Surveillance: Fed's Balancing Act With Hornbach

morning as well. And we begin this morning's program with Matt Hornback of Morecan Stanley. We're lucky to have access to several great rate strategists on the street. Matt, I'm pleased to say it's one of them. Matt. Fantastic to have you with us on the program. Let's just start with the price action right in front of our faces right now, equitris law again and a bond market that's really not doing a whole lot. Why so, Matt, Hey, John,

thanks for having me on. So you know, look, this goes back to an issue that we actually talked about a couple of weeks back, which is the idea that bond markets are caught between a fiscal rock and a quee hard place right where's basically talking about. Uh, this this interplay between all of the issuance coming to market and all of the issuance that's ultimately going to be bought in the secondary by the Federal Reserve UM. You know, now, what we're seeing recently is the FED peeling back on

the pace at which it is buying treasuries. UM. That's probably one of the reasons why on a daylight today where the SMP is down about a percentage point, uh, you're only getting a basis point rally in the treasury market. Investors are very worried about the supply matt If you look at the two year yield in the US, it's linear and certainly log linear, and it's just grinding ever

lower yield. Do you extrapolate that out to an ever lower and lower and lower yield or can the FED actually can control that guide glide path at the end of the day, That that the FED um has a monoicum of control over the markets during certain periods of time, and then there are other periods of time. Remember the Taper tantrum in two thousand thirteen, where it completely loses control of the market based on you know, a handful of words coming out of somebody's mouth, and so it's

a it's a very delicate balance. Um. I'd say at this point, what the FED is trying to figure out is what kind of forward guidance can can get them to allow yields to remain low and yet when the time is right, allow those yields to start to gradually rise. It's a very tough balance. This is not an easy thing to accomplish. Matt. What would yield to be if the US for not selling record amounts of debt right now? I think yeah, I like I think they would They

would probably be much lower. Um. You you could easily see the tenure treasury yield revisit the all time low of thirty basis points. Again, the amount of securities that the FED is removing from the market is unprecedented. And when we talk about the supply demand balance between what the Treasury will issue and what the FED is buying, we also have to put that into the context of coupon bonds. Right now, we we know that there has been a tremendous amount of Treasury bills that have been

issued this year. We also know that towards the end of last year, the FED was buying a lot of treasury bills. Now the FEED is buying a lot of treasury coupon bearing bonds. UH. And if they weren't, if if the US government wasn't going to issue any of those coupon bonds, almost certainly the tenure yield would be closer to zero than one. Man. You've got a macro mandate for Morgan Stanley right now, let's macro over to Ellen Zanner. Combine her inflation view with your view of

fixed income as indicator a choice for our listeners. Are they ever going to garner a constructive real yield? I don't mean a positive real yield, I mean one that they can actually bank well. I mean this has been a phenomenon in the world over And the answer, probably for the next five years is no. Um, you know it. It's you know, real yield is a scarce sset these days, especially when the FED is removing so many of those securities that would otherwise offer you a positive real yield.

I think you would need to see in order in order for me to be wrong on that, you would need to see the government expand the deficit UH in a continuous way, I'm not talking about one year of higher deficits or two years of higher deficits. I'm talking about year after year after year of continuously expanding deficits. This is about a rate of change, not just a nominal number every year. We need to see that happen in order for real yells to really start going considerably higher.

Let's talk about the recovery as well, Matt. A little bit later this morning, I'll be catching up with your colleague chat and I Ah the chief economist at more Con Stanley. There is a focus on consumption, and as I look at the sequencing of the reopening across Europe in a place like Italy, it's manufacturing last first rather and then at the back end it will be the consumer facing sectors of the economy that opened last. And you guys are pointing out the consumption will be the

LaGG art here, the slowest to recover. Now with that in mind, how hopeful can you be about a short, sharp recovery if consumer facing sectors the economy a last to open and consumption will be the laggett here. Well,

I mean particularly in the US. John. If if that's the case, it's it's going to be a long slog because at the end of the day of the US economy is mostly a consumer based economy, and so if we experience the same type of dynamic that we're seeing play out in China, for example, Uh, then it is going to be a slow recovery. And that is what

our economists are suggesting in their forecast. We're not really getting back to any any kind of consistent level of potential growth until two uh, you know, and and that is something that, um, we're all going to have to deal with, right It's the U s economy is is driven by consumption. I'm struck by Warren Buffett and what

he said this weekend. He was saying that he didn't get calls because, frankly, or the fact that he was getting calls were not actually in terms that were attractive to him based on what the FED had done, based on the intervention that basically they had artificially propped up some of these companies and lowered borrowing costs. Do you think that investors who are investing alongside the FED ultimately will be struck with insolvencies and losses or do you

think that they just won't get very big returns. Well, I just I don't think they're going to get very big return please. Uh. At the end of the day that the government, um has the government and the Fed in the sense have a have a special ability uh that it is not sort of commonplace in the sense that they can go in uh and they can increase their debtload. Right, the government can increase its debtload, um. And and the cost of that over time ultimately would

be borne out through the currency. Right. And and what we're seeing um over the over recent months is that the currency hasn't had a problem with it. Now, that's not to say that it will never have a problem with it. And in fact, we do believe that the dollar is evolving through a topping process. And at the end of the end of the this year, the end of of of the next year, the dollar is going to be weaker, perhaps substantially weaker than it is today.

But that's ultimately where you would see uh see the pain if you will, hitting the government and the government's balance sheet uh is through the current see and we have not yet really seen that to any degree worth worth writing home about. Matt. We've gotta leave it that sam My bestaid of saying, well you mouhm back that of Morgan Stanley on the latest and the Treasury market beyond right now is a really important interview, folks. I'm looking down at the Plaza Hotel here on Central Park.

Jane Foley knows the history of the Plaza Hotel, but what she really knows is eighteen months, seventeen months after the Plaza Chord, three or five years ago, there was the Louver Accord. The coffee was better there, and and Jane, what's so important here is you can have dollar dynamics and all this international economics and China in the US now and all that, and then it leads to instabilities where you've got to have a brand new meeting. How

close are we to instabilities in the Jane Foley world? Well, I mean that is quite interesting. I think if the dollar continued to be at these sorts of levels, maybe for the next year or so, then I certainly think that politics would certainly be coming into that equation. But I think for now it's perhaps too early to be wondering whether or not politics are going to come in,

what politics are going to potentially do. But I think there's one thing that we can say is that we are still, I think very much in the early phases of this crisis. What you've just been outlining with respect to unemployment is really just still the beginnings of the

demand site aspect of this crisis. If we get to the end of the year, and as most economists untokipating, we've still got very elevated unemployment used very suppressed wage inflation, then we are still looking at very poor demand dynamic, and that is going to feed back into stock market valuations.

It's going to feed through into all the economic data that we're going to see, and it's not going to be a pretty site, and gay not the way that people are trying to Our governments are trying to plug this gap, this demand gap is by printing money and by issuing record amounts of debt. And we've talked about the U s set to announce its quarterly funding on Wednesday with record badge of debt sales. But it's not just the US. It's also China, which is set to

issue a record amount of local government debt. It's also in Europe or the e c B is expanding its balance sheet. What is the long term consequence of this massive sale of debt in nations worldwide. Well, I think it depends which nation that you're in, because if you're issuing debt in the currency that people really want to have, which would be really most Western economies of the US obviously and then European economies, they can issue debt and

they'll they'll they'll probably do okay. But if you want to issue debt and you happen to be an emerging market nation and you do not have at the patients of international investors just wanting or lining up to buy your debt, then you have an issue. And that is I think again a real aspect of this crisis. I think that the crisis that the emerging markets suffer it could be really quite marked. And whereas Western governments can find a way through this, and it's going to be

pretty tough. I think it's going to be really, really tough if you happened to be in a very poor country. Jen Let's touch on the US dollar as well. Many people were talking about this for a long long time that in the next downturn, any crisis, whatever shape it might take, we might question the riskman againing characteristics of the U. S dollar. Have we just cemented the status as the haven currency. Do your in fact for a

whole lot longer the U S Dollar. I think we have to be honest, and I think this is a function of, you know, the last ten years. Maybe that's the last twenty years, but certainly the last ten infer instance, if you look at the data from the Bank of International Secuments over the last ten years, really after the global financial crisis, a huge amount of debt started to

be issued in US dollars. A huge amount of cash of U. S. Dollars is held outside of the U S. A lot of this is used for transactional purposes, again in emerging market countries, and because a lot of these have grown really very significantly in the last ten years, there's just the need for dollars just to carry out businesses.

So from that point of view, the dollar is a sort of a practical safe haven for many types of smaller businesses and people around the world, particularly in e M. And that's why I think when the dollar does eventually turn lower, it could be a while, yeah, and it could be linked to when confidence really does come back

in emerging markets. Jane, this is fascinating to me because the implication here is that the Fed essentially monetizing the debt of the United States and the United States selling an unprecedented amount of treasuries will have no effective consequence on the nation. I mean that is sort of the the implication here if the dollar remains the funding source to your and and and the the prime way that that that people look for the currency. Is that correct?

Is that your is that your take? It certainly does seem to be like that. And to put that into perspective, I remember righting essays on this when I was at university, and that was a long time ago. And yet you know, we we can project ourselves forwards till today and we're still at this situation. You know, when does the market crack? Now,

if you like, you can liken this to Japan. Now, in Japan, of course, they've got a huge amount of that, much larger than the US, and they have been issuing huge amounts of Jgbsdvangage, Bannabeen hoovering up huge amounts of of jgbs as well, and for years the market I said, well, you know, our investor is going to give up on this is as wrong as a yel is going to go up, and yet they haven't. And it seems as long as credit rating agencies remain calm, then the market

carries on buying this step. And it seems as long as the government's do just enough to give this era of fiscal control, then the market seems to poke with this quite well. Jane, thank you so much, Jane, fully with rabble banking. Julian, Emanuel, I read every word of us note. He's got a note for so then they've got seven pages of Excel spreadsheet in a fund that I think I couldn't read when I was seventeen. I

certainly can't read it now. So Emmanuel of bt I, you can claiming about the guest before they even get to speak, But come on, he's one of these guys. It's it's like at the end of the conversation, it's like something off of a hieroglyphic, a fault museum of art. So when it was Julian translate forest right now and this and this continuum, Julian, Emmanuel, where do you fit in on sell in May and go away? Well, Tom, I hope you're going to disinfect the package with the

magnifying glass. That's gonna be on your doorstep tomorrow. So that's the first thing I'd say, Look, if you if you think about it, it's very clear that the rally Austin the March is very much about the fat injections of liquidity. Obviously the fiscal policy as well. And now we're at this point where we've we've come all this way and and frankly, what we're looking at is seven are weeks of uncertainty. How does the economy reopen? What does that look like? And you know, crucially, do we

have a spike in the coronavirus? Julian Gray is risk okay? Beautifully, frank Julian Robert Kirby, the giant of capital Guardian Trust of a million years ago, would say, opportunity, uncertainty go together. Is this with this uncertainty, lousy March grade April is now the mother of all times to reaffirm optimism. We don't think it's right now. We think May could be rocky. Ultimately, we do think that in the bigger picture it is a time to reaffirm optimism. But I think we have

to be very honest and upfront about this. There is an element of medicine that needs to progress over the next five or six months. We're not exactly sure what it is. Obviously a vaccine would be the best case scenario, but we do need some sort of medical events or some signs that the virus is going to be less of an issue as we reopened the economy. But tell you a great judy and science is going to be a huge factor in the reopening of all of this.

I think there are some basic economic assumptions that you can make and start to think about the kinds of equities, the kinds of businesses you want to own in those scenarios. So let's talk about it, Julian. This could be a high debt, low growth world. Goldman is saying, for that reason, you want to pay up for growth by the big players, by the big five, by the big tech companies. That seems to be the call for a lot of people on Wall Street at the moment, increasingly a call on

the margin of the conversation. Is something we discussed at the top of this program. Start to get exposure to small caps, the most cyclical aspects of this equity market. How do you manage your equity exposure right now, Julian,

So we are on the small cap cyclical side. We looked at every bear market over the last thirty years and and absolutely with consistency, and think about it, it did very two thousand and eight, the financials led the way down, two thousand technology led the way down, etcetera.

But invariably what we saw is all the sectors and the styles and the market caps that were the worst performers during the bear market phase ultimately lead the market higher once you made the transition to a newable market. And for us, that means financials, that means small caps, that means energy and industrials. It does not mean fang and it doesn't mean sort of the shelter and place ministers who's which we think are going to be sources of fun as we make this transition to a newable market,

which is Lisa. Sources of fun is Julian Emmanuel talk is they're going to sell the puppies. Sell the puppies. Actually, you could get a lot of buyers right now. I hear the pounds are actually out of puppies because everyone's adopting puppies. Julian. I do want to get a sense though, of the numbers versus the hope, and I'm looking right now,

there's about halfway. We're about halfway through the first quarter earnings reporting season, and the Russell two thousand Small Cap Index report companies are down sixteen point four percent year over year, that is with respect to earnings, and that as much more than you're seeing in the SMP five in terms of the of the companies that have reported there. How do you square that with the optimism that you're

expressing and recommending that investors go and buy these companies. Well, you square with this whole idea that if you think about the relative return of the SMP for the versus the Russell that is very largely discounted. You also look at it and we think about it in terms of the risk. Several weeks ago, the Russell two thousand vics got to an all time wide versus the S and P five vics, and that told you that, you know, it was absolute abject panic in the small cap universe,

even after the market had turned. And then the last thing we say about is, you know, think about the targeting of the stimulus. We're not you know, we're buying large targeting industries, but overall the emphasis is on a small town, you know, small main Street us A companies, which by the way, make up a large part of the electorate this November. So we think it's it's in the price, So Julie, and this conversation has gone the way if many of these conversations go, which is why

do you want to buy X? And then I get told because in history it shows X, Y and C. And I think we can all agree that this shutdown this economic downtown. It's totally unprecedented. So with that in mind, isn't the comflict branket of history totally redundant as we

exit this? Uh? No, I don't think so, because this has been so extraordinary that there really are only a couple of periods that you can measure against um and if you look at it, sort of the the incredible craft off of an all time high coming in a

month or two really only harkins. And from our view, the reason this isn't nine where you wouldn't say, you know, cyck locality is is on the verge of bankruptcy and so on and so forth, is because of the response that you know, we are now over of us g d P in enacted and proposed stimulus, right, and and the question is can that last? Yeah, it's it's an

incredible number. Can that last long enough? There's an optionality to it that putting our derivatives at on, there's an optionality to can it last long enough to get to a medical solution um that helps reopen the economy. And we think the answer is likely going to be yea, Julia Manuel, thank you so much, great briefing. Bill Smede joins us right now. Smede Capital. Of course, value investors they sort of like sequoil like stocks, some real concentration.

They're less diversified, uh, and they're in the value space. Will speed your track record over long term is nothing short of an act of God. It is a miracle unlike the last year, you know, anyway you want to look at it, it's been a tough, tough slog for large cap vailue away from the seven or eight stocks doing well. How do you manage that forward? Well? You

you get more excited about it. Tom. We took a lot look about a week ago at the year to date, one year, three year, five year, and tenure on the Russell one thousand value versus the Russell one thousand growth, and the spreads were and a hundred. Uh So, so what it tells you that in virtually every single time period for the last ten years, growth has beaten value. And and that's we find that really a key in

the for example, the Birrthire Hathaway meeting. Because from a value standpoint, today is a great day to be a Ben Graham person, right, this is a great point in time to be somebody that looks at asset values and cash flows and all those kind of important things for today. And and we we uh we definitely like this market for that reason. All right, so we give us your sense of your takeaways from Warren Buffett over the weekend.

Uh you know, he's always been enthusiastic about America long term American exceptionalism, but it didn't necessarily come across in

some of his actions. What were your takeaways? Well, first of all, you have to understand the capital structure of what he's running, Right, He's running a five hundred billion dollar market cap company with a hundred and thirty some billion dollars in cash, And for him to be able to buy something, it's got to be a very large company that is very deeply out of favor and the very largest companies. As Tom mentioned in the intro, they've had favor uh uh. Mason Hawkins calls it quality at

any price. See when when you're buying a dip and you're paying thirty times for Costco or thirty five times for Visa, or or uh eighty times or a hundred times for Netflix and Amazon because they seem to be benefiting from the misery, you're exacerbating the growth trend. And then you're there's massive selling on the value side and there's no capital in the hands of the value people to sit there and buy with bids below the market. Yeah, but what Bill, Bill, I I get that. But the

fact of the matter is their revenue profile forward. It's like Mars and Venus. I. I mean, the revenue profile of some of those high flying texts is extraordinary compared to most single digit If revenue profiles were important, and that was the most important thing, uh. Targets revenues are up eight mostly on the back of their their e

commerce business exploding and groceries which are low. In other words, the thing that's doing the best for Target at the moment is the thing that Amazon does, and Amazon is finding our our targets, finding out the same thing that Amazon's finding out is that even when the business is as good as it could possibly be, there's no margins

in it. And where where targets gonna make a lot of money is We're gonna have a zillion four year old kids in four years and the Oshkosh bagsh overall of overalls is gonna fly off the shelves and there's huge margins in that. And by the way, a week ago, there was a survey in the states that were about to reopen and they asked people what are the three things they'd most like to do that they haven't been able to do. It was travel, close, and entertainment exactly.

So Bill, are you concerned? Paul, Yeah, I'm gonna go. I'm gonna tap into kind of your experience here, uh, your vast experience in the markets. One of the things people are concerned about, or not concerned about, it just wondering about, is will consumer behaviors be altered, you know, maybe permanently by what's happening here in the pandemic? Is this something akin to the Great Depression of the thirties

were kind of impacted a generation and consumer behavior? Are you thinking about some of those bigger issues and how people's uh consumer behavior might be impacted. I personally believe and we as a company believe that people are drastically overestimating this. They're overestimating. And let me give you an example.

Uh when when I was fifteen years old, sixteen years old, I kind of got bored with a lot of subject in high school, but I was always excited to go there every day because the state had a mode howdn eighty days a year, the cuterst girls in my hometown had to go there. Year old girls? Okay, appropriate, you know, okay,

what what's gonna happen? What's just gonna happen? As soon as we open up the fifteen to five year old kids are all going to gather somewhere where where they think that the opposite sex is going to be there. How that'll try the economy? I don't remember this in the cf A Curriculum bill. Are you under diversified? Now? When you have this shock? When you have a economic backdrop, we've got should I be smeet diversified or should I

try to be more over diversified? No, just the opposite to see, that's the deal with Explain that to our audience please. Yeah. So, so here's Buffett recommending the S and T index. He started his talk explaining that from ninety nine to nineteen fifty four, the index of the day in ninety nine was the DOO and it went nowhere for twenty five years. Now, think of the time period since then. Uh, From fifty fifty four to sixty six, the index was good. From sixty six to eighty two,

the index was terrible. From eighty two to ninety nine, the index was good. From two th eleven, the index was terrible, and then up until two months ago, the index was really good for nine years. Okay, So what does that tell you? It tells you that half the time the index is terrible and the index the index is usually terrible, beginning with a point in time where it's extremely popular and it gets heavily overweighted in the most popular stocks. And that's one of the reasons why

we're starting again. Well, one final question, what do you think of the financials? Our audience wants to know if you find value in the financials, do you have to go to Europe to look at their bank valuations. No, we're we're excited about the financials. Uh, the fact that Buffett couldn't say more nice things about him, even though he thinks very highly of him, to me was a bi signal. Did he give a bicycle on the airlines? Uh? You know, it's funny you mentioned that because I looked.

I thought, gosh, if those things go down, see they're a lot lower than where Buffetts told them, and then they're probably down another ten percent. Today said, well, yeah, I remember to two instances. We stopped flying for eighteen days after nine eleven, and it took a while to recover. And then uh, in oh nine, o eight oh nine, obviously things backed way off in the in the airlines, and I can remember we were out starting to promote our company. We started in oh seven, and the funds

started at the beginning of away. So in oh nine, oh ten, o eleven we went on what we called the No Tour. We flew all over the country and pitched what we were doing, and everyone said no. But the fares were cheap. But by the end of it, the fairs weren't keep right. In other words, by two or three years into it, everybody was back to fly it Like I'm gonna steal that from Bill Speed. The surveillance and no tour bill Speed always, thank you so much.

It best to value invest with speed capital. With the pandemic, with all the different news flows that we've had from it, and the statistics occur flattenings that we've seen in such, it's been important to get the perspective of the Johns Hopkins University. Joshua Sharfstein is with the Bloomberg School of

Public Health. They should point out that Mr Bloomberger is of course the founder of Bloomberg LP, this radio and television property as well, and he's been a philanthropist to his engineering school at Johns Hopkins and of course the

greater university. Here is Joshua Sharfstein. An update on the pandemic overall, at the plateau in the United States, that's not really going down particularly quickly, and her, you know, there are certainly places like New York where it is declining, but there are also quite a few places, even some smaller cities, where it is increasing, well, it's recreasing increasing as well. Can they use the same methods from New York?

I mean, what is the difference in medical treatment in Baltimore or New York versus the remoteness of some of these new places in America. You mean, you're putting your finger on an important issue, which is that the hospital that some is not nearly as robots. In many places, many of the hospitals have been have closed in rural areas.

Those that are open are very small and financially unstable, and so, UM, this has created an enormous challenge if people are gonna and so it creates this dynamic where UM, people may feel like, oh, you know, we're never gonna have a problem like New York. But it doesn't take a problem like New York to tip that entire local healthcare system over There is all sorts of issues here about getting out of lockdown. Every you know, all the

images over the weekend and all that. What do you learn earned in the last twenty four hours about getting out of lockdown? Well, I think that people, um have to look past just the overall government decision. I think what's really going to matter is whether all of us, all the businesses are following good public health guidance to stay away from each other, to continue to physically distance from each other. You know that that is as important, I think as some of the specific policies that are

put into place. UM. If people just go out and defy what's being done, it's going to be very hard to keep this disease under control. And if we open a little which may be appropriate in some areas, could people take that as a green light to do whatever they want to do. It's really going to be a problem. There's nothing holding this disease back except our ability to stay away from each other. Right now, Josh, what are we going to be able to understand this disease better?

So there are a number of studies also trying to understand genetics to try and understand why in certain countries, you know, the mortality rate isn't much higher than others, although the lockdowns were very similar. What are some of the questions that you want answered to to understand it

better and how soon can those answers come? I think there are some very important questions, you know, including some continued questions about how the disease is transmitted UM and the role particularly the children play in transmitting the disease. I think that's going to be very important as we think about whether and how to open up schools UM.

There's also some basic issues about the illness, why people with certain conditions are so much higher risk of dying UM, and is there any way to predict early in the courts of disease who is going to have a more severe illness. I'm also very intrigued by the report that perhaps earlier medical treatment of certain kinds really helps. I mean, if that can be established, that could be very very important.

If it's in doubt that earlier oxygen therapy or some other type of UM intervention matters, that might change the way that medical services are organized and keep a number of people out of the hospital. So I do think that we've gotten a lot of scientific information, and we're

going to see every week more and more insights. I think the frustration is that science doesn't necessarily operate by, you know, one big headline and everyone agrees it's going to be like these little, you know, incremental steps, a couple of steps back, a couple of steps forward. But it's the kind of thing when you look backwards you'll see how far I think we've come in our understanding. What can you tell us about the gilly add therapy? So there was a setback and now it seems to

be on better track again. Can we find out by the summer. If this is one of the biggest hopes for the world, this particular therapy, I think it's going to be as potentially some benefit, but most likely not as like a major, you know, tremendous benefit I think.

But I mentioned last time, I still think, which is we're gonna have to see the ongoing studies which are are using that drug at different stages of the illness, because the medicine might work so so at one stage the illness, but work much better or not at all at a different stage. And so it's going to be like a bunch of little studies that will add up to a much greater understanding. And then when as we learn more about a particular medication, we'll learn more about

the disease. If it turns out that, you know, trying to block viral replication really makes a lot of the difference if it's given early, the drugs given early, that might help us target other kinds of therapies. So I'm hopeful that we'll learn more um from these other studies that will will round out the picture from the vier gesture. Sure see the Johns Hopkins University, Bloomberg School of Public Health.

Thanks for listening to the Bloomberg Surveillance podcast. Subscribe and listen to interviews on Apple Podcasts, SoundCloud, or whichever podcast platform him you prefer. I'm on Twitter at Tom Keane before the podcast. You can always catch us worldwide. I'm Bloomberg Radio