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Speaker 1: Bloomberg Audio Studios, Podcasts, radio News.

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Speaker 2: This is the Bloomberg Surveillance Podcast. I'm Jonathan Ferrow, along

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Speaker 2: with Lisa Bromwitz and Amrie Hordert. Join us each day

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Speaker 2: for insight from the best in markets, economics, and geopolitics

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Speaker 2: from our global headquarters in New York City. We are

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Speaker 2: live on Bloomberg Television weekday mornings from six to nine

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Speaker 2: am Eastern. Subscribe to the podcast on Apple, Spotify or

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Speaker 2: anywhere else you listen, and as always on the Bloomberg

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Speaker 2: Terminal and the Bloomberg Business app. We begin this soum

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Speaker 2: with the Chip sell off building, Cameron Dawson and New

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Speaker 2: Wedgewalth writing the following, the semiconductor profit cycle depends on

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Speaker 2: two big factors. Hyper scare is continuing to spend aggressively

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Speaker 2: and limited new competition entering the space that could challenge margins.

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Speaker 2: Markets seem to be questioning both. Cam joins us now

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Speaker 2: for more, Cam, good morning, go to see you.

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Speaker 3: Good morning.

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Speaker 2: That quote just perfectly illustrates this moment we're in right now.

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Speaker 2: We are questioning both. Do you think it is valid

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Speaker 2: to question both?

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Speaker 3: I think it is, But I think before we get

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Speaker 3: to the fundamentals. We have to appreciate the technicals because

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Speaker 3: so much of the upside was driven by positioning chases

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Speaker 3: and squeezes and flows, and so what we're experiencing now

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Speaker 3: is effectively the mirror image of that because flows were

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Speaker 3: so aggressive into leverage products within the semiconductor space, not

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Speaker 3: just in the US, but of course in South Korea.

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Speaker 3: What we're seeing is the dynamic is that as that

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Speaker 3: leverage unwind, you're seeing a lot more downside. Effectively, these

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Speaker 3: stocks got so overbought by the time you got to

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Speaker 3: the middle of June that even though we've seen things

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Speaker 3: like a forty percent drawdown in something like s k Heinex,

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Speaker 3: you're technically not over sold yet. So if you look

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Speaker 3: at a name like Micron, yes it's down over twenty percent,

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Speaker 3: but it's still forty percent above its two hundred day

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Speaker 3: moving average, you can say think the same thing for

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Speaker 3: the socks overall. So it's important to remember narrative follows price.

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Speaker 3: So all of these negative narratives on the fundamentals we're

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Speaker 3: talking about, it's effectively just following the negative process.

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Speaker 2: So is this a price move looking for a narrative

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Speaker 2: or is there a story here I think it's.

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Speaker 3: A matter of both. I think some of the dynamic

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Speaker 3: that we saw in the upside mood was ignoring the

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Speaker 3: fact that a lot of these capacity editions. While you're

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Speaker 3: thinking about Microun itself adding capacity, as khihinch, Samsung adding capacity,

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Speaker 3: and now China adding capacity, we've all known this for

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Speaker 3: the last six months over a year, because we've known

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Speaker 3: that there has been a capacity shortage. But now the

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Speaker 3: market is starting to wake up to it. And at

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Speaker 3: the end of the day you had this clarion call

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Speaker 3: from big bowls on things like Micron saying, of course

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Speaker 3: the eighty five percent gross margin is sustainable. This time

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Speaker 3: is in fact different. But this is still a very

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Speaker 3: very cyclical business. And so given the fact that you

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Speaker 3: are going to have capacity editions over the course of

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Speaker 3: the next few years, you will see downward pressure on

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Speaker 3: those growth margins. The big difference, or the big thing

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Speaker 3: to watch is that is there any downward pressure on

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Speaker 3: the revenue line, because that's really when you start to

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Speaker 3: see the deleveraging and the operating leverage of these businesses,

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Speaker 3: and if you continue to see weakness within the hyperscaler names.

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Speaker 3: The question that we have been asking is if the

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Speaker 3: stocks continue to get pressured, will they continue to raise capex.

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Speaker 1: At the same time, there's this issue of exactly whether

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Speaker 1: the economics are changing and moving away from certain companies.

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Speaker 4: And I'm thinking of.

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Speaker 1: Say the closed models like the open ayes and the

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Speaker 1: anthropics that are suddenly coming under pressure from open source

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Speaker 1: models that are coming out of China but are being

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Speaker 1: adopted rapidly by a lot of US companies seek the

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Speaker 1: search for cheaper models is definitely taking steam. Do you

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Speaker 1: think that does fundamentally alter the tech story?

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Speaker 3: Yeah, because I think the big question that you have

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Speaker 3: is a scaling factor. We know that we are getting

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Speaker 3: growth because of some of this capex investment, but effectively

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Speaker 3: the growth is coming in slower than what the capex

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Speaker 3: investment is. So you can see that by looking up

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Speaker 3: free cash flow. Free cash flow for a name like

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Speaker 3: Google was negative in the corner because their capex is

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Speaker 3: growing faster than they're operating cash flow. You go to

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Speaker 3: twenty twenty seven, that's going to be the case for

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Speaker 3: all of the hyperscalers, and so you're going to have

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Speaker 3: a world where capex grows faster than operating cash flow.

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Speaker 3: You're not seeing it show up in the operating fundamentals. Yet,

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Speaker 3: and this is in a world where we're still thinking

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Speaker 3: that we're going to be at the leading edge, and

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Speaker 3: those are going to be the areas, those leading edge

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Speaker 3: models are going to.

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Speaker 4: Be the areas that drive growth.

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Speaker 3: If you have competition, then you could still be in

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Speaker 3: a world where capex continues to grow faster than operating

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Speaker 3: cash flow, not just in twenty seven, but potentially in

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Speaker 3: twenty eight. That of course would come into a head

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Speaker 3: with where consensus is, simply because consensus is expecting a

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Speaker 3: big acceleration and operating cash flow.

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Speaker 1: In twenty eight, chip stocks and hyperscal as sold off

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Speaker 1: enough to make them attractive to you on.

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Speaker 4: A technical basis.

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Speaker 3: No, I think that if you're looking at oversold indicators

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Speaker 3: for something like the semiconductor area, certainly you're not at

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Speaker 3: that level of a total wash and flush out. Yet

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Speaker 3: for the hyperscalers, you're now trading out of valuation that

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Speaker 3: is as low as it was back at Liberation Day.

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Speaker 3: Valuations that are as low as it was back in

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Speaker 3: the lows in twenty twenty two. For certain names, Meta

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Speaker 3: for example, has undercut those lows. You can also look

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Speaker 3: at ETF flows mag seven. ETF flows have been very

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Speaker 3: aggressive outwards over the course of the last month or so,

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Speaker 3: so there's probably some opportunity there to step in. The

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Speaker 3: challenge that we have is that we know these businesses

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Speaker 3: are fundamentally changing. They were monopolies that had very high

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Speaker 3: return and invested capital because they didn't have to spend

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Speaker 3: a lot of money to make money. These are now

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Speaker 3: competitive businesses. They're having to spend a lot of money

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Speaker 3: to make money, which means that ROCs are going lower.

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Speaker 3: So we think structural evaluations will go lower as well.

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Speaker 2: It's why me's re microsoft to some extent in a

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Speaker 2: bear market. You alluded to it earlier in the conversation.

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Speaker 2: I don't want to bury it's important. Do you think

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Speaker 2: they respond to what their stocks are doing. Do you

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Speaker 2: think the stock moves shaped their approach to CAPEX.

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Speaker 3: Well in a way. They kind of have to, because

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Speaker 3: if free cash flow is negative, that means that you

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Speaker 3: have to rely on outside funding to meet your CAPEX goals.

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Speaker 3: But now that outside funding is getting more expensive. If

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Speaker 3: your equity prices down, your incremental equity raises will be

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Speaker 3: more deluded. If your credit spreads are up, your incremental

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Speaker 3: debt raises will be more expensive, so they cannot ignore

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Speaker 3: the markets. And if you're a name like Microsoft who's

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Speaker 3: seen its valuation fall by forty five percent since October,

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Speaker 3: at what point do you say, Hey, maybe this is

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Speaker 3: being perceived as being profilgate and we need to pull back.

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Speaker 2: On that spending that has been a massive tail one

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Speaker 2: for this economy.

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Speaker 4: So let's work through it.

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Speaker 2: The year so far, rolling sharks, through energy, through rates,

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Speaker 2: now through tech. Does that become a growth scare at

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Speaker 2: some point? Does the shake up in tech translate into

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Speaker 2: some kind of fundamental story down the road.

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Speaker 3: Potentially, yes, if we see more weakness within the s

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Speaker 3: and P. Five hundred. The strength of the equity market

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Speaker 3: has been such an important driver of economic growth or

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Speaker 3: support for economic growth in the US. It's allowed the

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Speaker 3: consumer in many ways to deal with the fact that

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Speaker 3: real income growth has been negative because of higher inflation

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Speaker 3: and low wage growth. But if you continue to see

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Speaker 3: pressure within equity markets and put this into context, we're

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Speaker 3: still three and a half percent off high. So this

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Speaker 3: is nothing to necessary cause a big pullback and spending.

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Speaker 3: But if you were to see a deeper, more protracted route,

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Speaker 3: you could effectively have a negative feedback loop where the

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Speaker 3: equity market weakness translates into economic weakness.

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Speaker 4: Stay with us.

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Speaker 2: More Bloomberg surveillance coming up after this. So here's the laces.

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Speaker 2: This morning, the US and Iran pausing strikes straightforth consecutive night,

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Speaker 2: the President saying, both sides are engaging in talks, and

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Speaker 2: let's build on this with Stephen Kirk of the Council

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Speaker 2: on Foreign Relations. He writes the following, the Trump administration

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Speaker 2: made it clear that it was standing down because the

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Speaker 2: United States does not have the weaponry to carry on.

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Speaker 2: The Iranians now know that they have impunity. Stephen joins us.

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Speaker 2: Now for more, Steve, you say, in your words, the

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Speaker 2: Trump administration made it clear? Did they make that clear?

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Speaker 4: Well?

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Speaker 5: All of the reporting from the advice that the President

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Speaker 5: has gotten from the Secretary and I'm sorry, not the

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Speaker 5: Secretary of State, the Chairman of the Joint Use of Staff,

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Speaker 5: as well as as Admiral Bradley Cooper, the head of Sencom,

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Speaker 5: was that we were running out of munitions and that

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Speaker 5: the bombing in the Strait had diminishing returns, so that

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Speaker 5: the President called it off and is now relying on

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Speaker 5: the Oman Channel, where the real negotiations are underway. Meanwhile,

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Speaker 5: Iran's proxies, the Houkies, as well as the Rocky militias,

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Speaker 5: are doing a lot of damage to Saudi oil processing

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Speaker 5: facilities and other energy infrastructure around the region. The Iranians

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Speaker 5: are doing what they normally do, is that they are

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Speaker 5: signaling directly to the United States and its allies, that

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Speaker 5: and its neighbors in the region that it's willing to

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Speaker 5: talk while directing its proxies to so chaos when it.

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Speaker 6: Comes to rebuilding stockpiles. It's not like turning on and

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Speaker 6: off a light switch. So do you expect this pause

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Speaker 6: to be a long one?

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Speaker 5: Well, it does seem that despite the president's threat of escalation,

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Speaker 5: that he has made decision that that's not really in

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Speaker 5: the car. So I think that the pause will go

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Speaker 5: on longer than he was indicating on Air Force One yesterday,

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Speaker 5: which has really become just an idle threat. The last

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Speaker 5: two weeks of bombing did not change the Iranian position

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Speaker 5: at all, and in fact left them in a somewhat

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Speaker 5: stronger position because it was the United States that essentially

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Speaker 5: called off the campaign.

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Speaker 6: We know that Oman tries to keep friendly relations with everyone.

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Speaker 6: They somewhat play both sides. Do you expect them to

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Speaker 6: come out and support Saudi Arabia.

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Speaker 4: For a toll.

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Speaker 5: The Omanis have at times sounded a lot more like

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Speaker 5: Iran's lawyer than a mediator. They maintain that they are

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Speaker 5: being bullied by the Iranians because there is some daylight

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Speaker 5: between Washington and Muscat. That of course is a self

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Speaker 5: serving statement, but it does seem that the Omanis are

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Speaker 5: really the best chance for trying to figure out how

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Speaker 5: to reopen the strait, whether it will be a toll

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Speaker 5: or not. They say public at the moment that they

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Speaker 5: don't support a toll. We'll see what happens as the

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Speaker 5: negotiations take place. It's important to note that there's a

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Speaker 5: negotiation going on between Oman and Iran right now, not

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Speaker 5: between the United States and Iran and Oman.

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Speaker 1: At the same time, Stephen, attacks are continuing. There were

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Speaker 1: reports on satellite images of smoke coming from an oil

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Speaker 1: facility in Saudi Arabia. In Bahrain, there were two Amazon

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Speaker 1: Centers data centers that were reportedly under attack. How much

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Speaker 1: do you expect to see a region wide war amplified

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Speaker 1: and participation of the likes of the UAE as well

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Speaker 1: as Saudi Arabia.

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Speaker 5: It's a good question, and it seems to me as

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Speaker 5: I was noting before, that while the Iranians are signaling

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Speaker 5: a willingness to talk through the Omanis, its proxies are

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Speaker 5: being directed to attack American partners in the region, with

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Speaker 5: the exception, I should say, of the United Our Memirates,

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Speaker 5: which does not take any hits thus far. But the Huthis,

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Speaker 5: who have a separate conflict with the Saudias, have hit

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Speaker 5: Obcake and Obcake, a major oil processing facility in Saudi Arabia,

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Speaker 5: as well as a number of other facilities. Iraqi militias

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Speaker 5: have also joined in these attacks. So once again it

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Speaker 5: is the Iranians talking from one aspect of this, while

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Speaker 5: at the same time their proxies undermining hopes for regional security.

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Speaker 1: I'm just wondering what it's going to take for some

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Speaker 1: of these Middle Easted economies to really become once again

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Speaker 1: a safe haven for businesses. Helton just reported earnings and

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Speaker 1: said that revenues from the Middle East and Africa declined

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Speaker 1: by nearly thirty percent as a result of the war

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Speaker 1: in the region. This was a hot spot for so

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Speaker 1: many different companies to really go and do business. I mean,

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Speaker 1: is that kind of over for the foreseeable future.

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Speaker 4: Well, this war has raised.

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Speaker 5: A question about the Gulf development model, which was based

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Speaker 5: on security and stability and attracting the talent of the

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Speaker 5: world to these city states and thus attracting lots of investment.

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Speaker 5: If you cannot provide security, people are not going to

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Speaker 5: come and people aren't going to invest. The Amortis have

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Speaker 5: taken somewhat different course. They have invested in the relationship

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Speaker 5: with the United States and Israel, while at the same

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Speaker 5: time signaling to the Iranians that they want to have

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Speaker 5: better relations. That seems to have shielded them during this round.

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Speaker 5: It's possible that the Bahrainis and others will follow suit.

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Speaker 5: But once again, the Iranians are intent on disrupting American

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Speaker 5: military operations in the region, and as long as the

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Speaker 5: Kuwaitis and the Bahrainians and Cupleries and others have major

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Speaker 5: American bases there, they are going to come under Iranian fire.

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Speaker 2: Stay with US Mulblomberg surveillance coming up after this. So

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Speaker 2: here's the LASS this morning, the FEDS today meeting kicking

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Speaker 2: off later on today. Marcus widely expand in the Central

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Speaker 2: Bank to hold raise steady surprise hike by fetcheck. Kevin

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Speaker 2: Walsh is not completely off the table my home back

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Speaker 2: of more caan standing writes, and we expect the Fed

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Speaker 2: to stay on hold that set inflation has to perform

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Speaker 2: in the coming months or the feed will switched to

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Speaker 2: hikes later this year. Matt, John, just now for more Ma,

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Speaker 2: good morning, good morning. How much descent are you expecting

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Speaker 2: tomorrow afternoon? Well, it's interesting.

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Speaker 7: I mean, we are expecting a couple of descents coming

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Speaker 7: off out of the committee, But I do think that

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Speaker 7: you could make the case that there may not be

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Speaker 7: any descents, actually, John, because in the end, if we

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Speaker 7: look at what has happened since the June FMC meeting

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Speaker 7: where there were no descents, the data has been better,

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Speaker 7: The inflation data has been better, the labor market data

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Speaker 7: has been somewhat disappointing relative to the trend that we

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Speaker 7: had seen in March, April and May. And so if

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Speaker 7: they weren't willing to dissent in June, why all of

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Speaker 7: a sudden.

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Speaker 4: The change of heart.

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Speaker 7: I mean, crude oil prices are roughly where they were

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Speaker 7: going into the June meeting. They're obviously a lot lower

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Speaker 7: than they were three months ago.

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Speaker 4: What's the rationale to dissent?

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Speaker 7: It's you can make the argument that there will be

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Speaker 7: no descents tomorrow.

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Speaker 2: Beth Hannock, Cleveland FED President, making a statement on LinkedIn

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Speaker 2: going into the quiet period, which was interesting timing making

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Speaker 2: the statement the suggestion that companies in her district a

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Speaker 2: talent cre the prices is too high and perhaps ultimately

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Speaker 2: this fight should do something about said what was your

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Speaker 2: reaction to that piece.

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Speaker 7: I think people have thought prices were too high for

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Speaker 7: twenty years.

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Speaker 4: John.

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Speaker 7: The real question is have the increase in prices that

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Speaker 7: we've seen over the past five years fed into inflation

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Speaker 7: expectations such that people continue to expect inflation to be

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Speaker 7: running very, very hot for a very very long time

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Speaker 7: to come. There's not a lot of evidence to suggest

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Speaker 7: that that's the case. And when you look at markets,

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Speaker 7: just look at five year forward five year break even

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Speaker 7: inflation rates. Right the Fed publishes this measure, it's on

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Speaker 7: the Bloomberg terminal. It's been very stable since the Fed

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Speaker 7: height rates in twenty twenty t too. Where is the

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Speaker 7: need for the Fed to get inflation fighting credibility it

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Speaker 7: already has. I don't see the rationale for a rate

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Speaker 7: hike on Wednesday to solidify credibility the Fed already has it,

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Speaker 7: doesn't make much sense to.

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Speaker 1: Me, well, does it still have it in the same way?

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Speaker 1: And I ask this because I'm looking at long end

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Speaker 1: long ends of the yield curve continuing to rise and

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Speaker 1: this feeling that right now in markets people are pricing

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Speaker 1: in more than a seventy percent chance of a September

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Speaker 1: rate hike if there are no descents, do people take

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Speaker 1: back some of that pricing of a potential rate hike ahead.

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Speaker 4: Absolutely. The thing that we have to recognize.

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Speaker 7: Is that real rates have gone up a lot, financial

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Speaker 7: conditions have already tightened a lot. The big question facing

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Speaker 7: the Fed today is have they tightened enough? And I

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Speaker 7: just don't think that they have enough information to say

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Speaker 7: one way or the other.

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Speaker 1: Does it behoove them, though, to take that pricing out

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Speaker 1: of the market to give a sort of doubvish signal

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Speaker 1: at a time when the market is doing the work

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Speaker 1: for them and could potentially get inflation lower without them

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Speaker 1: even having to act.

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Speaker 4: As long as.

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Speaker 1: There are descents, as long as there is this family fight, gosh, I.

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Speaker 7: Think if they were being that clever, then we've got

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Speaker 7: a whole other situation on our hands. I mean, do

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Speaker 7: they manipulate the dots to try to get a certain outcome.

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Speaker 7: I think the answer has always been no, Right they do,

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Speaker 7: of course, look at the statement language. They have a

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Speaker 7: message they want to convey to the public. But are

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Speaker 7: they going to play games with the public's perception of

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Speaker 7: I think the answer is no. I think they have

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Speaker 7: a clear mission. They've made that very transparent to the public.

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Speaker 7: They want inflation to come down. Interest rates have gone

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Speaker 7: up a lot since Chairman worsh delivered that message at

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Speaker 7: the June FOMC meeting. The question they face today is

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Speaker 7: have those rates gone up enough to help inflation come

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Speaker 7: down in the manner that they would like to see.

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Speaker 4: It's only been six weeks.

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Speaker 7: I don't think they have enough information in hand to

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Speaker 7: say one way or the other with confidence, which is

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Speaker 7: what I think you need to have if you're delivering

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Speaker 7: a rate hike that isn't fully priced in by the market,

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Speaker 7: you need to have confidence that you're doing the right thing.

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Speaker 7: I think the answer is that they don't yet have

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Speaker 7: that confidence.

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Speaker 4: We don't think they're hiking.

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Speaker 6: Rates, but at some point, if inflation doesn't come down,

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Speaker 6: quick enough this year, don't they have to hike or

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Speaker 6: they just look like they're talking at both sides of

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Speaker 6: their mouth and not delivering. It's just empty promises.

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Speaker 7: Absolutely, if inflation doesn't come down in the way that

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Speaker 7: they would like to see, rate hikes are on the table.

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Speaker 7: I mean, that's what we're saying at Morgan Stanley, our

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Speaker 7: chief US economists, Mike Gapen, is making that point very

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Speaker 7: very clearly. He happens to believe inflation will come down

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Speaker 7: such that the FED isn't going to deliver rate hikes

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Speaker 7: this year. It's a view based on a solid rationale.

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Speaker 4: The issue that we.

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Speaker 7: Face today in this moment, for this meeting is do

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Speaker 7: they have enough information to say with confidence that financial

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Speaker 7: conditions have ent tightened nut And I think the answer

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Speaker 7: is clearly no.

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Speaker 2: So matches quickly. Do you expect that gap between the

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Speaker 2: two year guild and the policy rate just to be

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Speaker 2: sustained for the time bank for.

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Speaker 4: The time being.

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Speaker 7: Absolutely, After this meeting, we're going to get two rounds

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Speaker 7: of economic data before the FED has to make a

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Speaker 7: decision in September. That is a lot of economic data

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Speaker 7: that will inform their decision in September. We think the

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Speaker 7: data will come in and tell them they don't need

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Speaker 7: to high rates.

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Speaker 4: We'll see.

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