Surveillance: The Case for Credit With Sheets

on SPX. You know down December of a few years ago, down twenty in the ugliness a year or so ago, and then you know in the recent pullback down nine or point nine percent, you have had the courage to stay in the market and participate. Justify that. How do you go through the process of staying in the market when we pull back, Well, it depends on what you

mean by stay. What we have been espousing, which is not terribly unique versus any other quote normal time in the environment is not just stay, but be disciplined, particularly around things like periodic rebalancing. And specific to that, our message has been for investors that have historically done rebalancing on a calendar basis, they might do it on a quarterly basis. Or an annual basis, similar to what mutual funds do. They typically rebound for last week and each quarter.

But to let volatility be your guide as to wander rebalance. I have your portfolio dictate a message around rebalancing. So you're sort of trimming into some of these big pops in the market. You're adding during periods of weakness. It's not all or nothing decision making, but it keeps you in gear and forces us, of course to do what we know we're supposed to, which is you know, ad low and trim high. So it's that rebalancing shift that we have been pushing this year. There's not just in

terms of your approach the single names. What are you advising clients at the moment. So, of course I don't analyze individual stocks, but two investors who like to pick stocks. What we have been telling investors to focus on is

factor more than either sector or style. And the factor that has been most consistently successful in this environment really throughout the entire year pre pandemic, you know, into the the bear market portion of this, and then since March twenty three low is balance sheet quality and even in sectors that have not been as dominant from a performance perspective. That quality factor has been leadership. So you can look for that quality basis, and I think factor in particular

is more important than sector in this environment. So listen. Yesterday black Rock chief executive Larry Fink came out after they reported that their assets had surged to nearly eight trillion dollars, and he said, I believe we still have more to go on the upside. He was talking about equities. We have a strong conviction that the average investor still is underinvested. Some people say he's just talking his book. Do agree with him? Well, it depends on what you

mean by the average investor. You can bring at the market and investors into cohorts. I think the you know, the cohort that's getting a lot of attention recently. I've been calling the newly minted day trader. I'm not sure there's a lot of liquidity left there, but they're trading fairly small amounts. If you look at other measures of sentiment. Certainly from an attitudinal standpoint, older investors they're a little

bit more cautious. But when you look at money market UH funds and the amount in there sitting there is and sort of pseudo cash on the sidelines aren't necessarily like that term. Relative to overall market cap, it's a fairly low number, and cash and mutual funds is a fairly low number. Two. If you look over the long term at households exposure to equities, it's down a little bit off the recent peak, but in kind of the

highest quintile historically. So I'm not so sure I buy the argument that there's just massive amounts of money um sitting there waiting to go into the market. I think it's a mixed bag. Listen, I want to go back to something you and I know well, which is the work of Stephen Ross at m I T on factor analysis.

You've got to talk more about this. I want you to explain why so much of what we do day to day within investment firms and within the newly minted ignores factor analysis and what's going to be the the the variable at three in five years that drives Steven Ross's original world, well, the newly minted day traders, uh, the the data we have both anecdotally and then just looking at the activity among that cohort clearly is not

focusing really on anything terribly fundamental be evaluation, UH factors, long term learning growth. I think it's it's purely a momentum play. That momentum can be in areas that may be justified by some fundamental certain tech type stocks, but also just purely gambling plays like some of the activity

that we saw in areas like the bankruptcy stock. So I would I wouldn't sort of add that cohort in as making decisions based on any fundamental I think the reason why the quality factor and I and I agree. I think there will be increasing focus on factor based decision making um, not just because of the positive bias that's had in terms of performance in this environment, but the realization that there's so much diversity within sectors that making that blanket sector call is probably not the path

toward long term investing success. That those factors around things like in this environment, quality I think supersede a more simplistic focus just on the sector level. Is that great to catch up this morning, Thanks for a time stone as that joh schwapwagon on this equity market right now. Instets joins us with Morgan Stanley. Always wonderful to have them on. Truly on the dynamics and correlations of the

market inder sheets. Is the equity market alone year or is it other markets that adapting and adjusting to the expectation out there? Well, good morning and good to be with you. You know what I think is pretty fascinating about both the equity market, but but a lot of different markets is that you know that the headline levels speak to quite a bit of optimism. We're back near the highs and the SMP five um that that would clearly suggest a quite optimistic outlook on the economy and events.

And yet I think across a lot of these markets you still have a lot of the kind of the micro relationships, the inner market relationships that reflect a lot of growth pessimism. Um Right, small caps still trade to historically large discount to large caps. Yields are still very low, the curve is still very flat on the race show between high yield and investment grade spreads is still pretty wide.

Um And and all those things are are what you would expect if investors were less confident about growth, not more confident. So I do think it's a pretty nuanced picture. Yes, you know, the headline indusicries are high. It's it's easy to kind of read that as, oh, there's there's an enormous amount of growth optimism that's come into the market. But but actually, I think looking below the surface, what I think that would suggest is there's a lot more confidence.

I think on there's a that that there's a lot of liquidity in the market, then there's a lot of confidence and high expectation that growth is going to rebound strongly. Andrew, I might have misheard you. Did you just say that spreads are still pretty wide? Yeah, so, I I know

it might have sounded like a like a misquote. No, if if we look at, you know, the relationship between high yield and investment grade UM, you know that relationship is still pretty pretty elevated UM in the sense that high yield spreads have come in a lot less relative to too higher quality spreads. And even you know, within the high old market, you know, you still see pretty average levels of UM evaluation gaps between say kind of

single BE credit and double B credit. So you know, our our view is has you know, is and remains pretty constructive on the credit space. You know, yes, it has rallied in. Yes, there's a lot less value than there was there over the summer but I think this is an asset class that rarely trades at the average, and I think we're in one of those phases where we're moving from spreads being kind of too wide to probably the next phase being they need to move to

being too tight. All right, Andrew John Farrow is just setting me up because he wants me to ask you, I'm sure about the incredible amount of money that's poured into the triple C space and this question about whether

we've seen the end of the bankruptcy cycle. In other words, are you saying that spreads are going to tighten because credit quality is perhaps under priced right now that basically investors aren't giving the benefit of the doubt the likes of Carnival at Delta and these other companies have yet to get back on board. Or you saying that liquidity will overcome all of those concerns and they won't be

an issue for creditors. Yeah, So I think it's actually a little bit of a little bit between the two. I think actually it's a would be a pretty common, pretty normal credit cycle to see the market rally and improve ahead of kind of the ahead of the peak in the default rate, ahead of um the worst of

of of the downgrade cycle. You know, we saw some of that in two thousand nine and ten, where where the market had had largely recovered in even as there were still quite a few downgrades to happen, even as you know, many companies did go on and default. That the credit market I think does have some some precedent

of of moving well ahead of those factors. And so you know, I guess what I would see it more consistent with is that kind of that normal, that normal cycle that yes, you know you still will see down grades, you'll still see defaults, but that you know, the credit market is and I think a reasonable job of some differentiation there and that those those events won't be enough to derail the broader high yield market. Andrew is so

constructive you make in Leasa depress. Can you just tell me what would make you bearish on a Sunday when you write that Sunday start and note that everyone wants to be on the distribution list for what makes Andrew sheets bearish? Thank you that note? When it comes out? What changes it? Yeah? Sure? So, so I do think the case for credit is better than than other asset classes. You know, we have we have less upside to our to our US equity targets, we have less upside to

our emerging market equity targets. I think those are markets that we do think are are more fully valued than the credit market is, and and they do think if we kind of think through us, you know, election outcomes, and I think there's a lot of focus on you know, what's what's the immediate market reaction to different combinations. But but there are certainly combinations where you could uh inhibit further fiscal stimulus in the US, and I think that

could be problematic. You know, if you if you had to ask me, you know, what's the broader scenario that would worry me most longer term. It's it's almost that we have a little bit of a groundhog day with where you know, back then, we were coming out of a recession, we were coming out of a really bad place. There was a lot of stimulus in the system, and then the stimulus just kind of stopped and the market focus shifted to balancing the budget, fiscal austerity, and those

types of things really slowed down the recovery. And so my my concern would be that maybe you go through that again, that you've You've had this very sharp recovery off the loads, and in March and April um that that actually kind of policy makers take their their feet off the gas next year and the recovery isn't as as strong as we expect. Andrew right to catch up, Andrew Chase and Morgan Stanley, and congratulations on the call so far in twenty far more constructive than the consensus

through this year for an economic recovery. Not just Andrew Chase, my Wilson on equities alon zetting around the economy and the United States. Chet and I are laid in the research Matt holmeback named the right side of things right now on the reality, which is, if you're a shareholder of Morgan Stanley and Goldman Sachs, guess what, it's been a lousy ten years. You're compared to a lot of other things out there, given all the challenges, it hasn't happened.

The Fortress Gorman Okay, eight percent a year, maybe tenure return. Golden Sacks totally unacceptable under four percent return per year. Christian below holding Court at Credit Suites and particularly at Bernstein joins us now with Autonomous Research and their senior analyst Christian. You are long these guys and particularly long Golden Sacks. How do they do better than the terrible performance of the last ten years? Good good, good morning Tom Um trying to help you on Goldman. I thought

help in the iPhone though one twelve UM on Goldman. Look, I think, UM, there are many differences this cycle versus last cycle UM in terms of business mix. UM, I think the lack of UM owner incremental regulation, which is generally how well managed the companies are left in a life cycle. So I do think there are there are better prospects for both the brokerage stocks, Goldman and Morgan UM. You know, headed forward and you've seen that somewhat this

year in a recession, in a somewhat tough environment. For example, this morning Goldman putting up almost tc UM which which really was best in class relative to the other banks have reported so far. So so I do think, UM, you know, you know, knock on Wood at this time is somewhat different. You know, I look at this so this time it's different. It starts with management. The belief over ten years, going back to Bradhain's at Sanford Bernstein

is you know they're really in it for themselves. They're really not doing it for the shareholders. What's changed. Well, today's results are a really good example of what has changed. Right. So, for example, a big part of the really strong results is discipline on compensation UM. And that speaks to a business that's a far more geared towards sort of platform businesses versus people's businesses, which allows far more operating leverage.

Now clearly, um, um, this is still a talent business and you still have to pay up a performance and you still have to attract the very best. But what with the business makes and the focus on efficiency um, Again, like this morning, they can put up decent results Christian platform business versus people business and efficiency. It screams job cuts? How big are the job cuts be next year? On Wall Street? Yeah? No, look look I think, um, you know,

I think broadly speaking the um. You know, just generally speaking, you've seen cuts on wall streets over the last decade for the most part. And as you see automation increase, UM, digitization increase, UM, electronic trading increase, there are problem that is probably still going to be UM. You know some

uh some more cut. It is inevitable um. That said, Um, there are also opportunities that come come through using the likes of Golden sides, for example, recruits far heavily, far more heavily in engineering type disciplines and technology type disciplines versus what they would have traditionally, you know, ten fifteen

years ago. So so I do think to your point that there will be some head count rationalization, but as I think there's a lot of opportunities in areas like like technology to bring on new talent which bank right now based on the earnings results that we've gotten so far,

are you most impressed by Yeah? So so I look at the Goldman and Morgan, so um, it has to be golden, I would say, a so far and you know, again just just just looking at the returns today, um um, you know, you know, kind of speak to that, I would say, more broadly speaking, if I was kind of thinking about the more broad strategic direction of the companies. We really like Morgan Stanley. I think James Coming has done a really good job in changing the business mix.

They'd be very um clever and way to use excess capital to really remix the business by by a knee trade. And you know, very recently eaten fans almost two thirds of that of Morgan Stanley will come from you know, capital l businesses like wealth and asset managed asset management. So so overall, I would say Morgan Stanley in terms of thinking about the long term and strategic direction, Morgan stand the stuff we we like the most Christian before

we let you go. Just on the acquisition option, it's an option that's not available for many of the other big banks. It's an option that could be available to Goldman. Why do you think Goldman hasn't gone in that direction? Yeah, so you know, look I think, um, you know, again, Morgan Stanley, some of more bands strategically than go right, you know, a newer management team, um less in the way of capital flexibility. Um, you know. So so I

do think there's somewhat behind strategically to Morgan Stanley. And and you know, you need to know where you want to go first and be very clear or your direction before you go out into deals. Um. But but but I do think they will be in the conversation for for acquisitions. Um, they're beginning to build capital now. And and you know they've always spoken to wealth management as a management and digital consumer banking as areas that would

benefit from scale acquisitions. So so I do think Goldman will be in the conversation for equation going forward. Christian, looking forward to getting you back on the show soon. Look forward to Christine Bolo that autonomas research senior analysts on the banks right now. This is a joint Michael Ferrod him out of Boot Schools Chicago and New York University as a fed economist and joined a small bank

in New York called JP Morgan. He wrote for Melman, he wrote for Kasman and the others, and within their weekly prospects defined in this Nation this odd phrase potential g d P. John and Lisa have a whole bunch of questions for Dr Feroli on where we are right now. Michael, I want to go back to your initial acclaim on potential g d P. Do you adjust that statistic because of the pandemic. So, I think that's an open question

right now. Normally, a really bad recession would lead want to lower their estimate of trend GDP growth because there are longer run impacts from short run of that's like recessions. However, I think it's a little early to say right now because this recession was so short and the recovery so far has been robust and offense. I think it's an open question. So, for example, normally one would say that the slow down in capital spending after a recession would

lead to slower productivity growth. Right now, it's not clear how much capital spending is actually slow, and we obviously had a bad second quarter but a good rebound in the third course. I think, um, the jury is still out. It's something we've we've been considering quite a bit, but right now we're leaving our estimate unchanged and wanting a

half percent for for potential GDP growth. Michael, since an increasing number of people are saying the same thing that you are, that this economic recovery has been more robust than people had expected, and that the recession perhaps a bit shallower, does that mean that there is a greater chance of bigger inflationary pressure has given the amount of money that the federal government has thrown at this at the margin, yes, uh, you know, better growth should lead

to better firm our inflation outcomes. It's still the case, however, that unemployment looks like it will be elevated for several quarters to come. So so while we may revise our views towards somewhat higher inflation. It's still going to be inflation that we've think will remain below the FATS two percent objective for for PC inflation at least, so directionally, I would agree with what you're saying, but I wouldn't want to take it too far and say that we're

you know, we're looking at a big inflationary year to come. Michael, we talked about this before. I just wonder how polarized the conversation is with clients at the moment on this issue on inflation. Well, inflation has gotten interesting. So we obviously had a few uh week months around UH during the worst of the pandemic. We've had a few strong months since. A lot of that strength has been reversing. Some of the category is that we're week during the pandemic,

but it has kept the discussion alive. I think it's um you know, my in my opain, I think we are in a disinflationary environment. And you know, as you say, the discussion, I'm sure it's polarizing as much as it was perhaps in two thousand and nine when we first were experimenting with expanding the fact balongy. But people definitely are interested in it, particularly given the central importance. Now

it hasn't the prospects for a future federate. We caught up a Catherine Maunt of City yesterday and she brought up a series of issues. I love your thoughts on them. She was talking about the gap between consumers perception of inflation, statistical measures of inflation, and financial market pricing of inflation. Michael, how do those three different things? What's that spread look

like at the moment? Right? So? I think financial market expectations are closer to what you're seeing in the actual statistical measures of inflation. Uh. I would say consumer perceptions of inflation are higher. I think one of the reasons for that is that consumers tend to UH put more weight on prices that are more salient. So, for example, food prices tend to seem to carry more weight in consumers perceptions than they do in the UH than they do in the actual baskets of goods and services, and

food prices had been a little firm recently. Uh so I think that maybe one factor that is leading to that disconnect between consumer perceptions and either financial market expectations, which are renamed relatively depressed or uh, you know, the actual measures like core PC, which is also sub degree Michael, how does real estate play into our guestimate of new inflation? How do rents play in owners adjusted rent, et cetera. How does ownership of homes play in to our guestimate

or reality of inflation in twelve or thirty six months. Yeah, this this is actually pretty interesting issue because both tenants rent and owners imputed rent, which is the rent people who own their homes would be paying hypothetically if they had to rent at those homes. Both of those has

have accelerated very sharply in the past three months. Some of that may be due to a phenomena that is similar to what we saw in the early two thousands, which is when there's a very hot housing market and everyone's rushing to buy a house, what you see is

weakness in the rental market. So it may be a bit of a statistical mirage in a sense, but it nonetheless it will feature pretty prominently because those measures are of the core PC basketb the FED looks at so so carefully so um so, maybe sort of an odd byproduct of a hot housing market is a depressed or depressed set of rental measures for inflation, Michael, pushing forward the next six to twelve months, how much does your

unemployment forecast vary depending on whether there's a fiscal support plan passed in Washington or not. Yeah, it could, It could vary quite a bit because the growth outlook could vary quite a bit. Uh, you know, if we got something like you know, some of the numbers have been coalescing around two trillion dollars recently. You know that's uh,

that's ten percent of GDP. Even if you haircuffed that for you know, people savings, some of that stimulus, that would still have a pretty significant effect on GDP growth. And you know, as GDP growth goes, so goes with so much your unemployment rate. So so clearly the the you know this is um you know, the markets are not. I think mislead to be focusing so intently on on where fiscal standless negotiations are going. Michael Feroli, I don't

get much gloom out of the House of Chasman. But you had that chart on the trade deficit and weekly prospects this week. Tell me about the twin deficits. Do you link together our trade deficit and our fiscal are new and enlarge fiscal deficit into something that you need to think about, study about, right about, and we need

to understand. Yeah, so, uh, you know, one of the interesting things is normally in recessions, the US trade deficit tends to tends to contract because US de na for imports tend to contract more than foreigned an ad for exports. That hasn't been the case in this most recent recession, in part because it was unusually global in nature. So usually the US kind of leads the global recession. This time, everyone kinds, you know, part took a the recession in a way equally, and so that was one factor I

think that contributed to this widening the trade deficit. The other thing is that, given the nature of this recession, the US actually runs a a surplus in trade in services. However, trading services has contracted quite a bit given the inability to maintain social distance in any of those services. So we think it's uh, you know that that winding the trade deficit may partly be due to physical definity concerns,

physical deficit issues. I think it's also partly due to h the global nature of this recent slow Now Michael Grant to catch up as always, send up best to the team. Wind you Michael ferraudt that Checking mon Securities, Chief US economist. 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 care just worldwide.

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