Speaker 1: Well, can a trillions. I'm Joel Webber and i am
Speaker 1: Eric belchiernas eric Um. The stock market over the past
Speaker 1: week has given given me heart palpitations. Uh. And it
Speaker 1: feels like we've just been on this like roller coaster,
Speaker 1: and there's been dread about inflation rising rates. Uh, and
Speaker 1: then there's been corporate earnings in the backdrop which have
Speaker 1: kind of exceeded expectations. I'm really confused. Can you help
Speaker 1: me make sense of that? And do you have any
Speaker 1: guests who could help? Yeah, well, we have a two
Speaker 1: great guests. It's a perfect one to punch because everything
Speaker 1: going on to the market now really mostly is is
Speaker 1: a derivative of the Fed and their plan to be
Speaker 1: more hawkish. There's two ways of doing that, which we'll
Speaker 1: go into. But it's not just rate hikes, but the
Speaker 1: idea of raising interest rates because they're obviously concerned about
Speaker 1: inflation and inflation I think is actually trumping the idea
Speaker 1: that the stock market could fall. Especially politically, I don't think, uh,
Speaker 1: you know, any of these politicians want to go into
Speaker 1: mid terms or the presidential election with inflation running high.
Speaker 1: So the Fed uh looks like they're committed. I've been
Speaker 1: pretty critical of the FED always folding like a lawn
Speaker 1: chair where they get hawkish and they just fold immediately
Speaker 1: when the stock market goes down two points. But they
Speaker 1: seem pretty persistent. That last um UH press conference that
Speaker 1: Pal had, I felt he was the strongest he've been.
Speaker 1: I'm a casual observer, I'm not an expert, but as
Speaker 1: somebody who's doubted them, I feel like they have more
Speaker 1: of a spy now. And so everybody's just repositioning, and
Speaker 1: they're saying, well, if if, if rates are going to
Speaker 1: go up a little bit, I've got to figure different
Speaker 1: things out my portfolio. So it's hurt growth stocks, help
Speaker 1: bank stocks, hurt bonds, and so there's a lot of repositioning.
Speaker 1: I will say that general mass blob of retail flow
Speaker 1: is still kind of buying Vanguard, but the outer layers definitely.
Speaker 1: You can feel a lot of activity around this, including
Speaker 1: some selling of of stocks and et f s. So
Speaker 1: you'll help us with the E t F side, but
Speaker 1: who's gonna help us with sort of the equity slash
Speaker 1: economic outlook through all of this? So Carl Rickadonna, who
Speaker 1: I've known for a while and now is sort of
Speaker 1: in my group. Um, he's gonna take the FED part
Speaker 1: of this, and he's so good at simplifying FED speak,
Speaker 1: and I really go always go to him when I
Speaker 1: have a question. And then Gina Martin Adams, who is
Speaker 1: both of our bosses. She covers the macro outlook, so
Speaker 1: she's always looking at earnings and the FED and how
Speaker 1: the whole thing fits together. So I think she can
Speaker 1: also talk about how the new environment is affecting her outlook. Alright,
Speaker 1: So joining us on Trillions Carl Rickadonna, the chief economist
Speaker 1: for Bloomberg Intelligence, as well as Gina Martin Adams back
Speaker 1: on the pod, the chief equity strategist for Bloomberg Intelligence.
Speaker 1: Next time on trying buckle up for a roller coaster. Carl, Gina,
Speaker 1: welcome back to Trillions. Thank you, thanks for having us,
Speaker 1: glad to be here, thanks for providing me on. I'm
Speaker 1: gonna start with you, Carl. Is the FED going to
Speaker 1: fold like Eric's lawn chair? The FED is not going
Speaker 1: to fold like a lawn chair here, but I don't
Speaker 1: think they're going to be as aggressive as some of
Speaker 1: the worst concerns in the marketplace. So, as Eric mentioned
Speaker 1: in the past, the FED has been a very reactive
Speaker 1: to a resetting of financial conditions, explicitly sharp declines in
Speaker 1: the equity markets. Because the stock market in the economy
Speaker 1: are not too uh independent creatures. What happens in the
Speaker 1: stock market often has very significant consequences for wealth effects
Speaker 1: for households, for confidence effects among companies who may be
Speaker 1: pulled back on the pace of hiring when when equities
Speaker 1: take a schoon or become much less confident in the
Speaker 1: economic outlook. Because equities are in the nose dives, so
Speaker 1: that that does have implications for the commodity for the
Speaker 1: FED the reaction function. But front and center at the
Speaker 1: moment is the fact that now the fence two main objectives,
Speaker 1: maximizing the level of employment in the economy and achieving
Speaker 1: price stability, are now both on the same side of
Speaker 1: the two cold too hot spectrum. They are both running
Speaker 1: too hot. So we have the unemployment rate below where
Speaker 1: the FED thinks it should settle in the longer run,
Speaker 1: and obviously inflation for outstripping the fence two percent objective.
Speaker 1: The last reading on the CPI showed a seven percent print.
Speaker 1: So let's go into what they do. Okay, So there's
Speaker 1: we all know that over the past ten years, they've
Speaker 1: kept rates low, and they've fought they fought assets. I
Speaker 1: mean they have a balance sheet. That's uh, I want
Speaker 1: to say fortually, but you'll correct me in a minute
Speaker 1: if I'm wrong. Now, explain this idea of what are
Speaker 1: they doing on the rate side and what are they
Speaker 1: doing on the balance sheet side going forward? So what's
Speaker 1: happening the Fed that uses interest rates the overnight lending
Speaker 1: rate as its primary policy tool, and so as uh,
Speaker 1: you know, as the economy heats up, they raise interest
Speaker 1: rates to slow things down. What happens in the overnight
Speaker 1: rate then often gets multiplied out into longer term lending rates,
Speaker 1: whether it's your credit card rate, the interest rate on
Speaker 1: your car loan, your mortgage, or corporate lending rates. So
Speaker 1: what the Fed does then has ripple effects throughout the
Speaker 1: broader economy. The problem for the FED if you keep
Speaker 1: cutting interest rates, eventually you get to zero uh. And
Speaker 1: once you get to zero, then negative interest rates don't
Speaker 1: really work that well. So that's a policy option the
Speaker 1: Fed has abandoned. Uh. And so what the Fed does
Speaker 1: then is reach further out into the maturity spectrum or
Speaker 1: further out on the yield curve. By influencing other interest rates.
Speaker 1: So as we saw after the global financial crisis in
Speaker 1: two thousand and seven to two thousand and nine, the
Speaker 1: FED cut rates to zero for the first time and
Speaker 1: saw the need to do more UH, and so in
Speaker 1: doing more, they purchase assets. So they purchase in this
Speaker 1: case treasury securities of of varying maturity, so across the
Speaker 1: yield curve. And also they purchased mortgages. Now, the mortgages
Speaker 1: kind of a legacy of the housing bust in O
Speaker 1: A DO nine, and they saw particular need to influence,
Speaker 1: you know, financial conditions for households. We come out of
Speaker 1: the O nine recession and have a very weak economic recovery,
Speaker 1: so the Fed's very slow to tighten policy by both
Speaker 1: raising interest rates and also starting to shrink the size
Speaker 1: of its balance sheet. Sure enough, COVID comes along in
Speaker 1: the Fed again has to aggressively cut rates and doesn't
Speaker 1: have enough room to just achieve their objectives through interest
Speaker 1: rate cuts. They cut to zero and once again start
Speaker 1: expanding the balance sheet, in this case even more aggressively
Speaker 1: than they did back around the global financial crisis, so
Speaker 1: they have UH. In O nine, they quadrupled the size
Speaker 1: of their balance sheet, and now the balance sheet is
Speaker 1: approaching nine or ten trillion dollars. So it's a huge
Speaker 1: number here for the Fed. Uh. And this provided tremendous
Speaker 1: stimulus during the COVID crisis. Uh. You know, we can say, well,
Speaker 1: the FED did too much in in in the hindsight
Speaker 1: that that created some inflation problems, but we cannot underestimate,
Speaker 1: you know, what could have potentially transpired had the FED
Speaker 1: not acted so aggressively. We saw even the most deep
Speaker 1: and liquid financial market in the world, the US treasury market,
Speaker 1: basically seizing up in March of and so this was
Speaker 1: a matter of not only propping up the economy but
Speaker 1: also preserving the sanctity the liquid city of the most
Speaker 1: deep mark asset classes said that are hugely consequential for
Speaker 1: the global economy and the US economy. So the FED
Speaker 1: had to step in in a major way. We didn't
Speaker 1: know exactly how the pandemic would play out. We didn't
Speaker 1: fully understand what the mortality rate was in the early
Speaker 1: stages of the pandemic, so the FED acted in a
Speaker 1: very big fashion. The other factor they didn't understand was
Speaker 1: how much fiscal stimulus would be coming through because they know,
Speaker 1: the experience after the global financial crisis, Congress was very
Speaker 1: stingy providing stimulus to the economy, and so the you know,
Speaker 1: the risk was that if we saw a reprise of that,
Speaker 1: given the political tension in the economy in the country
Speaker 1: at that time, that maybe there would not be much
Speaker 1: fiscal support. So the Fed went massively. Uh. We got
Speaker 1: a lot of fiscal stimulus, trillions of fiscal stimulus. So
Speaker 1: that did very importantly prop up the economy until it
Speaker 1: could get back onto its own feet. And now the
Speaker 1: FED has realized where at a stage where it is
Speaker 1: now time, you know, the pandemic is becoming endemic. It's
Speaker 1: less of a threat to the economy, and so the
Speaker 1: Fed is pulling back on those uh, those levels of accommodation,
Speaker 1: which means we'll soon be seeing both interest rate increases
Speaker 1: uh and later this year, perhaps much later this year,
Speaker 1: the FED will start to gradually shrink its balance sheet.
Speaker 1: Gina um Carl's successfully has ratcheted up my anxiety. I
Speaker 1: feel like I'm at the top of that roller coaster now,
Speaker 1: and which was not what I needed after the last
Speaker 1: week and of watching this market. Uh, take me, take
Speaker 1: me on some whiplash we had you on a few
Speaker 1: months ago. One of the things that I that we
Speaker 1: did spend some time talking about then was inflation. It's gotten.
Speaker 1: It's just become like almost the only thing that the
Speaker 1: market and the FED is has been centered on since
Speaker 1: that conversation. So just bring us up to speed on
Speaker 1: on where where you are now, what what you feel
Speaker 1: like that outlook is um and and how powerful um
Speaker 1: the FED is and what the market is gonna be
Speaker 1: doing in the weeks and months to come. Yeah, UM,
Speaker 1: long a lot of questions to answer there. I'll try
Speaker 1: to get to all of them. First, Joel, I have
Speaker 1: to say, you're gonna have to toughen up. You're gonna
Speaker 1: have to get stronger, because it's going to be a
Speaker 1: wild ride in two. We have been here before, right,
Speaker 1: The FED has attempted to reverse or normalize policy multiple
Speaker 1: times over the course of the last ten years. In
Speaker 1: each case, especially when they stopped inflating the balance sheet,
Speaker 1: the stock market goes through a pretty rough correction. Right
Speaker 1: on average, we see the stock market fall somewhere between
Speaker 1: fifteen and in each of those cases that that Carl
Speaker 1: alluded to. So I do think we have to we're
Speaker 1: gonna have to be tougher. In two. We've gotten very
Speaker 1: complacent as equity investors over the last two years, just
Speaker 1: really accustomed to constant gains in the equity market, and
Speaker 1: that's highly unlikely to be the case in two. That said,
Speaker 1: you know, I think a couple of things has changed
Speaker 1: since the last time I was on and most of
Speaker 1: it is really the Fed's interpretation of what's going on.
Speaker 1: If you recall when we talked last, we talked about
Speaker 1: the fact that I believe the economy is on much
Speaker 1: much stronger footing than most economists are forecasting, and the
Speaker 1: demand side of inflation is completely underappreciated, and the FED
Speaker 1: really leaned on this idea that inflation was going to
Speaker 1: be transitory, it would go away because it was all
Speaker 1: supply driven. And the reality is that household balance sheets
Speaker 1: are in much much better condition than they were last cycles,
Speaker 1: so sort of going on a last cycle playbook for
Speaker 1: how slow they can move. Uh. That's really changed over
Speaker 1: the course of the last few months, where the FED
Speaker 1: is now acknowledging well, you know, even some of the
Speaker 1: most esoteric unemployment rate measures that we like to follow
Speaker 1: to suggest that we're not yet at maximum employment well
Speaker 1: low and behold, we're back to where we were in
Speaker 1: two thousand nineteen. Right. Retail sales are still on fire
Speaker 1: for the most part. Inflation is still very strong. There's
Speaker 1: there's really very few slignes signs that the economy is
Speaker 1: even slowing down, so inflation may actually sustain. And I
Speaker 1: think they finally have capitulated on the idea that, yeah,
Speaker 1: as Carl mentioned, the pandemic is becoming endemic. It's less
Speaker 1: of a risk to broader economic growth, and we need
Speaker 1: to normalize things. So the natural reaction and the stock
Speaker 1: market is oh, hey, okay, we thought you're going to
Speaker 1: be our best buddy, and now you're gonna leave us be.
Speaker 1: So valuations are naturally reacting. Um. I think Eric mentioned
Speaker 1: at the onset that you know, the market has reacted
Speaker 1: to inflation. I totally agree. In particular, the market has
Speaker 1: reacted to how rates are are moving with respect to
Speaker 1: inflation and with respect to what the FED is going
Speaker 1: to do specifically. And we see that in our work
Speaker 1: in the equity market, the stocks with the most sensitivity
Speaker 1: two rates have dramatically underperformed the stocks with the least
Speaker 1: sensitivity to rates. And and I think that that's going
Speaker 1: to be the prevailing case for most of because this
Speaker 1: is an adjustment process. Now that's set head. There is
Speaker 1: a saving grace here that nobody's talking about, and that is, Hey,
Speaker 1: the economy is still strong, and I think we're going
Speaker 1: to continue to underappreciate just how strong the economy is,
Speaker 1: even in the face of FED tightening, even in the
Speaker 1: face of potential balance sheet runoff. We probably will continue
Speaker 1: to underappreciate just how strong that economy is. And that
Speaker 1: shows up in earnings. So the offset for the market
Speaker 1: is this sort of pull and push kind of metaphor
Speaker 1: where valuations are constantly under some degree of pressure, but
Speaker 1: earnings do make up some of that difference. And as
Speaker 1: long as earnings hold in, you know, the longer term
Speaker 1: uptrend for the stock market probably remains intact. Um. Let
Speaker 1: me follow up on this whole idea, because I think
Speaker 1: people out there here all the time, Oh, higher rates
Speaker 1: bad for growth stocks, They're bad for the ARC stocks.
Speaker 1: Clearly that's happened right. ARC is down in the past year,
Speaker 1: but the S and PS up twenty That is a
Speaker 1: big spread. Although art crushed in long story, short just
Speaker 1: exp plane why just basis proints make that big of
Speaker 1: a difference for some of these stocks like Zoom Roku.
Speaker 1: I mean, these are pretty big companies. It's not like
Speaker 1: they're like nobody companies who have nothing going on. I
Speaker 1: guess maybe try to square that. Yeah, so a couple
Speaker 1: of things happen. Right. If you're a purest if you're
Speaker 1: a pure fundamentalist, you believe the value of any equity
Speaker 1: is it's discounted future to cash flow stream, right, And
Speaker 1: so if that discount rate is going higher and your
Speaker 1: future cash flows are not changing as the discount rate
Speaker 1: goes higher, the stocks that had the longest term future
Speaker 1: cash flow growth are going to be impacted the most.
Speaker 1: Those are the growth stocks in the market in agent
Speaker 1: most in the most generic sense. At the same time,
Speaker 1: there is a proven relationship between high volatility stucks in
Speaker 1: the balance sheet for the FED, and not very many
Speaker 1: people can really explain this, but the reality of the
Speaker 1: situation is every time that balance sheet has exceler rated,
Speaker 1: the highest volatility stocks in the SNP five hundred, no
Speaker 1: matter what type of stock they are, have tended to benefit.
Speaker 1: So we what we started to see all the way
Speaker 1: back in March of last year, actually, as some of
Speaker 1: these most high volatility stocks in the market started to
Speaker 1: suss out this idea that the FED was going to
Speaker 1: have to tighten policy and liquidity conditions would start to change,
Speaker 1: and the reduced this materially reduced risk tolerance for these
Speaker 1: type of stocks. Some of them are high growth or
Speaker 1: high cash flow growth stocks. Some of them have no
Speaker 1: cash flow at all, so you can't explain it through
Speaker 1: a traditional fundamental metric, but they are sensitive because they're
Speaker 1: high vall And we've really started to see this in
Speaker 1: some of our factor work over the course of the
Speaker 1: last six months, especially as the factor models that we run,
Speaker 1: we're saying, get out of the way of high volatility
Speaker 1: volatility stocks, start to move your portfolio to lower volatility stocks,
Speaker 1: and that is reflecting what's happening with interest rate expectations,
Speaker 1: but also what's happening with expectations for the ballot sheet.
Speaker 1: If the balance sheet is not going to continue to rise,
Speaker 1: it will impact the most volatle stocks in the market
Speaker 1: most um. And I think that's what's happened with some
Speaker 1: of the arcs and you know, some of these meme
Speaker 1: stocks and the like. You know, as is typically the case,
Speaker 1: the market really started to suss this out, as I mentioned,
Speaker 1: almost a full year ago now, but you had some
Speaker 1: offsets that made us kind of not you know, maybe
Speaker 1: when we're looking at the aggregate numbers, the SMP five
Speaker 1: hundred looked great, but if you look at where the
Speaker 1: returns came from in the SNP five hundred, it was
Speaker 1: characteristically very different than the returns. Just to paraphrase Gina
Speaker 1: in very blunt Layman's terms, stocks love que quantitine of easing, Yes,
Speaker 1: that purchases from the Fed. If the Fed so much
Speaker 1: as whispers QUI, stocks rally. And when the Fed does
Speaker 1: the opposite, which is what they've been doing over the
Speaker 1: course of the last year, when they talk about quantitative tightening,
Speaker 1: the shrinking of the balance sheet, then though you know,
Speaker 1: stocks as much as they like QUEI, they despise QT.
Speaker 1: And the FED has been murmuring increasingly loudly about quantitative
Speaker 1: tightening and what that's going to look like over the
Speaker 1: course of the last several months, especially in since the
Speaker 1: December FOMC meeting, and stocks don't like that, especially the
Speaker 1: risky stocks don't like that. And that's totally consistent with
Speaker 1: what we've seen play out in the marketplace. So Carlos,
Speaker 1: stick with that for a second. Say I give you
Speaker 1: the football. You are j pal, When do you next
Speaker 1: look at the stock market? Well, you have to continuously
Speaker 1: watch the stock market and see how it's reacting to
Speaker 1: what you're doing. Because again, the stock market is not
Speaker 1: divorced from the real economy. Everyone says Wall Street is
Speaker 1: not main Street, but there are very important linkage is here.
Speaker 1: The stock market is a periscope into the future, into
Speaker 1: future company earnings, into the future health of the economy.
Speaker 1: So stocks are tanking. That's giving you a very negative
Speaker 1: signal on the economy, and that tells you maybe you
Speaker 1: need to move at a slower pace in terms of
Speaker 1: tightening policy. Mind you, if we're thinking about Eric Incorporated,
Speaker 1: let's call it a small business. Eric is producing widgets now,
Speaker 1: and if it's chairs, lawn chairs, lawn chairs, okay, Eric,
Speaker 1: slawn chair company. If his business is growing at a
Speaker 1: ten percent pace and the cost of his financing is
Speaker 1: one percent, what are you gonna do, Eric? Grow the business? Sure, sure,
Speaker 1: keep growing it. Okay. Now your business slows down to
Speaker 1: eight percent, your cost of financing goes up to four percent.
Speaker 1: Keep growing the business a little a little. Okay. Now
Speaker 1: the business is growing four percent and your cost of
Speaker 1: financing is five percent, you're going to grow the business. No,
Speaker 1: I'm gonna I'm gonna cash any more. I'm gonna cash
Speaker 1: up with you. Oh cash out? Well, you're you're not
Speaker 1: going to continue to grow the business. And what's true
Speaker 1: for Eric's lawn Chairs Incorporated is also true for a
Speaker 1: twenty trillion dollar US economy. When the cost of financing
Speaker 1: approaches the growth rate, then all of a sudden, we're
Speaker 1: not stepping on the gas pedal anymore. Now we're starting
Speaker 1: to move towards the brake pedal. So as the FED
Speaker 1: lifts rates from zero to maybe one percent at year end,
Speaker 1: that's really just easing off of the accelerator. It's not
Speaker 1: stepping on the brake pedal, but it's moving in the
Speaker 1: direction of the brake pedal. And so that's why GENA
Speaker 1: can have a very constructive outlook for the economy and
Speaker 1: for stocks, just to to put those numbers around instead
Speaker 1: of Eric's lawn chair business, the U s economy right
Speaker 1: interest rates or zero or effectively zero h The economy
Speaker 1: as of the final quarter of grew at a nominal
Speaker 1: pace of twelve percent year on year, So there's a
Speaker 1: huge gap between twelve the growth rate of the business
Speaker 1: and zero the cost of financing. The FED is going
Speaker 1: to start narrowing that gap, and probably nominal GDP slows down,
Speaker 1: you know, considerably, to something closer to five or six
Speaker 1: percent by the end of this year. But if the
Speaker 1: FAN is hiking once per quarter, that puts them at
Speaker 1: one percent, So you still have a huge interest rate differentials.
Speaker 1: We're not talking until maybe twenty four or beyond. If
Speaker 1: the FED continues on this steady pace of tightening to
Speaker 1: really move that interest rate differential down to what we
Speaker 1: would call a neutral pace. The FAN is giving it
Speaker 1: a very aggressive steroid to the economy and will continue
Speaker 1: to do so, albeit in slightly smaller doses going forward.
Speaker 1: I would just add one thing because I think that
Speaker 1: was a great explanation. We're surrounding the cost of financing
Speaker 1: um I would say when we look at corporate balance sheets,
Speaker 1: the thing that also is completely underappreciated is that cost
Speaker 1: of financing is significantly lower than you might observe when
Speaker 1: you're looking at even spreads because of the degree to
Speaker 1: which companies have built up cash stores, and it's very
Speaker 1: similar with households, where we are substantially less dependent on
Speaker 1: on financing to grow, especially relative to the last cycle,
Speaker 1: where corporate balance sheets and household balance sheets were in
Speaker 1: tremendous disrepair following the Great Financial Crisis, there on significantly
Speaker 1: sounder footing. And you know, the perfect example of this
Speaker 1: is Microsoft wants to grow. They don't need to go
Speaker 1: issue debt to even buy a company as large as Activision,
Speaker 1: which is a huge testament to just how much insane
Speaker 1: amount of cash is just sitting on balance sheets. And
Speaker 1: it's the same across most of the S and P
Speaker 1: five hundred, where corporate cash is still sitting near and
Speaker 1: all time high, even though we're this far into recovery,
Speaker 1: and it's it's quite phenomenal, right, is this? Companies just
Speaker 1: haven't spent a ton yet on anything, And even though
Speaker 1: they've been able to tap the bond markets for the
Speaker 1: last couple of years, they have stored up a lot
Speaker 1: of capability of keeping the cycle going for longer than
Speaker 1: many people anticipate, even if the fet ist tight. And
Speaker 1: I should just add to what jetas saying, what she's
Speaker 1: seeing at the company level is also true at the
Speaker 1: household level. Households stockpiled cash during the pandemic, they got
Speaker 1: rebate checks from the government. They didn't have the opportunity
Speaker 1: to spend money in many cases, and a lot of
Speaker 1: households were significantly invested in the markets and so they
Speaker 1: saw their wealth increase on that front as well. So
Speaker 1: there's a a mountain of savings that's in the trillions
Speaker 1: of dollars that households are sitting on, which is why
Speaker 1: they can weather the storm of slightly higher inflation and
Speaker 1: higher interest rates as well. But it's gonna be a
Speaker 1: bumpy little ride here, Eric, for all of them. And
Speaker 1: I'm curious, like, just as flows go something I know
Speaker 1: you watch closely all the time, what's it? What's it
Speaker 1: been like of late? Where have people gotten out of
Speaker 1: I saw that spy was had a massive outflow, Um
Speaker 1: what what? Other? What? Other kind of things of culture
Speaker 1: and bring it back to the world of ets for us? Yeah, sure,
Speaker 1: And I think this I'll pivot to a question for Gina,
Speaker 1: which is the main vanguard investor is just totally oblivious.
Speaker 1: They're just investing vanguards taken into one billion. That's they're
Speaker 1: just like nothing's happening. Um, Schwab is doing well too.
Speaker 1: So if you're like a passive bogel And type investor,
Speaker 1: none of this really but bothers you. That said, there's
Speaker 1: the trading crowd and people institutions who are repositioning on
Speaker 1: the on the fringes especially so for example, we've seen
Speaker 1: a lot of money go into financial E T s.
Speaker 1: Obviously rates go up, they can lend, get a higher rate,
Speaker 1: or they can get more their interest rates are good
Speaker 1: for them. We've also seen gold get a bid because
Speaker 1: I think there's some nerves on like, hey, I should
Speaker 1: be more diversified because my sixty and my forty is
Speaker 1: going down. And we've seen value E t F s
Speaker 1: UM and energy. I put energy in value together almost
Speaker 1: because they're beat up for so long. So there's a
Speaker 1: bit of a repositioning, uh. And that's where it's happening.
Speaker 1: And the other thing that's the big loser this year,
Speaker 1: besides the cueues which is seeing outflows, is bonds. If
Speaker 1: you look at the outflow list, it's basically it's a
Speaker 1: who's who of the all the bond E t F
Speaker 1: t l t H y G, even the tip E
Speaker 1: t F tips e tfs l q D I E,
Speaker 1: F J, and K. It's basically treasuries mortgages because if
Speaker 1: rates go up, all those current bonds are just worthless
Speaker 1: because you can get more with the new rate. So
Speaker 1: what the Fed is doing clearly is going to impact
Speaker 1: the bond market. And there's been this huge monster bowl
Speaker 1: market for the twenty years. And like I guess I
Speaker 1: would throw it to Gina. I just went over a lot.
Speaker 1: But is the bond market going to have real problems
Speaker 1: and is that going to spill over into the stock mark? Um?
Speaker 1: You know, I think that we certainly are on the
Speaker 1: precipice of a longer term shift in rates, and and
Speaker 1: I base that opinion based simply on my views of
Speaker 1: the economy. I just think the economy is in a
Speaker 1: copletely different condition than it was for the bulk of
Speaker 1: the last ten years. I also think the inflationary scenario
Speaker 1: is very different, in part as a result of that,
Speaker 1: but other longer term structural factors as well. And the
Speaker 1: result of that is we are very unlikely to see
Speaker 1: rates as low as we did for the for much
Speaker 1: of the last ten years or the first call it
Speaker 1: ten years of this of this bull market in stocks.
Speaker 1: So the value of your future cash flows. You know
Speaker 1: your is naturally going to adjust to rates moving higher.
Speaker 1: But again, the offset there is that cash flow growth
Speaker 1: should also be stronger. And the thing that we might
Speaker 1: all be under appreciating is if bonds move from thirty
Speaker 1: year bull market, two bear market, or even just moving
Speaker 1: sideways and then slightly bear market, what we could be
Speaker 1: under appreciating is just the amount of capital that comes
Speaker 1: out of bonds and goes into stocks, and that I
Speaker 1: think is much more difficult to model. Um It's been
Speaker 1: one of the anomalies of the past the first ten
Speaker 1: years of the cycle. We're not about investors putting more
Speaker 1: money to work in stocks. We know that for sure.
Speaker 1: We know that investors, broadly household ownership of equities merely
Speaker 1: went up because market value went up. On net, they
Speaker 1: didn't add anything to their equity portfolio, which is completely anomalous. Historically,
Speaker 1: you don't see a tenure economic recovery in which investors
Speaker 1: don't add any more capital to the equity market on net.
Speaker 1: It's just it's just wildly strange. UM. I think starting
Speaker 1: in probably extending into and I do think moving into
Speaker 1: two and beyond, we're going to continue to see this
Speaker 1: great rotation really in we started to see the first
Speaker 1: signs that equity and the investors are interested in stocks again,
Speaker 1: with flows coming back to the market, longer term flows
Speaker 1: moving back into stocks. We started to see I p
Speaker 1: o issuance again. One These are things that I didn't
Speaker 1: talk about for ten years um because they just weren't
Speaker 1: supports to the stock market. Instead, the stock market went
Speaker 1: up because the supply of equities went down, not because
Speaker 1: demand for equities went higher. So I think that we
Speaker 1: are seeing a little bit more exuberance in the stock
Speaker 1: market developed simply because the barn market is in disrepair.
Speaker 1: There will be offsets, and in periods of time in
Speaker 1: which rates are dominating attention and moving into a spiking fashion,
Speaker 1: it does create volatility for the stock market. But longer term,
Speaker 1: you know, you just model what happened in the nineteen
Speaker 1: fifties and sixties. The stock market went through a twenty
Speaker 1: year bull market as rates were rising. This is certainly
Speaker 1: possible to have rates rise and the stock market rise
Speaker 1: at the same time, but you do have to have
Speaker 1: very strong growth, and you have to have somewhat contained
Speaker 1: inflation before it gets If there's a switch that gets flipped. Okay,
Speaker 1: So that whole idea of bonds and stocks and this
Speaker 1: is what most people have in a retirement portfolio. This
Speaker 1: brings me to a theory. I want to I want
Speaker 1: to throw it, Carl. I've thrown I threw it at
Speaker 1: Genia last time. She was on lawn chair right now. Yeah,
Speaker 1: this is this is this is kind of why my
Speaker 1: the lawn chair thing comes up with me. I have
Speaker 1: this thing called the boom Errati theory, which is that
Speaker 1: you know how like j Pal's a boomer, Trump was
Speaker 1: a boomer, isn't it. First of all, it's interesting that
Speaker 1: Trump and Biden kept the same fed chair. They would
Speaker 1: agree on nothing. Two things they agree on they like
Speaker 1: pale and they hate bitcoin. Right, there's a boomer thing.
Speaker 1: It transcends politics. They have all the money, if you
Speaker 1: look at the stock and bond market over the years,
Speaker 1: has become America's retirement fund. So all these boomers, which
Speaker 1: they own about like se of the stock market, it's
Speaker 1: their money and they're at all the levels of power.
Speaker 1: So is there possibly subconsciously or consciously going to always
Speaker 1: be a fed put because this is literally America's retirement money.
Speaker 1: We cannot let the stock and bar market go down
Speaker 1: that much, I would say that this is not First
Speaker 1: of all, as you're sitting in your lawn chair, I
Speaker 1: suggest you take off the tinfoil or at least luc
Speaker 1: around the down. So in some capacity, we could view
Speaker 1: this through the eyes of the boomers preserving their wealth
Speaker 1: and uh, some conspiracy against the millennials and their disruptions
Speaker 1: and whatnot, although the millennials are you know, poised for
Speaker 1: the largest transfer of wealth and the history of humankind
Speaker 1: as we look twenty twenty years down the road and whatnot. However, again,
Speaker 1: this preservation of the stock market or the FED puts
Speaker 1: so the FED is not just acting to prop up assets.
Speaker 1: The FED is looking at economic looking to achieve successful
Speaker 1: economic stewardship. Now, if they successfully achieve that goal of
Speaker 1: price stability and maximum employment, then they are creating the
Speaker 1: type of economy that GENA is describing, where you have
Speaker 1: controlled inflation pressures and healthy growth in the economy, and
Speaker 1: that should be favorable for the equity market. So you know,
Speaker 1: it's more about the economic stewardship question, which the side
Speaker 1: effect of that is a healthy stock market, than some
Speaker 1: sort of nefarious plot for some generation to hoard, hoard
Speaker 1: the wealth, as you say, and you know, as Gina
Speaker 1: described it as I think she used the expression the
Speaker 1: great rotation that we're seeing playing out over the next
Speaker 1: couple of years. I think of it in macro terms
Speaker 1: as the great competition, right, and the competition is with
Speaker 1: let's say a two year government yield. Right during the
Speaker 1: crisis to year government government notes, we're yielding about point
Speaker 1: one percent. They are now yielding a full percentage point higher,
Speaker 1: about one point one percent, and that will only go
Speaker 1: up as a FED formalizes its plans to continue raising rates.
Speaker 1: If the Fed is raising the overnight rate, two year
Speaker 1: yields are going to go up as well. So now, uh, stocks,
Speaker 1: whether it's Cathy Woods ARC or a dividend paying uh
Speaker 1: you know what equity aristocrat, they they're not competing against
Speaker 1: the point one percent rate of return. They're now competing
Speaker 1: against a one point one percent yield on a two
Speaker 1: year government security. So that competition is heating up, and
Speaker 1: that means you're you're less happy holding uh those longer
Speaker 1: maturity assets like a ten year yield or you know,
Speaker 1: a third year bond for instance, or some of the corporates,
Speaker 1: you know, a very highly rated corporates that are not
Speaker 1: giving you much return. The competition is heating up, and
Speaker 1: so now there's more of that rotation into higher yielding
Speaker 1: equities for instance, which is you know, another way of
Speaker 1: framing that growth versus value debate. Okay, as we start
Speaker 1: to bring this roller coaster ride to to an end, Um, Carl, Gina,
Speaker 1: I'm gonna ask you a question, and uh, it's it's
Speaker 1: a free for all. You can do whatever you want
Speaker 1: with it. Um. Eric knows a lot about E t
Speaker 1: F s. We've talked a lot about the economy, about
Speaker 1: the FED, about equities. What E t F question would
Speaker 1: you like to ask? Eric, Carl, you go first? Okay, Well, first,
Speaker 1: before I asked that question, I'm just going to go
Speaker 1: back to Joel's roller coaster analogy because Gina and I
Speaker 1: have done our best here to kind of signal that
Speaker 1: the roller coaster just because it goes up the steep
Speaker 1: hill doesn't mean there's a scary descent thereafter. And we
Speaker 1: both have a relatively constructive outlook where the FED can
Speaker 1: move towards the exit and the economy performs soundly. And
Speaker 1: that's our my baseline scenario. I believe it's Gina's baseline
Speaker 1: scenario as well. That doesn't mean this can't be a scarier,
Speaker 1: bumpy roller coaster ride, because you know, this is a
Speaker 1: path fraught with danger, right if the FED is too
Speaker 1: worried over the inflation outlook, tightens too aggressively, unwinds the
Speaker 1: balance sheet, which is again a tool we we've only
Speaker 1: used once before, so we're not entirely uh sure of
Speaker 1: what the potency of that tool is. So if we
Speaker 1: we take the unknown medicine and take too high of
Speaker 1: a dosage, you can have some real problems here, and
Speaker 1: so it can certainly be a bumpy ride. And the
Speaker 1: risk is, you know, the FED could move too slowly
Speaker 1: and inflation gets out of control. I think the bigger
Speaker 1: concern is that the FED could potentially panic move too
Speaker 1: aggressively and nudge the economy into a downturn, into a recession,
Speaker 1: which then you know, you're back to applying all of
Speaker 1: this aggressive medication to try to restimulate growth. So there's
Speaker 1: certainly a you know, uh, potentially exciting roller coaster ride ahead, Joel,
Speaker 1: as you according to your analogy, But I would be
Speaker 1: interested in asking Eric about the passive uh is passive
Speaker 1: investing passive versus active? Is that How confident are you
Speaker 1: that that trend continues? Because if you're a passive investor, uh,
Speaker 1: and you're in the type of economic cycle we saw
Speaker 1: over the past couple of years, FED delivers massive uh
Speaker 1: you know, stimulus to the economy. So we you know,
Speaker 1: the rising tides going to lift all ships. It's a
Speaker 1: great environment to be passive. I would just to play
Speaker 1: Devil's advocate. Wonder if we're not heading into the stock
Speaker 1: pickers paradise now where we've had a big rise in
Speaker 1: the equity markets. But now the differentiation starts to occur
Speaker 1: as as the tide as as Warren Buffett says, as
Speaker 1: the tide starts to roll out, we find out who's
Speaker 1: wearing a bathing suit and who's not. Aren't we heading
Speaker 1: into that realm right now? Eric? Where now the active
Speaker 1: investors are going to really be able to differentiate themselves
Speaker 1: as as it becomes a stock pickers market, uh, and
Speaker 1: therefore will be less of a pro E t F
Speaker 1: or at least a pro passive environment going forward. Well, yeah, good,
Speaker 1: You're good to separate E t F and passive because
Speaker 1: our big outlook theme this year is that um E
Speaker 1: t F have transcended the passive label. I mean it's
Speaker 1: a big tent, and more and more they're becoming active
Speaker 1: and people use them actively. So one thing I would
Speaker 1: say is we just went over how flows are going
Speaker 1: into financials and value et F So people are actively
Speaker 1: using passive E t F s to reposition, just like
Speaker 1: you're saying relative to the stock picker problem. Is this
Speaker 1: a stock picker? You know, if you're doing deep value
Speaker 1: stock picking, I think you have a bright future. If
Speaker 1: you're doing like closet indexing stock picking like the Fidelity
Speaker 1: Magellan which holds mostly SMP and tilts a little, your
Speaker 1: goose is cooked. You'll never get money again because nobody
Speaker 1: is going to sell a three basis point Vanguard fund
Speaker 1: and buy you for ad basis points when you're mostly
Speaker 1: the Vanguard fund and I can't even guarantee you'll perform.
Speaker 1: In fact, the s are you won't. Also, in past downturns,
Speaker 1: active has only outperformed at the same thirty three rate
Speaker 1: as when it's good. The look cheap data is just
Speaker 1: the hell of a drug. People are just not going
Speaker 1: to sell a three basis point Vanguard fund. My theory
Speaker 1: is if active got cheaper, if fidelities started passing on
Speaker 1: economies of scale and got to twenty BIPs fifteen BIPs,
Speaker 1: then there are little bets around the SMP could could
Speaker 1: actually be worth it. But at eight I just think
Speaker 1: I just don't think it stops anything. I think what
Speaker 1: you will see THO is more and more people use
Speaker 1: ETFs actively and so you'll see flows into financials, deep
Speaker 1: value and that kind of thing. But I, as we
Speaker 1: can see, Vanguard is taking in money like like nobody's business.
Speaker 1: And also the Vanguard type investor, the kind of person
Speaker 1: who goes to Vanguard typically is pretty aware that, uh,
Speaker 1: you own everything. So whether values in play or gross
Speaker 1: in play or energy stocks are a hit, it's fomo
Speaker 1: proof you already own it. I don't really care. I'll
Speaker 1: just you know, what am I going to do? Replace
Speaker 1: this with like the hot stock picker of that year
Speaker 1: and then probably underperform in the year after most of
Speaker 1: them have just come to the conclusion there's no better deal.
Speaker 1: That's my opinion on that. Gina, Do I get to
Speaker 1: ask my question now? So? Yeah, I was gonna say,
Speaker 1: you're Eric's really interested and it can be drug related.
Speaker 1: It could be launch. So my question really is around
Speaker 1: the non passive portion of e t s. And we
Speaker 1: have seen some active conversions. We've obviously seen thematic investing
Speaker 1: really just take off over the course of the last
Speaker 1: few years. And your team, Eric has done some insane
Speaker 1: work on themes and and the sort of the themes
Speaker 1: that are driving stocks. So, um, my question for you
Speaker 1: is who's the next arc? If ARC is over? If
Speaker 1: we can just assume that ARC is over for now,
Speaker 1: where are we going to see the next big theme?
Speaker 1: What's the next big theme that's going to drive stocks,
Speaker 1: and and and what shall we be on the guard
Speaker 1: on guard for. Yeah, this is really a fascinating question
Speaker 1: because we wrote a note that said a deep value
Speaker 1: et F could be the next Cathy would because it's
Speaker 1: it's not about growth, it's really about concentration. We think
Speaker 1: that if most people's core of their portfolio is now
Speaker 1: in dirt cheap beta and they're happy with that, they're
Speaker 1: not going to touch it. They're gonna let the paint
Speaker 1: dry for twenty years. They are looking for things to
Speaker 1: put on the outside, like hot sauce. So Kathy was
Speaker 1: perfectly positioned for a growth wave hot sauce. What comes
Speaker 1: next um you know, and and theme ETFs uh like
Speaker 1: cybersecurity and cryptocurrency ETFs. So I think you could see
Speaker 1: themes start to repackage value stocks in fun, clever ways,
Speaker 1: like maybe they'll come out with a stuff You're really
Speaker 1: effing F which is basically just like consumer staples, because
Speaker 1: themes have really done a good job of stealing thunder
Speaker 1: from sectors and from styles and from factors by sort
Speaker 1: of making it easy, you know, more fun and easy
Speaker 1: to understand, like the work from Home et F. That's
Speaker 1: just two sectors put together. It's not like rocket science,
Speaker 1: but the labeling is really is really powerful, and so
Speaker 1: we also think that So I think you'll find some
Speaker 1: themes that tap into like maybe the staples or value
Speaker 1: stocks UM and and just maybe a deep value E
Speaker 1: t F because we did see that the ones that
Speaker 1: have the most concentration pop the most in Q one
Speaker 1: and they were doubling and tripling the Vanguard Value et F,
Speaker 1: which is very weighted down with big cat names. So
Speaker 1: again our big theme is, look, we always say you
Speaker 1: have to there's three cs. There's the three cs to
Speaker 1: E C E t F success. You've gotta be cheap,
Speaker 1: you've got to be creative or concentrated or cabernet, which
Speaker 1: is you've got to sort of like wine and dine advisors.
Speaker 1: But I'll move that that lane aside. But clearly something
Speaker 1: shiny objects aren't limited to growth. They can be value,
Speaker 1: they can be energy. Um. You know there's an e
Speaker 1: t F called the fracking e t F. I mean
Speaker 1: there's certain ways you can sort of play with the energy,
Speaker 1: maybe like old guy old school energy or something, and
Speaker 1: maybe try to make oil producers interesting again because they're
Speaker 1: doing so well. So that's where I think you'll see it.
Speaker 1: But a lot of those flows are more on the fringe. Um,
Speaker 1: but they're gonna keep coming. I mean, we just saw
Speaker 1: an t F for airline cruises and hotels, which is
Speaker 1: essentially like the reopening trade. Joel, Joel, Can I get
Speaker 1: a second question? Okay? Thanks, thanks Genie. That's like asking
Speaker 1: the Genie for another three wishes. Um. I want to
Speaker 1: ask Eric if you think that this kind of deep
Speaker 1: value investment can outperform something like tech disruption, which is
Speaker 1: what ARC was all about, over a longer period of time.
Speaker 1: And I would, you know, as a skeptic, I would
Speaker 1: say no, it couldn't tech is going to out. You know,
Speaker 1: tech disruption is going to have a higher sustained growth
Speaker 1: rate over the long run than than deep value, which
Speaker 1: may in the short run have a bound and maybe
Speaker 1: outpaced chech, but not over the longer run. Well, it
Speaker 1: all moves in waves. You don't have a line in
Speaker 1: my new book coming out about Bogel because he was
Speaker 1: he launched the value et F and the growth ETF
Speaker 1: way back in the nineties. He actually pioneered style indexing,
Speaker 1: and he said, I thought you'd buy the growth ETF
Speaker 1: when you're young, and then you transfer to the value
Speaker 1: and you find out people tried to trade it, and
Speaker 1: they ended up doing worse than just don't need the
Speaker 1: S and P. And if you track growth and value
Speaker 1: over a long period of time, they sort of end
Speaker 1: up at the same spot. So I recite that line
Speaker 1: from Almost Famous when Lester Bangs tells the high school reporter, Oh,
Speaker 1: don't worry, you'll meet them all again in the long
Speaker 1: road to the middle. So I do think if you
Speaker 1: time it right, you can make a lot of money.
Speaker 1: But in the two thousand small cat Value and Gino,
Speaker 1: I think we'll attest to this. She probably better numbers
Speaker 1: than I do. In two thousand to two thousand ten,
Speaker 1: which is a whole decade, small value crushed the S
Speaker 1: and P, which was I think flat and small value
Speaker 1: was up a lot. And that was during a huge
Speaker 1: tech renaissance, right, You had a lot of the Internet
Speaker 1: was just kind of like exploding. Um so I would
Speaker 1: it's totally possible that there's a complete regime change, and
Speaker 1: it has to be like a psychological thing where people
Speaker 1: just like we were too crazy with the computers, we
Speaker 1: really want to get back to basics. I don't know,
Speaker 1: like there's a psychological thing and it all a sudden
Speaker 1: becomes it just seems so silly to go so far
Speaker 1: into the tech, and it seems more I guess it
Speaker 1: just seems right to go into staples and energy for
Speaker 1: some reason. I don't know if Gina has a comment
Speaker 1: on that, but I don't know if that psychological thing
Speaker 1: will ever To Carl's point, our culture is so tech oriented.
Speaker 1: Could someone ever get out of that psychological mindset that
Speaker 1: tech is in the future. Well, I think we're watching
Speaker 1: it happen to some degree, and we're watching it happen
Speaker 1: in energy stocks and technology related energy stocks. I mean,
Speaker 1: the perfect example, the S and P is even thinking
Speaker 1: about reconstituting industries because they don't know what to do
Speaker 1: with all these techie energy companies. Right, and we're in
Speaker 1: the midst of, you know, trying to tackle things like
Speaker 1: climate change and uh, you know, massive energy consumption problems
Speaker 1: that are resulting in energy stocks materially outperforming. I mean,
Speaker 1: I don't know how many people pay attention to this,
Speaker 1: but energy stocks were up twenty in January while the
Speaker 1: market crashed, And it's been our big call for the
Speaker 1: last year and a half that longer term, as long
Speaker 1: as inflation is at a much stronger pace, that's the key.
Speaker 1: And if you know commodity prices are contributing to that inflation,
Speaker 1: then it's even a bigger key than energy stocks will outperform.
Speaker 1: And if you look back in history, growth doesn't always outperform.
Speaker 1: Value usually outperforms when growth economic growth is faster, because
Speaker 1: value stocks tend to leverage that near term economic growth
Speaker 1: outlook better. Right, tech has longer dated cash flows. Value
Speaker 1: stocks get the immediate cash flow growth when the economy
Speaker 1: is running at a faster pace. So I completely agree
Speaker 1: that it's a I think it's a great call to
Speaker 1: be in small up value. I think value already is
Speaker 1: showing signs of topping out or beating out growth stocks,
Speaker 1: and will continue to beat out growth stocks. Our favorite
Speaker 1: sector is still energy, followed very closely by financials, and
Speaker 1: I don't see that changing um And what will make
Speaker 1: that chain, what will make that endure, is the inflation outlook.
Speaker 1: If you think inflation is going to settle this cycle
Speaker 1: at a pace above three percent, you have to be
Speaker 1: in value of our growth. If you think inflation is
Speaker 1: going to revert back to the slow inflation environment that
Speaker 1: we saw in the last cycle, then you want, you know,
Speaker 1: you want to move back toward the growth, growth sensitive
Speaker 1: stocks in the market. Carl, we have a question that
Speaker 1: we ask everybody on trillions first time on So are
Speaker 1: you gonna get it? What's your favorite E t F ticker? Oh,
Speaker 1: my goodness, my favorite E t F ticker. Don't worry, Carl,
Speaker 1: I bobble this question every time you're talking about E
Speaker 1: t F. I'm gonna go with like a kind of
Speaker 1: you know, passive vanguard, type of all cap kind of
Speaker 1: rising rising tide continues to lift all boats. Since we're
Speaker 1: allowed to bobble the answer here, I'm gonna go into
Speaker 1: my my E t F pick list. I'm gonna go
Speaker 1: with V I G the Vanguard Dividend Appreciation e t
Speaker 1: F and this factor's back into this whole camp, the
Speaker 1: great competition thesis, which I mentioned earlier in our discussion,
Speaker 1: because dividend appreciation is uh, you know, I think going
Speaker 1: to be so fundamentally important to stock valuations as we
Speaker 1: move into a higher inflation and higher interest rate regime
Speaker 1: for the foreseeable future. You bobbled it, recovered the fumble,
Speaker 1: and then like took off for a touchdown. Yeah. And
Speaker 1: also that's the first person who picked big your your
Speaker 1: original all right? When did they're Gina Martin Adams, Carl
Speaker 1: wi Ganna. Thank you so much for joining us on Trillians.
Speaker 1: Thank you my pleasure. Thanks for listening to Trillions until
Speaker 1: next time. You can find us on the Bloomberg Terminal,
Speaker 1: Bloomberg dot com, Apple Podcast, Spotify, and wherever else you'd
Speaker 1: like to listen. We'd love to hear from you. We're
Speaker 1: on Twitter, I'm at Joel Weber Show, He's at Eric Baltunas.
Speaker 1: This episode of Trillions was produced by Magnus Hendrickson, Francesca
Speaker 1: Levy is the head of Bloomberg podcast Bye