Surveillance: Earnings Story with Wilson

You've failed, you're done. The reality is the way strategists are used on Wall Street and no one has given more guidance this year, in the last twelve months, and Michael Wilson, C I O in chief US equity strategist at Morgan Stanley, because it's been a consistent and coagent message of beware the future. Mike. We are now where we have a Mike Wilson's stock market, and what I note is, you mentioned it is picked over. I can't find scale, there's not enough to choose from. WHERE DO

I hide? Yeah, well, thanks, Tom, appreciate your kind words. I mean look, I think the I mean the market, is picked over, because this is where we are in the evolution of this bear market. Essentially, when bear markets begin, they always go after the high flyers, you know, things that are kind of ridiculously priced or where their earnings risk is is more evident. And that's what happened really, you know, kind of earlier this year, late last year.

Quite frankly, really began almost a year ago and now. But as you kind of go through, people getting high. It's like, you know, in the water rise as you go to the higher part of the mountain, and so everybody's kind of crammed into the same stuff, just kind of waiting for, you know, some conclusion to this story. Either we avoid a recession and move forward to a soft landing, or we don't and we clear the decks

and then we can move forward from there. We're kind of more in that second camp because our view on earnings is just so negative, whether we have a recession or not. All of our top down models, which are, you know, pretty good, are telling us that, know, the spread between our forecasts and the actual forecast by the street, mean bottoms up, has never been wider. It's the only time it's been as wide. As you know, no eight, and then back in no one, and we know what

happened there. So the earning story is what we're focused on. I mean the Fed is important still. Obviously they're not getting off the gas here on their hawkishness, and nor should they. But that's pretty priced. I mean I I wouldn't be surprised if today we get some relief, quite frankly, led by the bottom market, after the Fed does their thing.

Maybe stocks can rally one more time. But the end game for us is all about the earnings and the growth now and we're you know, we're just not optimistic there for the next six or twelve months and that that will get price pretty quickly. So he got thirty four undred as the base case, fifty probability. My three thousand the back case recession scenario, forty percent probability. I put out this research, that quote on twitter in the last week and a lot of people wanted to know

where's the other ten percent, Mike, what's the ten percent? Yeah, that's uh, that's the mystery now. I mean it's pretty straightforward to me. In the bolt case is just not that probable. Uh, I think you know November and we talked about this, as you recall, John, the bolt case was goldilocks and we said well, you know, the probability of goldilocks looks pretty unlikely. So we, you know, are boat case. You know, we can flex that from you know zero, or not really zero but five, that we're,

you know, sort of five to ten percent now. But the boat case is not no longer goldilocks. It's kind of this soft landing for the economy. However, that's not a soft landing for earning. So, you know, our bowl case is not getting much different from our from our base case. I mean we think, we think maybe you don't make new loads in the bowlt case, but Um, there's not a lot of upside. Okay, over the next

six months. And that's really how we manage money. I mean we you know, we look at risk reward and you know, at thirty nine the risk reward is probably five to one. You know. On the down side it's sort of the it's sort of the middle of our our viewpoint, and that's at the SMP level. I want to make this clear because, you know, tom asked the right question, which is, you know, this is the part of the bear market we should be looking for individual stocks that you want to own coming out of this.

Some are priced, you know, appropriately where you want to take that risk. But look what happened this week with F X. I mean, like you know clearly that wasn't priced. Um. So you gotta be really careful, like thinking, oh well, everybody knows this, it's already priced. Then you get hit over the head and the stacks down. That's uh, you know that. Everybody has their own risk tolerance, they have their own work and you know, we have our own

focused list as well. We're staying defensively oriented. We're not reaching for cignicality or, you know, kind of crazy growth stacks yet. We think it's premature for that. But we're getting closer. I mean we think we're within a couple of months probably. So there's an issue with how long

this is going to last. We were speaking yesterday with Christopher own who talked of a lost decade of profits on the headline level for the SMP, just based on the fact that eelds are going to remain higher, inflation is going to be greater. Do you agree or do you think that we're gonna get a rebound on the

other side of this six months, twelve months down the line? Yeah, I mean I think we will get a rebound but you know, our view for a while now has been we've moved out of the monetary policy dominant world to a fiscal dominant policy world, and what that means is that the Fed is no longer another central banks quay.

Frank you can no longer smooth over the edges the way they have historically because inflation, while maybe it's gonna come down over the next six months, which is our core view, um it's not going away, it's gonna be dormant and then we'll re accelerate again in the next upturn. What's gonna Happen least, I think, is that you're going to clear the decks and up on expectations on growth, that you can then have a re acceleration and that will be driven by the natural ebbing and flowing of

supplying demand, but also more aggressive fiscal policy. I think it's interesting to note in the last month, I mean fiscal policy, has been turned down like a spicket again. Right, we have this debt forgiveness program here we have this two hundred billion pound stimulus for energy subsidies in the UK, which is equivalent to a trillion dollars in the US economic standpoint. So it's it's kind of interesting and you you have kind of everybody's worried about inflation, but the

fiscal policy is working counterproductively to the monetary tightening. But that's the world, I think we're living in now and you have to understand that, because it's not all barish right. There will be a time when fiscal picks it up a again next year, even though monetary can't do its job it has been doing in the past and in the fetes job in my view, and the in the in the CBS view and Exbus job and my view, their their main job going forward is to be funding

the government. Whatever the government decides to spend, they will have to fund implicitly, very similar to the forties analog that we've been using. Mike, just want for the question, and I think it's lost in the conversations. Often say with you that it's not just about an index level. Col with you and the team, there's some single name stuff in the mix too. Could you have us with just the call right now? Something you do like in the security market, something that has worked that you stick

in with? Yeah, I mean I think like the managed care stocks have been terrific Um and that's an area that you know, these are these are gross stacks Um, and they don't. They don't. They're not priced as grows stacks and they never have been because of, you know, concerns about perhaps regulatory oversight and things like that. But, you know, healthcare in general, I would argue, is an area of the market where you have pent up demand from the pandemic as opposed to back in demand like

for technology spending or consumer goods. And for whatever reason it's still trades really cheaply Um. And once again it goes back to this idea that there may be fear about, you know, pricing controls and things like that, but to me that's a fat pitch and uh, you know that that scenario. We've had a lot of exposure. UH, would be, you know, in Pharma, managed care, some of the cheaper areas of healthcare, and I think that continues to work.

The other area would be, say, integrated energy companies, where they're they're more defensively oriented, not so depending on the price deck. They pay a great dividend Um and you get some come out of exposure, you know, as a hedge against you know, inflation staying sticky or hot. But the overwriting message, John, as you know, this year from us has been defensive, earning, stability, operational efficiency, boring type metrics.

But you know it's been working nicely and I think it will continue until we get the trough in this beer market. It's been working in a tough, tough year. Congrats to you in the same Mike Wilson, so far for just absolutely brilliant. Mike Wilson, that of more CON Stanley. One of those some years ago was Michael Pond. His fancy title now is head of global inflation linked research at Barclay's. Far More Accurately, he is truly expert, with the exception maybe of Ian Lincoln at Demo. I'm full

faith in credit and he joins us today. Michael Pond. If I look at the real yield and I look at two partial differentials of the nominal yield and some measurement of inflation, which matters right now, it's the real yield that that matters and it's moved up a lot over the summer. The market was was not really buying into the feds resolved to hike rates enough to slow the economy and getting inflation down. Um, since Jackson Hole, though.

Really yields have have soared, particularly at the at the front end, where they were almost at at zero earlier this month. Now they're above one percent when we look at shorthand forward. So the markets moved a lot and accepted the hawks tone of the FT. So if I look not at the ten year real yield but Michael Pon, let's go shorter to maybe the two year, if you agree with me on that, from a negative three hundred basis points in version to a positive one hundred sixty

four basis points, that's a hugely linear jump condition. How do other asset classes react to the Michael Pond World? Well, risk assets do not love higher yields that are not supported by strong growth. Really, where really yields are rising here is because the fat has become much more Hawk is trying to slow the economy and that's in part why risk assets have been on the back foot since

Jackson Hall. So the Fed's trying to get the economy in a position where inflation comes down and then it can take it's its foot off the off the brake a little bit and allow growth to go back up. Well, we're, we think we're years from that. The Fed's resolve is strong here. That was clear at the at the Jackson Hole Speech by by chair Powell ripping up this, up the script then and channeling his his inner volcre risk assets have responded, but now they're at the point where

perhaps they've overreacted. You know, obviously we'll we'll get the message from the Fed that's on the hawkish side, but markets are already prepared for a very hawk is fed. So it's a delicate balance. Today, before we veer too far into that they might be prepared for Hawk is Fed, there's a question of how quickly that leads to economic deterioration,

and we can get there. But I want to sit on this idea right now of what it means to have a vulcarized fedsure reserve, particularly with wheel rates at the highest levels going back to two thousand and eleven. Do you foresee ever again in the next few decades this fedures are of going back to zero interest rates? It's very possible. You know, we we thought that the market was pricing in too much of a too high of a probability of strong fed cuts in next year,

in in late summer. Uh, those that basically been taken out as appropriate. But we certainly could if you look at the housing market and say the housing market becomes a sign of the broader economic outlook it, and then then we could be in in trouble here and the Fed would have to respond, putting its dove hat back on. We think we're we're not likely to enter that that regime,

but it's certainly possible that we enter a recession. They've had hastories, you know, backtrack and send rates right back to zero. Well, okay, so this is sort of the big attention right now in a bond markets, particularly on the long end, with your tenure yields at the highest levels that they've been going back years and years. And yet some people, including Michael Collins from peach of fixed income earlier, saying it's unclear whether it's really time to

pounce because there could be more. Is this the last time that we'll see real yields of this level, because this fed is poised to make some sort of turn in the not so distant future. I think depends on the path of core inflation readings and the labor market. That's why the FT is reacting so hawkishly here. They've

done quite a bit. Uh. Some parts of the economy has has begun to slow, such as the housing market, but the latest print on core CPI was point six and labor markets clearly remain quite, quite tight, quite robust, at a three point seven percent unemployment rate. The Fed really needs to see a slow down in the monthly pace of inflation readings, particularly on core, and a weakening of the labor market. Again, the chair talked about inducing

pain in the economy. Again, channeling is inner vocre uh, in order to get inflation down. So the fat has to do a lot more to get get the economy where it wants. Michael, they you embrace a dual mandate. I get that and you know, we could talk all day about jobless claims, this, that and the other thing, or trim mean Dallas. Maybe the chairman will bring that up today. He's got another mandate, which is the credibility

that fed. But just up against political realities. If we get a Barclay's recession, if we get a barklay sort of recession, does that become a third mandate for this chairman? Well, the Fed is absolutely trying to make sure it retains credibility, particularly what when it comes to UH inflation fighting. So one of the reasons why it's being so hawkish here is to make sure that inflation expectations don't get out of control, because that's when the Fed fears and inflationary spiral.

We're inflation is high, people expect it to be high and it just feeds on itself. So one of the things that Fed is trying to do here is make sure that high inflation itself doesn't lead to higher inflation expectations. So it's trying to maintain its credibility and if we look at break evens, if we look at surveys such as that from the New York Fed or the University of Michigan, the Fed is doing a good job on that front and it's able to ignore any political issues

with a with a slow down, John. I'm sorry, politics matters here. It's gonna Matter Tomorrow for Bank of England. It's gonna Matter Today for Chairman Paul. I dentists agree, and I think, Michael, this is going to be the difficult part. How do they convince people that high unemployment is a price worth paying for lower inflation? Easy to say that now, but when people actually start to see materially higher unemployment? How difficult you think this is going

to get? Well, that's one of the SEP the survey of economic productions, or the dots, if you will, will be so important today, Um, when we get the statement, when we look at the statement, one of the things we'll be looking at is the unemployment rate path. So you know the the the SEP is opposed to be the the economic outlook under a path of perfect monetary policy.

And if the unemployment rate remains elevated in their forecast, that's a signal to the market that they're willing to tolerate UH decently higher unemployment rates in order to get in Asian down. That's a message that the fete has been sending, but we'll really be looking at the SEP to confirm that. Michael, just real quick here. I'm wondering what your projection is for how quickly inflation will come down that headline CPI, at the end of this year,

at the end of next. We're fairly optimistic that it will start to slow particularly with the October reading, in part because of technical reasons, at least in CP I, but even beyond that, again we've seen signs and commodities and shipping rates, uh in in UH related futures, corn wheat, et CETERA. That many price pressures have peaked. Wages, though, are keeping inflation high and that's the key to inflation really rolling over. Michael, just quickly, what are you talking

about in terms of levels? Are we gonna end the year at six percent? When do we get back? We think we'll. Will certainly come down from that when it comes to headline inflation, in part because of the strong decline in gasoline prices since since since March, but core can remain sticky. So well, we think will slow in inflation readings, but certainly well above where the Fed would like them least. Thank you very good we will continue right now on this on corporate credit with Michael Collins,

senior portfolio manager of Pigeon Fixed Income. Michael, what I noticed here, and I understand the mathewness of it, let's forget that yield up. We all know that. Chairman Powell deal that today. But in many cases price very, very, very down, and we're seeing it in the Bloomberg Total Return Aggregate Index, the Old Lehman Barclay's indusease as well. What is the significance of new low price on those aggregate indices. Yeah, Tomas, as you point out, has really

been nowhere to hide this year. And Fixed Income, I mean in our shop we've gotten three big things right. We've kind of stepped aside on on duration, meaning taking our our long positions down to to neutral. We've taken credit risk way down, we've generally been a little along the dollar, but that has not been enough to protect

investors from that big trend down in prices. The good news is, as you know, when bond prices are down below par, which they all are really for the first time I can think of in my career, Tom we're seeing the bonds across the board, across all of our portfolios, trading a big discounts to par and, as you know, as long as they don't default, as Lisa pointed out,

they end up back at par right. So so you actually have this really uh positive long term opportunity and fixed income which we haven't had for for well over a decade. Michael, I look at the mantra of the real yield, the whole professional study of the inflation adjusted yield explained to mere mortals, while the real yield matters. Yeah,

I mean that is the world's discount right, right. I mean I'm always surprised when when people say, wow, I can't believe stocks and bonds are both selling off at the same time this year, and what I tell them is, well, you just wait until you see real estate and private debt and other assets that that haven't sold off because they're not actively traded, they're not marked to market every day.

Wait for those shoes to drop, because when the discount rate, the world's discount rate, which is really real treasury yields, by and large, goes up as much as it has, as much as you know, a couple hundred basis points, all asset prices have to come down and the question really is, have they come down enough at this point? Well, let's get into that right now. Mike. We caught up with our good friends buff Michael of jpmrecan asset management yesterday.

I asked him about high he already said not yet. Patients spreads need to get somewhere close to seven fifty basis points. The Trad series need to get somewhere close to four point five. The fat funds could push five. Any of that resonating with you? Right now, Mike, or would you take the other side of that trade? Yeah, you know, I'll take a little bit of the other side.

On on the rate thing, I think we're much closer on the rate side right our view is that the rates are going to crest and come down first, and then credit spreads and and equities will will continue to to widen and sell off before they they settle down. But but I think we're really getting close to a point, Jonathan, where the likelihood of the Fed and and most other central banks over shooting significantly on the upside and having

to reverse course. I know the whole concept of the pivot, you know, it was in vogue a couple of months ago and now people are pushing that aside. And Wow, as as as they keep pushing these rates up at the same time that global growth, you know, risk is coming down, earnings are coming down, as Lisa points out, the faults are probably going to go off, geopolitical risk continues to to elevate. Wow, and inflation globally is really kind of rolling over and I think it's going to

be probably a lot lower a year from now. Just as all those things are happening, these central banks are jacking up rates at Nauseam, and I think that's a real recipe for a big reverse course on the rate side. On the credit side, I think you're right. I mean earnings. We've done a lot of work on on earnings expectations

going forward and and I think they're gonna keep coming down. Right, and people don't talk enough about the dollar and the impact on that for US companies, for their competitiveness, for their repate patriated earnings. The labor costs continue to put pressure on margins and, as Lisa pointed out, you know, you're starting to see layoffs. Finally happened. So I think there's a little more downside and credit before before you jump in with both feet. This is all really messy.

Of Michael, I wonder, just to put it all together quickly, if you could give us a sense of how you play this, the conviction behind buying certain discounted bonds, taking the other side of Bob, Michael, but also acknowledging what you see coming. Yeah, I mean you stick with you stick with higher quality credit, right and and uh, presumably

that's what a big active shop. We have a hundred, forty analysts, Lisa right, and that's really our our bread and butter, and this is an opportunity in the market where where everything is kind of sold off right in unison to to some extent, and there are a lot of relative value opportunities. You can buy really high quality credits at really big yields, really big spreads, low dollar prices. H So there is a lot of opportunity there without

taking a lot of credit risk. And we've taken our credit risk down, but the yields that we're seeing across the board in the bonds we own, the high quality bonds we own, the portfolios we manage, are really big. Right. So, I mean you don't have to take a lot of credit risk. Ultimately you'll want to do that dip down and credit. But but it's definitely too early. Just so I can quite you for the rest of the day and get it right if you even found this tenure

at three. Yeah, we we. We haven't yet. We're dead neutral here, Jonathan Um. But but again, that is going to be the big first trade really out of the gates here, and maybe you have to wait for for today. The Fed is going to probably sound Pretty Hawk is today, even though they've done a good job on fed days. I know we've talked about this on the program before. UH, typically the days the Fed meets and the days Jerome Powell speaks, that the equity markets tend to go up.

So they do a good job of getting investors off the ledge a little bit. But but you know, though, that dot plot is going to be ugly. I think a lot of it's probably priced in and the markets are braced for it. But there will be an opportunity, I would bet, in the next couple of quarters, to to really start getting along duration. We'll catch up and talk about it. Mike Collins, the PM. Thank you, Mike.

Can particularly a shock to the nations of commodities. Kna Hack joins us now a head of research at E D N F man and is just brilliant. On the soft something we don't talk enough about. Cona the impact of a strong dollar on commodity nations, commodity E m. How large is it? Huge? Huge. I mean if you think about only six months ago when the war began in Ukraine, Um everything went up. When there was energy grains, they all went up and that was because it's highly inflasionary.

But then the inflationary store in the US letter higher US dollar. that US dollar then caused that whole commodity elevation to just come collapsing down and now we're back to pre war levels. Um. So yeah, the dollar impact on commodities, it's very intact. And reverse co invest correlations as intact as ever. My training is to always pivot to Indonesia and Brazil and dollar strength. Are they of interest? Well, yes, Indonesia, obviously, palm oil, massive producer of palm oil, exporter and cold

as well. Um. And for Brazil, I mean particularly the soft commodities. You cannot underestimate the impact of the Brazilian real on all of these commodities. So what we're seeing today is the strong dollar is causing the brl to weaken. Um. That intern is putting pressure on things like coffee, sugar, soy beans, all the major posian exports, iron or even. But it's not just that. I mean I think today

commodities are reacting. They were positive initially because of the inflation story, but now they're coming off because the inflation story has moved to a recessionary story and obviously that's not great for commodities. Um, the worse for metals. And Energy, arguably less so for soft but it's still it still isn't does have a dampling effect for sure. The focus so very much on the energy story, especially for Europe as they face off with a potentially catastrophic winter, depending

on the meteorologist reports that we get. I'm wondering, from your perspective, if the answer is what Germany is now doing, which is to nationalize energy companies, does that help support things in a more concrete way, or does it just basically put a band aid over the actual bill some of these countries are facing? Yes, so I think in my opinion it's a band aid because the reality is

that none of this is providing additional supply. So we have a supply demand mismatch right now in the energy crisis. So we either tackle demands, so you have to ration demand, and I can't see Germany effectively rational in the demand and certainly in the UK they're actually accepsidizing the demands. So that doesn't even ketch up with that sort of thing. And on the supply side, I think I don't see them investing or allowing more UM natural guests to come out.

So I don't see this as fundamentally altering the situation too much, and I think this this can go on for a while. Well, when when you say this can go on for a while, there is a question of how much has already been priced in in terms of what is to come for this winter, and then there is a question, as John's highlighted many times, of the duration of how long, how many years, we face off with this lack of supply and the face of demand?

What's your view on both of those? So with time, you know, humans are very innovative and markets are adapted. So with time what's going to happen is, as long as prices continue to provide this pain pressure, you will start seeking adaptation, so you will move towards alternatives, renewables, you will become more efficient. So that's definitely something that will happen with time. Overnight you're not going to get that.

So I think effectively what we're saying is we need that pain pressure to continue for a little bit, what more, to to materialize these kind of actions. Only then will we start seeing a proper diversification both in terms of demand and also supply, so we can start relying less on natural gas, relying less on Russia, um even relying less on energy. I'm of understanding that the energy carriers are, you know, the freights are going through the roof, that

they're strugging to get hold of ships. So it's a multitude of problems are not going to be fixed overnight and this is gonna take you a while. Kind of hack that of eight and F man. Thank you, Connor as owis. 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