Surveillance: Earnings Recession with Wilson

US equity Strategy, Morgan Stanley. Mike, I want to go to technique here. Do you change your technique your day to day grind at Morgan Stanley and the classic ideas? Are you bottom up? Top down? All this? There's the factor analysis out of m I t years ago. What is the process of Wilson strategy for this year? We good morningtime and happy new year to all of you. I mean the process never changes. Okay, we do all

of those things you mentioned, top down, bottoms of factor analysis. However, what I would say is and at certain times we emphasize you one over the other. And I would say that, you know, going into two thousands twenty three is probably gonna be a little bit more bobs up, a little bit,

more dispersion amongst stocks, even even perhaps within sectors. There's doing a lot of work on that this week actually for next week's note with respect to okay, well, how are we going to make money on a relative value basis? And that started to emerge again a little bit at the end of last year because at the end of these bear market is what happens is the big cahunas, right, the big market cap leaders are the ones that eventually have to fall, and that's exactly what we're seeing this

year at the end of last year. So we think there is going to be opportunity to stock level and we've been talking about that center. Where's the greatest variability to partial differential on the income statement? Is revenue the greater mystery? Or do you go down to ibata or down to net income? Now that's a great question, Tom. It's it's all about profitability. And we've been talking about

this one factor really since January February. Operational efficiency. That's what the market is paying for, and it continues to pay up for companies that can basically deliver to the bottom line. All right, So revenue growth, we know is going to be softer than last year. We don't know if it's gonna be negative, because that ties into the

question around recession, which you all are just debating. I think being a bond investor is harder than being a stock investor right now because being a bond investor, you don't know if you're gonna get a labor cycle. Okay, but in the acquity market, we don't. We don't really care because if you don't get a labor cycle, then the margins are gonna be even worse. So I think

either way, we're gonna get a nasty earnings recession. And so the companies that can deliver on the cost efficiency are the ones that are going to continue to perform until you fully price you know, whatever this downturn on earnings are going to be. So, Michael, were starting to see that cuts those cuts of much in big tech and does that make you a little bit more constructive on the sector into twenty three, Well not yet. I

mean we're starting to see it. I think the you know, the look, this is one of the areas I would say consume consumer goods in particular and tech were the two areas of most egregious over earning and margins as well as top line, and that just has to get wrung out. The thing the concerns about tech companies, John, is that they're not good cost cutters. Traditionally right there, their growth companies, they tend to want to invest into

these downturns. They want to invest, you know, aggressively through all periods of time. And they're just not good at cost cutting, and so they're gonna be late on that. They're probably not going to do enough, and so it will take longer than you think, and so the margin degradation could be more severe in those areas. Now, there are parts of tech that have already gone through that.

The other thing I would say is be careful about how you define tech, where if you look at the top six or seven stocks in the SMP, we all know what they are. Only two of them are real tech companies. The other ones are communication services and consumer retail. Mike, how has the potential reopening of China changed your view?

Because you've been talking about the potential for an earnings downturn for a while now, and a lot has changed the past couple of weeks with respect to China, with respect to a warmer an expected winter, you know, I mean like it. It factors into our analysis for sure. From an economic standpoint. I think from an earning standpoint, it's less important at leasta because you know, we look at it carefully. China only accounts for about four percent

of SMP revenue, so it's just not that significant. Now for some companies it's very significant. The other thing I would caution on is that, you know, China really hasn't been closed to a production standpoint, right, I mean, we haven't wanted for many things. We mean, we've they've been produced to be doing these rolling lockdowns, and the factories have been pretty wide opened quite frankly. So this is more about consumption at the at the at the domestic level.

So thing it's a real positive for the Chinese stock market and certain pockets of that. That's where we upgraded China a few months ago. But I'm not sure it's a big deal for the US stock market. But what about with consumer spending? We've seen that hang in there, that's come out better than expected at least over the past a number of weeks in select industries. Does that make you change your view at all? Or is that basically U. What's to be expected in the last gasps

for the downturn that we see in the first quarter. Yeah, I mean, unfortunately, I think we're just seeing the last gaps as you mentioned. I mean, part of that has holiday spen, okay, so you know, it's the American way. We don't want to be scrooge. People are gonna spend money on the holidays, and I think they're gonna probably hunker down. We've heard something's large consumer retailers talk about that dynamic where they expect demand to fall off sharply

once the holiday season is over. So that's what we're gonna be watching carefully. We're pretty confident about interest rate sensitive areas like housing and autos. Those are pretty obvious,

you know, victims of the higher rates. But I think even broader speaking, we're expecting a pretty sharp down turning consumption over the first six months of this year, at least as a stand as a stands in turns a profitable spending Okay, Discounting will return as one of our teams for this year, which is why we think inflation will come down pretty sharply. So Mike, with that in mind, during the team still believe it's about down side at

the index level. Here we do we think, we think three thousand is is a very achievable number given our confidence on our orange forecast and so and that you know, I would ironically, I would say, in the absence of, you know, a recession, meaning companies decide to not off aggressively, that target looks more achievable. That may sound counterintuitive, but

that's the way we're not modeling it today. So our bear case is actually kind of we avoid a recession, but not the slowdown that would be the three thousand scenario and a d dollars and earniers. My my quote from last year was from the Great not seem to Leb who said the gravity is back, the idea that money costs something the risk free rates there. To me, my theme for the year is the great zombie roll up.

Not the companies Morgan Stanley follows, but all the garbage companies out there that had a fifteen sixteen year free ride. What happens to them in two thousand twenty three. Well, I think it's already begun. I mean, we've seen what's going on right When the cost of Capitola goes up, these business is flat out don't work. Um. And so

we've had fifteen years of easy monetary policy globally. UM that that is now being normalized in a more rapid way than anybody expected, including us quite frankly, even though we had that forew a year ago. And that's just gonna run ramshot over these business models. And by the way, time, I'm not sure it's a bad thing if we can do it in a way that isn't too destructive, okay to the broader economy. And we need we need a normalization of the cost of capital because it's not healthy

for the broader economy. It's not healthy for five companies to account for the market cap, which is what happened in the last ten years. We need a more democratic economy where you know, medium small sized businesses have a fighting chance and it costs to capital arizing. Ironically, it's part of that. It's a nazing discipline. Makes the count back Mike wonderful as Old White Buddy happen New Year's even it's saying looking forward to plenty of contrees straight

three wis there? Stanley Jordan Ryansester a huge value of Bloomberg surveillance last year and he started stronging this year with us as well. Jordan, I'm gonna cut to the chase. The first thing I looked at it was a d x y the Pacific rim. But I want to bring it over to your inside on Euro as well. Is the week dollar trend intact led by strong euro. Well yesterday, Tom and happy New Year everybody. It was a pretty

tough day for that year long. We saw a big move over one percent, much bigger than a normal January move. For your own facts, it's been similar to the entire monthly move of of euro in January and previous years. It just tells you that volateerity was alive last year and it's still live in the first few train days of this year. Low liquidity, people dusting off their holiday emails and also putting fresh capital to work. And as you mentioned, there was that negative seasonality, so a sixty

four percent hit ratio. Since night, euro dollar has headed lower on average around point three. So we're currently betting on the thirty six historical chance that Euro goes higher for a number of reasons. The first one was proven today, which is I think the European growth data it's going to point towards recession, but it's not gonna be as

bad as what people think. We had. The p M eyes revised up this morning for the Euro Area, and I think the reopening in China will really help boost the Euro Area economy as well as as as we're also seeing gas prices, natural gas electricity prices much lower with the warmer weather. The ski season has been awful, but that's been fantastic for industry looking at much lower levels of input costs and therefore boosting production. So we're having a growth story. And then yesterday it was the

weird one. We had the North rest wine um German numbers. That's that signaled that German CPI would coming week. We've now had the French numbers suggesting the same. So we get euro inflation later this week. It's going to be weak than what was previously thought. That kind of means the ECB super hawkish in December that did boost euros slightly. Perhaps they won't need to be as hawkish as what was.

What the market thinks this year is the message from the inflation data just one data point and the growth numbers might offset that. But there's there's two factors going on here. Growth up inflation down that revises at your real GDP estimate for your area in some respects, and therefore I think euro can stay supported in January. How much does your one tent target at the end of

January hint on the weather? Well, the weather is already baked in so October, November, and we had that cold snap in December, but now we're back into a warm snap. So we've already got the story of Germany having having blackouts. That's kind of gone to the side, so it's unlikely that will run out of gas next winter could be

a bigger problem. But what we have seen is that Germany has just switched to coal burning um and so that has really allowed for the gas story to weaken as a problem for euro So yes, if some amazing blizzard came came along, that could be a factor for industry, but I just don't I don't see it in the forecast right now. You're where's the ECB fit into this call. It's been a tough one to use an ECB view

and put that directly onto euro It's been quite frivolous. Actually, if you kept doing that last year, because we're trading a stagflation story when it comes to framework for Foreign Exchange so e c B, yes, they'll be hawkish. That will boost European yields. We're already seeing portfolio inflows into European government bonds for the first time a long time, so that's going to boost euro I think on the ECB side, by raising rates, that's going to not growth though,

So those two forces offset each other properly. I guess John, we could bring it all back to the FED. If the Fed pauses as we think they will, and if they look to cut rates later this year, which we think they will as well, that'll keep your dollar supported no matter what the ECB do. You can't see the side of radio. Is he wearing an Estivilla tie? Just? I actually think he might be. I think it might be. I think it's an Estiville unlikely guys, Yeah, that's right. Wow,

he actually is with the team emblement as well. It's just why am I wearing a tie? John? Can you remind us all? Will you tell me? I watched the highlights of the Todds aston Villa game. Is aston Ville that good? Or is Tottenham that bad? Jordan's helped me make sure that too. It's been one of the worst runs for Tottenham in the league since you conceded more than two goals in each game for seven games in

a row. That hasn't been done since for Villa. We've got a new manager and things look to be on the app. We've had a good start. We should do a podcast with Jordan's we should we should just never mind phone exchange. Yeah, I like it, Jordaan Rochester, thank you for tomorrow. You're briefing today on oil and call emreada soon, joins US Director Research Energy aspects. Of course, they're looking at all of the different hydrocarbons, including the

grizzly call. I'm gonna look at and reader right now in our call links into oil. Is there a substitution effect if Germany uses call, if China uses call to that just brent crude price? No, no, tom thankfully, not that, but yet another variable. Of course, it impacts gas hugely. And yeah, look when we've had gas prices surge, we have seen in Europe, for instance, cooled usage go up a lot, and at the margin we've obviously seen oil

usage coal up a lot as well. But no, there isn't any direct links simply because you know, oil is barely used in part generation there does c mrideson microeconomics in place for oil to surge. People talking about brand eighty Dare I say higher as well? Is that set up in place here at the beginning of the year. I'd say the beginning of the year. No, But I really do think the second half of the year, in particularly of China opens up in the way we are.

You know, now we're kind of hearing headlines from them around the reopening scale. We've tended to forget what we saw in the West, right, It took us two years to get over the pent up demand in terms of airline travel, in terms of car travels or the mileage driven that we've seen. And I keep saying this, particularly for jet it's a multiplayer effect. When China reopens, other parts of the world will also you know, people from other parts of the world will also want to go

to China. And China is so connected to the rest of Asia, Beat Korea, Thailand, Vietnam, Philippines, all these countries they have huge trade relationships with China. Percent tourism or just spectrochemical exports linked to China. So we are going to see some big demand numbers. The problem now, Tom, is that we've seen these big freezeoffs in the US, and that's meant that the crude balance has actually weakened. We've seen so many refineries having to forcefully shut down

because of the cold. That's lost US crude demands. So that's why we are on a softer footing and it's and you know, then it kind of turns into seasonal turnaround season, so there's a few more weeks of softness. I will think, I'm gonna forgive the pun, but what's the canary in the coal mine when it comes to the reopening of China given the fact that there a whole host of different energy sources are playing the tabletime. I know it's kind of a terrible pun, but you

know what source of energy? Well, we see the first pickup in demand that will represent the next phase of China's reopening and the effect and energy markets. That's a great question because, like in you guys were saying this just now as well, when China does reopen, they will need all energy products, right, It's not just going to

be oil. You know, oil stocks aren't particularly high, so we should see them come out and buy crude oil probably, if not this cycle, definitely from next cycle onwards, they are going to need coal and gas as well. So I would genuinely say all three of those. I think

metals you've already seen them by. If anything, I think energy or energy imports should outperform the other commodities because right now with the reopening, the focus shifts back to consumers, which is kind of again goes directly into energy consumption as opposed to metals, which was more infrastructure driven. That

happened last year. Some people push back and they say, we'll trying to spent the past couple of years stackpiling, crewe starckpiling energy sources, and they're not going to need an access in supplies even if they do reopen in full, at least not for a very long time. Do you have any sense and radar of how significant those stack piles of energy sources are in China? Absolutely, Look, wee track stock bars in China to our best ability on a daily basis, and I think this is a big misnomeral.

Let's talk about oil. For instance, China's oil stocks have been rising, for sure, but over the course of last year, they've been drawing down stocks on a consistent basis. China was importing barely nine million barrels per day instead of eleven million barrels per day, So that stockpiling took place in one, not last year. We've de stocked enough in China for them to be at a heart the level that they require for their days of cover, where now

as they reopen they do need to buy again. I've got Emery Emoryson, I've got lergy moving here moving there. Have you a blast of bloomberg out with analysis of lergy in Japan today as well? Just a simple question, with all your expertise, is the United States energy independent? It's definitely more independent than it used to be. Look, the U still imports some oil um and simply that's to do with the location the ability of certain refiners to run certain crudes. But yes, I mean it's exporting

natural gas now. It does export well over three million barrels a day of crude right now. There's still global linkages. Right. So that's where I don't like to use the word independence, because Brent crude is still the biggest driver off the gasoline that you are buying at the pump, right So it's not an island and Therefore, yes, it's independent in the sense that it's exporting a lot more products. It's

still a net importer of certain products. But at this end of the day, the global linkages haven't broken down just because of the way the refining system is set up just quickly and reads A best guess for why you think crew it's going to end up City at Q four twenty three has crewed at seventy six. I've got Goldman at once ten. I've got other banks with triple digits as well. Where are you at? I'd be triple digits as well, And I think again people are

underestimating China's reopening and the multiplier effect on demand. Again basic one on one economics that it's going to have on the world economy. Yes, bad news for inflation, but it is definitely something to watch out for. I'm really saying thank you ad energy aspects with another triple digit crude code term for year end. We get further perspective from Greg Villier, chief US policy strategist at A G F. Gregg.

I randomly looked at the twenty names of these Congress people against Mr McCarthy, I guess against a lot of what we would call political normality. One of the congress people, the gentleman from I believe the ninth District Georgia, called the capital attack of January quote no insurrection quote a normal tourist visit is. Butch Cassidy said, who are these guys? Yeah,

you're right time. You know, I've been doing this for a long time, and I have never seen anything as crazy as this story, with a handful of extreme members of the House to denying the Republicans control of the House. And this could go on for a long long time. Mr Trump says it should not go along for a long time. John read his truth like the social media thing. Close the deal, take the victory, said the President. Could

that be enough to sway them today? It might. There's talk to a lot of Republicans are going to Sean Hannity and going to uh, you know, other conservative commentators to see if they can dissuade these rebels. I'm not sure it's gonna work. I think this drags on for weeks. What about the voters, I mean, is there a sense that this is what people want? That's sort of just you know, break things up or destroy the status quo, starts something new is that basically the voters will behind

some of these representatives. Not really, I mean it's a self inflicted wound by the Republicans. I don't think the voters would be pleased to see this kind of dysfunction, you know, for the markets right now, at least, I don't sense that this is the biggest story. There are biggest stories, as you know, and the Fed things like that.

But if this drags well into the spring, people are going to start worrying about the death ceiling, about a credit crunch, about some sort of default of the US budget. If this drags on, I think it will start to become an irritant for the markets. So Greg, let's stay there. Because I've been talking about this this morning and my co hosts have thought that I was being a bit histrionic.

How serious could it get? What are the sort of parallels here between what we're seeing with the Republican Congress. They're laughing at me and two thousand and eleven we did see a debt default. We are not debt default, but we did see the downgrade and the debt ceiling debate really go to the last minute. Well, most of these dis censers who don't like McCarthy want this to happen. They would like to see a debt crisis. So that's that's something you've got to be concerned about. You know.

Another important point is that let's say Kevin McCarthy does whip four or five or six House members in the next two years, could scuttle everything that they have him on such a short leash that on a lot of these issues they can still prevail. We hold on a second, Greg, why do they want to see a debt ceiling scuttle? Oh? Because it will curb spending. I mean they feel that is the only way you can get discipline on spending. They're furious at Mitch McConnell, who's going with Joe Biden

today to a new bridge construction spending a lot of money. Uh, there's huge divisions over spending money, and some Republicans a minority. I granted, I wouldn't mind seeing a debt defall credit crisis, which I think is crazy. Greg. The historical moment, it goes back to a H two. Oh, it goes back to the Democrat lustermatics and on and on. I don't want to do a history lesson here, but the reality is there's ramifications to this behavior. Does it make centrist

Democrats stronger? Absolutely? And it weakens the Republicans. I mean, there are some pretty decent whatever your politics were. Paul Ryan was a quality house speaker. John Baynard was a quality house speaker. They their careers were scuttled by a minority, a tiny minority of radicals who didn't want to compromise in the least that of HF investments on the nights to stand in Washington day sake, Greg, Thank you, Seth.

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 and this is Bloomberg