We're in Price Discovery Mode, Wilson Says

I'm pleased to say that we're joined by a fantastic guest on Bloomberg Radio. It's Mike Wilson, the Morgan Stanley chief US equity strategist and the c I oh for Morgan Stanley. Might always got a can shout with you. What a week so far? It's a little bit of action we haven't had any awhile. It's actually refreshing many ways because it's been so stagnant for so long. We're

now kind of shaking the trees a little bit. And I think the big question folks are asking, is this just a correction and an overbought market or is there actually a regime shift happening beneath the surface, and we think it's a bit bit of both. So walk me through why you see indications of a of a regime shift at this point when a lot of people come on this show inside what was seen in the last

few days. It's purely technical and not fundamental. The reason why is because of sequencing, right, So if you I mean the ball shock happened really Monday and Tues Monday overnight as a result of the correction we had last the week prior. And then if you if you're really objective about it, the reason we had a correction a week prior was because rates kind of broke through some levels where it started to affect valuations in the equity market,

and that was the real kickoff move. So you have to ask yourself why did that evaluation gap down happen? It happened because we finally reached a point where rates are now potentially a gating factor on this nirvana equity bowl market we've been in. Do you see volatile? It's normalizing? What is normal right now? Certainly sub tent wasn't normal, So so what is normal and what are we going

back to? Well? Normals fourteen uh and the US equity market and we've been you know, as you said subten, So we're making We're gonna make our way back to fourteen. I don't think there's any doubt that the real question is what's the path and do we need to overshoot fourteen for a while. You know, everybody talks about the FED now talking about they're going to overshoot their target and inflation. Well why can't we overshoot the target and

volatility too? I mean, this is these are moving pieces, you know, it's it's interesting everybody, you know, I always likes to point to the FED, you know, as the Fed's fault, the set and the other. You know, markets are dynamic, and uh, you know I would say that market participants are is you know, guilty of you know markets overshooting is you know, they have to take the bait, right, they have to go there. So there was a big

strategy last year. It was the short volved strategy. And I want to ask you whether you think that actually contributed towards love of flatility and now those products cease to exist, whether it also means that actually we can expect high folatility because we won't have these products they're suppress sink. It just walk me through those two points. Yeah, so look, first of all, you have to understand why

is why has volatively been low. There was a you know, a call last year some people were making back in August that the markets were really complacent and volves too is too low, and we we just actually disagreed with at that time because valls low for the last several years for fundamental reasons. The fundamental reasons are, we have a synchronous global recovery. There's no part in the world that's seeing you know, deteriorating economic conditions. We have the

lowest earnings estimate dispersion we've seen in forty years. So if there's no estimate dispersion, then why should there be volatility in the marketplace. So it was fundamentally driven. And then of course, you know, people get a little too carried away with it and they start trying to make

money on that trend. It's a trend following. And so we then saw structured products and notes and things that tied into this low vollity targeting strategy not to mention risk parity and variable nuities which targeted then as well. And and then of course we had a catalyst with rates moving up and all of that came crashing down. And that's and that's always what happens. Good morning, Tom Kane, good morning. Just very happy that our cohenk has joined

us in the studio. You know, take my entourage of course, from the TV to radio. The entourage is very difficult to get into the radio control which was there and the doors. They'm sure I get a Jamila which is somebody said, what's it Jamala? Jamila? Is this gorgeous hot tea with honey and also the name of one of your producers a thing as well. It's just Jamie, I mean, you know, and and it is absolutely phenomenal. Uh. It's gotten me, seriously, it's gotten me through the last look

at sterling hand Yeah, big moves. I think I think send a communication from the Bank of England's pretty clear, isn't it. We need another rate hike. Get ready for one. Most people pricing that in for May of this year. Tom, If you told me to halve months ago we get two hikes in the space of a year, I might have laughed. But if we would get to one forty sterling, nobody believed that. No, we were in the low one twenties it's just twelve Jeffrey, you killed that? How Rhetecker?

I believed that a great job at Morgan Stanley on that too. And and yet here we are Mike Wilson. This talks about what we heard from Mervin King, Rick Michigan, Robert Kaplan and Axel Weber. Is there seemed to be limited degrees of freedom when you get this kind of volatility? Is that true that the choices that bankers and institutions could make get gummed up when you have volatility or

its volatility ultimately actually a good thing for Chairman Powell. Well, I look, it definitely brings clarity, like we're we're in price discovery mode now right, we know you know and and and that, and so that's why there's no leadership, you know. With The most interesting development, the last I think forty eight hours is not getting enough press, is that we we have not seen any shift in leadership either way in the client has been across the board.

And that's very unusual because typically when you have a risk off event like this, usually what happens as the market goes after where the portfolios are exposed, So you would think them momentum would have been hurt. It didn't momentum is actually held in Okay, agreed, and so we haven't had the portfolio disruption yet. I think that's to come. I think we're gonna have portfolio disruption now the next couple of weeks, which is going to actually force people's hands.

One thing that we've seen in our data is even though we had this ball shock and some people monetize the few puts that were out there, put put buying is not picked up, meaning people are still not hedged. They're still buying the story of buying it, but they're not selling it either. So that we have not seen people heads. We have not seen people produced their portfolio

exposures because they haven't been punished for yet. So what's gonna happen the next two weeks is the market's going to figure out is this a regime shift that I need to worry about from a structural standpoint, or is it's just a temporary pause. We think it's more of the ladder. Then we need we need new leadership to emerge. And that's what's that's what's we're really watching in the next two weeks. Futures up a negative five rather futures

negative five the VIX point six seven. I was just gonna say, John Ferrell, price discovery is Mr Wilson uses it. Price discovery is what happens when you get a be you get price discovery. To the vet bil Vet Bill, let's start with cleaning the carpets. When let's start let's start with that. Let's start with clearing market a little bit, Mike Willson. Typically the volatility curve, the VIX curve stepens

the further you go out, and that's quite intuitive. The further you go out, the more uncertain things are, therefore implying volatility should be higher in the future. What we have right now is complete opposite. So at the front end you have an inverted curve pretty much. So the term structure looks very very weird on the VIX right now, and I'm trying to understand when that's going to shake out. How long it takes to shake out, So we talked

about this earlier. It takes a couple of weeks typically, So when once you see the inversion of the VIX curve, that's a good sign. That means that risk is getting repriced. And we've seen that. Let me give give you, and also I'll put in equity terms, which is very simple to understand. We picked at ps UH in December, right when the tax bill passed at eighteen point five times forward twelve UH. In the overnight session Monday night, we got down at sixteen times. All right, that's a pretty

healthy reset on price price discovery. Okay, I think sixteen times it's probably too cheap. That doesn't mean we're not going to go back down there, and we test that level. The VIX curve inversion is part of that price discovery process to people are saying, I don't know where we're gonna sell out. Let me protect myself. I'm gonna pay up for ball in the short term if I want to buy puts, and the market is very confused, so we suspect that curve will flatten out over the next

two weeks. It typically does unless there's something systemic going on, which we do not think it's a new higher elevated so you're gonna get it will flatten, but it'll stay at a higher realized level than what we've been when we've been at Mike Wilson, generous of your time this morning. He is with Mr Gorman's Morgan Stanley, what a joy to speak with Douglas Cass. Sbior's partners. Uh, Doug, one of the great things we've been doing here in surveillance.

Mervin King yesterday, Rick Michigan of Colombia, and then today President Capital of Dallas, and then axel Weber of UBS. And within all that, there's certain moments, Doug. As you know, it's it's not like the whole conversation. You get this one little phrase. An axel Weber talked about his worry of market based finance. It's not it's not two thousand seven, two thousand eight. There were other issues then, leverage, example,

lack of huge exposure by banks. But axel Weber now talking about market based finance, and that brings us over to this risk parity idea. Doug Cass, what is risk parity?

Risk parity is an attempt to maximize return and minimize risk by UM placing bets on different asset classes, typically placing a bit on the relationship between bonds and stocks UM and when that relationship MUF where it's been historically UM, there is a tendency, a need to de leverage and to cover short volatility positions and to be clear, away from the vixed trade, the general fixed income risk parity trade has been working like a charm for many many quarters,

hasn't it right? And all of a sudden it's it's reversed and we saw our stocks go down at the same time bond prices went down and yields went up. You know, it seems to me that that that January and early February will be looked at as a semilinel point in time with regard to these instruments. I think in January we experienced peak Hubris, and we had this ministreme moment in mix and the market was basically underpricing risk.

It was building up excesses in a low vall setting, and we knocked on the door of euphoria last month. Here is the key question, then, Douglas cass And you know this because you've been there. You have a structure, Things change and you have to re hedge within moving markets that really hasn't been tested yet, has it. No, it was tested Friday, which will likely go down to paraphrase Don McLean in his song American Pie the day

the short volatility trade died. Okay, But there's other asset classes where we really haven't tested it yet, right, that's correct, attends you know, we're in as Freedman Tom Friedman says, we're in this flat and interconnected world. So all asset classes have have a correlation of one these days, so it seeps into different asset classes, and the system is so leveraged that de risking occurs, and what they were buying they sell in this shocking environment like with portfolio insurance,

where bias by high and sellers through. But if you go to the basic idea, and I'm quoting here from the American philosopher John Tucker, if you have faith in God above, if the Bible tells you so, I'm kidding, folks, that's from American pie. But the faith in interest rate. Yeah, except these guys aren't driving Chevy's. They've been driving Bentley's

because they've been making a lot of money. Doug casts in the Bible here the you know whoever I'm talking to, folks, whether it's not seeing teleb or Douglas cast, there's a Bible of belief. What's gonna go wrong with that Bible of belief? When we see a thirty year bond at a three thirty or a ten ure yield pops three point four three point zero four. Who knows. But but what's gonna happen to that bible that will be in

trouble at that point? Costs um very quietly. Corporate America has leveraged up, and we know the problem of the public sector because you know, to paraphrase Howard Marks, we've lost physical discipline with the tax bill. Um. The interesting thing to me is that um um, we may be entering what I describe as portfolio insurance part do last scene in October, and perhaps that should be our trading

template over the term. In other words, if history rhymes, we look at what happened to equity back in October and November and December. I do know when SMP futures dropped by fifty five handles on no News, as it did in the last twenty five minutes of trading yesterday, you know we have a problem. And I would say that there are a lot of people you know. The question is is was Monday and Tuesday as it relates to uh an unwinding of the short VIX trade? Was

that address rehearsal? And I would just say that last November, Bank of America estimated that there was over over one point five trillion linked to volatility links strategies UM. You

know risk parity. You mentioned all trending, vault targeting c t A s. So if it took nearly a decade for the number of e t s and e t n s to outnumber the amount of publicly traded companies on the exchanges, and it took nearly a decade for the quand strategies UM to surpass active investing, something makes me think that this size makes shift in the market and a one point five trillion dollars invested in volatility link strategies that took ten years in the making to

develop is not going to end in three trading sessions? Doug? What's so important here? And this alludes again to dr Vember of ubs is important comments today on market based finance and what I'm calling the shadow vics economy, and by economy I means the trading economy. Doug Cass, do you have a real worry about over the counter structures away from visible e t f s and other prospective items that when we go we don't know that they're

right now we're going to discover this real quickly. Yeah, I remember when you know, I have been outspoken about the market's vulnerability to these volatility link strategies for about a year. I remember doing the same thing about c D O S and nine in two thousand seven, and no one was concerned, and the general consensus view that was that there would be no contagion. And look what happened. These instruments virtually crippled and bankrupted the world's financial system.

So we don't know what's out there. Well we know what what are you gonna do now? You say you're in cash, you just sort of what I'm gonna do is the coo Larry David. I'm trying to elevate small talk to medium too. You should be concerned about these instruments. You should use volatility opportunistically if you want them. If you're short and you buy, you know, and stocks are

violently lower, you should be covering. And if you're a value investor, you should buy be buying what you like during these periods of the equilibrium, but the price probably going to continue for a long time. You look at what happened in after the portfolio insurance crash. There was a test you know, you had turned around Tuesday, after Monday's big schmicing, you had a day rally, and then you had a test the following week, and then back in it rallied, and then you had another test, the

final successful test in early December. So I think you're gonna you're gonna basically follow the same pattern. Cass, thank you so much, greatly appreciate with severies partners, some perspectives they're using with the tinge of history. I'd love to hear from all of our listeners. David emails in. He says Tom not enough tar Heels Duke basketball discussion him. We've been remiss. We're not talking tar Heels and Duke.

We gotta find the nearest approximation to that, which would be I mean, it's tonight, eight pm tonight, right in Chapel Hill, so it should be another great game. But the Dukes are doing better this year. You're doing better. They're doing very well. But they're very young, lots and lots of freshman, lots of one and done. So coach has to, you know, make them into a team by March. And that's his that's what he said. But we're getting right towards March. Baptis it's February, and like like, Duke's

doing better, Virginia's killing Virginia's great, Virginia beat Duke. Duke loss to St. John's last weekend, and then St. John's beat number one in Villanova. So it's been Dave, David, if you're listening, that's it. We're doing. No more basketball talking. We don't care about the tar Heels, don't care about David. You are so news. But you read this on Twitter and I looked at their press release. It was almost

an adult press release, wasn't it. Yeah, and they actually made gap earnings for the for the first time, so uh yeah, So I think, you know, we got a relief rally here. The stock has been beaten down. Now we see some green shoots that maybe, uh, some of the changes they've made to the companies, to the offering, you know, might be you know, resonating with with their users and with advertisers. Well, Sweeney, you're on all of

Bloomberg Intelligence, you and your entire team and me. We know they don't have mass, they don't have scale, they got lousy revenue growth. Did I read a press release today which is basically ship shaping them to be a taken out possible, but it's gonna be much more expensive than it was, you know, three to six, six months ago. But I think you know what they've got going for them now? Tit the extent that somebody wants three fifty million uh subscribers a social network of three or fifty

uh increasingly engaged users. Um is now there's some green shoots to say, Okay, maybe this business has righted itself. Maybe it's found kind of a little bit way forward from a pro perspective. So if if you're a Google and you're looking for a social network to cobble onto your massive platform, maybe now you have a little bit more confidence in the business. You're just gonna have to pay more than you would have three or six months ago.

Paul Sweeney, How is it that for all previous quarters I was always informed that the most important and only relevant number was how many monthly active users there are of Twitter? That actually declined, at least in the United States. Why do investors now seem to throw out that, turn that into a footnote, and turn a ninety one million dollar profit after being a being a public company for four years and a real company for twelve. How Why

is it that that becomes the headline. I think the investors that are left in this stock have said, Okay, we're three or fifty million users, the monthly active users that ain't gonna good grow anymore. We're not going to be a billion dollar user base like Facebook or Instagram. What we are going to be is a much more engaged user base. And that's what we're going to pitch

to advertisers, the fact that users are more engaged. So we're not looking at monthly active users, but the bulls are looking at daily active users, which were up twelve percent year of a year. That was the metric that has become the metric that has kind of replaced monthly active users because a monthly active user story isn't very good. So that's the don't raise the bridge, lower the river exactly exactly and and uh, we'll see, but for this quarter,

that's that was enough. So who would buy it? You know, I don't know anybody again, anybody who's looking for a big social who you know doesn't have a big social play. Is that Google? Is that Apple? Um Disney? Uh? Possibly possibly, but you know they've got enough on their plate now with trying to close sixty billion dollars or the assets from from news Corps. But you know, but it's now getting I think probably too expensive for any traditional media company.

I think now you're looking tech and you're just looking at tech. Who somebody who doesn't have a big social platform per se and that you know again, then the number one name that I hear most of investors is Google. Um, it's still you know, a relatively small acquisition for Google. Is Twitter a growth story? Uh? No? Um? Right now? We had two percent growth in revenue and that was the first growth we've had in four years. So no, it's not because internet advertising is growing fifteen to twenty

percent a year and they only grew two percent. So it's an engagement story, and it's you know, we'll see some question, where's the advertising revenue? I'm on Twitter all the time and I never see it. We're we're Facebook, I see it. Yeah, where is it? It's it's in the feed. Maybe you're just not targeted by their advertisers. I don't know, maybe the market Well, why target anybody that has lots of users? Yeah, and lots of followers, I beg your pardon, lots of supposable income. Yeah, So No,

they're I mean, they're the advertisers are there. But the advertisers that you really want to see, the big brand advertisers of Coca Cola is at General Motors and and they're not They're they're on Facebook, they're on Instagram because each of those platforms books. Yeah, not even Snap a little bit. But you know, you gotta be somewhere where you can get a billion, a billion five users, and those opportunities are limited, and they're pretty much you know, YouTube, Facebook,

Instagram kind of thing. Juda Martin Adams killed it yesterday. Can I just say she was an equity and analysis and the heat of it all and she just killed a past tweene you thank you so much with Bloomberg Intelligence on Twitter. With James Trevidis, you've got to outline your topics because we could go with the Altimo for an hour, and we will today on parades and then on the Olympics, Vice President Pence uh and what we're doing with our two Koreas, And so we begin with

James Trevidis. I do want to say that I wandered a pim with the beast, the new puppy of the house by the bookshelves the other day, and there was The Leader's Bookshelf, which I really can't say enough about. It was my book of the summer a few years ago. James Trevidis with seventy books that you need to know. From his book The Leader's Bookshelf. I just can't say

enough about the quality everybody in The Leader's Bookshelf. Admiral paraded, and as you say, and you're wonderful essay, pushing against the president. You enjoyed praying for rain at Annapolis, hoping like crazy you would not have to parade as a midshipman, didn't you? I did, And I can assure you all four thousand members of the Brigade of Midshipman hate to march in parades. No one likes them. So that's kind of reason why it doesn't make a lot of sense.

You're taking a long weekend away from all these troops who have to set up the parade route. They have to create the security, they have to move their tanks to Washington, they have to march, they have to clean it all up afterward. It's really not a good deal for the troops. Tom But within second, oh, please go ahead, please please Adamiral, go ahead. Secondly, you know that this isn't huge money, but it's probably twenty to thirty million dollars.

We've probably got better used for that kind of funding. And Thirdly, and I think this is most important TOIME. We're a big, powerful, capable military. We don't need to act like North Korea and put on these silly parade. I just don't think it makes a lot of sense. It's just an anecdote, folks. I enjoyed the Bestill Day parade, Pim Fox. I got a glimpse of Charles de gaul and it was a fragile France. They were coming out of World War Two, They had some challenging politics and

it was fraught with the fragility of France. Admiral. We don't have that fragility, do we not at all? And this time you have put your finger precisely on this. I think nations that need to show off. We've mentioned North Korea, We've mentioned France in those days. I think it's the third one to think about it. The Soviet Union, which used to play the how big is my missile game, pushing it down the streets of Moscow, and it just

is not what you have to do. We have quiet confidence we are the most lethal military in the world. We don't need to right add most of Rita's Let's turn our attention now if we can to the Olympics and North and South Korea. The younger sister of the occurred North Korean leader is scheduled to attend. They're gonna do up closing personal weather Well, well, let's we'll see

whether they do up closing personal with her. But I want to get your thoughts on whether this could indeed mark some kind of change or at least the modest improvement in the relationship between North and South Korea and therefore between the United States and North Korea. I think you've correctly categorized it as modest um. There is a sliver of hope here, and we should focus on it and see what can grow from this tiny little seed. Uh. And this, in the end is the historic purpose of

the Olympics. If you go back even to ancient Greece, this was the time when you stopped fighting, you came together, and sometimes there can be positive results. I wouldn't overweighted, I wouldn't necessarily better on it. Things will probably get better before they'll get worse again if you will. But I think for the next to three weeks there is

a small opening North Korea, South Korea. If we could bring the United States and China into the equation, go from two party communication, if you will, to four party I think we'd have a chance of moving something here. Let's face it. In the end, all roads to Pyunyang, the capital of North Korea, lead through Beijing. I wonder

if I could just turn your attention now. I know I'm kind of going off script, Tom, but I just had to draw on the admiralst expertise because we have a NATO member, Turkey that is involved in a conflict that in one way or another seems to be in direct opposition to US stated policy. I wonder if you could just give us your thoughts about Turkey and whether that is a potential UH point of conflagration that may end up being much more important than we currently believe.

As you know, I spent four years as this Supreme eli Commander of NATO and I've operated with commanded Turkish troops in combat. I want to start by saying a they're very capable and professional and be uh. They have a lot of capability. And see they were contributors to the alliance. We had Turkish troops in Afghanistan, in Libya, in the Balkans, in Syrian fact on missions there. So

they have been historically quite good. Now here's the problem they are Turkey is deeply concerned about the Kurdish situation. They have what they perceive as Kurdish terrorists operating against them, and those Kurdish forces have become the object of a Turkish incursion in Syria and it does put us in opposition with Turkey. And this is the biggest problem in the region because it could conceivably crack the alliance. So

what should we do. We should be working with our Turkish allies, and they are our allies, to create kind of a buffer zone between Turkey and these Kurdish forces. I think that's possible to do. It's going to be very delicate diplomacy, and it will require us continued attention over the weeks and months ahead. Um well, I'm reading to Pim's well taken point on Turkey Thomas Madden's wonderful one volume on Venice, and a few years ago, Venice

was worried about controlling the Eastern Mediterranean. How does our navy move around the Mediterranean, the Bosphorus and into the Black Seat. Can we just go where we want to go, uh, to get into the Black Sea. Turkey controls, as you know, Tom, the Strait that leads into the Black Sea. Um. This is another reason that this is so important to keep

Turkey on side in this alliance. The Act the Strait is governed by what's called Montro Convention, which has limits on the size of ships and a number of very technical aspects. UM. But we're in a vastly better place than we were, say in the fifteen hundreds when the Ottoman Empire, the predecessor of today's Turkey, was battering the gates of Venice. On battering the gates at the Vienna. We've defeated them in the ocean at La Ponto. Um. This is a situation we don't want to return to.

We want to keep Turkey with us in the navy. Did you ever have to do the thing where in your admiral's outfit you had to steer a gondola with that or you know, way aubof the ground. Of course I did, Tom, and I sang at the same time, and that's an important part of learning to be an admiral, the politics of being an admiral. Then US one oh one. I held it. I was holding his bags while he was doing I could just see Travilla, the gondola through theails.

Thank you, James Trevisa Toughs. 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