Bloomberg Wall Street Week: July 29, 2022

which has fifty different regulators in fifty different states. It was an extravaganza of talk and data this week, with President Biden finally having that talk with China's President g President she actually emphasizing to President Biden that they should coordinate on macroeconomic policies. According to the Chinese Foreign Minister read out the EU Energy Commissioner laying out plans to

deal with further natural gas cuts from Russia. We will start saving cast now, and that we had a blue print to act together in a coordinate debate if the situation doosn't. Congress moved that chips bill towards the President's desk and to top it off. Senator Schumer and Mansion tried to pull our rabbit out of the hat with a surprise deal on climate and deficit reduction. This bill is far from perfect. It's to compromise, but is that's

often how progress is made. And of course the big one, the Fed setting a new funds rate and share pow, saying they'll keep tightening and we're strongly committed to returning inflation to our two percent objective. As the stance of monetary policy titans further, it likely will become appropriate to slow the pace of increases, but we shouldn't expect a

lot more of that forward guidance. We think it's time to to just go to a meeting by meeting basis and not provide the kind of clear guidance that we had provided on the way to new and if the Fed thought he would have an easy time, but the numbers kept coming in this week, making it more complicated, with GDP down for a second straight quarter on Thursday, and then on Friday, personal consumption and employment cost index numbers coming in higher than expected, showing that inflation is

not close to done with us yet. And the markets, well, they pretty much took it all in stride, with the SMP up almost four point three percent for the week, ending the month with its best performance since November, and the NASDAC posted even higher weekly gains, up some four point seven while bond yields remained subdued, with the ten year yield ending the week at two point six five,

giving up nearly thirty five basis points. To help us sort through all of this, we welcome now Rebecca Patterson, Bridgewater Chief Investment Strategists and Sarah Ketder, CEO of Causeway Capital. So welcome both of you back to Wall Street again. Rebecca, let me start with you and what the FED has in front of it. What is it trying to do.

The Fed is trying to get goldilocks, and that means it wants to get inflation back down as fast as it can towards its two percent target without engineering a recession, and the market is giving it the benefit of the doubt. If you look at what's discounted into markets today, it is basically two and a half percent inflation in just over a year and only a moderate slowdown in growth. And I think it's gonna be almost impossible for the FED to get everything it wants here. The porridge is

gonna be too hot or too cold. Either inflation will end up running much higher than the Fed's target and they risk losing their credibility, or if they're serious about getting inflation down, especially from the current high levels, it's going to require more targ more tightening, which we think is going to engineer a deeper recession, and that's what we're focused on. We think that within six to nine months we're going to be looking at us GDP that's

negative to negative three. So, Sarah, where aren't you on this? Because it felt like a tension this week between the markets, the futures markets on the one hand saying exactly what Rebcca just said, and economists on the other hand saying, you know what, we've got to really jack up the rates a lot to get inflation on control. Which side are you on more skeptical? I don't think that's how we are as value managers always want to have it

proven to us. But but note that we've had so much liquidity created four trillion dollars of of enlargement to the Fed's balance sheet since the beginning of the pandemic in early that's a lot of liquidity, and it's still there. The FED only just started to reduce go into it from a quantitative eavening to quantitative tightening starting to one of this year, and it's just beginning, and it'll go from thirty billion a month and then bump that up

to to sixty billion a month. Uh and letting those bonds roll off that again starts to compress bank reserves. This will take It's quite be quite lagged in its effect. So financial conditions will just tighten due to that reason alone. And we don't think markets anticipate that at all. And I think, just building Sarah on your point, it's it's important to remember that the markets are really looking at

um the rates. They're not thinking as much about quantitative tightening or do the roll off of the Fed's balance sheet, which is on autopilot, that's going to keep going. And so we don't have the Fed buying bonds, we don't have banks buying bonds anymore. And so we've seen bond yields come down in the last couple of weeks, But how much further can they come down without retail investors

institutional investors moving out of equities into bonds. I think what we've seen historically is when stocks go down, bonds rally and you get that diversification. We've had that for the last few weeks. We didn't have it for the first half of the year. I don't think we can count on that. As we get QT continuing quantitative tightening, continuing, bond yields may come down, but it's going to be a lot harder for them to do that in this

environment where the Fed's created a liquidity hole. It's taking liquidity out and it's not as clear today who's going to fill that, who's going to supply the demand to keep bond yields going further down. So let me pursue that liquidity issue a little bit, Sarah, because you mentioned the lack of liquidity that really makes the market DESI understand much more voluerable. So what does that do to

an investor? How do you do you have a GPS at this point given where we are, The key is to have a low entry price because you've got to have that margin of safety. And what this will mean if if massive increases in liquidity, And again this wasn't just the FED, central banks globally, we're all at this The European Central Bank, the Bank in Japan, and as they take all in unison, take liquidity out of the system.

What pushed up market multiples, what made valuations expand what made investors in different devaluations, it'll to be just the opposite. And we've already seen that start because some of the hardest hit stocks globally, including in the US market, and they had the most bloated valuations. Okay, Sarah Kader and Rebecca Patterson, we'll stay with us as we take a

look at earnings. It was a big earnings week as well for Wall Street and that's coming up next on Wall Street Week on Bloomberg about today that could be little launched corporations reported their worst profit decline in twenty nine years. Revised Commerce Department figures for the first quarter showed that both the economy's downturn and the pressures of inflation were worse than previously reported, and international speculators began dumping dollars and acquiring gold with a fervor not seen

for quite some time. That was the way things look. The Lewis ruck has around Wall Street week. Back in we were coming out of a recession. Today we may have inflation, but we haven't really seen a downturn in corporate profits at least yet, much less a week er dollar. We've seen just the reverse. In fact, Rebecca Patterson of Ridgewater and Sarah Kettter of Causeway Capital have stayed with us. So Sarah, let me go to you on the equities question.

We had a lot of earnings that this week. They went both ways, but I think sort of overall, earnings came in pretty well so far they have, and I think both Rebecca and I've commented on what's happened in

the past is initially reflective of this future. In other words, there are so many challenges ahead in a persistent inflationary environment for companies in terms of cost increases, not to mention a consumer that's deliberately being reined in that this just made me a really tough next several quarters of reporting. How tough, hard to say, but unlikely to be buoyant. And that's to the point that we've seen multiple de rating.

Now we made variable see earnings fall two, and that's typically what happens in market pullbacks, both multiples and earnings fall, and that again is a phenomena that likely occur globally. So, Rebecca, you have a little bit of money at Bridgewater you have to put to work every once in a while. What about the question, particularly that versus equity you mentioned before,

the question of when stocks are attractive. We had that Bank of America fund managers report coming in and saying, look at you're better off right now going into bonds. We don't see bonds as attractive at this point, um, in the US, but also in places like Europe. Um. You know, with the FED still tightening, with the Fed, demand for bonds now gone, it's going the other way. Banks were huge buyers of bonds last year. They're gone. We think there's gonna be a greater challenge for demand

to meet supply there um. But there was a there was another great point just made when we were referencing there, which was this fall in the dollar and this move into gold and and it's so interesting to compare what was happening then versus now, uh and and back then we saw the dollar fall in part because people thought that inflation expectations were unanchored and high inflation was going to undermine the value of currency. And as you just said,

it's the opposite right now. We've seen a strong dollar as the US has looked like the nicest house in a bad neighborhood. What what I would say, though, as we think about earnings and equities and bonds and people's portfolios, is that we're in a world that's so different from

the last decade. When it comes to currency markets, volatility is picking up and as we have inflation surprises, monetary policy surprise is and a huge cone of uncertainty, we should expect that FX volatility to continue and it flows through to companies. I think two big ways. One just if the companies themselves are hedging that risk or not. So we are seeing multinationals underperforming more domestic companies by

wide margins just year to date. We think that is likely to continue as these kind of relatively wild moves continuing currencies. And then more broadly, if you're thinking about your portfolio, what currency are you denominated and what currency risk are you taking, and it can make a very big difference to your performance. I mean, just year to date, if you think about if you hedged foreign currency equity or didn't hedge, it could be the difference in ten

percentage points and performance for those stocks. And we think that's going to continue and possibly escalate. So I would just say as we think about equities, we think about bonds and earnings. UM. I would also make sure not to ignore currencies as part of that equation for your total return. So Sarah, take all that, put it together. I think somebody who's really look at a particular kind

of value investor. You look for good value in terms of low valuations, buying at the bottom, moving up with it. What's attracted to you right now? The go where the currencies have been the weakest, where there's potential for a return to some sort of more normal currency valuation, and the euro might be a good place to start. The euros off about twelve versus the dollar year to date, and maybe fifteen over the last twelve months. So yes, it's on sale, and it has been painful having stocks

denominated in the euro unless they were dollar earners. But this does present an opportunity because likely the Eurozone will go into some sort of pullback as energy becomes scarce, particularly this winter, natural gas in particular. But out of that is the recovery, especially given them on spending that the Eurozone has in mind in order to revitalize their economies, and you know, worked for the US, it's likely to

work for the Eurozone. So there are stocks that companies now buying back large portions of their outstanding market cap. That's really interesting. You can if they're that confident in the future and they know a whole lot more about it than we do in terms of their own companies. There are a number of European banks. Unit Credit in Italy is one example. Not only they buying back four percent of their stock, they have a six percent dividend yield,

that's like twenty payout yield. That's fantastic on on of tangible book value. You may think that sounds terrified. Who wants to be in Italy right now? There's political uncertainty, But that's exactly when you want to buy, because the next stage you get back to sixty or seventy percent

of tangible book and you've doubled your money. And I guess I would contrast that you might be seeing great opportunities in in specific companies, but when we look at Europe overall from from our perspective, we are still bearished. Now there might be a timing element, Sarah, between what you're saying and I'm saying, but um, I agree that

they're doing some fiscal stimulus. I think with the potential for them to lose more energy supply in the winter, it will be important to see if the governments take those losses off the companies and onto the government balance sheets, just like we saw the US do for some US companies during COVID, Will Europe do that as well? That would certainly be a positive for European equities if that

move happens. In the absence of that, I do think you have to reckon with the e c V tightening and what is an incredibly challenging environment, so the European Central Bank slowing growth even worse than what we're seeing in the United States so far, and very high multidecade high inflation. So they're stuff between a rock and a hard place. And you mentioned Italy. You know, look, Italy tends to go through governments roughly every eighteen months going

back to World War Two, so this is not that unusual. However, Italy right now desperately needs these fiscal transfers from the European Union. And if this this government, which isn't as cohesive today, is unable to pass reforms the fiscal tap gets turned off. And if the fiscal tap gets turned off while the ECB is tightening, I think European equities are really going to struggle. Thank you so very much. Rebecca Patterson of Bridgewater and Sarah Header of Causeway Capital.

Coming up, we have a Supreme Court taking a different direction on a wide range of issues. But what could it mean for the markets and for that matter, deals, We asked Ken Jacobs of Lazard Prayer. That's next on Wall Street Week on Bloomberg. The Supreme Court is rocking the boat for us all. In an historic term, the Court managed to turn the heat up on just about everything it touched. From its overturning Row versus Wade, the health and life of women in this nation are now

at risk. It will save the lives of millions of children, and it will give families hope. To its permitting concealed weapons unquestionably the biggest Second Amendment ruling in more than a dead kid from this court to it's telling the e p A to back off on regulating power plants. The U. S. Supreme Court has restricted the Environmental Protection

Agencies authority to curb greenhouse gases from power plants. The debate continues on the wisdom of all these decisions, but taken together, they raised important questions for business and the markets, questions about how the rule of law that underpins our entire system will work under this new court, with some like Senator Deportment of Ohio saying, it's just an appropriate reminder that the power ultimately remains with the Congress, not

the regulators, not to Supreme Court. Was was essentially saying, is that, wait a minute, We've got to be sure that the Congress, which is the representative of the people, uh, you know, has has the final say. Well, Critics like Larry Tribes say the Court has abandoned principle in favor of personality. Strikes me as profoundly unprincipled, because the Supreme Court has long said that decisions of durability should not be overruled in the absence of some extraordinary change other

than the mere personnel of the Court. And to tell us whether there might really be a connection between what the Supreme Court is during the one hand, and the business world and the other, We're welcome a true leader in the business world. He is the chairman and CEO of Lazar For he is Ken Jacobs Ken great to have you back on. So we tend to think of things like abortion and social issues and the Supreme Court and even some of the regulary issues as more in

the zone of politics or even political philosophy. Can they affect the business world as well? Yes. So when you step back and you think about the United States, US has a handful of really true competitive advantages. One is um rule of law, a second is demographics uh, and a third is UH one market and by one market, where we're market of three million people with essentially one set of rules. So when a company goes to do business in the United States, by and large, it's it's

one set of rules for the whole country. And what the Supreme Court is doing is essentially saying, look, Uh, the administrative state has become unwieldy. Uh, it's taken on too much responsibility. Uh. Congress really should do a better job of writing laws more specifically, and we're gonna start to whittle back some of the things that the administrative

is doing. Well. On paper, that sounds great, I mean, perhaps will be less regulation, maybe the laws will be clearer, better written, But the reality is Congress is rife with polarization, it's difficult to get anything done without a supermajority. So the reality is that there's a vacuum. And so we're going from a from from a place where we have

a clear sense. We may not like all the regulation, but we have a clear sense of the rules to a place where the rules are uncertain, and increasingly the states are stepping in and making decisions on many of these rules. And what's ending up happening is is gonna end up with multiple rules with multiple states and candid league, probably written by by groups or people that aren't as

competent as exists in Congress. And that's worrisome. Take us into your business specifically, you've got a very large advisory business. You've also got a big asset management business. How do those challenges was perhaps a very diffuse set of rules and regulations laws? How could it potentially affect your bot's take asset management as an example, that's probably the easier

one of the two to see the impact. So you have a state that essentially says, look, we don't want to hire an asset manager that is worried about climate, and so they will restrict uh the ability of a state pension fund to invest in that manager. Another state may say, you know what, we will only invest in managers that take into account climate. Now, if it's a small state with very little population and very little um assets under management in there's a pension funds, maybe it

doesn't matter that much. But when we start having big states dueling on this, it's a real problem. Well, we're starting to see its like Texas and Florida and California, New York just to pick four. I seem to have different added to destroy these things. Are you seeing infect your business so far? Is this more on the horizon? It's I would say it's on the horizon, but it's worrisome and you sort of think about it. You have an industry like insurance, which has fifty different regulators in

fifty different states. That's a complex industry. But that's a real exception in the U. S economy. Most of the U. S economy is dominated by company or driven by companies that are able to operate in all fifty states without a concern, And this is something that I think really runs the risk of upsetting one of the true competitive advantages of the United States. Ken, Thank you so much

for being here. Really appreciated. As Ken Jacobs, he is the chairman and CEO of Lazard for Air coming off, we wrap up a week with our special contributor Larry Summers of Harvard. That's next on Wall Street Week on Bloomberg. This is Wall Street Week. I'm David Weston. We're welcome once again our very special contributor Larry Summers of Harvard. So, Larry, a lot happened this week, but let's start at the

end of the week. Was what you told us last week was the most important indicator that we should be looking at the economy, and that is the Employment cost Index. It came in. It came in above survey. David, We we weren't sure what was gonna be happening with wage inflation. We hoped that the indications in some of the monthly surveys that earnings growth was slowing and that that might slow the whole inflation process would materialize. That didn't happen.

Looks like inflation is running at a pretty stable rate. It's still two and a half points at least above where it was before this whole episode. Uh. Started. Uh depends on just how you look at the figures. But really, no evidence of a significant decline. If you look at the private sector and you take out benefits, then it's going up a bit. If you look at the twelve month figure, it's going up a bit. Those may be the wrong things to do, so it may be better

to look at the overall figure. But I think it's showing what I've been saying for quite some time now, which is that we are in ingrained moderate to high inflation economy. Nothing like nine percent inflation is built in, but inflation above four looks to be pretty securely built in, and if productivity growth doesn't accelerate, it could be UH

worse than that UH quite easily. So I'm pretty uncomfortable with UH the current UH situation, and I think it just points to the difficulties that the Fed UH is facing going forward and confirms the broad diagnosis that we have an overheated economy that's not going to fix itself, and therefore we're not likely to get out of this

excess inflation situation without having a recession. So so there you have been steadfast on this program and elsewhere on your views about inflation, and yet there's something of a debate going on right now behind between on the one hand, the markets and then the other hand economists with the markets sort of saying, Okay, the Fed will hike for a while and then then I'll start backing off next year and actually we'll have some reductions. But the economists say, boy,

the economy doesn't look that way. We're gonna have to keep going and keep it pretty high. What do you do when you have that kind of debate, You know, we'll see what judgment the Feds make makes. Uh. The challenge they're gonna have, and it's a agonizing challenge, and it's why it would be better if we weren't in the kind of configuration we were in, and it would

be better if we had not overstimulated. Uh. The economy last year is that on the one hand, I think you are likely to see a significant slowed down in growth, you are likely to see recessionary forces developed over the next year. And on the other hand, it's going to take a lot to get the inflation out of the system.

The danger, David, is that they don't persevere strongly enough in restrictive policy, and that's what gets you a stagflation situation where growth slows and you don't beat the inflation out of the system. It's like if you don't complete your course of antibiotics and then your illness comes back

and the drugs are bacteria resistant. On the other hand, I don't think we can deny that if they do what's necessary to contain UH inflation, then it's not going to be a happy economic situation over UH some over some interval. Secretary Yellen said yesterday that she held out the prospect of getting out of this without unemployment UH going above UH five. I've got enormous respect for her as an economist, but I have to say that statement

greatly surprised me. It didn't surprise me as much as the FED saying we were going to get out of this with four point one percent unemployment. But I don't see any basis for thinking that either of those statements is a reasonable UH prediction given what we know. What do you him is due when you put together these neutral rates. Look, I think J. Powell said things that to be blunts were analytically indefensible. He claimed twice in his press conference that the FED was now at the

neutral interest rate, calling it two and a half. It's elementary that the level of the neutral interest rate depends upon the inflation rate. We've got on the most quoted measure, a nine point one percent inflation measure he extrapolated off core or something. It's four or five percent inflation. There is no conceivable way that a two and a half percent interest rate in an economy inflating like this is

anywhere near neutral. And if you think it is neutral, you are misjudging the posture of policy in a fundament mental way. So I was very sorry uh to hear him uh say that, and frankly surprised. He said back in that the neutral interest rate that FED was approaching the neutral interest rate at a time when the inflation rate was one point nine percent. How he could be saying the same thing today when the inflation rate is

where it is, is inexplicable, uh to me. And it's the same kind of to be blunt, wishful thinking that got us into the problems we have now, So Larry, in the meantime, we have some legislation coming out of Capitol Hill, something perhaps we didn't even expect. We had the Chips Act, but now we have this proposed Inflation Reduction Act. Last week on this program, and you sent a powerful message to people who were saying increasing tax is actually might be inflationary. He said, that's really not

true at all. I suspect one of the people you were communicating with, maybe, but Joe mentioned through Wall Street Week. I don't want to ask you about what you've said specifically Joe mentioned, but give us your reaction to what the proposal is now that's come up with respect to increasing taxes he has paying for it, but also addressing

climate I was glad to see the bill. I think it's going to reduce the rate of inflation because it's going to reduce deficits and demand over time, because it's going to use the federal government's power to negotiate lower prices for pharmaceuticals, and because it's gonna increase UH supply of energy, so demand, supply, pricing power all working to reduce inflation. I think it's going to help the environment

because of the climate change measures. I think it's gonna help fairness in our country because of the expansions in healthcare available hility. I think it's going to help fairness in our country by closing UH some very important tax loopholes that allow very profitable companies to avoid paying uh any any taxes, Thank you so much. That's our special contributer, Larry Summers here on Wall Street week. Of course he's from Harvard University. Finally, one more thought, it's the economy, stupid,

but which economy? There is no end of worrying and complaining about the U. S economy these days. From too much inflation we certainly see peak inflation coming sometime in the second half, to too higher risk of recession. I think there many reasons why we're gonna have a severe recession and a severe that in financial crisis, to supply change that just won't cooperate, fakes the supply chain. Uh. These are all things that will be beneficial to the

country writ large. But through it all, the one thing the United States does not seem to lack is jobs. Just about twice as many jobs as we have people to fill them are still seeing John's added at pretty substantial fates, and that robust demand for labor may just be the one thing that keeps the wolf of recession from our collective door. You got some help, and you

got some down. You got the job market very strong, and yet at the same time you've got GDP growth stalling out, and so the FEDS got to figure out how hard to step on the break. So as we all continue to worry and complain about the US economy, and as the markets continue to be buffeted by all that worrying and complaining, you've got so many different cross currents that are going on and so many different forces acting on the market that you have these little mini moments.

Take a moment to consider the plight of China right now. Yes, China, that economic miracle now facing slowing growth and a deeply troubled property market. Unfortunately, the private sectors that's what's collapsing as far as the eye can see that China is going to take a wal to recover, and COVID shutdowns that have reaked havoc with companies like Phillips needing in puts for overseas markets. The second quarter was impacted by

a lot of headwinds. You had China lookdown supply issues and rising inflation and Elon Musk's Tesla not getting what it needs for the China market. Two was a unique coute for Tesla to lunch setdown of our Stina factory. The past few years that have been quite a few of course measures, and it's been it's been kind of supply chain hell for several years. Now. You can add

to China's woes and oversupply of young college graduates. It has ten times the number of college graduates that it had only ten years ago, and way too many of them cannot find jobs, with almost young people unemployed twice the rate in the United States. So as those of us in the United States complained about too few workers, are Chinese counterparts complained about too many. But in the end, whichever version of labor issues you have, it does come

back to James Carville thirty years ago. It's the economy stupid that doesn't. For this episode of Wall Street Week, I'm David Weston. This is Bloomberg. See you next week. M