Surveillance: Kass Says Investors Underpricing Risk

knee deep in CPI reachs, house sounds. I think this morning's time has come to have a little bit more of a deeper think about what's happening. You've compared crisis to recession, from crisis to recession and rat us distinction between the two. Can just walk me through that right now? Sure, Good morning, John, and good morning Time, Good morning Lisa, Thanks for having me on. A crisis is a downturn or an adverse situation where you don't have a policy response.

And that's where we were a year ago. All right, we had a pandemic. We had no solution for it other than to shut everything down. That wasn't a good solution. So with no good policy response, you have a crisis, that's my definition. And but we're in right now. What the crisis did was it created a recession, and in a recession, we know what we have to do, alright. The problem with this recession, which is different in so many ways from all the recessions before it, is that

most of our policy tools already exhausted. So going into a period where we normally would expect to see policy supporting reemployment, re engagement of people in the workforce, growth of the economy, and so forth, policy is pretty much hamstrung and is already doing all that it can do. Carl, you are a legendary across the time of Lehman Brothers into World Crisis two and three, four decades ago, of watching gloom turn into not optimism but a good workout.

Are we just impatient right now? Are we just impatient worried about fixing things in three months that may take three years to fix? Yeah, three years would be a conservative estimate of history as any guide. You know, some of the people in the market at least these days were also in the market in two thousand and two thousand and nine, And people forget that. Even though GDP got back to where it was prior to the global

financial crisis in just two years. The unemployment rate didn't regain two thousand and eight levels until a decade later. And that kind of delay and employment is actually normal. It's why we have recessions. Right, Recessions are a purge of excesses, so firms hire too many workers, right, it's easier there that uh, we we purge. We find we can do just as much with fewer workers in a recession, and then it's very, very slow to bring those workers

back on forward. Firms are reluctant to bring them back. So I think that we are overly optimistic and expecting that everything's going to get back to the way where it was by the end of this year, and especially in the labor market. And if the abor market is now our criteria for changing monetary policy, than recovery or changes or renormalization of monetary policy is going to be further out than most people expect. Carl, are you saying when you say policy is hamstrung, that the Federal Reserve

is out of tools to fight another recession. Well, I think that they've extended about as much as they can go in terms of q E. I mean technically they could go further than that, but practically will they do that? Will they take the heat if there were another downturn, if there was another shock right now, what would the FIT do? What could the FIT plausibly do without unsettling financial markets? And on the fiscal side, it's clear that there's not a lot of appetite anywhere in the world

for more deficit spending, yet that is what would be required. Remember, with fiscal policy, it doesn't increase growth unless you get more of it each year. So running bigger deficits than we saw last year next year, I think as a nonstarter. Even in the most dire circle stances, it's gonna catchhop Has so wise to get your input on this show

ahead of a big week for this market. Gun, it's the Fed next week, cal wand back that high frequency can always chief economist and managing direct d Okay, we're gonna stop the show. This is what we do. We talked to smart smart people Imperial College in London, Johns Hopkins. We've done a lot of at work with Thank you Mr Bloomberg for that. I think of University Washington Microbiology.

Joshua Scharstein from Johns Hopkins with us today and we're just gonna flat out stop, Joshua after I'm teen months and brilliant people like you trying to extricate a seal from this pandemic. To celebrate that one million kids will go back to school in New York City today, I mean, it's just a huge deal in New York City back to school. Let's cut to the chase. Is it gonna be safe? How do you go back to school and

be safe if you're not vaccinated under twelve years old? Well, I think it's gonna be uh, pretty safe because New York is taking as many precautions as it possibly can take. It's really important for kids to be back in school.

So you're right, it is a really great thing that they're doing it, but it's going to require, you know, a vigilance and it's going to require these different mitigation steps, masking, um testing, other kinds of things until we really get a handle on what the delta virus does in schools, particularly for younger kids. Link your knowledge of the unvaccinated, including the runner up at the US Open I believe

is unvaccinated on the male side, Djokovic. Link the unvaccinated across this nation with kids and teachers and staff going back to school. Well, one thing that's been clear is that UM states with more people who are unvaccinated are also seeing many more sick kids, particularly young sick kids. And that's probably because adults who are unvaccinated who gets sick can really infect kids effectively, and adults who are vaccinated are it's much harder for them to infect kids.

And so I think that one of the ways we can protect kids is to have adults generally vaccinated. A second way is to have adults in schools vaccinated. And so I'm very supportive of policies that that that require adults in schools to be vaccinated. It's absolutely for the safety of the kids. Dr. Scharfsine almost every parent out there is going to get a dreaded email one morning and the next couple of weeks saying somebody and your kids school was diagnosed with COVID. Don't worry or worry

you have to quarantine or not quarantine. What is the correct protocol if someone is in contact or within six feet for say, ten straight minutes, even if they are masked in a school. So UM, what I would say is it's really important for them to be good communication about this and to explain to parents as much as possible exactly how this will be handled, and then follow through on that rather in surprise everyone the first time there's a positive test, it is going to be expected

that that that may happen. Here's how we're going to deal with it. UM, and I think that in general UM, it is certainly for UM for kids who have vaccinated. Older kids who are vaccinated, they do not necessarily, according to the CDC, I think, need to be quarantined. Some schools may want to do that out of an abundance of caution. Others may want to try to use tests, for example, to keep kids in school. They're going to

be a few different practices. I think the most important thing is that they're explained clearly to parents and that the school is monitoring whether their particular approach works and it's flexible to changing UM if necessary based on what they see. Early in the school year, Dr Scharfson, the start of the New York City school year really highlights how people are trying to get back to some semblance of normal. People are saying, get back to the office.

City workers have to be back in person, and yet it is pock marked by all these notices and by the ongoing spread of the virus. When do we get to some sort of equilibrium or we're heading into a really perilous fall where people are trying to act like everything is normal when it is anything. But I think that we're headed right now into a bit of a new normal. You know, we can go to work, but we may need to wear a mask in the workplace or make sure everybody is vaccinated. UM, and the people

need to be a little bit more vigilant. I think we're going to be in that period for a while at least until cases really go down. UM, and we you know, get a little bit more of a distance between us and the virus. That obviously depends on where you are in the country in this situation. But for example, at our school, you know, we're we have kids back in class. Um, we have a little bit more distance than usual, fewer people in the classroom, but they can sit you know, three ft away with a mask on

and um, and everybody is vaccinated. So you know, we have a new normal. But we're excited to be in the classroom and teaching. And I've been doing some of that. I think it's fantasy, like so you and many others anticipating a bit of a problem this fold into WINSA Well. I mean, I'll tell you my kids actually went back back to school a little bit early because they go

to a charter school. And I will just tell you that they actually have already had to stay home for a week as a result, John, of this idea that they have been quarantined and basically somebody was exposed to scot started Lisa. I'm telling you it was the second week. So I just wonder what kind of provisions do people make to potentially have childcare when they have to go back to the office. Your experience, Leasa, the experience of so many right now, so keen across this country. Yeah,

it is. And you know, I think what's so important here, John, is the idea of how it linkson Joe Biden stridency. The President has made clear this is strident, but he talked enough about the schools within that stridency. Joshua going to leave it. They're gonna catch up. Joshua shafting there, Johns Hopkins Blinbo School of Public Health, Weinstein, do we get to Francisco the international standard out of London, Francisco blage Bank America ahead of global commodatives and too rivets

of research got to catch up. Francisco. Let's just start with what's going on with aluminum aluminium three K. What's happening is this old supply scarcity. UH. In the Jonathan there's a there's supply scarcity on a couple of different fronts. We've had, of course, UH a coo of tieing Guinea, which is created some anxiety around book side supplies. Book Side is the ingredient into alumina, which in turn as the key ingredients into aluminum or aluminium um so um so.

We we've had shortages there because of cool and but then more importantly, China has been curving aluminum supplies now for most of the most of the year because um they're trying to rain in power generation become cleaner. And remember it's been a low rainfall year in China. It's one of the reasons they've been trying to crack down on bitcoin too. So third generation is very strong, but it's mostly again filling the gap for that lack of

hydro power. So so if you look at the liminum production year to date in China's kind of flat as a pancake. Demand's kept growing. We hold this liquar in the system and and that's what's pushing prices higher. Francisco, I saw the London Medals index of Bloomberg indexes as well, show Medals as a group doing better. We know the Bloomberg Commodity index has done better as well. Does it

signal the commodities breakout? Can you call a bullmarket in commodities? Um? Well, I mean we you know, uh, Tom, we we've had a bit of a bull market already for a while, uh since since we hit the lowest back in April last year. So um, we remained constructive here. We we think prices of Marty's most commodities will keep going higher. But again, independs on where you look at. I remember iron ore has been coming down very hard since Valley

started exporting more volumes. But then oil, on the other hand, it's kind of sitting. It's a bit of a boiling frog waiting for the winter. And natural gas, of course is ripped around the world and also dragging up us mad gats with it. So it depends where you look at. But in world terms, commorities are very strong because we have a little liquid in the system. We are growing,

we have supply constraints, we have low inventories. It's kind of a perfect cocktail for commorities to keep breaking higher. And when you talk about oil and the cold winter, there was a note that I believe your team put out that you do see the potential for a hundred dollar barrel oil in the United States and elsewhere based on what supplies are doing. Just want to bring you these headlines. OPEC see stronger demand for its crew this year and next at the same time, non opeque output

is supposed to be down. And this really directly speaks to the shale patch. What's the tipping point at which point we start to see UH supplies go up to meet the demand and regulate well. So so I think I think right now we have a very short window into the winter. We're all still UH wearing flip flow ups and shorts in the northern hemisphere, but that's not changed very quickly. Within a month or two, get cold,

you can get very cold. I think natural gas is gonna be very strong and if if it breaks out, and remember we're already trading over twenty dosp mb tu, which is a hundred and twenty barrel foil equivalent in oil um and we go another ten bucks higher on then for mbtu, which would put US at a hundred

and eighty dollars per prepared barrel foil equivalent. I think that would drug up the entire oil sector because people will look for cheaper sources of of of of bt us of calorific value for for heating and for power generation. We see a very strong bunker fuel marketing Singapore already because of that recent So I'm a little concerned that, um, the winter gets cold, we're gonna see, uh, the entire energy complex ripping higher. Francisco, what does the move in

these commodities say about the resurgence of the Pacific rim Um? Well, I mean, I think the Pacific rim is is definitely coming back. Now. The one thing I would notice that China is a little softer. And remember one thing we've we've been tracking with with a lot of interest this what's going on in the property sector in China with ever grands bonds coming down very hard, Chinese new lawn issues also slowing down materially over the last few months. UM and that's one thing that you know, we we

keep a close eye on. But but generally the the Asia Pacific ram, the back ram as reported, it's definitely coming back with force. And remember over the next six months we're gonna have a huge search in vaccinations which will restart air travel. So we think a hundred oil is more likely next summer when we all start flying internationally much more um in in in a much much greater way. Otherwise it may happen sooner if the winter turn is very cold. But the pack rim is definitely

coming back. But it's a triple digit crew price the base case for you, Francisco, it's not your base case. Now. We we have are are we have a call for a hundred oil for next summer. What we are saying is if the winter is called, we would roll We could roll that up six months and it may have been this winter. Wow. But again, um, you know we're gonna type market for for energy and oil is again

it's still benefiting from OPEC excess capacity. But we don't have the the amount of shale available over a shore window of time to to meet that call if if the weather gets cold, Francisco, just an amazing cool, and we want you to come back again soon so we can talk about that the prospect that cool comes in six months. Francisco Blige their bank for America. Let's get straight to the quote of this morning. We've been jokingly calling this rally the d Sharon or Dave Matthews rally.

Essentially it is a rally that nobody likes, and yet it continues to go up. The author of that quote, and please to say as with us now, I mean with Silverman, RBC Capital Markets, Equity derivative strategist Amy, let's start right there. Any reason for that to change anytime soon?

So guys, so far no, you know, I was watching the draw down, you know, the past week with great interest because the option sentiment has been so glum through your end, and you know, once usually you get kind of a breather, it kind of comes off, and the reality is it hasn't. So you know, we remain glum.

We remain with demand for downside protection and even despite the move down, you know, that has kind of stayed solid, which just tells you that sentiment UH is still kind of saying this is this is unloved and they're waiting for even further of a move amy the week, the weekends, the week begins, and we have to focus on acuity here away from the lyrics of Ed shere And and Dave Matthews. You've created a firestorm out in the street with your vicious, mean spirited note. Give us the acuity

right now of why you can own equities. Yeah. Look, I think part of it is because the market is well hedged. We are very well positioned to the downside. I'll give you guys one step that I think really puts this in the context. You know, if you just sold one of these temper cent how the money put options on the SMP in October, Right now, you can buy the equivalent sixty times the upside. Now, just to provide some history on that metric, back in July that

was at fifteen times. So what that's telling you is the market is ready for the market going down. Um, and oftentimes when that happens that the reverse is not true. Right, the market is not ready for the market going up. And so you know that brings you to a potential path if something good does happen of people climbing having to scramble to get that leverage on the upside. Well, I can say, Amy's I'm sure you've got a lot of push back on the Dave Matthews point, especially based

on some of the people who read your notes. A lot of people like Dave Matthews, and we can discuss that in detail. They that's the hard way. Yeah, exactly, not a lot of haymail Um. There is a question about how people are looking at inflation, how people are

looking at margin pressures. And one thing that you said in your note that I thought was fascinating is the options market is not pricing in concern at all for a six month period or twelve month period for inflation in the consumer staples, however, not really the case in industrials. Can you explain, Yeah, you know, I think it's important because we kind of talk about inflation in this broad umbrella, and the reality is obviously different sectors are going to

be impacted differently. You know, when you look at consumer staples on a two month period, when you look at the names in it, like a Kroger for example, where you know it is down nine percent last week, you're seeing it short term, and yet that disappears over a six month period and a twelve month period when you look at those relative implied volatilities completely the opposite truest industrials. Now, you know, as I mentioned my notes, some of this

is tax related. But what this tells me is, look, if you believe that the cost pressures do remain in consumer staples over the longer term, that options market pricing has not put that there yet, So that is an opportunity to own those puts within that sector specifically. I think that's how you have to play inflation concerns right now.

How much is this the way that people are looking at the market rather than go along a particular sector, They're looking at how margin pressures are being priced in specific sectors and trying to get ahead of things that way. Yeah, I think, Look, it's gonna go sector by sector, Lisa, it's also going to go stock by stock, So you know, we're really focused on where we see that change in

auction sentiment. And you know stop by stop program for example, you know that the normalized skew in that name is at a two year high, so essentially the demand for downside protection. Again, this is even after it's gone down nine percent. That's what I think is key for people to remember it's you know, after you've had that moved down, oftentimes hedges are removed. This is not what is happening in names where you continue to see that inflation pressure,

so people think it will continue to go down. Okay, So I mean after this, I'm in love with the shape of this market. You know that's great. It's an actually go out there, folks and read edge sheering lyrics. It's um telling, you know, good jokes that needs to be explained, tak. So we're in love with the shape of this market. But the reason why the skew is the way it is. You know that Shearing taught me the Greek letters. The reason that the skews the way it is is fear. How do you know when to

step into fear and go along? Yeah? You know, Look you don't. I wish I did. It's always about timing, right, you don't. You know. The way I kind of think about it is what could possibly drive you know, this market to the upside. What Lisa said earlier about just the childcare point, I feel deeply personally because I have two school aged children. But look, if you get a vaccine earlier than expected for the under twelve crowd, right,

the crowd that actually needs childcare infrastructure. That's something that could potentially bring this market up the same with you know, better than expected NFP data point. Again, you know, the timing is always difficult. The point is just that the positioning is really not to be upside at all with it. I mean, that's some important let's finish that. Do you think that authorization for children could have a similar effect on this market in the same way that we saw

things developed in early November last year? Yeah, you know, look, I'm not a medical expert, but I think that that this is one of those things where you just kind of know personally if you're if you're living through it, right, Like, if if this is something that you know that you can safely send your children to school and so you're not you know, calling a backubsider at the eleventh hour because you still have to go to the office and you know you can't leave a seven year at home,

then then sure, of course it helps that that makes it so the stability of the return to work is is something that can happen. I mean, thank you, thank you for catching up with this morning, and we sail them in that and obviously, capital markets Postmanian time keen are the most important conversation of the day on the here and now. Mr Cass is with us this morning.

Douglas Cass, he reads investment, and his people briefed us this morning that we are not talking about the New York Yankees, the Boston Red Sax or the Toronto Blue Juice. Here nowhere, the Toronto's du Casse Good morning. Market breadth represents the total number of stacks that are increasing as opposed to the number of stacks that are undergoing a decline. You are focused, I am focused. I'm fearful about the equity market, and I'm basically of the view that investors

are underpricing risk UM. Investors today are really wildly bullish UM, despite a long laundry list of uncertainties and despite um a wide range of possible economic outcomes, there's virtually no one looking for anything other than a garden variety correction

at most. And as a measure of that optimism, Bank of America conducted a survey of their private wealth clients represented over three trillion dollars in assets, and their investors are at sixty in stocks and then all time high and Today's and you've just been discussing this for the past week. Today's strategists offer very precise and sometimes preposterous price targets at that reflective optimism that economic growth will not be threatened by inflation, by hierocaust, by continued supply

dis locations, by higher taxes, etcetera. The government's debtload and even higher deficits. Um. Yeah, a few strategists have recently voiced some short term concern pol Tom, but look at the shallowness of their downside targets. There is a unanimity that dips it A buy forgetting about draw downs over history, and as I said to you last time, Grandma co Fax taught me a more balanced way to look at the markets. She taught me to always look over my

shoulder because the Cossacks may be attacking us. So you could describe me now as the anti ethel merman who I prefer over edge Shearon and Dave Matthews. Everything doesn't always come up roses, and I would describe the market a little differently. I prefer the lyrics of Jerry see You to Dave Matthews from the Grateful Dead song Ripple. There is a road but it's no simple highway between the dawn and the dark. So I see things differently

than the bulls. And I would end by saying, among other things, when when Pale tells us that inflation is transitory, I'm reminded of that great scene and Princess Bride when a Nigo Montoyo tells Vessini, I do not think the word means what you think it means. Yeah. Yeah. Shoutout to Lisianne Sanders, who, like Doug, cast channel the past and excellence and mentioned the Stones in Philadelphia in Doug Paul's got a bunch of adult questions. Just one quick

question for you. Is our pontification about equities now shattered or changed because of all these media and social media. Well, that's a question. That's a great question. I would look. I would I have a different take on that. I think it's shattered because we rarely discuss the dangers associated

with the evolution of market structure. Um. You know, in the old days when we started talking to each other, the dominant investor used to be active investors like mutual funds and hedge funds, and today our markets are dominated by these passive investors E. T. F and quant strategies UM. I reminded of a quote that Warren Buffett said in two thousand six when he was talking about derivetives being financial weapons of mass destruction that led to the Great

Financial Crisis. He said, beware of geeks bearing formulas UM. So today the geek's account for over sevent the trading volume UH, and so Warrant's comments could apply to the risk parity voice and the quants today. So I don't think there's a I think there's a non trivial danger in this transition. As passive investors know everything about price but nothing about value. They act and are in herds. They feast on price momentum, that's their prey. They don't

consider reward versus risk. They're not c f as they know nothing about discount the dividend models. Um. They never looked at a balance sheet or a P and L statement and have no emotions because their algales and machines to take their strategies. So any inflection point momentum can lead to these abrupt and changes and even an avalanche of selling. Look what happened on Friday. S and P s were up twenty eight handles at nine thirty in the morning. They closed sixty handles lower the end the

day minus thirty four. There was no new news. It just happened. It's sort of like when the Yankees won thirteen in a row and then went you know, they went two for eight in the next ten ten games. You know, I'm looking at the Yankee schedule here, and I mean they end brutal three games with Toronto. You promised me the three games with Tampa. The Yankees are the toughest season clothes of any team, I mean Tampa Bay. Since when do we fear Tampa today? You have to

you have to alight? Can I can? I just mentioned one thing about stocks. Um You know. I usually come on and I have these cautious remarks, um um, you know, and I am concerned about the fragility of the economy, our market structure, and other reasons like stagflation. But I see some really extraordinary long opportunities today in deeper value and hated market sectors. The market has been so bifurcated. Um Can. I just mentioned very briefly one group that

I'm buying aggressively. It was a year ago in bank stocks. I think that we're in a generational loaf of cannabis stocks. And it's not dissimilar to when the SMP was at six sixty six on that faithful day in March of two thou nine, when I was on the Larry Cudlow Show and talking about a generational low in stocks. I think that cannabis represents a single best reward versus risk on the longside of any sector that I have encountered.

In the last decade. UM. Most of the major industry players are improved their franchises the footprints while the government deals with the Safe Banking Act and legalization, both of which I see happening during the next couple of months UM. But they've been increasingly profitable while legislative debate. Today, most institutionals can't even buy the stocks because they're on the pitch sheets or trade in candidate. But these are artificial constraints, and I'm buying M S O S, which is the

largest et the pink sheets. Is what the reason folks done casses live in large in Florida. You and Tom are grizzled veterans down putting it politely there, Um, you don't fight the FED is something we all learned a long time ago. If the FED is going to be more or less our friend, doesn't that support stocks? You know? Um, I would say the record high stock prices, the generational low and interest rates and the extreme valuations that we see today are fertile ground for bogus and new narratives

and paradigms. It's kind of the polar opposite of the dire pessimism. Again in March nine, do you remember a famous UH column published in wire by Peter Schwartz and Peter Leyden during the dot com boom when they talked about a long economic boon. Remember, all right, Well that famous It pushed the dot com stocks to new highs. And three years after that column there was an eight collapse in the nastacs. Seven years later there was a

great financial crisis. Um. The mantra that sky high valuations are now suddenly acceptable as interest rates well to almost zero has provided today's rational and popular narrative. But low rates provide the roots to historically high value valuations. And I would counter the teno argument with the statement that there's a fundamental problem with the low rates argument, that we may be comparing, oh, one over valued asset class

to another. You know, you know, a year and a half ago, when I like the dividing yield on the SMP, sedd that of the tenure. Today the dividing yield on the SMP is down to one point to eight. It's the lowest in twenty years and not far from the record low of one pen in two thousand. I get fifteen seconds. Michael from the Pocono's ask should he buy Amazon? Buy Amazon and put it away? Yet? There you go, There you go, Doug Cass, Thank you so much, greatly

appreciate it. Next time, Doune Cass on Jay's Rays and Yankees. This is the Bloomberg Surveillance Podcast. Thanks for listening. Join us live weekdays from seven to ten am Eastern on Bloomberg Radio and on Bloomberg Television each day from six to nine am for insight from the best in economics, finance, investment, and international relations. And subscribe to the Surveillance podcast on Apple podcast, SoundCloud, Bloomberg dot com, and of course on

the terminal. I'm I'm keen in. This is Bloomer