Surveillance: Recovery Bets With El-Erian

if you will, of this terrible virus. He has been hugely visible, persistently prolific, but Muhammad Alarian always writing smartly about economics, finance and investment from his core foundation of game theory. We're thrilled that Dr Alarian could join us this morning. Of course, writing too often for Bloomberg Opinion. He will take up a modest position at Cambridge University in the autumn months. Mohammed, wonderful to have you with us.

Everybody out there right now has to make a t decision of do they want to play on the markets or in fear, do they want to remove themselves from the markets. How do you approach that T decision? Good morning, Tom, and good morning for having me. Look, it fundamentally comes down to how you feel about the disconnect between finance

and the economy. If you believe, like I do, that ultimately fundamentals will assert themselves, then you are more cautious about this market, and you're worried not just about the level of the market, but you're starting to get worried also about relative pricing. If, however, you believe that technicals call them fomo, the fear of missing out called them tina,

there was no alternative. And if you believe that central banks will continue to protect every asset, then you can participate in this market on the longside, regardless of fundamentals. So it really comes down to how where it are you that fundamentals matter? So have it. Let's talk about the fundamentals. You and I have discussed this now for several weeks. What matters the initial improvement sequentially month or month week on week, or the overall limits of the recovery,

the limits of normalization. There's just a real push and pull there. One of those things will be a dominant driver for quite a while. Which one is it? So it's now both because of the level of the marketplace. So in the beginning, it was about the the the sequential improvement, and markets got reinforcement of sequentially improving situation on health and therefore on the economy, and Marcus got

carried away. So now the implicit valuation is that not only will the journey be a pleasant one, but you're also certain about the destination. And we've been getting over the last couple of days are digitimate questions are both about the journey and the destination. What we haven't been getting is any question mark about central bank support that is consistent and strong. No, really about market fundamentals, market technicals.

You see again today the buy the dip mentality, the conditioning to buy the dip is very deeply embedded in this market. Scarring, Mohammed. Scarring is something I want to talk about with you. The I m F mentioned that in the last twenty four hours, the permanent job losses, the bankruptcies, the sectors that just won't come back. I've got a headline crossing a Blimberg terminal right now. The American airlines see second quarter revenue decline of about capacity

down sev in the second quarter. Have you got your hands around the amount of scarring that we will have coming out of the other side of this pandemic. Yes, more on the supply side than on demand side. So on the supply side, we're going to see hits to both the productive dy on on on the capital side and on the labor side, we are going to see a process of deglobalization that is driven by households, governments,

and the corporate sector. And the result of that absent And I want to stress there's nothing we DestinE depends on policies, but absence policies to improve productivity will be lower productibility and lower growth. And that's what you hear from the IMF, you heard it from the O E, c D, you heard it from the World Bank. What's more uncertain is the demand side, John, we don't know what's going to happen to people's marginal propensities to consume.

How willing will people be to spend money, How willing will people be to um continue behavior that the U. S. Consumer has been so good at, which is drive the economy. Will we come out with a more frugal society or not? That's still a question mark Mohammed. I want to talk about this decline and productivity and growth that you're talking about.

Paired with the question marks are round demand and deglobalization, which a lot of people think will actually be inflationary because if you bring supply chains home, you won't necessarily capture the efficiencies of cost that some of the globalization did. I'm wondering, does this feel like a stagflationary environment? Is that what you're portraying here? Well, you do have two

inflationary pressures. One is simply the rewiring of supply chains and the inefficiencies that come with that, and the other one is we are seeing least a significant increase in industrial concentration. The big firms are getting bigger and we're

losing the mid size and the small firm. However, to translate that into a stagflationary projection, to say inflation will result means that you have a view on demand, and as I said earlier, the demand side is really uncertain right now, Mohammed, you are going to go to Cambridge and the legacy there of all this mathematics and foundational theory is Frank ram Zee, who we lost at a

shockingly young age, distant distant distant ago. Right now, our foundations are being shaken to the ground, we've got a pandemic, we've got the shocks of this economy, and really original economics and monetary theory. Do you understand the foundations right now that we're standing on or is the mathematics broken. Look, we're dealing with unusual uncertainty to use per Nankee's term, or radical uncertainty to use morfern king. So the structure

of the economy is in play. And as you know, when the structure of the economy is in play, you've got to bring in many elements um of economics or behavioral finance, of game theory to try to understand what's going on. I keep on stressing to people the most important thing right now is not what you think, but how you think. It is this ability to bring in a multidisciplinary approach to try and figure out what are the questions and what you should be monitoring and talk

about monitoring. Look, Tom, even the data that you and I look at these days, it's completely different from four months ago. We didn't look at mobility data, we didn't look at the restaurant booking data. But that's what we're looking at right now to try and understand what's going on. So I think it's a different challenge. What it's exciting for economists is they have the tools, but they have to make sure that they adapt accordingly. Somehippens. Let's just

finish that. The data point that you are laser focused on at the moment, the high frequency data. Maybe what is it? So I look, like everybody else, at the high high frequency data. UM so I look at mobility data, certainly at health data. I look at infections, I look at hospitalization, I look at what how how is the individual household interacting with the economy travel data. I mean, you're just trying to get a notion of three things, John. One is what is the health situation? Two is our

households engaging? And three is our humping is engaging. Remember it's these thweet things are not of health because there are people who are whisk loving the people who are whisker verse who react differently to health indicators. So we've got to keep all three under close monitoring, and they'll give you some feel for how we are going through this journey. It is going to be a checkmark, it's not going to be a shop v and it's going to be one subject to a lot of volatility. Mohammed.

Always great to catch out with you five ten on the West coast. Can you apologize to the family on our behalf if we've welkened them up with this interview? Muhammad Alarian a Bloomberg opinion. Some of all Street hides in the Greek letters. We hide in the derivative dynamics and expert at that is Dean Current at mcrow Risk Advisors. I'll be direct, I don't understand half of his research.

Note he does extremely sophisticated analysis of the interior dynamics of the market and he joins us right now, Dean, you were the first name we mentioned yesterday. Basically it was get Dean Currentent. What did you observe in the interior dynamics yesterday? Yeah, thanks Tom. A tremendous move obviously in the SPUM So we were running at about a twenty five implied volatility, so that's about a one point five move a day. That that's high in of course

historical context. We moved six percent, so that's a four standard deviation move. Our little normal distribution table is going to tell us that's supposed to happen once every sixty three years. So first we know of course markets aren't normally distributed. That the tails are fat and they're active. Um. But the biggest I think conclusion from yesterday is just below the surface of the market UM. As has been

discussed widely, the factor rotation is violent. UM. So I keep track of a market neutral index from momentum stocks, and again I underscore market neutral and it has had seven straight days of four and four point five pc moves or more, and that's a hundred volve for a market neutral index. It's it's just it's staggering. So again it's it's just negative stocks moving like panty stock staying. It's been absolutely remarkable, and I think what we're looking

for are signs that maybe the coast is clear. And I know that's the trillion dollar question it always is. But as you look at the VIX curve right now, what signal do you take away from that at the moment. Yeah, So, I think what what the VIX is telling us is that the market was really unprepared for this. So anytime the market moves down like it did, the VIX is obviously going to fly higher. It outperformed the move uh

lower in the SMP by quite a bit. So so the move higher involved is telling us the degree to which people were caught off side, and I think that can be confirmed by looking at open interest in VIX options had gotten very quiet, so the ownership of let's say things like upside calls to protect portfolios was quite

low coming into this. Dean taking a step back. After two thousand ten, a lot of people were saying that the FED stimulus and involvement in markets had dampened volatility dramatically, and we saw a real flat market, a real calm market.

I'm wondering if there is a larger takeaway from yesterday that the FED is throwing the kitchen sink at the market in order to improve and smooth out market functioning, and you still see these whip saw technical reactions that indicate some sort of liquidity issues or high degrees of leverage getting unwound. Is there some larger takeaway about the FED reaching its limit and in terms of being able

to dampen volatility, I think it's exactly right there. At every turn when we have these significant risk offs two twenty, At every turn, the degree to which the policy responses larger and more overwhelming and wades further into private markets. UH, it just is telling us that the financial system is something that's it's unwheeled. UM. I think that that old adage don't fight the Fed. UM is of course focused on asset prices the stock market, but I think in

terms of buying volatility buy insurance. Whenever you're doing so, you are fighting the FED. And so I we have to respect the significance of this move yesterday. It's violent, it tells us something. But at the end of the day, UM, a stable VIX or a low lower vix UH is part of the fed's playbook. It can't sit by idly and allow the VIX get that back up into the fifties,

allow high yield spreads to spiral higher. UM. It'll sit for a little bit, but at some point you're going to have the FED come back in UM in the name of market functioning. And so again, when you buy insurance, you've got to keep that in mind. The policy response Dean. One final question, and I'm just going to be as direct as I can, and you can go nuanced as you like. The game is momentum. Do you buy the shift from momentum to vailue, momentum to small cap momentum

to international or do you stay momentum. I stay with momentum. I think that the real economy is what is ultimately going to drive that relationship. And of course we've seen that shift back into small caps and value. It came undone violently, UM a lot. So much of it's just the function of the success to which the economy reopens.

I'm skeptical on that. You know, again, you're you're fighting the said you're fighting the policy response from the government, UM that they are going to feel invested in keeping uh, you know, keeping income earners with with income if they don't have jobs. But the degree to which these weaker companies with weaker balance sheets are gonna be able to uh to thrive, I think is very much an open question, just given how challenging the reopening the economy is going

to be. Tancount it a macro risk advisors stay always fantastic to catch up with these. My best to you and the whold of the scene now is a real treat And this is without question the must listen interview for Global Wall Street. How good of an interview is this? Muhammadalarian will take notes. That's because he knows Jeremy Stein owns a high ground of our theoretical finance, the underpinning of what we do. He's a former Fed governor, also a member of Princeton Gymnastics. Just a few years ago.

He runs the herd of cats at Harvard known as the Harvard Department of Economics. Professor thrilled to have you with us. I want to talk about the foundations of Marko Witz, of William Sharp Objet trainer from a million years ago. Does any of that stuff work at the zero bound? Well, some of it works, um, But I think one issue with the zero bound is if you're a stock market investor, um, you know, there's not a lot of other attractive stuff out there, and they want

to diversify that. Your general risk appetite is pretty hot, and I think we're seeing some of that in markets now. I look at the zero bound, and of course what we do at Bloomberg Surveillance is talk macroeconomics and monetary theory. I want you to take the zero bound over to the capital asset pricing model, the fundamental theorems that everybody

on Wall Street uses. How does that geometry work if there isn't a real yield if there isn't a virtual nominal yield and even negative rates in Europe, how does the geometry work. I'm not sure about the geometry, but you know, I sit on the board at the Harvard and Downland and one of the things that you see in Downman's generally a whole class of other investors when ranks are zero um and they have targets for returns,

they end up pushing pretty hard into riskier assets. And I think that more than anything is the sort of uh, the sort of mechanism that's that's that play days. Professor. One concept that people have discussed, not just through this pandemic, but over the last several years at the so called reversal rate, when rates go beyond a certain level and become counter productive. Professor, what are your thoughts on that concept?

You know, it's an interesting idea, and the basic idea is that when rates are very low, it damages the profitability of the banking sector, makes it harder for banks to lend. It's an interesting idea, I would say, an idea that I'm more focused on now that's related is, you know, another thing that can make it hard for the banks to lend is when their capital position is

badly repaired. UM And in that vein, you know, well, I think the FED has done basically an admirable job, and I really want to applaud the Fed and share Powell. I think that on a number of dimensions have really risen to the moment. One concern I have is that they've been more passive UM with respect of the banking system than you would ideally like. UM. Another, a number of other countries have gotten their banks to stop paying

of it ends to conserve capital. The bigger thing that again that I worry about for the banking system now is not the reversal interest rate, but as as we saw last time around the global financial crisis, they take a big enough hit to their capital, they're going to be very impaired in their ability to land any interest rate UM And I think Professor, pretty much every CEO that would come on a program like this would probably tell us that the capital position is strong when they

can afford their capital RESTERM programs, they've suspended their buy backs, and they can meet their dividends. What is it about the big banks on Wall Street that you think maybe some people are missing? Well, I mean I think it's

good to to to remember the lessons from last time around. UM. So if you think about the financial crisis, last time the banks paid I would say something like over a hundred billion dollars in UH share repurchases and dividends between mid two thousand seven, and women didn't really raise a lot of capital, didn't really get to to raising equity capital until after the stress test period. UM. You know, the thing is deteriorate, and the deterior not necessarily immediately

all at once. UM. I think here the market is trying to tell us something, as it did last time around. Banks stocks probably down, bankstockuments. I'm gonna say it's down about thirty five relative to an SMP. That's down only a handful of percent year to date. UM. Last time around, the market was pretty good at being forward looking. Um. Those banks who stops declining the most were the ones that had the biggest loan losses. But I think, you know, this is a very big economic shock. It's a very

big economic shock. The conventional measures of capitalization that banks look at our counting base, they tend to be backward looking. If you look at more forward looking indicators, I think there's reason and I wouldn't even say it's the baseline expectation. But is there a tail whereby you should be seriously concerned. I think the answer is probably has Wait. Just to be really clear here, professor, are you saying that the risk of a banking failure is greater the PHOED to

reserve is acknowledging right now? Okay, I wouldn't use the word to failure. I'm not. I think the banks are well enough capitalized that that's not something even in a sort of tale scenario. But you know, well before failure, if they lose three, four or five basis points of capital, that seriously impairs their ability to lend. And so back to the sort of concept of the reversal interest rate again, the bigger, the bigger constraint on their lending will be

a shock. Again, it can be a moderate and not catastrophic shock to their capital. But if you're thinking about you know what will help the recovery um in the next year, Having a strongly capitalized banking sector I think will be one of the more important, one of the

more important elements Professor's time. We're talking about some of the consequences of the FEDS policies, and you have, uh, the potential oversight of banks on one hand, and on the other hand, you have a question of capital efficiency. And I know you've done a lot of work on this. A lot of people saying it doesn't make sense for Hurts to be bankrupt, for people to be buying its shares and now to be potentially raising additional money and

selling more shares. It just seems like the market is getting less efficient as rates go down, and people look at the FED as a perpetual backstop. What is the consequence of the lack of efficiency that a lot of people are talking about in markets? Well, you know, I think, uh, you know, Mark, there's an old saying that markets are I think this was to Paul Samuels, and the markets are macro inefficient but micro efficient. And I think you

see some of that now. I mean, I would would not want to try to even begin to explain the overall level of the market. But again, if you look at individual companies, there's some logic there. As I said, in the banking sector being one example. Um, you know, I think the relative performance of bank stocks tells you something. I think even within bank stocks, we're seeing those that are most consumer exposed being hit the hardest, And I think there's some So I don't think, I don't think.

I'm not sure. I buy the idea that all this sort of micro efficiency has has been taken out of the market. Jeremy Stunt, I want to go against your expertise and finance right now as a representative of Harvard Economics and all of that heritage. Of course, we speak to Ken Rogoff and to Benjamin Friedman and back through Marty Feldstein. You lost a giant here in this tragic summer and Alberto Elisina. How will you replace the unreplaceable

of Alberto Elisina? How do you replace that beautiful holistics of political economics of Professor Ellissina? Did? Wow? Okay, I was not expecting that question. That's a very moving question. Um. You know, it's just a heartbreaking loss for our department. And as you say, um, Um, it's gonna be hard to repla very very hard impossible to replace him in terms of what he brought as a researcher. I mean,

this was a guy who was doing really nobel. Calbert or Um founded the modern field of political economy in many ways. Um, But you know I sat in the office basically next to him for twenty so when you know, when you raise the question and swert of not like thinking of that. I'm just thinking of one of the warmest, kindest and most general uh colleagues I had. And you know, in talking to others in our department and they think of,

you know, what we've lost and how we missen. It's it's the personal that swort of everybody seems to seems to speak to. Jeremy Stein, thank you so much for joining Bloomberg Surveillance today. He is at Harvard University for Lisa, John and I. Folks, there have been benchmarks through this pandemic, and one of them has been good informed in intelligent conversations with the Lieutenant Governor of the Empire State, Kathy

Hokel joins us again for an update of briefing. Kathy, let me give you the safe general question first, how is the reopening of the state from Buffalo to New York and out to the Hampton's how's it going? Thank you for having me on the show again. It is going phenomenally well. And I say that not just from my business Lieutenant Governor, but as someone who literally as recently as yesterday walked the streets. I was in Niger Falls,

I was in Lockport. The day before, I was in Rochester, and there is such an excitement about reopening and an energy on the streets that I am actually shocked to see because I thought people would be more sort of depressed and in a dark place after what they've had to endure. And the truth is, uh, this just demonstrates the resiliency of New Yorkers. So the reopening is going well. He's not had complaints as we reopen that we are very closely monitoring our health outcomes and the rate of

transmissions and our hospitalizations. And if you look at the charts every single day, as I do and the Governor does, you'll see an incredible downward trajectory, unlike what we're seeing elsewhere in this country. So the opening is going well. We're in phase one in New York City, most of Upstate is UH now as of today, just today is now in Phase three, which is restaurants and more personal services.

So people are feeling a sense of normalcy, except they know that it link continues if we keep social disclin and wearing the mask and all the business owners have been really great about complying, Lieutenant Governor. Perhaps they're in a dark place and they're turning to retail therapy to soothe some of those feelings. I am curious about threatening this needle of encouraging people to go back out there and embrace the economy while also practicing social distancing and

some of these other measures. How much are you trying to encourage people to come back, and how much are you able to deploy tracers, trackers to really make sure that people are not super spreaders. At this point, we

don't see a big resurgence of the virus. You have hit on exactly the answer to the problem that I'm not seeing going on in the other states that open even before New York did, and some people criticize us for taking too slow of an approach, but we were not going to send a message that any part of the state could open until we listen to not just

national experts, but global healthcare experts. We've enlisted from London to US to US in analyzing the data to make sure we don't cross that I'm between risk and reward. We've always wanted to make sure that we are doing this in a smart way. But the answer is testing. And there is no state in the nation that tests more people than we do here in the State of New York, over fifty thousands and I'm sixty five thousand

a day. And what happens after the testing is that information goes directly to our contact tracers, an army of individuals.

And we think former Mayor Bloomberg for his assistance with the State of New York, working with our Governor Andrew Cuomo to bring in the resources to allow us to have individuals trained, have them in every corner of the state, even in most rural areas, and I oversee the reopening even in western New York the second largest city of Bussalo, but we have incredibly rural areas, small towns, and we have contact tracers were ready to jump if anyone tests positive,

even in the furthest corner of states down in Alleghany County, Chautauka County, up in Plattsburgh. So that is what other states should be doing, and that is how we can get control over this virus. And was frustrating to us to New York because we've figured this out. We have led the nation in terms of how we've managed this pandemic. No one has done a better job than Governor Cuomo.

And if the other states simply followed our lead, they'd be in a far better place today, because we're going to continue reopening in a smart way based on healthcare data. But we're going to do it. You mentioned former Mayor Mike Bloomberg, of course, the parent company Bloomberg Alpa. He was the fan of majority Onis still is of course of Bloomberg Alpe, the parent company of Bloomberg News. Lieutenant Governor, just to continue the conversation, there is clearly some tension

down in Texas. I've spoken to the administration and they've suggested to me that the bar is high for another lockdown. Quite clearly. You've suggested that to us as well in the last several weeks too. I'm just wondering if you can establish some guardrails for us, the kind of data that you would need to see to reconsider locking things down again. Well, we've said we don't expect to go there, and again, this is why we did it right in the state of New York. And I can't emphasize that enough.

That there was another alternative, which was to listen to the many voices were saying, you know, we're short on revenues. Our county's can't function. You know, the State of New York is dire straits in terms of the loss of revenue coming in during this three and a half month period. But we are never going to sacrifice people's lives in public health, and so that what people have to look at. When you can go right to forward dot ny dot gov, you can literally pull up regional dashboards to see the

metrics that we're examining. And the one that's most important now is the rate of transmission and how we can determine what the testing rates are showing. And if you look at a place like Western New York a few weeks ago, it was nine percent of people are testing positive.

That number is now point eight percent. That's extraordinary. When you look at New York City, where we hadent testing positive not long ago, and the numbers are down to one to three percent higher in certain neighborhoods that we're putting a laser focus on, communities of color have been harder hit, and that's why we have even more testing and contact tracers deployed there. But that's it's not hard. We followed what the Centers for the Ease Control had

recommended early on in terms of the stazing. These guidelines have been out there, but very few states we're enlightened enough to actually follow them. And so we're feeling not over confidence, but a sense of confidence that this is the right path to be on and we're going to continue here. And if we see a change in the numbers that are alarming, and that's what all of our regional control rooms do, we're watching every quarter of the state. Uh, then we'll talk about whether or not we had for

the next days. But thus far we've not had any hold ups. The numbers keep going down. New York's new tenantant governor on some better News, Kathy. Hopefully we can catch up any soon on some mall thank better news here in New York. 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.