Bloomberg Wall Street Week: September 9, 2022

just how hot the U. S. Economy really is. Through the eyes of the most influential voices Larry Summers, the former Treatory Secretary, Katherine Keating, CEO of d n Y mom Sam's l Sharmon and founder of Equatic Group Investment in Bloomberg Wall Street Week with David Weston from Bloomberg Radio. History was made this week with the death of Queen Elizabeth of Great Britain, the longest serving monarch in British history, overshadowing for a moment economics and currencies and central banks

and yes, even wars. This is Bloomberg Wall Street Week. I'm David Weston. This week special contributor Larry Summers and Rick Reader of Black Rock. Queen Elizabeth a Great Britain passed away this week at the age of nine six, leaving behind a seventy year reign and a new king, King Charles the Third. Queen Elizabeth was a life well lived a promise with destiny kept, and she has mourned

most deeply in her post. But even as the world took a moment to reflect on an era that has passed, it continued to contend with the current one, where war in Ukraine has led to an energy crisis in Europe. As President Putin insisted that he is not using oil and gas as a weapon, even as he shut down his nord Stream pipeline indefinitely. Nord Stream one is now practically shut down, and everyone is saying Russia is using

energy as a weapon. Ship more nonsense. We deliver as much as our partner's needs, and the easy be reacted to the inflation triggered by the energy crisis by raising rates and historic seventy five basis points with more to come. The Governing Council today decided to raise the three key

ECB interest rates by seventy five basis points. This may just frontloads the transition from the prevailing highly accommodative level of policy rates towards levels that will ensure the timely return of inflation to our two percent medium term target. While in the United Kingdom, just before news came the Queen's death, the Prime minister she had installed only two days before, and now has caps on household energy costs and promised to pull her economy through. I have a

bowl plan to grow the economy. Three tax cuts and reform. I will cut taxes to reward hard work and base business led growth and investment. I will dry of a film in my mission to get the unitsing, Kingdom working, building and grabbing. In the United States, markets waited for the next Fed decision, now less than two weeks away, with all indications that the f m C will stay the course and keep raising rates until it's sure inflation is under control. We're in this for as long as

it takes to get inflation down. So far, we've expeditiously raised the policy rate to the peak of the previous cycle, and the policy rate will need to rise further. And when all was said and done, the market has had a good week, at least if you were along with the SMP three point six in a shortened trading week with much of the game coming on Friday, while the NASDAK track the SMP nicely up over four with the

game once again on Friday. And all this was despite a rise in bond yield, with the yield on the tenure and the week just over three point up about twelve basis points. Here to explain all this equity appetite, how are Sarah Malick, chief investment officer at Nuvine and Jim McDonald, Northern Trust, chief Investment Strategies. Welcome to both of you here to Wall Street Weeks. Let me start with you, Jim, what do we read into this market? Are happy days here again? I mean, we did have

a really nice game this week, David. I think you could spend a couple of hours looking through all the fundamental data and not find anything that really supported a big increase in risk appetite this week. So I think you really have to attribute it to the fact that we had a couple of weeks of softness preceding this, and then sentiment is terrible, and then technically the market is making higher lows. So technically it looks okay here.

But if you think about what's going to drive the market over the next six to twelve eighteen months, the growth outlook is deteriorating. Europe's likely in recession, China's is clearly in recession. In the US fifty fifty, we think over the next twelve months, the FED in the e c B or raising rates resolutely, and the inflation picture,

while improving, is probably overly discounted in the markets. At one year break even on the tip, this is a two percent, so we think that the environment is probably not as robust as this week's market action might indicate. Well, I'm sorry, Sarah. When I hear two percent in one year break even, that sounds like maybe inflation is coming back down again. I think that that number is coming

back down. Inflation is moderating. Will likely see a little bit more moderation when CPI comes out next week, but that slope is probably too aggressive. I think inflation will remain sticky. We have higher wages and higher shelter prices. Those likely stick around, and that's going to keep core inflation numbers probably much higher. I wouldn't would would be wouldn't be surprised to see that break even actually increase over time. The other thing we're watching for is the FED.

Before we decide if this rally is sustainable, we'd want to see more signs of a FED pivot, and we're not seeing that. So we agree with Jim, this is probably not a sustainable recovery. What about the FED pivot? Is it dead effectively? I mean, certainly sounds like J. Powe recently has not been saying much it would be consisted of the pivot. I don't think we're going to

see a pivot in early twenty three. But J Pell has been saying is that he's going to do what's necessary to fight inflation, even if that comes somewhat at the spence of the economy, and given that inflation likely has the sticky components to it, I think he continues to raise rates, likely basis points at the September meeting, and then more moderate rate increases from there. If anything, you'll see a pause in three, but you will see rate cuts until we hit a recession and we see

that demand destruction. Yeah, David, we've seen in the last month a reduction in the cuts that the market is priced in. They were pricing in fifty basis points of cuts in twenty three. It's now come down to just twenty five basis points. And what I'm most interested in keeping an eye on is the labor markets. I think the FED can't stop raising rates because growth is hurt. They can't stop because the market is struggling. They need to see the unemployment rate increase to give them cover

to be able to start slowing down the pace of increase. Okay, Sarah Malick and Jim McDonald will be staying with us as we get their thoughts on what the smart investor does with their portfolio given more we've just been talking about. This is Wall Street Week on Bloomberg. This is Bloomberg Wall Street Week with David Weston from Bloomberg Radio. Well,

it wasn't pretty. There was unforgettable heroism among the victims and the rescuers, but the financial markets, even after what was supposed to have been a useful time out, staged a historically panicky retreat, mumbling legalistic rationalizations like fiduciary responsibility as an excuse for what rapidly descended into unchecked hysteria.

That was Lewis Orchiser, of course, describing the immediate market reaction to the tragic events of nine eleven That was twenty one years ago this coming weekend, a reaction delayed by the closing at the time of the New York Stock Exchange and heroic efforts to get it back up and running after just six days. So with us are Sara Manic of Nuvine and Jim McDonald of Northern Trust.

So I'm happy to say we do not have anything like the tragedy of nine eleven that we're going fronting right now at the same time, impair amount of pressure on the markets and things. Fair to say, in this environment, how does one constructive portfolio? Well, it's not all doom and gloom when we think about portfolio construction. There are waste of bl portfolios that are resilient to inflationary environments across asset classes that the typical sixty forty equities fixed

income portfolio has struggled this year. But within equities there's companies that are more resilient, like dividend growers. These are companies like that continue to grow their divon is over time. Broad Com is a great example of that. In fixed income, an area that people may not be thinking about it for approaching our session is high yield. You can get returns of over eight percent and high yield fixed income so you're paid to wait until spreads tightened, and the

companies are higher quality than they used to be. So that's a lot to chew on. But let's start with one of them, which is credit and high yield. Where are you on that? So we're very constructive on how yield. It's our largest tactical overweights with a yield the worst of eight and a half percent or so downside risk of about a third of the equity markets. UH. In the high yield markets, you need to think about high

yield as a risk asset. So this is not something we're taking UH investment great bonds and putting it into high yields. It's much more of an equity substitutenous environment. But that kind of return looks really attractive here. Another aspect I would mention is geographic exposure with inequities, So we have a slight overweight to the US and underweights x US and an emerging market equities really reflecting the significant growth issues and inflation problems that are being realized overseas.

That's another way to give clients some confidence that we're positioning for what we think is going to unfold over the next twelve months. And lastly, I would say the real assets side, we also very much support having some inflation exposure, whether it's in globalist and infrastructure which has that pricing power, or on a long term basis commodities, where we think you can get in a basket of listed commodity producers a yield near six percent, which is

really attractive in this environment. So we're actually more concerned about commodities excluding energy because we think that commodities are very exposed to demand destruction. But energy is a different story where supply remains tight demanded to remain strong. And what we love about energy producers is that they're being very disciplined this cycle. They're returning cash to shareholders rather

than just working to just increase volume. Good for those companies and to keep oil prices but beneficial to them. But Sarah put together, if you will, the slight overweight to us not much more than slight that Jim talked about, and what you just said about energy, because given this energy situation, one might say it's more than a slight overweight to U S. Where are you? We are probably more constructive on the U S and the rest of

the world. We think the U S will continue to be the safe haven trade because of the resilience of the economy versus the rest of the world. Europe could run into sagflationary issues with their aggressive increases in interest rates while the economy suffers and emerging markets are challenged because of the continued lockdowns in China and some of the other areas that are having issues. So I think non US is going to be a struggle, especially with the strong dollar, and so I would add to that

from a US exposure standpoint. We also like the energy sector and the other one that we like our technology stocks. They have really struggled this year, improved the valuation. Is clearly a long term growth leader globally, and so it's a bit of a balanced approach within a US equity portfolio, liking both energy and technology stocks. Interesting technology socks tend to struggle though when interestrates are increasing because they're considered

long duration stocks. An area for example Sema Connectors, which have even underperformed the technology benchmark. But I think you can find value in some of these areas. This this goes back to dividend growers. Abroad Coms, a company that within the Sema conactor space, tends to be kind of offenses and defensive, more resilient business with their enterprise demand and also with their software mix and a nice dividend

that's growing over time. So so as you're putting together your portfolio, do you take into account the possibility or even some say likelihood of recession or not, Because, for example, when you say hi yield, HI, it's a good thing, I get a little nervous if we're going into anything. But it's a real recession, right Jim. So you have to have a view on what the recession will be if it unfolds. We're at a fifty fifty probability in

the US, but we think it will be shallow. The baggage system is in dramatically better situation than it was during global financial crisis, so credit creation won't really be hurts howlshold balance sheets are not in bad shape, so it's much more likely to be a shallow cyclical recession. And how yield with a starting yield the worst of eight and a half percent gives you a very nice

question in that environment, I agree with that. I mean, we're looking for areas, given the environment out there, where you're getting the best bang for your book. And so even though we do predict a recession, now you're getting paid to weight and how yield with that kind of return, you can have that resilient income producing portfolio and equities with divining growers, and then look for those asset classes that actually can benefit from inflation, like within real assets.

How important is liquidity in all this? When you start talking about real estate, for example, farmland, things like that, that sounds like I'm giving up something on duration, Right, You're giving up something, You're giving up some liquidity, um, you're also dampening your volatility. That's why we recommend a

balanced portfolio. You want to make sure that you have your publics and your privates within your portfolio so that you do have warries where you can get liquidity if you need it, but also the resilience and less volatile pieces of the private asset classes can be beneficial, especially in this year which is unique where the sixty forty typical equity and fixed income portfolios, if people have have been highly correlated, all fixed income obviously has not created

equal Where are you in investment grade, Jim? So we're significantly underweight investment grade. We just don't think that the nominal yield or the real yield opportunity looks particularly attractive. And our number one risk case around sticky inflation, investment grade bonds are not going to do well in that environment, so that's an underweight in our tactual portfolios. Do you agree, Sarah? Generally we would prefer high yield over investment grade for

the same thing. You're getting greater returns, more bank for your buck from high yield. And where are you on tech, Jim Teddy? Tech might be a good idea, although, as you said, if the interests are going up, typically that hurts tech. Yeah, I mean generally, bigger picture, the macro

environment is not good for long duration technology socks. That's why you need to be selective, and we're looking for what we said, kind of offensive and defensive tech together the companies that either or more resilient because they have healthy growing dividends or they have pricing power so they can survive the environment. The trade of pre pandemic where all technology socks kind of all did well, I think

that's over. I would just add that the market knows that interest rates are going up and have gone up, and that has killed evaluations within the technology sector. So we think that's what's set up the opportunity today. Tech stocks have discounted a great amount of the higher rates. But it's interesting if you look at markets are actually less less hawkish than the FED. So there's a mismatch

there in markets. If now caught up to the Fed same level of hawkishness, markets are saying, you know what, we expect less rate hikes in the FED expects, and we'll see if that happens. Probably depends on if we hit that recession and inflation finally dropped significantly. Okay, this is really, as I say, really truly discussion. Thank you so very much. That's Sarah Mallick of now Vene as

well as Jim McDonald of Northern Trust coming up. It's an uncertain time for investors, full of risk without a lot of certain return, but Rippery or black Rock thinks that there's the potential for the patient investment to really do quite well. That's going up next on Wall Street Week on Bloomberg. This is Bloomberg Wall Street Week with David Weston from Bloomberg Radio. They say it's always darkest before the dawn, and there's plenty of dark out there

for investors right now. With the stock market off, overall positioning has still been pretty depressed, and sentiment reflects that inflation still raging. Inflation seekiness is not going away anytime. Soon, and the FED intent on continuing to hike rates was fairly obvious coming a year that the FED would tighten. But there may also be some early rays of light with commodity prices coming back down. If the Fed continues to tighten, and we believe the dollar will turn back

up and these commodities will continue to fall. So the question is whether this is a false dawn or whether it's actually a good time for the patient investor to position for a rosier future. And that till tell us which of those it is. We welcome back now, Rick Reader, black Rock ce IO for Global Income and also ahead of the Global Allocation Investment team, which includes the black Rock Strategic Income Opportunities Fund, rated five stars and gold

by morning Star. I'm sure you don't want to brag about that, but I think we should read for your Rick there. So we're very good. Rick. Give us your sense of this market from your point of view. I mean, you're putting the money to work all the time, both on fixed income and also inequities. What do you make of this market right now? So I mean, David, I mean you're thinking about We came in the beginning of this week and so We've got energy caps, You've got

the turning off of nord Stream. You've got China growth, China, COVID, China, Taiwan. You've got a series of issues, uh that are that are hard to get your arms around. By the way, the good sector of the US economy is softening, So there's a lot of challenges out there in the world. That being said, you know, if you take a step back and you think about as an investor, you know, with the FED moving rates higher, all of a sudden, you could buy short end interest rates at levels we

haven't seen a really long time. I was thinking about a year or two ago. You know, you had to pay less than one percent of fund companies fifty basis points, so Amazon twenty five basis points. In three years, all of a sudden, you could buy You could buy short end assets at four or four and a half five cent, Put some money to work, get some carry, and then tactically look at areas that are that are where there's

opportunity and listen. I mean, you can get really really concerned about where the world is when you when you step back and think about US economy, we think is going to have nominal GDP this year five nominal GDP of five. You know, you've got a service sector that's doing well. I've got a healthcare sector that's doing well. You've got parts of the economy. So there's things to do.

I mean, you know, while it is one of the most challenging uncertain times that we've seen in markets in a long time, with central banks tightening, there's some things to do in the markets, and there's some there's some reason to look at some some opportunities out there. So there's just as my math works, from a quarter of a percent to five cents, pretty big difference. That sounds pretty good. You get that kind of return. The same time, it depends on what's going on inflation, Right we get

cp I nembers come out next week. If we've got a headline inflation around eight and we've got core around five or six, that five percent doesn't look quite so good, does it. It actually doesn't look good at all. And if you assume that we're going to be running at

those sort of levels for a period of time. But you look at where the inflation markets are, where the where real capital including ourselves, are transacting, and today we were we were locking in inflation in two years at under two point two percent, for two years, five years, five years around two and a half percent, ten years around two point four. So if you say, gosh, I can buy one in two year high quality assets at four and a half to five, I'm projecting my inflation

risk in the low two's. Boy, I'm locking in real rates. I'm financing company by the way, not just companies commercial mortgages, UM financing companies with a real rate. That's pretty attractive. And you can actually people can talk about the stickiness of inflation, which is real shelter inflations, high wages are high. But boy, you can do some things in the market that can that can certainly hedge your your inflation risk

and then carried quite well in the market today. So it's the inflation risk is not what some people fear, it is is actually coming down. Why is that? Is that because the feed is tightening and tightening the money or is it actually is there something the notion the supply chain is loosening up some So I think it's two parts. One. I think the Fed deserves an awful lot of credit, don't So now is there was enough criticism to go around myself included that last year they're

waited too long, Kui. I think that's been well chronicled. This year. They cannot be anymore clear. They cannot be uh more more strident in inflation is what they're doing, and they're not going to back off that. And you know, I think they're going to get the funds rate to four or three and three quarters of the four probably four, and then I think they're gonna let long and variable lags of montary policy do their things. So they're pretty clear.

So I think there's a credibility from the Fed that I think you've you've got to uh, you've got to applaud in terms of what they're doing today. Second is, as you said, supply chain. You see real, real improvement and supply change. You see in some of the PPI numbers. You see freight costs coming down, you see commodity costs coming down. So there are some reasons to see you

to see that they cash some of this inflation. You know, by the way, you also see an inventory levels look at retailers or inventory levels are up quite a bit. In fact, there's not there's not places to put some things that I see you'll see some price discounts. Um there and uh. And by the way, in semiconductors, it's not it's not perfectly solved around supply chains. But you look at some of the semiconductor show stocks these days,

people are concerned about oversupply. That's not something we've talked about for a long time. So it's better and there's some reason for optimism, But I think you have to start with a central bank that is there is no ambiguity and they're quite clear in how they're communicating that. Thank you so much, always great to have you with us. It's Rick Reader of Black Rock. Coming up. We're gonna wrap up the week with our special com twitter Larry

Summers of Harvard. This is Wall Street Week on Bloomberg. This is Bloomberg Wall Street Week with David Weston from Bloomberg Radio. This is Wall Street Week. I'm David western. We were joined once again by our very special contributor

Larry Summers of Harvard. Larry, welcome back. At one of the big events of this week, besides the queen passing, was actually what's going on with currencies with the US dollar setting record after record at the same time, the yours really falling on and boy, look at the end, what is going on with the economies. Look, the United

States has a huge advantage. We've recognized it for a long time in terms of our lack of dependence on egregiously expensive foreign energy, and that is benefiting the relative strength of our economy. At the same time, we've mounted a stronger response macro economically to the pandemic. Our central bank is moving faster to do necessary are tightening with

respect to UH, the respect to monetary policy. UH. Given inflation and all those various factors are making us safe haven a mecca for capital, and that's causing resources to flow into the dollar. It's remarkable that people were saying that the dollar's day was past, uh not very long ago, given its current strength, and my guess is that there's

room for this to continue. You know, the euro was in the low eighties against the dollar UH twenty some years ago, and in some ways the relative fundamentals of the United States compared to Europe are even stronger now than they were then. So Larry, Uh, there's talk actually about for the possibility of intervention in Japan to try to support the end given what you just said that it's larger macroeconomic factors. Is it possible for Japan actually

intervened and actually shore up the end? I tend to be skeptical that intervention can have sustained impacts UM. The capital markets are just so big, even relative to the resources that the authorities UH have UH that I would be surprised in today's world if interventions could have large sustained impacts on maintaining UH the value of the end.

I think the more fundamental questions UH for the end involve the level of Japanese interest rates, both in the short and over the longer term, and the extent to which the Japanese will at some point feel comfortable raising those interest rates, which is not a simple proposition given

the magnitude of debts in Japan. So we're seeing a different sort of intervention over in Europe, both through the respect of the United Kingdom, where the new Prime Minister is Trust now is trying to impose a cap on the cost of households. We also have the possibility of a price cap being agreed upon in Europe. Is that a reasonable intervention is likely to be effective at dealing

with the runaway energy costs, particularly in Europe. Look, it's an extraordinarily difficult situation, and it's a mistake to be too judgmental from too far away. But when I saw the emerging plan, it reminded me of standard UM Latin American populist approaches fixed the price and commit to unlimited subsidy, and those policies often have not worked out well at all for those who implemented them, and so it seems

a very dangerous course. Now. I think we ought to give the British authorities an opportunity to explain the rationale for their policy, to explain the financing mechanisms behind UH their policies. But a policy of tax cutting, avoiding taxation of windfall profits, subsidizing consumers for UH low priced energy in the face of a nearly unlimited potential liability UH seems to me to at least raise very serious and

severe arithmetic UH questions. And I think people who are thinking about the pound are thinking about that is the story that overshadowed the entire week, not necessarily in economics or finance, but overall, was the passing of Queen Elizabeth the Second at the age of ninety six, And I wonder if that gives us an occasion to reflect on what has happened to the British economy since the nine

when she became queen and to the present time. It's been through an awful lot, it's grown up firm at the same time, and what we think is likely in store for King Charles the Third. You know, in today's world, there are very few leaders who command nearly universal respect, and there are very few leaders who are able, through decades in the public eye, to maintain um, that dignity

and to maintain respect. And Queen Elizabeth did that, and did it as recently as this year at the age of ninety six, and it's a quite extraordinary thing that I think history will uh long remember. She stood for taking the long view. She stood for rising above passions of the moment, and I think those are useful lessons for all of us involved in political economy, useful lessons when the urge to point scoring or cheap partisan advantage um looms large in politics, and useful lessons in with

respect to uh economics and economic policy as well. And one has to take a longer view. And so Queen Elizabeth was always acting not with a view to the newspaper headline, but with a view to the history books. And my counsel to uh those who will lead Britain politically at this very difficult moment is to do the same thing. And I think that's something we can all uh usefully keep in mind in every country. So, Larry, let's convened the Larry Summers Book Club. Here. Who are

you reading these days? I understand you have a book you like a lot. Brad DeLong, my former student, now colleague at the Treasury Department, now a professor at Berkeley, has written the one economic history book that I think everybody should take a very serious look at. Slouching towards Utopia is the title, and it chronicles the world from the moment uh growth really took off in eighteen seventy

pretty much up to the present. And the only thing we really can learn from for thinking about the future economy is history. And Brad tells it in a dramatic and strongly thematic uh way. Thank you so much. I really appreciate you being back with us since Larry Summers of Harvard our very special contributor here on Wall Street Week. Finally, one more thought, everything that goes up must come down, or to put it in financial terms, reverts to the mean.

We've seen it recently in things like Bitcoin coming back down towards Earth. The weight that we've seen on Bitcoin in the crypto space at large denverblementum. From a longer term spect it is very barished right now. In meme stocks shooting up and shooting right back down again, so called meat stocks like Game Stop down eight percent, AMC

Entertainment will sit down. And in those n f T s that we're going to take us all into the bold new world of the metaverse n f team market has crashed for the glost has come off of that particular world, and now we're seeing it in the world of specs. Those special purpose acquisition companies that held out the promise of all the benefits of going public without all those pesky sec requirements in this back market in particular not doing well. This fact craze is over. I

think that investor sentiment has soured on the product. This week we saw the latest stumble of US back when the company former President Trump chose to help him take his truth. Social media company Public ran into trouble with shareholders who refused to let an extend the time to close the deal, as the app itself continues to have issues,

including a ban from the Google Play Store. Truth Social, that content moderation piece and making sure that they can kind of abide by the standards that Google expects seems to be the breaking point at the moment, which brings us to baseball and to the New York Yankees, the best team in baseball at least through the month of June, winning almost seventy of their games during that time period, only to revert to that mean with a record well

below five since then. But in a world of things coming back down to earth, there is one part of

the Yankees that hasn't. He's named Aaron Judge, who has already hit well over fifty home runs this season, and he's on a pace that, with a little luck and a bit of his skill, could approach or even pass Roger Morris's record of I'm just blessed to be in this position, to be with those guys, and you know, looking forward him, you know, send more records with those guys and hopefully eventually getting a ring at the end

of the year. As big a deal as that is for the sport of baseball, it may be even a bigger deal for Judge's bank account. He was offered two thoint five million dollars in a contract attention at the beginning of the year, only to turn it down and beat on himself and decide he was going to have a new contract than the year. Well that that it looks like it's likely to pay off. That does it for this episode of Wall Street Week. I'm David Weston.

This is Bloomberg. See you next week. It's turn, It's turn.