Bloomberg Wall Street Week - March 10th, 2023

the US economy really is. Through the eyes of the most influential voices Larry Summers, the former Treattery Secretary, Katherine Keening, CEO of ny moan Sam's l Shearmon n founder of Equatic Group Investment in Bloomberg Wall Street Week with David Weston from Bloomberg Radio. Second thoughts about back Wood and Ukraine, about Chinese economy, and about where the Fed is heading.

This is Bloomberg Wall Street Week. I'm David Weston. This week special contributor Larry Summers of Harvard on Silicon Valley Bank and the risk of contagion. I don't see if this is handled reasonably, and I have every reason to think it will be that this will be a source of systemic wresting. Outsideing Inveashelists of Rock Creek about the politics and returns of ESG Investing, and investor Sam Zell about what ports to seek when the storms are coming in.

We're talking about ending free money, but we're not ending free money. This week was a time for reconsidering on Global Wall Street, as the war in Europe raged on and Ukrainian forces fought valiantly to hold on de Bach Mood back. Mood Is surrounded on three sides. Reportedly, the calculation Celenski's making is that he'll wear down Russian forces, which are not very capable, even as leaders like Jamie Diamond of JP Morgan warned that the situation there posts

one of the biggest risks with the global economy. I think I worry the most about if is Ukraine soil gas fill the leadership of the world, and you know our lady with China, I mean that that is much more serious though the economic by grazing you'll have to deal with on a day to day base. At its National People's Congress, China's leadership laid out new war modest projections, raising questions not only for China but for global growth.

If you look at the trends of the GDP taget dates set over the years, actually since twenty eighteen, they've been gradually lowering the GDP growth. Hagets so I think this is also a sign that increasingly the PUS makers are increasingly emphasizing on the quality of growth rather than quantity. Well fetch Yer J. Powe left a little doubt that the continued strengthen the economy makes higher rates more likely

than lower. The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher and previously anticipated. If the totality of the data were to indicate that faster tightening is warranted, we'd be prepared to increase the pace of rate heights. And the prospect of those higher rates hit tech banking hard as Silicon Valley Bank went from panic to receivership in twenty four hours. A SVB bank

has now failed. The FDIC takes over and has appointed a receiver. It is the first insured institution to fail

so far this year. Jobs numbers out on Friday would have been encouraging but for that SVP's failure, with the US adding another three hundred eleven thousand jobs while wage increases slowed a bit, but all the jobs in the world couldn't overcome Chairpile's warnings about higher rates, and then the shutter sent through the banking sector, leaving the SMP five hundred down over four point five percent of the week,

while the NAZAC lost four point seven percent. But of course, the flight to safety drove investors to bonds, leaving the yield on the ten year twenty five basis points lower on the week, with almost all of it really coming on Friday. Here to help us sort all this out, our Sarah Ketder Causeway Capital Management CEO, and Barbara Reinhardt, head of Asset Allocation Investment Management. So welcome to both of you. Barbara, great to have you here with us.

So it was quite a back and forth week. We had the pile testimony that seemed to inca we go higher, we had the jobs numbers, and then we had the SVB situation. What do you make of all of it? Look, I think that the overwhelming thing that happened this week was the receivership of SVB. Right, it's a It's one of the largest bank failures that we've had since the Financial crisis. It's the sixteenth largest bank in the US. I don't think that the issues that you see with

SBB are systemic. I would agree with what Larry Summers has said earlier. However, I do think it was an opportunity for everyone in the market to take a very big pause today and really think about their positions and think about their liquidity, which is why you saw some of them. You know, less liquid parts of the market really get hit much harder today, like small cap stocks and high yeld bonds. Also, we know we're down pretty dramatically today. So Sarah, even if it's not systemic, is

it possibly a canary in the coal mine? Is they talk about they although it maybe just SVB and they got special situations, the underlying circumstances could be reflected in other parts of the of the economy as well as frankly financial markets. David one never knows, but but Silicon Valley Bank did have a very concentrated corporate deposit base, and so there are other regional banks in the US their deposit bases in general seem to be much more diversified.

So that's one of the primary reasons why this may not be systematic. But confidence is crucial for banks, and there doesn't appear, especially given the likelihood that Silicon Valley Bank depositors will be made whole, any reason for this to spread through the banking system, which could be a reason to be looking at some of the other banks as investments, given they're selling off so rapidly. Well, it wasn't even I don't think as a practical owner, Sarah.

By the time it started to sort out, it looked like the regional banks were getting hit harder than the big money center banks. Does that suggest that some of the regional banks maybe opportunities for investors right now? It does depend on what they hold. If in their asset basis they have a huge amount of commercial real estate, particularly office, that could end up being very problematic. What

we're all really talking about, here's a new era. Interest rates are rising, and until they stop rising in full again, there's a complete new view on credit. Credit is going to be very difficult to obtain. We're in a credit crunch. So whether you're a real estate and you have a tough time with occupancy or you're a technology banker, this

is a whole different environment. So be really careful if you're looking at regional banks, make sure if they're trading down at their tangible book value book less good will, but that's really solid ground. There's nothing else you can go terribly wrong in their asset side of their balance sheet. Well, we're on other parts of the economy and a business are interest rates sensitive in the centil Because we've had a long regime frankly of pretty low interest rates that

seems to be gone right. Well, MC who has benefited the most from very low inch strates? You know, the real estate sector was probably the first one, right, that's the single biggest beneficiary of it. You'd have to also take a look at the private markets. Private credit, private equity, private real estate all benefited from very low rates. So you know the fact that you have is drying up liquidity. The Federal Reserve has been raising interest rates aggressively for

the past twelve months. They're trying to slow down the economy. And when you slow down the economy, certain things break, just like cryptocurrency broke last year. Then you had the problems in the guilt market in the UK, and now you have a US bank that's just failed try to slow down the economy. How much, Barbara, are we going into recessions for practic matter? Because the inflation seems to be more durable than people thought. Are they going to have to stop in the break so hard that we

have to go into recessions. I don't think there's a recession on the horizon over the course of the next twelve months. Right, there's a very long lead time between policy implementation, when you're raising your interest rates and when you would go into recession. The US economy is extremely strong, right. You had three hundred and eleven thousand jobs printed this past month. While it looks like the labor market is starting to ease a bit and weaken a little bit.

I would say that the US economy is a very durable supertanker. It would probably take a seismic shock of some sort in order to derail it at this point, and I don't think SPB is that shock. Sarah, you specialize in equities, in particularly investing in equities. When it comes to equities, what is your base case on recession? And more importantly, does it matter? Does it really affect which equities invest in whether you think there's going to be a recession or not. It matters if a stock

doesn't already price in some slowing. There's no doubt. I mean, my colleagues and I really do believe that the FED is intent on slowing the US economy and the same with the European central banks. Maybe they're a year behind the FED, and at some point in time maybe the Japanese will tighten monetary policy with a new central bankhead. So there's a lot of tightening out there. And the other side of that is typical economic slowing. That's what

brings down inflation, and inflation is the target. So we're expecting some element of slowing. It may be severe. It's hard to know. But what we do know is what's priced into stocks, and not all stocks, but in certain areas that many of them have already discounted in economic slowing. Not all the cyclicals, for example, but there are sub industries that have and that's the opportunity where it's already

priced and then we can have it. Then then the worst can happen and the stock has in nowhere to go but up. So Barbara's played the parlor game. What do you think the terminal rd's got to be for the FED to get inflation down to where one needs to go. I don't think it's as high as probably what the markets pricing in. I think maybe the foeder reserve has to tighten one, maybe two more times if that,

and then be done. The reason is the way that you price in a higher terminal rate is either you have a faster labor force growth or a faster productivity growth. The US doesn't have any any thought showing of that being the case at this point. So for US, we do not believe that our star is six percent or

something above there at this point. I don't think that the US economy can grow so fast or it's been such a dramatic change that it's been over the past twenty years, so we don't think that rates have to go much higher at this point. Sarah Header and Barbara Reinhardt will be staying with us as we turn to what all this means for your portfolio. This is Wall

Street Week on Bluebird in Darkness Washington. The Reagan administration stuck to which proposed six hundred and ninety five billion dollars budget, a number of that in Washington is somehow regarded as lean and austere, and the Democratic leadership in Congress stuck to its view that the budget is, as one senator put it, cool, in human, and unfair. To

an end next week for further non surprises. That was Lewis Roguiser back in March of nineteen nine eighty one, when the number one movie in the country was Back Roads with Sally Fields and Time and Lee Jones, the number one song was nine to five with Valley Parton, and the proposed federal budget was a whopping six hundred ninety five billion dollars instead of the six point nine trillion dollars proposed by President Biden just this week, Still

with us or Barbara Reinhardt of Voya Investment Management and Sarah Header of Causeway Capital. So Barbara, let me start with you here. We want to turn down of the question with the portfolio. This is your job in party is to figure out how to allocate portfolios. Given all that we've said about where we are in the tightening curve, everything we've seen, how do you manage your portfolios these days? One thing that we're thinking greatly about, David, is our

international equity exposure. So when we think about global equities, we look around the world and we look for the opportunity set. One thing that stands out to us that's probably a little bit overextended at this point is international developed equities. Over the past one year, the SMP is down four percent. International developed equities, you know, Europe in Japan are up almost seven percent. That is a very big disparity in returns between those two parts of the world.

For Europe, it had been priced for a very big, very bad recession. It didn't transpire. They had much warmer weather than it'd been expected. But we don't think that all those great things that Europe averted, or the luck that Europe had in averting some of that disaster over the past year, is likely to be repeated. So we're

actually keeping our assets closer to home. In the US, we think that the FED is one of the first central banks or major market central banks that has raised interest rates, it's likely to be one of the first ones to stop. And we think as the world slows down, the dollar is likely to get a little bit stronger as a flight to safety and somewhat quality in the US.

So we're staying a little bit closer to home, but we're barbelling it with some exposure to the emerging markets because we do realize that there's been a lot of stimulas put into the pipeline, and we think that again emerging markets are so cheap at this point if you can hold them for a three to four to five year period, you're likely to be very pleased with your portfolio. Okay, so someone said, Barbara's talking your equity bookhare you specialize inequities.

Where are you in developed market equities these days? Well, for developed markets, And Barbara has a point that Europe and Japan have outperformed the US. Really more Europe. The Eurostocks fifty is up eleven percent year to date in dollars. That's not even a full three months. However, that's a rather short time period. Non US Developed has vastly underperformed the US or less decade. And I've heard this from clients,

you know, they get very anxious. But so it might be quite some time, if you think about it, in that longer context, for Non US developed to catch up with the US. And there's still a significant valuation discount for non US versus US, in part due to the different sector weights in the two areas. The US has much more in the way of technology, and here today, interestingly, in a broad global context, technology has led along with

consumer discretionary and communication services. So investors are still really interested in tech. There's them like I just say, this is the environment we're in. It's one of active management. With rising rates, just can't buy an index anymore. In my opinion, you have to have a manager who can sift through and let's say, go to non US developed and find the stocks that haven't yet had their earnings recovery recognized. Some of them haven't even gone into a downturn.

I mean, Barbara noted the tightening cycle and I mentioned this as well as a little bit lagged in Europe. Old all that additional tightening, there may be more casualties. So being very careful about price entry point be extremely cheap in terms of what you'll pay is a way to avoid those pitfalls. It's been really great having both of us. Thank you so much to Sarah Header of

Causeway Capital and to Barbara Reinhardt. A voya. Investing related to environmental, social and governance issues so called ESG has been on our roller coaster ride. From being all the rage and embraced by some of the largest financial institutions in the world, it's being scorned and even the subject

of legislation to limit its use. And through it all, it's sometimes hard to sort out how much is investing based on social values and how much is just pursuing value through taking into account all the risks of Sonny Beschilists, CEO of Rock Creek, was an early proponent of ESG investing, at least in certain circumstances, and she's back with us now on Wall Street Week. It's great to have you here, Sonny, great to be with you. Such a treat. So I mean,

take us to this. Is it a choice between return on the one hand and social values on the other, because that's the way some people like to put the question. You are absolutely right, and I have to tell you I don't necessarily like the word ESG just to put

that on the table right here. But I think what is happening right now in Washington, President Biden did vetoed the bill that was trying to pass through to allow corporate tension plans to consider ESG factors in their investments, not to actually necessarily adopt them, but to actually consider them. So it was a pretty soft requirement. I think that what that is not showing us is what you said,

which is right now. If you and I were investing in let's say, renewable energy, we would have lost this year. Just in twenty twenty three one point four percent or so. Of course today the markets got pretty murky. But if you had invested in oil and gas, we would have lost three point eight percent in the last five years. We would have made seventeen point four percent in renewable energy, and we would have made about seven to ten percent,

depending on which index you're looking at in oil and gas. Now, if you looked at other periods, oil and gas might very well be ahead. But what does that mean. It means for investors renewable energy is really economic. It has now changed the technologies with us such that clean energy happens to economic. So when you're looking at purely financial decisions,

it should certainly be a part of your portfolio. So I wonder, if I can put it this way, how much that's on the fundamentals, That is to say, you can actually make more money by taking head environmental I'll just takeing environmentals, so I won't bother with the esp okay, And how much is actually just the hydraulic pressure behind environmental investing. It's so popular, the money goes there and it drives it up rather than actually being on the fundamentals.

So just purely on the fundamentals, just purely on the costs of how much it costs now to produce solar energy. If you look at that, it has become totally fundamentally economic. If you look at Texas, because we see tis in Florida are right in the front of the conversation that you mentioned. But Texas is producing fourteen percent of renewable energy in America. Do you think you know that would

be the case if the fundamentals were not there. They're just as we speak, building a huge wind farm that will produce energy for three million households. I'm siddy. You've been in the markets for a good long time, all sorts of different positions. Well, the markets sort this out, that is to say, if you're right, and in fact, you'll get better returns on average over time by taking your account environmental concerns. Will that drive people into those investors,

whether they want to be there or not. I actually think people are moving in that direction. So there is one thing is the political conversations that are going on. But if you look, if you talk to any businessman, again, not just in Texas, but all over the country, people are investing in an integrated way into into these sources of energy. And they'll continue and insurance companies, by the way, are looking at the same factors to make sure they

don't lose money. It's very much it's how the job is, how to maximize returns, how do you minimize risk out of those are very important for investors. So as I'll just again say with climate rather than social and governments for their owns. Has it gotten a bad name because some people are using it as a marketing different technique. It's actually hard to know which companies are actually making decisions based on it, as opposed to just saying there

because everyone wants to say they're environmentally correct. I think you're absolutely right. There's the greenwashing. The green bonds led to some companies that were even using coal calling themselves green. So climate has become not such a positive word, just like ESG. But if we just talked about energy transition, I don't think many people would disagree. We need to use oil and gas. Most people are using them in

the transition, but we're moving towards cheaper, sustainable energy. I think everyone is doing that, whether you're looking at Saudi Arabia, UAE or Texas. It's so wonderful to have you here. Alfsani always thank you so much as Halfsani Baschelas of Rock Creek. Coming up, we wrap up our week with special contributor Larry Summers of Harvard at the next on Wall Street Week on Bloomberg. This is Wall Street Week. I'm David Weston. We welcome now our special Wall Street

Week contributor Larry Summers of Harvard. Larry, thank you so much for joining us here. We have to talk about Silicon Valley Bank. It's been developing. Towards the end of the week, a lot happened. They pretty quickly went into receivorship from the FDIC. What does it tell us more broadly about what's going on in the banking sector or in the economy. Look, there's still plenty of fog of war here and we're still all trying to sort through it.

There clearly was a big managerial failure. It sure looks like regulators were not on the case in the way they could have been. Right now, it looks like this

is not a broad systemic issue. That Silicon Valley Bank and perhaps perhaps several other banks, but not many other banks, and none of the largest banks, had a mismatch between the kind of depots they had and the ways in which they had invested their money in longer term bonds, and so I don't think this is likely to be a broadly systemic problem, but it certainly is going to have very substantial consequences for Silicon Valley, for the economy

of the whole venture sector, which has been dynamic, unless the government is able to assure that this situation is worked through. Right now, the holders of uninsured deposits have been told that those deposits are frozen and camp be withdrawn. There are dozens, if not hundreds of startups that we're planning to use that cash to meet their payroll next week. If that's not able to happen, the consequences will it

will be quite severe for our innovation system. I suspect that ways will be found to at least provide significant advances on those deposits to enable the payment of payrolls. I think the FDIC is going to have to think very hard about how to be maximally creative in using its authorities to assure that this doesn't have a set of collateral consequences for the innovation economy. I don't think this is a time for moral hazard lectures or for

talk about teaching people lessons. We have enough strains and challenges in the economy without adding the collateral consequences of a breakdown in an important sector of the economy. So I hope that they will in the short run be aggressive about containing the problem and containing possible contagion, and then over the medium term, I think there are important lessons for how we regulate what roles we use for market values in regulation that need to be learned from

this experience. I think we have tended to have a bit of a romance with the community bank relative to the larger banks, and we're going to have to figure out how to maintain banking services for communities while moving to also pay attention to making sure that we've got as much financial stability as we possibly can. Whenever we talk about financial stability, we are reassured that the banking system is so much stronger than it was before twenty eight,

two thousand and nine, so many reforms. Is there some question now about whether that's exactly right? And let me be very specific, what about the stress tests? Why didn't they kick this out? Look? I think I have written that there are a lot of concerns about the stress tests I do not believe the stress tests give an accurate picture of the resilience of the banking system. I think they are far too optimistic in thinking about what

would happen in a catastrophic kind of scenario. That's said, I think any fair minded observer has to think that banks are better protected than they were before the two thousand and eight financial crisis. Though I think we have to recognize that a large part of the lending in the country, and lending to businesses is now done by institutions that are not banks, and so there are important

issues in the shadow banking system. So this certainly should come as a reminder that rational financial regulation is hugely important to the success of the American economy. Larry also got jobs numbers out on Friday this week, and they were more robust, once again than expected, three eleven thousand new jobs. At the same time, the rate of wage increase actually came down just a little bit. What did those tell you about the strength the economy and, for

that matter, where we're headed with inflation. I think that most of us probably have a kind of now more than ever view after these numbers. If you were a person who is very worried about inflation, you focus on the strength in the economy and the seemingly ever tighter labor market. If you're a person who is less concerned about inflation, you probably take heart from the lower wage inflation number. So I doubt these numbers changed too many minds.

I'm gonna be watching for the CPI number next week. But I think more broadly, it seems to me that we don't have a lot of evidence of a basic downwards trend in inflation. It looks to me more like the inflation story is fluctuation around an underlying inflation rate of four and a half or five and if that's close to right, it suggests that the FED has considerably more work to do. Well. That's exactly my question. What does it mean for monetary policy? What do you think

the FED should take away from these numbers? What does that mean they should do? For example, on terminal rate, I suspect that there's a quite good chance that we're going to need to get to a terminal rate near six. After all, we have inflation running it close to five percent, and we have interest rates at about five percent, and so interest rates and inflation in the same range doesn't point to a lot of pressure to bring inflation down.

So I'm very much open to changing my mind, and I think confident pronouncements about these things are a mistake. If we get a strong CPI number on Tuesday, I think the right thing to do will quite likely be to increase rates by fifty basis points in March, because if we're pretty confident that rate increases of that magnitude or necessary, I don't see much reason not to get

on not to get on with it. If the CPI number is more moderate, then I think it's a or comes in surprisingly low, then I think it's a very different kind of judgment that needs to be reached. In general, I think there is more risk of underreacting to the inflation concern than of overreacting. Larry, Finally, and briefly, if we can what about the budget that we saw out of the White House this week as six point nine trillion dollars spending an awful lot more on a lot

of things. Are we having a serious discussion about the federal budget on either the Democrats or the Repulican side at this point? And if not, how do we get to one? A lot of good ideas in the budget. But I think for a variety of reasons, the deficit path is likely to end up greater than the administration imagines unless there are substantial policy actions. And I think we're getting back into a phase as interest rates rise, where it's going to be very important to think about

the long run behavior of budget deficits. In many ways, the picture is more adverse than it was a decade ago when the Simpson Bowls process was launched. So I do think we need to have that as a bipartisan conversation. I welcome the President's providing his budgetary blueprint and asking the Republicans to provide their political blueprint as a basis

for conversation and dialogue. I am glad to see rising focus on containing healthcare costs, because that's probably the single most important issue in thinking about the budget over the longer term. Though I'd have to say that my judgment is that the ultimately necessary expenditures on national security are going to be substantially greater than the President's budget. Larry, thank you so much. As Larry Summers of Harvard coming up, whatever you think of chat GPT, maybe it can help

us get rid of some of those pesky lawyers. That's next on Wall Street Week on Bloomberg. Finally, one more thought. The first thing we do, let's kill all the lawyers. Well, that wasn't really my idea. Shakespeare had his character Dick the Butcher say it in Hendry the Sixth, Part two, but it's something we've heard often repeated, even by some lawyers like me. Now for the first time, it may just be possible, maybe not to kill the lawyers, but

to make them a little less necessary. It's a use case for artificial intelligence and all those chatbots we're hearing so much about. This is chat gpt. It is routing out an AI chat bought service. Is chat gpt. Feva suits the world. It's way too early to say where AI will lead us, but it's hard to find anyone denying that it's going to be. This could be the most important generals technology since the wheel or fire, with the potential to transform everything from banking. As Jamie Diamond

told us this week, AI is real. This is not no crypt tongue, that's not crypt done. This is a technology which is staggering, and we're fully engaged to hedge funds. According to Ken Griffin of Citadel. This branch of AI will be game changing for the economy and like most changes in technology, with clear winners and losers to it, with HPE CEO Narry pointing to AI for his company's growth prospects, a no AI is total mind for people today and that's where it has a big opportunity for

us as a company. And now chatbots are stepping up to the bar, the legal bar, that is, with reports that chat GPT scored a passing C plus on a standard law school exam at the University of Minnesota. Now that's not good enough to make a law review, but a passing grade it is, nonetheless, and that may just

be good enough for routine contracts and memoranda. At global law firm Allen and Ovary, which has been using its own chatbot dubbed Harvey eerily similar to the half of two thousand and one a space odyssey, and I want to help you not to be outdone. Major international law firm DLA Piper said this week it has hired a new chief Data Scientists to oversee ten as what they call top tier data scientists for its new artificial intelligence and data analytics practice, but for all the anticipation of

a brave new world. It's a little hard to imagine a chatbot, no matter how smart, taking the place of a good old country lawyer. I've been appointed to defend Tom Robinson now that has been charged. That's what I intend to do. That does it for this episode of Wall Street Week. I'm David Weston. This is Bloomberg. C you next week.