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Speaker 2: This is the Bloomberg Surveillance Podcast. I'm Jonathan Ferrow, along
Speaker 2: with Lisa Bromwitz and Amrie Hordern. Join us each day
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Speaker 2: Terminal and the Bloomberg Business app. Thel Orlando Federated writing this,
Speaker 2: we're not buyers of the SPX whole hog here, however,
Speaker 2: we still expect the rully in stocks will broaden out
Speaker 2: from mag seventh Centric to include domestic large camp value,
Speaker 2: small cap growth and international film. Pleased to say it's
Speaker 2: with us now for more, Phil, Let's go straight to it.
Speaker 2: The data of yesterday. How much weight would you put
Speaker 2: on that manufacturing reed?
Speaker 3: John? Good morning, Thank you again very much for me
Speaker 3: back on. I think yesterday's data was very significant that
Speaker 3: the ism, as you guys pointed out, was back above
Speaker 3: the fifty level, the contraction line of demarcation if you will,
Speaker 3: for the first time in sixteen months. And as Lisa
Speaker 3: pointed out, the number that was stunning was the prices
Speaker 3: paid component. So you've got a situation where the economy
Speaker 3: is strengthening, yet inflation is sticky, perhaps even accelerating. Now
Speaker 3: pair that with the LI data we saw last week.
Speaker 3: Leading economic indicators went back positive for the first time
Speaker 3: in twenty two months. And you sit down and talk
Speaker 3: to our bond people and they look at these inverted
Speaker 3: deal curves that we've been watching for the last two years,
Speaker 3: funds to tends, twoes to tens, three months to tens.
Speaker 3: They're flattening out. Our bond guys think that those may
Speaker 3: become positively sloped again. So the risk of recession or
Speaker 3: lower risk of a modest soft landing is starting to
Speaker 3: shift to a stronger period of economic growth. But the
Speaker 3: inflation question, I think is the more important one. Look
Speaker 3: at last week's PCEE print core two point eight percent
Speaker 3: for the month of February. Now what really caught our
Speaker 3: attention was the changes in the SVP. At the Fed's
Speaker 3: last meeting, they're going to increase their core PC forecast
Speaker 3: to two point six percent for next year and kept
Speaker 3: their two percent target in place for calendar twenty six.
Speaker 3: So the FED is telling us that inflation is still
Speaker 3: a problem. It's going to be a problem as the
Speaker 3: economy comes back, And what all of that means is
Speaker 3: that it's going to be less rate cuts relative to
Speaker 3: what the market was expecting just a couple of months ago.
Speaker 2: So, Phil, given everything you've said, every item on that
Speaker 2: list in the last couple of minutes, is that good
Speaker 2: or bad for stocks? Let's make it really simple, good
Speaker 2: or bad for stocks?
Speaker 3: So SMP five hundred up ten percent here in the
Speaker 3: first three months of the year, up twenty eight percent
Speaker 3: since October. In our view, stocks are ahead of themselves,
Speaker 3: but we expect sort of a rolling correction, if you will.
Speaker 3: The MAG seven in the last fifteen months is up
Speaker 3: ninety nine percent. The Forgotten four ninety three is up
Speaker 3: twenty two percent. Our view has been that this rally
Speaker 3: was broaden out, that we would see some profit taking
Speaker 3: in the MAG seven and the domestic large cap value stocks,
Speaker 3: the small cap GIRLD stocks, the international stocks which were
Speaker 3: largely left for dead over the course of the last
Speaker 3: year or so, they would find some love and we'd
Speaker 3: start to see some improvement in the share prices of
Speaker 3: those categories.
Speaker 4: But phil how much do higher rates really challenge the
Speaker 4: idea of broadening out, particularly to small caps, considering that
Speaker 4: these companies usually are more leveraged and are more vulnerable
Speaker 4: to higher rates.
Speaker 3: Fair point, But remember that the US economy is doing
Speaker 3: relatively better than a lot of our trading partners Japan, Germany, UK,
Speaker 3: all in recession. The reality is that small cap companies
Speaker 3: here in the United States do eighty percent of their
Speaker 3: business right here at home, and from an economic standpoint,
Speaker 3: we're doing better here in terms of underlying fundamentals. The
Speaker 3: sectors within the small cap market, Biotechnology, for example, is
Speaker 3: our favorite, is really well positioned. Biotech stocks have very
Speaker 3: strong pipelines, the valuations have probably never been cheaper, and
Speaker 3: with interest rates down at the margin, the prospect of
Speaker 3: M and A activity is enhanced today versus where they
Speaker 3: were a year or so ago. We do like small
Speaker 3: cap here.
Speaker 5: What about oil?
Speaker 4: How much is oil? The new mag seven at this
Speaker 4: point where people are talking about the fact that suddenly
Speaker 4: there is the reality check of supply and demand, to
Speaker 4: the fact that this economy isn't rolling over the way
Speaker 4: so many people thought.
Speaker 3: Music to our ears Lisa, that we were very lonely
Speaker 3: at the beginning of the year talking about oil WTI
Speaker 3: in the mid sixties, thinking that we could see eighty
Speaker 3: to ninety dollars a barrel by the end of the year.
Speaker 3: We're now sitting in the mid eighties three months into
Speaker 3: the year, so this has happened a lot quicker than
Speaker 3: we thought. But the combination of increased geopolitical risks in
Speaker 3: combination with the fact that we don't have a lot
Speaker 3: of levers here. In the past we might have utilized
Speaker 3: the Strategic Petroleum Reserve to perhaps adjust the price of oil.
Speaker 3: We took the SPR down three hundred and fifty million
Speaker 3: barrels a couple of years ago and didn't replace it.
Speaker 3: So at this point we are sort of at the
Speaker 3: mercy of the vicissitudes of what's going on globally. Crude
Speaker 3: oil last September was at ninety five dollars a barrel.
Speaker 3: What we could see the crude oil market retest that
Speaker 3: gasoline prices at three point fifty or so a gallon
Speaker 3: now could be at four dollars over the course of
Speaker 3: the next couple of quarters. So this move and energy
Speaker 3: for us is real and energy has been one of
Speaker 3: our favorite categories on the domestic large cap value side.
Speaker 1: Well, Phil, with Brent already trading within your reign range
Speaker 1: of eighty nine dollars a barrow, what do you see
Speaker 1: for your end.
Speaker 3: Higher We think that the TI could could trade up
Speaker 3: another ten dollars, and Brent, you know, maintaining that spread,
Speaker 3: could probably approach one hundred dollars a barrow.
Speaker 2: So when we were talking to Nowt in November and
Speaker 2: you were talking about double digit rallies on a sm
Speaker 2: P five hundred, did you ever expect things to go
Speaker 2: as far as they have in the Stone market.
Speaker 3: Not as quickly as as it has that We've got
Speaker 3: a six thousand target on the S and P fully
Speaker 3: discounting calendar twenty twenty five earnings, the market seems to
Speaker 3: be focusing on that number. We didn't think that we
Speaker 3: would get up, you know, the fifty two to fifty
Speaker 3: three hundred level in the first quarter of this year.
Speaker 3: So the rally, this twenty eight percent rally we've seen
Speaker 3: over the last five months, has been much faster than
Speaker 3: we had expected last fall.
Speaker 2: So much faster. Great to catch up, Phil, Thank you,
Speaker 2: sir Filowlando, Thanks for that federates at times. Troygeski of
Speaker 2: FS Investments saying the performance of the US economy is
Speaker 2: an opportunity for a spring cleaning of portfolios, writing this
Speaker 2: cash has been a great place to hang out for
Speaker 2: quite some time and still offers a positive real rate
Speaker 2: of return. But gradually deploying those massive cash hoards into
Speaker 2: a select group of alternative strategies can substantially increase return
Speaker 2: potential without having to take on uncomfortable levels of risk.
Speaker 2: Try and police to say, is with us now for more?
Speaker 3: Try?
Speaker 2: I want to reflect on the data we've had so
Speaker 2: far this week, going into a week full of economic
Speaker 2: data really concluding with payrolls on Friday morning, would you
Speaker 2: see that data that strength as a good thing or
Speaker 2: a bad thing for risk assets?
Speaker 6: Well, for risk assets it still continues to be a
Speaker 6: good thing over the medium term, in that stronger economic
Speaker 6: growth leads to more revenue, leads to lower default rates
Speaker 6: and credit. We're getting to that inflection point though, where
Speaker 6: you had a violent enough curve move yesterday that equity
Speaker 6: markets finally paid attention. Right if you think a Q one,
Speaker 6: you know you had another quarter where fixed income was down,
Speaker 6: you know, like a broken record, like we joke around about,
Speaker 6: but equity is able to power ahead because not only
Speaker 6: did you have very strong earnings, but obviously the economic
Speaker 6: growth surprises relative to robust and Powell started to job
Speaker 6: own about someone's say, premature cuts.
Speaker 3: So you know, we're at a.
Speaker 6: More dangerous level in terms of valuations, but generally that
Speaker 6: rebounded manufacturing should be looked at it as a positive
Speaker 6: outcome and a positive driver.
Speaker 2: Atroy you said the equity markets started to wake up.
Speaker 2: I mean, I've got a question that we were down
Speaker 2: point two percent yesterday on the SMP with down point
Speaker 2: two percent this morning. I think the equity market is
Speaker 2: still snoozing, isn't it.
Speaker 7: Yeah, well, compared to previous higher rate driven dislocations, I
Speaker 7: mean the most recent one, of course, was August to
Speaker 7: October last year, where you got a material curve move in.
Speaker 6: You know, point two percent. Point two percent is kind
Speaker 6: of a rounding error, but you know, at twenty one
Speaker 6: times for earnings, you just have to ask yourself, how
Speaker 6: much more upside do you have when so much the
Speaker 6: good news is priced in and to the points you've
Speaker 6: been making already, there's a material risk of substantially higher
Speaker 6: rates at the back end of the curve, we still
Speaker 6: are fairly inverted. The curve has obviously been gradually pricing
Speaker 6: out cuts this year. But bottom line is, to Lisa's point,
Speaker 6: in this scenario where there are no cuts, you have
Speaker 6: to think the back end of the curve is going higher,
Speaker 6: and we could retest the five percent level at some
Speaker 6: point given the substantial supply that's coming on and obviously
Speaker 6: a technical picture that's not terribly supportive.
Speaker 4: That's five percent this year, we have thought and.
Speaker 6: We still think that's definitely possible. I mean, look the way,
Speaker 6: when you think of the FOD reaction function for the FED, right,
Speaker 6: we've always said that this cutting cycle is going to
Speaker 6: be the mirror image of the fifteen to eighteen or sorry,
Speaker 6: this hiking cycle is going to be in the mirror
Speaker 6: image of the fifteen to eighteen cutting cycle, very slow
Speaker 6: and steady, and there's a reasonable probability that the FED
Speaker 6: first starts to cut, you know, the back end sells
Speaker 6: off as inflation expectations get anchored higher. In the event
Speaker 6: that they don't cut at all and they continue to
Speaker 6: pursue QT, which they still are as you know, there's
Speaker 6: certainly a risk that we make higher, highest as cycle,
Speaker 6: and that's one of the risks that markets have priced out,
Speaker 6: we think far too fast, particularly late last year and
Speaker 6: early this year. So yeah, it's not that fixed incomes
Speaker 6: is tragic like it was in twenty twenty, early twenty one,
Speaker 6: or late twenty one as well. It's just that the
Speaker 6: risk reward still isn't fantastic like many people have been
Speaker 6: articulating it is.
Speaker 4: I love the idea of fixed income as tragic, Troy.
Speaker 4: There is this question though, about what assets get hit hardest.
Speaker 4: If a ten year yield does climb back up to
Speaker 4: five percenta starts to retest some of these levels. Is
Speaker 4: it just public equity markets or is it also some
Speaker 4: of the private markets that have seen incredible amounts of
Speaker 4: cash flow in that are kind of peg to floating
Speaker 4: rate types of instruments.
Speaker 6: Yeah, so I think when you start with private credit
Speaker 6: is one example, which has been an area of tremendous
Speaker 6: growth and really very attractive positive returns, not only in
Speaker 6: twenty one and twenty three, but also in twenty twenty two,
Speaker 6: where the index is up roughly six to seven percent
Speaker 6: in a very tough year. You know, so when you're
Speaker 6: always rooting for higher front end rates for longer with
Speaker 6: the lowest probability of those that tighter FED policy creating.
Speaker 7: The economy right.
Speaker 6: And that's why when we first came up with the
Speaker 6: scenario last year we called the dare To Dream scenario,
Speaker 6: because you know, from a probability standpoint, it was almost
Speaker 6: too good to be true. But of course that is
Speaker 6: now the base case, where the FED is typed a lot,
Speaker 6: They're keeping rates higher for longer and the economy continues
Speaker 6: to be incredibly robust. However, to your point, if you
Speaker 6: get a high enough back end in financial conditions tighten enough,
Speaker 6: that could lead to slightly higher defaults over time, so
Speaker 6: you give back some of that excess income in the
Speaker 6: form of defaults. But so far we're seeing it is
Speaker 6: very low default rates, the ability for companies to restructure
Speaker 6: with strong handed growth private equity and public equity partners,
Speaker 6: and that means less income being returned through defaults, which
Speaker 6: is really as good of a scenario as you can
Speaker 6: hope for in private credit markets.
Speaker 4: I get the sense, and it's not just from you, Troy,
Speaker 4: but a lot of investment managers who come on say,
Speaker 4: you know, cash, you're running out of time. You got
Speaker 4: to deploy it, whether it's alternatives, whether it's into other
Speaker 4: parts of the equity market, the you know forgotten four
Speaker 4: hundred and ninety three. As we heard earlier, is there
Speaker 4: really a sort of pressure for time for cash? And no,
Speaker 4: I'm not just talking my own book, but there is
Speaker 4: this question of if the Fed's going to hold rates
Speaker 4: higher for longer, and it doesn't seem like this is
Speaker 4: that restrictive. Why couldn't you clip five percent on a
Speaker 4: money market fund for the foreseeable future?
Speaker 6: Oh yeah, Look, we've argued for the last two years,
Speaker 6: right that what you want to focus on is northwest
Speaker 6: quadron strategy strategies that have higher returns with lower risk,
Speaker 6: and cash actually is one of those alternatives to traditional
Speaker 6: fixed income and all also equities. However, when you look
Speaker 6: at where you are today, you know, really five and
Speaker 6: quarters five and a half's the peak, right. The probability
Speaker 6: of the FED hiking from here has always been non existent.
Speaker 6: It still is non existent. So you only have one
Speaker 6: way to go, and that's lower. Now, as we've discussed,
Speaker 6: it's going to be very slow, very plotting cutting cycles,
Speaker 6: so you'll still have incomes. But the question is, when
Speaker 6: you think of you know whether you're looking at actuarial
Speaker 6: studies or what folks need to retire comfortably. Typically you're
Speaker 6: in that high single digit to low teen drains, and
Speaker 6: the question now is should you at least gradually think
Speaker 6: about deploying you know that extra two and a half
Speaker 6: trillion in money markets at extra four trillion commercial bank
Speaker 6: deposits into strategies where you're not taking uncomfortable levels of risk.
Speaker 6: You're not going to walk into a potential ten or
Speaker 6: fifteen percent draw down, or if you're in inequities, or
Speaker 6: you're reaching for duration right now, as many have done
Speaker 6: the past two years, much to their chagrin, and you
Speaker 6: take a five to seven percent duration related draw down
Speaker 6: where you have certainly your conceding liquidity, you're going to
Speaker 6: have marginally more risk, but you're boosting your return potential
Speaker 6: to high smolel digits the low teens. And you know,
Speaker 6: one of the unique things about private credit now, which
Speaker 6: is really fascinating, is that you actually have potentially higher
Speaker 6: returns in the debt part of the capital structure than
Speaker 6: the equity part of the capital structure, right because that
Speaker 6: extra debt service payments that go to the lenders comes
Speaker 6: at the expense of free cash flow for a lot
Speaker 6: of big cap LBO firms, so the equity for the
Speaker 6: terms there will be lower to the benefit of the
Speaker 6: debt holder. So it's an unusual period of market industry,
Speaker 6: for sure.
Speaker 2: I love how Lisa tolking around book is standing cash
Speaker 2: if a lot of people as single names, right, you know,
Speaker 2: But for Bramo is standing cash.
Speaker 4: I'm just look, I'm not, you know, swing my head
Speaker 4: too much.
Speaker 3: I actually carry on.
Speaker 1: We don't have to continue.
Speaker 2: I want to squeaze this in. Actually it's a random question,
Speaker 2: so forgive me for this. The Ft had a strange
Speaker 2: front page yesterday and I'd love your thoughts on it.
Speaker 2: It was about the record supply, the bond issuance we
Speaker 2: had in the corporate debt market, and this really odd
Speaker 2: link about the election in the back end of this year.
Speaker 2: And I have to say, I haven't even thought of that.
Speaker 2: We linking the boom and supply in the first quarter
Speaker 2: of twenty four to the prospect of the market closing
Speaker 2: up in four q this year.
Speaker 6: You know, I think that's a bridge too far. I
Speaker 6: think what's really happened here again, you know, in our
Speaker 6: investment committee meeting we discussed that a lot of the
Speaker 6: explanatory variables for what's going on in terms of market
Speaker 6: price action as well as in terms of risk appetite
Speaker 6: gets back to those huge cash boards that the FED
Speaker 6: created during the pandemic and still lurk with us today.
Speaker 6: So what we've seen across the board, whether it's middle
Speaker 6: market corporate lending, whether it's senior serit of commercial real
Speaker 6: estate lending, whether it's HYO bonds or IG and even
Speaker 6: agency pastors which really have horrific technicals, is a gradual, steady,
Speaker 6: relentless tightening. And obviously issuers are taking advantage of that,
Speaker 6: and you're looking at the past two years and they're
Speaker 6: thinking the next six to nine months forward. This is
Speaker 6: probably one of the better points to issue new debt
Speaker 6: and lock in new financing. Just as critically, if you
Speaker 6: have a roll day coming, whether it's floating rate, dead
Speaker 6: or fixed, you know this is the window you're getting.
Speaker 6: And if you have turbulences at the back half of
Speaker 6: the year, you're probably getting better pricing now than you
Speaker 6: know perhaps in Q four. But I think that's a stretch.
Speaker 2: Very diplomatic even calling a stretch. Troy, Thank you, Troy,
Speaker 2: ESCI of FS Investments. Joining us now to discuss is
Speaker 2: Stephen Cook of the Council on Foreign Relations. Stephen waterfore
Speaker 2: to get your insight, your valuable insight on this program
Speaker 2: this morning, Could you talk us to us about possible
Speaker 2: consequences from that striking Damascus.
Speaker 5: Yeah, this is a significant escalation and the risk of
Speaker 5: the Iranians responding in any number of ways is very
Speaker 5: very high. The Iranians have attacked American forces and American
Speaker 5: forces are in Iraq and Iran, which are obviouss we've
Speaker 5: seen that happen over the course of the conflict that
Speaker 5: began on October seventh. There is also the very real
Speaker 5: possibility that whatever restraints the Iranians have placed on Lebanon's
Speaker 5: his Belah may start to loosen. There's already a very
Speaker 5: significant conflict between Israel and His Belah. The two have
Speaker 5: been trading fire since October seventh, and strikes against each
Speaker 5: other's countries have been getting bolder and deeper in recent
Speaker 5: weeks and months. So this is a very big step
Speaker 5: for the Israelis, who quite rightly point out that the
Speaker 5: multi front conflict that they are fighting is a consequence
Speaker 5: of the Iranian sponsorship of the Axis of Resistance in
Speaker 5: the North obviously in Gaza, as well as the Huti's
Speaker 5: unrelenting fire on Israel from Yemen. So the Israelis clearly
Speaker 5: want to go after what they consider to be the
Speaker 5: head of the snake.
Speaker 1: Ironian forign Minister amid Lyon in the early hours this
Speaker 1: morning said that he summoned the Switzerland envoy to give
Speaker 1: a message to United States. Potentially this is also going
Speaker 1: on with maybe back channels in Oman. What kind of
Speaker 1: back channel do you see potentially between Washington and Tehran
Speaker 1: to try to take the temperature down.
Speaker 5: There is and has long been a robust communication between
Speaker 5: Tehran and Washington through the Swiss embassy. The United States
Speaker 5: communicated to the Iranians at the outset of the conflict,
Speaker 5: communicated to the Iranians after the incident in Tower twenty
Speaker 5: two when three American soldiers were killed, that the Iranians
Speaker 5: needed to back off otherwise there would be very significant
Speaker 5: consequences for them. I imagine the Iranians are using that
Speaker 5: in reverse, communicating to the United States that unless Washington
Speaker 5: brings the Israelis to heal, the Iranians have the capability
Speaker 5: of raising a storm of violence in the region.
Speaker 1: How close are the Americans to bringing the Israelis to
Speaker 1: heal given the fact that they had this call yesterday,
Speaker 1: a strategic call, and then potentially we are going to
Speaker 1: see Israeli officials in Washington next week.
Speaker 5: I think that the American influence on the Israelis at
Speaker 5: this point is rather limited. The Israelis frame their conflict
Speaker 5: with Hamas and in fact there are a conflict on
Speaker 5: multiple fronts, as an existential threat under those circumstances. Although
Speaker 5: the United States is obviously an important strategic partner of
Speaker 5: the Israelis, advice given is not always advice taken. We
Speaker 5: have seen this throughout the conflict. President Biden believed that
Speaker 5: his bear hug of the Israeli government would give him
Speaker 5: the leverage with the Israelis to shape their military operations
Speaker 5: in the Gaza Strip. That has not happened. So the
Speaker 5: conversations between Washington and Jerusalem yesterday virtually in next week's
Speaker 5: meetings are about Israeli planned military operations in Rufa. Prime
Speaker 5: Minister Nataniello said those plans have been approved and the
Speaker 5: idea of is ready to execute them. It's unclear whether
Speaker 5: these talks will bear fruit for the United States and
Speaker 5: shaping the way the Israelis undertake this operation.
Speaker 4: Steven, there are a lot of moving pieces here, and
Speaker 4: you honed in on the northern border of Israel, the
Speaker 4: border with Lebanon, the Hesblah conflict that has been ongoing
Speaker 4: for a long time, the tit for tat and not
Speaker 4: being the true source of an escalation that could draw
Speaker 4: in a larger swath of the region and potentially disrupt
Speaker 4: things like oil markets. I'm wondering how close you think
Speaker 4: we are to that. If you could quantify how much
Speaker 4: closer we are now after these assassinations than we were
Speaker 4: before them, it would be really important, because this is
Speaker 4: really what a lot of strategists are honing in them
Speaker 4: this morning.
Speaker 5: Well, it's hard to put numbers on it, especially for
Speaker 5: historically minded political scientists like myself, but I would say
Speaker 5: that it is a strong likelihood that we will see
Speaker 5: a significant conflict between Israel and Hesbelah in the north.
Speaker 5: The constraints on both parties have been loosening in recent
Speaker 5: weeks and months. The strike in ask Us yesterday that
Speaker 5: killed two IRGC generals something that the Iranians are going
Speaker 5: to be unable to not respond to. I think the
Speaker 5: only thing really holding the Israels back right now is,
Speaker 5: in an odd and twisted way, is concreditional dysfunction. The
Speaker 5: Israels need that security assistance that has been locked in
Speaker 5: Congress in order to acquire the kind of precision munitions
Speaker 5: they would like to use in a conflict with his Belah.
Speaker 5: But I think in the next four six months we're
Speaker 5: likely to see a major escalation in the North.
Speaker 4: Was to stop that from percolating out into a broader
Speaker 4: region that really does disrupt broader trade markets in the
Speaker 4: way that a lot of people have suspected was the
Speaker 4: worst case scenario.
Speaker 5: Yeah, I think the major factor here is that the
Speaker 5: Israelis and has ball getting involved in a major conflict
Speaker 5: that the Iranians and the Huthis continue to interfere with
Speaker 5: global shipping and meaning also for the oil markets. Neither
Speaker 5: Israel nor Lebanon are major players in the energy markets,
Speaker 5: so there's a lot of gas off booth their coach.
Speaker 5: But the knock on effects in which Iran and its
Speaker 5: access of resistance can disrupt the global economy as they've
Speaker 5: done or tried to do in the Red Sea is
Speaker 5: something that I think everybody needs to be well aware.
Speaker 2: Of Steven, appreciate your time this morning. Thanks very insight
Speaker 2: so Stephen Cook there of CFR. This is the Bloomberg
Speaker 2: Surveillance Podcast, bringing you the best in markets, economics, angiopolitics.
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