Surveillance: In The Long Term, Cash Is Trash, Sowerby Says

chief equity strategist, Stocks over Bonds. I'm sure she does, and we're going to get into that in a moment. I just want to begin Kate with saying good morning, Good morning, welcome to the crazy house here in New York and Brussels, to Bloombag Surveillance right here. It's worth Tom, I don't always say stocks over bonds. There are environments

where I can imagine fixing commertine return being okay. But you know, for most of the investors that we speak to you you over the time horizons they invest in, it pays to kind of weather their volatility in stocks and to really you know, if you're going to shift in sort of tilt your portfolio more towards quality and more in certain times it just still pays to stay invested.

So um, you know, we are continuing to recommend stocks over bonds, although as we noted in the surveillance, lower conviction, let's just develop your framework for thinking about the global economy and the global market at the moment. This isn't the story of the last month. It's the story of eighteen for the global economy. Deceleration in Europe, deceleration in China as well. Do you see that catching up with the United States? I don't see it in the data yet.

Do you see it in the data next year? Well, deceleration from some of the gride of growth we had in two thousand eighteen, but nothing that's going to really raise a flag. Look, you know, as much as people like to wring their hands and have great debate over you know, recession probabilities over the next twelve months, it seems extremely unlikely in our view and also in our analytical assessment that the U S could enter in any

types of recession in the near term. That said, we are talking about a slower growth rate next year and that has implications. So you know, our view is that you have to be much more thoughtful about how you construct your portfolio over your head, that you need to be a little bit more tactical and that you're gonna have to be taking advantage of opportunities when prices and

things get dislocated. Okay, but if you have a slower growth rate, which I would suggest of our audience agrees with you on Kate more, does that make growthiness of a greater premium and value? Look, our biases that yes, there's still going to be a bid for assets that can grow even in a slower growth environment. You know, the funny thing is that we've had this like almost ten year period where growth has continued to have a bid and value has not really been able to catch

a lot of attention. The truth of the matter is that what falls into value today, some of it is structurally in hair and not everything that's cheap is cheap unfairly. Some of the stuff that's cheap deserves this. So let me ask you this question of banks part of that story. Do they deserve to be where they are? Because this quiet vicious sell off happening and I don't think enough people are talking about It's city is on a seven day losing streak coming into today's session. It's done about

fourteen over those seven days. That is brutal. It's that justified. It's totally brutal, in part because I had been significantly overweight the banks and here, yeah, I know, I had good company and getting this dead wrong. And you know, it seemed like there was this perfect environment from growth and policy and less regulatory pressure and better cash return, and you know, none of that seemed to really matter.

And today, you know, despite the fact that we are in what we think is the very worst case scenario, stable growth but likely I continue to expanding economy. The regulatory pressure is still easing. These banks are still in very good shape. Their balance sheets look awesome. No one cares, and they're getting sold off vision slee as the expectation that the FETE is going to pause that really takes

hold across the investor base. So the story to be bullish the banks, I keep getting told the same story, to be bullish the banks. And my question really is when our investors are going to start responding differently to the same story they experienced in they don't necessarily have to. I think we're going to go back to the question you just asked me a moment ago. Does growth continue

to get a bid in this in this environment. And I think that's right, Like, even though the banks are in good shape, they're not going to be shooting the lights out when it comes to growth. And so I think there's gonna be a preference for sectors and for industries and companies that can really put up stronger numbers, not just solid numbers, but stronger numbers at this point in the cycle. And I'm not sure banks are there kit more. What is a mergers and acquisitions type to do?

What's a CFO to do? I mean, if you're gonna have slower growth, you've got to buy revenues. So this word synergy comes up for next year. I mean it just keeps on going, right. Well, I think if you have slower growth, you've got to do a couple of things. Maintain control of your costs, be really thoughtful about your investment program, make sure your allocated capital internally to those parts of your business that they had the ability to

grow through all parts of the cycle. And You're right, in some cases you're gonna have to think about acquisitions. And valuations have come down across the board. I would suggest that valuations and private markets have not come down as much, so if you're thinking about acquiring assets, um, you'd have to think about you know, public looking at it a bit more of a discount than the private

stuff at this point. Okay, more great to can't shop with you Blank Look Institute Investment Institute Chief Equity Strategists. You have a wonderful Christmas. If we don't see you before, Thank you, Mary, Mary. I want to bring in David Sowerby and Cora Managing director and portfolio manager. David, it feels like a growth scare. At how different is it? It's very similar to late two thousand fifteen early two

thousand sixteen. Stock prices are trading about the same valuation as they were in February of sixteen at the bottom, whether it's on a price to earnings or as Tom knows quite well, how I want to value it on a free cash flow yield basis. Sentiment is getting very washed out. The dollar was strong in in two thousand fifteen and then it retreated. It is similar, and I think because it's similar, it's becomes an interesting buying opportunity. John.

That's equity talk that you're hearing there. It's different than what you cover on the real we can can see the equity, so you can talk about you can do that with David Sarby. I also want to point out the press gathered here in Brussels awaiting Prime Minister May the British flags and one EU flag as well, position behind the lectern and a blue backdrop, and we'll look for that from Prime Minister May here in a moment.

David Sarby, we always talk about the focus, focused, focus of all of the media, and that's the big stuff. You love to go mid you love to go small. I want to talk about mid caps. Have mid caps and joined the correction or have they shown their usual historic resiliency. They have more bruises this year than large cap the Russell two thousand to go even smaller down six percent year to date, mid caps a similar number.

It's been a it's been a tough environment. Yet at the same time, when GDP growth is better than three on an inflation adjusted basis, that's a good backdrop for earnings and a good backdrop for the small caps to re emerge. Do you agree that cash is an asset? No, not in a long term and a long term time cash is trash. It is a dragon portfolios, but two thousand eighteen will be that year when cash beats everything

large cap, small cap, US, non US bonds. Cash is a nice thing to have this year, but in the long term cash is trash. It's interesting the justice Payperl stots to fall in love with cash, and my colleague Luke Care of Bloomberg brought this up as well. Cash was heighted at the start of the year in January, and then that was the thing that outperformed. Now everyone's in love with cash, and now duration starts to outperform.

So here's the here's the key. In January, investor sentiment, individual investor sentiment was more than fifty bullish when nobody liked cash. As of yesterday, investor sentiment was forty percent barrish, above the long term average. When people want more cash. From a contrarian perspective, it's a good time to be a selective, selective net buyer. So selective, Well, let's be more specific. Do you like the banks here? The banks have been totally hammet of the last couple of weeks

has been pretty ugly mediocre. How's that for a portfolio manager view? Uh? Citizens financial? I think that that's a regional bank that has good loan growth, lower charge offs. That that's interesting. But for the most part, the bank story this year, which was to call everybody wanted to make hasn't worked. David, with with your experience and and particularly with your institutional service to pension funds and giving

them advice. How do you handle a General Electric? Let's say you own it, you've enjoyed the losses, how do you do that. I'm not talking about some trade or somebody like Doug Casts. It's in and out and all that. I'm talking about mom and pop they own ge oops. How do you handle that? It's I think it's it goes back to two thousand when when a high profile CEO leaves a company on a high note, that's usually a better time to sell than buy hindsight, but that's

been the story with General Electric. You and I have talked about other conglomerates which have been better return on capitol companies. Honeywell that that's been a so much better play than than General Electric. And I think that's still the story today. Okay, so u T Actually NIT of Technologies has to break up into three David Sowerby companies for you that's a good thing. Do you buy all three? What do you do well? One thing you want to watch is where does the CFO go in the breakup?

And and where the CFO goes is usually because they're pretty got some good inside baseball that that's a good place to be. And in the case of Honeywell, they spun off their their home security business Residio symbol are easy. I I think that's an interesting play as a spinoff on on Honeywell. What do they do? What does residy they are? You can control your heat, you're you're lighting in from a remote in your house. They're very good on home security for a person like me who writes

checks and doesn't do it himself. Residio uses professional service people to put that all together. And there are a recent spinoff out of Honeywell. When was the last time you can't about Brexit? I remember when Brexit the vote the day after the market went down initially and then and then it got right back on its bicycle and continue to do well. And I think this is maybe too simple. No wonder the UK wants to depart that

they don't want to be dictated by uncompetitive countries. Whether it's Belgium, France, Italy, you name it, and the u K is is the eighth most competitive country on this planet and the rest of their peers there are simply not maybe Germany or Switzerland. That's what they have an issue with. John. The single most important conversation I've had on this junket was with a guy that runs the

national health system. Uh. My recollection is Matthew Hancock is his name, and he was heated John that he's a remainer, he's an elitist London, you know, the usual thing in his case, directly supporting the Prime Minister. And he says the vast majority of his district, his constituency is leaf that's the problem the MPs half he was he has a single most important conversation I've had, other than trying

to figure out Waterloo Street of Brussels. A very thin majority of the United Kingdom who did vote voted to leave. There is an overwhelming majority within Parliament to stay within the European Union. The officials don't seem to represent what their constituents want, and I think that's the political problem these parties have. On top of that, the parties themselves aren't just divided by party. They're divided by the one issue.

So the Labor Party has divided, the Conservative Party is divided, and the Labor Party is offering very little alternative to what the Prime Minister is bringing home from Brussels again today, which is the same things she had last week, but not to run a survey here and they'll be pulling and all that coming up. With all this uproar, John Ferrell, would you suggest there could be even a greater Leave constituency. I've got no idea, to be honest with you, Tom,

and I hate to call it. And every time I've offered a view on Brexit, I've been wrong five minutes later and have to Brexit. When you let our coverage the day after Brexit, was I wrong five minutes, every five minutes, every four minutes was I have to say that someone that did stand up and did lead was Governor Connie Um. It helped his reputation for about twenty

four hours because he has had a tough time. I have a since tone well, I and this is so important and we can go to David sar beyond this right now, David, I thought Mr drog yesterday showed the limited degrees of freedom that central bankers have given global slowdown and given the realities of price change, do you look for next year Chairman Powell to have a limited choice se versus what was thought of six months ago.

I had no problem with Chairman Paul's comments in October when he said my mission is FED chairs as it always should be, as low inflation and price stability. And maybe maybe he retreats from that somewhat, but as long as the FED is committed to that, I don't have a problem with two or three rate hikes, uh, even a little bit more, because real FED funds are still effectively zero and ultimately that's great for finance traw markets, but it hasn't showed up yet, but it can be inflationary.

Are there mid caps David Sarby? In Europe? There are? I'm getting out of my wheelhouse a little bit in in uh in that space. So turning back to the US, I talked about Residio as an example, Windham Hotels, which has spun off. It's it's travel business there and they're right there, right in the sweet spot of Ramada days. In Howard Johnson's to go back in time, that is I think a good play in the mid cap space.

It's about a five billion dollar market cap, and I think that's that's really interesting for again believing in the long term you're gonna make money buying spinoffs. Windham has nine analysts who follow it. I like that. You know, someone run into me yes today, Salm and I think it's a subject that we can perhaps talk about now

between the three of us. And they said, the economy has been so strong through and if things have been as good as this administration and the Federals of site, why does this market fall out of bed every time real rights breach one percent? Why? Why is it should it shouldn't. I think the key is put interest rates and inflation together. And if interest rates are going up because the economy is stronger, loan demand is higher, I s M Index closer to sixty than fifty. That's not

a bad thing. But when interest rates are going up because we're way behind a curve on inflation, and inflation is pushing not at not at two percent today, but closer to fork, then we've got serious problems. But I think it rises a much bigger issue since the financial crisis has our tolerance. There's a global economy and a

global market place. Our tolerance for higher interest rates has it diminished to that degree that we can't get away from one percent real I think ultimately that as long as your return on capital is greater than your cost of capital, and return on capital is more like five percent, cost to capital is more like three, that's a good spread for the backdrop for equity investors, and good good

luck forecasting interest rates. You're wrong more than you're right, but but I think they're still going to go higher. The expectations is incredibly dovish the economists that I'm reading ahead of next week's decision is a dovish interest rate hike. And my response to that is doubbish to what dovish relative to walk Because expectations right now are already so dovish.

I would say it's a high bar govern into next week for the Federal Reserve and what we're to deliver already very very dovish expectations for what the Fed's going to deliver in nineteen chair, and I'll please keep your independence and don't pay attention to the tweets and know what your mission is and will do just fine, and and for and for interest rate forecasts. As a former bank economist, economists are notoriously wrong on forecasting interest rates.

That's why I manage money, and I'm not an economist anymore. David, what's the polish you see away from the elites of New York City on the West coast and Washington the rest of it? What's the pulse you see out in your Midwest? It's what you affectionately refer to as the flyover zone in the Midwest. It's just fine. Michigan's unemployment rate is less than four percent, down from fourteen percent in two thousand and nine. Is this boy in economy filtered down to the broad part of America? Or has

it been a make America great again? Elite growth, wage growth, income growth for the last year has started, has been better for middle income earners now growing better than three So it has it has filtered down. That's why I think a window name works because of the the properties they own. Ramadas right days in We're not talking about the Riz, Carlton, We're talking about more medium price points

to stay at. That would sound wonderful. Thank you always always great to catch How you thank you didn't count it? Joining us Macro risk advises the volatility of the last couple of weeks day and what do you make of it? Yeah, I think it's the markets are grappling with a bunch of different cross currents at once. Um, You've obviously got tariffs as the overriding story with the markets, but you know, below the surface, there's a bunch of other things going

on as well. There is concerns that the sort of firm handshake that the markets and the FED had agreed upon for for many years in the Bernankeian and Yelling era is is coming to a close in the sense that Jerome Powell is effectively having to take back some of the assurances that his predecessors were able to give markets because he just doesn't know. And so the markets are trying to understand where the FED is heading from here. Um, So that that's one of the markets and FED talking

past each other. And then I'd say the second one is, Look, markets are discounting mechanisms, and there are concerns that global growth has peaked, and that some of the quote overbuilding that occurs during very benign cycles, especially in the credit markets,

is starting to kind of come home to roost. So there's a lot of uh, sort of pricing of distress that's in markets, and and you know, we're gonna in some ways have to wait and see whether the economic fundamentals are strong enough or the markets right that things are actually starting to slow. Well, let's get into that day. The market is trying to get ahead of something. Some people are trying to figure out whether it's overshooting, is

it it's it's so difficult to say. I would I would comment that the markets and the economy are very distinct things. And then for quite a long time, actually what the benefit to the market of a weak economy was that the Fed state in town for longer and longer, right, the justification for ongoing FED policy that was very supportive to the market was in fact a weak economy. And

now it's almost that the reverse is occurring. That the at least for the U. S economy, that the strength of the economy, uh, that the Feds looking forward and trying to ascertain whether inflation is headed higher uh via um, you know, diminished slack in the economy. Um, that's Fed policy. That's um uh you know, indicates that things are actually going well, but it may not be supportive to the markets as we try to understand how much of you know, how much of asset prices were a function of low

rates Dan currnet. How should our audience use the VIX? The VIX is n twenty long term average. Boy, these are odd times different times. Is the one VIX now the same as a twenty one VIX and two thousand six or One of the things that is important to understand is that the VIX has used to be just an index that we observed. The VIX is the price of insurance for one month options on the SMP five hundred. It's a measure of implied volatility, and it's something that

we just looked at. It was a calculated figure. Uh. Now it is a vastly traded instrument. There are vixed futures, there are VIX options, all of which trade with substantial UH liquidity and find their way into the portfolios both from an offensive and defensive standpoint. Um if you look actually at the realized volatility of the VIX itself, so this is in some ways a measure of the vowel

of the vol uh. It starts to rise right around two thousand four, and with some ups and downs along the way, it's it's generally risen for the last fourteen years, and it it almost corresponds exactly with the introduction of VIX futures and options. So the financialization of the product is what makes now different. It's not in an observation of index. It's a traded asset that people wanted to get into an out of what is de incurrent average VIX.

I'm assuming it's not twenty anymore. Well, listen, the VIX is really just uh, it's very correlated to the the movement back and forth in in markets. UH, and by that I mean, UM, if if you look at realized volatility, so just the HVG function on on the terminal, you're going to see that. UM. Since October, the realized volatility SMP has been slightly north of twenty UM. So it's actually no surprise that the VIX is sitting here at twenty. In fact, many would say that options, even with the

VIX up here, are actually a pretty good deal. They're justified by the much more substantial not not just close to close movements, which is what uh most of most folks look at. Uh, if you look at the intra day movements, they're actually illustrating a almost far greater level of volatility than just close to close. It's these it's these back and forth intra day they're actually painingful with the sspect to option pricing. Did you get all that? I got some of it and I wanted to follow up?

If that's I think if you asked money people right now whether downside protection was expensive, they might answer yes, is it? Yeah? So again it's uh, when we look at options, we uh, we're looking at two things. We're looking at the the cost. Uh, just the So we're going to score the price of the option in the context of its history. So. Um, to answer your question the first way, Jonathan, relative to last year, at this time, these options are vastly more expensive. Remember last December, Uh,

the vix's was closing very consistently below ten. The realized volatility in the SMP was he was sort of half that, about five percent. Uh. Now you have the realized volatility about twenty, so up fifteen points from a year ago, and the options are up about ten points from a year ago. Um. So so in some ways this is the paradox. In some ways, options at twenty VIX right now are in some ways less expensive relative to the

realized volatility than they were last year. Last year the VIX was ten, but the realized was only five UM And so it's it's a tricky it's a tricky thing to answer, Um, what what do we need to sustain a VIX of twenty? You need movements in the SMP of about one point to one point three percent a day. So you need to run, you know, through through a

bunch of SMP handles. But frankly, that's what's been happening with a great degree of just to jump in and make it clearer, to make the judgment that implied vols cheap versus realized vol you have to believe that it lasts. That's exactly right. You when when you look at options and you compare and applied to realize, you're just looking backwards at the data that's already occurred. That's the realized And then, as you said, you're asking yourself, is this sustainable? Um? So,

a couple of things. They're one. We are about to head into this late seasonal period where we've got Thanksgiving and i'm sorry, Christmas and New Year's that tends to be a pretty bad time for volatility. Folks if they can try to shut it down and get away from the down. UM. Not not much to expect there, but but of course you've got these these headlines that keep hitting the markets uh as well, and those have been, you know, an engine for volatility. This has been wonderful.

We're gonna try to get this out on our podcast today, UH because it bears really listening for those trying to figure out the dynamics and the Greek letters of the option system. Mr Kurnitt is with maccar Risk Advisors, Dean Kern right now, while Sweeney in New York. I'm Tom keenan Brussels and joining us. There's someone who can give us great perspective on I'm gonna call it sort of

the zeitgeist beat at the moment. Gabriel Santos is with JP Morgan and Gabriel it's become so fashionable in the last ten weeks to say get back into e M. I get it, e M bad market down and I guess it becomes a value, but I'm not sure I see the economic data that tells me that whether e M A your JP Morgan. Yeah, Tom, So it's great to be here with you. Um, definitely a much more difficult ear for emerging markets than we expected. Uh. And I think really you just see that reflected and sentiment

very very clearly. We've seen multiples contracting a lot for emerging market equities, we've seen currencies weakening. So sentiment is just incredibly negative right now when we look at the actual data, UM, we are not in crisis mode in emerging markets, unlike back in UH, I'm not sure it's necessarily a twelve with twelve month window we're talking about here right for emerging markets, that tends to be a fee store famine. I like to think it more over

a multi year process. Uh. And there I think if you still don't have a lot of exposure to emerging markets, as a lot of US based investors tend not to, then now is a good time to slowly add back in, but with a multi year window in mind here, So, Gabriela, back here in in in the US, UM, the R word, as in recession is being bannied about it seemingly increasingly every week. Is a recession in your forecast for nineteen? If not, what what are some of the risks that

could push us into recession? So it's also become I think, very fashionable to talk about recession in the US these days and to try to ascribe a specific year and month to it, with late becoming UH consensus. I think our view though, is when you look at the actual data, it does not sport that kind of call, especially when you look at the consumer, which of course is seventy of the US economy, who just got some very strong retail sales this morning. UH. Consumption has been very strong

here in for next year. We can't sustain that kind of pace of consumption. It's been three three and a half percent, four percent in the second quarter. We have to slow down, but you can still see consumption growing at two percent next year with with difficulty in seeing what can really knock that off course absent let's see a spike in inflation or a big shock that all of a sudden leads businesses to, you know, go into

layoffs for example. UH. So for US we acknowledge where later on in the cycle the probability goes up of a recession over the next few years. But I think it's very hard to say that it has to be in given such a strong consumer. Right, So, given that fairly constructive outlook for where are you advising your clients

in terms of asset allocations at when these versus fixed income? Yeah, and so the clients that we speak to an asset management tend to have a longer term horizon in view right there, planning for retirement, for paying for college, for things like that. Um, So in that environment, we would still tend to prefer to be slightly overweight the equity piece to the fixed income piece. But we have been talking to our clients about slowly dimming the dials a

little bit and what we need. What does that mean mean by that tom um is slowly starting to bring risk down. So let's say, you know, when I was sitting here with with you, let's say a year a year and a half ago, we were saying, we're very bullish, go very very overweight the equity piece, let's call it EUC.

We're not in that kind of conversation anymore. It's probably closer to your to your neutral uh closer, And I think it's it becomes more important also to take a look beneath the hood, right really taking a look at actual quality company is taking a look at the kind of leverage companies have. We're starting to see that really play out this year is single digit in our minds. Yet we keep talking about this in the media, and experts like you talk about single digit. I don't buy

it for a minute. People are addicted to twelve percent a year, and that is a conversation. We tend to have a lot um. You know, you look at returns over the last ten years, you have had you know, double digit returns and equity markets, so that feels normal. That's because Paul Sweeney bought Netflix at two. That feels like something one should be counting on for the next decade. However, Tom, we really do think it is more of a mid

single digit world, whether it's equities or sixty portfolio. What we pencil in for the next decade is closer to five and a half annualized. So that's much lower, I think than what people do in their mental math. So you know, we've got to be more active about it. You've got to have emerging markets, um you should. You know, also can think about adding some alternatives to try to boose that and also just save more. I think compare to perhaps when people have penciling in their minds. Gabriel

Sensi thank you so much. Greatly appreciate it with JP Morgan. Thanks for listening to the Bloomberg Surveillance podcast. Subscribe and listen to interviews on Apple Podcasts, SoundCloud, or whichever podcast platform you prefer. I'm on Twitter at Tom Keane before the podcast. You can always catch us worldwide. I'm Bloomberg Radio