Surveillance: Global Market Selloff (Podcast)

head of US Equity Strategy at RBC Capital Markets. What's so extraordinary about the Kelvasina view, Lorie, what's the distinction that got global wall streets attention this weekend? You tell me, Tom, I mean I try to keep a cool head in in topsy turvy markets, whether it's to the upside or to the downside. Um But look, I will tell you I think we were at a crossroads. Back in mid May.

We wrote a piece titled that saying that if the market kind of broke below the thirty thirty fifty type level exited growth stick air territory, that we'd be pricing in a full recession. We bounced back and we're right now, right back at that crossroads, UM, and I think it's very interesting the market did not break hundred on Friday, UM,

that May nineteenth low actually ended up holding. I also thought it was interesting, frankly, UM, that the small cap space, while it did get hit as hard as the SMP five hundred, it didn't get hit materially worse on Friday. That's important because we had seen that positioning had already been washed out in the futures market. There the peak

and small cap came last March versus large UM. And you know, I think we can start to sort of look for areas of the market now that have been de risked, even though there may be more risk in the aggregate. We have focused and we did this to great credit to our team Thursday and Friday. On the five year out five year view of Inflation from the University of Michigan survey, Laura, you highlight that if we have a reset to hire inflation expectations, is that good

for equities or less good? I think that it keeps the value trade going forward, and I think that ends up being a destabilizing force for the equity market, simply because we do need that growth side to really stabilize. That's really where more of the market cap is in the SMP five hundred these days. But we actually just took a look at how different sectors in the market have traded in regards to that University of Michigan five year inflation expectation number. People used to make fun of

me for using it. It actually, you know, turned out it was good. We had it to dust off the shelf. Um. But the reality is it's things like energy, materials, financials, and even in the big cap space rates that tend to outperform when inflation expectations are rising. So if that trend continues, it's you know, gonna let this value trade live a little bit longer and keep some pressure on the growth trade, which again is a is a pressure on the SMP. Yeah, and we've certainly seen growth bearing

the bulk of the selling pressure. The Nasdaq one hundred is down twenty seven and a half percent year a date, But even beyond tech, there's been more pain for one area in particular, Lorie retail. The SNP five retailing index is down a full thirty percentage points so far in two of course, you've heard from target cutting in out like twice, the focus really being on margins. When are we going to start to see that bleeding into more areas of this market, because it started with retail, doesn't

end there. It's a great question, Kayley. And one of the things we point out in our pieces that if you look at the declines we've seen in the consumer discretionary sector as well as the communication services sector, which has a lot of sort of consumer sensitive names in it as well, the declines we've already seen in those sectors are very close to the average declines that we've

seen in them in the past four recessions. Now, what's interesting if we are headed into a recession, areas like financials, industrials, materials should have been underperforming. That's part of the historical recession playbook that the cyclical areas tend to underperform heading into recessions, though they of course do quite well in the rebounds. Another one that we've been talking to people

a little bit about is energy. Um Energy has you know, actually done quite well this year for obvious reasons, but heading into recessions it does normally see decline. So I think it's fair to ask whether some of those winners that we've seen here to date. If this recession fear really does continue to take cold, are they going to continue to see that resilience or will there be a

bit of a catchdown. Okay, so maybe you don't want to continue to buy into areas of the market that have been ripping, Laurie, but you mentioned that there are some now pockets of this market in which you've seen enough to be risking that maybe it provides some kind

of an entry point. What would those be? So one place we've been putting people towards its small caps, and we're technically neutral on small cap versus large cap, but we did say if you've been underweight, now, we think is the time to remove that underweight and get back to neutral um. And really, when we look at the positioning data on the CFTC work, you've been below financial

crisis lows. Valuations are cheap, not just in relative terms, but they're also getting pretty darn close to where they tend to bottom out um in in recent years if you're not in a massive recession like the financial crisis. So we've got a clearvaluation appeal. What we don't have right as a fundamental tailwind here, This is not really an area you typically want to be in when the FETE is hiking rates, when GDP growth is slowing, when

I s M is falling. But we do know that that risk started to get priced in very early and historically recessions are great buying opportunities in that part of the market. And for those of you who want to know, Lori Kelvisina catch down is a phrase from cf A level five. That's that's where she got that from. You know where she probably learned that to the Great University of Virginia. She's a fellow cavalier. Oh my word, yeah, go, who's okay, Lauri Kelvisina with us. Thank you. We'll do

something in dardn here in the future. RBC Capital Markets. I have been data dependent. I've been criticized for calling it a Fred parlor game. Francis Donald agrees with me, because Francis Donald is writing brilliant economics for manual life investment asking if her mother in law knows who Chairman Powell is, and you know, Francis, that your mother in law will drive. She's lovely, by the way, folks, She'll drive thirty kilometers out of her way to save ten

cents a gale. And how does Chairman Powell speak to your mother in law? Well, he's not He's tried, he said, let me speak directly to the American people. But the big challenge for this Federal Reserve is that inflation expectations, which they're so desperate to control, are really not going

to calm down, at least in the near term. On rate heikes, most of the general public is going to see what they're paying at the pub and what they're paying at the checkout simultaneously here that rates are rising. This is gonna be a very different communication. They're very difficult communications challenge for all central banks. Uh, they don't have the luxury of being honest about what control they have on inflation. That's the underlying problems facing Chair Powell,

Legard and many other central bankers. Jeron Bernankian CNN this week, and let's get out his textbook, Able Bernankey, which is in my hallway at home. Francis, I look at Able Bernankey and back in chapter twenty two ish, it's about the effect of what the Fed does on finance. If they pop seventy beeps now or July or whenever, what does that do to North American banking. Well, it's a struggle,

and it's another strain on the system. We're looking we could be inverted on the yield curve again by today or tomorrow, And unlike back in April, you're not gonna hear as much pushback that this isn't a signal or a precursor to a recession ahead. Financials are tightening, the economy is slowing. The consumer looks fine now, but all leading indicators suggests it slower. Do your political risk is up.

If you made a whole table of challenges for the economy, almost every single one would tell you that for the next sense to twelve months things are going to be much more challenging. That's why this is such a difficult situation because despite all of these leading indicators, we have not seen the central banks blink. Fact last week we saw most central banks that we're seeking actually appear even

more hawkish. So the hope that bad news would be good news and create a reversal in this market, it's just falling away in front of us Francis. Consumer sentiment at its lowest on record, and your mother in law driving thirty st kilometers to get a ten cents less on a gas can drive around and see a lot

of variation as things just climb higher and higher. Francis, at what point does it have to reach peak negativity before you get uh some response from the Fed that can to really address this, because right now that between a rock and a hard place. If they actually come out as hawkish, perhaps I will create better sentiment underpinning

markets and consumers. This is a great question. I mean, macro tends to be most valuable at inflection points in the story, and we're not at an inflection point just yet. We haven't seen a blink from central bankers, we haven't materially seen employment start to rise. All those some leading into pater suggests that gets better consumer sentiment. There's a range of indicators. A lot of people focused on University of Michigan last Friday. Consumer confidence, which waits a little

bit more towards jobs, doesn't look as bad. But the challenge for consumers is we're gonna get retail sales numbers this week, and in nominal terms they might look just fine, and you'll hear a lot of the consumers good narrative, but in real terms, every single month, this is a consumer that loses purchasing power, and now initial jobless can starting to move up, so they're losing purchasing power and

they're gonna start worrying about their jobs. That transition from capital to labor, well, it's looking like it was very short lived. And that's really the biggest challenge facing this consumer right now. Francis Mike Wilson over at Morgan Stanley came out and said, people are not pricing in the consumer weakness that we are going to see given exactly

how much their budgets are being crimped. You have Lori Calvacino of RBC saying that if we break through the levels that lows that we have seen here to date, we could get down to thirty four hundred pretty quickly on the SMP. Do you think that this is all act that people have not taken into account how much the disposable income is getting eaten into Two of my favorite strategists, two very good calls. That's the challenge here is that the narrative has been for the last two

and a half years. There were huge simulus checks. The balance sheets look good, death service ratios are fantastic, but actually real wages are declining. We're gonna start seeing challenges and jobs and that age old idea. Oh, the balance sheets are really solid. Well that's where they are now, but where they're gonna be in this next six and twelve months is more challenging. So that brings me to the question of when does the central bank really start

to pivot? And it looks like what they're telling to us is they can't do it until inflation mollifies. What I'd like to see from share Powell this week because maybe some yell in type comments we want to focus a little bit more on core as opposed to headline and reminding the general public whoever is listening. My mother in law will not be listening, that they can control

some segments of inflation but not other ones. That would be for the beginning seedlings of what we could hope for in terms of a of it ahead, But generally I don't think this Wednesday we're going to get it, and that's why we're not yet at an inflection point in the macro story. Are we going to get a hint at seventy five is coming in July? Francis, Oh, I'm not sure. I mean sexual banks are trying to

open the door. The Bank of Canada did it last week previously that they said, oh, we're not interested in seventy five basis points, and then when asked if they would raise it by fifty basis points, they said maybe more than that. Thin. These are central banks that want full optionality. What we might get which might be helpful with a little more symmetry in that optionality. More talk about a September reassessment could be very valuable. But again

I don't think we get that this week. We probably need much more indication than inflation and inflation expectations beginning to cool. Well, they're definitely not cooling yet, Francis. And as you say, the FED can't be responsible for bringing in all of the factors contributing to inflation. They can't do anything about the supply side. How confident are you in their ability to get it down towards their target without a hard landing. Not very confident if this is

their current strategy. So we're reevaluating our forecasts now, and there is a very significant weak patch in most economic models between Q one and Q three. Of whether or not it tips the scales into mathematical recession depends what you're looking at But the real story is this is a material growth slow down and guess what, whether it's recession or not recession, that's not the name of the game here. That's overly binary type of focus. Francis, Thanks

so much, Stephen Whiting. Let's go to your wheelhouse. Our profits threatened, Yes, um, we are in a period of very high profits and that makes them more vulnerable. We think that will be a year of decline for EPs UM at this point. Again, we don't see the need for a plunge in every industry's profits. We don't see a need to unwind all of the gains that we've had over the last couple of years. But clearly the impact of stimulus fiscal stimulus on demand bled through into

profits in a positive way. That's how we had at EPs year last year. Now this means downward earnings estimate revisions. This is not going to be a year of ten EPs gains followed by another next year. I do think share prices already understand this. In other words, the drop is already uh to some extent said that these estimates or nonsense. Steve. When when we get tested like this, do companies that display free cash flow persistency. Do they go down with everything else or do they partition and

separate from the gloom. They do, And it really often comes down to dividend courage, dividend delivery. Again, it's really boring stuff, but but good stuff. If we take a look at US shares that have the most consider to long run UH dividend increases UM, they fall in half as much as the broad market and they yield nearly twice as much. So UM, this is an area again

to hide out in our own discretionary portfolios. We have eleven percent of all discretionary portfolios US or non US and for any asset class benchmarked to that particular type of style investing. Again, and these were not the companies that could gain in twenty They weren't the tech solutions and they weren't the really beaten down cyclicals of one. So they didn't perform terribly well for the last couple

of years. And we think they're a very good place again now, UM, in a market that's far from perfect even what's the distance between now and later? And I look at Bank of America putting out this idea that's just way too existential. What did you say this idea that you have a consumer that's strong, you have corporations

that are strong. How far is the distance from now to a lesser now to one that people are forecasting and the prices of stocks so so look, Um, some of the lagging indicators like inflation will take a long time to roll over, but it doesn't mean we have to assume that inflation will rise forever. And just because consumer fundamentals are are firm in many ways, you know a lot is chipping against it. So we would expect, for example, this slowdown in goods consumption to result in

lesser need for employment. UM. So employment growth will be slowing down by later in the year. UM, you won't be able to say that a low unemployment rate um is the reason why nothing is going to go wrong. And I don't want to see ultra bearish here, but this is again the reasons why UM. I think from a forward looking perspective in terms of monetary policy, you can't say, well, we need to raise rates until inflation

is low. By then you will have created the forward looking conditions for a much much deeper decline in the on me than you're aiming for. Alan Blinder, the former Fed Vice chair came out over the weekend in a story and said, the Chair of the Fed doesn't want to let the R words slip out of his mouth in a positive way, that we need a recession, but there are a lot of euphemisms and he'll use them. Stephen, what are we going to hear from him on Wednesday?

It will be very interesting because you can't really satisfy markets over short term inflation outcomes. You know, again, we we've kind of joked around. It's like, well, you know, why don't you raise rates a thousand basis points? And it's like, what will that do to next month's CPI reading? And there's very little they can do. I think that there has been less acknowledgement than we might have seen, and everybody's it's probably spending so much time criticizing the Fed.

It's too easy um for all of us. But supply shocks periods in which we have instability in the economy, think about we were just talking earlier on the break airfares have shot up by thirty two over two months. That's non annualized. What were we seeing at goods prices last year? The same thing? The sources of demanded economy or too unstable. We think monetary policy can take care of everything. It can't. These are periods where we don't

stabilize short in the short term. Stephen whyn you with us, and we continue with City Group, Private Bank. I want to look at a better tape right now. Futures negative up ten ten points in negative eighties six on futures futures negative five seven yields to a little better. Really, across the Bloomberg screen, everything doing better, even the two stents spread from quick inversion two hours ago. We're now

up ten basis points on the two stands spread. Kaylee, Well, on the subject of the two year, yes, things have moderated, Tom, but you are still seeing that selling pressure in the short end of the curve. I was just taking a look at what has happened to the two year treasury yield in the month of June, and keep in mind it's only June three. We're not even halfway there, and we're not yet to the Fed decision on Wednesday. That two year treasury yield is up sixty one basis points.

This is a market that has moved incredibly quickly. Stephen now to price in a hundred and seventy five basis points of tightening by the Federal Reserve or hikes by the Federal Reserve by September. So I guess one word question, and I say that with a little shrug for our listeners on radio. Well, look, um, if they're going to do seventy five, it's better to do it sooner than later when policy is still at a very low interest rate. But it also goes to the fact that they've could

have lost control of the dialogue over this. I mean they need a monetary policy approach that they can sustain. Just take a look at the history of FED tightening cycles over the last forty five years. When the Federal Reserve reaches its maximum policy rate, it's unly kept it before cutting seven months on average. And if you really wanted again to to deal with the longer term inflationary and balances in the economy, you want a monetary policy

that you can sustain. Now again, you can gain this out. Maybe I'm the wrong person to guess this, but if you just had created a shock and awe effect where everyone believes, okay, this is under wraps, and then a couple of months later the CPI is still arising, I don't know what you've accomplished if you were tightening so much that you have a recession and then you have

any easing cycle and you are doing QT. So now you've got to do QUI again, this whole approach again of the Federal Reserve going from feast to faminine back again in a pro sequable way. I mean, look, the mistake that was made was easing in a boom last year. You can make two mistakes of monetary policy, not just one. So I think again, trying to satisfy the market, uh and short term inflation outcomes might be the wrong approach,

at least as far as I'm concerned. Okay, so what you're describing, Stephen is essentially Jerome Powell with an impossible job that he just can't do this right. Either you're going to upset the market potentially get inflation under control, or you don't want to move to aggressively and surprise the market. Therefore inflation as a allowed to run hotter for longer. Isn't that binary? Realistically? Well, the one thing that we just can't um dispute it is the fact

that monetary policy doesn't complete control of the economy. UM there are really positive developments beneath the surface. On the supply side. You know, you could see the price of appliances was down. Okay, why well, consumer goods production is now rising four and a half percent unit terms, consumer goods consumption is falling, imports arising. If you want to get through this, you know, we need to get through the next leg event, which is going to be services,

which is going to be housing related issues. Um, do you really want to create more instability? I think they're gonna be in an environment where they're trying to avoid that and still communicate effectively. Maybe they can't do both. Stephen Whiting, thank you so much. Great brief this morning with City Global Wealth Management here with some turmoil, a little bit of a pullback working with Edward a Heiman over evercre I s I, Julian Emmanuel joins us now

their chief equity and quantitative strategists. You have such a privilege to work with the evercres I s I team and dovetail the micro analysis of ed Heiman into your equity work. And the heart of it is inflation comes down, but it only gets down in the vicinity of four percent.

That's a change, right that that is a change, that is an acknowledgment that basically what we saw last week says well, there may be a peak somewhere in here, because mathematically, if you get to nothing but base effects, you probably get a peek, but it is likely to be a higher plateau for longer. And Ed took his inflation number for up to four percent. And that's the issue. That's where the Fed has much less wiggle room than we would potentially like given the stress that we're seeing

on assets since its days of c. J. Lawrence. We've all watched the white paper with the black mark. You got the black marker and one of my shirts once you had to buy me a new shirt. It was stupid black mark. Tom Oh, I'm sorry, Tom, I got you. Is the black marker calling for a recession? Right now? I've been nailed with the yellow highlighters the last couple of weeks. Umh no no. Ed took his growth number down to one point four percent for two a long

time ago, and he saw these headwinds. We still think the base case is no recession, but obviously, again the same math that applies to the potential peaking of inflation also tells you that you know, one point four percent to what could be a recessionary number. There's not a lot of distance there, Julian. When does your a bear

case become your base case of sp uh? Well, all I can say is when we spoke about this last week, we certainly didn't envision three days of carnage in the markets that that we've seen since we adopted that much more cautious view. And frankly, you know, when you think about it from a trading perspective, what's been missing the entire last several months is sort of what I would call a cathartic flush out where you get the vix above forty, which is one of the things you need

for at least the trading bottom. This week is fraught with peril. I got a ay questions, but Lesa's you're just folks. I just want to, you know, in the carners that we've got here, in the more data checks, we need to point out that it is the Bramo base case bearcase. Yeah, well, this week is brought frought with peril, Julian. I mean, I couldn't say it better than than you know myself. Going forward, then, how do you determine if we've hit catharsis just a forty level

on the VIX or is there something more? Is there some sort of forced selling, a disorderly unwind that we have yet to see despite all the pain. So what we are likely to see, regardless of you know, whether the markets decisively take out the May twenty low, which looks like is a distinct stability today, uh, certainly into Wednesday, is you're gonna have an enormous amount of volume at mid month and the end of the month, quadruple witching

the Russell Index rebalance. We'd love to see that kind of volume, you know, twenty billion shares, perhaps twenty five billion shares on a day, along with the vix UH surging towards those levels. Those are the kinds of recipes for a Catharsis that we think you need really to entice buyers back. And the less several weeks has not been about selling overwhelming. It's been about a complete lack

of buying well. And yet the case remains Julian that we've already seen this immense selling pressure, and even before today, the SMP five hundred has already teetered on the edge of bear market territory. You already have a tenure yield that has at three four and we've only just seen

the start of quantitative tightening. It only really has just begun, because of course these markets are anticipatory there forward looking how long is are going to be until this market is looking even further out and saying, well, the Fed's gonna actually have to pump on the brakes here a

little bit and we start to see things reversing. Well, that is that is a question that watching the bond market, and one of our core thess around the view that two was going to be volatile, you know, before Russian invaded Ukraine, was the fact that the correlation between stocks and bonds in a higher inflation environment was flipping from risk on risk off. Of that's been twenty five years along to a positive correlation. We will be looking for the ten year yield, the ascent in the ten year

yield to start to moderate a little bit. It wouldn't be a surprise if we get towards three and a half uh in the near term to start to see some buyers come into bonds that would stabilize stocks. Okay, so maybe there's going to be eventually an entry point to buy the dip into bonds or do you see any entry points at this time in the equity market anywhere that valuations have come in enough that it actually

is safe to dip your toe back in. Yet, I think there are pockets of value, pockets of stocks that have been proven, you know, still growing earnings in this environment, and that are returning cash. Remember, in in an environment where we are focused on return of capital, companies that can return capital successfully, our names you want to own, are they going to return cost cutting? Because if we get an ed him in four percent stability and inflation,

I'm a corporation. I have to adjust, you do, and And part of the dynamic here that's causing this incremental market pricing closer to recession being a base case is the fact that all of these factors together is going to cause pressure in the labor market, which paradoxically, again the FED would wish to see a little bit of that. But you know, the difference between soft soft dish and something else is very fine. Julian Emmanuel, thank you so much.

With every core I s I because Brands is talking about a gallon of gas, there's an entire another story in hydrocarbons. Daraikun joins US now Head of Commodities dws UH and we're just thrilled a good join us here on what I've ignored and I've been remiss on the star way, which is natural gas. No one talks about the price of a gallon of natural gas, do they. It's much less known. But outside of US, I'm sure people are very concerned about high price of natural gas.

US natural gas has kind of multiple times of the price since beginning of the year, and um that strong demand couple with limited production growth and now more robust export demand has driven off the US price as well. You you are so go to the fundamentals of all of this and the underlying fundamentals of export import pressure of hydrocarbons in the United States. Describe right now who's gonna win the battle. Do we export more? Do we keep it instead of exporting it? Do we start to

import hydrocarbons again? At this point in the near term, we are fairly maxed out on export capacity and that won't change until we anticipate four and beyond. And there are scheduled projects to come online to convert our natural gas into liquid form that can be exported. Our export capacity to Mexico via pipelines fairly maxed out, and we always have some import and export between Canada and US to deliver gas from places that's less accessible in each country,

but most of those pipelines are in maximum capacity. In the near term one not going to see a significant dynamic change. UM. Even how low US price still is compared to the global price, were less than about between a half to a third of global price, the pressure will be there for us to export more once that pipeline UM, I'm sorry, it wants that capacity to explore liquid natural gas increases from natural gas to crude gas,

refined goods gasoline and diesel. The fact that we're seeing such incredible lifts in gasoline prices really basically regardless of what happens in the brand crude market. At what point the prices fall enough for it to actually matter for refined goods given the lack of refineries, Well, that's a great question. I think in the near term we still

see strong draws from gasoline inventory. Up to this point, we should have been seeing seasonal build in gasoline inventory as refiners prepare for summer, and we've seemed just opposite, so that natural demand raw will continue. I think that the solution to gasoline high gasoline price really comes from demand reduction. We have to see a significant remnt reduction to allow for the price to fall. We still see quite a bit of pinned up driving demand and that's

driving the castling price right now. So how long we're at what level will that demand destruction really start to kick in? How far away are we from that? Well, anticipating a year from now, we'll probably seek less of that recovery demand from COVID nineteen x China and that should help with the price next summer. Unfortunately, for this summer we probably won't see that realized. Well, you mentioned China.

Obviously COVID zero still an overhanging that economy. You're still seeing large parts of it dealing with restrictions to contain the virus Shanghai just one example. If and when China opens back up, what does that do to this entire supply and demand dynamic globally. That's a great question. The time means very important. Uh. We do anticipate the additional stimulus program as well announced ahead of time, both fiscal

and monetary, to help with demand growth. In China. However, it's very difficult to tell exactly when that's going to take place. UM. Even recently we've seen additional lockdown efforts again from Shanghai just because of the zero policy. Zero COVID nineteen faction policy is still in effect. UM. Without that being resolve, we don't see the demand coming back up.

We do hope though, in the next twelve month, as the demand go down, we have to spend themand go down x China because of the old interest rate moves US has made and other countries are like to follow. Uh we are hoping that the demand from China will help balance that down a downward movement and keep the

price stabilized in the near term. The way uh In City Group put out a report overnight where they were talking about how the amount of GDP destruction from where gas prices, where oil prices are right now is really reminiscent of what we saw in the nineteen seventies. Do you think that that oil shock analogy is the right one?

It's similar. We do see both in both situations. We see sharp rising oil prices and we've seen artificial constraints on supply which we're resulting as we have seen before. Eventually we're going to see demand destruction, whether we see a significant destruction that leads to a significant economic downturn or a more moderate, a soft landing scenario that will determine the outcome of oil price going forward. Are we thank you so much? Are we coming with us today

with DWS here on commodities. We'll get them back here soon, particularly on the commodity dynamics of China. This is the Bloomberg Surveillance Podcast. Thanks for listening. Join us live week days 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