort of trauma to the financial system? Are you basically plotting in this idea that there's going to be some catalyst to that downturn that's going to prompt the cuts, And that's sort of the reason why you expect the deeper and sooner cuts than the West of.
Wall Street correct. Typically, you do have higher rates acting in some unexpected way. We saw that back in March with the SVB crisis. I wouldn't be surprised to see more tremors in the months ahead. I don't think the market is looking ahead and realizing that higher rates a real high cost of cash, you know, five percent is not exactly cheap at this point. That tends to put some downward pressure on the growth momentum that could actually
push the US economy into recession over time. I do think people underestimate how much that can create shocks in the economy over the course of the coming year. I don't think we're quite pricing that in just yet.
Let's say we don't get any shocks, Gannadi. Let's say that they is truly more resilient to higher rates than anyone previously imagined, and that companies continue to, as Tom would say, adapt and adjust. Then how high should rates go and how high should they stay for a longer period of time?
Well, I think what you're describing right now is the nightmare scenario for the FED. You know, they think that they're right near the terminal rate. They're actually dancing around where exactly they want to dial into on the terminal funds rate. If you know, inflation continues to rage, if there's no real impact on the economy, higher much higher at that point, and that would be very, very scary.
And honestly, the higher you push rates like that, the more likely you want to get downside shocks to the economy, to the financial system. You know, something the on par with what we saw with SVB good on if people like.
You talk about the economic consequences of price down yield up. I mentioned the Bloomberg Total Return and Aggregate Index here earlier. It hasn't breached through to new price lows. But nevertheless it's on the cusp. If we get bonds to go down in price up and yield on an aggregate, do we get gamma. Do they have an accelerative behavioral tendency like equities where it picks up steam.
Well, you saw that back last year, where investors are looking at their bond portfolio and saying, well, what is this. I thought that these bonds are safe, you know, I don't think they were supposed to lose value, and they were down a very substantial at some point last year, they were down quite substantially. If that happens again this year, certainly you can have investors actually selling out interestingly enough.
The rates are now attractive enough where a lot of investors who are you know, really looking at the bond market and saying, you know, these yields are quite attractive, even if they back up a little bit more, Even if I'm down a little bit on my Barbin portfolio, I'm looking ahead to the next one year or two years. And that's why actually this year, despite the fact that the aggregate index hasn't done much, you've seen tons and
tons of inflows. You've seen over one hundred and twenty billion dollars flowing into the fixed income space overall, and really not a lot of outflows. So I don't know if there's necessarily that kind of moment that happens with fixed income this year.
Good Nattie, I just find it fascinating. What's your ten yere yield call? Quickly? Here, what's a ten year yield call?
Well, as we're heading into the end of the year, we do think things start to slow down. The consumer starts to slow, labor markets are to slow. So we're looking for three and a quarter on tenure rates by the end of the year.
Gotta do appreciate it. Got to go back that of Ted Securities.
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