Surveillance: Margin Pressure With Wilson

as always serving. Let's start with margin has been a big thing for us this morning. A lot of people think that maybe this margin story, which has held up in corporate America, that story can persist into a new year. Do you think it can? Well, look, I mean I think margins have surprise on the upside. That was really the call last year, which always happens, as you know,

coming out of recession you get operating leverage. This time it was extraordinary because you had policy support essentially subsidize the unemployment that was out there. Right People were home, but they were still getting checks from the government and they could spend it digitally. So that is unique. Um, and we see that being a problem going forward where people have made assumptions now that those extraordinary margins are

going to be carried forward. We see a couple of areas of particular consumer discretionary industrials, parts of the technology market look to be a little bit lofty in terms of margin expectations. That's where we are in the cycle. Um, we see no reason why it's gonna be any different. And because it was so acute on the upside with operating leverage on the upside, it's not going to be a surprised as if we see a little bit more margin degradations we go into two and that needs to

get baked into people's expectations. Mike, your great strength as a sell side analysts at Morgan Stanley, I know you and I are all Jack Welch one oh one on pricing power sector to sector analysts to analysts, what does your team say about the ability of corporations to adapt and generate pricing power? Yeah, it's it's the key question. I mean, there's gonna be companies that absolutely have pricing power. We've been, you know, looking for those types of companies

and our recommendations going forward. You know, one thing we've noticed time as you know, I mean, the market's gotten very narrow. Obviously we've seen companies, higher quality companies and larger cap companies who have scale um. The market is paying up for those now because those are the types of companies that typically have pricing power. Okay, So I mean that's the name of the game. It's like costs

are going up for everyone. So two areas I think you can look to to say maybe they'll be protected. Companies that don't have as big of a labor component. We do think labor is going to be an issue not just for the economy, but the for the fit Ultimately that they're gonna have to tap down there and

and that's that that that's gonna be. You know. So technology companies as an example, where they don't have as much labor um, they can maybe managed student and of course scale always gives you the ability to kind of spread costs across a bigger slater revenue. So, Mike, does this mean tech continues to outperform and other types of sectors the ones that lead the move lower Where you see the SMP ending the year below, where we are now now I think technology has gotten a double boost here, Lisa.

I mean, it's obvious candidate for you know, pricing power or the ability to kind of manage costs, but it also is probably the single biggest beneficiary of this incredibly move move lower in rates at the back end, which doesn't really jibe with what's going on in the really economy. We know why that's happening. The fend has been ultra slow, ultra dubbish to to kind of get off the maximum accommodation mode. And and so that's been baked in now.

So as rates move higher, which is our call for the rest of this year, you know, the valuation on some of these long duration TEX stacks will offset their ability to generate the earnings growth that's been spectacular, Mike, What does that mean for your index level? Cool going into year round? Because you have looked for that index level correction as we work on way through this mid cycle transition. Where are we now, Mike? So we're you know,

we're working through that mid cycle transition. We're seeing corrections kind of happen around the market, but not at the end X level, which is typical to John, you know, and then it usually ends with an index level correction when the market can't find anywhere else to go where there's value. So we think we're kind of in the I don't know, six inning um. We probably have three or four months left to go for this med cycle transition.

Usually it ends with the FED finally moving forward with either a tightening like it did at ninety four or in O four, or some form of tapering or balance sheet running off um like it did in two thousand eleven. And we think it's no different this time. I mean, by the way, that's not a crazy statement. I mean, is there anybody in the planet who doesn't think the FED is going to be tapering next year? No? Well, in fact, if they're not tapering, then that we got

a serious problem. So the mid cycle transition will end with multiple you know, multiples coming down the index level because the FED is tightening policy. It's that simple, Mike. A lot of people expect the FED to tighten policy, and as you said, if they don't, that may become more of a problem. You said that the one point eight percent year on target for the ten year note actually could be conservative because the FED is so behind the curve and may be forced to raise rates faster

than expected. Play out what that would look like and when we would know that perhaps race should rise more and that would be later this year, right, it could be sooner than later this year. It could be next month, you know. I mean, let's see how the FED wants to communicate this path. I mean, maybe it starts at Jackson Hole, and maybe it starts in September, which is our bet that they start to communicate when they're gonna do this. And you know, but the other way to

think about, at least is the bomb market. You know, it's not stagnant. The bomb market will start to challenge the FED in their timing of that communication if it believes they're falling too far behind the curve. Right, I mean, we're we're basically close to full employment now based on you know, the wage increases that we're seeing in the commentary. We're hearing from companies like we don't really know what

neghru is. Maybe it's four percent, maybe it's four and a half, maybe it's five percent, we don't really know. What we do know is that labor supply has probably been impaired during the pandemic. Maybe permanently we'll find out, and you know, typically the FED is tightening policy long before we get the neighbor. They start the process. You know.

Once again, I don't think anybody would disagree with this statement, which is, does it seem right that we have emergency monetary accommodation at a time when the economy is growing six and a half percent real eight and a half nine percent nominally. That doesn't seem like it. Jibs and I think the delta variant is the market is same. Okay, let's see how the delta varian plays out. But if we find that the delta barian is fading, schools are reopening, we are going to get back to work. You know.

The BAB market can adjust quickly, very much like we saw in January and February, the last time that we were kind of out of consentus on the rate moves, you know, probably surprising at the upset. It's such a good final point, Mike, I'm gonna leave it that it's gonna catch up SA Michael Wilson, Morgan Stanley, Chief US Equity Strategists, and see a decade ago or even more, I should say I learned about field economics from Pascaline Dupart.

Her colleague is Esther Duflo, who won the Nobel Prize with Energy Energy and the Flow become definitive on poverty economics. That new effort out is good Economics for hard Times out in paperback today and Esther, congratulations again, not only on the acclaim you've received, but the persistency that you've worked with in studying poverty. And part of that is in one of the chapters of your book, the End

of Growth. Give us the optimism that growth is not ended. Oh, I don't know if I can give you the optimism. I think it depends if you have a left has food or left has empty type of person. Because the tooth is we don't know, We have no idea ghost does whatever it wants to do. Economies have found very difficult to predict how to do nurtur it. We know very went how to kill it. Venezuela is a good case study on how to kill ghoth. But once the basic conditions are there, we don't really know how to

nurturing it. So that's the bad news. But the good news also means that it also comes and goes and and and policy makers and economies can do a lot of things to make sure that once it's there, everyone in the economy, including the poor, take maximum advantage of it. I look at the idea of growth and poverty, and of course the foundation of this is Robert Solo at your M I T and the study of growth over the years. And the elephant in the room is technology

and its advantages. Can we process technology over to relieve poverty or is the benefits of technology the benefits of the elite. Well, another thing Bobsulo told us he was really one of the gen field is that technology is really the measure of our ignorance. And what it called technology is basically what we're not very good at measuring. And for the certain reasons, we don't know whether it helps or hot. And but it depends a little bit

on what we are doing. For example, if we have a new machines that replace workers, it happened during the Industrial Revolution, is happening again today with autovation with AI. There is no big law of economics that says that these workers will necessarily find another job, and there is no big law of economics that says that they want the tools. That it depends on whether their help, whether they are accompanied, whether they are trained in the new

technology to find new jobs. So there is a massive rule for policy and for policymaking to accompany the process of the diffusion of technology too, to all out our economies and to make it a post for good as oppose as a post for destruction. And a perfect example, frankly, is the technology that we've seen deployed for the m R and A and arculations that have at least helped save off some of the progress of the COVID nineteen virus.

One thing I find fascinating is that your book, which was first published in November two nine, focused intensely on the need to get vaccines across the world to prevent certain diseases. Why has there not been more money and more of a coordinated effort to create a network of vaccinations globally well before this pandemic. Well, what is really sad in a way is that to some extent this

network does exist. There is a very successful international initiative gold Gaby, that has been quite effective at promoting the spread of ammunition around the world before the COVID nineteen pandemic. Childhood a munician, and there has been a lot of progress in the decade starting two thousand uh till put thousand nineteen in childhood ammunition. And we haven't found a more effective or coustictive where to save life than childhood musician.

So when COVID nineteen pandemic came and thanks to technology and wonderful with that ingenuity and love effort and government funding, we had a vaccine so quickly this network was clear existing, but somehow to this date we haven't been able to mobilize it to uh with the code mine to immunize the entire world against COVID. And this is really sad

because in a sense it was there. It really wasn't going to take much more than money and single minded focused on the entire award and not just on the US or Professor Thank you so much, greatly, greatly appreciate this morning and celebration of her new effort with Professor Banerji as well. Right now, Joy Maryland Watson joins US with black Rock, head of Global Fundamental Fixed Income Strategy.

Her public service to the United Kingdom working at the Bank of England, noted Maryland, I look at the band market right now and it's a jumble. In fiscal stimulus in the United States, is the fiscal stimulus in the United States a global phenomenon or is it discreet to

the United States. So I think that the fiscal stimulus that we saw before certainly was a global phenomenon, and it certainly did help to promote growth globally, even though we did see these issues obviously with the pandemic and supply chain issues, UM and and global mobility really being restricted.

I think going forward, when we do see the new package coming through, it will be largely very pertinent to the US, particularly when you think when you look at the focus on infrastructure and on things that are very domestic to the US that wasstanding. I do think it was going to still have a significant impact globally as well, when you look at the demand that you might have for um, you know, for commodities from abroad, you look at the demand for various things that will feed into

the different packages. I do think it will have some impact globally, but this time around, I think it will be more pertinent to the US. How big will the impact be on the bond market? Maryland tends right now at one thirty three, Yeah, so the market I think is already pricing it into you know, to do it to a large degree. I think at the moment, I mean, when you look at the bond market, it really is very difficult to really understand why yields are still down

at this level. And I heard you know, your previous speakers and you saying that you know, we do think the tends will rise further throughout this year. I think at the moment, you know, the market is still digesting some negative news around covid um, and also it's still continuing to see this huge amount of suppression coming from the central banks. As you do start to get more from the FMC, as they do start to start to taper, start to withdraw this very very very comgeliative munship policy,

I think that will help to shift yields higher. And then I also think that you know you are seeing in the equity mark kits, you're seeing in the bond market as well, already pricing in the stimulus that you're going to come through from the fiscal as well. And we started to discriminate within credit Marly, and given what's happened with the data arrant in this country, I'm thinking of the likes of Carnival and others in the credit market, we're starting to discriminate a little bit more. I think

that's right. So obviously, at the beginning of the pandemic you did see quite a large amount of dispersion and discrimination between the different names. I think now again where you see that spreads are still incredibly tight, really across the board, across all sectors, when you look at the huge amount of crowding that we have in different asset classes and the sectors of the bond market, because again the Montro policy stimulus is really pushing investors down the

risk spectrum. Now, I think is the time where you really are to see a lot more from a bottom up perspective, and I think it's important as you start to look where to invest in the bond market at these incredibly tight spreads um and they're pretty rich valuations in general, then I think, you know, it's really, really really important that you really understand from a boss up perspective exactly the dynamics behind that company, behind the sector,

and you really have a very very high conviction in the bonds that you're buying. And I think we are starting to see that, and I think we'll see that further going forward, and it's incredibly important now Maryland. A lot of people have said that the credit cycle is dead. What you are saying is that it is not. And that is why it is so important to do bottom

up research. What does this credit cycle look like? Given where we are with treasury yields and given where we are with the balance sheets of corporate America that are pretty good. Yeah, they do look pretty good. And you know, I think I think there are quite a few positives when you look at the as you say, the balance sheets some of these corporates. When you think that even when the FED does start to reduce, you know, it's a covert amount of policy, it's still going to be

incredibly supportive for a very long time. And as the economy continues to do well, we're seeing this huge amount of demand. And you spake earlier about the demand supply um, you know imbalance that still will take some time to correct.

I think we're going to continue to see a lot more demand going forward, and this is going to bode I think very well, particularly those companies that have already been investing that are going to be investing in you know there in technology communications, They're going to be improving their supply chains, and I think that those companies will do well as we see growth continue to you know, carry on at this very very robust pace that we're seeing.

All right, Marylyn, what's more important for an investor clipping coupons and a company that looks like it has a promising trajectory, even if that coupon is a lot lower, or searching for some sort of growth story at a time when the economy does seem to be expanding and when the consumer does have a lot of money to spend well. I actually think that you need a balance

of both. It's very hard at the moment. You really have to do a lot of altimate research to find those companies where you are going to see the significant growth and you can really capture the price appreciation, so to speak. Um. I also think it's important to find, you know, in the bond market areas of carry where you can get that steady income that you need. It

also depends on the investor. So we've seen, you know, the huge continuing amount of demand even for juries from patient funds that have very very good funding status, is from investors from abroad. You're continuing to see investors, corporate investors investing in um, you know, corporate bonds, even high yield where they're looking for a little bit more carry

to match their liabilities. So I think both are important, but I think really understanding the liquidity of those positions, understanding the risk award dynamic, understanding the potential volatility of all very important. And actually think a very well constructed balanced portfolio is the most important thing. Now, thank you, It's going to catch up. As always Marin and Watson,

their blackdog head of global fundamental fixed income strategy. The research report is so important for Doug has Paul Sweeney that we've got to get right to it. But have you noticed like Brett Gardner just endures. Every time I hear somebody say we need to trade in orcutto I'm like you crazy, if for no other reason, then he shows up every day. No oblique, there's no oblique tears, there's no I know everybody hit two. He's there every day. Doug Cass joins us to further the conversation now with

Seabres Partners. Brett Gardner, would you trade him? Doug, so much to say about the markets in the red sox, but so little time. All I could say is the last time I appeared Paul with you and Tom, the odds makers I mentioned had the Yankees out of four percent odds of making the playoffs. As I said on the show, I made that bet. Now the odds opposed to Tampa Bay. Toronto and the Yankees have each one eight of the last ten ball game. The Red Sox have lost eight of the last ten. It's August for

the Red Sox. You know Latin, I say, races loqual Tour. Yeah, it's the It's the August of my many childhoods as well. Doug. Let's move on to the markets. In an important research note from you yesterday, with a single sentence, well, I would distill my my current view by twisting around a

quote from a student of Bob Farrell, Walt Eamer. Now, while he, like Bob, is a legendary technical analyst who worked at Putnam when I was there, And while he used to say, when the time comes to buy, you won't want to, so I say, now twisting around his quote, when the when the time comes to sell or short, you won't to you won't want to either. I think we're in a well defined tug of war. On one hand, we have a quickening federal debt spiral that is now

out of control. The rate of domestic economic growth is decelerating. We have a mark slow down in China, which has been the engine of global growth over the last twenty years. The federal reserve is like the dissume pivot. Inflation and inflationary expectations are climbing. Course pressures are intensifying. There's an acceleration in the spread of delta variant and the individual and corporate tax rates moving higher. Moreover, and this is

really important. I touched on it last time. A lot of demand has to pull forward, as we learned in the quarterly releases at Apple, Amazon and terrorists, Facebook, Netflix and many others, and that pull forward is now ending as people begin to normalize the life their lies. I think to make matters worse. Historic valuations based upon all traditional metrics, mostly at all time highs. In fact, I have fifteen metrics on the SMPS valuation and three quarters

of them are at the historic percentile. Now we have to be balanced, and on the other hand, the positives are also pretty clear. The offset to my concerns is obviously something you touched on in the last segment. The tailwind of liquidity. Last time I was with you and Paul I stated that if we grafted the Fed's balance sheet with the SMP index, it's a perfect fit. It's a high R squared or coefficient determination. And for the CFAs out there, I know you reference the failing rate

of CFAs over the last twelve months. Our square is basically the proportion of the variation. Here we go in a dependent variable from an independent vable Bob Shill. Of course, so for some time it's been clear to end this modern and undisciplined physical and monetary policy, coupled with the market structure, have been the primary determinant of market support. And it could be argued today that investors are the least informed and least educated because the role Listen to you, Yeah,

it's true. I mean just that was like a dis no no, no, no, no. Look look look I'm ripping up the street the script to use your phrase. Unlike a lot of very confident guests parading in the media, I don't have all the answers. I'm often wrong, I'm always in doubt, and I recognize that the market will do the best to twist around the consensus. I remember Grandma co Fax used to tell me always look over

my shoulder because the Cossacks might be coming. So when I questioned my investment sanity, as I do today, I go to people like Leekoverman and Howard Marks and I give him a call. And arguably the best go to guy, the greatest investment hit or of all time to use a baseball metaphor are Ruth Garrig and Williams combined is

stand the Man. And I don't mean stand usual, I mean stan Drucket Miller and And just to conclude, if you, if you, if your listeners, go to YouTube and search USC Marshall School of Business speech that Stanley just he allies the unusual state uh and highly recommend it. It runs only twenty five minutes. It's available for free. Discusses

the uniqueness of this time in our economic monogue. Dog, I read your note, and you know a lot of the items that you just noted went through in terms of the challenges for this market, some of them have been there for a while. Do you have a catalyst in mind that you think will kind of bring these to the four for the marketplace? That's the best question ever, because every night it keeps me awake, you know what is going to make me. I really launched Sea Breeze

Partners my hedge fund on July one. I was absent in the hedge fund business rate years after recovering from cancer, and I have been slightly net short since then for the last five weeks, and we're actually in the black, which is a good accomplishment. UM. To me, the single most important factor will be a sustained UM level of the ten year yield and excess at one point three, and I think we're moving in that direction. So the the issue here is I think the market probably Doug

is saying, Okay, we understand tapering is coming. We understand that rates are likely going up certainly, you know it's called it perhaps um, But we have faith in this fed and that that seems to be what we hear. Is that faith not enough? It's not enough, you know. Webster defines a Ponzi scheme as an investment swindle in which some early investors have paid off with money put up by ladder ones in order to encourage more and more risks, bigger risks, and our economic policy Paul is

beginning to look that way. We have massive government spending it's benefiting current citizens and being financed by taking enormous amounts of debt which will um burden our future citizens um As a result, we live in a world where economic health is a bit of an artificially created illusion in both the market. The stock market and the bond market have stored as a result. The question is whether, as you put it, this is sustainable, and what are

the consequences if it is not so? In a sense, I think Tom and Paul, and I'm not being hyperbolic, we could be witnessing the biggest Ponzi scheme in history. So the risk, especially at current valuations, is extraordinary, and it seems to me that with a substantial recovery underway, the Fed should immediately begin to reduce its artificial support which is so distorted the economy in our markets. Doug Cass quickly here on Amazon, you've got a short term view,

You've got a bullish lung term view. Doug Cass on Amazon, I'm a buyer thirty fifty after having sold it uh right before the disappointing second quarter release. The stock immediately fell three thirty points dollars in the next day. Again, that was an example, as I referenced of pulling forward demand, I think the stock will trade in a pretty narrow range, and I would be a buyer at that level. We wanted to get a breath of fresh air always with

a g F Investments. Greg Villier on our political system, Greg, I am so fed up with a cluelessness that also editors are the same. I consider the Senator from Vermont winning six of the vote in his last go around, and I look at Tina Smith in Minneapolis, who we featured earlier in Minnesota, who I think was winning with or something like that. I mean, there's a lot of people like the Senator from Minnesota right now that have

to step very carefully in these two uh proposals. Absolutely taught this first one we'll get in a few hours. We all know that. But I am not euphoric that this somehow means we've got this done. The really heavy lifting now comes on the second bill, which would have three point five trillion dollars in spending in new taxes. That's crazy. It's never gonna happen, and people like Tina Smith know it, and at some point they're going to have to give this bill a very big haircut. Is

is it a new deal? I mean, I get the politics and I get the symbol. Is Greg your expert on the breadth of history of our politics? Is it a Biden new deal? Yes? It is to a large extent. It's the biggest new deal type of spending sense f DR. If we got what they proposed yesterday, and I would argue that three point five trillion could quickly go down to two five, maybe the two maybe even below that,

I think we'll get a bill. But there are some big, big obstacles, the death ceiling, the fact that a smaller price tag would infuriate the progressives like Alexanderocascio Cortez, who has votes that she could put into this fight. So the fall is going to be a ferocious fight. And just because we get a deal today does not portend

that we're going to get a deal in two months. Greg, how far can the fifty billion dollar bar bipartisan infrastructure bill go without something more concrete on this other reconciliation package. That's a great question, Lisa, and I think that if if we don't get the second part saying we're gonna do use reconciliation, that's the big Schumer goal where you won't have to have a big veto fight. Yeah, that'll

get us into the fall. But once we do get into the fall, the price tags are going to be huge. And there looks like, at least for now, a very intractable battle over raising the death ceiling that's going to complicate everything. Well, the reason why I ask is because a lot of people are treating the bipartisan plan as

a sure thing. It basically has a lot of support on all sides, and yet it does seem to be linked in sort of an unknowable way to this other proposal that seems like pie in the sky according to

almost all accounts. So there is a question of what is the willingness of Democrats torpedo the bipartisan effort in order to push forward something on the other side, Well, there is a willingness if you talk to people like Joe Manchin or Kristen Cinema of Arizona, that they would never read attacks increases of this magnitude, if I'm not mistaken. We have an election coming up next year, and the idea that we're going to raise taxes this dramatically, I

think would be suicidal on the part of the Democrats. Meanwhile, inflation very much in the forefront of people's minds. We got a survey yesterday out of the Federal Reserve showing that consumers expectations for inflation over the next couple of years arising to the highest levels since at least two thousand and thirteen. How does that play in some of these spending debates. Well, it's a factor, and the Republicans are arguing, I think somewhat disingenuously that the spending will

cause inflation. A lot of commodities, as you guys know, have dropped in the last few weeks, oil, copper, lumber. You know, we do have a wage problem. I think that's more intractable obviously, But the Republicans will will play this up. They've got some big issues immigration, inflation, and in my opinion, especially crime. Who are you watching on the Republican Party, I mean, away from former President Trump,

does Grege value watch in Washington? Well, for weeks and weeks and weeks everyone said to Santis and his his halo has slipped in Florida, no question. So the new hot name right now is an African American Republican from South Carolina, Tim Scott, very well spoken, not not way way out on the right, A likable guy. He may run for president, and he's raising a lot of money. Right. No, I just I'm sorry. My brain was just going there

and raising money. We can talk. I'm sorry, John. Now you can get a fun one in Can I get one? Raising money is a huge deal, explained to our audience, Greg. Why raising money is the heart of the matter. Oh, you gotta have ads on TV. And if you want to have ads on TV, you've got to raise a ton of money. We're already seeing saturation ads here in d C for the Virginia gubernatorial race. You're just still it's still two and a half months away, John, Is

it like that in the United Kingdom? Does Boris Johnson have to raise a lot of money? No? Thanks are a little bit more straightforward in the UK. Tom, we talk about this every cycle dime. No, but I just wish we'd get I know which one you'd prefer. We get it done in a shorter time frame. Greg, thank you, We can go. JF Investment's Chief US policy strategistic. This is the Bloomberg Surveillance Podcast. Thanks for listening. Join us

live weekdays from seven to ten am. Eastern on Bloomberg Radio and on Bloomberg Television each day from six to nine am for insight from the best in economics, finance, investment, and international relations. And subscribe to the Surveillance podcast on Apple podcast, SoundCloud, Bloomberg dot com, and of course, on the terminal. I'm Tom Keene, and this is Bloomberg