Surveillance: The Best Game in Town

year fifty fifty? Walk us through it? Sure, Look, it's all about the numbers for us, John. And before I get into that, let me just tell you I sympathize with where your head is at. We called our weekly this morning good bye one. We're ready for it to be God. But look, I think it's you know, it's first off, the strong economy. Most of our economic modeling is playing us to an SMP five hundred north. Then it is looking at stocks versus bond that Lee for

another year. I think stocks are still the best game in town. So are models. They are appointing us to about an eight percent type return. I think where things get interesting is what happens with pe multiples. If you assume a flattish pe we should be you know, around my target if you assume some crack contraction, but based on more aggressive FED and that's a realistic risk in here. Um that does point you to about down two percent on the year on our models, that would be our

worst case scenario. It's a real risk monitor But the preponderance of the evidence on the economy and again stocks versusponse is telling us to look for another good year in stock, not as good as what we had this year, though frankly it felt lousy to get to this return that we've gotten UM, but I think we'll have another good year next year, but it's gonna be a bit harder.

It's gonna be a bit harder on your outline. How in the first half of the year you might get an out performance of the value trades of some of the cyclicals, and in the back end it's going to be a rotation back into growth. Can you give us a sense of what that means in terms of the ongoing barishness in terms of economic growth that you see to the second half of the year. So look at it, it's not and you know, I'm sure my economist is

kind of shuddering if he's hearing this right now. But you know, what we're seeing in tree is that if you look where the street economists are forecasting, they're right and around two and a half percent. Now, that's not a recession by any stretch, but it is a deceleration

back to trend like growth. And what we do tend to see is that when markets and markets again are very forward looking, when we're in a hot economy like we're supposed to be in next year, for percent is basically the number in place for next year by most economists value, small cap cyclicals tend to outperform. But when you move back down to trend like growth or below trend like growth, that's when those more defensive parts of the market, like large cap secular growers and the growth

trade itself tend to outperform. And we think at some point in the middle of next year, we're going to see markets start to focus on three and be done with two, and once that happens, will probably be well into fed rate hikes, and that also tends to be a trigger to get you away from those cyclical trades and back towards the growth trades. Wishing time away all right, let's dwell on the hair and the now for our radio audience. You've got a beautiful backtrol sciantistic communing or house.

I love the name. My son's called Leo two, and you've got one for Leo of your family. I'm interested in Santa rally or lack thereof talk to us at the very end of one, even though there's but this week left. According to John Farrow, are you expecting value to still stabilizes it in last week a little bit towards the end. It's a great question, Caroline, and we've said in the very near term, if you're trying to trade now through December thirty feet, we just stay balanced

on everything. Look, I think, oh Macron is really, at the end of the day a threat to the value trade. And while the little drifts and drafts of news we've been getting have helped stabilize the value trade, ultimately if we do see case counts worsen that actually all year has portended out performance by things like growth, large cap

and secular more defensive positioning. But the problem we have right now is that the Fed in this more hawkish tilt, that we're all of a sudden having to digest is really a threat to the growth trade because that's where the expensive valuations are, and when we're in hiking periods, expensive stocks tend to underperform um when rapes are rising um. And so we really think that that's we're sort of

hot between a rock and a hard place. Over the next couple of weeks, we just build on that a little bit because what we've seen in Credit Suite have pointed this out that the expectations for high rates that have fed haven't translated into high yields and that hasn't hurt the multiple. Can you want me through the relationship between fed rate high expectations and multiples on the SMP

that you expect to evolve through next year? So look, I think the multiple question is a very very challenging one. And I know that there are some of my peers out there in the strategy world here saying, hey, fed rate HIGs always produced contraction, we gotta bake that in for next year. And I actually don't think it's quite that simple, John. We're starting to see pe multiples compressed at the individual stock level. If you look at the Russell two thousand, if you even look at the medium

stock in the SMP. But we've seen a very kind of flattish move on the overall top down numbers. And I'll just take you back to the fact that we're still in this keewee world. And yes, the tapering is coming, it's more aggressive than expected. But the FED balance sheet has really kind of distorted what happens with PE multiples recently. If you expect sort of a flattish balance sheet over the next year or so, what that should tell you is that we should have a flat ish PE multiple.

It's really when you get into quantitative tightening and he contracts and you contract the balance sheet, that's what the recent history is telling that should cause the contraction and the multiple. So it's just very complicated right now, Lori. This is a really important point and goes to the idea that we heard out of out of Seth Carpenter

from Morgan Stanley over the weekend. The Fed is not willing to go to quantitative tightening too quickly because they do not understand the effect on Marcus the same degree. Are you saying that that's had a bigger effect in propping up equity valuations and on the flip side, would have a bigger effect on the downside if they were starting to withdraw that liquidity than even rate hikes or anything else. So let's go back to you know, John

and my Frankly desire for this year to just be over. Um. If you go back to I remember I was on vacation at the time that last week of the year. I thought I could take vacation, and we had just a ridiculous down draft in the equity market. A lot of holidays were ruined on, a lot of portfolios were ruined in that last week of the year. But what we were dealing with back then, um was the kind of two through ats right. It was a threat to growth from the trade war, and it was a tighter

fed that we were actually pricing and quantitative tightening. So that's really you know, it's not in my base case, it's not even on my poe Haast to rise on. But that is sort of a dire scenario that you know, Frankly will keep me up at night on on some of the nights where I'm you know, letting my mind race um. But look, I think at the end of the day, quantitative easing, quantitative tightening, this is all a

new tool right. But what I can tell you, Lisa, is that since the year over year trend in the FED balance sheet has really dovetailed very nicely with the year over year trend in the PE multiples in the market. Um, so it is having an impact. And I've sympathize, you know, with with those who say they don't quite understand what the unwind is going to do. But what I can tell you is that the Fed has propped up PE multiples through the balance sheet. Laurie magnificent as always and

going to catch up with you. Thank you for everything you've done for us this year. Have been great to work with you. Lorie Cavassein that of Obbos on a secret market. She wants the year done. Mike College joins us now City of Portfolio Manager for PATM Fixed Income. Mike, I promise would get to this coal at the front end. You think that maybe we've seen the peak of ye's at the front end and at the long end on

tent as well. Might just walk us through the framework at PATM right now when you get around the table together, how you explain this Jonathan, Again, it's looking at the long term view, right, and everybody's so caught up on this growth surge and on this inflation surgeon, and we've done a lot of work on this, and when you really peel it back, it's been more demand driven than

supply driven. Right. If you look at supply of stuff that's being made around the world and being shipped, it's higher in many places, in many cases than pre COVID, but the demand has jumped, like especially for goods, for durable goods, for imports. That demand is going to come down, right.

That big jump in the savings rate we saw last year with all the fiscal stimulus, all the helicopter money that has already been spent, it's gone, right, So what's going to happen going forward as the fiscal stimulus really retrenches. Notwithstanding these infrastructure and BBB packages, which I think are just really non events in terms of their economic impact.

It was the helicopter money sending people cash last year that really jumped spending and that is going away, right, So so the supply demand in balance is going to come back into balance over the next twelve months. So that's really the big picture. And the FED, though, right is kind of trapped or they paying themselves in the corner they're going to hike rates because they see these headline numbers. So the front end selling off the back end is is flattening, which happens every time you get

a FED rate hiking cycle. So I think the curve is going to continue to the point where it's totally flat. But that's already priced in. If you look at the one year note, Jonathan in two years from now, which is reflected in the three year yield. Not to sound to wonky on a Monday morning, but that's at one six. The ten year note ten years forward is at one. So the market is already priced in a totally flat curve,

which is ultimately what will happen when the Fed's done hiking. Michael, you're talking about an idea that a lot of people disagree about that you're going to see inflation come down enough that can justify the Fed's patients. How can you see their rhetoric this Wednesday kind of confirming that if say, they do accelerate the taper as they're expected to do and continue to talk about uncertainty, you know they're they're not being patient, right, That's why the front end is

getting killed here. I mean two thirties this cycle. Just earlier this year peaked at around basis points. I always look at thirties because you know, we are, you know, manage a lot of long term money. For insurance companies, pension plans, they live in that thirty year space. Not like retail investors that was at two thirty. It's at one today. It's been cut in half, so it's halfway to zero, right, and it will get to zero. But again that's already priced in. The FED has turned really

hawk ish. Uh, they're getting really us if they're gonna accelerate their taper, they're probably going to pull forward and accelerate rate hikes. But ultimately, what's priced into that ten year note and the twenty year note is where that funds rate is going to average over the next ten years. And yeah, an average, it's probably gonna be one percent or less. They're gonna get it to one and a half. Maybe they overshoot and get it to two or two and a quarter this cycle, but sometime in the next

ten years, Lisa, it's going to be back to zero. Right. So on average, it's gonna bounce around between zero and two, and it's gonna average one or probably even less. Which puts, you know, ten year notes at reasonable value. Here, Michael, are you pricing in at all the risk that they might have to be more patient? I'm here in England with the Bank of England was really hawkish and none

and not. Yeah, I'm Caroline, good morning. That's that's the risk, right, there's so much, so many ice stand in the front end now. Basically, you know three next year and and three three. That's a lot, right, That's a FED that's really moved thing moving for two plus straight years, right, I mean that's a lot. That's a long time to try to price in and figure out what the economy is gonna look like, what inflation is gonna look like, and what cold is gonna look right, So you're you're right,

one of the risks right now. I think the hawk is scenario has kind of been priced in with this really flat forward curve. But but the risk is that you do get a big drop in activity over the next six and twelve months, and that inflation comes down a little more quickly than people think, and the FED and other central banks say, we're not going to be able to hike three times a year. Let's pull that back, and then the curve, you know, bull Bull Stephens, right,

and we're not really ideally positioned for that. We're in the flattener, which has been working like crazy, but we're starting to cover something that in because we are concerned about that risk that the FED isn't able to hike six times, which is a pretty pretty high probability for sure. Mike, you always get me thinking, it's always great a cash out with you, Sir Michael Collins that of ahm, Mike,

you're the best. Thank you. Sir. Ye joining us now is white leg level chief investment strategists at Black Rock, whiley I wanted to start with China and then we'll work our way back to the United States. But can you give me your rate on the Chinese economy following a week where people already started to reset their expectations for a policy shift from the Chinese Communist Party, what's

your view on that? Well, what we have seen so far this year is that there is this greater pivot towards social objectives and common prosperity, and as evidenced in the regulatory climb down earlier in the year. But what we have also seen this year is that growth is deteriorating from quarter to quarter, from above in Q one to now below five percent in Q three, and kill Foy is looking even worse in terms of the kind

of the growth levels. And as a result of the deteriorating growth trajectory, we have been off the view that support will have to ramp up heading into a significant year.

There is twenty two, characterized by the Winter Olympics, characterized by the Party Congress, and sure enough we have seen support actually date comes through in the form of triple our cut, in the form of greater phisical standing expectations that we continue to think that will be the case as we head into next year, which is why we are modestly constructive China assets, both on the equity side as well as on fixing come site CGB. You are

not alone in this. A lot of people have said that there needs to be more accommodation in China because of some of these issues. And yet over the weekend the polop Euro of China it came out with rhetoric that was new around the housing market, talking about bringing down pricing because this is a place that people live, not just invested. How much is there sort of a talking out of both sides of the mouth, and frankly a harder line in maintaining the de leveraging stands from

the polop era over the past few weeks. It's a It's a fine balance, isn't it. There's always a dance between this longer term journey of quality revolution, thinking about the leveraging and balancing that with the near term support. So indeed, we have seen kind of rhetoric pointing to wanting to deliver in the private sector in the housing market and also thinking about the resolution of how is

it going to look like for a grant. But in order to make sure that in order to contain the spill over effects from the leveraging activities, growth side needs to be showed up even more, which is why we see easing policy coming through to make sure that the way is happening the housing market is properly contained within the housing market and does not lead to a broader spill over on the economic more broadly, uh and leading to a broader risk of which is not what we

expect heading into next year. The warning really, I mean, it's great to get your perspective from China moving out to its worldwide impact. Of course, as China tries to give some support to its own economy and the acting

markets reacted off US earlier. What about the supply chain issues is Jonathan was just mentioning, we get that first case of Omcrown coming into China, are you worried at any point of the inflationary pressure that we might see once again if indeed the new variant hits China, hits supply chains, hits US in Europe and in the US.

You're absolutely right in that the zero policy, zero tolerance policy in China does mean that omic crown cases popping up in China will have even more kind of significant impact on the supply side, on the economic activity side, which is why we expect on the policy side things will have come to even more because they would have to kind of shut down on the economic side even more in comparison with their developed market develop market counterparts.

Now in terms of the spill over more broadly and thinking about the kind of policy room we do see on the inflation side not too elevated. In the case of China, PPI is hyher CPI is still reasonably contained, and that actually does give them room to ease a bit more, even needs to be and if you think about versus last year, developed world has really kind of come through with policy revolution coordination of monetary side as

well as the physical side. China has been rather reserved in their policy response, leaving the great room to to to to to act. So that that that is why our case in China is modestly constructive against the broader backdrop of a very very low starting allocation to China in global portfolios. But more broadly, thinking about twenty twenty

two UM, we talked about supply side constraint. We do expect that kind of getting alleviated somewhat second half of the next year, and the combination of still robots to growth dynamics as well as the negative rate environment should continue to support equities. And within aquities, we prefer developed market aquities over emerging market aquities. Really within d M, it's for an international bias to the asset allocation, that equity allocation away from the United States towards the US.

It's interesting that you should mention that so our d M equity core has gone through a bit of a journey in twenty twenty one. The first half of twenty one, we preferred US equities because the restart was way ahead in the US, but at the media point we pivoted from US to European maquities. Is the baton of growth

pick acceleration shifted from the US to Europe. And sure enough, this this differentiated approach to play the uneven pace of restart was also reflected in the fact that the difference in earnings materialized earnings growth in Europe and in the US. The differences so far this year almost fifteen. But now looking ahead to twenty one, the uneven pace of restart

is washing through a little bit. And if you look as kind of the earnings expectation difference across the US, Europe, Japan, you know they're different, arranging from to half percent to fifteen percent. So well, less kind of playing the theme of uneven restart and instead we see actually what I just talked about, this combination of netive real rate and dynamic kind of growth environments supporting DM aquities across the across the board were modestly constructive across DM aquiti is.

But under that we also want to kind of think about bar boweling across cyclical sectors as well as secular growers. Growers like technology and healthcare. Well, they always smile, weally of black Rock on Europe, the international story, China too, against the United States. The focus right now on the pandemic. Primarister Boris john S saying O Macron represents of COVID nineteen cases right now in London and by tomorrow it

will become the dominant strain. Joining us now to discuss is Joshua Chastein, weistein the Johns Hopkins bloom By skill of public health. Josh when let's start right here. Trust. How much trust is that of these politicians delivering these emphatic statements and scaring society. And that's the issue we have right now, isn't it. Who should we trust? And how long do we have to wait to have some data, some numbers that we can trust. Well, I think that

you know the numbers themselves. How many cases, what percentages are of amacon those are true. The governments are saying, unfortunately there's some percentage of the population that has tuned everything out. But I think most people realize that this is a new variant, just like Delta was a new variant, and we're going to have to respond accordingly. Given the fact that omicron is now expected to become the dominant

strain in the United Kingdom. As Boris Johnson was outlining this morning, is the third dose, is the booster shot go to be considered required in order to be fully vaccinated? I think that is becoming a distinct possibility with each study that comes out suggesting actually good news, which is, with three shots of the MR and a vaccine, people

have a reasonable degree of protection from amacron. This is not the case of complete escape from the vaccines, but that third dose seems to really help, and that may in fact, you know, change some of the policies, but was considered fully vaccinated so far, companies have really led

private companies when it comes to setting policy. You see in the United States a survey of companies actually shows that nearly two thirds of all of them are going to mandate vaccines for their workers, whether or not there is any sort of overarching law about that or policy. How have you seen the discussion changing among private corporations to get that third shot, the booster as part of

the requirement. Well, I think the recognition right now is that to have a safe work place, which people want, you really can't you know, open up to a macron and doing things that are necessary to prevent this virus from getting into the workplace, spreading in the workplace, really rereaking havoc on all the plans that companies have is um you know, a priority to doing something to prevent that.

So I think that companies are looking at the data just like public health officials are looking at the data, and it wouldn't surprise me if they start requiring the third chat. I mean, the third chat is very safe and it protects against amacron, So it's pretty logical that we could get there. You talk about we can have it in terms of the workplace, we can have it con travel plans ahead of the holidays as well. And I'm seeing, of course Prime Minister Johnson saying that the

U has already supply of COVID lateral flow tests. It's interesting from a cultural perspective coming into the UK, everyone is testing every single day using these collateral flow tests that are being given out on the street or you're into your nearest pharmacy. How is testing distinguishing itself? As I'm looking at airlines fighting back against more PCR testing because of the length of weight and the hoops you have to jump in the price tag. What are the

testing could they do well? I mean they could be doing the an engine testing as well. I mean I think that we now are at a point where with the virus sticking around and you know, making itself the unwanted holiday guests, it's really important to have testing, but to integrate testing into our lives and PCR testing isn't that great for that if you've got to wait an entire day, because even if you were negative, something could have happened in the interim. And so these an engine

tests offer the opportunity to do things quicker. I don't think we really figured out completely, particularly with travel, how to integrate it into our routine. Just like you know, you know, not too many years ago we integrated all the security stuff into our routine. We have to integrate testing for a while into our routine. And you know, we're in a little bit of a rocky phase while that gets worked out. And this is what everyone from an individual perspective, war is about and comes a macro

issue if everyone starts to worry. From Mr Johnson saying, look he declines to rule out new COVID curbs before Christmas, it's an important family moment, but it's an important important economic moment for spending, for consumer sentiment. How likely are we to see further lockdowns in the United States and worldwide? I don't think we're likely to see you know, full lockdowns unless we have a situation where there's just an

incredible searche and hospitalizations. And you know, we don't yet have evidence that that i'm o'con is going to cause that in highly vaccine and population, so we are going to have to see UM if that were to happen, and of course the health care systemwhere to come, you know, be at risk, then probably all bets are off on the kind of restrictions that might be necessary. But probably we'll see very, very limited and target targeted policies to reduce the spread UM. And you know, again it's the

uncertainty that gives everyone anxiety. But we are not back in March. We have vaccines that provide for action. We know a lot about the virus, we can find it, we can test for it. So I don't think that people have to be so worried they're going to be watching a replay of last year. Don't just quickly How much more time do you need personally to conclude that this is less natalie than previous variants. Well, it really

you know, there are a lot of different views out there. UM, I think a very strong argument is we need to see how it behaves in different populations. And so I think when you see you know, for example, London, when it really does become you know, the dominant variant, looking at what happens to hospitalizations, I think we'll give a really a good view for the United States. Um, what the the the likely out come it's highly vaccinated population,

um getting omicron spreading around? Does that really make people very sick? And we'll find out soon. Joshua, thank you sir for catching up. As always, Joshua Shausting that of John Sulkins. This is the Bloomberg Surveillance Podcast. Thanks for listening. Join us live we days 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 In. This is Bloomberg,