00:00:02 Speaker 1: Bloomberg Audio Studios. Podcasts Radio News. This is the Bloomberg Surveillance Podcast. I'm Jonathan Farrow, along with Lisa Abramowitz and Anne-Marie Hordern. Join us each day for insight from the best in markets, economics and geopolitics. From our global headquarters in New York City, we are live on Bloomberg Television weekday mornings from 6 to 9 a.m. Eastern. Subscribe to the podcast on Apple, Spotify or anywhere else you listen. And as always, on the Bloomberg Terminal and the Bloomberg Business App. We begin this hour with stocks lower and yields at multi-decade highs. Crude resuming its advance. Osun Kwon of Wells Fargo trimming his year-end target to 7,700 from 7,950, writing oil has also been in the driver's seat for both stocks and bonds. Osun joins us now for more. Osun, good morning. 00:00:53 Speaker 2: Morning. 00:00:53 Speaker 1: What's the downside here? Still 5% to 10%? 00:00:55 Speaker 3: Yeah, that's what we're penciling in. And I'm usually in the camp that the level of interest rates doesn't really matter. It's really the volatility of rates. But if you look at the equity allocation today versus bond allocation, it's 72% versus 28%. It's at the highest level since 1969. If you try to estimate what the fair equity allocation should be based on the cost of equity and the 5% interest rate, that number should be around 60%. That 12 percentage point gap, that's the widest level since 1969 again, and that gap has usually explained how the S & P is going to do versus the risk-free rate. And if you assume like a 7% EPS growth over the next five years per year, that basically, that 12% basically implies 0% access return on top of that 5% risk-free rate for the S & P. So that's a pretty negative setup for equities overall. 00:01:51 Speaker 1: Let's talk about where we got to that negative setup. Is it because stocks are so good or bonds are so bad? 00:01:57 Speaker 3: It's really because of the allocation gap between the two. Stocks are good. It's inflation protected. Earnings are still rising. But we're no longer in the 2%, 3% interest rate environment. We're firmly about 5% now. 00:02:10 Speaker 4: So. 00:02:14 Speaker 3: The allocation right now is not reflecting the 5% interest rate word, and I think that's the risk, really. 00:02:23 Speaker 4: You put out a chart that I thought was fabulous last week, talking about how equity allocations versus bonds are the highest going back to 1969, at about 72%. And ultimately, this is what we hear from everybody. Overweight equities, what are bonds doing in your portfolio? They're not a ballast anymore, and they weren't providing enough income to justify them versus stocks. Are we getting to a place where bonds are becoming competitive with stocks in a very real way? Do you see that in allocations in a meaningful way? 00:02:51 Speaker 1: I think so, at least a little bit. 00:02:53 Speaker 3: People who are hesitant to go into bonds are really worried about inflation and fiscal deficit as well. But if you're really worried about inflation, then you could go into TIPS. I think there are some ways to reallocate your assets, not just in equities, but in more diversified ways. Equity valuation isn't crazy, but it's still pretty elevated. It's everyone's consensus that earnings are going to continue to print 20% or 15% plus. Our view is that earnings are elevated. Everyone's over-earning right now. If you look at the 10-year EPS cycle, by next year, we're going to have one of the strongest 10-year EPS cycles in history. That's only been surpassed by the 1950s bull market after the World War II. 2027 EPS is expected to be about 42% above the cyclically adjusted EPS based on our calculation. So, you know, everything that we're seeing is showing that earnings are likely cyclically elevated, which argues for lower multiples going forward. 00:04:03 Speaker 4: Let's just say oil prices come down. Let's say they come down by $ 10 to $ 20 per barrel. Does this whole thing change and suddenly you become bullish on stocks again? 00:04:13 Speaker 3: I think that's the bull case. The war ending or oil prices collapsing. And just purely based on how stocks have been trading versus oil, if WTI falls to $ 70, $ 75, then the S & P could potentially test $ 8, 000. And hedge funds have de-grossed quite a lot over the past two weeks. And we've seen massive re-grossing Monday and Tuesday. But I still think the, based on positioning, I think the pain trade could potentially be higher from here in the near term. But I also wonder who's going to be the incremental buyer other than hedge funds because I think retail's tapped out. In the first half of the year, we were very bullish on retail flows because of One Big Beautiful Bill. 00:04:59 Speaker 1: That money is gone now. 00:05:02 Speaker 3: And retail participation has been slowing for the past two months. Loan-onlys are fully invested. We are in a corporate buyback blackout period for the next month. So other than hedge funds, I really don't see that many incremental buyers. I think it's just going to be choppy regrossing, degrossing by hedge funds. 00:05:21 Speaker 1: So we expect volatility. 00:05:23 Speaker 5: Lisa asked about the downside of oil, but what if we see what people were talking about in the very beginning of this war, 150, 200 potentially on Brent? 00:05:31 Speaker 3: Yeah, I mean, that's the real bear case, right? I think if oil hits $ 150, $ 200, I think the S & P is going to be below $ 7, 000, just purely based. 00:05:42 Speaker 1: On the relationship. 00:05:45 Speaker 3: And we're probably going to be talking about a potential recession almost. I think the consumer is still okay at $ 100. We're not calling for a recession at $ 100, but if oil really goes up to $ 150 and $ 200, then I think. 00:06:00 Speaker 3: There will be rising concerns that we could be headed to a downturn. 00:06:04 Speaker 1: Stay with us. More Bloomberg surveillance coming up after this. the Trump-Xi summit yielding some early success. The U.S. and China are agreeing to a two-month extension to their trade truce. Diplomatic efforts continuing today with a series of events with President Donald Trump and the Chinese leader. Elsewhere, the Energy Secretary Chris Wright telling oil industry leaders to prepare for curbs on diesel exports. Sources telling us here at Bloomberg potential limits are still in discussion. and a final decision has not been reached. And finally, calls for AI safeguards growing on the world stage. 00:06:43 Speaker 2: It doesn't matter whether people put their risk of catastrophe at 10% or 1% or 12% or 0.1%. None of these levels are remotely acceptable. 00:06:51 Speaker 6: We called for global cooperation across the world between governments to set international standards. 00:06:57 Speaker 2: As AI becomes more capable... people must remain at the center of AI decision-making. 00:07:02 Speaker 1: The OpenAI CEO, Sam Altman, will join several tech leaders at a state dinner for Chinese leader Xi Jinping this evening, and already there's some pushback to what we're hearing from them. The Trump-Xi summit just around the corner, the president already posting on social media saying, AI will be a big topic of discussion, but I want to leave it exactly where it is. Scott Singer of the Carnegie Endowment for International Peace, writing, the US and China should not pursue a grand bargain. They need to do more to regulate frontier AI safely, domestically, before they can engage in international coordination. Scott joins us now for more. Scott, good morning. 00:07:32 Speaker 6: Good morning. 00:07:33 Speaker 1: Lisa asked a key question earlier on this morning. Can there be coordination where there is limited trust? 00:07:38 Speaker 7: I think it has to happen. You know, it's clear that this is a super strategic technology that's going to power both economies. At the same time, when you have a technology that, on the one hand, has so many potential benefits but also has some risks... You need to be able to manage that competition in a pragmatic way. And I think that both the president and the treasury secretary are very pragmatic and are going to need to find ways to put guardrails on the relationship. 00:08:05 Speaker 4: There's this difficult question of what happens if there is some sort of superbug that is transmitting through the ecosystem and you have rogue bots that are going and causing a lot of damage, releasing biological weapons. I'm just coming out with a nightmare scenario. 00:08:21 Speaker 1: And the U.S. 00:08:21 Speaker 4: Wants to alert China. How would they even do it? Do they pick up the phone and say, hey, gee, we got a problem? Do they end up sending a fax? Do they email to whom it may concern? There's a problem. I mean, ultimately, can you walk us through what that could look like? 00:08:35 Speaker 7: I think that this is one of the areas where the two sides can begin to have an important conversation. Right now, there is no permanent channel to discuss these AI risks. And if there were a cross-border crisis, like imagine hypothetically that we saw with OpenAI, Hugging Face was actually a U.S. company whose agents hacked into a Chinese company or vice versa. That becomes a pretty... scary cross-border crisis. And so having some permanent channel, some ability to exchange information, and making sure that actually works with how these systems actually operate. 00:09:08 Speaker 1: Can I jump in? You know, you guys are talking about hypotheticals, and you're saying, can you imagine? I don't have to imagine. I don't need a hypothetical. It happened. It happened with a virus five years ago. Six years ago, we had a pandemic. Did we learn anything from that about coordination with the Chinese? 00:09:23 Speaker 7: I think that you need to build the infrastructure for coordination early. You need to have the channels and have some idea of what information you're going to share at what time and build in domestic guardrails. I think a key lesson here is to make sure that you are doing enough, whether it's pandemic preparedness, whether it's AI safety, domestically to make sure that you are doing this precisely because it's in your own interest. I think if China were to look back at this now, I don't think that COVID was favorable to their economy or their society. I think everyone would have, you know, wanted a redo with that one. 00:09:54 Speaker 1: Brammo, as soon as you said it, I was just thinking, well, we saw that. A virus did escape. 00:09:58 Speaker 8: Totally. 00:09:58 Speaker 1: And I remember speaking to officials from China who said it was contained and it was going to be fine. But this is exactly the model. 00:10:03 Speaker 4: And it was exactly where I was thinking in the idea of, well, they didn't want to let on that their economy was potentially going to weaken. 00:10:11 Speaker 1: Significantly. 00:10:11 Speaker 4: They didn't want to show vulnerability just to the same extent that both nations don't want to show how advanced they're getting and they don't want to show vulnerability. So how, given that backdrop, do you get communication to prevent some sort of catastrophic event like the one that we just had six years ago? 00:10:29 Speaker 7: I think it has to rely on enlightened self-interest. I mean, the economic devastation in the long term was so real for both countries and the social instability for both countries was so real. And so it's going to be hard to get sort of a more concrete idea of what specific information needs to be shared. But I think, you know, let diplomacy play its course. And for now, having some channel where as you're seeing some spooky things, we have reports that coming from independent third-party evaluators that explain what we're seeing in the U.S. Being able to actually have a channel where we're sharing key insights without going really deep into the technical details that are much more sensitive, making sure that both sides understand some of the symptoms that are going to be similar potentially across both countries is going to be really important. 00:11:16 Speaker 5: As we continue this analogy towards what happened with COVID, China was part of the World Health Organization. We had a body that was supposed to help monitor all of this and actually help economies and citizens around the world. That didn't really work, did it? 00:11:29 Speaker 7: Well, I think that right now, both sides are building up domestic infrastructure to test and understand what the risk landscape looks like. In the US, we have the Center for AI Standards Innovation. This is a super important body whose job is to make sure that the government has visibility into the risks. We have independent evaluators who are increasingly empowered by the companies and others to go in and monitor for these risks. And so You know, China is beginning to build this sort of similar infrastructure now and how they engage with each other internationally is going to be important. And I think that this is just the most pragmatic way to actually make progress on this key issue. 00:12:07 Speaker 1: I think we all hope this time we'll do it the right way. Thank you, sir. Stay with us. More Bloomberg surveillance coming up after this. under Savannah's this morning, strong growth fueling a bond market sell-off. 00:12:28 Speaker 6: The economy is very strong. And what I would say is we saw the PMI numbers strongest, the Purchasing Managers Agreement index, strongest since 2021. We will get to the other side of this Iran conflict. The energy prices will drop and you will pick your purchasing power back up. 00:12:50 Speaker 1: I want to see Besson quoting new orders. Get on Fox & Friends this morning and quote new orders. How about ADP? Why not? I mean, honestly. Make it happen. Let's get to this bond market. Ed Hosani of Columbia Threadneedle writing, the Fed will have to work harder to squeeze excess demand out of this economy. They will be looking for feedback from markets. Ed joins us now for more. Ed, good morning. Good to see you. 00:13:12 Speaker 8: Good morning. 00:13:12 Speaker 1: Is this bond market a buy yet? 00:13:14 Speaker 8: I think it's getting in the zone, to be honest. I think we are starting to overshoot a little bit. In terms of what we know about the demand story right now versus about 100 basis points or so of Fed hikes, I feel like we found a nice equilibrium right now where there's some value coming up. 00:13:29 Speaker 6: Absolutely. 00:13:30 Speaker 1: Just on the front end, as you think about what the floor is for hikes and where the ceiling might be, what's the range of outcomes you and the team are discussing at the moment? 00:13:38 Speaker 8: I would kind of ballpark three to four as the floor. That's roughly where we are priced for right now. I think it will take some sort of accident for us to not get to that level in terms of a growth accident, labor market accident. These things happen. But getting to that three to four hike level over the next six months, I think, is going to be critical. I think the speed matters as well. And then I think we can get the luxury of taking a little bit of a step back. 00:14:05 Speaker 4: Will that do anything to counter inflation if the Fed were to hike three or four more times? 00:14:11 Speaker 1: This is a really good question. 00:14:13 Speaker 8: If the theory of inflation is we have some excess demand in the system, that demand ultimately has to be, to some extent, interest rate sensitive. 00:14:23 Speaker 1: For us to. 00:14:23 Speaker 8: Squeeze it out over the next, again, 12 to 18 months? The answer is yes. This will take a step in the right direction. If the answer is, look, inflation is a supply-side phenomenon. There are tariffs. There are energy shocks playing through. There's a number of energy shocks, a number of shocks playing through that are interest rate agnostic. They may phase out on their own The Fed hikes may just coincide with inflation coming down. We'll take that as well. It just keeps inflation expectations in the right place. 00:14:56 Speaker 4: Do you have confidence to go ultra long, go into 30-year debt with yields at the highest going back to 2004? Do you think that the long end is being uniquely affected by factors that aren't going to change regardless of what the Fed does? 00:15:09 Speaker 8: I would say my read of the repricing so far this year is the large vast majority has been driven by the Fed. There's been very little term premium. There's been very little in terms of the fiscal story that has changed. Now, the fiscal story isn't great, but it hasn't changed this year. Expected deficits are right in that 6% area. If anything, the fact that growth is accelerating a little bit take some of the pressure off the fiscal story in the background. So we have a better shot at achieving a slightly smaller deficit in the coming years if that growth story stays in place. 00:15:45 Speaker 5: When it comes to the Fed outlook for the rest of the year, what are you expecting? 00:15:50 Speaker 8: My baseline is consecutive hikes through December. 00:15:53 Speaker 5: So even October's in play. A lot of people say it can't because of the politics, just days away from an election. 00:15:58 Speaker 1: I mean, I think. 00:15:59 Speaker 8: They've given us a decent amount of history to show that they can be active ahead of elections, and. 00:16:05 Speaker 1: That's not really the case. A cut is different, though, than a hike. A cut is different than a hike. 00:16:09 Speaker 8: Absolutely. But once you embark on this process and it becomes clear that what you're doing is being reinforced by the economy, I think it makes sense to go in a pretty rapid direction. 00:16:21 Speaker 1: Can we finish on market feedback? the kind of feedback they're getting from markets already, and just turn to credit briefly. Any flashing lights anywhere beneath the surface that are telling them, you're doing the work, this is working? 00:16:32 Speaker 8: The short answer in risk markets is no. Where you are getting feedback is in rates markets, so the yield curve is flattening out. Real rates are going up, so this is not a break-even story. That shows you that you are putting the brakes through the rates market, and the dollar is starting to strengthen as well. So those are first steps in the feedback. A crack in risk markets, you can't really engineer that. You probably don't want to engineer it, but you do want to see tighter financial conditions. 00:16:59 Speaker 1: Is it sufficient just to have that tighter financial conditions just through those two channels you described, or do you need it to happen elsewhere? 00:17:05 Speaker 8: We're going to find out, and I think... Usually, the way this works is it affects risk appetite. It has not affected risk appetite so far. We just never know exactly where that threshold is. But I think we're moving in that direction, absolutely. 00:17:19 Speaker 1: This is the Bloomberg Surveillance Podcast, bringing you the best in markets, economics, and geopolitics. You can watch the show live on Bloomberg TV, weekday mornings from 6 a.m. to 9 a.m. 00:17:30 Speaker 2: Eastern. 00:17:31 Speaker 1: Subscribe to the podcast on Apple, Spotify, or anywhere else you listen. And as always, on the Bloomberg Terminal, and the Bloomberg Business App.