Surveillance: Cash Over Bonds, Goldman Says

time that you reset. Christian Mueller Glissman at Goldman Sachs is hugely qualified to talk about the linkage of the dynamics of the market into your portfolios, retail and institutional around the foundation back to nineteen of the sixty forty portfolio. Christian, thank you so much for joining and your work with the cf A Institute, of which I'm remember is well

how dead is the dead sixty portfolio? Yeah, listen, it always is a bit aggressive to say that you have the debt or death of of kind of one of the most basic and and well known investment strategies. I think there's always going to be some benefit to be balanced now. But I think you have a particularly poor kind of starting point for these type of portfolios from two perspectives. No. I mean, first of all, everything is expensive. We know that, and equities and bonds are expensive at

the same time. That was actually the same a few years ago, and still these portfolios continued performing really well. But what's new is how we are starting the cycle. And all the cycle is starting with more inflation and flatter yearth curves, and and that just means that what bonds can offer you in the portfolio is even more limited, both in terms of returns and and and with regards

to to to risk reduction. One of the other determinants here is diversification, which over my span I've seen, for example, three hundred stocks down to fidelity fifty years. What Sequoia did years ago tell us about your view and the new diversification. If bonds are so unattractive, do I own Apple, Amazon and seven other stocks? Listen. It's exactly a good point you make there. I think you need to look for older sources of diversification than than just what equities

and bonds can offer you. I actually think there's going to be much more potential for regional diversification. In the last twenty thirty years, all the academic evidence is showing that there's no benefit of having a global portfolio. If anything, the best thing was to have all your money just

in the US equity market. But now that we introduce inflation risk, inflation volatility, policy uncertainty which we haven't had in the last twenty thirty years, and possibly much more macro volatility de synchronized cycles, what we could get is more diversification across the markets, and and also across styles, across sectors and and and and be the leadership is much much less narrow, So to some extent, you should not just be in the winners of the last cycle

um and run a really concentrated portfolio. You need to branch out the bit you need need to diversity find. Obviously, the other key area, which we all know um and has already done really well, which will be more important than the portfolio's real assets, if it's commodities or other sources of of of of kind of real cash flaws. I think that that will also feature more heavily in the coming cycle. Is cash better than developed market bonds?

Right now? Listen, this is the most interesting discussion, in my opinion, which is new. I think we all know that activities look better than bonds um in the long run on most models which you can come up with. But the more interesting discussion is really bonds versus cash. People are forgetting, but bonds have for very prolonged periods

of time lost your money versus cash. Actually, the hit ratio of cash outperforming bonds over a ten year rolling period is nearly so it's nearly fifty fifty that you essentially do better with cash than with bonds. Based on the last hundred years, we obviously have been in the biggest bond bill market on records, so so we kind

of feel that's quite unusual. But if you look back in history, there were plenty periods and one of the most important indicators of how bonds might do versus cash is the steepness of the youth curve, and and the steepness of the youth curve is half of what we normally get after a recession, exactly to some of the comments we had earlier. Because there's so little optimism about the duration and the longevity of the cycle and how

much central banks can hike. That means you have less buffer, and you have less returned potential for bonds versus cash. So I think definitely cash looks better versus bonds in the coming cycle than than what we've experienced in recent years. But inflation doesn't that sort of a road the idea, because your buying power is steadily going away with no coupon. Yeah. I mean it's always like you do you want to

lose money fast or slow? No? I think that that the big problem is with cash you're losing money very slowly, whereas with bonds you obviously have other drivers. And and we all know that real yields have moved to incredibly low levels, and there's really weird relationship you currently have where inflation expectations go higher and higher and higher, but the really yield stay will follow, and we know that might change, and then you have some losses in bonds.

Christian one quick question. You can't have a Moller Glistman article without Anibbitson chart. You try out the Roger Ibbitson chart like Clark work here. The long term log performance of the equity market and the Great Unspoken Fear is another nineties seventies, the dismal seventies, the Carter malaise, the flatness of equity return. What's the probability of that? Listen. I think it's definitely higher post COVID and post the crisis than before because we of the you have. Now

there's a new inflation uncertainty. And inflation is a very I always say it's a very autocorelated animal. Once you set it loose, I think it does create more uncertainty, It has spillover effects and and and I think as we sult of that, the probability has gone up. We still would argue that like a seventy stack inflation. Don't forget there was ten percent annualized inflation over a decade.

I mean that is quite aggressive. And you also have to consider at the time, like the type of macro backdrop, both with regards to demand supply disruptions which were related to OPEC embargo, Iranian revolution. There were things going on which seemed much more extreme than what we're dealing with.

I think stagflationary momentum is something we need to fear next week, not down next week, next year, um um where I think we know that growth will come down, inflation might remain sticky, and we get a bit of monetary policy normalization, and and and and potentially a bit of a catch up for monetary policy, and that can be a bit harmful for market. It's but I think the seventies staculation to US is still a pretty extreme event, which which I would still put more into the tail

risk bucket, not the base case. Christian, that was a clinic. It's going to catch up, says send out best to patter up in honor as well, Christie Milli Glisman there, I've got one sacks. Thank you, buddy. It's going to see it. One stock I want to look at in the pre market, Tom and now you want a brief comment on this to Jan J to split into two companies that coming from the company this morning the stock positive by about four percent, just short of one seventeen

Now Tom at one sixty nine sixty two. It is not the J and J those older perceived. What's remarkable here in this data wonderful in the Bloomberg, I can't say enough about the d E S screen to get a snapshot of a company that we think we know that we don't know John Household, Baby Oil, the powder, all the rest of it. It's seventeen of the company. It is amazing how they have deconsumered with their pharmaceutic called the medical devices growth over the last twenty years.

And tell me this company is still an absolute based what are we looking at four hundred five d pillion dollarmarket gonna take eighteen to twenty four months to split it out. I know we've got an important conversation here, John, but I just can't say enough about how the margins fall in that income is hugely profitable. That important conversation Tom starts now with Jean Barvan, the head of the

Investment Institute of Black Rock. John, your words, what ultimately matters is not the timing of liftoff on policy rights, but the cumulative response. John, can you build on that for us? Yeah, I mean we all focus on when exactly the lifto is gonna happen. And as you mentioned, like some are being brought pretty aggressively into twenty two.

Now I would push back on you know, three hikes in twenty wee do seem like extremely aggressive to us, um, but we might see the beginning of the hiking cycle in twenty twenty two. But ultimately, what's gonna matter what this very unusually discycle is that the cumulative response to this kind of inflation that we haven't seen in thirty

years will be much more muted than history lead. And that's gonna be meaning that the real rates in our view, are are remained very low for a sustained amount of time. And that's a that's a different way true to risk asset. I think that's a much more constructive backgroup that's sustained and and that's where there's a risk of confusion, we think, so hashtag confusion that for us is a is a starting point of manic conversation. What does the fiscal impulse

of this natural disaster, this pandemic? What is it due to the geometry that any given central bank faces. It's not in the textbooks, is it. It's not in the textbox? Uh. And you know we call this whole kind of complex. Well, we've talked about a policy revolution over the last few years, this complex of both monstrey policy and fiscal policy moving very aggressively. But that leaves us at the place now where um, you know, we we kind of forget about this,

but the dead levels are very high not long ago. Um, you know, the narrative in the US, was you the death servicing costs are solow like the trick or levels are low that we can afford to increase the debt very significantly, which we've done. The flip side of this, which will see soon, is that it won't take much in terms of rate increase to change the story completely

on its head. Um, you know, we can add a ten year back at two point five and at that point that servicing costs in the US will be back to their to their historical level, throwing a completely out of the window. Uh, you know the argument that Summers and Lasha we're making just a couple of years ago. So point being to your point, Tom, it's um, it's not textbook, and it's going to be a constraint on

how quickly rates that can go up. Jean, I find this fascinating the idea here the central bankers and praying frankly, policymakers in general don't want to see rates go up too high because the economy is no longer able to

withstand it because of what you're just talking about. Does that mean that the more volatile asset class is perhaps short term yields that a very little room to maneuver, but could potentially be offset dramatically by what my people might speculate about policy changes, whereas stocks continue to be supported no matter what by the negative real yields that

you see persisting. Yeah, so certainly consistent with what we've seen over the last month or two, right, I mean, lots of swings around the repricing of North Newton policy, and yet the backdrop has been you know, continues to be constructive more broadly for his causes. So I think that would be consistent with uh, you know, UH, rates might be lifting up at different point in time, but there's a conviction that overall, uh, this is going to

be a muted the hiking cycle. And if it were not, I think we've seen some example of that, then markets are quick to surprive some kind of policy mistakes, of quick reversal of policy, which speaks to this environment we're talking about. It's gonna be difficult to raise rates or I don't know, want to put it is like any rate right, Um, we'll have a bigger impact, Jean. I'm honored to do this with your work at Princeton. As you know, the great Olivier Blanchard of France, of m

I T and of the International Monetary Fund. Professor Blanchard is out with a blistering note this morning in the Peterson Institute, saying, forget about team temporary, forget about team gloom. John mentions Dr Ollarion. He says, we need to get used to the consequences of higher inflation. What are the

consequences of a sustained higher inflation is Olivier. Blanchard mentions, well, I mean it feeds to the entire economy, so you know there will be adjustment through you know, obviously prices, but that means also we'll see some wage dynamics, that nominal wage dynamic that will be different than eventually you know, um, workers will want to keep up with this. Inflation is going to change the boggaining kind of situation, and I think we'll see wages sketching up. We haven't seen, um,

I think I don't know. I haven't read yet the Olivier's piece, but I would suspect, like one of the key point is for the last twenty years, where you know, inflation was missing in action. And even if we are you know, two point five percent, well, going back, you know, after some some spikes, it's gonna feel different for that reason. And the other big point is, um, how will people react in terms of the expectation of inflation? And I

don't think people we have collectively a good handle. There's no good models of in flash expectations UM, and so that's a big unknown. I guess that we'll need to track and live with now. John, always quite get your thoughts as always fantastic, John ban a blank rock right now. An important essay by See Michure. She's senior global investment strategist of Principal Group and Seema. I want to draw

right into what we see on emerging markets. You are bold into the end of the year, you are bold into the beginning of the year and say you may not be on board with e M, but the belieguered e M has your attention. Tell me about the when of die thing in the e M. What do you need to see to generate a belief in emerging markets? Hi, John, So, I think the key thing is China. Right, we look

at the fundamentals of emerging markets. We feel that there's a lot of promising movement with regards to vaccines to kind of a shift away from zero COVID in a number of countries um and and also you know, compared to a lot of the other parts of emerging markets lat term, Eastern Europe, Emerging Asia kind of you know, not having as as significant rate hyps. But really the

catsule is China. You know, we need to see some kind of movement there with regards to stimulus, potentially at bottoming of growth, maybe a pull back in a bit of regulation. And the problem here is is that we don't know when that will happen. You know, we think there is a pain threshold, but unfortunately are not able. I think anyone is able to call that time in. So the only thing that we can do here is stay ready on the sidelines, waiting to to increase the

exposure because valuations have become more attractive. But we just need China to play ball. Say what's your read at the moment on how far down road we are in these tightening cycles in places like Brazil, like Mexico. Are we closely done yet? I think we're definitely getting there, right so, you know, Russia will almost at the end. Brazil,

I think that we're they're going to move quickly. They're going to move a lot, and then we should kind of normalize by middle of next year, so I think, And the fun thing is is, you know, they're going to be finished with their rate hikes, are going to have gone to pre pandemic levels before the FED even gets going, So we have to take that into consideration.

So I do think that as we're get into two developed markets start really moving faster towards their normalization process, that actually emerging markets start to look a little bit more attractive at that point. Okay, so they look more attractive. However, there is the issue of the dollar. What happens if the Federals serve does hike twice or even three times in the next eighteen months, how much does that potentially

crimp the bet that you're making. Yeah, you know, we think that for the US actually we're not expecting kind of very very early hikes. We think it's going to be right all the end of next year, that going to look through a lot of that inflation tension um and wait there and then from there on actually have quite a shallow upper trajectory, we think. You know, we look at the debt markets, we look at you know the fact that the growth profile is on a slowdown,

and we don't see very significant moves. So I think there is upper movement on the dollar, but I don't think it's going to be to a point that it

starts to strangle the measure markets. And actually, the other thing is is that you know, I know a lot of investors have been really concerned about how do emerging markets deal with fair tapering, and at the same time, the investors who are looking at a measure markets and thinking, right, well, there's a little a far more credible Montrey policy framework and incredible on the fiscal side across a number of countries, and I think that actually this is a slightly more

stable emerging markets and what we've been used to do in previous years. So this is a really constructive outlook. Why then, are you seeing potential wibles in the US equity markets considering that there is this sort of reflation trade in a constructive narrative around the rest of the world. Well, so even for the United States that we're looking at growth slowdown, but we're still expecting growth to be a own trend of not above trend. So this isn't a

very very negative outlook at all. There are going to be pressures on profits. We need to keep a very very close sign on that. But when we look at earnings of the earning season just gone, I think that equity markets have generally been really encouraged by signs that there is continued strong demand. So you know, we are expecting lower returns through two in a number of markets, including your including the US. But are we looking at

negative returns? Absolutely not. What's the correlation here to week dollar? Basically e M investors are standing around waiting for a week dollar. Is that all this is about? No. I think emergine market investors are really watching to see what happens with China, and you know, it's it's too big to ignore. It has to be something that is working

for them, um, you know. But having said that, there's pockets within emerging markets away from the e M Asia, such as in Latin America, where valuations are starting to look more attractive. I think it's just being ready for that opportunity. Don't get to underwaiting your portfolios. Be neutral and be ready to increase explosion when the right time comes. When China does start to pull back at a bit from from a lot of the veriest regulations, tightly constraints

that were started to introduce. Sama, thank you as always great to catch you up principal level investors on emerging markets. Right now, right now, let's go to George gun call Us. This is really important, he said of the US macro strategy at m u f G, and he writes one of the most interesting in George, I love saying this to you twisted notes on Wall Street and that it's very thoughtful paragraph to paragraph about what the unseen is out there. George, I love what you say about the

lack of depth in the three month market. The gloom crew is worried about liquidity, they're worried about savings dynamics, and you're focused on the lack of depth and treasuries. What do you mean, Well, I mean look, and definitely go down as a year that the bomb market could not catch the breaks um And we start off, you know, as John was pointing out, with the two stens curve steepening, you know, really kind of encourage further steepeners. Those trades

got on the lound. Then during the month of October around all the Central Bank kind of interventions which they obviously didn't really deliver. Hawkish messages or hikes from the b East point of view, really tripped up all these short term rates markets. And then now as we head into a year end, you know where liquidity is super precious and we're seeing some forms of cracks forming. I mean it's too early to say, but if you look at like, you know, the Government Liquidity Index on the

Bloomberg terminal, you compare against move. I think there's a good article by someone on on the Bloomberg team to put it out there, but there is you know, some concerns I mean both in the bomb market. I think that if this word persists, I think other markets would care as well. I mean, the bond market is the first to feel these things out. If you look at the you know, the ball market has more than one one curve going on right now, Well, let's go there.

I got three ways to go here, folks. And when Mr gun Covas mentions there about the bond market, this out front, I firmly believe in. I've seen it time and time and time again. What does the bond market telling the equity market in six months? Well, I mean right now, because CP I I think, you know, finally is a wake up call because the fact that it continues to stay persistently high last this reading is the

strong the book. The camel's back on the long end of the curve, and we saw that in the really poor auctions of the thirty year um. But again, even then, you know, it's good to kind of get around the idea that we're gonna have to positive strong growth next year in high inflation. But if inflation persists at this level, I think other markets are gonna start to care because it could you know, fast forward, you know, fed action and like and even if it's just two heights in

a faster taper, markets broadly are not ready for that. George, let's have therapy Friday. Why are bond traders so gloomy? Because we're realistic? I think no. I asked this seriously because whenever I read notes, and frankly I I gravitate to the bond market, as many people would acknowledge. For a reason, have been a lot of prognostications about cracks forming. You really talked about the idea that as a tapering starts to accelerate, it will reveal some of the significant

cracks in markets. What is the bond market so worried about that will happen as the FEDS starts to more meaningfully pull back. Who's gonna warehouse all this risk? I mean it comes down to just that we've been we saw massive q we to expect it to kind of just go away quietly into the night. That to me is whichful thinking. I think the bond market knows that, and so you're seeing you know, multiple bond markets, you know,

forming around a central core of the treasury market. The treasury market is made up of on the run benchmark treasuries which everyone looks at every day, and then there's the you know, the bonds that trade around that, these off the run treasuries which start to get less liquid, especially this time of the year, and with the fist stepping back George in some ways are stocks and bonds switching profiles where you start to see bonds becoming the

more volatile asset class and sort of equities following along with this presumption that central bankers will step in and stem declines create a backdrop where Tina civil exist. I mean, that really comes down to which I think discussed another episodes like it comes out to the credit market, which is kind of in the middle of the two, and he says, you look at just once rate ball starts to infect credit utility, and then I think then equities

will matter. But until that happens, there's so much money chasing yield, and so as long as that dynamic is still there, then credit should you know, hanging in there, and the next we should as well. But I mean, I think ultimately, if the bad market gets a little

bit uh illiquid, it's gonna hurt others. Is there so much money chasing yield a two thousand and six equivalent, that's actually a great point because if you look at like, um, the way that like so overall of all and and and how like the last year of that that period of oh six, when you know we've got a lot of complacency in the markets. Back then we're like, hey, you know, things are gonna be super smooth forever. We're gonna have this positive kind of reinforces mechanism on growth.

And it didn't last into two thousand seven. Sassanate, I don't think have to have a repeat of that per se. But yeah, we've we've been on the backup central banks, largest and fiscal supply A cistal sinulus and now that's going away, and so I think, yeah, I think that probably thousand one is like the oh six period ofstalogy Georgia.

Delicate question. But with m u f j's Japanese heritage in Japanese reality one are the lessons from Japan the fixed income market in the West needs to understand right now? Uh that you know, eventually, if you don't get the growthing, the deflation always wins going forward. What are you looking at in terms of the trigger point for the long end? You said that this was a wake up call the CPI print, Yeah, the wake up call seems relatively muted when you take a look at the flattening gield curve

that John was talking about. What do you expect to happen here as the wake up wake up call becomes more widely accepted. So, I mean, look, in general, we'll see uh more curve altility and relative to specific points on the curve. So if the curve continue to kind of move in the erratic behaviors, I mean, it's been in the flattening trends, it's hard to kind of distinguish that. But the realized ball has been pretty high in curves and so just looking at curve altility is gonna be

a big deal. Um. I mean, I do think that, you know, like look on the grand scheme of things, we all know rates are low, but it means it's it's really the starting points that matter. So if we start to move well back above one sixty on a ten year, back above two percent in a meaningful way about on the third year, that's when I think, you know, it will start to see some concerns about people that got along basically at the lows and rates when they

knew growth was strong and inflation was super higher. And if it keeps going and then that's what I think you have less interest and further tails and things like that that we that I think you guys cover well on Bloomberg. We appreciate that. Thanks for the con Wood, You're welcome back anytime. Jorge can compass that of m u f G on the sball Knock Kid. This is the Bloomberg Surveillance Podcast. Thanks for listening. Join us live

weekdays from seven to ten AMI Eastern. I'm Bloomberg Radio and on Bloomberg Television each a 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 In. This is Bloomberg.