Surveillance: Wall Street Optimism With Slimmon

Morgan Stanley, a senior portfolio manager among other duties. Is well, Andrew, I want to talk about the nuance here. As we went to air, you were talking about not raging but being a raving bull. You're not a raving bull, but you're in the market. How can you do that? Well, I mean, I'm trying to say, is lucky. I mean, let's keep it simple here. Stocks are the present value of future expectations. And what I see is companies are

blowing out expectations. So I don't see how you can't take a step back and say, wow, you know, uh, something's going on. Companies are saying things are better than what Wall Street expects, and I think you have to respect that uh, and what the market saying. The term of your research note is you've got the usual bladder and then you've got a killer paragraph of data where you go, oh he and Morgan Stanley did your homework. You have the Street with an eleven percent miscalculation on earnings.

They just they missed it by eleven percent. Put that in scope and scale, What does it mean forward? Well, you know that's why I've a hard time someone telling me, well, you know, we started the year with a hundred and sixty seven dollars of earning. That was what Wall Street expected. We're now. I guess I'm just not smart enough to for to listen to someone who says that's it. It's not going up. I mean I have a hard time

believing that. And the market is only up by the magnitude of that earnings with so I don't think you can say the market has gotten frothier than it was earlier in the year. No, the markets just repriced based on that miss. And if we continue to move higher, which I think it's always very dangerous to draw the kind of the line that saying said this is it, then I think the market will continue to push higher.

The other thing that I think it's really important. Here is the down Jones Industrial Transport, the old index that tells you how the market. It's kind of thirteen weeks in a row. That's you got to respect that something is going on here that I think Wall Street is not optimistic enough about the what companies are saying. And that's healthy though, isn't it. It's healthy. We're not getting carried away with this at the moment. We're looking at

prices almost exclusively. At the moment, we're focused on execution risk, very little attention plate and what's actually happening with margins entry focus? It was actually happening with margins well, I mean there's certainly a reals of margins uh peeking or being constrained. I agree with that, but you know, could that be overcome by revenues being stronger than expected. That remains to be seen. But clearly I think there is a rotation into companies that will not be as margin squeeze.

Whether that's in some of the commodities, areas, energy, financials. I think those are the areas that are most intriguing in the market because there's probably the least margin squeeze out there and shooting. Emmanuel yesterday put it down another Andrew. They upgraded Staples price action, pricing power rather being the focus that did the Staples. They only right down right now, Andrew, no one like them because I think they will have

margin squeeze. Number one. Number two is if I am if I'm right about the fact that the economy is stronger than what is priced in the stocks. I don't want defensive stocks. I want cyclical socks. I want value stocks. And I think as much as I hear people talk about owning uh, cyclical socks, the data suggests they really don't, they really don't. So I think gearing up your own consavele Staples. If the market's gonna fall, gearing up for a fall, well, that's not what the second quarter first

quarter earnings reports has sold you. Andrew. Is there any logic behind the caution that we're seeing with stock investors and frankly with the analysts on Wall Street? Well, it sounds smarter, all it does. It all sounds smarter, Uh, But I I think you have to be a little humble here and think us the market's telling you something that leads you to be a little bit more optimistic

than what you're hearing. Look, I there's no question in my mind we're gonna have a pull back at some point, but I don't think it's in the near future, not with what's coming out of these uh these earnings report. They're just too powerful. So if a company, you know, if if a Wall Street is forced to raise earning but the stock doesn't respond, don't get don't get pulled out of those stocks. Stocks don't go down for long. You know, when you know the future is better than

what it's presently twice in this stock. And the reason why I ask this is because there is then an incoherence with respect to the bond market and what we're seeing in equities. Because if you're right and the balance is toward more gains and a further growth trajectory here, then the bond market is not making sense at a time when the US is increasing its deficit and you've got big nationals in the United States raising their dividends and offering way more income to investors just purely on

an income basis, even let alone the potential returns. Can you square these realities exactly? That's maybe why the markets going up. Um. Look, I think rates are going to go up because I think basically the economy is stronger than we realize. But I don't think it's going to go up at a very rapid right because there's this you know that the different menial to the rest of the world is great enough that creates a bid for

our for our bond prices. But I'm a I'm an equity guy, and I think it's saying to you that remain in the cyclical. I think there's a long way to go. I think people are you know, energy stocked. They were the best performing sector in the first quarter. They get no love because there's this expectation that the economy is peaking. I think the best of it how many times again, yesterday, Tom, the M the p M, I was seen the best of it, peak growth, Tom again and again on the peak. I love the doing

me a favorite, Jonathan. When someone says to you, we've seen the best of it, say, were your estimates eleven eleven percent too low at the beginning of the year. I mean, that's what you have to come to challenge them. The fact is, Andrew, you and I are watching the internet gloom. The peak is Friday evening. Everybody's got a Martini in their hand right, and I'm the gloom and the doom, And the answer is it's a long ticket.

I mean, the fact of the matter is you can't go up on Pharaoh to those kind of levels you're hearing from Costin and Lori, Kelvinsina and the rest John Gollub. You can't get there unless you've got the gloom. Well, I think the problem I have with the peak growth concept, and Andrew, I'd love your opinion on this as well, is that the peak right of growth was always going to become at the beginning of this particular cycle because of the nature of the slowdown. It was a mandated recession,

reopen spring, coiled, bang, you jump high. For me, I'm not sure that's any indication of where the cycle goes though, Andrew, what's your take on it. I think the cycle is going to last longer. This concept of peak. I'm just I have a hard time with this peak concept given the magnitude of the earnings revisions and the blowout so far. So I'm just not sure we're there yet. And so calling the end they're calling the peak, I think it's premature.

So let's talk about the potential returns. Let's go to the Jonathan Gollup call for returns. Can we get what are you looking for here? Well, I think that next year's earnings are already up to about two d eight dollars from the low one nineties at the beginning of year, So that was the s to be getting low, you know, around one night, and we're up to two hundred eight dollars.

Well on hams. If we get to two hundred twenty dollars to begin next year, I mean, I think that hundred is very doable as a forward p. The point of this is, I think that what's the most important here is we all look at pease and we based them off forward estimates, and the flaw of four peas is what happens if that E is very wrong. And that's what we're seeing this year. The Ford p has been way too pessimistic. So I think that's very possible we'll see mid for four thousands by year end. Because

I'm just looking at the trajectory of the entry. It's gonna catch up. As always, Entry slimming that with a little bit of media training for me as well as tell I think it's trying to tell me what to

last next time someone talks about PETE growth. Right now, we've got the perfect guest to get us started in this our Semasha joins from Principal Global Investments and Seema Within your note, what I really loved was the linkage, the study of the linkage rather between equity and debt, the idea of what the stock market is going to do versus what fixed income is gonna do. Describe that

linkage right now. Yeah, I mean we've been talking about it earlier today that the acting market is looking so strong at the moment, you know, of course, or concerns that we're not going to get the continued economic surprises which may keep pushing the market as as much as we've seen recently. But it's looking really strong out there. Whereas the bond market, you've got bond deals around the one sixty level. It just doesn't seem to be lining

up to me. The main factor which is holding bond deals down is still there's expectation that the fan is going to stay on hold. But some point, I think we're all in agreement here that bond deals are on their way up this year. It's just the speed at which they're going to move and that's what's gonna be um,

the major impact for markets. I think one thing that people are struggling with at the moment in the bond market, if this data doesn't get it done, if this data does not translate into higher yields, what data will yeah to me? It's the inflation data. You know, we need to keep watching that. And the thing is is that we're all expecting inflation to move up over the next

couple of months, so there's no surprise there. It's really when you start getting into autumn winter and if you're still seeing inflation moving up at that pace, that's and I think when the bond market is really going to freak out. Um. And that's I think when the acting market becomes increasingly invulnerable. And the thing is that, look, you know, the market is very very divided on what the path for inflation is. But I think that even the ones and I'm going to put ourselves in there included,

we do think it's transitory. But we also have to admit that there is a very fair chance that inflation will turn out to be sticky. And that's all the risks a lying At the moment, there's a big debate among stock investors of when higher yields is good or when higher yields is bad. Up to a point it's good. It indicates that people are upgrading their expectations for the economy at a point that's too high. It reassesses perhaps some of the valuations currently baked into markets. What is

that tipping point? Sema, I think rather than the tipping point, I think it's really that speed, right, what is driving markets high? And you can look at it, but just even just looking at financial conditions, a financial condition still really really loose, and thech case the ACTI market is really fine. It's when you start to see a really turbulent and unsettling move in bond deals that's when I

think markets really start to struggle to digest this. So in terms of a level, it's probably higher than what most people are thinking. It's probably above the two level. It's but if you start to get to yields at about two pc within the next month, of course that's going to freak out markets. So it's all the drivers.

Is the speed which is really the key point here, Well, the speed it is gonna be out of the first and second derivative I was talking, you should seem into our Keiley lines about this, I mean just the rates of change out there. Do you expect stability or do we need to be really really aware of potential convexity

not only in bonds, but the equivalent convexity inequities. I think there are risks out there that we and that is obviously a risk, but I think a lot of it is going to be down now, at least for the next few months. To the FEDS communication, where are they telling us that they feel rates are where they feel about inflation. They have the ability to keep the

market calm. But if that starts to unwind, then of course you know that that speed the second derivative becomes a very very key risk up our Our view at the moment, though, is that markets are really on a steady upper path. There may be points of pullbacks, but it's really an upward movement from here seement. Do you have a regional bias right now outside of the United States? Where is it? It's an interesting one actually, because look, we have really favored the US over the last few months.

We have pulled back some of our kind of preference for emerging markets because of all the reasons with COVID writing, inflation concerns around China. Now Europe is increasingly becoming more attractive, but I have to say that would be a very tactical trade because further up, beyond the kind of the joy of reopenings, we still think that Europe is very very much under pressure from a long term growth prospect.

Until they can get their fiscal policy really moving at the same pace as what we're seeing in the US, which really doesn't look likely, Europe will continue to be the under performer. So you know, a few months of baby maybe good performance from Europe, but then it goes back against Actually overall we still prefer the US seema.

I want to just wrap up with dovetailing the conversation that we had earlier this morning with Andrew slimming into this dialogue a question of this eleven percent miss when it comes to Wall Street estimates for earning so far in the S and P five hundred, you're getting a little bit more cautious than some of the large cap stocks are reducing certain allocations. I believe if I have this right, what do you say to people who say earnings have been blowing it out of the water. Does

that make you reassess, why do you dismiss it? No, Look, look, there have been a continued upward movement in earnings expectations. Actually we would anticipate that as a year progresses. You have to be very careful though at this point, and this is again active management really will do well at this point because you need to look under the surface, start to start thinking about which sector is going to outperform,

which ones are going to do badly. You know, you you refer to our reduced allocation to large cap tech. We still like mega cap tech, but we just don't think that you're going to see the same kind of retense that we saw last year. But if you're looking at earnings potential, if you're looking at cash flow, those are the companies which are really going to provide stability, not just over the next few months, but actually a

longer term. So there is still a place for secular trades within your portfolios, as well as the allocation to cyclicals. We've got to leave it there. SMA Principal Global Investors Chief Strategist Ethan Harris with US writing her Bank of America Securities their global economist, Dr Harris, thank you so

much for joining us. I want to go to Michelle Myers spectacular two charts on the makeup of our pain, our jobs pain out of this pandemic, and what she does, and she looks at the area underneath the former labor participation rate and it is an ugly integral as the math people call it, that space that we've got to get back to to get back to normal. When do we do that? Um? I don't think we quite recover that whole gap. I think that in the later this

year we'll recover a lot of it. Um. I mean what's causing the gap, of course, is the COVID crisis is making people reluctant to work. People need to take care of their kids at home. Unemployment benefits are very generous, and there's been very high retirements going on as people kind of rethink their life in a way in this crisis. So a lot of that will come back in the fall and into next year, but there'll be a chunk of lost workers that never come back. She has a

mismatch seven hundred thousand mispatch. Taking this in view of labor statistics and CPS date. Okay, fine, do we get back to a fully employed America? Is that a feasible reach for anything, But politicians were supposed to say that, Yeah, I mean, we're we'll get back to full employment, but full employment may not be as low as it was before because you've got these structural problems of job mismatch.

I mean, we've seen in other cycles where you'll have a big shock to the economy, some sectors grow, others don't. Workers get kind of displaced along the way, and you end up with a higher unemployment rate on a chronic basis. So I think we'll get back to very low unemployment. We probably can get below four percent, but there's gonna be a little bit to that structural unemployment that that

hangs over well into the recovery. Just want to touch on this data eighthean just give me a second, the trite deficit, the trite balance, come and get a seventy four point four billion dollars negative in line with the survey. Mike McKay straightaway pointing out that is the widest monthly gap in history of data going all the way back. Tom k too, that's as wide as it's been for a long long time. Negative seventy four point four billion, And I'm glad to bring it up, John, I missed out.

I'm sorry for it's a little bit of a blurrier. Dr Harris comment on that on the trade deficit to GDP another record we didn't want to make. So, I mean, it's obviously the case that the US is coming out of this recession very fast compared to our trading partners. So and the growth is initially is in goods demand, which of course is traded, uh, not in services tend to be domestically delivered. So you've had a massive sucking in of imports. Uh. You folks talked about this. You know,

China in particular, big beneficiary of this. Uh, And we're not. Our exports aren't growing quite as as gangbusters. So you're gonna have a record trade deficit and it's going to get bigger going forward. It's it's the it's because the US is so exceptional from the amount of stimulus, it's doing well. It kind of thinness the story, isn't. It's a reflection of this massive demand shock that we're experiencing in this country right now that other countries, other nations,

other exporters I'm going through. So we're getting all of their exports and we're getting none of them, getting none of us right now because that demands are not their. Europe a case study for us all to look at. Yeah, I mean, if you compare or contrast to US and Europe, I mean, the amount of fiscal stimulus in the US is three times bigger than what they're doing in Europe. Um. Europe as a pretty small next generation stimulus coming, it's spread out over many years. The U US is poured

massive money in and continues to do it. I think a lot of the stuff that's on the table now will pass. So it's gonna you know, when you weigh out grow your trading partners, um, you're gonna your own economy is gonna look very good. But you're gonna pull them along with you. And that's what the US is doing.

It's the global engine of growth. You're gonna pull them along with you, or they're gonna Perhaps why you doubt a little bit as you try to get into a new economic cycle, there has been a huge question about where we are in this economic cycle. There's an idea of burn hotter and shorter. There's an idea perhaps that we never left the old cycle. Where do you fall in in this issue. Well, I think in the we're gonna recover extremely fast. This is gonna be, we think,

the fastest recovery in history. So we think by uh, you know, early next year, we're going to be back where we we started from. So in a sense, it's almost like this was this kind of bad nightmare to your period and how we're out of it. Um. But there's a danger in this and that Right now high growth is fantastic. Let's get back to normal fest possible.

But at some point we need to slow down. We're going to go through the stop signs next year, I think, and at some point the Fed needs to change gears. They need to say, Okay, yeah, we are going to hike uh and we're gonna hike a little bit more than we're telling you, and we need to slow things down. So it's it is. It's a remarkably fast recovery. We're moving.

We're jumping from deepercession to full recovery in record time. Ethan, do you ascribe to the Robert Kaplan idea here that markets themselves, given how exuberant they have gotten, could pose a material risk to the economy in a year or two years. If the Fed does have to hike more than people are currently pricing in and there is a quick end to this recovery. I think there's a risk of that. I think it's a very good point. I mean, right now, the markets are being fed an incredible mix

of positive news. You've got Fed not hiking anytime soon, You've got big fiscal standards, got great growth numbers, um, the great very good news on vaccines and the COVID crisis. So you're gonna have a red hot risk acid market from whether it's home prices or equity valuations. But that's an environment where you tend to overshoot, and you know, we could be in an environment where the FED has to take away the punch bowls. So the rest of the economy in two and twenty four is pretty high.

I think of a of an accident here Ethan with the ties of Bank of America has coast to coast. What do you see for business investment? There is actually gonna affect cap X or is it one big share buy back? Now? I think the cap X is gonna be strong. Um, if you look at our surveys of of fund managers, they're telling companies invest in CAPEX right that's a sign of a lot of optimism about the outlook.

If you look at models of capital spending and economist estimate the main driver of cap X is growth and growth expectations. If a company thinks their market's going to grow, they do cap X. And it's not really that important the funding aspect. The funding is kind of something you have to take care of in order to create the cap X. But the real story is about rip roaring recovery. Uh,

encouraging a lot of investments. So we're gonna have a We're gonna have a recovery that starts very much concentrated in the consumer as they come out of their cave, their COVID caves and get out there and to engage. And then over time CAPEX is actually gonna start outgrowing consumption. That that's what we expect next year. Ethan, just quickly the guide for Friday. What's the focus for you away from the headline number? You know, Um, it's it's uh,

there isn't any big folk. It's just that this is a ripping labor market. Um. You know, to have another nine hundred thousand plus number. Um. I think the story of the job market and the story for the Fed is the consistency of the strength. So are we going to keep getting these big numbers? And at some point then the Fed has to say, okay, now we not need to think about tapering our bond purchases. So it's not so much about one report, It's about the cumulative

evidence that this is not a temporary caffeine high. This is a real strong recovery going on. To catch up Ethan Harris, Bank American securities global economist, we get lucky with our analysis and that we have the finances visor and with us on my sadology of John's hob Because John Farrell, let me go to you. At first, I see a single line item, beautifully laid out. I should say, by viser, they're not hiding anything here where vaccines go from one six billion one point six billion and explode

up to four point nine billion. John Ferroll, why do you bring in Dr a dolge of JOHNS Hopkins with Fiser getting it done well? Here's the headline from the New York Times to him that you allude to. In the last twenty four hours, the FDA to approve the Fiser vaccine for ages twelve to fifteen. Next week a report coming from the New York Times in place to say that doctor Amos, shadow of John's help consent for Health Security joined us right now. Dot, let's just start

with that headline. How important is that next step on

rolling out this vaccine. Well, if we're going to get cases down from the tens of thousands that occur every day, we need to have more of the population vaccinated, more population level immunity, and as we get to children, the older child groups twelve to fifteen are groups that are in extra curric activities where you see them spreading in, so you will likely get a benefit in terms of closer to her immunity, more population level immunity, and decrease

cases as we get twelve to fifteen year olds. And it will help help some of those schools that have been holding out and not going to full in person learning have us obstacles in their way to do it. So I think this is a good step forward, and I think we'll probably see even younger age groups approved are probably not until two. Capacity is building out as well.

Finds are indicating that can manufacture at least three billion doses. Two. Doctor, the problems of a couple of months ago and no longer the problems Now it's not about capacity or supply. In fact, this country is now talking about exporting some of that stock pile of vaccines. In your opinion, is the biggest issue that we have to confront right now.

Still hesitancy. Yes, that's the biggest issue by far. We're basically hit a wall where we're seeing vaccines different, you know, to one million, they're probably lower than one million people who have gotten vaccinated the early adopters. Those are people who are really enthusiastic about the vaccine. Now we're kind of hitting that vaccine hesitancy, people on the fence, and there are people who are opposed to the vaccine. So we're kind of going at a much slower pace now.

I think the Johnson and Johnson pause definitely knocked down the use of that vaccine even after the pause was lifted. So right now we're really just kind of trudging along in people vaccinated. But I don't think we're gonna see major jumps for sometime. It's gonna take some time to accrue a large proportion of the population vaccinated, but this twelve to fifteen approval will boost at that number significantly.

People who have gotten vaccinated have had the experience of the second shot, and everyone always calls each other up saying, how are you doing? Because the side effects have gotten to be pretty well known. Are the side effects theoretically for say a twelve year old child going to be worse? Given the fact that the stronger the immune system, it seems, the stronger the reactions, it's hard to make a one

to one comparison that way. What we know from the phase three clinical trial data in that age group was that the side effects are not considered to be very severe, and there are people who get this vaccine and have no side effects, and it's hard to know exactly where twelve to fifteen year old would fall. But I know that's something that the CDC panel is going to look at because remember, children are not likely to have severe disease.

Children are not likely to be the major spreaders. So that's going to be part of the risk benefit of calculation that both the FDA and the CDC do. And that's important to do it because scenes you know, have our risk benefit tradeoff that you have to look at in each specific age group when you talk about the

risk benefit weighing that we're doing every day. There is a transition going on, when do health officials say enough high risk individuals have been vaccinated that the COVID pandemic can be downgraded to a bad flu and we can go about our lives. What I think will have to happen is we're going to have to get closer to

the U S population totally vaccinated. And I say, because that's where we saw precipitous declines in Israel, which is a much more highly vaccinated country, but they still haven't reached her immunity either, but their percent positivity of tests

is less than one percent. So I do think once we get more people vaccinated and you see cases plummet, uh maybe less than ten thousand or ten thousand, you're going to see just kind of a whole rethinking of how we come up with a better risk calculation, how we how we live with this virus. Because it's not going to go to zero, that's a that's a foregone conclusion.

It's not going to happen, but we will get to a point where this is something that has lost the ability to cause serious disease at the ring that it can dr indulgia. The cynics and the non science crew will say that the Fiser's minting all this money, they should come to the rescue to the aid of India in my in their wonderful press release which quite frankly, folks, I didn't do a word search and they don't address the catastrophe we see in these other countries. Is the

Fiser vaccine too fancy for the realities of India. I don't know that it's too fancy, but it's probably going to be one of several solutions. And remember India as a net vaccine exporter and they exported most of their vaccine to other countries. They maker of the astrosenica vaccine, they have their own homegrown vaccine. So this is a question of kind of logistics and getting in the ability

to make more vaccines. They can handle the Fiser vaccine in terms of manufacturing, the delivery situation with visor with the ultracold storage that makes it more difficult. A two dose vaccine is something that's also not optimal. So if they are able to use a single dose vaccine like the Johnson and Johnson vaccine in India, that would be

probably ideal. Could take it into rural areas, so They basically have to have all hands on deck using any type of safe and effective vaccine that's available to staunch what is really an out of control pandemic and to get them back online. Doctor, We've gotta leave it that. Thanks for catching up this morning. This is the Bloomberg

Surveillance Podcast. Thanks for listening. Join us live weekdays from seven to ten a m. Eastern on Bloomberg Radio and on Bloomberg Television each day from six to nine am for insight from the best in economics, finance, investment, and international relations. And subscribe to the Surveillance podcast on Apple podcast, SoundCloud, Bloomberg dot com, and of course on the terminal. I'm Tom Keene, and this is Bloomberg