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Speaker 1: Welcome to the Bloomberg PENL podcast. I'm Paul Sweene. You,

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Speaker 1: along with my co host Lisa Brahma wits each day

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Speaker 1: we bring you the most noteworthy and useful interviews for

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Speaker 1: you and your money. Whether at the grocery store or

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Speaker 1: the trading floor. Find a Bloomberg Penl podcast on Apple

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Speaker 1: podcast or wherever you listen to podcasts, as well as

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Speaker 1: at Bloomberg dot com. Let's welcome our good friend Nathan Sheets.

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Speaker 1: Nathan is chief Economists and head of macro economic Research

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Speaker 1: for p g i M Fixed Income based in Newark,

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Speaker 1: New Jersey, but joining us live here in our Bloomberg

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Speaker 1: and or Active Brooker studio. So, Nathan, I mean, there's

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Speaker 1: so many topics to talk about here. Um, just last week,

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Speaker 1: you know, we had the Fed, we had trade, we

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Speaker 1: had tariffs and so on and so forth. Let's start

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Speaker 1: with trade because that seems to be, uh, the number

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Speaker 1: one issue driving financial markets here just given what we've

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Speaker 1: seen over the last several days, several weeks. How do

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Speaker 1: you think this could play out? And what how are

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Speaker 1: you kind of you know, thinking about your portfolio and

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Speaker 1: global trade uncertainty. So it's a pleasure to be here,

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Speaker 1: and as you say, uncertainty is certainly the word of

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Speaker 1: the day and probably the word of the week. I

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Speaker 1: would uh say that the president's remarks this morning that

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Speaker 1: he's received a call from the Chinese and they want

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Speaker 1: to negotiate, actually it should be interpreted as saying President

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Speaker 1: Trump wants to negotiate. Um. My feeling has long been

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Speaker 1: that he's not inclined to want to push the markets

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Speaker 1: or the economy uh to to the precipice or to

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Speaker 1: the breaking point. And so I would expect that the

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Speaker 1: administration will be uh finding ways to come to the table.

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Speaker 1: And then the key question is how did the Chinese

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Speaker 1: respond to that? All right, So we could get out

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Speaker 1: a book to analyze both characters and what's going on

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Speaker 1: in their mind space, but that might prove fruitless. I

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Speaker 1: think one of the key questions here is moving forward,

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Speaker 1: how much damage is already happening with respect to businesses

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Speaker 1: and their plans. Do you have a sense of that? Well,

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Speaker 1: right now we have a two speed to tier US economy.

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Speaker 1: The consumer sector in the labor market are quite solid,

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Speaker 1: but the business sector is is really feeling a meaningful

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Speaker 1: imprint of the uncertainty that you described. Which I think

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Speaker 1: is largely about this trade wall. I guess that there's

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Speaker 1: a question, there's sort of an understanding or a feeling

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Speaker 1: that Trump President Trump will back down or come to

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Speaker 1: some kind of deal in order to save the markets

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Speaker 1: and save the economics. It doesn't want to go into

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Speaker 1: with a stock market that's crashing. At the same time,

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Speaker 1: it's hard to know how much can be rolled back.

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Speaker 1: At what point do we hit the point of no

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Speaker 1: return and businesses have already changed their plans so much

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Speaker 1: that even some sort of trade truce could not bring

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Speaker 1: necessarily markets back. And uh, I think that Uh, I

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Speaker 1: think that's an open question. My feeling is that we're

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Speaker 1: not there yet. But if we get to a point

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Speaker 1: where we have say, thirty percent tariffs on everything that

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Speaker 1: the United States is importing uh from China, and sanctions

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Speaker 1: on whalwei, and the list goes on, we may very

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Speaker 1: quickly get to that point where the impact on US

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Speaker 1: business on investment and investment plans is essentially irreversible, which

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Speaker 1: means that recessionary forces at that point will be will

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Speaker 1: be quite powerful. I don't think we're there yet, but

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Speaker 1: it's it's a possibility. So on the flip side. To

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Speaker 1: what extent are the tariffs impacting the Chinese economy do

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Speaker 1: you think? I think the uh, the impact on the

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Speaker 1: Chinese economy is quite substantial. My rule of thumb is

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Speaker 1: that if if the tariffs are taking say three or

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Speaker 1: four tenths of a percent off the level of US GDP,

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Speaker 1: that it's at least twice that much for the Chinese economy.

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Speaker 1: So the Chinese are certainly absorbing a meaningful economic shock,

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Speaker 1: and I think you're seeing that in their numbers. But

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Speaker 1: the key here is that China also has a higher

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Speaker 1: pain threshold. So that's kind of the challenge the US.

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Speaker 1: We're feeling less pain, but we have a lower pain threshold.

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Speaker 1: China more pain and a higher pain threshold. How how

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Speaker 1: do these incentives that result from that? How do they

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Speaker 1: play through well? And I guess that that's the question.

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Speaker 1: You know, China seems to be playing a more hardball

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Speaker 1: this morning than President Trump, indicating that there have not

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Speaker 1: been material talk. So at what point will they be

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Speaker 1: forced to the table, regardless of the fact that they've

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Speaker 1: got a higher pain threshold. So I think that China,

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Speaker 1: I don't know the mechanism to force them to the table.

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Speaker 1: I do think that as they feel economic effects and

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Speaker 1: as the Trump administration UH puts gifts in the negotiation

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Speaker 1: on the table. I mean one of the challenges before

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Speaker 1: I was at the U S Treasury and I would

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Speaker 1: negotiate with the Chinese, one of the challenges was the

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Speaker 1: U S didn't have gifts for the Chinese. We were

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Speaker 1: asking them to do things, but we didn't have a

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Speaker 1: lot to give back. Now the US has has Wahwei,

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Speaker 1: we have currency manipulation, and we have tariffs, and so

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Speaker 1: I think it does open up a negotiation. We're both claimed.

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Speaker 1: Both sides could claim a UH a scope for victory

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Speaker 1: or that they got something from it. So you mentioned Hahwei.

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Speaker 1: That is a part of the negotiations that sometimes gets forgotten,

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Speaker 1: but that could in fact be a material stumbling block.

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Speaker 1: How how did does that play into it? So I

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Speaker 1: think Hahwei is critical. I think that if the Chinese

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Speaker 1: leaders were, you know, to disclose what they feel are

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Speaker 1: the key issues, Whahwei would be at the very top

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Speaker 1: of the list. So I think that progress from the

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Speaker 1: Chinese standpoint, progress on hahweis is central. Then the question is, UH,

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Speaker 1: to what extent does the US actually see wahway as

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Speaker 1: a national security concern. And even if the administration is

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Speaker 1: inclined to want to be software a wahaway, will Capitol

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Speaker 1: Hill allow it? So I think always somehow has to

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Speaker 1: be included, but there are lots of question marks there.

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Speaker 1: We're speaking with Nathan Sheets. He's chief economist and head

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Speaker 1: of macroeconomic research at PGM Fixed Income. Just by way

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Speaker 1: of background, you also were under the Secretary of the

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Speaker 1: US for the U. S. Treasury focusing on international affairs.

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Speaker 1: You're representing the U S. Governments. You come with with

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Speaker 1: quite a bit of authority on these issues. From an

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Speaker 1: investment side, How would you advise or how are you advising?

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Speaker 1: UH had a position around this uncertainty at a time

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Speaker 1: when growth is still okay. Yeah, so we are. We

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Speaker 1: are at a in a place where there is enormous

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Speaker 1: demand for safe assets, and I think con significant that

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Speaker 1: in that world we see the end appreciate, we see

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Speaker 1: the tenure treasury yield UH decline. UH investors are are

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Speaker 1: are seeking those places where they can have some confidence

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Speaker 1: that they'll actually they'll actually be repaid and we'll be

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Speaker 1: able to weather a storm. And frankly, that's my feeling.

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Speaker 1: This is uh, this is a challenging environment for risk

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Speaker 1: on kinds of assets. We are awaiting the press conference

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Speaker 1: with President Macron of France and President Trump of the

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Speaker 1: United States that is coming up in moments. We will

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Speaker 1: carry that live. Uh, Nathan, was there anything that came

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Speaker 1: out of Jackson Hole last week that surprised you or

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Speaker 1: kind of made you rethink maybe a little bit of

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Speaker 1: your outlook? So H J. Powell's remarks were I thought,

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Speaker 1: just a restatement with emphasis of what he had said

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Speaker 1: at the July press conference. The Feds in the midst

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Speaker 1: of a mid cycle adjustment, which likely means one or

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Speaker 1: two more rate cuts, but they're watching closely. Uh. The

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Speaker 1: The additional thought that emerged from what Powell implied and

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Speaker 1: then what some of the other speakers that Jackson Hole

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Speaker 1: uh spoke about is there was a symphasis that central

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Speaker 1: banks can't entirely fix the trade war. And I think

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Speaker 1: that's a recognition that there's the risk of a vicious

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Speaker 1: moral hazard feedback loop where central bank see a week

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Speaker 1: economy cut rates and that gives the president more scope

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Speaker 1: to pursue the trade war. And I think that that

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Speaker 1: was more in the background of Jackson Hole than it

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Speaker 1: had been in previous FED communications. You were saying earlier

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Speaker 1: that you do think that haven plays are a good

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Speaker 1: place to go right now or people are going to

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Speaker 1: get their money back and they have that confidence. I

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Speaker 1: guess there's a hup side to that. Those are getting

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Speaker 1: very crowded, and there is a potential that if there

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Speaker 1: is some sort of trade truce that could completely upend

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Speaker 1: the way that people are positioned. What sort of the

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Speaker 1: chance of that near opinion? So, I would say, over

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Speaker 1: over say a six month horizon, I think that both sides,

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Speaker 1: both as I've described, both the US and Chinese have

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Speaker 1: incentives to find something that they can call on agreement

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Speaker 1: and de escalate where things are in the nearer term,

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Speaker 1: I don't see how we get to a d D escalation.

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Speaker 1: It's gonna be, It's gonna be a ways and uh,

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Speaker 1: you know, hopefully over time we'll see it. But I

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Speaker 1: wouldn't put a high probability that over the next few

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Speaker 1: weeks somehow this all magically goes away. I wish I

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Speaker 1: could be more optimistic. And to what extent do you

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Speaker 1: think that? I mean, well, that way on corporate America,

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Speaker 1: you know what we're gonna see see it in the

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Speaker 1: earnings coming up. And we we've seen, we've we've heard

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Speaker 1: certainly in the past couple of quarters of earnings that

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Speaker 1: you know, CEOs across a variety of industries have highlighted

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Speaker 1: the uncertainty of the trade negotiations kind of either weighing

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Speaker 1: on their business, weighing on their customers businesses, affecting maybe

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Speaker 1: capital spending in R and D. When do you expect

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Speaker 1: to see, you know, a big impact on corporate America.

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Speaker 1: So we are seeing a a lackluster global economy, and

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Speaker 1: I think that these even as the US economy is

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Speaker 1: doing all right, the rest of the world is feeling

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Speaker 1: adverse effects. As we describe the Chinese economy has slowed.

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Speaker 1: I think they're stimulating, but UH, the underlying economy there

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Speaker 1: is soft. The European economy is slaw, particularly in the

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Speaker 1: manufacturing sector, and UH and global growth is meaningfully below trend.

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Speaker 1: And I think given all of that, that's going to

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Speaker 1: leave a signature in UH, the earning of Corporate American.

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Speaker 1: A large share of those earnings do come from their

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Speaker 1: their their operations abroad. Just lastly, here to wrap things up,

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Speaker 1: you talk about haven bets, you talk about how it

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Speaker 1: wouldn't be a really prudent thing to go into risk assets,

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Speaker 1: and yet we do have a tepid rally underway today

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Speaker 1: on some of these tweets. How long can markets continue

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Speaker 1: to melt up? Good question? Good question. Uh, you know,

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Speaker 1: I think what's supporting the equities is the fact that

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Speaker 1: corporate earnings so far been okay, coupled with lower long

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Speaker 1: term interest rates, and so discount factors are are are

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Speaker 1: are affected accordingly. And you put that together, I mean,

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Speaker 1: where else are you going to go other than the

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Speaker 1: US equities? So there is a narrative that things are

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Speaker 1: hanging in there. Okay. In the US bonds look maybe

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Speaker 1: a little less attractive for the reasons we've described, and uh,

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Speaker 1: you know, equities are done well, and maybe things maybe

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Speaker 1: we're all too pessimistic. Nathan needs thank you so much

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Speaker 1: for being with. Nathan Sheets is chief economist and head

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Speaker 1: of macroeconomic research at p JIM Fixed Income, which overseas

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Speaker 1: more than eight hundred billion dollars here so, uh, formerly

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Speaker 1: worked on international trade negotiations for the US Treasure Department.

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Speaker 1: So he comes to this with a good deal of

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Speaker 1: experience and insight. Thank you. What is an investor to

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Speaker 1: do as we get a deepening uncertainty around trade negotiations,

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Speaker 1: around global growth, around a lot of things, leaving a

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Speaker 1: lot of investors sitting on their hands and wondering what

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Speaker 1: direction to take next. Not sitting on his hands, Phil

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Speaker 1: Orlando joining us here at our blueborgod Active broker Studios.

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Speaker 1: Phil is chief equity and market strategist and head of

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Speaker 1: client protfolio management and Federated Investors, which overseas more than

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Speaker 1: a four hundred and eighty billion dollars. Fill. Let's just

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Speaker 1: start with what we just heard from President Trump, because

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Speaker 1: that has been sort of the prevailing force in dictating

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Speaker 1: some of the volatility right now. How much would you

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Speaker 1: be trading off of any kind of development on trade

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Speaker 1: on any given day? Uh, The answer is not much.

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Speaker 1: UM that that clearly the market is under some pressure

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Speaker 1: given the escalation of trade and tariff war between the

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Speaker 1: U S and China. UH. If you listen to this

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Speaker 1: press conference, there's a lot of pushback from the reporters

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Speaker 1: who were there, questioning the veracity as to whether or

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Speaker 1: not the Chinese had actually reached out to the US

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Speaker 1: over the last twenty four hours to restart UH talks

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Speaker 1: ET cetera. And um, I'm not sure if the president

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Speaker 1: was able to say any of their desire for some

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Speaker 1: corroborative information and to suggest that the talks are back

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Speaker 1: on track. I happen to think that the China issue

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Speaker 1: UH is probably one of the three most important issues

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Speaker 1: that investors are focused on right now. And I think

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Speaker 1: all three of these issues are probably interrelated, UH, the

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Speaker 1: China trade war, what's the Federal Reserve doing in terms

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Speaker 1: of monetary policy, and the inversion of the yield curve.

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Speaker 1: And I think that, you know, depending upon what you

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Speaker 1: want to talk about today, all of those issues UH

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Speaker 1: are significantly inter related in my mind. So it's interesting.

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Speaker 1: I think we used to see the least as we

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Speaker 1: sit here and look at our screens every day and

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Speaker 1: we say and we and we see the markets reacting

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Speaker 1: to the tweets as it relates to trade. So clearly

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Speaker 1: trade is a big, big issue for investors. To what

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Speaker 1: extent would this be, you know, a a real drag

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Speaker 1: on the market in general, If in fact these negotiations

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Speaker 1: drag on too maybe pass the election, for example, well

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Speaker 1: it would be a significant drag. And and our Bay

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Speaker 1: case has been that there were significant fiscal policy reasons

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Speaker 1: for why Trump had initiated this trade war, if you will.

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Speaker 1: We've talked about this before, but you look at the math, uh.

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Speaker 1: We the United States running roughly a six hundred billion

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Speaker 1: dollar balance of trade deficit in a twenty one trillion

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Speaker 1: dollar economy. That that's costing US about three percentage points

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Speaker 1: of GDP growth. When you look at the composition of

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Speaker 1: that deficit, roughly two thirds of it, let's call it

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Speaker 1: four billion dollars is related to China. China's running a

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Speaker 1: four billion dollar surplus against the United States. The United States, Trump,

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Speaker 1: I think was trying to achieve two things here. Try

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Speaker 1: to balance out narrow, have the size of that deficit,

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Speaker 1: cut it from four to two billion, and in the

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Speaker 1: process boost GDP growth by one percentage point potentially. The

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Speaker 1: other thing is the structural issues that have been ongoing

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Speaker 1: now for the better of twenty five years, and by

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Speaker 1: that I mean the theft of intellectual property, the currency manipulation. Uh.

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Speaker 1: These are ongoing developments that that that President Clinton didn't address,

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Speaker 1: President Bush didn't address, President Obama didn't address. Yet US

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Speaker 1: companies have been sort of pounding on the White House's

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Speaker 1: door for a long time suggesting that that we our

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Speaker 1: administration should attempt to do something about it. So so

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Speaker 1: I think you've got sort of a two front war,

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Speaker 1: the structural issues and and an effort to try to

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Speaker 1: narrow the deficit and and potentially boost GDP growth in

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Speaker 1: the process. Phil was the last time it materally changed

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Speaker 1: your recommendation for allocation? Uh we UH started the year,

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Speaker 1: remember the declining stocks in the fourth quarter uh SMP

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Speaker 1: was down about the level. In our view that that

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Speaker 1: that was a complete head fake, that there was nothing

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Speaker 1: structurally wrong with the economy. We thought that toxic sentiment

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Speaker 1: was what had driven the market down. So we actually

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Speaker 1: took our allocation up to an eight percent equity overweight.

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Speaker 1: We felt that stocks from that Christmas Eve bottom, we're

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Speaker 1: gonna rebound about thirty two percent over the course of

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Speaker 1: this year. Our target was thirty Where we stand now

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Speaker 1: at the end of July, we we took our allocation

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Speaker 1: down from an eight percent overweight to about a three

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Speaker 1: percent overweight in terms of our model and in July

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Speaker 1: and in our global allocation fund we're actually managing money.

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Speaker 1: We took that allocation down a neutral. Our view was

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Speaker 1: that at the end of July. Looking out over the August,

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Speaker 1: September and October timeframe, there were a number of things

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Speaker 1: that concerned us on the immediate horizon, central bank policy,

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Speaker 1: UH and and China. We're we're first and foremost on

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Speaker 1: that list. But as we look out further into that

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Speaker 1: period Halloween, there there are three global developments that are

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Speaker 1: coming together on Halloween that a lot of people aren't

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Speaker 1: really focused upon. We've moved the bregsit deadline. Remember from

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Speaker 1: March thirty one to Halloween. UM Draggy is going to

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Speaker 1: transition his role as the head of the e c

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Speaker 1: B to leguard on Halloween. UH. And then the Chinese

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Speaker 1: of the Chinese, the Japanese are going to have to

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Speaker 1: make a decision on whether or not to increase their

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Speaker 1: value added tacks from eight percent to ten percent on Halloween.

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Speaker 1: Why is that important Because the last two times the

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Speaker 1: Japanese increased their value added attacks UH, that decision, that

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Speaker 1: fiscal policy decision, pushed the Japanese economy in a recession.

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Speaker 1: So you've got these three issues at the back end

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Speaker 1: of October. You've got these other issues central bank policy

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Speaker 1: and China trade at the front part of this period.

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Speaker 1: So given the fact that stocks had rallied, we felt

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Speaker 1: that it was prudent to take some chips off the table.

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Speaker 1: Are there sectors here, given where, given your neutral position,

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Speaker 1: given where we are in the cycle, that still look

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Speaker 1: attractive to you? On the margin, some people have talked

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Speaker 1: about defensive style, but they're not cheap by any stretch.

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Speaker 1: So is there any place for people to look so so, yes,

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Speaker 1: they're not cheap, but but being defensive is exactly where

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Speaker 1: you want to be um having constable demand kind of

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Speaker 1: companies with with the the outsize dividend payments. Remember the

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Speaker 1: the SNP dividend yield right now is around two percent.

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Speaker 1: Treasury yields are you know, one and a half percent,

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Speaker 1: and and the yields that we can get in in

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Speaker 1: these defensive kind of companies are are north of four percent.

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Speaker 1: For for example, I'll just give a plug for a

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Speaker 1: strategic value fund. That's exactly the sort of things that

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Speaker 1: they do. Uh separate and apart from defense, I think

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Speaker 1: that that small cap still makes a lot of sense here.

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Speaker 1: For a number of reasons, small caps underperformed large cap

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Speaker 1: by more than a thousand basis points over to last year.

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Speaker 1: Yet most of the concerns that we're seeing are overseas

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Speaker 1: economic concerns. A small cap company is going to do

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Speaker 1: eight percent of their business here. The U S economy

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Speaker 1: is fill in pretty good shape. You've got the dollars

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Speaker 1: pretty strong right now. A strong dollar tends to be

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Speaker 1: very supportive of small cap companies. So for a lot

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Speaker 1: of reasons. Oh and then you know M and A activity.

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Speaker 1: Companies are are out there actively looking for companies. Greater

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Speaker 1: merger and acquisition activity tends to benefit small cap company.

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Speaker 1: So we still like small cap here as well, domestic

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Speaker 1: small cap. Just real quick, since you didn't mention the

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Speaker 1: yield curve, I'm looking right now at a two tents

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Speaker 1: spread of negative zero point six percent UH, inverting the

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Speaker 1: most since two thousand seven. Do you think that this

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Speaker 1: indicates recession in the near term? So I would prefer

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Speaker 1: to look at the spread between the funds rate and

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Speaker 1: the benchmark tenure treasury yield. We think that's a better predictor,

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Speaker 1: a more accurate predictor of recession. So you're looking at

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Speaker 1: a tune a quarter up a band of the funds

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Speaker 1: rate with let's call it one and a half percent

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Speaker 1: in the tents. So you've got a seventy five bases

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Speaker 1: point in version there that that's absolutely a signal that

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Speaker 1: we're respecting. But based upon our analysis of that cycle,

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Speaker 1: we do not see an increased risk of recession before

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Speaker 1: we get into the early part of no recession in

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Speaker 1: eighteen nineteen or twenty. We are concerned about the first

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Speaker 1: half of twenty one. Phil Orlando, thank you so much

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Speaker 1: for joining us. Phil Nando, chief equity market strategist and

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Speaker 1: have of client portfolio management at Federated Investors Investors joinings

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Speaker 1: here on our Bloomberg Interactive Broker Studio. Thanks for listening

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Speaker 1: to the Bloomberg P and L podcast. You can subscribe

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Speaker 1: and listen to interviews at Apple Podcasts or whatever podcast

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Speaker 1: platform you prefer. Paul Sweeney, I'm on Twitter at pt Sweeney.

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Speaker 1: I'm Lisa Abram Woyd's I'm on Twitter at Lisa Abram

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Speaker 1: woits one. Before the podcast, you can always catch us

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Speaker 1: worldwide on Bloomberg Radio.