Speaker 1: Hello, and welcome to another episode of the Odd Lots Podcast.
Speaker 1: I'm Joe Wisenthal and unfortunately my colleague Tracy Elloway is
Speaker 1: uh still out. But you can think of this week
Speaker 1: as sort of a part two to last week's episode.
Speaker 1: So last week we talked about the biggest stories for
Speaker 1: traders in markets in eighteen, and this week we start
Speaker 1: the new year looking ahead to try to figure out
Speaker 1: what the biggest stories in markets will be for nineteen
Speaker 1: and so we've brought back the same guests this time,
Speaker 1: they're going to look ahead with me. Now in the
Speaker 1: studio we have Bloomberg Cross Assets reporter Luke Kawa and
Speaker 1: Bloomberg's macro strategist Cameron Christ. So Luke and Cameron, thank
Speaker 1: you very much for joining us. Looking forward to hearing
Speaker 1: your your crystal balls for the year ahead. Cameron, I
Speaker 1: will start with you, So, going into the new year,
Speaker 1: what are like the big I guess events or things
Speaker 1: you'll be thinking about that you'll want to see develop. Well,
Speaker 1: it strikes me that there's a few important issues here.
Speaker 1: One is what happens with the Federal Reserve UM. Right now,
Speaker 1: markets are pricing basically a fifty fifty shot whether they
Speaker 1: hike at all in and just to be clear for
Speaker 1: those listening at home, we are recording this December eighteen, uh,
Speaker 1: right before December. The question, it's just important for when
Speaker 1: people listen to this to realize when this is truly
Speaker 1: we're truly looking actually looking at not with the benefit
Speaker 1: of perfect information and all. You know, the trades story
Speaker 1: is as much as we like to think it's gonna
Speaker 1: just go away with the turn of the calendar, that's
Speaker 1: not realistic. We need to get some sort of resolution here.
Speaker 1: And I think a third at least domestic issue for
Speaker 1: the United States, which is a new entry, will be
Speaker 1: a more targeted attack on the president and and the
Speaker 1: sort of the the the tapestry that's formed the backdrop
Speaker 1: in terms of political intrigue will become part of the
Speaker 1: foreground rather than the background next year. I suspect, yeah,
Speaker 1: I'm interested in this topic because for the first like
Speaker 1: I would say, year and a half of the Trump presidency,
Speaker 1: I recall one of the constant discussions being there's so
Speaker 1: much chaos at the White House, why does it not
Speaker 1: seem to matter for the markets? Uh? And the responses
Speaker 1: typically like well things are going fine, and earnings are
Speaker 1: going up and all that, so whatever, it just is
Speaker 1: background noise. Do you both get the impression that that's
Speaker 1: changing a little bit and that people really are for
Speaker 1: the first time kind of trading on uh political risk
Speaker 1: at the White House? Well, I think to a certain extent,
Speaker 1: we're using this to rationalize how we feel now. I
Speaker 1: think the market is in a much more vulnerable place,
Speaker 1: so the potential of adding another headwind from the White
Speaker 1: House does mean more than it did in the past.
Speaker 1: But I'll also remember back in August, Yeah, I guess
Speaker 1: it was when we were getting rumors that Gary Cohene
Speaker 1: was leaving the White House because of his uh he
Speaker 1: was upset about the the Charlottesville protests and the president's response.
Speaker 1: That inter day move was one of the bigger retreats
Speaker 1: we saw in the SMP five hundred that year. It's
Speaker 1: just the fact that, you know, it was a nothing
Speaker 1: burger and the market was able to wash that away
Speaker 1: so quickly. But right now, I think that it's just
Speaker 1: something that adds to market vulnerability. But I think it's
Speaker 1: a cause and a headache, but it's not you know,
Speaker 1: every proximate cause of weakness for the markets, Well, there's
Speaker 1: so much going on. It's it's hard to say that
Speaker 1: people are selling stocks because Nancy Pelosi is going to
Speaker 1: be the Speaker of the House. But I think moving forward,
Speaker 1: does it represent a reason to have a risk premium
Speaker 1: in the markets generally? Probably? Probably that's the area of
Speaker 1: the market that you would look at to try to
Speaker 1: isolate political risk, like with trade or trade proxies, FED
Speaker 1: rage sensitive ones, Like could you even begin to try
Speaker 1: constructing some basket of politically sensitive multiples relative to other
Speaker 1: developed markets changing multiples because like, yeah, I I wouldn't
Speaker 1: know how to do it on the non index level
Speaker 1: because you'd think if it was you know, something that
Speaker 1: was affecting the U S sucks in general, that would
Speaker 1: have to it would have to not be a sector
Speaker 1: specific thing and have to be an index level thing
Speaker 1: or that I mean maybe the builders of walls. Yeah,
Speaker 1: I mean, it's kind of a joke that keeps on giving, right,
Speaker 1: But I think on your themes, there's a couple that
Speaker 1: you know worth developing, and they take us into more
Speaker 1: of a markets place, both on on trade and the FED.
Speaker 1: I think in a lot of sense from all the
Speaker 1: twenty nineteen Outlook reports, I read their Wall Street essentially
Speaker 1: averaging down into the outlooks. And two areas where I
Speaker 1: I think try where trade and the FED come into play,
Speaker 1: is I would expect to see any more any negative
Speaker 1: trade headlines manifest more to the downside in US equities
Speaker 1: than they do to emerging market equities. I think emerging
Speaker 1: markets have priced in a ton of pain, and we
Speaker 1: have already seen a turn in this year in the
Speaker 1: e M versus you know SMP five hundred ratio, so
Speaker 1: even on you know, not material improvement in trade. So
Speaker 1: I think there's more of a potential for U S
Speaker 1: stocks to start to price in the downside risk to
Speaker 1: trade at the index level than emerging market stocks. And
Speaker 1: another on the US dollar in the FED. I'm wondering
Speaker 1: if this is finally the time we do truly get
Speaker 1: that U. S dollar top. If twenty nineteen is a
Speaker 1: year of US dollar weakness, and it has to do
Speaker 1: with just you know, your second derivative, the fact that
Speaker 1: the FED isn't going to speed up the pace of
Speaker 1: rate hikes, and the fact that the US is probably
Speaker 1: going to decelerate more than other economies on a like
Speaker 1: or over your basis, Well, I would say this VSA
Speaker 1: V the US market versus emerging markets. If you look
Speaker 1: at this year, actually the multiple has contracted by roughly
Speaker 1: the same amount in the SMP and uh the M
Speaker 1: s c I Emerging Market Index. What has separated the
Speaker 1: performance between the two has been earnings, where the US
Speaker 1: is obviously delivered great earnings growth and uh E M
Speaker 1: earnings have been basically flat on an earnings per share basis.
Speaker 1: So the one of the issues I'm wrestling with is,
Speaker 1: right now, the consensus top down forecast looks for something
Speaker 1: like eight percent earnings growth for the US over the
Speaker 1: next twelve months. That looks way too high, right Everyone
Speaker 1: expects that to come down. Everyone expects that to come down.
Speaker 1: That being said, even if we assume zero earnings growth
Speaker 1: for the US, I think you could argue that the
Speaker 1: multiples contracted enough that the market actually offer right now.
Speaker 1: With your third way to look at the multiple, UM, well,
Speaker 1: I look I like to look at the multiple relative
Speaker 1: to the rolling twelve month forward UM earnings estimate, which
Speaker 1: I have to construct in the spreadsheet because for the
Speaker 1: SMP there's no unfortunately, there's no easy way to do
Speaker 1: it on the terminal. You can get it on the
Speaker 1: M s C I US index a twelve month rolling
Speaker 1: EPs or or price earnings ratio, but that allows for
Speaker 1: sort of constant apples to apples comparisons over over time.
Speaker 1: And I think we're in about fifteen and a bit
Speaker 1: in terms of in terms of the PE relative to
Speaker 1: the spot earnings. So if we assume no earnings growth,
Speaker 1: that would be fifteen relative to twelve month forward earnings,
Speaker 1: which is an earnings yield of about six and a
Speaker 1: half six point seven. Uh. You compare that to inflation.
Speaker 1: As you know, Joe, the real earnings yield is one
Speaker 1: of my favorite metrics. Uh, So we can compare that
Speaker 1: where inflation is likely to go. That could present an
Speaker 1: earning a real earning shield of sort of four or
Speaker 1: four and a half percent by the middle of next year,
Speaker 1: which is a level that's consistent historically with fantastic returns
Speaker 1: for US stocks. To compare it with bond yields. You know,
Speaker 1: the quote unquote FED model not perfect, but that's still
Speaker 1: a pretty tasty, tasty premium. So I do wonder how
Speaker 1: much further multiples can actually contract from here, barring uh,
Speaker 1: an economy a proper economic downturn, and that's really gonna
Speaker 1: be the story for the end of next year is
Speaker 1: does recession become the self fulfilling prophecy? And a part
Speaker 1: of that story that I'm starting to see in markets,
Speaker 1: and I'm wondering if this will be a developing theme
Speaker 1: in twenty nine is the return of rates volatility, like
Speaker 1: we we talked about right before the February volatility explosion,
Speaker 1: and you know, the demise of my friend X I
Speaker 1: V and then again the sell off we got up
Speaker 1: in October after Jerome Powell talked about long way from neutral.
Speaker 1: Those are both rate sensitive and rate related moves, but
Speaker 1: they weren't really accompanied by a lot of implied rate volatility.
Speaker 1: A huge move higher there. And one thing I'm looking about,
Speaker 1: as you know, something to spur rate volatility is a
Speaker 1: lot more uncertainty and confusion about the federal reserves path.
Speaker 1: I think that's a pretty easy catalyst, and I think
Speaker 1: that's something that we've been working through in Q four.
Speaker 1: And one of the places I l racy that coming
Speaker 1: up is looking at the ratio of one year two
Speaker 1: year swaption volatility, So the implied volatility of two year
Speaker 1: rates over the next year versus one year tenure swaption
Speaker 1: volatility implied volatility of tenure rates over the next year,
Speaker 1: and that ratio is very elevated right now, you know,
Speaker 1: and it's moved upwards at a speed not seen since
Speaker 1: the Taper tantrum. Taper tantrum, to me, was like a
Speaker 1: clear indication of the market pricing in an inflection point
Speaker 1: for Federal reserve policy, even though it took a while
Speaker 1: to arrive. I think we're getting the same here and
Speaker 1: where we've you know, we're starting to sniff out what
Speaker 1: does the end of the FED cycle look like, what
Speaker 1: does the turn look like, and that as a catalyst
Speaker 1: for rate volatility at that start, it's at the short
Speaker 1: end and perhaps moved further up of the curve, and
Speaker 1: you know, has an effect on cross asset volatility, on spreads,
Speaker 1: on equities more so. I that's something I'm looking forward
Speaker 1: to to seeing because it has been the dog that
Speaker 1: hasn't really barked. I think I'd probably take the under
Speaker 1: on rate's fall for the simple for two reasons. Um
Speaker 1: One is, we have much more explicit forward guidance than
Speaker 1: we've ever had in the past, and it's almost irrelevant
Speaker 1: whether the Fed actually is right or accurate in their forecast.
Speaker 1: There's a well known behavioral finance UH concept called anchoring,
Speaker 1: and it provides these The dot plot provides an anchor
Speaker 1: for market expectations, and you can observe that in many
Speaker 1: ways that realize volatility throughout this entire cycle has been
Speaker 1: much much, much lower than it has been historically because
Speaker 1: of this anchoring process. One change that's gonna be different
Speaker 1: in twenty nineteen is that every FED decision now will
Speaker 1: be accompanied by a press conference. Previously it's just been
Speaker 1: four year. Used to be none a year. There was
Speaker 1: a belief and it was never officially stated, but there
Speaker 1: was a belief that I guess kind of got confirmed though,
Speaker 1: that only the press conference meetings were live. Well, they
Speaker 1: did claim that all meetings were loved. They never hiked
Speaker 1: on a non press conference meeting. I don't ever believed
Speaker 1: it does. The theoretical liveness of all the meetings introduce
Speaker 1: any sort of volatility into a short range a little bit.
Speaker 1: I think though, that markets will still anchor on the
Speaker 1: quarterly meetings simply because that's when the new round of
Speaker 1: forecasts are unveiling, and we've sort of seen that there
Speaker 1: are still special meetings. Yeah, well we've seen that with
Speaker 1: the ECB right where every meeting is theoretically live, but
Speaker 1: half of them are just mail ins because there's not
Speaker 1: the you know, the backdrop of the new staff forecast
Speaker 1: from the from the e c B. Do you think,
Speaker 1: like you know, they talked about quote unquote normalization, and
Speaker 1: I still don't think I understand what that word means,
Speaker 1: even I've heard it a bunch of times. But do
Speaker 1: you think that we're better off for all of these
Speaker 1: communication innovations or should we just go back to where
Speaker 1: they have a little statement and hike and move on.
Speaker 1: I think they should go back to the way it
Speaker 1: was before. But on the other hand, you you know,
Speaker 1: you talk about how volatility has been suppressed this cycle
Speaker 1: in part because of those communications. Uh, if lower I
Speaker 1: don't know which way the feedback loop runs or the
Speaker 1: mechanism chicken egg here, But if the lower financial market
Speaker 1: volatility and lower macro economic volatility, if those two aren't
Speaker 1: all related, and the FEDS forward guidance is helping to
Speaker 1: promote one and the other, that that seems to me
Speaker 1: to be somewhat of a free lunch. However, I think
Speaker 1: we could get into the Minsky and view of that
Speaker 1: this is breeding some level in the uncertainty and instability.
Speaker 1: But you've just gone yeah, you just refer to your
Speaker 1: friend XIT, your late lamented friend x I V. And
Speaker 1: I think that's a manifestation of artificial sense of certainty
Speaker 1: that's afforded by forward guidance. Uh. It's it's an interesting phenomena.
Speaker 1: If we go back over the last quarter century, forward
Speaker 1: GUIDs by the Fed has gotten more and more explicit,
Speaker 1: starting when they started releasing statements sort of explaining what
Speaker 1: they were doing too. Now when obviously we get the
Speaker 1: dot plot and all this other stuff, and what we've
Speaker 1: observed is that realized volatility of fixed income markets has
Speaker 1: gone down. Broadly speaking, um, the lead time which money
Speaker 1: market curbs invert to until the Fed cuts rates has broadened,
Speaker 1: and to date, each subsequent economic downturn has become more
Speaker 1: and more severe. The two rate cuts in nine in
Speaker 1: the d's after ninety four, which was there was one
Speaker 1: and then cycle. There was no recession that followed. But
Speaker 1: yet as they got more explicit in the tightening cycle,
Speaker 1: that ended with a recession obviously with the dot com bust,
Speaker 1: and then they got even more explicit. Remember uh, measured pace, YadA, YadA,
Speaker 1: YadA uh in the five basis points every meeting exactly.
Speaker 1: And then we followed that with a period of extraordinarily
Speaker 1: low volatility, which bread excessive risk taking, and we ended
Speaker 1: up You can argue that this is why the nature
Speaker 1: of recessions has been more balance sheet oriented and kind
Speaker 1: of providing certain data balance sheets that doesn't exist, and
Speaker 1: then you get, you know, more abrupt tipping points when
Speaker 1: you look forward to nineteen though, and right now, I
Speaker 1: think one thing that people have been really banging the
Speaker 1: table about is they're worried about the credit market. They're
Speaker 1: worried about a very severe downturn and credit. A lot
Speaker 1: of talk about triple b s. Then, on the other hand,
Speaker 1: you have, you know, a lot of corporates taking steps
Speaker 1: to improve their balance sheets. What do you think about
Speaker 1: in terms of a credit versus equity outlook in I
Speaker 1: would say from a relative value perspective, I I would
Speaker 1: prefer at current valuation, I think I would prefer equity
Speaker 1: to credit. It seems to me that we've sort of
Speaker 1: the credit The credit cycle I've view is sort of
Speaker 1: like a cruise ship. You know, you can't just turn it,
Speaker 1: turn it like water skis or a power boat. It's
Speaker 1: a very long and gradual cycle, and it seems to
Speaker 1: me that we have now bottomed in terms of spreads,
Speaker 1: and that fundamentally speaking over for the remainder of the cycle,
Speaker 1: spreads should on aggregate be water. Um. Now, if equity
Speaker 1: market evaluations were elevated, then you would say sell everything.
Speaker 1: But given that we've had this this come down in
Speaker 1: terms of valuation as we as we just discussed, I know,
Speaker 1: I think we're kind of at the point where I
Speaker 1: prefer equity of credit. Let's uh, trade, let's talk a
Speaker 1: little bit more about that, because, uh, the interesting thing
Speaker 1: is soen we obviously got the I guess, the so
Speaker 1: called trade truce that that said a ninety or a
Speaker 1: hundred and twenty day clock depending on when it started
Speaker 1: on getting a deal. Since then, the truce hasn't fallen
Speaker 1: apart some people might have expected it to. Uh, I
Speaker 1: don't know that there's a ton of progress being made
Speaker 1: on it. But it's not like there's been a ton
Speaker 1: of like backtracking or undermining of it. Right, But this
Speaker 1: is this is the trade truce and the trade war,
Speaker 1: excuse me, in the trade policy and a nutshell, you know,
Speaker 1: everyone sings Kubai are around the campfire and toast marshmallows
Speaker 1: and buenos aires. And then two days later we get
Speaker 1: news a that Trump is still a tariff man and
Speaker 1: the Wallway arrest. Now if that's if that's the truce,
Speaker 1: I really don't want to I don't want to know
Speaker 1: what a war looks like. And this is why it's
Speaker 1: so we're gonna find out in t what the war
Speaker 1: looks like. I tend to think not. I've basically taken
Speaker 1: the view that that Trump would push the push the
Speaker 1: envelope on trade until financial markets told him it was
Speaker 1: time to pull back. And it seems to me pretty
Speaker 1: clear that financial markets in the fourth quarter of I
Speaker 1: immediately after he imposed the two billion dollars the tariff
Speaker 1: onion dollars of goods, financial markets are saying, all right,
Speaker 1: that's probably enough for now. And it also seems like
Speaker 1: an issue in which it is positive for the president
Speaker 1: to keep it alive issue without real negative repercussions on
Speaker 1: financial markets or the economy. So if you can go
Speaker 1: and you can have these many winds or these symbolic
Speaker 1: wins over and over and over, well at the same time,
Speaker 1: you don't have the legislative control that you once have.
Speaker 1: It's a winning issue that you can keep for yourself
Speaker 1: and no one else can really touch. As long as
Speaker 1: you don't push it a little too far overboard, it
Speaker 1: does not become a negative for you. Do you think
Speaker 1: other or other four leaders are willing to play that
Speaker 1: game for him, which is basically like you know, don't
Speaker 1: let anything too bad happen and just keep giving it,
Speaker 1: giving Trump marginal wins that don't mean a lot, and
Speaker 1: let the sort of persistent din of risks just sort
Speaker 1: of sit out there completely. You think so completely? I'm
Speaker 1: not sure. I'm not sure. Um. I mean, that's a
Speaker 1: that's a tough question to be honest with you. I
Speaker 1: think if Trump is under political pressure domestically, then surely
Speaker 1: that which he will be next year. I think, um,
Speaker 1: given that the House will have subpoena power and that
Speaker 1: they might actually use on the White House, that surely
Speaker 1: gives foreign governments more of a leverage against Trump than
Speaker 1: they've had here before. Speaking of event risk in twenty nineteen,
Speaker 1: something that hardly anyone is talking about, but which I
Speaker 1: had a recent conversation with David wou over a b
Speaker 1: of aml H the Dead ceiling has to be lifted.
Speaker 1: In the last tight we had a really or Congress
Speaker 1: flipped uh in the mid term was and dead ceiling
Speaker 1: fight was pretty brutal. It went to the end. The politics,
Speaker 1: I guess, are a little bit different because Democrats maybe
Speaker 1: are a little less motivated by that's less of a
Speaker 1: talking point for them, the debt. But nonetheless they have
Speaker 1: leverage and presumably they're gonna watch something. Do either of
Speaker 1: you think this is gonna be a big story or
Speaker 1: is your guest that the Democratic leaders are going to say, like,
Speaker 1: let's just come up with a deal. It'll be a
Speaker 1: big story, but not something that ultimately matters, right, Like
Speaker 1: it'll be something we worry about and huge like that
Speaker 1: that's story dominated that There was also another back to remember,
Speaker 1: the the Euros down crisis. There was a lot of
Speaker 1: stuff going on back then, but that was a huge
Speaker 1: I mean, I remember that summer going out to the
Speaker 1: beach on weekend. Is it just like a lot big
Speaker 1: glued to Twitter watching every utterance from who Eric Canter
Speaker 1: and all them about that? Is that gonna be what
Speaker 1: this year's like? I think like it's something that's lost
Speaker 1: its power to hurt the markets as much as it
Speaker 1: once did because of how big and crazy and how
Speaker 1: much it dominated attention in two thousand eleven, and Base done.
Speaker 1: All these kind of mini government squabbles we've been able
Speaker 1: to get over. Yeah, I'm gonna I'm gonna hedge my
Speaker 1: bets a little bit. I I generally don't care about
Speaker 1: this sort of stuff because I think it's it's noise
Speaker 1: relative rather than signal, because ultimately it gets resolved. But
Speaker 1: it seems to me that has taught us anything. It's
Speaker 1: that these things that end up impacting markets are things
Speaker 1: that in hindsight you can say, well, obviously that had
Speaker 1: an impact, but didn't you You didn't forecast it in
Speaker 1: advance because you thought that, yes, it's an issue, but
Speaker 1: it's not gonna matter because it didn't matter in the past. So,
Speaker 1: I mean, the rules of engagement between the White House
Speaker 1: and Congress and the White House and the Fed, and
Speaker 1: the White House and the market have totally changed. So
Speaker 1: we're all in sort of uncharted territory here. So while
Speaker 1: I don't think that this sort of thing will have
Speaker 1: any sort of meaningful, lasting impact on the market, if
Speaker 1: we're sitting here our next year and it turns out
Speaker 1: that it did. I'm not gonna have been terribly surprised.
Speaker 1: All Right, you gotta wrap it up here. Any sort
Speaker 1: of quick last parting thoughts from the two of you.
Speaker 1: I expect a hard Brexit good one. Well, I like
Speaker 1: that we didn't even get in there. But maybe we'll
Speaker 1: do a Breakxit episode soon. That's that's a really good one.
Speaker 1: I I expect that the rotation to value that we've
Speaker 1: been waiting for forever does not happen. Okay, great stuff.
Speaker 1: Really enjoyed having you both on for both our look
Speaker 1: back and our look ahead. Luke Cowa and Cameron Christ,
Speaker 1: thanks for joining us, and this has been another episode
Speaker 1: of the Odd Lots Podcast. Thanks for listening, and of
Speaker 1: course please stick with us for twenty nine as we
Speaker 1: watched these stories unfold. I'm Joe Wisenthal. You can follow
Speaker 1: me on Twitter at the Stalwarts. Tracy wasn't here this week,
Speaker 1: but you should still follow her on Twitter at Tracy Elloway.
Speaker 1: You should definitely follow our guests. Luke is on Twitter
Speaker 1: at l J Kawa. Cameron is on Twitter at Fifth Rule.
Speaker 1: You should follow our producer on Twitter tofur four Has.
Speaker 1: He's at four has T, as well as our substitute producer.
Speaker 1: This week Liz Smith at Liz the Smith and don't
Speaker 1: forget to follow the Bloomberg Head of podcasts, Francesca Levy
Speaker 1: at Francesca Today. Thanks for listening.