Surveillance: Temple Sees Inflation Paradigm Shift (Podcast)

cut right to the equity paragraph. And you're always crystal clear note, which is you are focused on the grand conundrum in the next year, which is measuring the persistency of cash flow, the persistency of free cash flow. How do you actually do that? Well, this is all about doing the bottom up fundamental analysis, Tom, I'm sure you're

familiar with that. I mean looking out and trying to un understand what makes a company generate higher returns on capitol and what are the drivers of whether that return

on capital can stay high or whether it declines. And so we're really focused here in terms of you know, what I'm looking at in the equity market is trying to avoid the speculative growth stocks that are all about earnings that might come down the pike, say five, seven, ten years, where all of the value of the companies in that terminal value and it's much more vulnerable to hire discount rates and avoiding the deep value cyclical stocks.

They are most at risk if you have a recession and sticking right in the middle of that kind of continuum. On the quality stocks, the companies with high returns on capital, that a pricing power, brand advantages, um, strong management, strong balance sheets, and that's where you really want to do the work to understand what makes a company so strong

and how they can maintain that position over time. Rod, We've heard this before from other people who are trying to gird for a recession, But it feels like the mood shifted this week. Have you shifted anything about your thesis and the heels of the CPI report and p p I and even what we're seeing in terms of Fed funds futures. I think the market is reacting to the positive sign that we've probably seen the peak and inflation.

We've finally seen inflation roll over, and it's more of those cyclical items, the items that we all thought were transitory about a year ago that are rolling over. If you look at the decline and cp I that we saw this week from last month from June to July basis points of the forty basis point deceleration was cars and airfare. So those are factors that we knew would roll over at some point. What I'm really watching is

rent of shelter. What I'm watching is wage growth. And so I think investors should be careful because you know, as I listened to you for the last few minutes, I think there's a propensity in the market to say, Okay, this story is over. We're gonna go back to the old playbook. The FED won't have to raise rates as much, and I can buy these companies that are growthy kind of call options. I don't think that's the right call.

I think we're in the midst of a paradigm shift on inflation, and when inflation does settle, I think it's going to settle with a three handle, not a one and a half to two percent like we saw for the decade into nine. So I would be a little a lot more careful than I think I'm seeing in the markets of kind of overreacting to data in the short term Okay, so Ron, if you're more careful, does that mean you still view what we've seen is more of a bear market rally than a bona fide sustainable rally.

I I do still believe it's a bear market rally. I could always be proven wrong. We always have that risk. But when I look at is, I think we need to wait for data next month. I expect CPI to come down again. I'm very interested to see the job numbers. There's their mixed signals in the job market. We had a great payroll number last Friday, but if you look at the Jolt State of the Job Opening Labor Turnover Survey, we've seen a million job decrease in the number of

unfilled positions in the last two months. Now, again that data is a month lagged relative to payroll data. But what I want to see is are those unfilled jobs going away, which then means labor has less negotiating power, which then means you're less likely to see wage with which would is less likely than to pass through the prices going up for goods and services. So so I think we need to watch more data. But right now I think this is a bear market rally. As a

base case assumption. And again, I would be careful of running back to the playbook that worked for the last ten fifteen years, because I think that playbooks should probably be thrown out. We're on a temple. If we throw out quality large cap stocks, which is the mantra right now, we're all going to read about it five times this weekend. What is the new mantra going to be? Well, to be careful, I think quality is the playbook you want.

I think the playbook for the last ten fifteen years that worked was by the call option by the company that is a really cool business plan that's getting access to capital at zero interest rates, unlimited capital. I think that's gonna be much tougher. So it's that into the spectrum I think is more at risk. I think quality. It's interesting, Tom, there's been a Venn diagram overlap right where a lot of the quality and the growth were

the same company. I still like the quality growth companies, you know, those companies that can generate high cash flow and grow. That's great to share at the right valuation. Ronald Temple, thank you is by the way, the valuations have come down, so thank you. Well they have Ronald Temple thank you so much for starting us off strong with lazard asset management. Right now and hugely anticipated for November is a book. But when Stephen Roach writes a book on China, it has a focus and intent on

their economics and politics like no other. The book is Accidental Conflict America, China and the Clash of False Narratives. This is hugely anticipated by the Chinese watching community. The gentleman from Yale in the Saudi China Center at Yale Law School joins us this morning. Dr Roach, thank you so much for joining. You've written three or four books on China. Why is this one different? What is the tension at this moment? Is Mr She goes to the

Party Congress. Well, Tom. In the past five years, we've gone from trade war to tech War two, now a cold war conflict is escalating. There is no real framework to manage this conflict effectively, let alone conceive of even the slightest semblance of resolution. And in a period of escalating conflict, the smallest spark can lead to a major uh clash, and we certainly have seen one in the

last week over Taiwan. And I'm very worried about the possibility of you know, a military accident in the Taiwan Straits occurring in the context of this escalating economic and technology conflict that could really lead to a serious UH outbreak between the United States and China. The thesis of the book is the conflict would not have happened were it not for the false narratives that both the nation's harbor with respect to other and I developed these narratives

in detail in the new book. Well, what is important here is what matter of diplomacy has needed. What is the roach approach to a new diplomacy that can perhaps calm down these pressure points. Well, my idea and I developed it in detail on the final part of the book, is that the current structure of engagement, whether it's you know, leader to leader phone calls between Biden and hijin Ping or earlier strategic and economic dialogues as grand summons, has

failed miserably. And so I am proposing a permanent institution that I call for lack of a better term, at US China Secretariat that meets full time seven UH staffed by an equal number of professionals on both sides of the the relationship, whose full time job is to deal with all aspects of the relationship, from economics and trade to cyber and human rights. And we need a new approach.

And this is uh, you know, one idea may not be perfect, but it certainly beats the current failed approach Stephen. There might be a lot of uncertainty on the policy side, but businesses have to make moves. They have to either expand and double down on their expansion plans in China, or they have to withdraw, which we've seen a number of companies do on the margins. And we hear more and more about reshoring or on shoring of US companies

away from China. How materially will that shift the dynamic of trade at a time when a lot of people say this will be inflationary, Well, I think I think it will be inflationary. I think that the trench word re short reshoring is an unmistakable our growth of geostrategic tensions between the United States and China. They can better be addressed through a structure such as the one I

just outlined, Lisa. But you know, make no mistake, this is very destabilizing, uh, not just for the US and inflation, but also for China. China benefited the most of any nation in the world from the upswing of globalization, and it has the most to lose. I think as we now move from globalization to deglobalization. There's a larger issue though for the economy. And this is something that we

were just hearing about from Ron Temple. How he thinks that perhaps will get back down to a three percent inflation rate, but not much below that because we are in a new paradigm. And I wonder how much is

China the main part of that. If you have reshoring, which incurs more expense, and you have slower growth in China because of exactly what you said, Because this is going to affect the world's second biggest economy significantly, how much does this portend a slower growth, higher inflation environment

for a longer term. Well, you know, we debate how much China has held down US inflation over the past twenty years, but it's been significant, as has uh the rapid expansion of global value chains or global supply chains, and as supply chains are disrupted by China and other developments around the world as we moved from offshore to onshore. Good luck in getting inflation down to three It's it's gonna be a very difficult goal to achieve. Steph, I've

been trying to ask you this. She built Morgan Stanley Economics. You were the first American economists I know that tried to make a three leg FED policy of unemployment inflation and you said, watch the balance sheet, the expansion of the balance sheet. All that came true as you wrote about years ago. What's the FED theory now, if you were to if you were to parachute into Jackson Hall here at the end of office, what is the theory

you're gonna find about central banking? Well, you know, hard for me to know how they're in a phrase of Tom but I think the FED theory has got to go back to basics. You know, forget this UH QUI balance sheet asset dependent economy. It's blown up repeatedly since Greenspan and Bernankey tried to UH in the the nineties and in the early two thousands. The FETs got to go back to inflation targeting, not average inflation targeting, but

plain old inflation targeting. UH and UH we need a you know, a dose of the very simplistic but tough and disciplined approach by Paul Vulker. J. Powell is you know, says he's very much committed to doing this. The FET's taken some big steps, but you know, child played compared to what they have to do, the real federal funds rate is still sharply negative. You're not going to control inflation with a sharply negative federal that's on that's on the LM side. Okay, help me here with the real

economy and the unemployment rate. If we go Laurence Summers this morning and pop it up, as Annawanga Bloomberg says, to a four percent or five percent regime, what does that do to America's unemployment rate? It's gonna go up. Tom. I mean, you know, we give me a magnitude here,

no one's watching. Give me, give me a magnitude somewhere in the four to five percent zone, which is, you know, a small price to pay, not for those who are affected by of course, but a small price to pay to to get inflation back under a more UH stable UH path consistent with sustainable growth in the US. The path we're on right now doesn't cut it, okay, So Stephen, obviously there is a trade off potentially between keeping inflation in check and supporting growth and to tie it back

to China. The PBOC earlier this week was saying, we aren't going to go with massive stimulus to support the economy despite the turmoil and the property sector of the COVID zero policy causing issues, because we are worried about the specter of inflation. Do you expect that eventually, if China isn't going to take steps to breach a five and a half percent growth target, that the Federal Reserve is going to BOK two? Well, I think you know.

Are you asking about the Fed's concerns over US economic growth? I think you know the mandate is going from duel to single. Inflation is the focus, and they can't afford to flinch on bringing inflation back because of political pressures that will be evident as the unemployment rate starts to rise, and and the Fed has just got to be fierce and focused on its independence and on its desire to

bring inflation down as soon as possible. Steven Roads, wonderful to catch up with you today, of course at Yale Law School and formally where the Wall Street firm name Morgan Stanley. Right now, we're gonna it's a digress here. I thought what Lisa was talking when Dr Schiller about on the break was really really important. Wendy schillers with Brown University, director of the Talbin Center for American Politics and a writer of core textbooks on our civics as well.

We've alluded to this before, Wendy, but I want to talk about two candidates who I believe will be seventy eight and eight d two in two thousand twenty four, and that means, if my math is right, there'll be eighty two and eighties six on the way out the door in two thousand. How did we get the fossils running for president? Well, I think general trends and aging are are good, and people are aging better across the country,

so that's a good thing. I think in time, we came out of a very long where people thought it was a very long recession. Uh, and the world has become less stable. Obviously, Cold War ended and we all celebrated freedom around the world, but freedom brought with it a lot of unpredictability, and then of course we had the wars in Iraq and Afghanistan. And when you have that much tumult and uncertainty, and certainly even the not eleven attacks. People want comfort, They want people who've been

around a long time. You can tell them this too, this too shall pass. People look to the familiar. They look to people with quote unquote experience. Donald Trump had business experience that he touted, and Joe Biden had more than thirty years in government. Wendy, I'm struggling with that idea because we've seen poll after pole is saying that they would like to see new blood who leading the

Democratic Party. They would like to see a younger slew of Congress members across the board as we enter into a very new phase. Is it a good thing or a bad thing for the Democrats that President Biden denounced his intention to run again. I think it's a good thing. You can't have a president not even ending his second year, full year in office, who says, well, I'm not in anymore.

I mean, even if there's the slightest chance Biden can still beat President a couple of years from now, that makes a difference in terms of influence, That makes the difference in terms of public opinion. You just can't be written off. We saw this with Clinton after the Republicans won the mid terms in ninety four, you know, always irrelevant. He doesn't. He won two years later relatively easily. You have to maintain the exercise of power and the illusion

that you want to keep that power. So I think that's a strategically important thing for Biden to do, and there is no reason for him not to do it. So you think that this is more about the visual, it's more about the illusion and less about a true intention to run. Well, I think he can stay. He can stay in this race until somebody in the primary starts to beat him. And and you know, the myth that primaries are bad for our parties at the presidential

levels and has been debunked. Now we know that it generates more turnout, It generates people registering to vote, knowing a pulling places, they get out the door. There's you know, we know that it increases turnout amongst the party members. So that means that it's a good thing to have

some fighting, some challenging, uh, some anticipation. So if he's in it and other people want to challenge him, that just means more Democrats get in the games to vote, and we know the Republicans will be very, very energized in twenty four, about whom they will be loyal. We don't know who they're gonna pick. You know, I think there'll be more than one person in that race. Yeah, it's a good point, Wendy. Obviously there's multiple variables at play.

Let's just assume for the moment that candidate on the Republican side hypothetically would be President Trump. Is there anyone on the Democratic side of likely potential candidates who would be able to beat him other than President Biden? Well, if the election were held today, unclear to me that anybody could accept for Biden. And again, people like what they're used to. There's been a lot of victories lately for the Democrats, you know, of economications, you know, ease up.

I think that you know, the president, former President Trump is facing a lot of different inquiries. Some of them aren't more scary than others. I think to voters, and again that that core of independent suburban voters is key. They rejected Trump in twenty uh and I think there isn't any reason to think they're gonna welcome them back local arms in twenty four. So I think that's what

the Democrats are counting on. But you know, we got Pritzkur in Illinois, big state go Gavin Newsom, the California big state Kathy Hokele if she wins again, big in New York becomes a player. And then of course it's got a couple of ones cabinet that might want to run, which makes for awkward cabinet meetings theoretically later on. But you know, we we are seeing energy, energy on the Republican side, and now we're starting to see a little

bit more energy on the Democratic side. You have to maintain the energy, so you have to give him choice. But you are the most powerful person in the world. And why you would walk away from that two years early, you know, that's just that's political malpractice. And when he finally if we could just look to the more immediate future and the mid terms in November, there was a sense prior to this week that Democratic momentum was building.

You have the inflation reduction, at gas prices are coming down. It is looking a little bit more optimistic for the Biden administration. And yet, as you allude to, you now have this galvanizing force when it comes to President Trump's base because of the FBI search of Mara Lago. Do those two forces cancel each other out, and we're now left with kind of the same outlook on the mid

terms as we had before. That's an outstanding question I think for Democrats though, and again, this independent group if Trump looks like this base of Trump's is going to get out the door and there and they are behaving in ways that are frightening to some people, like trying to bust into an FBI office with you know, being armored, U being armed. I think that scares suburban voters, that scares independent voters, And it looks like this will give

Trump momentum. I think the same forces that go out the door in eighteen on the Democratic side will get out the door again. You load up abortion on that and key states it's gonna be a referend statewide. I think that is going to help the Democrats. I don't know if it saves them for the House, but it could very well save them for the Senate. Many shoulders. Thank you so much for joining us with an August update. She is at Brown University. Here on the politics of

the moment right now. Dennis Scarpan joins here with Futures of fourteen. Always good to speak. The gentleman, chairman of the University of Akron's Endowmond Fund. And he's retired. No, he's not still writing the garment letter on an hour by our basis and joins us today. Dennis Lisa wants to talk about bonds. I want to talk about hydrocarbons. You know, they're out of control in Europe. They've got a modest matter of a war. Are we going to see methane natural gas? Are we going to see different

forms of gasoline in America surge like electricity in France? Probably, so propane is probably gonna go a lot higher, and that gas is probably gonna go a lot higher. At inventories are extremely limited here in the United States. They're unbelievably limited in Europe. If we start pushing nearby that gas through nine dollars per million British thermal units, and we're training about eight dollars and fifty eight dollars and

sixty cents per million British thermal units. If we start moving through nine dollars, you start to go back to where we were in two thousand five, two thousand six, and two thousand seven, When we get thirteen dollars per million British thermal units, so you have to be very careful. Things are very tight and likely to get tighter. So it's it's not a pretty sign out there right now, and you're talking about natural gas tennis. But you could

also apply this to certain oil inventory reports. There are some different ones, and I wonder how much we are fragile heading into the winter to see a spike in oil that could reverse some of the optimism about the disinflation that we've seen in this week's reports. Keep an eye on the term structure. That's that tells you more than anything else about what goes on in crude oil, specifically especially a historable commodities such as crude oil. We're

in a small backwardation. We were at a larger backwardation a month and a half ago. The backwardation has narrowed, but in the past couple of days as prices of crude oil have fallen just a little bit taken we got what the ut I down to eighty eight dollars prepaire the other day, and the nearby backwardation began to

widen marginally. Acwardation is where sophisticated and inform money leaves its footprints and If the backwardation starts to widen a bit, we're gonna start seeing crude oil start to go higher again. So I think you've seen most of the decline in crude oil dedicated upon a decline and driving miles here in the United States and the demand and decline and

demand for gasoline and diesel. I think you start to see at eighty eight dollars a barrel, that's probably the low and I bet we I bet we trade seven and not too distant future. So keep an eye on the backwardation. A widening backwardation is always bullish for the crude oil market. Wow. So let's transfer that ninety six dollar barrel barrels forecast here into your projection for the economy for markets, especially because a lot of the trading

activity has hinged on this lower oil price. How much does that reverse some of the gains that we've seen in stocks and send yields higher. I'm afraid that we're seeing that the low on yields. We're going to see the much higher prices in in in yield, much much lower prices and bonds. You have something that occurred last week which I think not enough people are paying attention to you had an outside reversal week and an outside reversal day in the long bond future, very rare circumstance.

We've only seen it one time before here, and we've only the two or three times in the course of the last five or six years. When you have an outside of reversal, I pay attention to it. It's one of the it's one of the technicals that I paid great, great deal of heed too. And an outside reversal week is a very rare event. Probably means lower bond prices, probably means higher yields over the course of the next

several weeks, the next several months. Be careful, and I think that that's the decline that we've had in the long bond for long bond yields over the course of the last month and a half was predicated upon a decline in in inflation, decline in crude oil prices, decline in grain prices, decline in livestock prices, and decline in copper prices, and all those seon turning around and turning back to the upside. So be careful up there, keep an eye on gold. If both starts to get to

the game changes completely well. Dennis. We know the story in the first half of the year was when yields go up, it's bad for the equity market. That is why we saw grows stocks under performing to such a degree. They have staged a pretty remarkable comeback over the last month. Is essentially what you're saying. If yields are going higher from here, that's not gonna last much longer. I don't

think it lasts much longer. As the chairman of the University of Akrons, and then I got us to move a good fourteen or fifteen percent of the portfolio out. We got very lucky we did in December thirty one. And as I've always said to everybody in a bear market, he or she who loses the least will be the winner. We've lost less than most other endowments. We have a meeting next week and I'm probably gonna say we need to reduce our exposure just a tad more. You're gonna

reduce equities. You're gonna reduce equities exposure even with this ginormous rally we've seen from June sixteenth, Tentnis at the margin probably another one or two or three percent. Nothing dramatic, nothing extraordinary. But I think the rally has been a rally bear market. The volume has not been as a lustrative or as the dramatic as it should be on a on a move to the upside, and over the course of the past six months or seven months, volume seems to come in on the downside rather than on

the up side. Another technical circumstance to pay attention to. So I'm gonna my position will be that I'd like to reduce our exposure juice to tad whether I get the rest of the committee to agree another story, What do you do with it? What do you do the rest of it? By options in the Cincinnati Reds, or do you do you go into cash? What do you do? It was a good game last night and watching the Cincinnati Reds. But I think cash is probably not a bad place to be. In fact, I think cash is

a very good place to be. Cash being two year at bonds and under two year treasuries and under Dennison to continue to invert it's it's been inverted for now for a month and a half. It's probably gonna. I think the two versus tends get to gets to eighty basis points without too much difficulty Dennis, we've heard that this week. Thank you so much, Dennis Gartment with us with the University of Eckmen and Domind Fund, and of

course the acclaimed Gartment letters. Paul Sanky, founder and lead analysts at Sanky Research, with decades and decades of experience of the microeconomic analysis of all this, Paul, how close is America to the many deviation leaps that we're seeing in European? How ydric carbons are we delinked or linked to those war events? Well, good news is, you know, Tomas, that we produce a vast amount of oil and gas here.

So ten years ago we were net importers of eight million barrels a day of oil, believe it or not. Now we're net neutral. So the US oil and gas industry has done a phenomenal job, not only of oil, but we're also now the world's largest natural gas exports are And as you know, the problem in Europe is that they really don't produce a whole lot of domestic energy full stop, certainly since they shut their nuclear and coals,

so they've added to their own problems. So the big pool here is going to be a concern, which is exports to the Europe. And whether or not that drives double gas prices very high, as natural gas prices very high, is quite possible. You can parse a barrel of oil like no one, let's wind her over to methane and natural gas. When Paul, thank you sees n G one go from two to eight, what is that signal for you?

Probably that we're going to send The price in Europe, as you know, is more like fifty for mm btu I mean extraordinary prices. So the draw there if it costs you about five eight dollars to cross the Atlantic, there's obviously implicitly a massive pull on our exports and that's I think going to be sufficiently large to pressure natural gas prices into winter. It now becomes a question of weather. We've got hurricane season, which hasn't really happened

yet at all. And then of course the really concerning question, and it's a major concern, is how cold it gets this winter. And if we get a globally cold winter, we're going to have death. I'm afraid. Well, that's on the natural gas side, and that's a pretty dire projection on this Friday. On the oil side, the I A saying that an increasing number of gas relying electricity providers are turning to gas to oil prices to oil in order to stave off some of the shortages. How underfunded

is this market? How cheap is this market relative to where it will be at the end of this year? The U S prices, I mean, it's way below as I said, I mean, you know, as I said, we're over fifty dollars per and b to you more or less in Europe and quite possibly going higher based on what Tom and I were just discussing European electricity prices. They've they're just you know, they've gone as he said,

exponential essentially. But I mean in terms of oil prices, that's where I was going with this, with this idea that we've seen this disinflationary input. Yeah, okay, So the oil situation is a bit different because essentially Russia makes more money from oil and continues to supply oil to the market. So the oil crisis is not a crisis to the extent that the gas crisis is. So there's going to be a major pressure upwards on natural gas prices.

At the moment, there is marginal use of oil, which the idea is highlighted as you said, not least propane, for example, is a direct substitute for natural gas. But also generally the use of oil and coal is going to be driven by by the problems in Europe, no question. It's just that the Russians really haven't reduced their supply a boil anything like what they've done to the natural gas side, Paul. Here in the United States, later today, the House is expected to pass the Inflation Reduction Act

and eventually the President assumably will sign it. The measures within that, some of them including the tax on methane emissions. How do you expect that could impact the supply landscape here in the US. It's significant. It's split the industry. So the big, the big oils, the excellence of Chevrons, Iconic Phillips already have very strong methane limits and continue to pursue zero flaring as a target, for example. And

then you have this enormous tale of companies. I think there's six thousand US oil and gas companies, of which I can only name fifty. So if at best, so this enormous tale is under direct threat and it could be assuming that it passes and then it's implemented strongly, it will be a major pressure to the downside on marginal US gas production, no question. So is there a threat the Inflation Reduction Act at least when it comes

to energy prices, actually becomes more inflationary. Yes, all right, Paula or Paul, I think we probably should leave it there, Tom, what do you say? I think? Paul? Thank you, Thank you on short notice for joining us here today with what has been underreported in the American present. 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