Surveillance: Equity Risk with Stubbs

Can you give me one good reason to be bullish right now? Well, John, I think if you're going to meet the bullish case, I think you're going to look at the resilience of domestic consumer spending in parts of the Western world. I think you're also going to look at how much tightening has been priced in and and indeed expectations of recession you're broadening across across Wall Street. But I think bullish is not that we're going to see the kind of boom conditions we saw last year.

Bullish would be a soft landing, a pretty soggy your economy next next year, but one that avoids a recession and avoids a major door down and earning. That's a

bullish as you can get. I think right now. That's not exactly a ren endorsement of risk as it's David, I do wonder, especially at a time when Tina is dead right, there is an alternative and it is cash, it is short term instruments that are actually yielding something on inflation adjusted terms for the first time in a long time, is there any justification not to just hide out some of these instruments, collect the income and wait

for a better, more clear entry? Well, we're absolutely recommending parts of the Fixed Income Universe at this point. As you as you rightly say, a lot of value is being created both at the short and long end. As as you were thinking the Intro, the ten years, at three, three fifty. We would be buyers of that in in portfolios that don't have any duration right now. We see

a lot of value in preferreds as well. So there's plenty of ways to meet your financial goals if you want a mid single digit return without taking a lot of exerty risk. And it's maybe the first time you could say that in in a long, long time, given the lower for longer era that we've been on interest

rates also. least, I think that. I think that you've really seen still some value be created in the structural in the structural changes that we see in the economy going to be going for clean energy, Fintech, genetic trapy, some tremendous but value there in factors and themes that are going to be huge drivers of our society going forward. David, I just want you to elaborate a little bit. You said that you would be buyers of ten year treasuries

at three and a half percent. Do you think that this is the new peak and that basically, they cannot continue to lose more value yields up further? Oh No, we never we'd never say that definitively, but we just think that parts of the Fixed Income Space Right now have asymmetry about them. If you do go into a recession next year, we would fact your bond deals to fall significantly and we think that the potential returns and that scenario are now greater than the losses you may

get if if bond deals continue to drift higher. So look, there's absolutely not a risk free trade right now, but a lot of our client's portfolios have very, very short to Anneel duration and clients have been waiting to leg in tow better yields over over the mediums, longer term. Well, now here they are and I think, for for the right portfolio for clients looking Um you for for that yield and for that stable return. Treasuries now are an option in the way, as you said, that they had

not been in the previous decond thank you. There was stubbs there of JP Morgan Private Bank. Dana Peterson joins us now. Chief economists at the Conference Board. Dana, can you tell us how bad things are in this economy, because the data we're still getting signals resilience. You see the same thing? Sure, we're definitely seeing resil into the U S economy. The labor markets still strong. Jobless claims have been coming off. The adults data tell us that

there's still a lot of job openings. When we look at GDP tracking for the third quarter, maybe we'll have something just slightly north of zero. Certainly consumers did spend in August. Spending was up two tenths of a percentage point in real terms, and also the trade outlook is looking a little bit better. With all that, we think that the Fed is it's a it's a great opportunity for the Fed to continue to raise interest rates to tackle really elevated inflation. Okay, so to go to John's point,

is consumer resilience good or bad? You're saying it's a good opportunity for the Fed to raise rates, which other people would say is bad for the economy longer term. Well, I mean the thing is that inflation is is really bad. Right. So the headline inflation for the C P I only tick down the eight point three percent. Meanwhile the corps moved outward to six point three percent. A lot of the drivers, our food and shelter costs, basics for consumers.

So that's really negative for the consumer and certainly the roads their incomes. And so it's definitely not a good thing if you have high inflation, but certainly it is a good thing if consumers are able to still weather higher interest rate hikes. Certainly that weighs on housing uh purchases, but nonetheless it's still a good thing overall for the economy.

Do you have a sense of how quickly we're going to see the effects of the rate rises that we've already seen, of quantitative tightening that has yet to really happen, but ostensibly will happen at some point in the near future. How long does it take before it hits the economy? Well, I mean the thing is that it's really difficult to know. I mean back a long time ago we would say, well, it takes twelve to eighteen months for any fat actions

to really feed through. But we're already seeing that fat actions are having an impact on the housing market Um and that's certainly a positive for the FT in terms of it's it's addressing inflation. So you're getting at these asset prices, even though the Fed is not target asset prices, but certainly in terms of the consumer price index is the Fed still, you know, really needs to do the work now and we should probably start seeing the effects

later on next year. We're thinking that, uh, core and fleet, well key inflation gauges, probably won't return to two percent until very early Dana, every single piece of research we've had basically over the last week has been a bank somewhere on Wall Street upgrading their terminal rate view. Goldman the latest they look for four to fourth point to five by year ended twenty two, and maybe higher than

that by the time we get through three DNA. The number one pushback, the LESA gets, that I get, the Tom gets, is that we can't live with four percent rates, that this economy just can't live with it, that the debt piles is too high the sovereign and the Treasury Na. Do you agree with that? What's the constructive view on why we can live with a four or four point

five percent fed funds rate? Well, I mean, first of all I want to say the Conference Board came out really early with that call for or interest rate topping out at four percent and we've even been saying it could be even higher. Inflation doesn't really move and it remain sticky. But I think the Agus economy can and certainly, when you think about Um what policy makers have been saying, they're saying, look, you know we're in for a bit of pain, which I think is code for a recession,

a mild, maybe brief recession. And certainly when you look at the labor markets, that's still super strong. It's going to remain uh, pretty robust, especially given the fact that you have labor shortages and so that means there's still going to be some hiring and not a cratering in the labor market. I think with all of that, yes, the US economy is going to have to endure a period of elevated interest rates in order to tackle inflation.

Inflation is the worst problem here. So, Dana, that's going to lead to higher unemployment by design, and we've been talking about this. How much higher, I mean, do we see a commensurate increase in your expectations for the unemployment rate with every increase that we hear? To John's point from all street about the Fed funds rate and where we end up? We think with our forecasts of the four percent fed funds rate, we think the unemployment rate

will probably arise to four percent even still. Les's incredibly low Um and even if we go into four and a half, go to four and a half percent, that's probably around the neutral rate Um, and so that suggests we still have a very strong labor market. We're not expecting to see five and six percent unemployment here. This is a very different labor market. We didn't have shortages ten twenty years ago. We do now and that's really going to help, uh, I think, keep the labor market

from worsening relative to the overall economy. Is it instructive for us to look at averages here when we talk about the labor market, when we talk about how well different households can weather this, especially because you're talking about, you know, half of the income in the United States driven by households that earn more than a hundred thousand dollars,

is put out there by Morgan Stanley. Most of them own their own homes, either outright or else with mortgage rates that were locked in lower, at very low rates. The rest of the economy, the rest of the households are really struggling, both because they've got lower income and because they have, if not fixed costs, but pay rents and have to deal with the increase there. How do you gauge that out at a time where we're looking

at averages to determine policy? Well, it's interesting when you look at certainly wage gains, the folks who have gained the most in terms of wage gains, the next last over the last couple of years, have been people on the lower end of the income spectrum, also people who have been quitting, also people work in those in person services types of jobs that tend to have lower wages

in general. Those are the people who have seen the biggest gains and wages, and so it's I mean, we certainly should look at the granular data, but it's not necessarily the case that, you know, folks at the lower

end of the spectrum have been losing out here. They've actually been gaining by quitting and also through the very aggressive tactics that pleas have been using to attract labor, especially for things for businesses like restaurants and hotels and manufacturing and transportation, which tend to have folks on the lower end of the income spectrum. At least. The credit is Jean Barvan of black rock for coming out in

the last month or so. I'm raising a question that I don't think we've talked enough about, which is what is the appropriate time frame to try and bring inflation back towards target? What you hear there from Dana is not three story and I just wonder if the risk ascue towards maybe pushing that out even further. This task might be big and more difficult than maybe we've given it credit for, and perhaps people won't have the appetite for some of the economic pain in order to get

it down to two or even four and I think that. That, to your point, is the whole Adam posing view. Do we get comfortable with a three percent target for a little bit longer? Is that politically feasible? But they would you go with that? Do you think maybe risk askew to this taking longer? Well, it certainly isn't our forecast that it's going to take a while. I like we don't have the policy. I'm sorry, we don't have interest rates.

We don't have interest rates falling next year because we think inflation is going to remain elevated and certainly this is going to take some time. But there is that possibility out there. Is something that I was saying earlier in the spring that maybe the Fed will get more comfortable with having an inflation close to the three percent than two percent, especially if we have a very significant

downturn and economic activity. But I think it's also a function of the fact that we have a lot more inflationary pressures, long term inflationary pressures such as labor shortages, such as the semiconductor shortage, such as industrial policies where businesses have to reorient their supply chain that's very expensive, and so all those things are going to get passed on to the customer, and so it's going to be very difficult, I think, for the Fed to keep interest rate,

I'm sorry, to keep inflation close to that too percent target, and so either. So I think that those are all forces out there that are going to weigh on the Fed and certainly the economy over the longer term. Danna, you want of the best. Thanks for being with us, Danna Petterson. There at the Conference Board. Matto joins US now. They had a few s investment grade and seeing a portfolio manager at investco. Matt, have we seen the worst

of it and do you want to stop buying Hagan Warton, Jonathan? Uh? Yeah, I think we've. We've probably not seen the worst of it yet, Um, but things are certainly attractive. I think you look at valuations, it's it's impossible to argue that they don't. Things don't look cheap, particularly investment grade and I yield. They look very cheap. But the problem as investors keep being early and it's painful to be early.

You know that. The old saying is Um, you know, if you're earlier, you're wrong, and right now everybody that's been early has been wrong. And so even though the valuations are there. It looks attractive. You're probably gonna make money over the next year, but over the next few weeks, who knows? We've still got to get to the next CPI prep before you can have any sort of clarity

at this point. On Matt, a lot of people question what credit spreads, with the extra premium that investors demand to own corporate debt over benchmark rates, over the benchmark full faith and credit at the United States, whether that's actually pricing in the economic pain that a four to four and a half percent fed funds rate is conferring. Do you think so? So at this point it's not. It's it's really pricing in a slowdown of the economy.

It's not pricing in a hard procession. Um, you know, I think at this point all in yields, you know, historically, you know I have not been not been this high in thirty years. So if you're looking at pure credit spreads versus all in yields is a little bit different a story. But we're not seeing a lot of pain in corporate credit. The last few weeks, even, or last week or so, even after the CPI, it's mainly been

rate driven. So the credit markets are telling you that corporations can get through this Um that unless this, this inflation, continues for forever. Um You know, at some point we're gonna get the Fed more in balance and we're actually gonna see Um, the strength of these balance sheets went out. But we still have to get to that terminal, you know, terminal high in terminal rate, in order to know, you know,

how bad it's gonna be from the Fed. A number of investors have gotten pretty bullish actually on the prospect of credit. I'm thinking, for example, of Jeff gunlock over at double line or oak tree, seeing equity like potential returns in credit. Do you agree that at this point it's a time to lean in and that you're gonna

get really good returns? So, yeah, we look at the difference between Equity Yields and credit yields and if you I like to look at three to five of your credit yields because you don't have to take on a lot of duration there and you're you're getting about three percentage points extra yield by buying bonds and you are buying stocks. And so to me it's it's, it's, it's it's a very, very attractive time to be buying bonds versus stocks, and I'm not, you know, stock expert, but

I'm just staying on a relevant basis. It looks pretty good to me, Um and so, from that same point you're locking in five percent yields for the first time since two thousand and nine on ten year credit. You can lock in pretty much the same on front end credit. So I like credit at this point. Again, I just think that the timing is very difficult. But if you're able to close your eyes and buy, we think they're gonna do well. I've got no problem with the bond

market guys talking about stokes. The stock market guys do it all the time. They're always talking about the bum market, Matt, least when I've reflect on the following over the last week or so. In fact, we've been doing it for a few months now. The tone that I still get from a lot of guests on this program is that these issues are still somewhat temporary, that even if the Fed goes to four or four and a half, ultimately we returned to the world world of the last ten

years or so. Are you pushing back against that, Matt? I think we'll eventually get there, but it's just taking so long to get anywhere. If you just think about how long we've been in this pandemic. How long been? You know, we're officially out of it now, I guess, but it's just taking longer to get out of everything

and get back to normal. So Um, I think the longer term trends down the road, aging demographics, technological innovation, those are key drivers of of having deflation or lower inflation, but they just can't take place fast enough right now. And so in that regard, any expectations that we would have had for a quicker turnaround and have been have been put on hold. Um or a quicker a quicker return to normal. And so from that standpoint we're gonna

have to ride this out a little longer. The next NPI print is going to be, you know, on everybody's mind, but that may not be enough, for we'd have to wait for another one and then another one. So, you know, call it two thousand and five, but it's not happening nearly as quickly as we'd like it too. We just have to rely on evaluations being attractive at this point. Just quickly, Matt, what would you be asking Fred Chair j Powell, this Wednesday. What do you want to hear

from him? So I want to know two things. First off, what are you gonna do with your your mortgage book? Um, you know. Are you going to start to sell is? Are you? Are you? Are you? Are you considering that at this point at least? And then second I want to know how patient are you? You know, we know that there's a lot of hikes that have been in the pipeline. There's a lot of pipes that a lot of hikes that are going to hit the economy at some point. You know, how patient are you willing to be?

And at what point are you? Are you going to be more, even more aggressive? You know that would be a hunter basis points rather than seventy five. I think he's going to take his time. I think he has to know that this is going to slow the economy. But if he just says I'm out of patience, Um, you know, that's gonna be a problem of a vest to catch Hump Buddy as a white Peter Sheer, head

of macro strategy at Academy Securities, joining us now. And Peter, you were talking about last week and that something happened that was pretty dramatic in your view, and it wasn't necessarily a total reset of fed expectations. It was fedex explain. Listen, I keep looking at the data and a lot of the data we get is backward looking, it's weak, it

tends to get revised. So I'm kind of looking what is really contemporaneous, what is effective, and the Fed x warning to me is real right that that's someone seeing business move in real time. Stated today. It came right on the heels of CPI where we had housing inflation was up point seven, one of the biggest contributors to the CPI. And yet, as far as anyone can tell, nothing good is going on in the housing market right now.

So I think we all know where the data is headed as the official data catches up, and it's going to be weak and it's gonna be a little bit scary. So do you think that the Fed is going to reflect this on Wednesday when we hear from them? Wow, I think they are caught on such a you know, between a rock and a hard spot, where they've been so hockey, starting at Jackson old they've been continuing that message. I think someone's got to step back and say okay,

we've got to be a little bit careful. Traditionally it does take some time for our hikes to come through the economy and everything we're seeing real time, especially if you look at the wealth effect, is saying, Whoa, this is getting a little bit dangerous. I think the fixation on CP I, how it's calculated, is wrong. I think how as usual, is going to wind up having to let some of his inner dub come out. So you

said it's getting a little bit dangerous. Can you explain, because a lot of people are pointing to the resilience of the consumer. Yes, perhaps Fedex is an outlier, perhaps there's some idiosyncratic issues in Tantem with a global economy that's slowing down, but what are you looking at that's telling you that things are getting dangerous? Well, I'll even

go back to the consumer. Right people are saying the consumer did well, but if you look at the control group, people thought they spent point eight percent last month, it turns out they only spent point four. Expectations were point five. This month they spend zero percent. So I don't think the consumer is anywhere near and strong. I think they're going back to buying discounting. I'm watching the inventory build, which has been shocking. You're seeing month after month after

month of inventory build as two things I think happened. One, companies overestimated consumer demand. They didn't realize how much consumers were pulling forward because they were worried about supply chains, and two, companies were so worried about supply chains they've overstocked. So I think that's a real hangover for this economy. And then I look at Crypto and that whole market space. Right, it went to two trillion. It funded all these industries.

They're all struggling and they were sending money wherever they could. Right they were buying chips, they were buying new computer systems, they were buying, you know, ads on anything as they have to focus on actually just survival and turning casual positive. That's gonna be a big chunk of this economy. These

disruptive stocks that keep coming back to them. They were such a huge part of the growth story and I think they're going to really weigh on the economy because their employers were rich in spending and the companies themselves were cash rich in spending, and that's not occurring right now. Okay. So, Peter, you said that Fed Chair j Powell needs to let out his inner dove in order to counteract some of the weakness that you're seeing uh to build at a

pretty rapid clip throughout the economy. But that to other people, particularly Equity Bulls, would argue this is exactly what they're counting on, basically the Fed pivoting right. This goes back to that discussion that exhausted so many people and no one, nobody wanted to hear the p word ever again. I mean, is that basically what you're saying, that this is a bull case for markets, because it is a bear case for the economy and a bear case for this Federal Reserve?

I think it's a temporary bull case. I think we're well past the stage of lower yields being good for the economy. I think you might get a bounced on the Fed if he does this little bit of a pivot. But I think the reality, reality is just he's gone too far. We're still feeling, starting to feel the impacts of what's gone on. Before people are going to realize generally lower commodity prices, lower bond yields are the risk off type trade I think we forgot all about that.

And then, let's not forget we've started quantitative tightening a little bit more aggressively. We're going to see more of that and to me I've always believed that quantitative easing really forced people out the risk spectrum and inflated all asset prices, and so I think the crawlity of that is going to be that quantitative tightening allows people to move down the risk spectrum. So I think you've got that as an additional headwind and that's just starting to

ramp up. So right now I'm looking at two year yields that have really pushed hired dramatically this morning. Three point nine three. We're really close to that four percent level. If you talk about lower yields being a bad thing for the economy, is it a good thing as an investor to go into bonds as an actual haven at a time when they're providing yield? We're hearing from David Stubbs, from JP Morgan, we've heard from Matt Brill over at Invest Go, both talking up the bull case for bonds. Yeah,

I would agree with that. I'm definitely overweight bonds. I like them. You know, I hate to even say this because it's been such a disaster, but the twenty year Treasury action is appealing and over the past three weeks I think we've seen a little bit more support for that twenty year. It's just such an outlier in the yield curve that it seems attractive. So I like the overweight bonds. I like the longer day to more than the front end just because I think we'll get more

bang for the buck. But I think that's really it's going to be important and I don't think stocks are going to go higher on the back of lower yields. Maybe initially, but it's going to be one of these risk oftect trades. So we've heard from oak tree, we've heard form double line Jeff Gunlock, and they've been talking about pretty extreme yield returns for credit for some of

this longer term debt, talking up equity like returns. Is that plausible in your view, or do you think this is going to just be less painful for bond investors than for stocks? Yeah, I think it is going to be less painful. I think quantitative tightening is going to keep a lid on the ability for bonds to really really rally and I think it's going to take a little bit of time for the economic data to think in.

So I think you'll get a decent game. Uh. You know, I could see a ten percent we turn on the long bond over the next month or two, over the next month or two. So yeah, wow. What are you looking to hear from Fed Chair J Powell on Wednesday? What I'd like to hear is him paying a little bit more attention to the ECON data, to the forward looking stuff, maybe even, you know, shout out to the Fed X and say, Hey, we have to manage both sides of this right. We do have full employment as

well as inflation. There's a lot of signs inflation are rolling over. We've got to look at the more CONTEMPORANEOUSA. I think something like that would be realistic. I think if he starts pounting on that for the next meeting, blah, blah, blah, I think markets are going to be respawnd very, very poorly, because he's just going to drive us into a recession. Just real quick here. I'm wondering your perspective on oil prices.

We were talking earlier. What signal is nearly eighty dollars on w t I sending to global markets that are still looking with this disproportionate imbalance with supply and demand. So to me I think it's a negative signal, and I've been talking about this going back for months. We've all been kind of looking a lower oiler prices, lower inflation. That's good. Historically, when you go back to the two thousands, the great financial crisis, Um European debt crisis, lower oil

prices is generally bad for equities. Right it is a signal that economy is slowing. And if you just go back to my one big argument about we underestimate how important crypto was. Right, if they were generating through their minding, all this energy usage and that industry starts dying off, which I think it's very high probability that it does in the coming months, that's just another their source of

demand that we have. So I think again, we're spending way too much policy time responding to prior problems than to the current problems. Peter Sheer of academic securities. Thank you so much for being with us. 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