Surveillance: Market Value With Joseph Cohen

a few years. She is their advisory director and senior investment strategists and arguably no one has ordered America to participate in the equity markets like Abby Joseph Cohen. We're thrilled she could join us this morning. Abby reaffirmed this morning why we need to participate in the stock market given the sum of all our fears. Tom Will, good morning to you, um, and thank you for inviting me

to to be here today. UM. You know, what we know about the stock market over a long period of time is that if you have confidence in the economic outlook, equities are usually the best place to be UM, and clearly that has been the case now for an extended period and I think that one of the important things for investors to think about now is valuation. UM. You you want to participate in equities, but you want to

make sure that you're doing it at the right price. UM. And one of the things that you and your colleagues have spoken about very clearly already this morning is that interest rates UM maybe becoming less friendly uh than they

have been towards valuation. When we look at the valuation models that are used by so many investors and so many analysts, including those at Goldman Sacks, there's this general sense that the market is roughly at fair value, and that sounds like, you know, not bad um, if you believe that this will in fact be a protracted economic recovery and then expansion. Uh, not a bad thing. However, we're sort of on a knife s edge. Um. The

valuation becomes less appealing um if interest rates rise. Uh. My colleague David Costin, who does this specific forecast, has been saying for a while now that he thinks that fair value off with the S and P five hundred this year is fort which is pretty much where we are. One more point, and that is, when you're at fair value, there's no margin for error. Um. If there are disappointments, UM, be it on interest rates, the disappointment on OPEQ, for example,

over the last few days. That's where you start to see a big increase in volatility within the market itself. So many would so many would say, Abby Joseph Cohen, that none of what we're living right now was in your economic textbooks at Cornell a few years ago, for example. And I do this for my colleague John Farrell. How do you respond to the confidence to invest given this colossally odd negative real yield? Um? Great question that we're asking ourselves as well, uh, Tom, And and the answer

is carefully, very carefully. UM. We are in an unprecedented period both with regard to an extended length of time for these negative real yields. By the way, they've been negative real yields in Europe now for quite a period of time. UM. And we are also in an unusual period with regard to nominal interest rates. So when we run our models, we're looking at both those nominal and real yields and recognize that we truly are in uncharted territory. UM. So let me say one more thing, as somebody who

used to be a quantitative anialist. UM. I to say I'm a reformed quant um. I use these models as a starting point. UM. I don't use them um as gospel. I use them to give me some direction. Are we undervalued, fairly valued, overvalued? And then once we have that general sense of direction, what could go wrong and what could go right? Um? And as we take a look at things now, the things that could go wrong include, UH,

commodity prices. We've seen what OPEC has done. This, by the way, it could be more of a problem for markets outside the United States. In the US, commodity prices are actually a fairly small component of our total cost. The second thing that I'm perhaps even more worried about has to do with public health. UM. You know, we we've had these incredible vaccines, extraordinarily effective, and now we're sort of bumping into problems with regard to distribution. In

the United States. We think this will be a re regional issue rather than nationwide. But you take a look at the reopening of places like Europe, this is much more problematic. The distribution in Europe of their mr NA vaccines UM really has been lagging. It's one of the reasons there for GDP expectation in Europe continent is below what we what we look like and John, you've absolutely nailed that. On world travel or the luck thereof, for the airlines have suffered because of that time and a

cyclical story of many ways, sector to sector. The airlines have peaked in the minds of some people. They're struggling now. The banks are starting to struggle a little bit as well. Over the last month. Abe, what was interesting in your response to Tom is that you turn to your process and for the following question, I'm less interested in the call and far more interest in the process. The debate right now on the cyclicals is the debate has always

been over the last six months. Is it just a short term reopening trade or something more durable, something more sustainable? What is your progress process? Rather to distinguish between the two things, what are the signposts you look for? Well, we're also looking at the idiosyncratic opportunities, because just because a particular company happens to be in a particular sector or industry, according to the SMP definition, doesn't tell us as much as we need to know. So we're really

looking at how individual companies have positioned and or repositioned themselves. UM. I happen to believe that there will be a movement ahead in capex. UM. UH, we think there will be an infrastructure bill of some sort UM. Obviously we're not privy to the negotiations now in the Congress. We think there's a desperate need for spending on infrastructure, but there's

also a need for private engagement in CAPEX. One of the things that we have seen UM in the last decade or so has been this decline in the use of corporate cash flow for these purposes. UM. We have seen much more of it than usual go into things like UH dividend payment and share repurchases UM. Those dividend payments UM may continue to increase, but if you are a corporate CFO and you look at your current share price, you say, do I really want to be repurchasing at

these levels? And that's one thing that, in addition to the need to expand physical capacity, main fact lead to improvements in CAPEX. So the short answer to your question, John, is, we do think that there will be a movement towards some of the industrials. UH. And let's recognize that industrials are all over the lot and we need to look

too at the international trade aspects of this. Some of the companies that have repositioned themselves well for the twenty one century needs, including things like renewable energy and more efficient processes, UH, the use of improved metallurgy and so on. Some of these are US companies, some of them are outside the United States but are important suppliers to US companies.

Do you think that the impetus so for some of that capex spending and the potential for that UH to finally sort of maybe get back to levels that we saw in previous generations, that that's going to come completely at the behest of these companies, or do you need a little bit more government government involvement to sort of

move this along? Abbey, Yeah, Well, let me be careful when when I discussed the numbers here, because I don't think we're going back to where we were twenty years ago as a percentage of the total use of cash flow. Because of the change in the composition of the S and P five, we now have so many more service oriented companies that are not heavy duty industrial spenders. So we need to be looking at things industry by industry. So I do think that there will be a movement

back towards more capex UM. The thing that worries me most about government spending has been the significant d emphasis of spending on things by the government that corporations don't usually spend on. And let me be more specific, and that is over the last several decades, in fact, going back to eighteen sixty, the US government has been one of the major investors in long term basic research UM. And what we have seen over the last twenty years has been a decline in basic research spending as a

percentage of the federal budget. UM. I think this is a mistake. You know, we have to keep in mind, for example, that those terrific mr NA vaccines that we all are so happy to have now, uh, that initial research was done by spending given by the n I h M ten fifteen years ago. We forget uh you get that cod It's going to be David's David. David's very worried you might make a because David custom right now is forty three three hundred year n t K and we couldn't be bored by that. Right now, tell

you that that was my granddaughter calling. What did she say? It's it's her sixth birthday today. Just say hello, so happy birthday. I will call her in just a minute. Because I let you go happy. It's going to catch up. We think this is more important. You want to make a more important point than sound happy birthday. I'm going to sing happy birthday to her, and you don't want

to hear everyway. So basically, the federal government has been the basic provider of funds for research but also for infrastructure, UM, and we have seen a notable decline in that overlay twenty years. We just need to get back to where you were, UM and that would be extraordinarily helpful for long term economic growth. Abby, Thank you. It's going to catch up in their government Sacks advisory director, senior investment

strategist joining us now. The former governor of the Federal Reserve System, Frederick Michigan is a Columbia University and one thing I know for certain is everything he's ever written has paid great respect to markets as an observer of what our economics does. Rick Michigan, you, Peter Hooper and

am your SUFI. A number of years ago to three years ago talked about a monetary policy, a federal reserve of Phillips curve that was hibernating, is our traditional monetary policy hibernating, and someday we'll get back to it, or are we moving on to some form of new paradigm.

So I think you're right, we're hibernating that the FED I think very well, maybe behind the curve that they have basically two UH elements here, which is one is that they've gone to this average inflation target, which I actually think is a good thing, but haven't defined it well enough to actually anchor insputations the way they should, so I think that's a alumn But the other is that they basically have said that the Phillips curve UH

is not something they're particularly worried about. But on the other hand, I think they will find out that that that it is hibernating and that there is an issue, and I think that the FED will actually end up doing what it has to do, but it may be a little bit late. So I don't think that it's so much that that I think that they're gonna be

a month by reality. I think that's what's gonna happen here. Unfortunately, I think that they they maybe a little bit too complacent about the fact that the economy is running very hot, that that inflation I think is gonna be less temporary

than they think it is. It's true that there is a supply shock which is temporary, but the real reality here is just demand is really jumped a lot because of of a very expansion and fiscal policy and pent up demand because most Americans are financially much better off than they were before the pandemic, and they have been

able to stand rick every time. The point we look at the American economy over the last six months, yet today called it the last seven months since the end of last year, has improved with the exception of the participation rate in the labor market. How complicated do you think that is? Does that complicate things for the FED that this participation rate has just flattened out? Well, I think it's a it's a surprise from what we've what

the typically happened before the pandemic. But you know, we have a situation where a lot of people are at basically uh, wondering whether they want to go back to work the same way after the shift in terms of or work at home. Uh, And so it does complicate things in terms of the deciding how tight the labor market is. I think the labor market is a little bit tighter than it used to be. That the three and a half percent unemployment looked like that some of

the natural rate of unemployment. It may be somewhat higher in this case. So it is complicating things, but not unaware that they can't figure out. So I think as soon as I think a key issue here is a central bank never should take its eye off the inflation ball, and inflation has been very high, and if it's not as temporary as the FED thinks it's going to be, they need to move and move relatively fast at that point. Are they already too late? Though, Rick, I think there

may be a little bit behind the curve. So you know, the issue is that, uh, in some sense there there is a little concern about deja whu all over again in terms of the sixties, where the FED was in a very similar situation, very combinating monetary policy with with very expansionary EPISCO policy. I don't think we're going back to the sixties, but I think that they that they are a little bit behind the curve here, uh, and so that it's going to be more costly for them

to get inflation under control. UH. And that's added to the fact that I think they haven't managed their new monetary policy strategy as well as they could. Uh. The results inflation expectations may not be anchored as well as they should be. I want to go back to the mathematics of Rick Michigan, and the mathematics describes folks the path of putting the genie back in the bottle Rick michikin how do we put the fiscal genie back in

the bottle? I don't know if we can. Uh. The only thing that's sort of a bipartisans in Congress is UH the unwillingness to worry about budget deficits. UH that that I failed. The Biden bill that was passed was was much too large. It was I think a bad bill. UH. That it had paying a hundred paying a big checks to people who are earning a hundred fifty thousand dollars who were not at all hurt by the pandemic was

a bad idea. I think they should have had more contingency in terms of the three hundred dollar payment in terms of undeployment insurance, which I think is creating some problems for them. Uh so. Uh, and then uh, there really is is no one in Congress right now who's really very serious about balancing the budget. The Republicans are perfectly happy to say let's not spend when in fact the Democrats are doing it. But on the other hand, they certainly were not the uh serious about getting fiscal

policy under control during the Trump error. So I think we do have a problem here, Rick, Just find a question from me. I'm just talking at the Bloomberg right now. We just had a break a one thirty on tens to four decimal points. You're lower, the session is six for you, You're saf from your perspective, What on earth does this bond market tell you? I told anymore? And at this point with a yield on a tenure of

one thirty, yeah, I think I tend to different. I think that there's more potential for problems in terms of inflation in the bond market is things. Uh so, may rather, I should tell you. I hope that the bond markets right, and that is right, the inflation will not be a problem. I think there will be much better for the economy. But I think that the balance of risks here now

is one where there's much more danger. So I think complacency one of the things I worry about a little bit of complacency in general in the markets, not just in terms of the bond market, brols, the stock market, and that could could that could be a problem, not to to distant future. Rick, it's gonna cash. You have come back soon. Rich Miskin there of Columbia University, Thank you, sir. Let's take off the morning with Jim Cartamo can Standard

investment management fixed income portfolio manager. Jim, Let's go strike the number one question, the ex cyclical trite, the inflation trite? Is they still on? Well, good morning, thanks for having me on your show, and I do think it's still on, but we we have shifted down gears. So so let me just kind of unpack this and go through this little what we what we have to understand is that the delta or the rate of change, is really what

matters the most to bond investors. So in the first quarter and even in parts of the second quarter, what we were seeing is rising growth, rising inflation, and an increase in policy easiness. Policy was getting easier. At this point, what the market is sensing is that we're past the peak. Growth is going to decelerate, inflation is likely to decelerate, and policy were past the peak, and policy and we're

already starting to talk about ways to take that away. Now, that doesn't mean that the level of growth is bad, that doesn't mean that the level of inflation is too low, or that the level of policy easiness is is that that that policy is too tight. But what it does mean is that we're not going is that we're past the peak. So essentially the reflation trade that we're talking about is still going to be there, it's just going

to take a bit longer to actually achieve these goals. So, for example, if we start to think about the more macro elements that make up the reflation trade, right, there are three of those. One is that you got higher tenure yields. Then you've got higher tenure yields or higher long term yields, and a steepening of the curve, which is pretty rare in and of itself, and you also

got a weaker dollar. So what happened is when everybody got into the reflation trades, they were underweight treasuries, they had curve s deepeners on, and they were short the dollars, and now that that at the rate of change, of the pace of that move is starting to decline. The second derivative, as they say, people are unwinding their short in the dollar, they're taking off their curve steepeners, and they're buying back they're under in the U. S. Treasuries,

and that's what's making this all happen. Okay, Jim brilliantly explained. But I want to go to let's talk some math here, folks. It is math Wednesday here on Bloomberg Surveillance. Okay, you mentioned the delta. If I look at the convexity and is is um Galley? Oh, Steven Galley over it? Nord says today it's a bear squeeze. Okay, fine. The delta is the first derivative. The gamma is the second derivative.

Right now, are you observing a convexity trade that overshoots to the all climback on the reflation trade or is there some substance to this lower yield market that we're

in now? So so, I do think that there is a convexity component to this to the extent that you can't overshoot lower I do think the tenure Treasury eels can get down to one one point five, but I think Tom, it's going to get hard to really get below that for any real material period of time, at least given what we know right now with the with the expectations for growth, I mean growth this year is supposed to come in somewhere around eight percent in the US.

Next year it's somewhere around four or four and a half percent. It's quite hard for ten year yields to stay as low, especially as the FED starts to pull back and taper even a little bit. So I think this is a correction. The reflation trade is still with us, but it's gonna take some time for these positions to get cleaned up. Okay, you know, Romaine, this is where you step in. If Lisa was here, she'd be talking

to third derivative, go at it. Okay, all right, I'm gonna stick with the first derivative for right now, and that it remains the Fed. Jim here, and we talk about the messaging coming out of them. It seemed like a few weeks ago there was general consensus, at least the perception that there was consensus at the Fed. Here, it doesn't seem that's the case anymore here, and I'm wondering how you view the messaging coming out of the

FED and how the market's interpreting it. So that's a great question remain because for the past couple of weeks, the hawks at the FED have been absolutely winning the narrative in the marketplace, and now I think it's become a lot more dubbish where people are taking the doves a lot more seriously at this point. So look, I mean, what did the FED tell us in in the middle of June at their FOMC meeting. Effectively, they said it's time to start talking about talking about tapering and and

and and we need to see further substantial progress. Well, look, the data is good right now. The problem is is that it's not good enough. And I think that's the debate at the FED. It's not whether or not the data is good. It's always about is a good enough to get us to the next level, which is for the FED to enact a policy change. And right now, I would argue that the data is good, but I

just don't see how. I just don't see an acceleration in the in the data to the point where we're going to have unanchored inflation, and that's going to cause the FED to actually start to act sooner rather than later. So look the mid two thousand twenty three dot the expectation for the FED to high grades in mid two thousand twenty three. I think that's valid. The problem is that the markets had started to push that in already to the end of two for the first rate hikes.

Some had even earlier than that. So I think that's all going away, and as people push back their expectations for FED rate hikes, probably into that mid to late area,

bond yields are going to fall on that. Jim the economic te to Cantani you so much, how the market responds to it, Cantani a little more sometimes what you'll read on that over the last couple of weeks, Yeah, I mean, I mean, the markets are telling you that we're going into a period where we've you know, where we're past the peak, and that even if we look at the OPEC and the oil discussions right now, some people are talking about now more stable to lower levels

in in in in oil. That's gonna weigh on inflation. The jobs data is is not as strong as we helped. It's strong, it's it's still very very good. So what the price action is effectively telling us is that they're chopping off that right tail where things are going to be great, but things just might be good going forward. And we recogn eyes that it took a lot of policy stimulus, It took a lot of fiscal stimulus, It took a lot of work to get us to these levels.

Now that that now a lot of that stimulus is starting to go away, or it's already well known and priced into the markets, we need another catalyst to bring us back towards higher yields. Now that catalyst needs to be there is after everybody's cleaned up some of their positions, and I think the underweights in the dollar, the underweights and U S treasuries, this is still in the process of being cleaned up. I don't think the trend towards

higher yield is over. I think that it's just gonna be a lot slower, and it's going to be more of a grind, and we're gonna have to see changes in the data relative to your point, relative in the

actual positioning in the market. And it's been paying folks commit to that right over the last coupital of ways, Jim is gonna catch up, said Jim Karen and Mokan Stanley Investment Management right now on your fear of delta of a variant that came from India, And can you imagine if there were variants from Afghanistan, Bangladesh, Ecuador, Guatemala, India, Ghana, Kenya, Mozambique in Ethiopia and that would lead to the expertise of bacti and Saudi of Johns Hopkins to say she's

Associate Professor of Emergency Medicine, doesn't describe it all her international epidemic study. Doctor, do we underestimate the delta variant? If we're in Missouri, or for that matter, if we're in Manhattan. Should we be afraid of these foreign variants? So, I think it's so much challenging to call them foreign variants variants of variants. It's just when they were first discovered, right,

and variants are emerging everywhere. Should we be concerned about variants? Yes, And there is a higher likely of various emerging from countries that have lower vaccination rates or lower access to resources because they have a higher amount of virus um in circulation. And so should be worried. Until we have a global pandemic control, we will get new emerging variants here and abroad. Is that something the U should be

concerned about given the vaccination levels we've already achieved. Yes, completely, So we have to look at our sister country across the pond, the United Kingdom. United Kingdom had similar vaccination rates to US around six sixty seven. Vaccination is extremely impressive. But despite that, we have seen consistently rising cases over the last six weeks in the United Kingdom, cases almost doubling every single week I think right now, and not seeing that in the UK US, but there is a

tipping point. Cases are on the up, so we should be wary. Cases are on the up. Let's use the UK as a case study. Is there anything to worry about as far as hospitalizations and deaths are concerned? So what we have found is that countries that have higher vaccination rates and hospitalizations are lower because even though vaccinated people can get the delta variant, and the delta variant has been reported to be more dangerous, if you're vaccinated,

your disease is likely to be less severe. Also, many countries have successfully vaccinated the elderly those are immune to compromise, transplant patients, cancer patients, those are the highest risk of severe complications and death, dr anxiety. This isn't totally unexpected. Even when we started down this path of vaccinations, there was a lot of talk about UH new variants popping up and the need potentially to reformulate some of these vaccines down the road. Here, what do we know about

the process for doing that? So the vaccines are currently being constantly being evaluated. They're constantly trying to identify through genomic sequencing the mutations are making the vaccine more valiant and making sure that the vaccine m RNA matches those mutations. Um, it's an iterative process, but we know how to do this right. We do it every single year with the fluid, and every year we are prepared with a new flu vaccine. So it's not beyond the realms of our capabilities as

a country. And are we at a stage now where we have to start thinking about uh these covid variants as sort of an annual shot that folks will need, presuming how they're willing to take them. I think it's likely to be honest, I think it's very likely that this is going to be something like the flu that sticks with us UM and that regular repetitive vaccinations are going to be needed. Now flu is seasonal, which is where we have this whole annual shot um with COVID.

I think it's uncertain wouldn't be an annual shot or just a booster shot as new variants emerged to your anxiety. If you were to parachute into Tokyo today and give counsel to a Beliyard government trying to do this ginormous event, Okay, there're gonna be no fans, let's say. But even with that, you've got many sports with multiple people involved, basketball, whatever, How do they do this given COVID? How do they do this given the fears of variants like we're seeing

now in Spain, Portugal and other places. So I think if I was flying in personally, I'd be saying, why are we doing this? Right when your vaccination rates a less than You're putting your populace at risk by inviting individuals who maybe carrying the Delta B, which we've already seen in Tokyo UM with the Ugandan team, Why are we doing this? Why? Why is it important to have the Olympics. If you're going to have the Olympics, I

think you would have to do universal mass mandates. I think you're going to have to restrict unvaccinated individuals from entering gaming arenas. I think you're going to have to have on site facilities for media isolation, quarantine if someone has symptoms or symptomatic, and then rapid quickly available testing to be able to identify individuals who are symptomatic quickly so they could self isolate. Doctor, get a catch shop. Good to see you come back. St. Dr Bati The

Jones Helkins, Associate Professor Emergency Medicine. 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