Surveillance: Earnings Optimism With Ward

Day on Friday. Somebody who's expert at that is Howard Ward trying to get out beyond the next quarter with Gabelly Funds, and certainly I can say legendary in growthiness, Howard. Let's look at the debris right now, twelve months trailing. A sophisticate like Howard Ward knows that's t MT and the answer is the twelve month trailing numbers are a ginormous bullmarket up or So, how do you get out to your measurement of growthiness, Howard in two thousand twenty

three out two years? Well, Tom uh first of all, let me just say that the stimulus combined with the vaccination to the extent that it's been used and unfortunately hasn't been used enough yet have really combined to give us a very strong recovery. The GDP growth this year could be seven or eight percent. We haven't seen growth of that magnitude since nineteen fifty one when Harry Truman

was president. Earnings expectations UH, which were high two months ago when I was last on your show, people were expecting earnings of about a D eighty two dollars on the SMP this year. That numbers now about a hundred nine three dollars, and based on the numbers that were reported for Q one and Q two, I think that number is still too low. It's probably too of at least ten percent um, which means that the three uh excuse me, the expectation right now is too low. That's

it around around two d and twelve dollars. So we have continually UH several years of continued good, good earnings growth ahead of us, I believe. And so it is this. You know, in real estate they say location, location, location, and with stocks, I would say earnings, earnings and earnings, and the earnings outlook is rarely brighter. How this is so important? And John brought it up the idea of

the NASAC out performing. You provided worldwide leadership on rationalizing these nast deck stocks out further state the case now for owning those glorified revenue builders out two years, five years, ten years. So so tom Um, what's happened since I was on two months ago is inflation expectations, while while they're higher than we would like because of the delta variant being introduced to the extent it has uh, interest rates have gone down, but at the same time, as

I just mentioned, earning estimates have gone up. And when you look at the economic growth as strong as it is this year seven or eight percent GDP, it's probably more like four percent next year. We're already in an economy that has seen PEAT growth on a quarter to

quarter basis and will be is beginning to slow. Slowing growth is generally a good environment for growth stocks, and when you get beyond next year, we're probably going back to GDP growth that has a handle on it of about two simply constrained by the limits of the increase in the labor supply and productivity growth. So slow growth, whether it's slowing or slow, these are good environments for growth stocks. So the present value of those future earnings

remains hot. There's a question also about whether they're a mono left right. We always talk about the fang stocks as one entity, and yet we've seen a lot of divergence within the recent earnings and the outlooks. For example, the likes of Alphabet Whogl's parent companies seeing ad revenue really picking up, whereas the likes of Amazon seeing a lower sales estimate. How much do you expect this bifurcation to continue of the halves and the have nots within

the growth world. Well, you know, it's a little bit tricky right now when we look at the numbers, because you have uh companies like Amazon that are growing free cash flow like few other companies. In fact, the fang stocks in general are among the greatest free cash flow generators of all and the market in the last two months in particular, as rates have moderated, has been rewarding free cash flow more than anything else. In the first quarter,

it was really rewarding earnings estimate revisions, positive revisions. Last year, it was sales growth. Right now it's free cash flow growth. And so so many of these growth stocks, and all of the fang stocks, including Netflix, although they were free cash flow last year, probably not this year, but they will get on a permanent or trajectory of free cash flow growth next year. Uh. These are wonderful places to go. And in the case of Amazon in particular, bear in

mind the company is up against monster comparisons. And Amazon has become Amazon because of Jeff bezos willingness to sacrifice short term profit for long term geed. He's become the richest person in the world following following that strategy. And in the case of Amazon, they have investment cycles. They keep investing to give the consumer a better experience, and that has been a successful formula and it is continuing

to show the way for Amazon's future growth. They remain the leader in e commerce, they remain the leader in web services, and they have a rapidly growing digital ad business which puts them up there in the you know, as number three behind Google and Facebook. So so free cash flow growth right now is the primary mantra. And I think really all the Thanks Dots and so many other these software and even semiconductor type companies are generating this,

and this is what really gets us excited. I gotta say, tom as I hear Howard talk, I think about the case for growth, the case for buying stocks look expensive for people who say are in too intall cash who might not have been in this. You know, that's been the howard Ward mantra for years and goes to Mario Gabelly and Howard Wards saying that growth is the new value. What's the value trap right now? Howard Ward outter that

two thousand three, what's the trap? You see? Well, you know, you know, I think that the market got very excited about the potential for cyclical earnings growth UM. And I'm not saying that that that has gone away. Uh, it's simply that. And so you had stocks like Caterpillar, for example, which should be an obvious beneficiary of the pending infrastructure package UM and also benefiting from the reopening trade and and booming housing markets and construction. But yet the market

had discounted that. And in fact, it's a good point to mention that, as we saw with this most recent batch of earnings, UH, whether it's Amazon or some of the others, the market has discounted efficant earnings growth. But my my perspective is it's still not where it should be. The earnings expectations are still too low for the market overall.

But when you look at some of the cyclical names, particularly now with COVID striking us again, some of that cyclical fervor is going to going to come down, and some of that reopening trade in hospitality might be put on hold. And so I'd be very careful with a number of those stocks, whether they're transportation or or or or hotel restaurants. I think you have to be very careful there, because well, I don't think we're going back to a base case of any kind of a countrywide lockdown.

Lockdown on a regional basis, on a state by state basis, that's not so certain. And this is a problem, and the risk has risen because of the failure of more people to vaccinate. And I have to say that the TV personalities and politicians that have discouraged the vaccine and are continuing to discourage max mask wearing are doing a real disservice to this country and it's costing us illness and lives, and those people need to be held accountable.

How would Ward of Cabelly Funds, Howard, thank you, sir as always gonna catch up a number of summers ago. My book of the summer was Elizabeth Economy of President gy and she called it the Third Revolution. It was cover to cover, read every word. Someone expert on the granularity of Liz economies China is Leland Miller with China Beije book. He is definitive on the cadence and the pulse of domestic China. Leland Miller, what's it looked like right now? How does domestic China react to what they

see from Beijing. Well, you've got a lot of factors that are pushing things in both directions. You've obviously got these nasty crackdowns and tech and the education sector that's hitting the stock market, which is looking sort of nasty. You've got spread of delta variant, which is which is creating uncertainty for the future. At the same time, you know, some of the numbers that we're looking at are not

as bad as everyone sperit. Yet a recent are Our cut and that made people think, well, well, China must be doing really poorly if they're looking to stimulate the economy. Well, I think manufacturing is doing okay. Services actually doing a little bit better. So so we're not as negative on on the actual underlying economy, even though you have these awful headlines just coming from every direction. Okay, great, what do you do if you're advising Tim Cook of Apple?

What is the Leland Miller perspective for big American companies who have this this codependency almost with Beijing. Well, you know, Apple is almost unique in that it figured out a bunch of years ago that it needed to have a contingency plan. But its needs and its production China is so big that it can't really just move things. So I think what Apple is doing is what they can in terms of trying to create other markets where they can where they can produce too, so they don't have

so much of an emphasis and reliance on China. But they produce so much you can't just move everything to India or to Vietnam or somewhere else in Southeast Asia. So so they're doing the best they can. But but if you're not Apple, and you know, you should be way down the road in terms of contingency planning just so you don't have over reliance on on China for the market, for the production, just because of all the different things are going on, from the virus to trade wars,

to geopolitical tensions. Okay, so we've been talking about the fundamentals and the potential slowing down of the economy. The data seeming to confirm that that we got out overnight. The question is how much does this matter and how much is the focus squarely on the regulatory regime. The fact that there does seem to be a shift by

President jin Ping, there's definitely a shift. The question is is this step one of twelve steps where they keep ramping up crackdowns between now and the Party Congress, which is a little over year year from now, or is this uh their attempt to try to fix problems during what is basically a little bit of hiatus from disaster disasters. Headlines they recovered from COVID faster than others. Uh, there's a little bit of a global recovery going on right now.

So so to some extent, this may be Beijing seeing a window to try to do some of these things that they pushed off for a long time. It's more likely that this is the first of many steps. Uh. So then I think you're gonna have to to watch not just the regulatory crackdown because that affects stocks, but but whether this spills over into pessimism on the economy at large. Right now, we're not seeing that yet, but that's something to watch for the second half of the year.

What are potential regulatory measures that you expect the PBOC to consider, they expect j Pink potentially signal and upcoming speeches. I think the most important thing over the next year will be signaling a continued pull away from a reliance on the United States or the West. Uh. You know, the law of the headlines the past couple of years have been how the US is threatening to kick China off its stock markets and and and decoupling through you know,

chip chips and other aspects of the technological relationship. What's Jumping really has to signal from a political standpoint is that China can go its own way. Now that's not completely true, and in some things like chips, it's not true at all, But that's the signal that he has

to be sending. Uh, China can do its own way as they enter a very politically sensitive year next year, Leland, I'm trying to understand what's happening on the ground in the country at the moment, and I'm not getting a ton of information Nanjing and the spread of the downta variant supposedly from the airport there and the restrictions with standing to see what are you seeing on the ground,

what are you hearing? But we actually attract us now, so we have a China beged book COVID tracker, and what we do is we asked our corporate networks whether they're seeing a spike amongst their workforce, either in a particular city or nationally. Uh. We saw the spike in Guangdong two weeks before it was announced, affecting the ports and the shutdowns. Uh, you know, and we saw something a couple of weeks ago showing that that that the that there looked like there was a bit of an

outbreak going on. It's hard to know what is a mildly serious outbreak and something bigger because Beijing is is vary suppressing information on it. It's not good news, so they don't like to report it. They're also cracked down. They see six cases and they shut things down. So really it's it's watching the spikes and our COVID tracker to see to see what is what is just sort of the role of this thing. So the EBB and flow and what looks like it could be a serious

spike that's gonna affect economic activity. That's the question I have Leland the restrictions you're starting to see introduced on the ground and cities light managing. Is this a threat to economic growth in China for the coming months. Absolutely. I mean, we all know how how incredibly contagious the delta variant is, and that's what China's dealing with right now. They have a vaccine, but it's not really a vaccine.

It doesn't it doesn't show anywhere near the protection that all these other UH vaccines being used United States and elsewhere are are. You are are are boasting. So there is a real worry about this, and so what you're gonna see from China is a continued, very aggressive shutdown response every time they see a small outbreak. What does that do? If rows off commerce, it throws off the economy, and if you see it in enough places, it's gonna

affect macro economic activity. So we haven't seen that yet, but what we're seeing right now with these mini spikes is something to watch going into September, because this is this is this is something new, This is something new. Yeah, especially given the efficacy rights of the particular vaccine that was distributed that compared to say, fine some of Madonna in much of the West, lean and grant to catch up running poll and tell pink lea mill of that,

Shanna Basbook CEO. Let us return John to May seven of two thousand twenty one. The survey was what a millionaire this or that? Nine hundred thousand oops, and it came in a little lower. Stephen Stanley, like all of us, sobered up that day with Amber's pier Pont chief Economists and joins us right now, Stephen Stanley, why is this time around different than the joy of May seven, two thousand twenty one? Right? Well, I think that was the day that we realized just how severe the supply side

constraints were on the labor market. And as an economist, you know, I've been trained, the FED economists have been trained for decades that when you look at the peril numbers, when you look at the unemployment rate, what you're really trying to get at is the strength of demand in the labor market. And we knew that demand was very strong.

In the spring. We had seen a big peril number uh the month before, and what we've learned in the intervening months is that demand is indeed very strong, but there there have been some pretty severe supply side constraints. People are not flocking back into the labor force in the numbers that we had hoped, you know, for the reasons that everyone suggested, health concerns, childcare issues, and the supplemental unemploment benefits, and the latter two of those should

be starting to ease now. Um. Obviously remote schooling should be less of an issue in the summer than it was during the school year, and the supplemental unemployment but if it's have expired about half the states, so um, I think that's one story that we're likely to see

in July. The other one, with regard to payrolls is is just a seasonal quirk, which is, you know, the the education the seasonality around education workers is pretty extreme and obviously they're being um, you know, they're they're not on the payroll in the summer, and so to the extent that schools weren't operating full bore, you would have a smaller number of education related layoffs in July, and therefore the seasonal in justused number in July for the

education workers is likely to be up very sharply, Stephen. You're anticipating the supply side of this economy to respond from September on woods. If it doesn't, can you see wage pressures persisting, this inflation re pressure persisting in a way that could reshape the conversation of the Fed. Absolutely, I think that's the that may be the problem for the FED. As long as demand is as strong as it has been, then you know, it's it's a pay

me now, pay me later thing. Either we're going to get a very strong recovery and economic activity as the supply side normalizes, if it normalizes quickly, or if it doesn't, we're going to continue to see these bottle now x that have helped to generate wage and price pressures. So um, neither of those scenarios is really entirely uh consistent with the sort of monetary policy that the FED is running.

There is, of course, very little they can do about the supply side of the economy, Stephen, except let demand writ for long enough that the supply side eventually responds. But if the participation rate doesn't recover, that surely changes the path of things for the Federal Reserve. At what point do you think that's conversation could gain a little bit more traction. Is that a year end conversation or

a new year conversation? Well, I mean they've they've been pointing September right, school starts again, the unemployment benefits expiring the other states. Um, so you know, let's see what happens in September and the months forward. I think things may pick up even before September. But if they don't and we're still talking about these same issues in October, November, and then yeah, I think that definitely needs to have

a pretty tough conversation around that. Stephen. You keep mentioning the enhancement employment benefits rolling off in September, and there have been a number of states that have already ended them in large measure, and some studies have shown that they haven't really added that many more jobs in other states, that they aren't necessarily on the forefront. The early data does it should suggest that perhaps there's more a slack of the economy, or less slack in the economy than

people think. You know, I think it may be early to tell. Obviously, this July peril number will be the first one where we'll get a gauge on that um on a you know, in terms of the really big national data UM we've seen, we've definitely seen some impact on the claims numbers, so we know that fewer people are collecting benefits in those states. Um. You know, the presumption is you think they you know, a lot of them would want to go out and uh and get

a job. So and there's certainly plenty of opening. So UM, we'll see what happens. I think you don't have to give it a month or two before we have a better sense of exactly what's going on. The inflationary pressures meanwhile, that we are seeing in wages. We've been talking about Goldman Sacks raising their entry level salaries this morning, Others doing the same credit squeeze coming out and saying that they were going to also. Hey, initial associates have a

hundred thousand dollars a year. Question, is this just isolated to the white collar jobs, to the more hiring paying professions, or you seeing it consistently and evenly throughout all careers. No. I mean, I think most of the headlines over the last few months have been more on the lower end of the spectrum. You know, the Walmarts of the world and the fast food restaurants and and you know a lot of cross really across the restaurant industry having to

raise wages to get people in the door. Um. So I don't think that it's that it's just white collar or blue collar or service sector. I think it's it's

kind of across the board. And I think part of what's going on, I think this is directly applicable maybe to the to the Wall Street headlines is after the pandemic, people are kind of reexamining the whole work life balance issue, and it may be that people are inclined to either work a little less or if they're gonna work really hard, they want to get compensated more, um, you know, more for it. So, um, let's see how that all plays out. I mean, as the dust settles and we get back

to normal. Um, it may take a couple of years before we have a good handle on that, but you know that that is something that you could see as a as a big factor for the economy moving forward. Steven Stanley, it's real sophisticated Monday question. Which is the horse and which is the cart? If there's an inflation adjusted wage which is negative. Does that lead to wage increases or is there some other mystery thing that leads us out to a wage breakout? Well, I think that's so.

There are two things, really um that should be driving that wage picture. One is the inflation story, and in particular inflation expectations, and that's I think why the FED is so focused on that. So if inflation just bulges up once and people don't expect it to last, then they're not necessarily gonna storm into the boss's office and say, hey, I need a race to make up for this five

percent inflation we're going to see forever. The second thing is the leverage that workers have in the labor market. And right now, the labor market, despite the level of the unemployment rate, I would argue, the labor market is as tight, if not tighter, than any we've seen in decades.

And so, yeah, workers have a lot of leverage in that sort of an environment, and you know, we'll see if that persists, and if it does, I think workers are going to continue to to be able to demand higher wages and and then you do run that risk of of kind of you know, one step in front of the other, and you get wages going up, and then inflation and then back the wages, and um, you know, you end up eventually if if you don't arrest that you end up back in the Stephen just quickly here,

this is as tight as it ever has been. And you think that that can persist, You think if it's wrong here, That's what I'm hearing. And I'm just wondering when you think they will actually break down to your point of view of the world and what kind of liftoff you're expecting here. I do think the FED is

looking at it incorrectly. I think they're looking at it the way that I indicated at the outset, which is the way that we've always looked at it, which is you focus whatever you're looking at in terms of the level of the unemployment rate. The pace of job growth is only an indicator of of labor demand. I do think they're coming around if you look at you know, three or four meetings ago, all Power was talking about was, oh, the unemploant rates too high, and even the stated unemployment

rate understates the health of the labor market. Um. And with each successive meeting he started to talk a little bit more acknowledging that labor demand is very strong. I think they get it. Um. I think that they're just coming around slowly to that point. So as you mentioned before, UM, it seems like it's it's probably, you know, end of the summer, as some of these special factors should be starting to fade, that they're really going to be able

to focus on what's actually going on. What's your lift off, coach Stapen, I I still think it's next year. I think yeah, I have my first rate hike is June, so middle of the year. Wow, Stamens Donley, we should have stied that, shouldn't we. Economys Stephen, thank you. We get smarter with Lisa Hornby, with Schroder's head of US multisector fixed income and very sophisticated at the entire depth of the yield market. Lisa, I want to channel Ted

Lasso this morning. That's what we're doing here. And the basic idea is the belief in yield higher? Do you believe and yield higher? What's the path to get us to higher yields where we can frame an intelligent belief? Yeah? Well, first of all, I think it depends on whether we're talking about nominal or real yields. But just to start

with nominal, we do think that yields belong higher. I mean, basically, any sort of fundamental economic model that you could run today suggests that based on the longer term level of growth, and I don't mean the next quarter or so, which is still quite elevated thanks to the COVID recovery. But if any longer term basis, ten year, yields probably do belong at a higher level. And that's compounded by the fact that, uh, the FED will eventually be starting to

taper its purchases. I think what we've seen recently is that one, there's a tremendous amount of liquidity in the system and it's chasing yields lower. Uh. And to the fact that, uh, you know, the market has essentially taken the terminal rate all the way down to around one and a half percent. So the market kind of has this view right now that if the FED start hiking in the next let's say year and a half or so, they will not be able to get many rate hikes

actually done UM. And that means the terminal rate will be one and a half percent UM, and so that the level of tenure yields, and my view is is artificially depressed by that view, and I think that that will start to correct itself, in part because I actually think that the Fed wants to take a slightly easier path to all of this and might delay the rate hiking cycle more than the market currently believes, which means the terminal rate actually belongs higher and nominal yields actually

belong higher. They said just quickly on this for debate. There's more debate to this, and I think some people might imagine outside of the market, looking again, you think tapering is actually bearish for treasuries because some people have taken the other side of that. Um, well, it's it's hard to say right now, right because we've had we had the sell off, and now we've had the rally. Um, So where does that actually leave us. I don't think taper is actually the big story, because I think the

Fed is going to try to focus it on. Look, the size of the balance sheet is going to remain extraordinarily large, So the incremental flow they'll take down ten billion per month perhaps, um it'll take them maybe close to a year to actually taper. But the real question is what happens after that, and last time they waited a year to actually start hiking rates after they finished

they finished the tapering cycle um. But also last time around, they started hiking rates and then they also started reducing their balance sheet actively. So I think they're going to try and sequence this in a much more extended way, and that's probably, in our view, going to result in a higher inflation backdrop than the market has become accustomed

to over the last decade. We're not talking about pernicious, you know, four or five six percent inflation um, but we think the inflation regime for the next let's say several years is probably closer to two and a half percent versus the one and a half percent regime we

had been in previously. So well, Lisa, we're focusing a lot on the ten year yield, and some people might say, really, that's the one metric and markets, and yet this underpins people's call when it comes to stocks, when it comes to currencies, literally with everything, and increasingly this is one of the most important factors to keep an eye on.

And we keep talking about the demand side, the idea of the FEDS buying and how much they are buying, how much they might remove accommodation, And yet the supply side is also important. We came into the year talking about fiscal stimulus that was way above where we are seeing it come in. Now, how much does that play a factor in this The idea that supply of treasuries being sold into the market probably will decrease a little bit more than people had expect or at least not

go as high as people expected. Does this lead naturally to perhaps a lower yield than might have others wise naturally been the case. Yeah? Absolutely, But I do think some of that perhaps has been discounted. Right. So, when we started the year we were talking about an infrastructure package of two three four trillion dollars, rates were significantly higher. UM. So that has to some degree been been marginalized. You know, we're now we're talking about a five and fifty billion

dollar package. Honestly, who knows where this is going to end up. I mean that the conversation changes week to week. Um. But at this point I think that the market's expectations for another large fiscal plan have been dampened to some degree. So if we got something significantly larger, I think that would need to be discounted into the into rates markets. This quote from a Lim and just to jump in

least off I can. The extent to which try series will be driven by the fundamentals is as much of an unknown as the actual dates for itself at this stage. That's the problem, isn't it. It's fair That's absolutely right, and that's that's why that fundamental divergence that I mentioned to you, when you look at a model of where tenure should be and where they are today, it's probably

as wide of the gap as it has been. However, in our view, when you look at that over kind of a long term, more structural way, those do tend to converge. Now that doesn't mean intends go right to the fair value model, but that does mean that we probably see ten year old start to drift higher in the next couple of months rather than in our view lower from here. Lisa always enjoy catching obvious send not best of the team one, Yeah, Lisa Hombi that strout

as head of US multisector fixed income. This is the Bloomberg Surveillance Podcast. Thanks for listening. Join us live weekdays from seven to ten am Eastern 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 In. This is Bloomer