Your Guide to the 2022 Market Roller Coaster

great guests. It's a perfect one to punch because everything going on to the market now really mostly is is a derivative of the Fed and their plan to be more hawkish. There's two ways of doing that, which we'll go into. But it's not just rate hikes, but the idea of raising interest rates because they're obviously concerned about inflation and inflation I think is actually trumping the idea

that the stock market could fall. Especially politically, I don't think, uh, you know, any of these politicians want to go into mid terms or the presidential election with inflation running high. So the Fed uh looks like they're committed. I've been pretty critical of the FED always folding like a lawn chair where they get hawkish and they just fold immediately when the stock market goes down two points. But they

seem pretty persistent. That last um UH press conference that Pal had, I felt he was the strongest he've been. I'm a casual observer, I'm not an expert, but as somebody who's doubted them, I feel like they have more of a spy now. And so everybody's just repositioning, and they're saying, well, if if, if rates are going to go up a little bit, I've got to figure different things out my portfolio. So it's hurt growth stocks, help bank stocks, hurt bonds, and so there's a lot of repositioning.

I will say that general mass blob of retail flow is still kind of buying Vanguard, but the outer layers definitely. You can feel a lot of activity around this, including some selling of of stocks and et f s. So you'll help us with the E t F side, but who's gonna help us with sort of the equity slash economic outlook through all of this? So Carl Rickadonna, who I've known for a while and now is sort of

in my group. Um, he's gonna take the FED part of this, and he's so good at simplifying FED speak, and I really go always go to him when I have a question. And then Gina Martin Adams, who is both of our bosses. She covers the macro outlook, so she's always looking at earnings and the FED and how the whole thing fits together. So I think she can

also talk about how the new environment is affecting her outlook. Alright, So joining us on Trillions Carl Rickadonna, the chief economist for Bloomberg Intelligence, as well as Gina Martin Adams back on the pod, the chief equity strategist for Bloomberg Intelligence. Next time on trying buckle up for a roller coaster. Carl, Gina, welcome back to Trillions. Thank you, thanks for having us, glad to be here, thanks for providing me on. I'm gonna start with you, Carl. Is the FED going to

fold like Eric's lawn chair? The FED is not going to fold like a lawn chair here, but I don't think they're going to be as aggressive as some of the worst concerns in the marketplace. So, as Eric mentioned in the past, the FED has been a very reactive to a resetting of financial conditions, explicitly sharp declines in the equity markets. Because the stock market in the economy

are not too uh independent creatures. What happens in the stock market often has very significant consequences for wealth effects for households, for confidence effects among companies who may be pulled back on the pace of hiring when when equities take a schoon or become much less confident in the economic outlook. Because equities are in the nose dives, so that that does have implications for the commodity for the

FED the reaction function. But front and center at the moment is the fact that now the fence two main objectives, maximizing the level of employment in the economy and achieving price stability, are now both on the same side of the two cold too hot spectrum. They are both running too hot. So we have the unemployment rate below where the FED thinks it should settle in the longer run, and obviously inflation for outstripping the fence two percent objective.

The last reading on the CPI showed a seven percent print. So let's go into what they do. Okay, So there's we all know that over the past ten years, they've kept rates low, and they've fought they fought assets. I mean they have a balance sheet. That's uh, I want to say fortually, but you'll correct me in a minute if I'm wrong. Now, explain this idea of what are they doing on the rate side and what are they

doing on the balance sheet side going forward? So what's happening the Fed that uses interest rates the overnight lending rate as its primary policy tool, and so as uh, you know, as the economy heats up, they raise interest rates to slow things down. What happens in the overnight rate then often gets multiplied out into longer term lending rates, whether it's your credit card rate, the interest rate on

your car loan, your mortgage, or corporate lending rates. So what the Fed does then has ripple effects throughout the broader economy. The problem for the FED if you keep cutting interest rates, eventually you get to zero uh. And once you get to zero, then negative interest rates don't really work that well. So that's a policy option the Fed has abandoned. Uh. And so what the Fed does then is reach further out into the maturity spectrum or

further out on the yield curve. By influencing other interest rates. So as we saw after the global financial crisis in two thousand and seven to two thousand and nine, the FED cut rates to zero for the first time and saw the need to do more UH, and so in doing more, they purchase assets. So they purchase in this case treasury securities of of varying maturity, so across the

yield curve. And also they purchased mortgages. Now, the mortgages kind of a legacy of the housing bust in O A DO nine, and they saw particular need to influence, you know, financial conditions for households. We come out of the O nine recession and have a very weak economic recovery, so the Fed's very slow to tighten policy by both raising interest rates and also starting to shrink the size

of its balance sheet. Sure enough, COVID comes along in the Fed again has to aggressively cut rates and doesn't have enough room to just achieve their objectives through interest rate cuts. They cut to zero and once again start expanding the balance sheet, in this case even more aggressively than they did back around the global financial crisis, so they have UH. In O nine, they quadrupled the size of their balance sheet, and now the balance sheet is

approaching nine or ten trillion dollars. So it's a huge number here for the Fed. Uh. And this provided tremendous stimulus during the COVID crisis. Uh. You know, we can say, well, the FED did too much in in in the hindsight that that created some inflation problems, but we cannot underestimate, you know, what could have potentially transpired had the FED

not acted so aggressively. We saw even the most deep and liquid financial market in the world, the US treasury market, basically seizing up in March of and so this was a matter of not only propping up the economy but also preserving the sanctity the liquid city of the most deep mark asset classes said that are hugely consequential for the global economy and the US economy. So the FED had to step in in a major way. We didn't

know exactly how the pandemic would play out. We didn't fully understand what the mortality rate was in the early stages of the pandemic, so the FED acted in a

very big fashion. The other factor they didn't understand was how much fiscal stimulus would be coming through because they know, the experience after the global financial crisis, Congress was very stingy providing stimulus to the economy, and so the you know, the risk was that if we saw a reprise of that, given the political tension in the economy in the country at that time, that maybe there would not be much fiscal support. So the Fed went massively. Uh. We got

a lot of fiscal stimulus, trillions of fiscal stimulus. So that did very importantly prop up the economy until it could get back onto its own feet. And now the FED has realized where at a stage where it is

now time, you know, the pandemic is becoming endemic. It's less of a threat to the economy, and so the Fed is pulling back on those uh, those levels of accommodation, which means we'll soon be seeing both interest rate increases uh and later this year, perhaps much later this year, the FED will start to gradually shrink its balance sheet. Gina um Carl's successfully has ratcheted up my anxiety. I feel like I'm at the top of that roller coaster now, and which was not what I needed after the last

week and of watching this market. Uh, take me, take me on some whiplash we had you on a few months ago. One of the things that I that we did spend some time talking about then was inflation. It's gotten. It's just become like almost the only thing that the market and the FED is has been centered on since that conversation. So just bring us up to speed on on where where you are now, what what you feel like that outlook is um and and how powerful um the FED is and what the market is gonna be

doing in the weeks and months to come. Yeah, UM, long a lot of questions to answer there. I'll try to get to all of them. First, Joel, I have to say, you're gonna have to toughen up. You're gonna have to get stronger, because it's going to be a wild ride in two. We have been here before, right, The FED has attempted to reverse or normalize policy multiple times over the course of the last ten years. In each case, especially when they stopped inflating the balance sheet,

the stock market goes through a pretty rough correction. Right on average, we see the stock market fall somewhere between fifteen and in each of those cases that that Carl alluded to. So I do think we have to we're gonna have to be tougher. In two. We've gotten very complacent as equity investors over the last two years, just really accustomed to constant gains in the equity market, and

that's highly unlikely to be the case in two. That said, you know, I think a couple of things has changed since the last time I was on and most of it is really the Fed's interpretation of what's going on.

If you recall when we talked last, we talked about the fact that I believe the economy is on much much stronger footing than most economists are forecasting, and the demand side of inflation is completely underappreciated, and the FED really leaned on this idea that inflation was going to be transitory, it would go away because it was all

supply driven. And the reality is that household balance sheets are in much much better condition than they were last cycles, so sort of going on a last cycle playbook for how slow they can move. Uh. That's really changed over the course of the last few months, where the FED is now acknowledging well, you know, even some of the most esoteric unemployment rate measures that we like to follow to suggest that we're not yet at maximum employment well low and behold, we're back to where we were in

two thousand nineteen. Right. Retail sales are still on fire for the most part. Inflation is still very strong. There's there's really very few slignes signs that the economy is even slowing down, so inflation may actually sustain. And I think they finally have capitulated on the idea that, yeah, as Carl mentioned, the pandemic is becoming endemic. It's less of a risk to broader economic growth, and we need

to normalize things. So the natural reaction and the stock market is oh, hey, okay, we thought you're going to be our best buddy, and now you're gonna leave us be. So valuations are naturally reacting. Um. I think Eric mentioned at the onset that you know, the market has reacted to inflation. I totally agree. In particular, the market has reacted to how rates are are moving with respect to inflation and with respect to what the FED is going

to do specifically. And we see that in our work in the equity market, the stocks with the most sensitivity two rates have dramatically underperformed the stocks with the least sensitivity to rates. And and I think that that's going to be the prevailing case for most of because this

is an adjustment process. Now that's set head. There is a saving grace here that nobody's talking about, and that is, Hey, the economy is still strong, and I think we're going to continue to underappreciate just how strong the economy is, even in the face of FED tightening, even in the face of potential balance sheet runoff. We probably will continue to underappreciate just how strong that economy is. And that

shows up in earnings. So the offset for the market is this sort of pull and push kind of metaphor where valuations are constantly under some degree of pressure, but earnings do make up some of that difference. And as long as earnings hold in, you know, the longer term uptrend for the stock market probably remains intact. Um. Let me follow up on this whole idea, because I think people out there here all the time, Oh, higher rates bad for growth stocks, They're bad for the ARC stocks.

Clearly that's happened right. ARC is down in the past year, but the S and PS up twenty That is a big spread. Although art crushed in long story, short just exp plane why just basis proints make that big of a difference for some of these stocks like Zoom Roku. I mean, these are pretty big companies. It's not like they're like nobody companies who have nothing going on. I guess maybe try to square that. Yeah, so a couple

of things happen. Right. If you're a purest if you're a pure fundamentalist, you believe the value of any equity is it's discounted future to cash flow stream, right, And so if that discount rate is going higher and your future cash flows are not changing as the discount rate goes higher, the stocks that had the longest term future cash flow growth are going to be impacted the most. Those are the growth stocks in the market in agent

most in the most generic sense. At the same time, there is a proven relationship between high volatility stucks in the balance sheet for the FED, and not very many people can really explain this, but the reality of the situation is every time that balance sheet has exceler rated, the highest volatility stocks in the SNP five hundred, no matter what type of stock they are, have tended to benefit.

So we what we started to see all the way back in March of last year, actually, as some of these most high volatility stocks in the market started to suss out this idea that the FED was going to have to tighten policy and liquidity conditions would start to change, and the reduced this materially reduced risk tolerance for these type of stocks. Some of them are high growth or

high cash flow growth stocks. Some of them have no cash flow at all, so you can't explain it through a traditional fundamental metric, but they are sensitive because they're high vall And we've really started to see this in some of our factor work over the course of the last six months, especially as the factor models that we run, we're saying, get out of the way of high volatility volatility stocks, start to move your portfolio to lower volatility stocks,

and that is reflecting what's happening with interest rate expectations, but also what's happening with expectations for the ballot sheet. If the balance sheet is not going to continue to rise, it will impact the most volatle stocks in the market most um. And I think that's what's happened with some of the arcs and you know, some of these meme

stocks and the like. You know, as is typically the case, the market really started to suss this out, as I mentioned, almost a full year ago now, but you had some offsets that made us kind of not you know, maybe when we're looking at the aggregate numbers, the SMP five hundred looked great, but if you look at where the returns came from in the SNP five hundred, it was

characteristically very different than the returns. Just to paraphrase Gina in very blunt Layman's terms, stocks love que quantitine of easing, Yes, that purchases from the Fed. If the Fed so much as whispers QUI, stocks rally. And when the Fed does the opposite, which is what they've been doing over the course of the last year, when they talk about quantitative tightening, the shrinking of the balance sheet, then though you know, stocks as much as they like QUEI, they despise QT.

And the FED has been murmuring increasingly loudly about quantitative tightening and what that's going to look like over the course of the last several months, especially in since the December FOMC meeting, and stocks don't like that, especially the risky stocks don't like that. And that's totally consistent with what we've seen play out in the marketplace. So Carlos, stick with that for a second. Say I give you the football. You are j pal, When do you next

look at the stock market? Well, you have to continuously watch the stock market and see how it's reacting to what you're doing. Because again, the stock market is not divorced from the real economy. Everyone says Wall Street is not main Street, but there are very important linkage is here. The stock market is a periscope into the future, into future company earnings, into the future health of the economy.

So stocks are tanking. That's giving you a very negative signal on the economy, and that tells you maybe you need to move at a slower pace in terms of tightening policy. Mind you, if we're thinking about Eric Incorporated, let's call it a small business. Eric is producing widgets now, and if it's chairs, lawn chairs, lawn chairs, okay, Eric, slawn chair company. If his business is growing at a ten percent pace and the cost of his financing is

one percent, what are you gonna do, Eric? Grow the business? Sure, sure, keep growing it. Okay. Now your business slows down to eight percent, your cost of financing goes up to four percent. Keep growing the business a little a little. Okay. Now the business is growing four percent and your cost of financing is five percent, you're going to grow the business. No, I'm gonna I'm gonna cash any more. I'm gonna cash up with you. Oh cash out? Well, you're you're not

going to continue to grow the business. And what's true for Eric's lawn Chairs Incorporated is also true for a twenty trillion dollar US economy. When the cost of financing approaches the growth rate, then all of a sudden, we're not stepping on the gas pedal anymore. Now we're starting to move towards the brake pedal. So as the FED lifts rates from zero to maybe one percent at year end, that's really just easing off of the accelerator. It's not stepping on the brake pedal, but it's moving in the

direction of the brake pedal. And so that's why GENA can have a very constructive outlook for the economy and for stocks, just to to put those numbers around instead of Eric's lawn chair business, the U s economy right interest rates or zero or effectively zero h The economy as of the final quarter of grew at a nominal pace of twelve percent year on year, So there's a huge gap between twelve the growth rate of the business

and zero the cost of financing. The FED is going to start narrowing that gap, and probably nominal GDP slows down, you know, considerably, to something closer to five or six percent by the end of this year. But if the FAN is hiking once per quarter, that puts them at one percent, So you still have a huge interest rate differentials.

We're not talking until maybe twenty four or beyond. If the FED continues on this steady pace of tightening to really move that interest rate differential down to what we would call a neutral pace. The FAN is giving it a very aggressive steroid to the economy and will continue to do so, albeit in slightly smaller doses going forward. I would just add one thing because I think that

was a great explanation. We're surrounding the cost of financing um I would say when we look at corporate balance sheets, the thing that also is completely underappreciated is that cost of financing is significantly lower than you might observe when you're looking at even spreads because of the degree to which companies have built up cash stores, and it's very similar with households, where we are substantially less dependent on on financing to grow, especially relative to the last cycle,

where corporate balance sheets and household balance sheets were in tremendous disrepair following the Great Financial Crisis, there on significantly sounder footing. And you know, the perfect example of this is Microsoft wants to grow. They don't need to go issue debt to even buy a company as large as Activision, which is a huge testament to just how much insane

amount of cash is just sitting on balance sheets. And it's the same across most of the S and P five hundred, where corporate cash is still sitting near and all time high, even though we're this far into recovery, and it's it's quite phenomenal, right, is this? Companies just haven't spent a ton yet on anything, And even though they've been able to tap the bond markets for the last couple of years, they have stored up a lot of capability of keeping the cycle going for longer than

many people anticipate, even if the fet ist tight. And I should just add to what jetas saying, what she's seeing at the company level is also true at the household level. Households stockpiled cash during the pandemic, they got rebate checks from the government. They didn't have the opportunity to spend money in many cases, and a lot of households were significantly invested in the markets and so they

saw their wealth increase on that front as well. So there's a a mountain of savings that's in the trillions of dollars that households are sitting on, which is why they can weather the storm of slightly higher inflation and higher interest rates as well. But it's gonna be a bumpy little ride here, Eric, for all of them. And I'm curious, like, just as flows go something I know you watch closely all the time, what's it? What's it

been like of late? Where have people gotten out of I saw that spy was had a massive outflow, Um what what? Other? What? Other kind of things of culture and bring it back to the world of ets for us? Yeah, sure, And I think this I'll pivot to a question for Gina, which is the main vanguard investor is just totally oblivious. They're just investing vanguards taken into one billion. That's they're just like nothing's happening. Um, Schwab is doing well too.

So if you're like a passive bogel And type investor, none of this really but bothers you. That said, there's the trading crowd and people institutions who are repositioning on the on the fringes especially so for example, we've seen a lot of money go into financial E T s. Obviously rates go up, they can lend, get a higher rate, or they can get more their interest rates are good

for them. We've also seen gold get a bid because I think there's some nerves on like, hey, I should be more diversified because my sixty and my forty is going down. And we've seen value E t F s UM and energy. I put energy in value together almost because they're beat up for so long. So there's a bit of a repositioning, uh. And that's where it's happening. And the other thing that's the big loser this year,

besides the cueues which is seeing outflows, is bonds. If you look at the outflow list, it's basically it's a who's who of the all the bond E t F t l t H y G, even the tip E t F tips e tfs l q D I E, F J, and K. It's basically treasuries mortgages because if rates go up, all those current bonds are just worthless because you can get more with the new rate. So what the Fed is doing clearly is going to impact the bond market. And there's been this huge monster bowl

market for the twenty years. And like I guess I would throw it to Gina. I just went over a lot. But is the bond market going to have real problems and is that going to spill over into the stock mark? Um? You know, I think that we certainly are on the precipice of a longer term shift in rates, and and I base that opinion based simply on my views of the economy. I just think the economy is in a copletely different condition than it was for the bulk of

the last ten years. I also think the inflationary scenario is very different, in part as a result of that, but other longer term structural factors as well. And the result of that is we are very unlikely to see rates as low as we did for the for much of the last ten years or the first call it ten years of this of this bull market in stocks. So the value of your future cash flows. You know your is naturally going to adjust to rates moving higher.

But again, the offset there is that cash flow growth should also be stronger. And the thing that we might all be under appreciating is if bonds move from thirty year bull market, two bear market, or even just moving sideways and then slightly bear market, what we could be under appreciating is just the amount of capital that comes out of bonds and goes into stocks, and that I think is much more difficult to model. Um It's been one of the anomalies of the past the first ten

years of the cycle. We're not about investors putting more money to work in stocks. We know that for sure. We know that investors, broadly household ownership of equities merely went up because market value went up. On net, they didn't add anything to their equity portfolio, which is completely anomalous. Historically, you don't see a tenure economic recovery in which investors don't add any more capital to the equity market on net.

It's just it's just wildly strange. UM. I think starting in probably extending into and I do think moving into two and beyond, we're going to continue to see this great rotation really in we started to see the first signs that equity and the investors are interested in stocks again, with flows coming back to the market, longer term flows moving back into stocks. We started to see I p o issuance again. One These are things that I didn't talk about for ten years um because they just weren't

supports to the stock market. Instead, the stock market went up because the supply of equities went down, not because demand for equities went higher. So I think that we are seeing a little bit more exuberance in the stock market developed simply because the barn market is in disrepair. There will be offsets, and in periods of time in which rates are dominating attention and moving into a spiking fashion,

it does create volatility for the stock market. But longer term, you know, you just model what happened in the nineteen fifties and sixties. The stock market went through a twenty year bull market as rates were rising. This is certainly possible to have rates rise and the stock market rise at the same time, but you do have to have very strong growth, and you have to have somewhat contained

inflation before it gets If there's a switch that gets flipped. Okay, So that whole idea of bonds and stocks and this is what most people have in a retirement portfolio. This brings me to a theory. I want to I want to throw it, Carl. I've thrown I threw it at Genia last time. She was on lawn chair right now. Yeah, this is this is this is kind of why my

the lawn chair thing comes up with me. I have this thing called the boom Errati theory, which is that you know how like j Pal's a boomer, Trump was a boomer, isn't it. First of all, it's interesting that Trump and Biden kept the same fed chair. They would agree on nothing. Two things they agree on they like pale and they hate bitcoin. Right, there's a boomer thing. It transcends politics. They have all the money, if you look at the stock and bond market over the years,

has become America's retirement fund. So all these boomers, which they own about like se of the stock market, it's their money and they're at all the levels of power. So is there possibly subconsciously or consciously going to always be a fed put because this is literally America's retirement money. We cannot let the stock and bar market go down that much, I would say that this is not First of all, as you're sitting in your lawn chair, I suggest you take off the tinfoil or at least luc

around the down. So in some capacity, we could view this through the eyes of the boomers preserving their wealth and uh, some conspiracy against the millennials and their disruptions and whatnot, although the millennials are you know, poised for the largest transfer of wealth and the history of humankind as we look twenty twenty years down the road and whatnot. However, again, this preservation of the stock market or the FED puts so the FED is not just acting to prop up assets.

The FED is looking at economic looking to achieve successful economic stewardship. Now, if they successfully achieve that goal of price stability and maximum employment, then they are creating the type of economy that GENA is describing, where you have controlled inflation pressures and healthy growth in the economy, and

that should be favorable for the equity market. So you know, it's more about the economic stewardship question, which the side effect of that is a healthy stock market, than some sort of nefarious plot for some generation to hoard, hoard the wealth, as you say, and you know, as Gina described it as I think she used the expression the great rotation that we're seeing playing out over the next

couple of years. I think of it in macro terms as the great competition, right, and the competition is with let's say a two year government yield. Right during the crisis to year government government notes, we're yielding about point one percent. They are now yielding a full percentage point higher, about one point one percent, and that will only go up as a FED formalizes its plans to continue raising rates. If the Fed is raising the overnight rate, two year

yields are going to go up as well. So now, uh, stocks, whether it's Cathy Woods ARC or a dividend paying uh you know what equity aristocrat, they they're not competing against the point one percent rate of return. They're now competing against a one point one percent yield on a two

year government security. So that competition is heating up, and that means you're you're less happy holding uh those longer maturity assets like a ten year yield or you know, a third year bond for instance, or some of the corporates, you know, a very highly rated corporates that are not giving you much return. The competition is heating up, and so now there's more of that rotation into higher yielding equities for instance, which is you know, another way of

framing that growth versus value debate. Okay, as we start to bring this roller coaster ride to to an end, Um, Carl, Gina, I'm gonna ask you a question, and uh, it's it's a free for all. You can do whatever you want with it. Um. Eric knows a lot about E t F s. We've talked a lot about the economy, about the FED, about equities. What E t F question would

you like to ask? Eric, Carl, you go first? Okay, Well, first, before I asked that question, I'm just going to go back to Joel's roller coaster analogy because Gina and I have done our best here to kind of signal that the roller coaster just because it goes up the steep hill doesn't mean there's a scary descent thereafter. And we both have a relatively constructive outlook where the FED can move towards the exit and the economy performs soundly. And

that's our my baseline scenario. I believe it's Gina's baseline scenario as well. That doesn't mean this can't be a scarier, bumpy roller coaster ride, because you know, this is a path fraught with danger, right if the FED is too worried over the inflation outlook, tightens too aggressively, unwinds the balance sheet, which is again a tool we we've only used once before, so we're not entirely uh sure of

what the potency of that tool is. So if we we take the unknown medicine and take too high of a dosage, you can have some real problems here, and so it can certainly be a bumpy ride. And the risk is, you know, the FED could move too slowly and inflation gets out of control. I think the bigger concern is that the FED could potentially panic move too aggressively and nudge the economy into a downturn, into a recession, which then you know, you're back to applying all of

this aggressive medication to try to restimulate growth. So there's certainly a you know, uh, potentially exciting roller coaster ride ahead, Joel, as you according to your analogy, But I would be interested in asking Eric about the passive uh is passive investing passive versus active? Is that How confident are you that that trend continues? Because if you're a passive investor, uh, and you're in the type of economic cycle we saw over the past couple of years, FED delivers massive uh

you know, stimulus to the economy. So we you know, the rising tides going to lift all ships. It's a great environment to be passive. I would just to play Devil's advocate. Wonder if we're not heading into the stock pickers paradise now where we've had a big rise in the equity markets. But now the differentiation starts to occur as as the tide as as Warren Buffett says, as the tide starts to roll out, we find out who's wearing a bathing suit and who's not. Aren't we heading

into that realm right now? Eric? Where now the active investors are going to really be able to differentiate themselves as as it becomes a stock pickers market, uh, and therefore will be less of a pro E t F or at least a pro passive environment going forward. Well, yeah, good, You're good to separate E t F and passive because our big outlook theme this year is that um E t F have transcended the passive label. I mean it's a big tent, and more and more they're becoming active

and people use them actively. So one thing I would say is we just went over how flows are going into financials and value et F So people are actively using passive E t F s to reposition, just like you're saying relative to the stock picker problem. Is this a stock picker? You know, if you're doing deep value stock picking, I think you have a bright future. If you're doing like closet indexing stock picking like the Fidelity Magellan which holds mostly SMP and tilts a little, your

goose is cooked. You'll never get money again because nobody is going to sell a three basis point Vanguard fund and buy you for ad basis points when you're mostly the Vanguard fund and I can't even guarantee you'll perform. In fact, the s are you won't. Also, in past downturns, active has only outperformed at the same thirty three rate as when it's good. The look cheap data is just the hell of a drug. People are just not going

to sell a three basis point Vanguard fund. My theory is if active got cheaper, if fidelities started passing on economies of scale and got to twenty BIPs fifteen BIPs, then there are little bets around the SMP could could actually be worth it. But at eight I just think I just don't think it stops anything. I think what you will see THO is more and more people use ETFs actively and so you'll see flows into financials, deep

value and that kind of thing. But I, as we can see, Vanguard is taking in money like like nobody's business. And also the Vanguard type investor, the kind of person who goes to Vanguard typically is pretty aware that, uh, you own everything. So whether values in play or gross in play or energy stocks are a hit, it's fomo proof you already own it. I don't really care. I'll

just you know, what am I going to do? Replace this with like the hot stock picker of that year and then probably underperform in the year after most of them have just come to the conclusion there's no better deal. That's my opinion on that. Gina, Do I get to ask my question now? So? Yeah, I was gonna say, you're Eric's really interested and it can be drug related. It could be launch. So my question really is around the non passive portion of e t s. And we

have seen some active conversions. We've obviously seen thematic investing really just take off over the course of the last few years. And your team, Eric has done some insane work on themes and and the sort of the themes that are driving stocks. So, um, my question for you is who's the next arc? If ARC is over? If we can just assume that ARC is over for now, where are we going to see the next big theme?

What's the next big theme that's going to drive stocks, and and and what shall we be on the guard on guard for. Yeah, this is really a fascinating question because we wrote a note that said a deep value et F could be the next Cathy would because it's it's not about growth, it's really about concentration. We think that if most people's core of their portfolio is now in dirt cheap beta and they're happy with that, they're not going to touch it. They're gonna let the paint

dry for twenty years. They are looking for things to put on the outside, like hot sauce. So Kathy was perfectly positioned for a growth wave hot sauce. What comes next um you know, and and theme ETFs uh like

cybersecurity and cryptocurrency ETFs. So I think you could see themes start to repackage value stocks in fun, clever ways, like maybe they'll come out with a stuff You're really effing F which is basically just like consumer staples, because themes have really done a good job of stealing thunder from sectors and from styles and from factors by sort of making it easy, you know, more fun and easy to understand, like the work from Home et F. That's

just two sectors put together. It's not like rocket science, but the labeling is really is really powerful, and so we also think that So I think you'll find some themes that tap into like maybe the staples or value stocks UM and and just maybe a deep value E t F because we did see that the ones that have the most concentration pop the most in Q one and they were doubling and tripling the Vanguard Value et F,

which is very weighted down with big cat names. So again our big theme is, look, we always say you have to there's three cs. There's the three cs to E C E t F success. You've gotta be cheap, you've got to be creative or concentrated or cabernet, which is you've got to sort of like wine and dine advisors. But I'll move that that lane aside. But clearly something shiny objects aren't limited to growth. They can be value,

they can be energy. Um. You know there's an e t F called the fracking e t F. I mean there's certain ways you can sort of play with the energy, maybe like old guy old school energy or something, and maybe try to make oil producers interesting again because they're doing so well. So that's where I think you'll see it. But a lot of those flows are more on the fringe. Um, but they're gonna keep coming. I mean, we just saw an t F for airline cruises and hotels, which is

essentially like the reopening trade. Joel, Joel, Can I get a second question? Okay? Thanks, thanks Genie. That's like asking the Genie for another three wishes. Um. I want to ask Eric if you think that this kind of deep value investment can outperform something like tech disruption, which is what ARC was all about, over a longer period of time. And I would, you know, as a skeptic, I would

say no, it couldn't tech is going to out. You know, tech disruption is going to have a higher sustained growth rate over the long run than than deep value, which may in the short run have a bound and maybe outpaced chech, but not over the longer run. Well, it all moves in waves. You don't have a line in my new book coming out about Bogel because he was he launched the value et F and the growth ETF

way back in the nineties. He actually pioneered style indexing, and he said, I thought you'd buy the growth ETF when you're young, and then you transfer to the value and you find out people tried to trade it, and they ended up doing worse than just don't need the S and P. And if you track growth and value over a long period of time, they sort of end

up at the same spot. So I recite that line from Almost Famous when Lester Bangs tells the high school reporter, Oh, don't worry, you'll meet them all again in the long road to the middle. So I do think if you time it right, you can make a lot of money. But in the two thousand small cat Value and Gino, I think we'll attest to this. She probably better numbers

than I do. In two thousand to two thousand ten, which is a whole decade, small value crushed the S and P, which was I think flat and small value was up a lot. And that was during a huge tech renaissance, right, You had a lot of the Internet was just kind of like exploding. Um so I would it's totally possible that there's a complete regime change, and it has to be like a psychological thing where people just like we were too crazy with the computers, we

really want to get back to basics. I don't know, like there's a psychological thing and it all a sudden becomes it just seems so silly to go so far into the tech, and it seems more I guess it just seems right to go into staples and energy for some reason. I don't know if Gina has a comment on that, but I don't know if that psychological thing will ever To Carl's point, our culture is so tech oriented. Could someone ever get out of that psychological mindset that

tech is in the future. Well, I think we're watching it happen to some degree, and we're watching it happen in energy stocks and technology related energy stocks. I mean, the perfect example, the S and P is even thinking about reconstituting industries because they don't know what to do with all these techie energy companies. Right, and we're in the midst of, you know, trying to tackle things like climate change and uh, you know, massive energy consumption problems

that are resulting in energy stocks materially outperforming. I mean, I don't know how many people pay attention to this, but energy stocks were up twenty in January while the market crashed, And it's been our big call for the last year and a half that longer term, as long as inflation is at a much stronger pace, that's the key. And if you know commodity prices are contributing to that inflation, then it's even a bigger key than energy stocks will outperform.

And if you look back in history, growth doesn't always outperform. Value usually outperforms when growth economic growth is faster, because value stocks tend to leverage that near term economic growth outlook better. Right, tech has longer dated cash flows. Value stocks get the immediate cash flow growth when the economy is running at a faster pace. So I completely agree that it's a I think it's a great call to

be in small up value. I think value already is showing signs of topping out or beating out growth stocks, and will continue to beat out growth stocks. Our favorite sector is still energy, followed very closely by financials, and I don't see that changing um And what will make that chain, what will make that endure, is the inflation outlook. If you think inflation is going to settle this cycle at a pace above three percent, you have to be

in value of our growth. If you think inflation is going to revert back to the slow inflation environment that we saw in the last cycle, then you want, you know, you want to move back toward the growth, growth sensitive stocks in the market. Carl, we have a question that we ask everybody on trillions first time on So are you gonna get it? What's your favorite E t F ticker? Oh,

my goodness, my favorite E t F ticker. Don't worry, Carl, I bobble this question every time you're talking about E t F. I'm gonna go with like a kind of you know, passive vanguard, type of all cap kind of rising rising tide continues to lift all boats. Since we're allowed to bobble the answer here, I'm gonna go into

my my E t F pick list. I'm gonna go with V I G the Vanguard Dividend Appreciation e t F and this factor's back into this whole camp, the great competition thesis, which I mentioned earlier in our discussion, because dividend appreciation is uh, you know, I think going to be so fundamentally important to stock valuations as we move into a higher inflation and higher interest rate regime for the foreseeable future. You bobbled it, recovered the fumble,

and then like took off for a touchdown. Yeah. And also that's the first person who picked big your your original all right? When did they're Gina Martin Adams, Carl wi Ganna. Thank you so much for joining us on Trillians. Thank you my pleasure. Thanks for listening to Trillions until next time. You can find us on the Bloomberg Terminal, Bloomberg dot com, Apple Podcast, Spotify, and wherever else you'd

like to listen. We'd love to hear from you. We're on Twitter, I'm at Joel Weber Show, He's at Eric Baltunas. This episode of Trillions was produced by Magnus Hendrickson, Francesca Levy is the head of Bloomberg podcast Bye