Surveillance: Rising Yields With Koesterich

manager Russell. Let's ask that question it's being asked in the ft here at Bloomberg and now swear as well. Do you think the events of the last week could lead to broader de leveraging in the hedge fund community. I think you you organ to see some people rethink their positioning. But look, I think there are a couple of things going on here apart from the question of leveraging derivatives. The first is we've known for many years

that liquidity can be a challenge. A lot of that discussion was focused on the credit markets, and obviously it extends to equity markets as well. But the second part of this is really you know, you alluded to the calm on the surface, and I think that's true. What hasn't been remarked about is much is how much positions below the surface are being whipsawed these daily rotations where you see sectors and styles moving to three standard deviations

in a day. Because investors flip back and forth between reopening trades uh in stay at home trades, that is also causing a lot of pain give on the wrong side of those moves, Russ. How do you synthesize a bloom economy into global allocation and for that matter, just trying to get the next Monday? How do you synthesize it? I'm gonna take hot seas over at Golden Sacks going out to a stunning ten percent plus statistic for Q two growth. You and I have never seen this. Um

Rosenberg got a Carnegie email. In all the years he studied a temper guess what, he's never seen this? How do you frame your work in a boom mill you like? I think this is exactly the right question, probably the most important, because as you've said, very few living investors have ever seen this up to me, means a couple of things. One you were alluding to before the break, which is that rates are going to continue to normalize. It doesn't mean that they melt up forever. But it

is very hard. I think Tommy, you nailed this before. To reconcile negative sixty bip real tenure yield and an economy that may grow seven eight uh in the back half of the year. One of those two things is wrong. We think rates continue to normalize. The other is a lot of investors were used to thinking only in terms of data, what's your market exposure? I think if you're gonna have an economy that's growing that fast, you also

have to think in terms of your cyclical exposure. There are going to be parts of this economy companies that they're gonna see demand they've not seen in decades. Can you lever to those themes? Can you take advantage of that very fundamental change in a portfolio? Those are two things. We're focusing on. Our duration as the lowest that's been in years, and we're looking for ways to add cyclical

exposure back into the portfolio. I know you're speaking metaphorically, Rusby said, how can we lever those cyclical themes in order to add exposure in your portfolio? There are people, however, who are taking this quite literally as we have learned, and they are leveraging up some of their positions. Yes, rates are normalizing, but there is a belief in the feed is adding to this that they are sitting on the front end. As we do see some push toward normalization.

Are there more accidents waiting to happen like what we just saw. I think whenever you see an abrupt move, they are always going to be blow ups. They're going to be people that are over extended. You know, you've had a very strong bullmark, there's going to be concentration. The thing that I would watch is actually the rapidity of the move. You know, we we know this. We've

seen that stocks and rates can move up together. A matter of fact, if you look at equities, equity multiples, and real rates, they tend to move up together for the obvious reason that as the economy gets better and companies gain operating leverage, earnings go up. What can trip up the market is the rapidity and more specifically the spike and bond market volatility. If you look at what's been happening the last three or four months, bond volatility

has been increasingly moving with stock volatility. That's where I think the danger is if we get these days these weeks where yields back up this quickly. That unnerves investors, and that's when you tend to see some of these blow ups, Russ. Before we let you run. I caught up with Rick reader yesterday, just briefly, and he did not sound as bullish as he has done over the last several months. He was talking about a big cash

allocation waiting for some volatility through the summer. You were all on the same page over a blank rock with that view. Well, I hope so Rick and port together we co manage the fund absolutely, we you know, so we we had been for the last five minutes. Delicately you sounded like a rig walk me throw it, Russ. We we've been doing exactly what's been described, which is, look, the fundamentals are strong with the cyclical recovery, stocks are likely to end the year higher. But we are looking

at a chop your market. So what have we done. We've done a couple of things. We have trimmed our equity exposure, and we have brought the duration way way down. As I spoke about a moment ago, instead rather than looking it bonds for that hedge in your portfolio. Is Rick described, We've been building up cash. Having that dry powder, there will be opportunities to reinvest. Not trying to cause trouble. Rus. You know that took that black Rock global allocation of

fun portfolio manage it. Okay, here's what we're gonna do, folks, And this is important for Global, Wall Street and everybody else on radio and TV. Why don't we find someone out there totally removed from the madness of margin calls and excess leverage. James Spevan would be a candidate with c c L a chief investment officer. He has been running sober money for decades and he joins us today. James, I'm not going to waste your time with the margin car discussion and that what I am going to say

to you is, how do you operate in this mill? You? What do you actually do when you've got big banks bouncing off of big losses. What I observe, Tom, is that we are indeed going to get excellent economic growth figures for April and may significantly on the back of the actions Biden administration and not least four hundred dollars

posted out to the eligible persons. And I think that therefore we will see something in the order of a hundred and eighty dollars of earnings to the S and P five hundred in the current calendar, rising to two hundred dollars next year, and of course, baked into the cake of those numbers is a premise that companies are going to invest in capital that improves productivity and allows

margins to stay elevators. And given element that one might observe for inflation and money rates, I think that justifies the year end target for the SMP five hundred this year of points rising to hundred points next year. And if there is a real risk, I think it is twofold one that the Federal Reserve continues to argue that it doesn't need to change rates, but the bond market

therefore does the work for quilling inflation. That leads to a dislocation between bond deals and equity prices and inevitably leads to a correction. The other risk, which I think is just as real, is that a large chunk of the fourteen hundred dollars that has been posted out is applying to the empty markets. We get them melt up during May and early June, and that's the point where we should take money off the table James optimal reopening

quite then, what is it for me? It's the world class banks that operate in the United States, so JP Morgan and Bank America. Seems to me that they have ample opportunity to lend sensibly into an accelerating market. They have excellent loan criteria. I don't think they're going to trip up, but they will be significant participants in economic recovery. The other big trade I think is shifting from consumer staples to consumer discretionary, which is a very obvious trade.

But I'm surprised when I look at the portfolios of fund managers in the marketplace. I hope you have yet to really make that switch. I gotta say, it does sound like there's some subtext there when you say your favoring banks that lend sensibly, and then you talk about JPMorgan and Bank of America to the banks that were someone immune from the recent blow up of our keegos.

Are you saying away from other banks, from perhaps European banks or Japanese banks they got embroiled in this issue, or do you see them also as potentially holding value as the yield curve steepens. Now I am absolutely staying out of those areas. I worry that the European banks face perfect storm of continuing negative rates. And after all, what one thinks about how the European central banks Target

two system operates. Unlike the federal reserve arrangements in the States, where the regional central banks to zero the inter bank balances, there are huge imbalances within the euro system. Germany has to lend huge sums into the Target two system. Buller's Bank then calls the commercial banks to provide capital, and having asked the capital, then sends from the bill because of negative interest rates. No surprise, the European banks are in real trouble. And I would observe that the French

banks have been pulling back in lending into Asia. That strikes me as a real sign the French banks are gain to be in relative trouble. You want you to look outside the States. I think the most interesting area is India, where I see an accelerating economy, I see a reasonably well run banking system. Names like HFC I think absolutely stand out for consideration. James are going to jump in just to bring a break in news, just quickly Germany to reassess the actress Nika vaccine after more

thrombosis cases. Tom this just speaks a divide between the United States and Europe right now. Just to compare and contrast to the last twenty four hours, President Biden talking about making the vaccine eligible for all adults in America of adults by the middle of next month, and here's Europe grappling still with the Astrosennaka vaccine to reassess the

Astrosennacha vaccine in Germany after more thrombosis cases. That headline just crossing a Bloomberg Canada yesterday with much the same treatment. I'm not saying equivalent treatment, but certainly, John, it's a trend. James, how on earth do you stay long Europe in any way, shape or form with this going on in the background. I think it's extremely difficult to be positive about the outlook for the European economy. Justical policy is a mess.

I think that there are real tensions within the euro system. If you asked me to talk about a country that is worth considering, it would be Italy. I do that there are political shifts in Italy to be positive for the long term. Equally, when I think about the sources of European companies that I would favor. It is the giants that are capable of making money like oh VMH, which I think remain extremely well run, and m Katy should be from my perspective, long term pool holdings of

a growth focused portfolio. James, thank you as always. Let's get back to that news. James Bavin c c L A chief investment officer. Right now, Gregory Meeks joins us. He is a Democrat, he is from New York. This could be a two hour conversation because of his perspective on foreign affairs and his perspective as a congressman from John Fitzgerald Kennedy Airport in New York, the fifth District in New York. And we welcome to Congressman back again.

Carruson Meeks. On infrastructure, I got good news. New Jersey's worse than New York. That's all we need to know. New York is doing fine right now by any civil engineering study. But you know, when you get off the plane in New York, at Laguardi, at JFK, anywhere else, there's a lot of roads that are troubled, a lot of bridges troubled. Some four hundred bridges in New York State or a hundred years older more. How do we fix it this with this new infrastructure bill? What's different

this time? Right now? I think that this time we're going to get something done. Um. I think that you know, if you talk to Democrats and Republicans, I believe they understand that if you look at our crumbling infrastructure, like you said, not only in the city of New York, but across this nation, that we've got to invest in it. It's just the same as you know, those of us who you know workn't let their own homes. You've got

to invest in your home to keep it up. Otherwise it will crumble down no matter how well it was built. But if it was built fifty sixty years ago, like our infrastructure, uh, it deteriorates. And therefore that you've got to invest in it. And if you invest in it, then that makes it profitable for everybody that will utilize it,

because everyone will utilize that infrastructure. Can we do this with bond financing of the maturity and lengths of our new bridges, our new roads, and indeed a new terminal of JFK. Why can't we just finance this out thirty fifty even dare I say seventy years. Well, I think that what we need to do it is a combination of all It's gonna take a little bit of everything from everybody. That's why I'm a firm believer in these

a number of public private partnerships. So as I look at, for example, of what we're doing at JFK Airport, UH, there needs to be there some government investment in it, UH, and we're fighting to get that. I tried to get some of it in UH because as the result of the pandemic. Of course, you look at the revenue that was at the Kennedy Airport, it went down tremendously, So government should help EDIT. But also we've had private industry that's investing in it, so we need some sacrifice from them.

And that's why we extended the lease on the airport, so that there's a long return for them to get a return on their investment for the morning that they will be putting into it. Also, so you're getting money from both sides in that regards is fair to the taxpayers and it's fair to the private investors. Also, Congressman, you wear many hats, and I want to turn to a delicate question about foreign policy, if I made companies are getting very much entangled with what is handling in China,

very much around the colin situation in Shinjang. And I wonder from your perspective whether you think that US based companies should face a band of using cortinado Shinjang. Well, here's what I think, you know, and I don't think I think that what we should do. Uh And as I believe there's are foreign affairs and work in multidagard ways. So I was a strong support, a strong supporter for example, And here's what I think that we made a mistake.

I was a strong supporter and TPP working with other countries to make sure that the rules were leveled and to instead of isolating ourselves, make sure that we all are playing by the China doesn't played by those same rules.

Then China would be isolated. And so when they are playing with certain products, particularly when you talk about the type of product that you just mentioned and chips, et cetera, that um um it is us who believe in you know, I'm a firm believing the w t L and others, and we need to enforce those laws and rules, and China who's violating though uh and so opposed the just just the United States by ourselves, we're not an effective, but it was the United States and our friends and

the EU and our other doing it collectively. Now you're having something that is really going to have effect on Taylor the congressman right now already And forgive me for jumping in if I may u s fake companies are already facing potentially a boy card in the mainland right now that will hurt their revenues, their profits, and to get in line with the policy of the United States, you need to get these multinationals on board. And we've

seen that repeatedly not work out. We saw it with the Walt Disney Company last year in the production of Mulan, and we're seeing it with Nike right now, who are trying to avoid using colin from Shinjiang, along with other multinationals too, and they face a boycott on the mainland. How do you offer them cover to make the decision that would be in line with your administration. Well, the way to know you offer them cover is that if

they work collectively together, we can reverse it. And we could reverse I know that they know China is doing what it's doing because they think that they would put pressure on us in that regards and isolate us. Uh. So the way that you change that is working with the multi naturals collectively, putting them all together, figuring out how we can work together to the their issues in their in their concerns or resolved, and then putting that

proposition versus China. But they want to be there, sir, That's ultimately the problem. They want to be there. They want to strandle that fine line between pleasing you and a progressive consumer base in the United States, and they want a presence in China at the same time. So I have to come back to the previous question. Is it something you would consider banning these companies and making the decision for all them fanning them from using Carton from that region. See, I don't like to use the

word banging. I'd like to use the word working collective together. And and that means that you can come to a resolution collectively, you know, understanding they all have the same business interests. I don't want them to to to to to damage uh their business interests that they have UH in China. I want China to be able to. You know, one of the things is to open up their markets in regards to our companies so that we can compete globally, just as China competes. And we have an open economy

here in the United States, and that's equitable. And that's what training is all about, that's what that's how you work both national multinational corporations. So in my estimation, what we wanna do is um is uh talk to our multinationals and let them know that it is important for them to work collected together in the long haul, all of us in the long run if we work in that and and that's in that cooperation. Congressman, is a really dedicate issue right now, and I appreciate your input

on the subject. I'd love to catch up with you against soon on it to Commeressman. Thank you, Congressman Gregory makes that a Democrat from New York. It is the micro day that leads to the macro call. And Ethan Harris joins us right now, expert at the macro call, but using the resources of his Bank of America where

he's head of Global Economics. Ethan, what I do is I look at the parlor game of one year guests or two year guests, and I take it considered Ethan Harris average, that's what Michelle Meyer does, and I come out with a Chinese economy. You guys have six and a quarter percent economic growth spread out over twenty four months. That is a Chinese equivalent economy. How will America and adapt and adjust to this? If we have an economy that's not structured like China, Well, we can grow at

that pace indefinitely. I mean, this is just a huge fiscally fueled recovery, fastest recovery in history for the US ecomy in the next two years. Um. And eventually we have to slow down and so uh, you know by the time we get to two thousand twenty three, Uh, there's gonna have to be some changes here. The FED is gonna have to pull back a bit. We can't really afford to continue to do trillion dollar fiscal packages

every year. Um. We can't grow at Chinese rates. We don't have the the population, we don't have the catching up to do a new technology that China has. But we can get to really robust years in a row. Ethan. I've been looking at the account spending data that you produce in your repulse, And I just wanted for you one, what are you seeing right now? And so how useful has that been just to have every twist and turn

spout out for you guys just ahead of time. Yeah, I mean, we aggregate the data, so obviously we don't know anything about the individuals involved in this data, um, and we we gets turned out to correlate quite well with turns and spending. And it's particularly interesting to look at the spending behavior when you can match it up to policy changes like the rollout of stimulus checks and

how that impacted households who got those checks. Um. And what you found was that the stimulus checks really boosted spending a lot, and it's one of the factors that convinced us to get even higher above consensus on growth with consumer spending. We think in the UH the start of the year at almost twelve percent annualized rates. So the stimulus check really have put a lot of caffeine into the economy. Unreal numbers, Ethan, Just forgive me, just give me a couple of minutes and I'll go through

some of your research for our audience. Least look at this seven days ending mass. Now you can do the year over year and you can look at the base effects and we're up forty pc. But just look at ten the last two years nineteen or rather into twentys is twenty one. Right now we're up on a two

year basis for retouth souths. Looking at the credit spec con spending that we got down to bank for America, it's not a huge But when do we move from recovery and just making up the lost ground into something more sustainable and that something that has perhaps longer legs adding to employment, adding to inflation over the longer term and ethan, it seems like the consensus is this is a momentary blip. Morgan Stanley is saying it will burn

hot and it'll burn short. Do you agree, or their longer lasting legs from all of this spending that could bleed into a faster economy for an even longer period of time. Well, I mean it is true that that that we're not going to grow at twelve percent every quarter going forward, but the fade and growth is not going to be that dramatic. Were we think by the end of next year will be growing four percent instead

of twelve percent. That's still a great number. By historic standards says double the normal growth rate of the US. And the reason we think there's legs in this is because they're going to continue to roll out fiscal stimulus. We're going to get another two or three trillion UH spread over the next four or five years UH. And the Fed is put got both feet planted on the accelerator. Keeping interest rates at zero in the face of a

strong recovery and rising inflation is very stimulative. It's unprecedented. So I don't agree with this idea of a short run kind of caffeine high that then goes away. I do think we slowed down, but we slow down to still strong rates. This is a really important point. And

you raised an issue of ongoing fiscal stimulus. How much are you thinking about these checks, not maybe four hundred, but still checks being sent to Americans as being the precursor to some sort of universal basic income, some sort of ongoing payments, and that the evidence of the spending that John was just talking about being used to justify that kind of plan. Well, you've got you've got elements of this already in the various plans from out of

the administration. So we've already seen an increase in the childcare credit just for the the next year, but it's very likely that's going to be extended, So they're gonna be elements of trying to support moderate income families that are developed on a sustained basis. I don't think we go to, you know, some of the more aggressive, broader proposals around kind of guaranteeing incomes at certain levels. I

don't think we get to that. But there's a lot of progressive elements to this, the stimulus and tom Here is the conundrum, in my opinion, when it comes to inflation, which is such a key issue for markets. The idea here that if we start getting payments directly into the economy and an ongoing basis, could that fuel an inflationary push that perhaps people are not factoring in. And how much does this finally lead to wage inflation that we have not yet seen that the wage inflation questions there,

and we'll get that evidence on Friday. Dr Harris, I want to go back to Columbia universe a city, in particularly to the engineering work at Clark University that was hit over your head at a young young age, and it goes back to systems analysis and the idea of many people that there has to be a cost. There has to be a price to any zero sum system. How do you have a boom with all the benefits of a boom that we're all hoping for and have that emotion And there's got to be a price to

this down the road. What's the Ethan Harris price that we will pay? Right? It just gave my whole resume away there, thank you for that. Um On the so in the short run we can afford to have a big bunch of deficits. We uh, we need to get the economy out of this whole unemployment rate still over six percent UM. But the problem is that while you can kind of have you know, your cake and eat it two during a recession and do this stimulus, once you get into a full recovery, now you're competing for

resources between the private sector and the public sector. And if you keep on rolling out big stimulus money and financing through the bond market, you're going to starve the private sector of capital. And that's where the danger comes. It's not right now. My concern is, you know, we get into a fully employed economy late next year, and the nobody kind of hits the stops, that sees the stop sign there, and we don't slow down at all. And then we get computing resources, we get some inflation,

we get some crowding out of private investment. Because you know what's fascinating Ethan about this in brilliant analysis, is it versus a closed economy versus open economy. If we get to a capital allocation moment two thousand twenty three, two thousand twenty four, we do that in a global economy, does that leak out into the global system. Yeah, I mean we're gonna be we are drying going to driving the global economy in the next couple of years to

a lesser degree. China as well. Um, we're gonna be buying a tremendous amount of imports, so we're gonna be exporting a big chunk of our fiscal stimulus um. And we're gonna be relying on foreign capital to help fund our economy. And so you know that's not free money, that's money that you you know, you owe to the rest of the world. Um. And so there's a growing indebted as the US to the rest of the world continue to borrow like crazy. So we're gonna have bigger

trade deficits can sustain high budget deficits. This isn't a free lunch here, yeah, John, this is so so important. Goes back to Bill Gross years ago talking about the locomotive of the system, and as Dr Harris says, there's no question the US is a locomotive front and center very much. You can see that in the data at the moment the recovery and China is already mature, you see in the credit Impulse data as well. So Ethan, we've gotta leave you there. Ethan Harris, Bank for America Securities,

Head of Global Economics. Thank you. 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