This is What Traders Will Be Watching In 2019

they're going to look ahead with me. Now in the studio we have Bloomberg Cross Assets reporter Luke Kawa and Bloomberg's macro strategist Cameron Christ. So Luke and Cameron, thank you very much for joining us. Looking forward to hearing your your crystal balls for the year ahead. Cameron, I will start with you, So, going into the new year, what are like the big I guess events or things

you'll be thinking about that you'll want to see develop. Well, it strikes me that there's a few important issues here. One is what happens with the Federal Reserve UM. Right now, markets are pricing basically a fifty fifty shot whether they hike at all in and just to be clear for those listening at home, we are recording this December eighteen, uh,

right before December. The question, it's just important for when people listen to this to realize when this is truly we're truly looking actually looking at not with the benefit of perfect information and all. You know, the trades story is as much as we like to think it's gonna just go away with the turn of the calendar, that's not realistic. We need to get some sort of resolution here.

And I think a third at least domestic issue for the United States, which is a new entry, will be a more targeted attack on the president and and the sort of the the the tapestry that's formed the backdrop in terms of political intrigue will become part of the

foreground rather than the background next year. I suspect, yeah, I'm interested in this topic because for the first like I would say, year and a half of the Trump presidency, I recall one of the constant discussions being there's so much chaos at the White House, why does it not seem to matter for the markets? Uh? And the responses typically like well things are going fine, and earnings are going up and all that, so whatever, it just is

background noise. Do you both get the impression that that's changing a little bit and that people really are for the first time kind of trading on uh political risk at the White House? Well, I think to a certain extent, we're using this to rationalize how we feel now. I think the market is in a much more vulnerable place, so the potential of adding another headwind from the White House does mean more than it did in the past.

But I'll also remember back in August, Yeah, I guess it was when we were getting rumors that Gary Cohene was leaving the White House because of his uh he was upset about the the Charlottesville protests and the president's response. That inter day move was one of the bigger retreats we saw in the SMP five hundred that year. It's just the fact that, you know, it was a nothing burger and the market was able to wash that away so quickly. But right now, I think that it's just

something that adds to market vulnerability. But I think it's a cause and a headache, but it's not you know, every proximate cause of weakness for the markets, Well, there's so much going on. It's it's hard to say that people are selling stocks because Nancy Pelosi is going to be the Speaker of the House. But I think moving forward, does it represent a reason to have a risk premium

in the markets generally? Probably? Probably that's the area of the market that you would look at to try to isolate political risk, like with trade or trade proxies, FED rage sensitive ones, Like could you even begin to try constructing some basket of politically sensitive multiples relative to other developed markets changing multiples because like, yeah, I I wouldn't know how to do it on the non index level because you'd think if it was you know, something that

was affecting the U S sucks in general, that would have to it would have to not be a sector specific thing and have to be an index level thing or that I mean maybe the builders of walls. Yeah, I mean, it's kind of a joke that keeps on giving, right, But I think on your themes, there's a couple that you know worth developing, and they take us into more of a markets place, both on on trade and the FED.

I think in a lot of sense from all the twenty nineteen Outlook reports, I read their Wall Street essentially averaging down into the outlooks. And two areas where I I think try where trade and the FED come into play, is I would expect to see any more any negative trade headlines manifest more to the downside in US equities

than they do to emerging market equities. I think emerging markets have priced in a ton of pain, and we have already seen a turn in this year in the e M versus you know SMP five hundred ratio, so even on you know, not material improvement in trade. So I think there's more of a potential for U S stocks to start to price in the downside risk to trade at the index level than emerging market stocks. And another on the US dollar in the FED. I'm wondering if this is finally the time we do truly get

that U. S dollar top. If twenty nineteen is a year of US dollar weakness, and it has to do with just you know, your second derivative, the fact that the FED isn't going to speed up the pace of rate hikes, and the fact that the US is probably going to decelerate more than other economies on a like or over your basis, Well, I would say this VSA V the US market versus emerging markets. If you look at this year, actually the multiple has contracted by roughly the same amount in the SMP and uh the M

s c I Emerging Market Index. What has separated the performance between the two has been earnings, where the US is obviously delivered great earnings growth and uh E M earnings have been basically flat on an earnings per share basis. So the one of the issues I'm wrestling with is, right now, the consensus top down forecast looks for something like eight percent earnings growth for the US over the next twelve months. That looks way too high, right Everyone

expects that to come down. Everyone expects that to come down. That being said, even if we assume zero earnings growth for the US, I think you could argue that the multiples contracted enough that the market actually offer right now.

With your third way to look at the multiple, UM, well, I look I like to look at the multiple relative to the rolling twelve month forward UM earnings estimate, which I have to construct in the spreadsheet because for the SMP there's no unfortunately, there's no easy way to do it on the terminal. You can get it on the M s C I US index a twelve month rolling EPs or or price earnings ratio, but that allows for sort of constant apples to apples comparisons over over time.

And I think we're in about fifteen and a bit in terms of in terms of the PE relative to the spot earnings. So if we assume no earnings growth, that would be fifteen relative to twelve month forward earnings, which is an earnings yield of about six and a half six point seven. Uh. You compare that to inflation. As you know, Joe, the real earnings yield is one of my favorite metrics. Uh, So we can compare that

where inflation is likely to go. That could present an earning a real earning shield of sort of four or four and a half percent by the middle of next year, which is a level that's consistent historically with fantastic returns for US stocks. To compare it with bond yields. You know, the quote unquote FED model not perfect, but that's still

a pretty tasty, tasty premium. So I do wonder how much further multiples can actually contract from here, barring uh, an economy a proper economic downturn, and that's really gonna be the story for the end of next year is

does recession become the self fulfilling prophecy? And a part of that story that I'm starting to see in markets, and I'm wondering if this will be a developing theme in twenty nine is the return of rates volatility, like we we talked about right before the February volatility explosion, and you know, the demise of my friend X I V and then again the sell off we got up in October after Jerome Powell talked about long way from neutral.

Those are both rate sensitive and rate related moves, but they weren't really accompanied by a lot of implied rate volatility. A huge move higher there. And one thing I'm looking about, as you know, something to spur rate volatility is a lot more uncertainty and confusion about the federal reserves path. I think that's a pretty easy catalyst, and I think that's something that we've been working through in Q four.

And one of the places I l racy that coming up is looking at the ratio of one year two year swaption volatility, So the implied volatility of two year rates over the next year versus one year tenure swaption volatility implied volatility of tenure rates over the next year, and that ratio is very elevated right now, you know, and it's moved upwards at a speed not seen since

the Taper tantrum. Taper tantrum, to me, was like a clear indication of the market pricing in an inflection point for Federal reserve policy, even though it took a while

to arrive. I think we're getting the same here and where we've you know, we're starting to sniff out what does the end of the FED cycle look like, what does the turn look like, and that as a catalyst for rate volatility at that start, it's at the short end and perhaps moved further up of the curve, and you know, has an effect on cross asset volatility, on spreads, on equities more so. I that's something I'm looking forward to to seeing because it has been the dog that

hasn't really barked. I think I'd probably take the under on rate's fall for the simple for two reasons. Um One is, we have much more explicit forward guidance than we've ever had in the past, and it's almost irrelevant whether the Fed actually is right or accurate in their forecast.

There's a well known behavioral finance UH concept called anchoring, and it provides these The dot plot provides an anchor for market expectations, and you can observe that in many ways that realize volatility throughout this entire cycle has been much much, much lower than it has been historically because of this anchoring process. One change that's gonna be different in twenty nineteen is that every FED decision now will be accompanied by a press conference. Previously it's just been

four year. Used to be none a year. There was a belief and it was never officially stated, but there was a belief that I guess kind of got confirmed though, that only the press conference meetings were live. Well, they did claim that all meetings were loved. They never hiked on a non press conference meeting. I don't ever believed it does. The theoretical liveness of all the meetings introduce any sort of volatility into a short range a little bit.

I think though, that markets will still anchor on the quarterly meetings simply because that's when the new round of forecasts are unveiling, and we've sort of seen that there

are still special meetings. Yeah, well we've seen that with the ECB right where every meeting is theoretically live, but half of them are just mail ins because there's not the you know, the backdrop of the new staff forecast from the from the e c B. Do you think, like you know, they talked about quote unquote normalization, and I still don't think I understand what that word means,

even I've heard it a bunch of times. But do you think that we're better off for all of these communication innovations or should we just go back to where they have a little statement and hike and move on. I think they should go back to the way it was before. But on the other hand, you you know, you talk about how volatility has been suppressed this cycle

in part because of those communications. Uh, if lower I don't know which way the feedback loop runs or the mechanism chicken egg here, But if the lower financial market volatility and lower macro economic volatility, if those two aren't all related, and the FEDS forward guidance is helping to promote one and the other, that that seems to me

to be somewhat of a free lunch. However, I think we could get into the Minsky and view of that this is breeding some level in the uncertainty and instability. But you've just gone yeah, you just refer to your friend XIT, your late lamented friend x I V. And I think that's a manifestation of artificial sense of certainty that's afforded by forward guidance. Uh. It's it's an interesting phenomena.

If we go back over the last quarter century, forward GUIDs by the Fed has gotten more and more explicit, starting when they started releasing statements sort of explaining what they were doing too. Now when obviously we get the dot plot and all this other stuff, and what we've observed is that realized volatility of fixed income markets has

gone down. Broadly speaking, um, the lead time which money market curbs invert to until the Fed cuts rates has broadened, and to date, each subsequent economic downturn has become more and more severe. The two rate cuts in nine in the d's after ninety four, which was there was one and then cycle. There was no recession that followed. But yet as they got more explicit in the tightening cycle, that ended with a recession obviously with the dot com bust,

and then they got even more explicit. Remember uh, measured pace, YadA, YadA, YadA uh in the five basis points every meeting exactly.

And then we followed that with a period of extraordinarily low volatility, which bread excessive risk taking, and we ended up You can argue that this is why the nature of recessions has been more balance sheet oriented and kind of providing certain data balance sheets that doesn't exist, and then you get, you know, more abrupt tipping points when you look forward to nineteen though, and right now, I think one thing that people have been really banging the

table about is they're worried about the credit market. They're worried about a very severe downturn and credit. A lot of talk about triple b s. Then, on the other hand, you have, you know, a lot of corporates taking steps to improve their balance sheets. What do you think about in terms of a credit versus equity outlook in I would say from a relative value perspective, I I would prefer at current valuation, I think I would prefer equity

to credit. It seems to me that we've sort of the credit The credit cycle I've view is sort of like a cruise ship. You know, you can't just turn it, turn it like water skis or a power boat. It's a very long and gradual cycle, and it seems to me that we have now bottomed in terms of spreads, and that fundamentally speaking over for the remainder of the cycle, spreads should on aggregate be water. Um. Now, if equity market evaluations were elevated, then you would say sell everything.

But given that we've had this this come down in terms of valuation as we as we just discussed, I know, I think we're kind of at the point where I prefer equity of credit. Let's uh, trade, let's talk a little bit more about that, because, uh, the interesting thing is soen we obviously got the I guess, the so called trade truce that that said a ninety or a hundred and twenty day clock depending on when it started on getting a deal. Since then, the truce hasn't fallen

apart some people might have expected it to. Uh, I don't know that there's a ton of progress being made on it. But it's not like there's been a ton of like backtracking or undermining of it. Right, But this is this is the trade truce and the trade war, excuse me, in the trade policy and a nutshell, you know, everyone sings Kubai are around the campfire and toast marshmallows and buenos aires. And then two days later we get news a that Trump is still a tariff man and

the Wallway arrest. Now if that's if that's the truce, I really don't want to I don't want to know what a war looks like. And this is why it's so we're gonna find out in t what the war looks like. I tend to think not. I've basically taken the view that that Trump would push the push the envelope on trade until financial markets told him it was

time to pull back. And it seems to me pretty clear that financial markets in the fourth quarter of I immediately after he imposed the two billion dollars the tariff onion dollars of goods, financial markets are saying, all right, that's probably enough for now. And it also seems like an issue in which it is positive for the president to keep it alive issue without real negative repercussions on

financial markets or the economy. So if you can go and you can have these many winds or these symbolic wins over and over and over, well at the same time, you don't have the legislative control that you once have. It's a winning issue that you can keep for yourself and no one else can really touch. As long as you don't push it a little too far overboard, it

does not become a negative for you. Do you think other or other four leaders are willing to play that game for him, which is basically like you know, don't let anything too bad happen and just keep giving it, giving Trump marginal wins that don't mean a lot, and let the sort of persistent din of risks just sort of sit out there completely. You think so completely? I'm not sure. I'm not sure. Um. I mean, that's a

that's a tough question to be honest with you. I think if Trump is under political pressure domestically, then surely that which he will be next year. I think, um, given that the House will have subpoena power and that they might actually use on the White House, that surely gives foreign governments more of a leverage against Trump than

they've had here before. Speaking of event risk in twenty nineteen, something that hardly anyone is talking about, but which I had a recent conversation with David wou over a b of aml H the Dead ceiling has to be lifted. In the last tight we had a really or Congress flipped uh in the mid term was and dead ceiling fight was pretty brutal. It went to the end. The politics, I guess, are a little bit different because Democrats maybe are a little less motivated by that's less of a

talking point for them, the debt. But nonetheless they have leverage and presumably they're gonna watch something. Do either of you think this is gonna be a big story or is your guest that the Democratic leaders are going to say, like, let's just come up with a deal. It'll be a big story, but not something that ultimately matters, right, Like it'll be something we worry about and huge like that that's story dominated that There was also another back to remember,

the the Euros down crisis. There was a lot of stuff going on back then, but that was a huge I mean, I remember that summer going out to the beach on weekend. Is it just like a lot big glued to Twitter watching every utterance from who Eric Canter and all them about that? Is that gonna be what

this year's like? I think like it's something that's lost its power to hurt the markets as much as it once did because of how big and crazy and how much it dominated attention in two thousand eleven, and Base done. All these kind of mini government squabbles we've been able to get over. Yeah, I'm gonna I'm gonna hedge my bets a little bit. I I generally don't care about this sort of stuff because I think it's it's noise relative rather than signal, because ultimately it gets resolved. But

it seems to me that has taught us anything. It's that these things that end up impacting markets are things that in hindsight you can say, well, obviously that had an impact, but didn't you You didn't forecast it in advance because you thought that, yes, it's an issue, but it's not gonna matter because it didn't matter in the past. So, I mean, the rules of engagement between the White House and Congress and the White House and the Fed, and the White House and the market have totally changed. So

we're all in sort of uncharted territory here. So while I don't think that this sort of thing will have any sort of meaningful, lasting impact on the market, if we're sitting here our next year and it turns out that it did. I'm not gonna have been terribly surprised. All Right, you gotta wrap it up here. Any sort of quick last parting thoughts from the two of you. I expect a hard Brexit good one. Well, I like that we didn't even get in there. But maybe we'll

do a Breakxit episode soon. That's that's a really good one. I I expect that the rotation to value that we've been waiting for forever does not happen. Okay, great stuff. Really enjoyed having you both on for both our look back and our look ahead. Luke Cowa and Cameron Christ, thanks for joining us, and this has been another episode of the Odd Lots Podcast. Thanks for listening, and of course please stick with us for twenty nine as we

watched these stories unfold. I'm Joe Wisenthal. You can follow me on Twitter at the Stalwarts. Tracy wasn't here this week, but you should still follow her on Twitter at Tracy Elloway. You should definitely follow our guests. Luke is on Twitter at l J Kawa. Cameron is on Twitter at Fifth Rule. You should follow our producer on Twitter tofur four Has. He's at four has T, as well as our substitute producer.

This week Liz Smith at Liz the Smith and don't forget to follow the Bloomberg Head of podcasts, Francesca Levy at Francesca Today. Thanks for listening.