WEBVTT - Morgan Stanley's Jim Caron Talks CPI Report, Fed

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<v Speaker 1>Bloomberg Audio Studios, Podcasts, Radio News.

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<v Speaker 2>Our Interview of the Day, I'm fixed income James Karen.

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<v Speaker 2>Jim Karen joins us with Morgan Stanley's CIO cross At Solutions. Jim,

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<v Speaker 2>you know, I love your note where you review nominal

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<v Speaker 2>GDP when you talk to your accountants, your economists, excuse me,

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<v Speaker 2>when you talk to your economists, do you see a

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<v Speaker 2>sustained nominal GDP or can it come down from the

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<v Speaker 2>five percent level?

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<v Speaker 1>Good morning, Tom and Paul.

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<v Speaker 3>Listen, you know nominal GDP is really if I'm talking

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<v Speaker 3>to my accountant, he sees only nominal dollars.

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<v Speaker 2>Right.

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<v Speaker 3>We all get paid in nominal dollars, right, so what

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<v Speaker 3>we observe in the world is a nominal world. We

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<v Speaker 3>don't observe like we don't get paid in real dollars.

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<v Speaker 3>So you know the fact that nominal GDP first quarter

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<v Speaker 3>of this year was running at six percent, which is

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<v Speaker 3>significantly above the average over the last you know, many years,

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<v Speaker 3>which was closer to four And in the second quarter,

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<v Speaker 3>nominal GDP if you look at the GDP deflator, nominal

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<v Speaker 3>GDP was running closer to seven point nine percent. If

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<v Speaker 3>you use PCE as your inflation measure, it's closer to

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<v Speaker 3>six and a half percent. But the point here, Tom,

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<v Speaker 3>is that if you're in a higher nominal GDP world,

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<v Speaker 3>you tend to get higher earnings.

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<v Speaker 1>No surprise there.

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<v Speaker 3>We can take a look and see what's going on

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<v Speaker 3>with second quarter earnings and even with first quarter earnings,

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<v Speaker 3>and that's the kind of connection that we should draw.

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<v Speaker 3>So when I talk about higher nominal GDP, think about

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<v Speaker 3>that as higher equity earnings and earnings per growth in

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<v Speaker 3>earnings per share growth.

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<v Speaker 4>So, Jim, how does our federal Reserve adapt to this

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<v Speaker 4>type of economic environment and growth environment?

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<v Speaker 3>Well, I mean, you know, part of this is the

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<v Speaker 3>inflation element to it, right, you know, so nominal GDP

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<v Speaker 3>is real growth plus the inflation. So you know what's

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<v Speaker 3>driving the higher nominal GDP is that we are living

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<v Speaker 3>in a higher inflation world, somewhere around two and a

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<v Speaker 3>half three percent, let's say.

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<v Speaker 1>Well, I guess we'll find out more on Wednesday.

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<v Speaker 3>So you know, the question is, is inflation accelerating higher? Can

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<v Speaker 3>we sustain a two and a half percent inflation to

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<v Speaker 3>three percent for the time being until it settles back down? Yes,

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<v Speaker 3>I don't think that that is going to be overly corrosive,

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<v Speaker 3>you know, for the FED, as long as they believe

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<v Speaker 3>that inflation and inflation expectations are not becoming ingrained where

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<v Speaker 3>it becomes, you know, something that you know becomes more

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<v Speaker 3>destructive going forward. But so at this point right now,

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<v Speaker 3>I think it's sustainable. But you know, I guess we'll

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<v Speaker 3>find out more on Wednesday with CPI.

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<v Speaker 4>How do you expect here? Just kind of interest rates

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<v Speaker 4>in general just feels like we're higher for longer here, Jim,

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<v Speaker 4>is that the world do you think we're in or

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<v Speaker 4>we're going to see some moderation.

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<v Speaker 3>Yeah, I do think that we're in a higher for

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<v Speaker 3>longer in environment. So you know, one of the correlations

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<v Speaker 3>that you can draw and you can go back over

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<v Speaker 3>a long period of time is nominal GDP versus the

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<v Speaker 3>ten year yield. Those two usually sit pretty close to

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<v Speaker 3>each other. And I'm not calling for ten year yields

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<v Speaker 3>to go up, you know, significantly. I think that we're

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<v Speaker 3>primarily in a range and we're going to go pretty

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<v Speaker 3>much sideways into the end of the year. But you know,

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<v Speaker 3>the ability for rates to move down sharply right now,

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<v Speaker 3>particularly at the back end, outside of having a recession

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<v Speaker 3>or some really sharp slowdown in the economy, I think

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<v Speaker 3>is somewhat limited because you know, in the environment that

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<v Speaker 3>we're in, you know, at the current moment, it just

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<v Speaker 3>seems that nominal growth is going to be higher, which

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<v Speaker 3>means that it just it just alleviates the risk of

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<v Speaker 3>yields moving down sharply.

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<v Speaker 2>So the Jim the Gloom crew is going to step

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<v Speaker 2>in and say, Okay, there's all this fancy Jim Karen talk.

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<v Speaker 2>But the question is the fiscal state we're in, how

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<v Speaker 2>do you pull in our debt and our deficit into

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<v Speaker 2>that ancient worry pop priced down yields up bigly.

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<v Speaker 3>So this is a great question, tom, So let's connect

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<v Speaker 3>the dots on this. So the idea is that if

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<v Speaker 3>you have higher nominal growth, which we do, that's what

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<v Speaker 3>pays down your deficit. Right, that is the number one

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<v Speaker 3>thing that pays down your deficit. So you're absolutely right.

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<v Speaker 3>The deficit is two high. It's around six percent of GDP.

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<v Speaker 3>It's been coming down by some measures. It's slightly under six.

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<v Speaker 3>I'm sorry, that's the fiscal deficit, not debt to GDP.

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<v Speaker 3>Debt to GDP is you know, it is still a

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<v Speaker 3>little bit high. Depending on what metric you're using, around

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<v Speaker 3>one hundred and twenty percent. Now, that's likely to come

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<v Speaker 3>down as long as you have higher nominal growth. That's

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<v Speaker 3>what brings that down the fastest. That's what we did

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<v Speaker 3>after World War two, right, we had yield curve control.

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<v Speaker 3>We capped you know, tenure yields of two and a

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<v Speaker 3>half percent, and we allowed nominal GDP to get above

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<v Speaker 3>six and that's what paid down the deficit after World

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<v Speaker 3>War two. So in some ways we're doing something similar

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<v Speaker 3>to the right now with higher nominal growth.

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<v Speaker 4>Jim, how is this kind of world of higher economic growth.

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<v Speaker 4>Has that changed your asset allocation at all?

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<v Speaker 1>Yeah? Absolutely.

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<v Speaker 3>So Basically, if you're in a higher nominal world, you're

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<v Speaker 3>likely going to favor more equities over fixed income. So

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<v Speaker 3>when you think of sixty forty, I would say, you know,

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<v Speaker 3>sixty percent equity forty percent fixed income is a traditional

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<v Speaker 3>balance portfolio.

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<v Speaker 1>I would say that the.

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<v Speaker 3>Forty percent in fixed income becomes somewhat challenged right now,

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<v Speaker 3>just because you don't have the ability to generate high

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<v Speaker 3>levels of return without rates moving down very sharply. So

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<v Speaker 3>the equity markets tend to have higher valuations when you

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<v Speaker 3>have inflation somewhere around two and a half to three

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<v Speaker 3>and a half percent, which is where it is today.

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<v Speaker 3>Valuations tend to be higher and sustainably higher. Companies have margins,

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<v Speaker 3>they have pricing power, they generate higher earnings. So equities

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<v Speaker 3>tend to be the asset class that is in favor

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<v Speaker 3>in a higher nominal growth world.

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<v Speaker 1>So me more towards the equity spectrum and a little

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<v Speaker 1>bit of way from fixed income.

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<v Speaker 2>So do you look in terms of use of cash,

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<v Speaker 2>is dividend growth and share buyback to be a constructive

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<v Speaker 2>yield equivalent forward three or five years?

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<v Speaker 3>Yeah, yes, you know absolutely, because look, you know, dividend

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<v Speaker 3>yields are real yields, right, you know that's the yield

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<v Speaker 3>you get after all the expenses, and inflation is a cost, right,

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<v Speaker 3>that's what you get back from the you know, the

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<v Speaker 3>you know, the stock that you bought. So what you

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<v Speaker 3>want to have are higher real returning assets, real yields,

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<v Speaker 3>And as I always like to say that, you know,

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<v Speaker 3>equities are are are are a nominal asset with real

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<v Speaker 3>returns because with equities you get the return after all

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<v Speaker 3>the expenses, inflation being one of those expenses. So whether

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<v Speaker 3>it's dividends or if it's buybacks or whatever the case

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<v Speaker 3>may be.

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<v Speaker 1>That's where you're likely to see the appreciation.

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<v Speaker 3>The most appreciated creation in your investment is likely to

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<v Speaker 3>come from the equity side of the ledger as opposed

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<v Speaker 3>to the fixed income side. That doesn't mean fixed income

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<v Speaker 3>is important. You still need that as a hedge and

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<v Speaker 3>it's a good source of income in your portfolios, but

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<v Speaker 3>you have to balance it properly.

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<v Speaker 2>Jim Carren, thank you. Terrific Monday morning Brief with MORTGANE.

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<v Speaker 2>Stanley and Jim Carre