Speaker 1: Hello, and welcome to What Goes Up, a weekly markets podcast.
Speaker 1: My name is Mike Reagan. I'm a senior editor at
Speaker 1: Bloomberg now Madonna higher across asset reporter with Bloomberg at
Speaker 1: this week on the show, Well, as you may have heard,
Speaker 1: both the stock and bond markets have gotten off to
Speaker 1: a rip roaring start this year, and that meant that
Speaker 1: basically everyone and their dog was predicting that Fed Chair
Speaker 1: Jerome Pow would come out to the podium this week
Speaker 1: and ruin all the fun for everyone. But he didn't
Speaker 1: quite do that, and stock prices continue to rip higher,
Speaker 1: bond yields continue there to sent back to Earth. So
Speaker 1: what's the deal? What's going on? Doesn't the Fed still
Speaker 1: want to tighten financial conditions? We'll get into it with
Speaker 1: a chief investment officer from a firm I think you've
Speaker 1: probably heard of, but Vildonna. Before that, I've got play
Speaker 1: a little word association with you. If I say to
Speaker 1: you the song remains the same, what's the first thing
Speaker 1: that pops into your head? Jerome Paul Jerome pal is
Speaker 1: the first thing that pops into your head? All right?
Speaker 1: How about if I say the end is near? What
Speaker 1: pops into your head. Um, I don't know some apocalyptic movies.
Speaker 1: I'm really bad at this. Okay, I'm really bad at this,
Speaker 1: so well, to me, it's my old record collection, because
Speaker 1: I think the sweet guest has a similar record collection.
Speaker 1: To mind, the song remains the same, is of course
Speaker 1: led Zeppelin song album and movie I total, I believe,
Speaker 1: and I'm not sure, but I think he was referring
Speaker 1: to Sinatra with the End is Near, but we'll have
Speaker 1: to find out. Okay, you're just dating our guests. Basically
Speaker 1: I'm dating myself a little bit too. And you just
Speaker 1: showed off you're too young to know who led Zeppelin is.
Speaker 1: You didn't have a gene jacket in the eighties with
Speaker 1: the led Zeppelin huge led Zeppelin patch on the back
Speaker 1: obviously not did I you're asking me? No, I was
Speaker 1: born in Hello, Okay, so let's see if if our
Speaker 1: guess is um mad at being dated by you. But
Speaker 1: it's Jim Karen. He's co chief investment Officer of Global
Speaker 1: Balance Funds at Morgan Stanley Investment Management. And Jim, thank
Speaker 1: you so much for joining us and apologies for for
Speaker 1: Mike's comments. No, no, my pleasure. I'm glad. He got
Speaker 1: the references. Those are exactly the references. And I did
Speaker 1: have a gene jacket in the seventies and also in
Speaker 1: the eighties, I did have like the little pins on
Speaker 1: the gene jacket. And part of the reference to is
Speaker 1: that that the record label for led Zeppelin was Swan signed.
Speaker 1: So the other reference is that this is also a
Speaker 1: Swan sign for the rate hiking psychos. There's a lot
Speaker 1: of references that are going on multi layer there, all right,
Speaker 1: I do understand this finance stuff after all, the don
Speaker 1: I I clearly, I clearly don't. This stuff should be
Speaker 1: on the CFA exam for sure. But it's funny though,
Speaker 1: you know, uh strategists realized they'll get a lot of
Speaker 1: readers of a certain age to to you know, read
Speaker 1: their stuff when they throw in those classic rock references.
Speaker 1: So I I applaud you, Jim. I definitely want to
Speaker 1: get into the markets talk. But I was I was
Speaker 1: just going through your background. And it's funny because I
Speaker 1: have this recurring dream where I'm back in college for
Speaker 1: a second bachelor's degree and everyone's like, what are you
Speaker 1: doing getting a second batrilo's degree. I'm like, I don't know.
Speaker 1: It just it just felt right. But I find it
Speaker 1: fascinating your education. So bachelor's in physics UH from Bowden
Speaker 1: then and other bachelor's UH in Aeronautical engineering from Californy
Speaker 1: Institute of Technology. Very interesting background, and it's always fascinating
Speaker 1: to me the different paths people take to Wall Street.
Speaker 1: A lot of times it is that physics or engineering background.
Speaker 1: So what were you thinking back then where you It
Speaker 1: sounds like you wanted to be a rocket scientist when
Speaker 1: you're when you're a kid. Yeah, that's that's probably correct.
Speaker 1: So I was on a program what was called a
Speaker 1: three two programs, So I spent three years of Bowden,
Speaker 1: got a physics degree, and then went to cal Tech
Speaker 1: to do engineering. And I always loved the markets, and
Speaker 1: I always thought of the markets as as almost like
Speaker 1: a financial engineering experience. That plus the fact that I
Speaker 1: was graduating during the time where there was a big recession,
Speaker 1: a big piece dividend was being paid. UM, the Berlin
Speaker 1: Wall had come down, a lot of the engineering work
Speaker 1: was going into the defense sector, which was being you know,
Speaker 1: eliminated pretty much. So UM, I really started to get
Speaker 1: interested in the markets, and that's where it led me
Speaker 1: and I loved all of the math and the complexity
Speaker 1: that was going through at the time. And it was
Speaker 1: actually when actually Bloomberg in some ways was it. It
Speaker 1: was in its infancy and today people take it as
Speaker 1: a as a granted, but I used to do a
Speaker 1: lot of my calculations on a calculator called him Monroe,
Speaker 1: and we would and that was the Bloomberg of the time.
Speaker 1: That was the high technology of the time. It was
Speaker 1: one of those big hand calculators. So I really have
Speaker 1: an appreciation for how things get done, how things come together,
Speaker 1: how things actually work. And I think of the broader
Speaker 1: markets is almost like a machine or or or an
Speaker 1: engine in some ways where everything needs to be just
Speaker 1: right for for it to run smoothly. So so that's
Speaker 1: the association that I have between the engineering and science
Speaker 1: background versus what's going on in markets today. I really
Speaker 1: like that and I like your description of it, and um,
Speaker 1: it's a perfect segue into what is going on in
Speaker 1: markets today. Because we did hear from the FED. The
Speaker 1: tone of the press conference was very different from what
Speaker 1: investors had been expecting. So maybe just like layout for
Speaker 1: our listeners, what do we get from the FED? UH
Speaker 1: and what your main takeaways were from from the pressor so.
Speaker 1: I think it's very interesting to the extent that how
Speaker 1: is really trying to walk a very very fine line,
Speaker 1: to the extent that he wants to signal that the
Speaker 1: rate hiking cycle is coming to an end. And he
Speaker 1: even made reference to that, and he said, we're talking
Speaker 1: about a couple of more hikes. Well, a couple to
Speaker 1: me means to possibly too. But at the same time,
Speaker 1: he doesn't want to let financial conditions become very very easy,
Speaker 1: have stock markets go up at credit spreads tightened very quickly,
Speaker 1: and all of a sudden bring in those inflationary pressures again,
Speaker 1: and that would really work against him. So in one sense,
Speaker 1: he wants to say, I'm slowing the pace of rate
Speaker 1: hikes and I might be coming towards the end, but
Speaker 1: the terminal policy rate has not yet been determined. Now, obviously,
Speaker 1: if you say we have a couple of more hikes
Speaker 1: to do, or we're you know, coming towards the end
Speaker 1: of this, you know, we can all do the math
Speaker 1: and say, well, then the fens either done in March
Speaker 1: with the next bases point rate hike, or or they're
Speaker 1: done on May three, which is their meeting after the
Speaker 1: March meeting with so they're either done at five or
Speaker 1: five point to five. And I think that is essentially
Speaker 1: what the market started a key off of if we
Speaker 1: think back to what the December Summary of Economic projections were,
Speaker 1: so the big meeting before this meeting that we had
Speaker 1: on Wednesday, it basically told us that the terminal policy
Speaker 1: rate was going to be somewhere between five and five
Speaker 1: point five. And now it seems like that's even coming
Speaker 1: down to a more truncated five to five point to five.
Speaker 1: But let's just say by by the end of the
Speaker 1: second quarter the FETE is done. Um, probably by the
Speaker 1: beginning of the second quarter, the FETE is going to
Speaker 1: be done. And I think the markets are taking some
Speaker 1: solace in that, and you're seeing interest rates come down
Speaker 1: and you're seeing equity prices move up as a result. Yeah,
Speaker 1: And it's interesting and he even refer to the past
Speaker 1: where they would you know, high creates every other meeting
Speaker 1: almost you know, perhaps signaling that that's a possibility that
Speaker 1: maybe they'll pause, pause in March and then come again
Speaker 1: in maybe What's I find fascinating, Jim, is you know,
Speaker 1: all of Wall Street, the financial world watching Pal's press
Speaker 1: press conference on one screen and on their their other screen,
Speaker 1: they've got the markets, you know, whether Bloomberg terminal or
Speaker 1: I don't know, there's something else other people use. But
Speaker 1: is there anything else? I don't know, I don't know,
Speaker 1: But you know, I almost wish Pal had the benefit
Speaker 1: of having a terminal in front of him when he's speaking,
Speaker 1: because you don't quite you know, it's the question is
Speaker 1: always you know, did he sort of not get the
Speaker 1: intended message that he wants out? You know, is there
Speaker 1: going to be some hawkish commentary coming from some of
Speaker 1: the other speakers in the next few weeks and from
Speaker 1: him himself to sort of walk back this loosening in
Speaker 1: financial conditions that we have to. I mean, we really
Speaker 1: quite loose all year, and looser after the press conference
Speaker 1: in terms of you know, stocks ripping, higher yields and
Speaker 1: spreads coming in. Do you think we'll get a little
Speaker 1: bit of that, a reminder that hey, you know, we're
Speaker 1: still going to keep these rates high, We're not gonna
Speaker 1: cut this year. You know, is is there sort of
Speaker 1: a whiplashed to expect in the coming weeks? You know,
Speaker 1: there was whiplash during the press conference, so so so Yes,
Speaker 1: I think, Look, I think this is a great question,
Speaker 1: because this is one of the risks that I think
Speaker 1: that we have coming up over the next few weeks,
Speaker 1: is that if the intended market reaction, if there even
Speaker 1: was one, doesn't match what the intended statement was supposed
Speaker 1: to convey, then, as is typical, there's going to be
Speaker 1: some walking back of this. And I want to really
Speaker 1: highlight this because I think it's extremely extremely important. What
Speaker 1: Powell said in the statement was viewed as relatively hawkish, right,
Speaker 1: and then all of a sudden, he starts his uh,
Speaker 1: he starts his his press conference, and he basically says
Speaker 1: the exact same thing that he said back in December.
Speaker 1: It was almost a carbon copy of of of the issues.
Speaker 1: First one was that labor markets remain tight, which is
Speaker 1: keeping inflation risks elevated. Second point that he made was
Speaker 1: he started to call out, you know, despite the decline
Speaker 1: and CPI and wageing for sation, it's still too high
Speaker 1: to be consistent with inflation becoming um anchored at at
Speaker 1: target levels. So he's still worried about it. And then
Speaker 1: he goes further and he starts to talk about again
Speaker 1: exactly what he talked about in December, the service sector
Speaker 1: inflation versus the goods sector inflation. And he said, look,
Speaker 1: we know why inflation is coming down. Durable goods, supply chains,
Speaker 1: all of these things are are certainly coming down, but
Speaker 1: service sector inflation is not coming down as fast as
Speaker 1: they like. And then he even went further up the
Speaker 1: anti on that even more, and he said that in fact,
Speaker 1: the service sector and inflation, if we look at it
Speaker 1: core services x housing again, core services x housing, that's
Speaker 1: what he's looking at, and that's what we should all
Speaker 1: be looking at. He said, hasn't even started to fall.
Speaker 1: So as I'm listening to this, this is a guy
Speaker 1: who's worried about inflation. This is somebody who's not done
Speaker 1: tightening by any stretch of the imagination. And and then
Speaker 1: he said that that was about percent or the majority
Speaker 1: of or a large part of the core PC in
Speaker 1: the index, which is what the FEDS favorite gauge of
Speaker 1: of inflation is. So if the core services X housing
Speaker 1: isn't hasn't even begun to fall yet and they look
Speaker 1: at core that the core PC index, um, he still
Speaker 1: believes it's going to be elevated. Then he went on
Speaker 1: even further to say wouldn't it be a shame if
Speaker 1: just when we had inflation on the brink of being,
Speaker 1: you know, a solved problem, that we didn't tighten enough,
Speaker 1: and then all of a sudden it started to resurge
Speaker 1: later on. That would be That would be really bad.
Speaker 1: And to me, that is my core risk. If somebody
Speaker 1: asks me, what's the risk that keeps you up at night?
Speaker 1: Aside from all the geopolitical potential risks, the risk that
Speaker 1: keeps me up at night is that we get this
Speaker 1: decline in inflation in the first half of the year,
Speaker 1: which we know is happening, but all of a sudden
Speaker 1: we realize in the second half of the year that
Speaker 1: it's not anchored. It comes down, but then all of
Speaker 1: a sudden starts to show signs and it may start
Speaker 1: to bubble up in four and beyond, and then they
Speaker 1: have to come back in and start hiking again from
Speaker 1: an already high base. The markets do not have this
Speaker 1: priced in. Everybody's talking about the pivot and FED funds
Speaker 1: and the expectation for rates to come down and what
Speaker 1: have you. It would be a significant surprise and really
Speaker 1: bad per house of prices if in fact that this
Speaker 1: all got turned on its head, and all of a sudden,
Speaker 1: the FED said, no, we actually have to start restart
Speaker 1: our hiking cycle, or we started to price that back
Speaker 1: in if that were to happen, if inflation became unanchored.
Speaker 1: And he again he mentioned this, so this is this
Speaker 1: is him saying this, So this does not sound like
Speaker 1: a person that is UM is ending their inflation fighting plight. UM.
Speaker 1: But then in the second part of the press conference
Speaker 1: he went on to say, yeah, but you know what,
Speaker 1: we're probably just talking about a couple of more hikes,
Speaker 1: and then he became a lot more devish in the
Speaker 1: market just seized on that. So I do think over
Speaker 1: the next couple of weeks we're going to see other
Speaker 1: FED officials come out and try to rebalance that statement
Speaker 1: so that there's two sided risk in the market that
Speaker 1: it shouldn't be taken according to the Fed as a
Speaker 1: done deal, that they're done, that that there may still
Speaker 1: be more to go. And I think this is really
Speaker 1: the key here, which is creating confusion. But you know,
Speaker 1: obviously in March there's gonna be a new summary of
Speaker 1: economic projections, their forecasts for the next quarter um or
Speaker 1: not just for the next quarter, but for the next
Speaker 1: few years, they redo their forecasts and we'll have a
Speaker 1: better understanding as to what they see in terms of
Speaker 1: inflation expectations and policy expectations. So I wonder, you know
Speaker 1: that risk that's keeping you up at night, how do
Speaker 1: you categorize it is at a tail risk? Or do
Speaker 1: you think that's something we're really got to worry about?
Speaker 1: And what would cause that sort of resurgence in inflation?
Speaker 1: Would we need some sort of exogenous event, oil price
Speaker 1: shock or something like that. Where is it just a
Speaker 1: matter of look, you know, uh, this is unchartered water,
Speaker 1: and inflation can can be unpredictable. Yeah, So so let
Speaker 1: me split the difference on the level of risk, and
Speaker 1: I'll say it's a fat tail risk. Right, So it's
Speaker 1: a tail risk, but it's a fat tail meaning that
Speaker 1: it has a higher than ordinary probability for um uh
Speaker 1: for the event to occur. And I would even subjectively
Speaker 1: put that as high as right, which is to me,
Speaker 1: that's you know, we can debate as a tail risk, right,
Speaker 1: I mean, it's it's a reasonable risk, but it's not
Speaker 1: to me, it's not in the majority. So so what
Speaker 1: creates that? Well, certainly energy prices could do that right. Certainly,
Speaker 1: that is um something that's out there. We know that
Speaker 1: there's been you know, not enough productive production relative to
Speaker 1: the demand, and we know all of the different factors.
Speaker 1: Their energy has come down for various reasons. In the
Speaker 1: second half of two it's started to come down, and
Speaker 1: it's it's still staying relatively low. But to me, that's
Speaker 1: not really the main issue here. The main issue is
Speaker 1: the labor market. The labor market is what's perplexing everybody,
Speaker 1: and everybody has different theories and different views on it,
Speaker 1: and there's one thing in common is that it really
Speaker 1: most models really just haven't worked in terms of trying
Speaker 1: to predict labor. And the issue that we have right
Speaker 1: now is that there's that there's a lot of tightness
Speaker 1: still in the labor market. Look, we got a Jolts
Speaker 1: survey that came out you know, this past week, and
Speaker 1: essentially it showed eleven million job openings, right, so the
Speaker 1: job opening is actually ticked up. They haven't been going
Speaker 1: down as as expected, again baffling most people's forecasts. The
Speaker 1: other is that the vacancy to unemployment rate, so the
Speaker 1: number of jobs open for every unemployed person is sitting
Speaker 1: at about one point nine to one. Let's call that
Speaker 1: two to one, So there are two jobs open for
Speaker 1: every unemployed person. So while consumer confidence is coming down
Speaker 1: because we're hearing about layoffs in the tech sector and
Speaker 1: in these big gargangea win numbers that are being thrown
Speaker 1: out there, the reality is is that when we look
Speaker 1: at all this claims, when we look at the unemployment
Speaker 1: rate um, and when we look at the BLS, UH
Speaker 1: surveys and statistics, what we're finding is that these people
Speaker 1: who are being laid off in the tech sector are
Speaker 1: finding jobs in other areas. Now, the nuance here is
Speaker 1: that the jobs that they're finding are lower pain. So
Speaker 1: now I want to be very very clear about this
Speaker 1: because I think this is an important point to make.
Speaker 1: Foreree is going to feel worse to Main Street and
Speaker 1: better to Wall Street. Felt worse for Wall Street and
Speaker 1: better for Main Street. So look, if we look at
Speaker 1: what we saw was inflation going to forty years highs,
Speaker 1: we'd have to go back to the eighties and the
Speaker 1: seventies to see the levels of inflation that we had.
Speaker 1: We had gas prices going up to sky high levels
Speaker 1: and all of these various things, but what we also
Speaker 1: had was job creation people were employed. The jobs market
Speaker 1: was still very, very strong and had our's weakened. So
Speaker 1: even though higher prices were coming into the economy, what
Speaker 1: people realized is that, well, they had a job, they
Speaker 1: could pay the higher prices. They would still go out
Speaker 1: to eat at restaurants and spend time at hotels and
Speaker 1: go on airplanes and do all these various things. So
Speaker 1: even though yes, all of that bad economic stuff was happening,
Speaker 1: and certainly the bond market took notice of that, bond
Speaker 1: yields rose quite a bit. Certainly equities took notice of that,
Speaker 1: and you know, we all know what the performance of
Speaker 1: equity prices were. But the consumer felt, Okay, now what
Speaker 1: we're seeing is the we're coming to the end of
Speaker 1: this inflation cycle. At least for now, it's starting to
Speaker 1: come down. We're coming to the end of this rate
Speaker 1: hiking cycle. So rates are coming down, equities are responding positively,
Speaker 1: bonds are responding positively. If you ask people on Wall Street, hey, look,
Speaker 1: things are pretty good. If you ask people on Main Street,
Speaker 1: they're saying the exact opposite thing. Now, why this now,
Speaker 1: all of a sudden becomes a lot more important. Is
Speaker 1: that in going into four starts the year of the
Speaker 1: political cycle of a presidential election. So all of these
Speaker 1: discussions around how do we control inflation? And I always
Speaker 1: think it's very informative that every press conference that Pal
Speaker 1: has started going back about you know, almost a year now,
Speaker 1: he starts off by apologizing to the American people. He says, listen,
Speaker 1: you know, we're sensitive to everybody's paying. We know that
Speaker 1: there's the unemployment rate. The employment situation may get worse
Speaker 1: in the future, but we think it's a necessary thing
Speaker 1: to do to control inflation. The reality is at the
Speaker 1: unemployment rate has stayed relatively low, with the jobs market
Speaker 1: has stayed relatively tight. So what that tells us is
Speaker 1: that if we do get into a situation where, um,
Speaker 1: where we do get a slowing in the economy, but
Speaker 1: the jobs market stays relatively robust, people still have uh
Speaker 1: you know, consumers still have dollars to spend um and
Speaker 1: consumption is GDP, that we could all of a sudden
Speaker 1: start to get a resurgence in demand. Now, remember when
Speaker 1: the Fed heights interest rates, what they're trying to do
Speaker 1: is push down demand. But if we get through this
Speaker 1: soft patch, this corrective patch of Fed policy, inflation and
Speaker 1: everything else, and we come through this with a soft
Speaker 1: landing or maybe a mild recession, then we're going to
Speaker 1: come out of that like wild horses, right, and that
Speaker 1: wage inflation, that inflation could then go on to create
Speaker 1: what what Powell calls and what the central bankers call
Speaker 1: the wage price spiral inflation. And he always says, look,
Speaker 1: there's no evidence of it yet, but as soon as
Speaker 1: we see it, game is already over right, So you
Speaker 1: never want to get to that point. And so that's
Speaker 1: why that's the risk that keeps me up is that
Speaker 1: I think that there could be some underpinnings to say, well,
Speaker 1: let's slow down the hikes right now, because you know,
Speaker 1: we need to be sensitive to you know, politically and
Speaker 1: everything else. But it doesn't do the inflation fighting job,
Speaker 1: and then we have a worse problem a year later,
Speaker 1: eleven million job openings out there. So it's so, you know,
Speaker 1: it's it's that labor market is still red hot. So so, Jim,
Speaker 1: what did you make of um Powell almost taking a
Speaker 1: victory lap when he said, this is the first time
Speaker 1: that the Fed can actually admit we are seeing disinflation,
Speaker 1: which was a common that really struck me. I think
Speaker 1: he wishes that he could take that word back, because
Speaker 1: that as soon as he said that, the markets took
Speaker 1: off like a rocket. I mean you could time it
Speaker 1: to that statement, and it was only he was only
Speaker 1: referring to goods prices too, you know. Specifically. I think, well,
Speaker 1: we'll see, now you were paying attention. Other people just
Speaker 1: heard the word, you know, disinflation, and they hit the
Speaker 1: buy button and they just left the finger on the
Speaker 1: button until all their orders were filled. Well, that's right,
Speaker 1: you know, And I think that's going to be part
Speaker 1: of the walk back is to say, well, what I
Speaker 1: said disinflation, what I really meant was goods disinflation, and
Speaker 1: that should be a good You know, he's getting too
Speaker 1: nuanced in these things, right, you have to really be
Speaker 1: a professional listening to this. I think most people are
Speaker 1: kind of listening to it out of one ear and
Speaker 1: and then they're trading in the markets, you know, um
Speaker 1: at the same time. So yeah, I think that he's
Speaker 1: correct in saying that about goods prices. I wish he
Speaker 1: framed it differently because I think it just creates more
Speaker 1: volatility markets. Yeah, can I can? I also ask you then,
Speaker 1: just to go back to the financial discussion about financial
Speaker 1: conditions because obviously the FED doesn't want looser financial conditions,
Speaker 1: but and we already mentioned this, they are looser because
Speaker 1: of the value we've seen in the stock market, etcetera.
Speaker 1: Powell said that they've tightened significantly, that the FED is
Speaker 1: looking at financial conditions in a longer term versus a
Speaker 1: shorter term time frame. And then the discussion on Twitter
Speaker 1: was like, Okay, where is he looking Like what models
Speaker 1: is he looking at? Because you know, even if we
Speaker 1: look at the there's a Bloomberg financial conditions um in
Speaker 1: next that has just loosened significantly since when they started
Speaker 1: hikes last March. Like, what do you what do you
Speaker 1: make of this discussion? What might Paul be referring to? I?
Speaker 1: I love that you're asking this question. It's a question
Speaker 1: that most people use the words financial conditions and they
Speaker 1: don't quite understand what that is um And it's actually
Speaker 1: questions that I've I've actually gotten I've gotten this question
Speaker 1: exactly because people are there are various ways to calculate
Speaker 1: financial conditions, and and let me just start from the
Speaker 1: top and just say financial conditions are really a measure
Speaker 1: of how the how market prices are reflecting central bank policy.
Speaker 1: So then it becomes okay, well, what market prices, what
Speaker 1: market indicators are you looking at? Because in theory, if
Speaker 1: you increase policy rates, you should get a weakening of
Speaker 1: financial asset prices. That's just the way these things work.
Speaker 1: But now we have to create um financial conditions is
Speaker 1: actually an index, right, So now we have to create
Speaker 1: a and I know Bloomberg has an index of financial
Speaker 1: conditions as well. It has a lot of different variables
Speaker 1: in it. The five principal components of financial conditions, meaning
Speaker 1: that the five factors that drive financial conditions the most.
Speaker 1: Where you're gonna get the information is going to come
Speaker 1: from five things. Number one, short term interest rates. That
Speaker 1: could be three month T bill rates. That could be
Speaker 1: policy rates. You know, let's call it three month TI
Speaker 1: bill rates, because that's something that we can measure in
Speaker 1: the markets, right, that's something that we can watch. The
Speaker 1: second would be intermediate term treasury rates, and that would
Speaker 1: be called that the tenure treasury yield, again, another market
Speaker 1: measurable item that we can use to reflect central bank policy.
Speaker 1: The third is going to be triple be credit spreads.
Speaker 1: So that tells us something about the credit conditions in
Speaker 1: the markets. The fourth is going to be the equity market,
Speaker 1: so let's call that the S and P five hundred broadly.
Speaker 1: The fifth is going to be the trade weighted value
Speaker 1: of the US dollar. Those five are the big five.
Speaker 1: Those matter the most. Now you could say, well, what
Speaker 1: about home prices, and how about oil or how about that.
Speaker 1: We could throw a hundred different things in there. The
Speaker 1: problem statistically when you do that is that you end
Speaker 1: up like losing the information. So those five if you
Speaker 1: did a pc a principal component analysis on financial conditions
Speaker 1: and reflected that to central bank policy, those five are
Speaker 1: the ones that matter the most. So it's an index,
Speaker 1: meaning that there's a waiting that gets attached to each
Speaker 1: one of those uh five variables or five five components,
Speaker 1: and then you come up with a number, right, and
Speaker 1: that becomes your index. It's just like a typical it's
Speaker 1: like calculating any any old index, and that's what you measured.
Speaker 1: So when we look at financial conditions, I would say
Speaker 1: that financial conditions you have become easier, but they've also
Speaker 1: tightened the lot. Just look at what happened last year.
Speaker 1: Credit spreads wide, end um interest rates rose, the dollar
Speaker 1: got very strong, so a stronger dollar is weaker for
Speaker 1: financial conditions. If you have UM, it just makes your
Speaker 1: exports more expensive and it's harder for you know, your
Speaker 1: companies to make money in that sense. Obviously, higher interest rates,
Speaker 1: higher cost of capital, higher credit spreads, tighter credit spreads
Speaker 1: are weaker for financial conditions, weaker equity prices, all of
Speaker 1: those things. So financial conditions actually tightened quite a bit
Speaker 1: recently with the decline and interest rates, the decline in
Speaker 1: the dollar, the decline and credit spreads, the increase in
Speaker 1: equity prices. Those have now recently started to ease financial conditions,
Speaker 1: but only after they've tightened a lot. But they're not
Speaker 1: easier today than where they were a year ago. There's
Speaker 1: still a lot tighter than where they were a year ago.
Speaker 1: But there has been an easing of financial conditions over
Speaker 1: the past say four or five weeks, just given the market.
Speaker 1: So when Pile saying I'm not concerned about short term
Speaker 1: financial conditions, I'm really more learned about longer term. I
Speaker 1: think what he's basically saying is like, look as I
Speaker 1: come to an end of the rate hiking cycle, UM
Speaker 1: and people start to price in more stable interest rates
Speaker 1: and possibly even lower interest rates at some point. Of course,
Speaker 1: in the near term you're going to get an easing
Speaker 1: of financial conditions because I'm not tightening anymore, um. But
Speaker 1: longer term, these are the long and variable legs. The
Speaker 1: fact that they may keep the policy rate at five percent,
Speaker 1: let's say, for an extended period of time, might actually
Speaker 1: tighten financial conditions because they're just going to keep the
Speaker 1: cost of capital, keep the costs of credit higher for
Speaker 1: a longer period of time. So he's just saying, look,
Speaker 1: I'm not trying to micro manage the markets by looking
Speaker 1: at financial conditions. We have to think about what our
Speaker 1: policy decision and keeping our policy decision in place is
Speaker 1: going to do for the longer term. And that's essentially
Speaker 1: what he's saying. Jim, if I'm remembering your resume correctly,
Speaker 1: you were rate strategist for a long time, right and
Speaker 1: uh now co chief investment of the Global balance funds
Speaker 1: at Morgan Stanley Investment Management. This is how I segue
Speaker 1: into the part of the podcast I call it the
Speaker 1: just tell me what to do with my money already
Speaker 1: element of the podcast. You know, obviously from from a
Speaker 1: balanced fund perspective, last year nothing work, you know, sixty
Speaker 1: forty was you know, just a nightmare this year. I
Speaker 1: gotta think back from the dead for sixty forty or
Speaker 1: whatever your preferred ratio is. To some degree, I'm curious
Speaker 1: how you're thinking about it. You know, whatever your allotment
Speaker 1: is to, if it's not six to socks and bonds,
Speaker 1: are you tweaking that ratio at all? Do you think
Speaker 1: maybe in favor of bonds and specifically in fixed income? Um, well,
Speaker 1: at totally. There's a lot of bankruptcy talk swelling around.
Speaker 1: You know, if these rates stay higher for longer, are
Speaker 1: are you worried about credit spreads? Are you leaning more
Speaker 1: towards just safe, safe treasuries in that fixed income bucket?
Speaker 1: So how are you thinking about portfolio composition as a whole?
Speaker 1: I guess is the to boil it down? So this
Speaker 1: is the key. This is a key issue here for
Speaker 1: this year, and not only just for this year, but
Speaker 1: even over the past few years. It's really about the
Speaker 1: portfolio construction. So what a global balanced strategy does is
Speaker 1: it tries to look across multiple assets fixed income, equities, commodities, currencies,
Speaker 1: and tries to put together a balance of risks that
Speaker 1: creates an optimal risk adjusted return, and that's what our
Speaker 1: strategy effectively does. And the the idea right now or
Speaker 1: the problem that we have right now is not a
Speaker 1: new problem, and this is something that I I so
Speaker 1: I'm glad, I'm glad, I'm glad you're asking this question
Speaker 1: because this is this is an important issue for us,
Speaker 1: which is that we have a high correlation in markets
Speaker 1: right now. So if we go back to two thousand
Speaker 1: and eighteen, we had high correlation markets there where fixed
Speaker 1: income and equity didn't work so well together. So the
Speaker 1: sixty forty didn't work. Two thousand and nineteen, the sixty
Speaker 1: forty portfolio worked well because all of a sudden, you know,
Speaker 1: equities and fixed income went up. Two thousand twenty was
Speaker 1: an odd year. It was the year of the pandemic.
Speaker 1: But ultimately, by the end of the year, the sixty
Speaker 1: forty portfolio did well because equities went up in price
Speaker 1: and bonds went up in price. So so so far,
Speaker 1: going back to what I've highlighted is that we've been
Speaker 1: in a high correlation market. In nineteen and now as
Speaker 1: we go to one, we also had a very high
Speaker 1: correlation market. We had fixed income and equity doing poorly,
Speaker 1: and people tend to notice high correlations when fixed income
Speaker 1: and equity do poorly. And now here we are in three,
Speaker 1: we also have a high correlation market. Both fixed income
Speaker 1: and equities are doing well. People ignore high correlation risks
Speaker 1: when both assets are doing well, but they tend to
Speaker 1: notice them greatly when both assets are doing poorly. The
Speaker 1: point that I'd like to make is that we were,
Speaker 1: we've been in a high correlation market for the past
Speaker 1: several years, and I think this really puts a lot
Speaker 1: of stress and pressure on the sixty portfolio. So to
Speaker 1: answer your question, you know, more directly after that preface
Speaker 1: is you know, so what do we do is what
Speaker 1: we need to do is we need to balance a portfolio.
Speaker 1: We need to think about how we balance the risks,
Speaker 1: meaning that um, how we look at equity risk, how
Speaker 1: we look at fixed income risk. If they're both going
Speaker 1: to be highly correlated, your traditional sixty forty isn't really
Speaker 1: going to work the way that it did in the past.
Speaker 1: Because what we have to remember is the reason the
Speaker 1: sixty forty portfolio works so well having six equity bonds
Speaker 1: was because the bond market fell you know, basically performed
Speaker 1: well in thirty six out of the last forty years
Speaker 1: except for last year, right, So we had a bullmarket
Speaker 1: in bonds for forty years just about and and essentially
Speaker 1: the bonds were a good hedge for anything. But now
Speaker 1: as we get to a point in the economic environment
Speaker 1: and the structure of the economy where risk free rates
Speaker 1: are going to be higher, I think we're gonna have
Speaker 1: inflation issues and risks for the foreseeable future for the
Speaker 1: next five or seven ten years, and you're gonna have
Speaker 1: more variability in interest rates. So now, all of a sudden,
Speaker 1: the sixty forty portfolio doesn't work as well as having
Speaker 1: a static allocation. So what we have to think about
Speaker 1: in terms of hedging and creating a more dynamic, better
Speaker 1: portfolio that optimizes risk adjusted returns is trying to manage
Speaker 1: the volatility. So, in other words, if what the sixty
Speaker 1: forty portfolio was supposed to do for you was give
Speaker 1: you a stable return profile, what I'm saying is that
Speaker 1: in that static sixty forty portfolio, you're not going to
Speaker 1: get that anymore. You haven't been getting it since. But
Speaker 1: what you need to do is target of volatility. What
Speaker 1: you have to say is, if I want to get
Speaker 1: pick a number. I want a seven percent return, right,
Speaker 1: But I want a seven percent return, but I want
Speaker 1: that within a range I don't want to I don't
Speaker 1: want to take on too much volatility to get that
Speaker 1: seven return. So I want my volatility to be in
Speaker 1: a range between say four and ten percent. Right, I'll
Speaker 1: accept that as an acceptable range from my return volatility.
Speaker 1: So really what we have to start thinking about today
Speaker 1: is not the static six forty portfolio, but really trying
Speaker 1: to target the volatility of the portfolio so that you
Speaker 1: you can manage your return profile in a more stable range.
Speaker 1: And what that allows you to do. The big benefit
Speaker 1: there is it allows you to compound your returns over
Speaker 1: time in a more stable manner. That's what the sixty
Speaker 1: portfolio was able to provide for like like since and
Speaker 1: what we've seen since is that that sixty forty hasn't
Speaker 1: been working as advertised, and that that's what I would
Speaker 1: say is start thinking about strategies, you know, like the
Speaker 1: one that I manage effectively that thinks about stabilizing the
Speaker 1: volatility of returns to have a more balanced portfolio. But Jim,
Speaker 1: you mentioned you expect inflation to be an issue for
Speaker 1: the next five, seven, ten, years. So where do you see?
Speaker 1: What do you see happening with inflation? Because we've had
Speaker 1: some guests on the podcast the last couple of weeks
Speaker 1: who have said they don't see they sort of see inflation, um,
Speaker 1: the downturn and inflation topping out at around five percent
Speaker 1: maybe and staying around five percent. So what do you see? Well,
Speaker 1: you know, even if the downturn in inflation tops out
Speaker 1: of five percent, that's way above the fed's target of two. Right.
Speaker 1: So so now we have to we have to think
Speaker 1: structurally about what's going on um from a very macro perspective. Right,
Speaker 1: So when we think about why inflation started to fall
Speaker 1: and when did it really start to fall, precipit this league.
Speaker 1: I mean, obviously it peaked in the in the early
Speaker 1: eighties under Vulcar he killed inflation hydrates a lot um.
Speaker 1: But then all of a sudden we had a big
Speaker 1: change in policy under President Reagan. He moved more towards
Speaker 1: the supply side economics UM type of a solution. And
Speaker 1: what he did was he deregulated and essentially what he
Speaker 1: did in the supply side economics is he increased the
Speaker 1: productive capacity of corporations to make supply meet demand and
Speaker 1: bring down prices so you can have higher growth and
Speaker 1: lower prices. And that was really the miracle of the
Speaker 1: eighties that then spilled over into the nineties. By two
Speaker 1: thousand and one, we had another big event China joined
Speaker 1: the w t O. And you know, China was a
Speaker 1: factor in the nineties as well, but really started to
Speaker 1: come online, you know, starting in two thousand and one.
Speaker 1: Now we had globalization and offshoring of production in all
Speaker 1: of these various factors, and that was it for inflation.
Speaker 1: We didn't worry about it, you know until two right
Speaker 1: inflation just came came write down. So now what do
Speaker 1: we know that's going on? Well, globalization is now in
Speaker 1: the globalization effectively, we're not offshoring production, we're on shoring production.
Speaker 1: Energy costs are are a lot higher, um, there are
Speaker 1: a lot of various for good reasons. Climate change initiatives
Speaker 1: that you know is constraining some of the production of energy,
Speaker 1: so so that's something that's out there as well. Energy
Speaker 1: and we also have to remember feeds into fertilizer prices,
Speaker 1: food prices, and everything else, so that all of a
Speaker 1: sudden really starts to bring inflation and prices of a
Speaker 1: lot of goods and consumables like food also also a
Speaker 1: lot higher. And we're not we're not at a point
Speaker 1: structurally where we're increasing the productive capacity to meet that demand.
Speaker 1: So that structurally where we are, we are at a
Speaker 1: structural change in the markets today. On top of that,
Speaker 1: we had this awful pandemic, you know, sadly, you know,
Speaker 1: many people left the workforce and um and aren't coming back,
Speaker 1: and that's created a lot of constraint in terms of labor.
Speaker 1: So so now labor is really in charge, not capital
Speaker 1: so much, and labor being in charge, are going to
Speaker 1: demand higher wages. You get higher wages, you get higher inflation. Structurally,
Speaker 1: that's where we are. Nothing's turning that around. Look, there
Speaker 1: are arguments that we've been in this period of secular
Speaker 1: stagnation for a long time and it's only been interrupted
Speaker 1: and it might reassert itself. I'll take that on board
Speaker 1: as as certainly a possibility, but so far I'm not
Speaker 1: seeing any real evidence of that. So I'm much more
Speaker 1: concerned about the fact that we are structurally moving into
Speaker 1: an onshoring, deglobalization, higher cost of productivity situation. Now, the
Speaker 1: only thing that solves this problem. Is a is higher
Speaker 1: business productivity, you know, capex, business investment. Productivity is output
Speaker 1: per hours work. Right, So if you can be rely
Speaker 1: on technology robotics AI to do the work of people
Speaker 1: that you can't find and higher, then that will bring
Speaker 1: down you know, wages, you know, essentially. But that's the
Speaker 1: measure that we're looking at right now. And that's and
Speaker 1: that's why I think that inflation is going to be
Speaker 1: with us for a while. It takes a long time
Speaker 1: for companies to become a lot more productive. Do need
Speaker 1: a supply side response, which means that you need and
Speaker 1: that's a fiscal policy. Fiscal policy creates a supply side response,
Speaker 1: that's taxes, regulation, you know, to to generate capex and
Speaker 1: productivity and things like that. We are nowhere near sending
Speaker 1: a message to the American people saying, I know everybody
Speaker 1: is suffering right now with higher wages and sorry, higher
Speaker 1: inflation and what have you. And the answer to that
Speaker 1: is to cut taxes for corporations, right, because that's the
Speaker 1: way the narrative will be spun. It's wrong, that's not
Speaker 1: that's not exactly true, but but that but that's the
Speaker 1: way the narrative will be spun and it's gonna be
Speaker 1: hard to get that supply side response. Until we get
Speaker 1: that supply side response where the abductive capacity of the
Speaker 1: economy is increased to make supply meet demand and bring
Speaker 1: down prices more durably, we're going to have an inflation problem.
Speaker 1: That's how it was solved in the eighties. That's how
Speaker 1: it will be solved again. It's just a matter of when,
Speaker 1: and I don't think it's any time soon. Great stuff,
Speaker 1: We really appreciate your time. We cannot let you go though,
Speaker 1: until we hear the craziest thing you've seen in markets
Speaker 1: this week data as always, Why don't you get us started? Okay,
Speaker 1: I have one with that I chose with you in mind,
Speaker 1: and I really hope you haven't seen it yet, so
Speaker 1: it's a nice surprise. Okay. A Porsche dealership in China
Speaker 1: has the ring bells. No, you haven't seen this? No?
Speaker 1: And why a Porsche dealership in China made you think
Speaker 1: of me? I I'm dying of Okay, listen, Okay, a
Speaker 1: Porsche dealership in China they put up an online ad
Speaker 1: for a I don't know this car, but maybe people
Speaker 1: do Panamera, a Panama a type of Porsche, I guess,
Speaker 1: but they accidentally put it up for eighteen thousand dollars
Speaker 1: instead of the starting price of a hundred and forty
Speaker 1: eight thousands. Oh my gosh, did they actually have to
Speaker 1: sell any at that price? So I guess hundreds of
Speaker 1: people immediately put in bids for it or try to
Speaker 1: buy it or however this process works, and they had
Speaker 1: to apologize and pulled the whole thing. But Porsche did
Speaker 1: say that they got in touch with the very first
Speaker 1: person who made the online reservation and they quote negotiated
Speaker 1: an agreeable outcomes. Still, you can't even get a used
Speaker 1: car for eighteen thousand. Used China's CPI would have gone
Speaker 1: negative for the quarter. If that there's if there's sales
Speaker 1: went through. That's pretty good. That's pretty good, thank you.
Speaker 1: Although I still don't know how Porsche made you think
Speaker 1: of me. I'm I'm like a Volkswagen Beetles because so
Speaker 1: just the listeners, No, Mike has, Mike has four Porsches now,
Speaker 1: because I knew you would like the you know posted
Speaker 1: for eighteen was supposed to I like a good a
Speaker 1: good fat finger train exactly, all right, that's a good one,
Speaker 1: Bill Don I'll hand it to you, Jim. How about you.
Speaker 1: You see anything crazy recently in markets? Well, you know,
Speaker 1: I don't have anything to compete with a eighteen thousand
Speaker 1: dollar Panama Porsche UM, which I wish I was the
Speaker 1: first person to actually see that. UM. I would say
Speaker 1: that the it's more of a it's more of a
Speaker 1: change in um in sentiment and thought where the growth
Speaker 1: sector was just so hated for so long. Nobody, anybody
Speaker 1: that you spoke to, UM, you know, going back over
Speaker 1: the past few weeks, I would say, you're you're crazy
Speaker 1: if you think that. UM. You know, look at the NASDAC,
Speaker 1: look at some of these high tech stocks and they're
Speaker 1: laying people off and the earnings are terrible, and how
Speaker 1: the earnings announcements have come down so much. But yet
Speaker 1: you looking at the markets today, it's just bewildering, maybe
Speaker 1: as much as, maybe not as bewildering as the eighteen
Speaker 1: thousand dollars, but it's just it's to me, it's it's
Speaker 1: in the same category of how in the world can
Speaker 1: this be happening with all of this bad news that's
Speaker 1: out there, so not not not as not as interesting,
Speaker 1: but but but it's my it's where it's where my
Speaker 1: mind went. Is that just a sort of a high
Speaker 1: beata reaction to this sense that the FED is going
Speaker 1: to cut this year? I mean, you know, I assume
Speaker 1: the rate these people must be assuming lower rates to
Speaker 1: be buying growth stocks like that, or is it just
Speaker 1: January mean reversion? Maybe? You know. I think it's a
Speaker 1: couple of things. And the thing I'll attribute it to
Speaker 1: is that people have a lot of cash and they're underinvested.
Speaker 1: And as I like to say, risk on is a
Speaker 1: risk and if you're under invested in the market goes up,
Speaker 1: you have a lot of explaining to do. So if so,
Speaker 1: you end up chasing the things that went up the most,
Speaker 1: and unfortunately, you know, or maybe fortunately, people are chasing
Speaker 1: these you know, these higher flying high beata names, and
Speaker 1: maybe we get silly levels at some point and it
Speaker 1: doesn't end well, but who knows. Yep, yep, Now that
Speaker 1: makes sense. Alright, Uh my turn, Viltano. Are you having
Speaker 1: a Super Bowl party this year? No? Hell, I know
Speaker 1: I'm going to have like a Super Bowl funeral. And
Speaker 1: the Bills aren't playing Eagles. I am an Eagles fan, now, yeah,
Speaker 1: I love the Eagles, flies, I have. I have an
Speaker 1: Eagle's jersey, you know, so I wore last for the
Speaker 1: last game and it brought it brought good luck. Yeah,
Speaker 1: I keep wearing it then, Yeah I will, I will.
Speaker 1: I'm not having one because that the a little too passionate,
Speaker 1: you know, the potential for violence is too great to
Speaker 1: have other uh other people around. But if you are
Speaker 1: having one, USA today as a story, some good news.
Speaker 1: Now Jim gets us to read his notes with good
Speaker 1: led Zeppelin references. The other the other thing is strategist
Speaker 1: can do is is somehow tied of football super Bowl
Speaker 1: into their research so wells Fargo. They looked at inflation
Speaker 1: on items popular at Super Bowl parties, um so. And
Speaker 1: the good news is there that there there does seem
Speaker 1: to be some disinflation, but not in everything. So I'm
Speaker 1: gonna make you guys play the little game show here
Speaker 1: the prices precise, and guess what has happened to prices
Speaker 1: of avocados over the last year. Avocados obviously super important
Speaker 1: for guacamole, and Jim, no pressure, I don't. I don't
Speaker 1: really expect you to know what what avocado inflation has done.
Speaker 1: But I'm still gonna make you play the prices precise,
Speaker 1: and guess I'm gonna say they're up for rex. I'm
Speaker 1: gonna say four x because I know, I know these
Speaker 1: things have gone up crazy because I love avocados and blackamol.
Speaker 1: You all is that close? And I'm going with the
Speaker 1: under I think avocado prices are down. I bought six
Speaker 1: avocados this week for four So I'm gonna go with yes.
Speaker 1: Am I wrong? Oh my gosh, I'm wrong? Should I
Speaker 1: redo my answer? I'm gonna say that prices went down?
Speaker 1: You buy him six? Up? Pop? You that's a lot
Speaker 1: of avocado toast. Well, I'm a millennial, that's true. That's
Speaker 1: why you broke that. Millennials. Uh, actually I agree with
Speaker 1: I was going to actually do they were, But I
Speaker 1: think it's a little mean reversion there too, because they were.
Speaker 1: They did go through the roof there for a while.
Speaker 1: But more importantly, all right, you can get uh get
Speaker 1: some vengeance here, Jim, restore your reputation here. Price of
Speaker 1: beer and even more important ingredients for a Super Bowl party.
Speaker 1: What do you think beer's done? Year over? Yere? You
Speaker 1: go first? Oh, I go first to time? Okay, well,
Speaker 1: obviously it's come up. Otherwise you wouldn't have chosen it. Um,
Speaker 1: I'll go with up up ten, up between ten and
Speaker 1: that's good. Uh, it's like psychology there. I don't know.
Speaker 1: I'm not saying it's that was the right Maybe I
Speaker 1: went reverse psychology. Jim, what you think Bear did in
Speaker 1: the last year. I want to say, let's say, yeah,
Speaker 1: I'm in that same category. So you guys are Yeah,
Speaker 1: I was in the right ballpark, Jam, Eagles are Kansas
Speaker 1: City and there's only one correct answer. Yeah, I know,
Speaker 1: I know, so. Um so. Admittedly, being from Boston, my
Speaker 1: team is a Patriots so so so they're out. But
Speaker 1: that's okay. Um So, I think it's going to be
Speaker 1: the Eagles that win. I think it's going to be
Speaker 1: a really good game. But I kind of like to
Speaker 1: see Kansas City. No, that's the wrong answer. That's the
Speaker 1: wrong answer. I know. But this podcast I said too
Speaker 1: late for that. Well, I I'm a little too emotionally invested.
Speaker 1: I'm not going to make any predictions. I don't want
Speaker 1: anything to drink anything. I hope both teams have have fun.
Speaker 1: How about that? Oh my gosh, that's the most diplomatic
Speaker 1: answer I've ever heard. I'll where my jersey all right,
Speaker 1: do you wear your jersey? Jim Karen, such a pleasure
Speaker 1: to pick your brain. I hope we can bring you
Speaker 1: back sometime and do it all again. Absolutely had a
Speaker 1: lot of fun with this. Thank you, Jim. What Goes Up.
Speaker 1: We'll be back next week and so then you can
Speaker 1: find us on the Bloomberg Terminal website and app or
Speaker 1: wherever you get your podcasts. We love it if you
Speaker 1: took the time to rate and review the show on
Speaker 1: Apple Podcasts, so more listeners can find us. And you
Speaker 1: can find us on Twitter, follow me at Reaganonymous. Well,
Speaker 1: Donna Hirich is at bil Donna high Rich. You can
Speaker 1: also follow Bloomberg Podcasts at podcasts. What Goes Up is
Speaker 1: produced by Stacy Wong. Thanks for listening, See you next time.
Speaker 1: The FO