Surveillance: Trade Issue Front & Center, Kostin Says

back in two thousand and nine. Wangan Steve Widing City Private Bank chief investment strategist, Good mornitor Steve, your thoughts on the swings through this week? Wow, So, look, I think this is the residual effect of the trade war

heating up the counter measures and the currency markets. Uh, the fact that markets who had fixated on a seven read being some magical number for the Chinese currency for examples, trying to get used to it, and just looking back to other market events where we've had turmoil and currency

markets spill over to other asset classes. So there may not be a lot of news at the moment on this, and markets have calmed down a bit, but we're still sort of in the aftermath of that big surgeon volatility and perhaps not as fixated with the Chinese currency fix night by night by night, I mean last night, everyone's standing by waiting for something. We've got a seven handle on the fix for the first time since two thousd and night. Maybe that was the headline for about five minutes,

but ready the story. It's tracking the spot right quite tightly. It is stronger than pretty much every single analyst that we serve a here at Bloomberg. And I think the signal coming from the Chinese at the moment is that we want to stable currency. And let's be clear here that's very much a selfish motive. That is what the Chinese want. Well, that's absolutely right. This is not a situation of China sort of seeing we will no longer

control our currency. We will completely subject this to market forces, come what may. Uh, And if the trade war takes us to a remarkable outflow of savings from from China, that's not where they're going to go on this. That's not the immediate outlook. But I do think that you do have some depreciation pressures, and China has signaled in fact that its currency will adjust as one of the ways in which if you want to call a retaliation or adjustment, you know, for this particular pressure on on

on the Tarer front. You know it's Thursday, John, and you know I was off on Monday, was my first vacation day of the year. And um, you know you were here holding the fort down on Monday and you got to Jamaica this year. I did. Actually, it's good. It's been a company vacations. It's no, it's all gonna ja. Queen's Yeah, long Island. Um. After seeing the mets Um lose. Now they're all winning. Um. But John, what's so important here? Monday, Tuesday, Wednesday, Thursday.

The note of the morning for me is Greg Valier, a g F who says, look, everybody, including in Steve Whiting's world, is waiting to see what the White House will do. And Greg's entire note is on is the somebody quoted last night brilliantly the Navarro recession, the idea of what we're doing on trade, Steve, how does city group fold in everybody waiting to see what the president does next into the sweat you face of what do I do with my equity investment? This this is really important.

We were trying to say on the television earlier, for example, that whatever the political pressure there may be on the FED, Chairman Powell has said, we are the takers of trade policy, and I doubt that they have any great insight at the Federal Reserve. What's next? Will they do something because they expect the trade situation to worsen or not? No,

they won't. They won't do anything. And the reality is that we have to build an asset allocation around the view that there are larger trade risks that we would have had in previous years. That's why again we've taken some evasive action and both fixed income in equities markets, but we'll also have to fold when that is priced into markets into that the opportunities when Johnet's classic Steve Whiting the keyword takers, which is out of derivatives and swaps,

and that nobody has a choice here. The FED is a taker of what we see from the White We had a bit of pushback earlier this week, though, we had that pushback from Bullet of St. Louis when he said he did not want to get drawn in for the tip fitat in trade. I didn't hear that from Evans of Chicago, just yesterday. So there seems to be a bit of a difference emerging on the fo m C on how we should respond to the recent escalation.

It's early days. We still have Jackson Hall, we will hear from a lot of FED speakers, Steve, But just your base case right now as to how the fo m C will respond or won't respond to the gyrations in this trade dispute. I think Chairman Powell was pretty clear on this aspect in the press conference, and that

might have disappointed markets. They're not going to just simply ease unconditionally, preemptively creating all you know, first of all, I don't think that the ability for the FED to create an economic boom independently of all of this is really there. But they're not going to say that we're going to just load up with all sorts of ammunition power up the economy so that we can absorb a larger trade issue. No, it's not that um that they will.

In essence, though, if they place deflationary macro circumstances external shocks, and they consider trade policy and external shock, they will react to it. That's what Powell said. What is your waiting or change in waiting of US domestic versus global equity investment right now. Um, there's been some minor changes.

For example, for US, have you know, reduced a bit of a First of all, we've been a little bit cautious because of UH anticipated trade friction and that so took us in June UM to expect things to be a bit worse. Um, we thought, for example, that we would have tariffs in place when these additional tariffs now in place when Trump and She met, But now they've come in a delayed fashion, So we were a little bit early in terms of putting a bit of caution

in on that. What we did, though, I would say, just giving all of that, is that take up small caps, slightly reduce our underweight in U S domestic small caps. But you know, this is a situation again like we were talking about earlier on the television, where there's pervasive effects across all financial markets. This is not a view

of a surgical strike here. If this was about very very specific Chinese commercial policies on the trade front, we might have seen a different market response around the world. But the view that there is ultimately a trade war with your up, there's UH issues with all sorts of other trade patterns. There are other skummishes, new ones coming exactly going to established some parameters to try and work through and make some decisions a range of probabilities. I

would send a consensus for you right now. As the wheat grows older, it is a twel risk that on it lets the currency go. That is the tail risk. The base case is that the trade risk don't diminish for a lot of people. That's the consensus view. Is that your view as well, statement that the parameters that you operate in right now? I think that that's very close.

That we have to think about the base case. And then again within your asset allocation, you must have, you know, some room for things to not go as you plan. So what are the securities? What are the asset classes that you want to allocate capital to that retain the risk mitigating characteristics that you need if things don't go to plan? So very clearly US investment grade debt or US dollar investment grade debt because you can allocate across

some higher and lower risk assets. Within that, you can have some thirty year U S treasuries, but yes, you can in fact also have uh some higher quality emerging markets long term US dollar bonds, but at a lower weighting. Um so. But the other side of this, which is interesting, is that we've always said, well, you know, an asset like gold or right has the problem that it doesn't give you yield, and you be for going the income

uh for the if you own this asset. And yet you take a look at Europe where you have negative yield bonds uh, and you have to say, well, wait a second, I can actually improve my my relative income position with gold. This is really important. The opportunity cost of owning gold has diminished massively through is that the basic document. Well that's a basic argument. And and look,

you know this is a more volatile asset class. But when you've had things like thirty year European negative yield bonds have a sort of a ten percent price jump in the month, you know you must have to consider that again. You know, gold does not have that move. And again that's one currency pair. This is not a story necessary for US dollar investors. You know, the environment for gold if the US currency were crashing, would be

much stronger, which is not the expectation. We're gonna let you go Before we ask if bitcoins of gold proxy people walking the door, John that we think are unexpected. It would be good. He's got check here, he's got his He's got his Goldman Sex deck House, which is deck it's about a hundred and forty brought a hundred and forty two pages. Abbey shows up with the back of an envelope, you know, and some pen scratch on it. I saw his name in the rundown. I didn't actually

think he'd turned up. But he's here, and I'm pleased to say. David custom is with us. Goldman Sacks, chief equity strategist. Good morning to David, and gentlemen, Let's talk about earnings just quickly, shall we. A lot of people said Q one worst is behind us, and then they start to look at Q two and said maybe it isn't. Then there were the fears of an earnings recession. Just where are we frame that for us, David? Where are we right now? The earnings realized and the earnings you

expect are still to come. So we have the earnings for the second quarter, which are pretty much finished. Radar About of the companies in the market have reported flat or the year year on year second quarter last year.

For the second quarter this year, flat earnings, and that's a little bit better than expected expectation going in to the quarter results were were probably down one But if you really focus on what's going forward, we're looking for around three percent earnest growth for this year two thousand and UH nineteen compared with two thousand, so about three percent earnest growth this year. That will accelerate to around

six percent next year. You have been a COLN voice for decades saying you have to participate in the markets. Here's a way to do it with courage. What I see on the screen and this is with great respects for some of the catharsis Monday is SPX is down all of four point one percent from the recent peak. Have we forgotten David Cousten how to take losses? No? I think we have to think about the concept that valuation has been the principal driver of the market for

this year. So the earnings for the market of pretty much coming in as expected and pers up and uh and the multiple has gone from fourteen times to eighteen times at the peak which you doesk reference, which is less than a month ago at three thousand five, and now we're down from that from those levels So here's how you want to think about it. You want to think about it in the sense that bond yields are

like one flip the reciprocal okay, flip, the reciprocal. The earnings yield is six percent six percent right now, and so that yield gap, that difference between the earnings yield and the bond yield is one of the widest it's been in years at northup does it close? What's the partial differential? How you close bond yield and equity yield. So, if we want to think about it, we're about four hundred and twenty five basis points yield gap right now,

and the long term averages about two thirty. So that well above that, we're closer to where we've been in the peak of the financial crisis in terms of the five hundred basis points kind of a yield gap. So that's the number one issue to think about in the sense of valuation of various asset classes, and bond yields

are so low. Clearly the issues on trade our front and UH and center for for so many portfolio managers inappropriately so, and so the way you want to think about this is to own the services companies, companies that are services providing as opposed to goods producing. So goods producing your subject to tariffs, your subject to retaliatory tariffs. You have higher input costs. You've got concerns about that. As an investor, you own services based companies, they are

less sensitive to that. They have more stable gross margins, higher higher margins. So we should know type the one thing the Federals of A really worried about, and central banks seemingly worldwide, including the CBS, that the weakness you see in manufacturing the goods providing companies bleeds across the services anyway, are you saying that's unlikely to happen all

the effects of it will be limited. Well, the effects, I would argue, we'll be somewhat more limited principally because of the U S economy and services and that is driving its domestically facing and concern is certainly relevant to think about what's happening with h with manufacturing in this country, but the services real ways driving the economy. You've made

a little headlines in the last couple of weeks. You came out with a year forecast, and I recall you dropped your EPs forecast, but raised your price target, and you believe that we could get some multiple expansion through makes sense of that for the people who don't believe in that story, that we could get some multiple expansion

from the P five hundred still through next year. So we're to think about this is as I said, the start of two thousand and nineteen, Margaret multiple was fourteen times forward earnings, peaked at around eighteen times a month ago around sixteen and a half sixteen point five times

forward earnings. And the Fed is likely to cut interest rates at least twice two more times this year, once in September, once in October, so the rates and bonds are liking to go lower and uh in my view, and then we look into next year, the idea of multiple expanding to maybe uh sixteen and a half to eighteen times, kind of going back to where we were before.

Let's get it up then on your call, inequities and also Goldman Sex fixed income, Jan Lowe's at JP Morgan headlines, yacolm Fells at Pimco headlines, Steve Major HSBC with a shocking boon call of a negative point eight one percent, what's the Goldman sex adjustment towards zero bound in the

United States. Do we get to a zero percent tenure? No, The expectation is somewhere between around one seventy five at the end of this year, one of one of three quarters, perhaps a little bit lower if the Fed cuts rates two more times and we're expecting but not significantly lower than we are currently, what do you do? Expectation is we're unlikely to have a recession and basically think about unemployment rate below four percent, which is real wage growth

is happening for the first time in twenty years. Uh, and that's not as consistent with a recession. And where are the imbalances? I know, David custom your minimum account is four hundred million dollars. Talk to one of our listeners now with a smaller account. They're sweating, particularly after Monday. Do you adjust a re kill four oh one k account? Here? In equities? Is this an opportunistic moment? Is it a moment to be in the markets with courage or do

you enjoy being in cash? No? The idea the answer would be to still be in the equity market at this at this juncture, given that the economy is likely to continue to grow, it's growing in part because the Fed's mandate is to keep it growing, and it's likely to be cutting interest rates a couple more times to maintain an expansion, and that's more consistent with art his growth than positive ear his growth is which generally leads the market higher. John my head spinning. This is too optimistic.

It's very constructive, very constructive. But he has been through the year and the year has been good so far. David Couston, I think we gotta let go because understand you've got to go into another studio. Is that rather property? That's why I didn't think he was going to drop by. So I'm very happy Kavis some of his time. David Couston, Thank you, gentlemen, like very healthy, looks great right now. We are thrilled to bring you, Sonya Meskin, US economist

Standard Charter. Sonya, you have a huge standard charter advantage and that you get to walk in every day and talk to Stephen Englander. He is a giant of foreign exchange dynamics. How do you dovetail your US economics work with the foreign exchange analysis of Mr Englander in the last five days? Well, um, it's really very true. It's

really been very much about the foreign exchange. But you know, the US is actually quite an isolated economy, and I think that the labor market, for one, shows that very clearly. We see UH definitely signs of weakness and ongoing weakening both globally in Europe, in Asia, but we don't really see it so much in the US except in the manufacturing actually related sectors. Um so, I think it's very

important contact. You know, in the dollar. Of course, UM plays a role in the sense reaction function, but it's really not even amongst the first three UH key elements. I think that they look at suddenly, do you see any sign at all that the witness in manufacturing though, is starting to come across lay through to the other parts of the economy. It's a question that we keep asking on this program, and so far a very very very limited, limited amount of people turn around and say, yes,

I'm seeing a signed sonya do you that's true? I would agree with that, because even in the latest sist the report, manufacturing game jobs more so than in the previous month. Um So, I think we see it in some of the sentiment indicators, and that's been the consistent theme throughout the last nine months. But the sentiment indicator data has not been as strongly correlated with what's actually going on on the ground, is maybe in some of

the previous periods. This goes back to a question we often ask Sonya, which is whether the fear that something is about to get worse can translate into the very your idea that it will happen, so it becomes reality the prospect of something, So the soft data becomes the heart data sort of speaks on here, is that what you anticipate? UM. I think the U S economy is very resilient, but I do think that there are certain

cross currents now that we have an experience before. China is obviously much bigger part of the global economy than it was even a decade ago. UM. Of course, what's going on in the foreign exchange markets UM, as you can see, is somewhat unprecedented. UM. And I think the

impact on money markets, for example, is um evident already. UM. So there are definitely elements I think within the market to pay attention to that are sort of critical, But the chances of those spilling over into the real economy UM. In short order, I don't think I'm necessarily very high well, the rate cuts, I mean the Standard Charter's expertise and UM, well the rate cuts we see from E M central banks affect US central bank policy. Well, I think it's

really the other way around. If I really opened the door for them to cut UM. And while there's, of course, in UM an outstanding argument as to whether if I needed to cut it all and you fell two descents UM on the committee following that decision, UM, I think for the emerging markets, UM, in terms of the economics, UM, it's something that is needed. Of course, it also introduces uh um, you know uh issues to the capital flight account potentially down the road. But so far, I think

we really opened the door for them. Wonderful son, and thank you so much. With Standard Charter in our studios right now, is any mass who goes to the coolest French major in America Advance or French and frank or Studies. It's like this totally cruel program. When when I was a kidding, it was like a big deal. What is it like doing French and Francophone studies at Vassar College. Well, it was just an obvious step in my career path towards becoming a business. Did you feel like you walked

in dumbest French speaker in the class. It was a great program. I've got to tell you. I spent uh semester in Paris. Yeah, I lived it up. It's I don't have enough good things to say about that program. Yeah, so it's very cool. I mean, we get all these kids in here with the academic backgrounds, you've got a home run. Here was Susie Waite and Christopher Cannon on the state of asset management. Abby Johnson came out and said,

we're gonna give away certain funds. You mentioned Will dan Off counter Fund, Fidelity counter Fund, and even the sainted Will dan Off is having outflows. It's that grim, right, that's right. So we took a look at the seventy four trillion dollar global asset management industry and some of the challenges that are that the biggest asset the biggest change right now facing So the biggest challenge is really

for active managers. There's a bit of a crisis of confidence as you see these outflows from actively managed funds, even from those that are beating their benchmarks. Um, so it's a real watershed. Well, it's I totally agree with. The point is that watershed moment we saw in Davos this year with active managers, they've gone through this plan Plan B, Plan C, Plan D. What's the plan into

autumn and into two thousand twenty to staunch the flows? Well, I think one plan that asset managers are rapidly realizing UM that they have to take on is you have to figure out what your Raisin detra is seeing French major um. So I would I would have pronounced it rich, I would have said, Raisin, that's what I would have said, that's what my very expensive education kind of timing. So you've got to be on one end of the spectrum

or the other. You've got to, um really either have a full comprehensive offering or you've got to be a niche, focus, boutique player. And for those in the middle, it's really a difficult moment. So give us a sense of the flows into the asset management business kind of where the money's going, active passes, all that kind of trends. Sure, So as we trace in our data is for years you've seen outflows from active mutual funds and you've seen

inflows into passive indexed products. So this is one of the major um trends of the past decade or management industry, it hasn't so far, and so you're seeing this scramble to figure out, Okay, what can you know? What can we offer? Does it mean getting into E t F? Does it mean getting into factor driven products? But are they going to merge? I mean everything standard over in your You've got a beautiful Europe and over the Monday in the article as well. This is in Bloomberg Business Week.

Folks asset manager with seventy four trillion on brink of historic shakeout? Okay, great, what's the plan? That's what I don't get. So that's a good question. So, uh, consolidation is definitely part of the plan for many of these firms. You saw Investco and Oppenheimer Funds merge for and that has combined a very passive business within a more actively focused business. So that's one that's for sure interesting to watch. Okay, but what's the gossip on a transaction like that? Forget

you come on, nobody's listening, Okay, what's the gossip? Okay? Well, so one other thing that we mentioned in this story on on the consolidation front is you look at Janice Henderson and Standard Life Aberdeen, and you're actually seeing outflows in the wake of those mergers. So it's not a sure thing that just merging to survive is going to you know, lead you down the path towards um salvation.

So is are we going to eventually get what percentage let's start to what percentage of money today roughly is actively managed versus passive? So it depends and we have got a chart that breaks it down. So the US is the sorry, guys, this is better. So in the US you've got thirty three per cent of UM in passive funds and that's where it's largest. So that and that's growing, right, and that's growing. Is there is the bear case scenario where that goes, where the active manage

goes to zero. Is anybody, I mean, why wouldn't it? Why would I pay a fee for performance that's not materially better than what I can get into passive. That's a good question. I mean, I think an active manager would tell you at a certain point, if everyone's an index products, it will make it. You know, people logically say, hey, wait, it should be easier to outperform with an active manager, so maybe you won't see it go to zero. But at this point the trend um isn't really abating. This

is so cool. Yeah, and not it's not cool if you're up in Boston or in this big mutual fund complexes. I don't the economics. The fee pressure just must be extraordinary. Giom sends it an email from Paris listening and you've got a global audience happen to this. He's I'm gonna butcher this. I'm gonna try. Should I tell him? Ave de Frey Leva? Okay, I was not Montreal today, but seriously, I believe what he's saying is I'm so done with high fees. That's all this debate comes down to. Right,

That's right. So yeah. Part of the reason that you've seen this interest in index products, particularly in the aftermath of the financial crisis in two thousand and eight, is investors are reassessing, Okay, how much am I just paying in fees and is it worth it instead to go for an index product that will charge less. So if I'm fidelity, um, you know this huge mutual fun complex, what is the stated strategy of of a fidelity? For example? What are these big companies that are had such great

brand names. I've got such a tradition. Um what is their strategy? Fidelity is an interesting one. They are definitely trying to catch people's attention in a couple of ways. So last year Fidelity kind of causes splash by introducing these zero fee um index products and well it totally I think shook the market up a little bit. What their competitors say is, Okay, if they're not if they're charging zero for these funds, where else are they making

that up? Because it doesn't cost, you know, zero dollars to run a fund? Where are they so, im that's the question. That's what we don't know that we don't know. Yeah, so in various other ways, but not on the fees. What do you see in four one case? I mean, I mean John Bogan was a huge friend of the show. He gave us immense support on Bloomberg on the economy and Bloomberg said always comes back to underfunded America. Yeah, I mean he he was really a visionary in this area.

He was Beeps visionary exactly. I mean, he was a pioneer in this idea that you can save investors all kinds of money by offering them index products. And you know, you know, he would say that active managers are very often not worth the fare, and they'd always say, no, it's gonna change, it's gonna change. And you're the lead of your story in Bloomberg Business Week. Is it hasn't changed? Am I right? It's accelerated. That's right. It's been a

trend that's accelerating. So it's an environment where you really have to either prove yourself, figure out a new strategy, maybe merged to survive. But um, it's looking bleaker and bleaker for active managers, especially the ones that can't beat their benchmarks. And thank you so much any mass It was Susie Waite and Christopher Cannon. It's a real nice summary step off to all the work we're gonna see Paul in the fall in this year on this struggle

of asset management. It's tangible. M 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 Keene before the podcast, you can always catch us worldwide. I'm Bloomberg Radio