Surveillance: The Case For Value With Kostin

in April he got it right? He made a call forget about another bot on the gloom Crew torm to shreds and Constant went long and there's been a nuance to Golden Sachs view forward through this tumultuous two thousand twenty David Constant, thank you so much for joining. Just simple now what now? What well? This year has been about the medical situation. At the core of the challenge

is medicine. And so if you think about what the super Forecasting Project at the University of Pennsylvania is showing, they have a estimate every day of what the likelihood that there will be twenty five million doses of an FDA approved vaccine somewhere in the next six months, twelve months,

eighteen months, various points in time. The reason I mentioned that, Tom is because if you look at where we were in July, middle of July, it was reading sixt likelihood that there would be a vaccine widely distributed between October of this year and April next year. Okay, that ran up to sev by the first week of September, and the market, the stock market went up around eleven, so

you check your numbers, that's around. However, that probability has since turned around and it's gone from seventy down to this morning, and that likelihood has corresponded with a decline in the S and P five hundred by around nearly ten. So my kind of message to you is that basically we have been treating the likelihood of a vaccine and you can see that in the data. And John, I just want to mention this is Phil Tetlock at the

University of Pennsylvania with this wonderful book super Forecasting. John and David, you were looking at the benchmark compared to the probability of getting a vaccine. Can you got beneath the benchmark? Because you put out some research on this recently, and I think it's really quite interesting. Can you build on it? Forest David? Sure. So, I'd say the fundamental just a couple of key debates they're going on with

the with the investor community right now. One is related into yield curve and inflation and with the rate interest rate market will be But another one at the core of that is about growth versus value and where should

one be. And the core argument is that the people behind the value story would say that, gee, when there's a vaccine that's developed, when and if that that that takes place, that will allow the acceleration of the normalization of economic activity, and that means the companies and the industries and the sectors that are more cyclical will rebound and do better. Uh, that's sort of the narrative behind

why to own cyclicals. Now I would reject that or say that there's a better approach, that the gap in valuation is so significant its value not necessarily cyclicals, that is the better place to be. So that's the first observation. You want to be in value as opposed to necessarily cyclicals. And then the question is what's the investment arising so tactically value maybe it maybe is attractive right now, no question about that, one of the more attractive UH times

to see value over the last twenty years. But ultimately, if you're looking for a longer term story, the secular growth companies the ones that have actually generated revenue growth and earn his growth despite the pandemic. If we look at what happened the second quarter, third quarter looking out, the way you want to think about this is if you go into the entire market, how many companies are

able to consistently deliver double digit revenue growth? Well, the answer is you start looking at who's generated revenue growth in two thousand eighteen and two thousand nineteen. We'll skip over this year for a minute. Expected for two thousand twenty one, two thousand twenty two, let's get a five year compound annual growth will pick up this year, So that five year period, only one stocks are expected to have been delivering and are expected to do so. So

that I think is an important argument. So I think there's a two two prong way to approach the market tactically value, but ultimately it's about growth and the secular growth stories I think are likely to be the winners for portfolio managers. If you look out twelve months from now. It's David, two parts to the argument that you just laid out. Let's get to the second part in just a moment and pick out the first part. Just give us a little one. I want the distinction between value

and cyclicals. What is that right now? So it's an excellent question, Jonathan. It is the idea most people conflate those two and they think about cyclical stocks that are necessary sort of industrial UH would be would be a classic example. UH. Financial stocks often interest rate sensitive. Our view basically, cyclical move with the economy, and that's true. But then when we think about that those are factually true. We can look at a correlation. You say, well, gee,

is economic data getting better? What sectors and and and and stocks tend to do better in that kind of environment. Those would be defined as cyclical sort of high UH correlation with economic activity. But value is about what is the market trading, and so you can look at at multiples and and pe multiples or earning zealds are different ways of thinking about valuation, and it doesn't necessarily mean

they're economically sensitive. And so the message Jonathan's kind of that first part is we want to find lower multiple companies valuation, they aren't necessarily cyclical sensitivity. For example, you look at the financials be challenging in a flat yield curve environment to actually deliver on better growth, slim net interest margins, big reserves because of potential UH long losses, UH difficulty to under the c CAR proposals, whether the

financials can pay dividends or buyback stock. So those are some of the headwinds. So those are classically cyclical areas of the market, but it wouldn't necessarily UH screen is attractive on evaluation basis. That's an example, David, just broadening out, you still reasserted your call for thirty six hundred on the SMP at year end less than two weeks ago. If we don't get fiscal support in Washington, do you

still affirm your thirty six hundred forecasts. The answer is yes, thirty six hundred is a target for end of the year, thirty eight hundred middle of next year. And the argument I said at the very beginning, ultimately this is a medical situation, medical challenge for the economy, for society, and ultimately for the equity markets. And I pointed out that the level of the market at the broad level has really been trading pretty carefully, pretty closely with the probability

of a vaccine being introduced. So part of the assumption, uh that I'm making is that there will be a vaccine that's identified. Probably what most portfolio managers are expecting and what some of the forecasts are are projecting is perhaps in October, may be approved by the FD at the end of the year and be widely distributed in the first six months and next year. The market, as you know, is forward looking, and so they'll start to

discount that back. And a few weeks ago, with a seventy likelihood that it was going to be a vaccine available by the end of the first quarter, stock market was close to our target, and now it's obviously pulled back. I think that's a little less uh probable in the in in terms of the data, So there's condrad remains it. I don't think it's as essential from a from a fundamental point of view, I want to see the resolution in Washington. David John Farrell loaded the boat on Apple

and Amazon a long time ago. That's why he's in London. He's looking at four thousand square feet and notting Hill, which is great, but what do you do on a relative or absolute basis if you want to rebalance out of a tech overload? I mean, how do you approach the institutional or retail account to high net worth account that says, look, I've made a success of it, like Pharaoh? What do I do? How do I move out of it?

How do you lighten up? Intelligently? So it is a an absolute essential issue that many growth portfolio managers are grappling with. And the issue is as follows that when you look at the Russell one thousand Growth Index, the top five stocks, those five stocks about twenty five of the equity cap of the SMP five andred but the thirty nine of the Russell one thousand Growth. So a lot of growth managers are actually uh in passive violation,

out of compliance with the SEC guidelines. What makes it diversified mutual fund because they have too great a concentration in some of those positions. So the answer that that I was sort of providing to you, and that framework is looking at which companies can emulate from a earning from a revenue, from a sales growth point. If you can emulate those big stocks, that you're just mentioning some of the big tech stocks and there's only there's not that many. But you can think about Vertex, you can

think about PayPal, UH, you can see Intuitive Surgical. There's a variety of companies that have delivered on ten percent revenue growth last several years and are projected to do so. In some cases have wide moats around their businesses. And when I work with the analysts at Goldman, these are some of the stocks that we screen as a strategist and then also UH that corresponds with the fundamental analysis

of the companies. And so the answer, Tom is that's a way of substituting for some of those large cap growth companies. Those growth companies will still do well, but these are companies that are maybe more middle size or sort of in the ranking order, maybe number seventy one or seventy three, seventy They can move up the ranking to be one of the larger stocks and that leads to out performance. And Tom, that's how I committed that tackle that problem. Devid is good to hear from you,

as always, send out best of the team. David coosten neck Alma, SAKS, Chief Equity Strategists. This is the Conversation of the Day on fixed income. Cathy Jones is a swab center for financial research, and what's important here is she's got a wonderful visibility on the challenges individual investors are having in bonds. Kathy Jones, where did the sixty forty portfolio go? Yeah, a lot of people have tried to abandon it and hopes of getting more income, getting

more safety, getting more diversification. But I really don't think it's disappeared entirely. I think it just has to be more nuanced on the fixed income side. So if you you know, if you look at rolling correlations over the last six months or five years, you're still getting diversification from treasuries and you know, higher quality bonds. It's just the upside is much more limited and the magnitude of

those changes is much smaller. What's the elasticity on the downside if we get yield up and priced down, what could be the magnitude of that price down? You know, I'm looking at if I look at the tenure treasury and we we get to move up and yield this year or in the next year, I'd say maybe ninety basis points to one percent. I don't think we get much more than that on the upside. On the downside, you might get down about forty five basis points or so in our even less I suppose in a real

negative scenario. So it isn't the kind of move used to see six to ten basis points a day on a big down day. And treasuries, I mean in the stock market. I'm you're not seeing that in treasuries now. It's a much more limited move. In fact, yield high in the last twenty four US by a basis point with two three move in the equity market, Kathy, so many people in stocks have been queuing off what's happened with real yields? Can you just unpack that for us

a little bit what you're seeing at the moment. Yeah, you know, the fattest holding nominal rates very steady between their zero policy, their forward guidance that it's going to stay there for a long time, and what we've seen

though as inflation expectations come up. So the real yield has come down to about negative one percent on the ten year treasury, and that gives you very limited choices in terms of where you invest your money and the fixed income market, But It does work for the FED because it makes the hurdle rate for investments very low. It encouraged as people to borrow, spend, and invest, and that's really what the FEED is trying to get the economy to do. The right side of the story anchored.

I'm just wondering, Kathy. I'm trying to work out where you think inflation expectations are going to turn and whether we could actually see really to get less negative because inflation expectations come in given what we're seeing worldwide at the moment. Any thoughts on that, on fact how things are developing, Kathy, Yeah, I want My biggest fear in the US, and now it extends to Europe because of

another round of outbreaks of the coronavirus. My biggest concern is we don't get fiscal stimulus, the economy slows down again. Worst case scenario is a double differ recession. It's not our base case, but it's a worst case scenario at particularly if we were starting would start to see a resurgence in in virus cases here as well. So um,

I think we're walking a fine line right now. Our base case is still for continued improvement in the economy, but without the phiscal stimulus, and if we were to see more virus cases, we could double dip into a recession in the next six months or so. What's the playbook? What's the haven in that scenario? If there isn't that much lower the ten ure yields can go. It used to be investment grade credit, and yet we've seen outflows in a little bit of under performance there. What is

it now? Yeah, I still think it's treasuries. I I You're not going to get as much as you did in the past out of that trade, but it's still treasuries. And keep in mind, I guess in a very negative scenario, nominally yields can go negative at the long end. That probably would force the Fed to take much more aggressive action. But it's not without precedent. If you look at Europe that's happened. What about with riskier credit, We've seen some pretty big outflows from high bond funds of lady. Is

this the beginning of a larger trend? You know? I think the market needs some correction in high yield has gotten very frothy. Some of the junkiest of the junk has rallied quite a bit. I don't think that we're going to see investors abandon it because you do get positive care, you're going to get a year that's you know, five percent in high yield. That's tough to get. So I think you'll see people come back in barring another recession.

But it did get overdone. Spreads were very tight, and the again the lowest of the low started to do well. You mentioned a couple of questions ago, Kathy Jones, this idea of what the Fed wants which is completely removed from the coupon given duration that the individual investor wants. And we spoke with Richard Clarity yesterday. It was a complete class act. Great but does he or the people around him, do they actually care about financial repression. I

would say no. Um. I think they look at the policy of the Fed as being better for the greater good and that that's not going to change their policy. They think that savers and investors, although we hear a lot of complaints about low interest rates, they think savers and investors are benefiting from the rise and risk set and their focus is really on the point. John Farrell,

I think this is just an absolute fundamental condition. We tried out in our fancy suits and ties and talk all those theoretic mumbo jumbo why retirees and others are getting absolutely crushed well over a decade, Kathy, this is really important that these interest rates have been low for a long long time, not just in the United States but also in Europe, and the lower they've gone in places like Europe and Japan, they've never gone back up again. Kathy,

do you worry about the same thing happening in America. Yeah, one of the biggest fears we have is something like Japanification, where we get stuck in a deflation area or a very low inflationary environment and there's not much more monetary policy can do. Again, it's not our base case scenario. We think that we're actually starting to see the economy do a little bit better. I'm relatively optimistic that get the virus under control, that it will continue to recover.

But it is a we're case scenario, and you can't rule it out. I mean, there's there's a probability there. Maybe it's a low probability, maybe it's five or ten percent, but it exists. Kathy. I can tell that I'm going to have a long morning with Tom Keane this morning, and you can make it a whole lot better if you turned around and just played a little tune on

that piano. Seriously, play the microphones going to work. If you can, just please, it would make you that she's got I can see you over on the left John and Bloomberg Radio, or her beautiful piano behind her, folks, and over on the left side. You can see she's got her one direction book. Okay. I can just see the real turning in her head saying do this show again a couple of minutes, Kathy, this is going to work. The piano is right by the microphone. Next time, I'll

play Claire to Loon for Lisa. I promise, thank you for Lisa, not for Tom. I love what that that right there, that right that describes our relationship with every guest that comes on this program. I'll do it for Lisa, but not for you, guys. Kathy is going to see it. Kathy giants, thank you. Trowan has provided real leadership in Washington with piecing together a really smart group linking policy

into reality. Chris Krueger has provided leadership there with the Cohen Washington Research Group, and he joins us right now Chris, I got eight ways to go here. But there's a point where there's a belief in salvation by Capitol Hill. Mark your calendar. When do we see salvation from Capitol Hill? Not this year? Um? So you know, uh, forty days to election day when hopefully we'll know the outcome of

the election. But you know, even before the tragic passing of Justice Ginsburg, the Phase four fiscal talks, the you know two trillion dollar or sort of fiscal lifeline for the economy was really hanging by a thread. And now with the Continuing Resolution having passed the House, which will keep the government from shutting down next week, you've really lost your last must pass bill to to get a

fiscal package done. I say this, Chris Kruger, with great respect for all the people working in Washington on policy. This debate that we're going to see on Tuesday is your world removed from it? Is it just going to be a debate about our culture wars, about the great differences between Mr Biden and the President. Well, so Chris

Wallace is moderating from Cleveland on Tuesday night. Um, he's announced six of the topics, and you know, one of the you know two of the topics involved the Supreme Court. And you know whether or not the candidates are going to agree to h the election results. So you know, at least a third of the debate is going to be deeply controversial for nearly four years. Chris, the abnormal has become normal. Yesterday President Trump refusing to confirm a

peaceful transceller of power. Should Joe Biden win the ballots? What kind of abnormal should we be girding ourselves for from November to December. I would even say November to to January twentieth, when the Constitution would end the the term of president and vice president. Um, so a few things, you know, I'm not I don't think people should be terribly surprised about this. I mean, recall in ts Sten when when when Trump won the won the presidency in

the electoral College, losing the popular vote. He then established a commission on voter fraud. Combine that with his views on mail in ballots over the past six months, and this is a pretty um, you know, obvious outcome to to where we are. When you look at some of the hard and fast dates as laid out by the Constitution, the first one is December eight. That's when the states must make their final decision on any controversies around the

appointments of their electors. So there are really no sort of hard catalyst between November three and December eight. Um. You know, hopefully we'll know the outcome of the election on election night, but with the amount of mail in ballots that um we we you know, it may not be election night. It could be election month. Chris, let's talk about that what this could mean for financial markets. That's something the market is pricing. It's price for you

see that in the volatility curve. We talk about that often on this program. Chris, I just wander, as you look at the polls right now, does it scream tight rice to you from what you look at? I think what is the real key? The real key here is going to be the margin of the Senate because for for investors, for markets, you know, a a fifty fifty Senate is very different than a you know, a fifty five fifty five Democrats in the Senate or even a

Republican Senate. So I think looking at the Senate margin is really going to be critical. And would would point out to that a number of the Senate races Uh, could come down to recounts, and you have too likely runoffs in Georgia which won't happen until January uh fourth or fifth. You know. Reminder that the Florida recount in two thousand took thirty six or thirty one days, thirty

two days, something like that. And the Minnesota Senate race in in two thousand eight, which was the crucial sixtie seat for Democrats, took over six months. So um, you know, it's not just the presidential race. I think senate recounts, uh in Senate runoffs or something to to keep in mind as well, Christ to building what John is talking about, a lot of people taking a look at the polls saying to very close race even though former Vice President

Joe Biden has come out ahead. Are you taking any messages from the polls that perhaps is different than what is commonly believed. Well, you have the national polls and you have the battleground state polls. Um. Despite all that has happened over the past six months, the pandemic, the recession, social protests, etcetera. The presidential race within the national polls is somewhat remarkable in that it doesn't really move that much. Um,

some of the battleground states, we have seen some tightening. Um, but you know, you you, I mean with the storyline thus far has been that Joe Biden has had a pretty durable, consistent lead. You know, the big question will be are the polls correct. The national polls in we're pretty good. I mean Hillary, you know, I think it was about a three basis point um advantage for Hillary. She won by you know, call it two and a half.

So you know, some of those state poles are really going to be key, and that's why you're seeing, you know, the overwhelming focus on states like Florida, North Carolina, Arizona, and obviously the three Rust Belt states. Chris, right, Thanks coming on the show this morning, Chris Crook at that colon Washington and Recess Group policy analysts. Right now, Ethan Harris joins us to say how the Bank of American

Economics barely describes his contribution over the years. Not only is informed book on Ben Bernanke, but also bringing concision to the study out of Clark University in Columbia. Dr Harris thrilled to have you with us at today. There's a lot of moving parts here, Ethan. Michelle Meyer's aged over this, uh studying this labor economy. What is the moving part that matters? To Ethan Harris, Well, I think

you guys just talked about it. I mean that the problem right now is that the lagged effects on the economy are still playing out. I mean, recessions always start with some kind of shock, and then as the pain kind of builds, you get these second round effects. And so having jobless claims, even if they're mismeasured at this level UM is quite disturbing. And it's it's a it's an indicator of the pain that's still out there UM.

And it's consistent with the idea that you know, we're getting past the phase where uh, you know, we're kind of rebounding from that shutdown and now more into the grinding uh forward phase with this massive head wind from the labor market. So we don't have to torture the data. The data is torturing us. Well, put Ethan Harris, I think a lot of people would agree with that as well. Ethan. Forgive me just for a moment, I want to talk

about the equity market briefly. Tom A little bit of a slip pair on the SMP five and eight tenths of one percent now and that's that one hundre of breaking down by about one point to eight percent, and still the under performance intact. You talked about a bit into the bond market. I agree with its subtle, but it's there on a tenure treasury. This is where things stand right now. You have to come in just a

single basis point. We're down two basis points on a thirty year so just a bit of a breakdown in this market. And Ethan, a couple of reasons for this breakdown in this market, and it all started over the weekend. The idea that because of the division down in Washington,

we don't get a fiscal agreement in Europe. The idea, because of more restrictions on the economies like the UK, France and elsewhere, that we have a more pronounced slowdown in Europe, maybe even and let's hope this isn't the case, a double dip recession. Ethan, how do you view things right now with those two issues front and center for this market? Right so? I think when you look at the equity market, you need to think about two different

stories here. One is there's a bit of a re rating in the market as the as investors realize that we're in a low interest rate environment forever going forward, and so the return and risk acid should be higher in a permanently low rate environment. So the recovery in the equity market I think reflects that. It reflects the fiscal statement. This reflects the FED and this kind of low rate environment. But now we're entering a period of

tremendous uncertainty. Um. We the fiscal stimulus is steadily fading. It peaked in the second quarter, and every quarter going forward the money continues to run out. Um And I've actually been surprised you haven't slowed down more than this by now. The fiscal package is basically dead now with this battle over the Supreme Court um, and even after the election, we may not get a package. So we're kind of removing the patient from the intensive care unit

too early here. And then you layer on top of that the fact that there's this kind of trade war stuff growing. You have a likely re escalation of COVID cases in the fall as people move indoors, and then you've got things like Brexit in the UK. So it's I think the market's simply got too many uncertainties on its plate and um, and it's going to be under pressure for a while here. Well, given the uncertainties, ethan, what are the indicators you're watching to indicate a true

slowdown that could potentially create the backdrop for a double deprocession. Well, I think that one of the challenges right now is that we're all kind of we've got a cottage industry of daily indicators we're all using, including the B of a card data, the home base and all that other, all the other stuff. Um, none of these indicators have really been stress tested through a period to see how accurate they are. They're they're useful, they're certainly I think

they're all this data is very useful. But the data we're a bit misleading. In the summer, the daily indicators were weaker than the official statistics. I think we need confirmation from the official data. We need to see hints that the slowdown in retail sales is accumulating into something much weaker. Uh need to see an from the job's report and so on. So uh, while these timely data are you know, we all look at very closely. Um, we need to need to get some confirmation from from

the hard data and Future deteria negative twenty nine. We're out of stick big almost two points on the VICS thirty point four seven. Right now, Ethan, one final questionnaire, We've got to get back to the markets. Dr Harris. This morning, the Chancel of the Exchequer talks about a United Kingdom permanent adjustment. Do you and your team just assume there will be an American permanent adjustment? Um? Well,

I mean we there's a structural damage to these economies. Um. I don't think it's I think we can recover largely back to where we started from. But you know, there's fundamental changes going on. There's been some good things. I mean, we've learned that we can do things more cost effectively, for example me working from home. Uh. But there's also a lot of damage out there. So yeah, there's a structure role component to this whole crisis. Ethan. Good to say,

you look wow. Send out best to the same. Ethan Harris, that Bank of American's Securities head of Global Economic Race such. Thanks for listening to the Bloomberg Surveillance podcast. Subscribe and listen to interviews on Apple Podcasts, SoundCloud, or whichever podcast platform you prefer. I'm on Twitter at Tom Keane. Before the podcast, you can always catch us worldwide. I'm Bloomberg Radio.