00:00:00 Speaker 1: Bloomberg Audio Studios, Podcasts, radio News. 00:00:11 Speaker 2: This is the Bloomberg Surveillance Podcast. I'm Jonathan Ferrow, along with Lisa Bromwitz and Amrie Hordert. Join us each day for insight from the best in markets, economics, and geopolitics from our global headquarters in New York City. We are live on Bloomberg Television weekday mornings from six to nine am Eastern. Subscribe to the podcast on Apple, Spotify or anywhere else you listen, and as always on the Bloomberg Terminal and the Bloomberg Business app. We begin this soum with the Chip sell off building, Cameron Dawson and New Wedgewalth writing the following, the semiconductor profit cycle depends on two big factors. Hyper scare is continuing to spend aggressively and limited new competition entering the space that could challenge margins. Markets seem to be questioning both. Cam joins us now for more, Cam, good morning, go to see you. 00:00:54 Speaker 3: Good morning. 00:00:55 Speaker 2: That quote just perfectly illustrates this moment we're in right now. We are questioning both. Do you think it is valid to question both? 00:01:01 Speaker 3: I think it is, But I think before we get to the fundamentals. We have to appreciate the technicals because so much of the upside was driven by positioning chases and squeezes and flows, and so what we're experiencing now is effectively the mirror image of that because flows were so aggressive into leverage products within the semiconductor space, not just in the US, but of course in South Korea. What we're seeing is the dynamic is that as that leverage unwind, you're seeing a lot more downside. Effectively, these stocks got so overbought by the time you got to the middle of June that even though we've seen things like a forty percent drawdown in something like s k Heinex, you're technically not over sold yet. So if you look at a name like Micron, yes it's down over twenty percent, but it's still forty percent above its two hundred day moving average, you can say think the same thing for the socks overall. So it's important to remember narrative follows price. So all of these negative narratives on the fundamentals we're talking about, it's effectively just following the negative process. 00:01:56 Speaker 2: So is this a price move looking for a narrative or is there a story here I think it's. 00:02:00 Speaker 3: A matter of both. I think some of the dynamic that we saw in the upside mood was ignoring the fact that a lot of these capacity editions. While you're thinking about Microun itself adding capacity, as khihinch, Samsung adding capacity, and now China adding capacity, we've all known this for the last six months over a year, because we've known that there has been a capacity shortage. But now the market is starting to wake up to it. And at the end of the day you had this clarion call from big bowls on things like Micron saying, of course the eighty five percent gross margin is sustainable. This time is in fact different. But this is still a very very cyclical business. And so given the fact that you are going to have capacity editions over the course of the next few years, you will see downward pressure on those growth margins. The big difference, or the big thing to watch is that is there any downward pressure on the revenue line, because that's really when you start to see the deleveraging and the operating leverage of these businesses, and if you continue to see weakness within the hyperscaler names. The question that we have been asking is if the stocks continue to get pressured, will they continue to raise capex. 00:03:04 Speaker 1: At the same time, there's this issue of exactly whether the economics are changing and moving away from certain companies. 00:03:10 Speaker 4: And I'm thinking of. 00:03:11 Speaker 1: Say the closed models like the open ayes and the anthropics that are suddenly coming under pressure from open source models that are coming out of China but are being adopted rapidly by a lot of US companies seek the search for cheaper models is definitely taking steam. Do you think that does fundamentally alter the tech story? 00:03:31 Speaker 3: Yeah, because I think the big question that you have is a scaling factor. We know that we are getting growth because of some of this capex investment, but effectively the growth is coming in slower than what the capex investment is. So you can see that by looking up free cash flow. Free cash flow for a name like Google was negative in the corner because their capex is growing faster than they're operating cash flow. You go to twenty twenty seven, that's going to be the case for all of the hyperscalers, and so you're going to have a world where capex grows faster than operating cash flow. You're not seeing it show up in the operating fundamentals. Yet, and this is in a world where we're still thinking that we're going to be at the leading edge, and those are going to be the areas, those leading edge models are going to. 00:04:11 Speaker 4: Be the areas that drive growth. 00:04:13 Speaker 3: If you have competition, then you could still be in a world where capex continues to grow faster than operating cash flow, not just in twenty seven, but potentially in twenty eight. That of course would come into a head with where consensus is, simply because consensus is expecting a big acceleration and operating cash flow. 00:04:30 Speaker 1: In twenty eight, chip stocks and hyperscal as sold off enough to make them attractive to you on. 00:04:35 Speaker 4: A technical basis. 00:04:36 Speaker 3: No, I think that if you're looking at oversold indicators for something like the semiconductor area, certainly you're not at that level of a total wash and flush out. Yet for the hyperscalers, you're now trading out of valuation that is as low as it was back at Liberation Day. Valuations that are as low as it was back in the lows in twenty twenty two. For certain names, Meta for example, has undercut those lows. You can also look at ETF flows mag seven. ETF flows have been very aggressive outwards over the course of the last month or so, so there's probably some opportunity there to step in. The challenge that we have is that we know these businesses are fundamentally changing. They were monopolies that had very high return and invested capital because they didn't have to spend a lot of money to make money. These are now competitive businesses. They're having to spend a lot of money to make money, which means that ROCs are going lower. So we think structural evaluations will go lower as well. 00:05:31 Speaker 2: It's why me's re microsoft to some extent in a bear market. You alluded to it earlier in the conversation. I don't want to bury it's important. Do you think they respond to what their stocks are doing. Do you think the stock moves shaped their approach to CAPEX. 00:05:42 Speaker 3: Well in a way. They kind of have to, because if free cash flow is negative, that means that you have to rely on outside funding to meet your CAPEX goals. But now that outside funding is getting more expensive. If your equity prices down, your incremental equity raises will be more deluded. If your credit spreads are up, your incremental debt raises will be more expensive, so they cannot ignore the markets. And if you're a name like Microsoft who's seen its valuation fall by forty five percent since October, at what point do you say, Hey, maybe this is being perceived as being profilgate and we need to pull back. 00:06:17 Speaker 2: On that spending that has been a massive tail one for this economy. 00:06:19 Speaker 4: So let's work through it. 00:06:20 Speaker 2: The year so far, rolling sharks, through energy, through rates, now through tech. Does that become a growth scare at some point? Does the shake up in tech translate into some kind of fundamental story down the road. 00:06:32 Speaker 3: Potentially, yes, if we see more weakness within the s and P. Five hundred. The strength of the equity market has been such an important driver of economic growth or support for economic growth in the US. It's allowed the consumer in many ways to deal with the fact that real income growth has been negative because of higher inflation and low wage growth. But if you continue to see pressure within equity markets and put this into context, we're still three and a half percent off high. So this is nothing to necessary cause a big pullback and spending. But if you were to see a deeper, more protracted route, you could effectively have a negative feedback loop where the equity market weakness translates into economic weakness. 00:07:11 Speaker 4: Stay with us. 00:07:12 Speaker 2: More Bloomberg surveillance coming up after this. So here's the laces. This morning, the US and Iran pausing strikes straightforth consecutive night, the President saying, both sides are engaging in talks, and let's build on this with Stephen Kirk of the Council on Foreign Relations. He writes the following, the Trump administration made it clear that it was standing down because the United States does not have the weaponry to carry on. The Iranians now know that they have impunity. Stephen joins us. Now for more, Steve, you say, in your words, the Trump administration made it clear? Did they make that clear? 00:07:50 Speaker 4: Well? 00:07:51 Speaker 5: All of the reporting from the advice that the President has gotten from the Secretary and I'm sorry, not the Secretary of State, the Chairman of the Joint Use of Staff, as well as as Admiral Bradley Cooper, the head of Sencom, was that we were running out of munitions and that the bombing in the Strait had diminishing returns, so that the President called it off and is now relying on the Oman Channel, where the real negotiations are underway. Meanwhile, Iran's proxies, the Houkies, as well as the Rocky militias, are doing a lot of damage to Saudi oil processing facilities and other energy infrastructure around the region. The Iranians are doing what they normally do, is that they are signaling directly to the United States and its allies, that and its neighbors in the region that it's willing to talk while directing its proxies to so chaos when it. 00:08:45 Speaker 6: Comes to rebuilding stockpiles. It's not like turning on and off a light switch. So do you expect this pause to be a long one? 00:08:53 Speaker 5: Well, it does seem that despite the president's threat of escalation, that he has made decision that that's not really in the car. So I think that the pause will go on longer than he was indicating on Air Force One yesterday, which has really become just an idle threat. The last two weeks of bombing did not change the Iranian position at all, and in fact left them in a somewhat stronger position because it was the United States that essentially called off the campaign. 00:09:22 Speaker 6: We know that Oman tries to keep friendly relations with everyone. They somewhat play both sides. Do you expect them to come out and support Saudi Arabia. 00:09:30 Speaker 4: For a toll. 00:09:32 Speaker 5: The Omanis have at times sounded a lot more like Iran's lawyer than a mediator. They maintain that they are being bullied by the Iranians because there is some daylight between Washington and Muscat. That of course is a self serving statement, but it does seem that the Omanis are really the best chance for trying to figure out how to reopen the strait, whether it will be a toll or not. They say public at the moment that they don't support a toll. We'll see what happens as the negotiations take place. It's important to note that there's a negotiation going on between Oman and Iran right now, not between the United States and Iran and Oman. 00:10:16 Speaker 1: At the same time, Stephen, attacks are continuing. There were reports on satellite images of smoke coming from an oil facility in Saudi Arabia. In Bahrain, there were two Amazon Centers data centers that were reportedly under attack. How much do you expect to see a region wide war amplified and participation of the likes of the UAE as well as Saudi Arabia. 00:10:41 Speaker 5: It's a good question, and it seems to me as I was noting before, that while the Iranians are signaling a willingness to talk through the Omanis, its proxies are being directed to attack American partners in the region, with the exception, I should say, of the United Our Memirates, which does not take any hits thus far. But the Huthis, who have a separate conflict with the Saudias, have hit Obcake and Obcake, a major oil processing facility in Saudi Arabia, as well as a number of other facilities. Iraqi militias have also joined in these attacks. So once again it is the Iranians talking from one aspect of this, while at the same time their proxies undermining hopes for regional security. 00:11:28 Speaker 1: I'm just wondering what it's going to take for some of these Middle Easted economies to really become once again a safe haven for businesses. Helton just reported earnings and said that revenues from the Middle East and Africa declined by nearly thirty percent as a result of the war in the region. This was a hot spot for so many different companies to really go and do business. I mean, is that kind of over for the foreseeable future. 00:11:51 Speaker 4: Well, this war has raised. 00:11:53 Speaker 5: A question about the Gulf development model, which was based on security and stability and attracting the talent of the world to these city states and thus attracting lots of investment. If you cannot provide security, people are not going to come and people aren't going to invest. The Amortis have taken somewhat different course. They have invested in the relationship with the United States and Israel, while at the same time signaling to the Iranians that they want to have better relations. That seems to have shielded them during this round. It's possible that the Bahrainis and others will follow suit. But once again, the Iranians are intent on disrupting American military operations in the region, and as long as the Kuwaitis and the Bahrainians and Cupleries and others have major American bases there, they are going to come under Iranian fire. 00:12:40 Speaker 2: Stay with US Mulblomberg surveillance coming up after this. So here's the LASS this morning, the FEDS today meeting kicking off later on today. Marcus widely expand in the Central Bank to hold raise steady surprise hike by fetcheck. Kevin Walsh is not completely off the table my home back of more caan standing writes, and we expect the Fed to stay on hold that set inflation has to perform in the coming months or the feed will switched to hikes later this year. Matt, John, just now for more Ma, good morning, good morning. How much descent are you expecting tomorrow afternoon? Well, it's interesting. 00:13:18 Speaker 7: I mean, we are expecting a couple of descents coming off out of the committee, But I do think that you could make the case that there may not be any descents, actually, John, because in the end, if we look at what has happened since the June FMC meeting where there were no descents, the data has been better, The inflation data has been better, the labor market data has been somewhat disappointing relative to the trend that we had seen in March, April and May. And so if they weren't willing to dissent in June, why all of a sudden. 00:13:52 Speaker 4: The change of heart. 00:13:52 Speaker 7: I mean, crude oil prices are roughly where they were going into the June meeting. They're obviously a lot lower than they were three months ago. 00:13:59 Speaker 4: What's the rationale to dissent? 00:14:02 Speaker 7: It's you can make the argument that there will be no descents tomorrow. 00:14:05 Speaker 2: Beth Hannock, Cleveland FED President, making a statement on LinkedIn going into the quiet period, which was interesting timing making the statement the suggestion that companies in her district a talent cre the prices is too high and perhaps ultimately this fight should do something about said what was your reaction to that piece. 00:14:23 Speaker 7: I think people have thought prices were too high for twenty years. 00:14:26 Speaker 4: John. 00:14:27 Speaker 7: The real question is have the increase in prices that we've seen over the past five years fed into inflation expectations such that people continue to expect inflation to be running very, very hot for a very very long time to come. There's not a lot of evidence to suggest that that's the case. And when you look at markets, just look at five year forward five year break even inflation rates. Right the Fed publishes this measure, it's on the Bloomberg terminal. It's been very stable since the Fed height rates in twenty twenty t too. Where is the need for the Fed to get inflation fighting credibility it already has. I don't see the rationale for a rate hike on Wednesday to solidify credibility the Fed already has it, doesn't make much sense to. 00:15:16 Speaker 1: Me, well, does it still have it in the same way? And I ask this because I'm looking at long end long ends of the yield curve continuing to rise and this feeling that right now in markets people are pricing in more than a seventy percent chance of a September rate hike if there are no descents, do people take back some of that pricing of a potential rate hike ahead. 00:15:35 Speaker 4: Absolutely. The thing that we have to recognize. 00:15:38 Speaker 7: Is that real rates have gone up a lot, financial conditions have already tightened a lot. The big question facing the Fed today is have they tightened enough? And I just don't think that they have enough information to say one way or the other. 00:15:54 Speaker 1: Does it behoove them, though, to take that pricing out of the market to give a sort of doubvish signal at a time when the market is doing the work for them and could potentially get inflation lower without them even having to act. 00:16:06 Speaker 4: As long as. 00:16:07 Speaker 1: There are descents, as long as there is this family fight, gosh, I. 00:16:10 Speaker 7: Think if they were being that clever, then we've got a whole other situation on our hands. I mean, do they manipulate the dots to try to get a certain outcome. I think the answer has always been no, Right they do, of course, look at the statement language. They have a message they want to convey to the public. But are they going to play games with the public's perception of I think the answer is no. I think they have a clear mission. They've made that very transparent to the public. They want inflation to come down. Interest rates have gone up a lot since Chairman worsh delivered that message at the June FOMC meeting. The question they face today is have those rates gone up enough to help inflation come down in the manner that they would like to see. 00:16:58 Speaker 4: It's only been six weeks. 00:16:59 Speaker 7: I don't think they have enough information in hand to say one way or the other with confidence, which is what I think you need to have if you're delivering a rate hike that isn't fully priced in by the market, you need to have confidence that you're doing the right thing. I think the answer is that they don't yet have that confidence. 00:17:17 Speaker 4: We don't think they're hiking. 00:17:18 Speaker 6: Rates, but at some point, if inflation doesn't come down, quick enough this year, don't they have to hike or they just look like they're talking at both sides of their mouth and not delivering. It's just empty promises. 00:17:28 Speaker 7: Absolutely, if inflation doesn't come down in the way that they would like to see, rate hikes are on the table. I mean, that's what we're saying at Morgan Stanley, our chief US economists, Mike Gapen, is making that point very very clearly. He happens to believe inflation will come down such that the FED isn't going to deliver rate hikes this year. It's a view based on a solid rationale. 00:17:50 Speaker 4: The issue that we. 00:17:51 Speaker 7: Face today in this moment, for this meeting is do they have enough information to say with confidence that financial conditions have ent tightened nut And I think the answer is clearly no. 00:18:01 Speaker 2: So matches quickly. Do you expect that gap between the two year guild and the policy rate just to be sustained for the time bank for. 00:18:07 Speaker 4: The time being. 00:18:08 Speaker 7: Absolutely, After this meeting, we're going to get two rounds of economic data before the FED has to make a decision in September. That is a lot of economic data that will inform their decision in September. We think the data will come in and tell them they don't need to high rates. 00:18:25 Speaker 4: We'll see. 00:18:26 Speaker 2: This is the Bloomberg Survandons podcast, bringing you the best in markets, economics, an gio politics. You can watch the show live on Bloomberg TV weekday mornings from six am to nine am Eastern. Subscribe to the podcast on Apple, Spotify, or anywhere else you listen, and as always on the Bloomberg Terminal and the Bloomberg Business Amp