Speaker 1: Bloomberg Audio Studios, Podcasts, Radio News.
Speaker 2: Our Interview of the Day, I'm fixed income James Karen.
Speaker 2: Jim Karen joins us with Morgan Stanley's CIO cross At Solutions. Jim,
Speaker 2: you know, I love your note where you review nominal
Speaker 2: GDP when you talk to your accountants, your economists, excuse me,
Speaker 2: when you talk to your economists, do you see a
Speaker 2: sustained nominal GDP or can it come down from the
Speaker 2: five percent level?
Speaker 1: Good morning, Tom and Paul.
Speaker 3: Listen, you know nominal GDP is really if I'm talking
Speaker 3: to my accountant, he sees only nominal dollars.
Speaker 2: Right.
Speaker 3: We all get paid in nominal dollars, right, so what
Speaker 3: we observe in the world is a nominal world. We
Speaker 3: don't observe like we don't get paid in real dollars.
Speaker 3: So you know the fact that nominal GDP first quarter
Speaker 3: of this year was running at six percent, which is
Speaker 3: significantly above the average over the last you know, many years,
Speaker 3: which was closer to four And in the second quarter,
Speaker 3: nominal GDP if you look at the GDP deflator, nominal
Speaker 3: GDP was running closer to seven point nine percent. If
Speaker 3: you use PCE as your inflation measure, it's closer to
Speaker 3: six and a half percent. But the point here, Tom,
Speaker 3: is that if you're in a higher nominal GDP world,
Speaker 3: you tend to get higher earnings.
Speaker 1: No surprise there.
Speaker 3: We can take a look and see what's going on
Speaker 3: with second quarter earnings and even with first quarter earnings,
Speaker 3: and that's the kind of connection that we should draw.
Speaker 3: So when I talk about higher nominal GDP, think about
Speaker 3: that as higher equity earnings and earnings per growth in
Speaker 3: earnings per share growth.
Speaker 4: So, Jim, how does our federal Reserve adapt to this
Speaker 4: type of economic environment and growth environment?
Speaker 3: Well, I mean, you know, part of this is the
Speaker 3: inflation element to it, right, you know, so nominal GDP
Speaker 3: is real growth plus the inflation. So you know what's
Speaker 3: driving the higher nominal GDP is that we are living
Speaker 3: in a higher inflation world, somewhere around two and a
Speaker 3: half three percent, let's say.
Speaker 1: Well, I guess we'll find out more on Wednesday.
Speaker 3: So you know, the question is, is inflation accelerating higher? Can
Speaker 3: we sustain a two and a half percent inflation to
Speaker 3: three percent for the time being until it settles back down? Yes,
Speaker 3: I don't think that that is going to be overly corrosive,
Speaker 3: you know, for the FED, as long as they believe
Speaker 3: that inflation and inflation expectations are not becoming ingrained where
Speaker 3: it becomes, you know, something that you know becomes more
Speaker 3: destructive going forward. But so at this point right now,
Speaker 3: I think it's sustainable. But you know, I guess we'll
Speaker 3: find out more on Wednesday with CPI.
Speaker 4: How do you expect here? Just kind of interest rates
Speaker 4: in general just feels like we're higher for longer here, Jim,
Speaker 4: is that the world do you think we're in or
Speaker 4: we're going to see some moderation.
Speaker 3: Yeah, I do think that we're in a higher for
Speaker 3: longer in environment. So you know, one of the correlations
Speaker 3: that you can draw and you can go back over
Speaker 3: a long period of time is nominal GDP versus the
Speaker 3: ten year yield. Those two usually sit pretty close to
Speaker 3: each other. And I'm not calling for ten year yields
Speaker 3: to go up, you know, significantly. I think that we're
Speaker 3: primarily in a range and we're going to go pretty
Speaker 3: much sideways into the end of the year. But you know,
Speaker 3: the ability for rates to move down sharply right now,
Speaker 3: particularly at the back end, outside of having a recession
Speaker 3: or some really sharp slowdown in the economy, I think
Speaker 3: is somewhat limited because you know, in the environment that
Speaker 3: we're in, you know, at the current moment, it just
Speaker 3: seems that nominal growth is going to be higher, which
Speaker 3: means that it just it just alleviates the risk of
Speaker 3: yields moving down sharply.
Speaker 2: So the Jim the Gloom crew is going to step
Speaker 2: in and say, Okay, there's all this fancy Jim Karen talk.
Speaker 2: But the question is the fiscal state we're in, how
Speaker 2: do you pull in our debt and our deficit into
Speaker 2: that ancient worry pop priced down yields up bigly.
Speaker 3: So this is a great question, tom, So let's connect
Speaker 3: the dots on this. So the idea is that if
Speaker 3: you have higher nominal growth, which we do, that's what
Speaker 3: pays down your deficit. Right, that is the number one
Speaker 3: thing that pays down your deficit. So you're absolutely right.
Speaker 3: The deficit is two high. It's around six percent of GDP.
Speaker 3: It's been coming down by some measures. It's slightly under six.
Speaker 3: I'm sorry, that's the fiscal deficit, not debt to GDP.
Speaker 3: Debt to GDP is you know, it is still a
Speaker 3: little bit high. Depending on what metric you're using, around
Speaker 3: one hundred and twenty percent. Now, that's likely to come
Speaker 3: down as long as you have higher nominal growth. That's
Speaker 3: what brings that down the fastest. That's what we did
Speaker 3: after World War two, right, we had yield curve control.
Speaker 3: We capped you know, tenure yields of two and a
Speaker 3: half percent, and we allowed nominal GDP to get above
Speaker 3: six and that's what paid down the deficit after World
Speaker 3: War two. So in some ways we're doing something similar
Speaker 3: to the right now with higher nominal growth.
Speaker 4: Jim, how is this kind of world of higher economic growth.
Speaker 4: Has that changed your asset allocation at all?
Speaker 1: Yeah? Absolutely.
Speaker 3: So Basically, if you're in a higher nominal world, you're
Speaker 3: likely going to favor more equities over fixed income. So
Speaker 3: when you think of sixty forty, I would say, you know,
Speaker 3: sixty percent equity forty percent fixed income is a traditional
Speaker 3: balance portfolio.
Speaker 1: I would say that the.
Speaker 3: Forty percent in fixed income becomes somewhat challenged right now,
Speaker 3: just because you don't have the ability to generate high
Speaker 3: levels of return without rates moving down very sharply. So
Speaker 3: the equity markets tend to have higher valuations when you
Speaker 3: have inflation somewhere around two and a half to three
Speaker 3: and a half percent, which is where it is today.
Speaker 3: Valuations tend to be higher and sustainably higher. Companies have margins,
Speaker 3: they have pricing power, they generate higher earnings. So equities
Speaker 3: tend to be the asset class that is in favor
Speaker 3: in a higher nominal growth world.
Speaker 1: So me more towards the equity spectrum and a little
Speaker 1: bit of way from fixed income.
Speaker 2: So do you look in terms of use of cash,
Speaker 2: is dividend growth and share buyback to be a constructive
Speaker 2: yield equivalent forward three or five years?
Speaker 3: Yeah, yes, you know absolutely, because look, you know, dividend
Speaker 3: yields are real yields, right, you know that's the yield
Speaker 3: you get after all the expenses, and inflation is a cost, right,
Speaker 3: that's what you get back from the you know, the
Speaker 3: you know, the stock that you bought. So what you
Speaker 3: want to have are higher real returning assets, real yields,
Speaker 3: And as I always like to say that, you know,
Speaker 3: equities are are are are a nominal asset with real
Speaker 3: returns because with equities you get the return after all
Speaker 3: the expenses, inflation being one of those expenses. So whether
Speaker 3: it's dividends or if it's buybacks or whatever the case
Speaker 3: may be.
Speaker 1: That's where you're likely to see the appreciation.
Speaker 3: The most appreciated creation in your investment is likely to
Speaker 3: come from the equity side of the ledger as opposed
Speaker 3: to the fixed income side. That doesn't mean fixed income
Speaker 3: is important. You still need that as a hedge and
Speaker 3: it's a good source of income in your portfolios, but
Speaker 3: you have to balance it properly.
Speaker 2: Jim Carren, thank you. Terrific Monday morning Brief with MORTGANE.
Speaker 2: Stanley and Jim Carre