Speaker 1: Hello, and welcome to What Goes Up, a weekly markets podcast.
Speaker 1: My name is Mike Reagan, I'm a senior editor at.
Speaker 2: Bloomberg, and I'm all Donna Hirich, across asset reporter with Bloomberg.
Speaker 1: And this week on the show, well, don't pinch yourself,
Speaker 1: you're not dreaming, and don't bother to call the IT
Speaker 1: department to adjust your computer monitor.
Speaker 3: It's working fine.
Speaker 1: The stock market really did just put in one of
Speaker 1: the strongest first halfs of a year in well forever,
Speaker 1: at least for the Nasdaq one hundred, which as of
Speaker 1: this recording is up about thirty seven percent so far
Speaker 1: in twenty twenty three. So how exactly did that happen
Speaker 1: when everyone and their dog was calling for a recession
Speaker 1: this year? And what can we expect next? We'll get
Speaker 1: into it with a very special guest. But first of Feldona,
Speaker 1: I think many listeners are probably familiar with the famous
Speaker 1: Bloomberg pantry. We're very lucky to have snacks and coffee
Speaker 1: on soft drinks.
Speaker 3: What's your favorite part of the Bloomberg pantry?
Speaker 2: Bloomberg pantry, Okay, we have these really cool machines that
Speaker 2: I heard are straight from Italy. That make lattes. Do
Speaker 2: you use those? They're like dotted all over the place.
Speaker 2: One of them is a brand new and makes like
Speaker 2: the silkiest latte, So I love those.
Speaker 3: I was going to be corny and say the people.
Speaker 2: Oh my god, please don't make me roll my eyes.
Speaker 3: All right. I was walking through the pantry the other.
Speaker 1: Day, and there is something to being back in the
Speaker 1: office and not working at home all the time, because
Speaker 1: you run in the people. I had my eggs, my
Speaker 1: hard boiled egg, my coffee, a pocket full of red liquorice,
Speaker 1: and I ran into our guests this week and made
Speaker 1: me think, you know what, it's about time we had
Speaker 1: on the show. We have a lot of strategists on
Speaker 1: the show from outside of the firm, but we're lucky
Speaker 1: to have one of the best in the business right here.
Speaker 2: When I see her in the hallways, I never say
Speaker 2: hi because I'm like, oh, no, I'm leaving her alone
Speaker 2: because she needs her time. She's so busy, really really, yes,
Speaker 2: hello to me. Oh I never say hello to you
Speaker 2: on purpose.
Speaker 3: Yeah, turn the other way, completely different reason.
Speaker 2: I guess, turned the other way. Yes, Okay, it's Gina
Speaker 2: Martin Adams, Chief Equity strategist at Bloomberg Intelligence. Since she's
Speaker 2: been on the show before, and we're so lucky to
Speaker 2: have you back. Thank you for joining me.
Speaker 4: Wow, thank you for having me. That was quite an introduction.
Speaker 4: Well we should just stop it right there on that
Speaker 4: high and call it a quit.
Speaker 2: Thanks everybody for listening this week.
Speaker 3: But it's a good week, Gina, to have you on.
Speaker 1: You guys just came out with your mid year outlook
Speaker 1: for equities. Talk to us about sort of your main
Speaker 1: takeaways about this crazy strong rally we've seen this year
Speaker 1: and what we should take away most from the mid
Speaker 1: year outlook.
Speaker 4: Yeah, I think there's a lot to unpack with the
Speaker 4: market so far this year. I think the biggest takeaway
Speaker 4: for me really is we cannot drop the ball on
Speaker 4: following earnings trends and earnings did give us a lot
Speaker 4: of indication that twenty twenty two was going to be weak.
Speaker 4: They also have given us a lot of support in
Speaker 4: twenty twenty three, and I think that many people dismissed
Speaker 4: the gains in the equity market. It has been a
Speaker 4: powerful rally, but remember it comes off of a really
Speaker 4: rough go in twenty twenty two. For that, Nasdaq and
Speaker 4: for some of those tech stocks, so earnings trends very
Speaker 4: very important. Inflation likewise important not only for its impact
Speaker 4: on earnings trends, but because inflation in the seventies and
Speaker 4: eighties was a really great timing mechanism for stock tops
Speaker 4: and bottoms. Once again, inflation peaks, stocks bottom, and we're
Speaker 4: off to the races as inflation is decelerating. So that's
Speaker 4: a big takeaway from US. I think thirdly, sentiment is
Speaker 4: still pretty mixed. A sentiment gave us an indication in
Speaker 4: Octo Tilboro of last year that we should start getting
Speaker 4: more constructive to stocks because everybody else had left the building.
Speaker 4: There was just nobody left that wanted to touch equity markets.
Speaker 4: And sentiment is still somewhat mixed. I do think that
Speaker 4: people are still really nervous about this potential economic recession
Speaker 4: and how deep or long it may be. People are
Speaker 4: still really nervous about the FED. As long as I
Speaker 4: keep getting pushed back from people that we shouldn't be constructive,
Speaker 4: and then we probably should be constructive.
Speaker 2: I really like the very first line of the midyear
Speaker 2: of your mid year outlook, so I want to read it.
Speaker 2: Stocks should breathe a sigh of relief as the inflation
Speaker 2: pig appears to have passed through the S and P
Speaker 2: five hundred earnings Python. That's so good and so visual.
Speaker 4: Thank you.
Speaker 2: And then you also mentioned margin pressures from twenty twenty two.
Speaker 2: They're fading and should offset any revenue weakness. Can you
Speaker 2: talk a little bit about that, And then also about
Speaker 2: the idea I want to bring AI into this as well,
Speaker 2: like if we are expecting all these companies to be
Speaker 2: spending on AI, does that hurt margins?
Speaker 4: Yeah? Really great questions. So I'm I am very well
Speaker 4: known as being obsessed with margins. As a matter of fact,
Speaker 4: one of my associates one time accidentally wrote my name
Speaker 4: Gina Margin Adams on a piece of work instead of
Speaker 4: Gena Martin Adams. She says it was an accident, but
Speaker 4: it's it's just something that I follow very very carefully.
Speaker 4: And margins had been just crashing when inflation was accelerating.
Speaker 4: Margins x energy, which is an important clarification on the
Speaker 4: S and P five hundred, crashed from late twenty twenty
Speaker 4: one right through to the first quarter of this year,
Speaker 4: but started we're starting to see margin improvement occur on
Speaker 4: the index, and that is a direct reflection of the
Speaker 4: inflation landscape. Consumer prices are decelerating, Producer prices growth is
Speaker 4: also decelerating, but consumer price growth is decelerating at a
Speaker 4: slower pace than producer price growth, and that margin is
Speaker 4: directly impacting the S and P five hundred. On top
Speaker 4: of that, we did go through some pretty significant layoffs
Speaker 4: in twenty twenty two, and that's enabling margin recovery for
Speaker 4: some of the index. So what we're starting to see
Speaker 4: is actually green shoots in the earning stream. And we
Speaker 4: started writing about this in the first quarter earning season.
Speaker 4: People were like, you got to be crazy. The economy
Speaker 4: is going to fall apart. You can't have green shoots
Speaker 4: in the earning stream when economy is going to be
Speaker 4: falling apart. But that's what we see, and as long
Speaker 4: as that continues, that fundamental shift in margins should lead
Speaker 4: to much better earning stability for the index going forward,
Speaker 4: in particular for X energy sectors. Now, tech is a
Speaker 4: really interesting phenomenon right now because what's happening in tech
Speaker 4: is in some cases very different from what's happening in
Speaker 4: the rest of the index, and in some cases the same,
Speaker 4: and where it's very different is there is optimism in tech.
Speaker 4: There's optimism nowhere else in the S and P five hundred.
Speaker 4: The equal weighted S and P still trading below its
Speaker 4: pre pandemic average levels, but there's a ton of optimism
Speaker 4: in tech. Tech valuations are at pandemic peace in the
Speaker 4: S and P specifically, and that's a function of both
Speaker 4: margins starting to improve. This really started the tech rally.
Speaker 4: Nobody wants to admit it because everybody thinks it's all
Speaker 4: about AI, but the reality is Tech cut costs. Tech
Speaker 4: cut those costs that created a margin bottom for tech
Speaker 4: and created an uptrend in an updraft in earnings estimate
Speaker 4: revision for that space going into latter the later part
Speaker 4: of this year. So that created the initial rounds of optimism.
Speaker 4: And then what's different is AI and AI certainly is
Speaker 4: driving an anticipated recovery and spending at large, and capital
Speaker 4: spending in particular, that impacts different segments of tech and
Speaker 4: communications and some of the consumer discretionary sectors in very
Speaker 4: different ways. So some of the companies that are big
Speaker 4: beneficiaries of that capital spending obviously can see really significant
Speaker 4: revenue growth to offset any any spend that they have
Speaker 4: to develop product Companies that are simply going to have
Speaker 4: to spend in or to onboard have face a different scenario.
Speaker 4: They'll need to see revenue growth in other spaces. But
Speaker 4: it does appear to be creating this sort of snowball
Speaker 4: effect throughout the entire in the entirety of the tech sector,
Speaker 4: where there is this optimism embedded in prices. That could
Speaker 4: be a risk later this year if tech companies aren't
Speaker 4: starting to post the earnings growth that it's anticipated in
Speaker 4: that valuation, then we could face some downdraft in tech,
Speaker 4: But for now, it looks like it's only creating an
Speaker 4: upwave in expectations.
Speaker 1: You know, one of the most interesting things to me
Speaker 1: in the mid year outlook is you guys have at
Speaker 1: BI Equity Strategy have your own economic regime model. That
Speaker 1: model actually suggests that the recession is come and gone,
Speaker 1: happened in what the second half of twenty twenty two,
Speaker 1: which sort of makes this market make a lot more
Speaker 1: sense than everyone bracing for a recession. But could you
Speaker 1: walk us through sort of the inputs of that model
Speaker 1: and what exactly it's showing and what makes you make
Speaker 1: that analysis that it really looked like a recession last year.
Speaker 4: Yeah, so the economic regime model. We designed this. I
Speaker 4: designed this many many years ago when I was with
Speaker 4: another firm that shall remain nameless. But nonetheless, it is
Speaker 4: designed to give us a read on the current read
Speaker 4: on the economy by indicators that are historically very meaningful
Speaker 4: for predicting stock prices. So we really isolate that read
Speaker 4: on the economy into four factors. We use consumer confidence,
Speaker 4: we use ism, we use capacity utilization, and we use
Speaker 4: continuing claims. And those four factors together have given us
Speaker 4: We put them into a logistic regression. I don't want
Speaker 4: to get too nerdy, but nonetheless, most of the time
Speaker 4: those factors give us an output of a range of
Speaker 4: from zero to one, and most of the time they
Speaker 4: give us an output of near one, which would suggest
Speaker 4: the economies just fine. The input from the economy for
Speaker 4: the equity market is very positive. You should expect positive
Speaker 4: returns over time when they the output is at one.
Speaker 4: When it drops below one, it creates risk to the
Speaker 4: equity market, right, And so this indicator gave us an
Speaker 4: started suggesting there were economic risks emerging for the equity
Speaker 4: market as early as June of last year, and then
Speaker 4: it hit just an outright low level, like a low
Speaker 4: that you never see outside of recession, near zero in
Speaker 4: December of last year. So we effectively had this big
Speaker 4: loss of momentum in the economy that impacted the equity
Speaker 4: market extremely negative between June and December of last year.
Speaker 4: Since December, it's certainly not out of the woods. It's
Speaker 4: still terrible. The reading is awful. It suggests we may
Speaker 4: and we may actually still be in some form of
Speaker 4: an economic correction or recession, but it's off of the low.
Speaker 4: So this is what's really meaningful for price direction is
Speaker 4: as we know, equity prices are driven by shifts in momentum. Right,
Speaker 4: So even if the economy is still in recession, the
Speaker 4: recession reached its big momentum trough according to this indicator
Speaker 4: as of December. Now, this is really contradictory to any
Speaker 4: economic thought out there, and you know every economist will
Speaker 4: tell you no way we're in recession. The job market
Speaker 4: was very stable.
Speaker 1: I was going to ask what was the main driver
Speaker 1: of that? Was it in poor consumer confidence?
Speaker 3: Mainly?
Speaker 4: Oh, it was everything. I mean, you know, remember ism
Speaker 4: peaked all the way back in twenty eleven. We use
Speaker 4: our twenty twenty one. We use ISM as another indicator
Speaker 4: as a component of our market health checklist, and it
Speaker 4: gave us a really early read that things were going
Speaker 4: south as of the end of twenty twenty one. So
Speaker 4: ism was plummeting for much of last year. May have
Speaker 4: crested it's low as well, and that certainly helps. Continuing
Speaker 4: claims were stable to hire, so they weren't particularly great.
Speaker 4: Consumer confidence was awful.
Speaker 2: We had those two back to back negative GDP readings
Speaker 2: as well.
Speaker 4: We did there were definite weaknesses, and we saw that
Speaker 4: really clearly in earnings. And I think that this is
Speaker 4: the important point. I'm not trying to make a forecast
Speaker 4: for the economy. It doesn't matter to me whether we
Speaker 4: fall into a technical recession or not. I need to
Speaker 4: forecast earnings, and I need to forecast what's going to
Speaker 4: happen with or figure out what's going to happen we're
Speaker 4: likely to happen with stock price returns, and these four
Speaker 4: indicators as a group, I've done a very good job
Speaker 4: of suggesting to me where I should be with respect
Speaker 4: to the equity market and how constructive you want to be.
Speaker 4: And basically what it said is go as far away
Speaker 4: from equities as you can in June and in December
Speaker 4: get back in. And that's what the model said to us.
Speaker 4: And it may or may not eventually prove. It could
Speaker 4: be the case that we did or did not fall
Speaker 4: in recession in twenty twenty two, But the economic indicators
Speaker 4: that matter to me as an equity strategist suggest that
Speaker 4: the distress has reached some sort of low point. We're
Speaker 4: still somewhat distressed, but not as distressed as we were
Speaker 4: last year.
Speaker 2: This is really interesting to me because I feel like
Speaker 2: in recent days more and more people have been bringing
Speaker 2: up the fact like we've been waiting for this recession.
Speaker 2: There still aren't crazy great signs that something is happening
Speaker 2: right now. But somebody I spoke with earlier this week said,
Speaker 2: if you're looking at the market, if you look at
Speaker 2: small caps for instance, or you mentioned the eco weight
Speaker 2: SMP index, that actually you could almost make the argument
Speaker 2: that those stocks are pricing in a recession because they're like,
Speaker 2: what do you think of that?
Speaker 4: Yeah, And as a matter of fact, I think large
Speaker 4: caps priced in recession as well. Last year. We were
Speaker 4: on a different model. We call it our fair value model,
Speaker 4: and this is a model that utilizes consensus expectations to
Speaker 4: suggest where the fair value for various equity markets are
Speaker 4: around the world macroeconomic expectations, and that model at the
Speaker 4: lows of last year, was anticipating of fifteen percent decline
Speaker 4: in earnings coming over the next twelve months, So that
Speaker 4: would say that, Okay, if the market is right here
Speaker 4: as of October first, twenty twenty two, we are officially
Speaker 4: headed into a major earnings recession in twenty twenty three,
Speaker 4: a major decline in earnings of fifteen percent more. Because
Speaker 4: remember earnings were already declining by that point in time,
Speaker 4: so that would be equivalent to roughly a twenty percent
Speaker 4: drop in earnings, which is very consistent with historical recession experience.
Speaker 4: We already priced it in the equity market, and unless
Speaker 4: we get a greater than twenty percent drop in earnings,
Speaker 4: those lows are probably pretty firm. Yep, the October lows
Speaker 4: are probably pretty firm. At least that would be what
Speaker 4: was implied in that model at that time. Small caps
Speaker 4: very similarly, small caps are much more economically sensitive or
Speaker 4: sensitive to the movements in the US economy than our
Speaker 4: large caps, so the divergence between large caps and small
Speaker 4: caps could be easily explained by the ongoing weakness and
Speaker 4: the domestic economy, the divergence between what's happening in tech
Speaker 4: and some of the bigger cap names and some of
Speaker 4: the multinationals that are more sensitive to foreign exchange in
Speaker 4: large caps versus small caps, which don't get those benefits
Speaker 4: of the dollar move. Small caps are not as beneficent,
Speaker 4: not as benefited by a re emerging Asia out of
Speaker 4: COVID restrictions, where large caps get a little bit of
Speaker 4: boost there. So there's I think a lot of what's
Speaker 4: happened in the equity market, As much as people think
Speaker 4: it's very mysterious and things are not a explained by fundamentals,
Speaker 4: I actually think the equity advance is largely explained by
Speaker 4: some fundamental shifts.
Speaker 1: Well, you also discuss the notion of a FED pause
Speaker 1: in your outlook and what historically has happened after a pause.
Speaker 1: I guess we don't really know if this is the
Speaker 1: highest that the Fed funds rate will be. Jerome Powell
Speaker 1: keeps saying maybe probably two more quarter point increases this year.
Speaker 1: I feel like the market could digest another half point
Speaker 1: on the Fed funds rate after this, And you know,
Speaker 1: whether this is a pause or it's a pause after
Speaker 1: another fifty basis points. I don't think it's that big
Speaker 1: of a difference, but I do wonder, you know, if
Speaker 1: we do plateau there for a while and the bond
Speaker 1: market falls in line with that, and we have an
Speaker 1: elevated risk free rate compared to what we saw a
Speaker 1: pre pandemic, how does that influence your thinking on what
Speaker 1: the market will do and valuations specifically, does that suggest
Speaker 1: to you a sort of lower ceiling for valuations or
Speaker 1: does this tech euphoria overshadow that and outweigh where the
Speaker 1: risk free rate is going to be.
Speaker 4: Yeah, it's a really good question. I think the equity
Speaker 4: market will really dismiss anything that happens with the FED
Speaker 4: in the short run. I think that we're kind of
Speaker 4: over it, right. It's just, yeah, okay, we're pausing. It
Speaker 4: might hike one or two more times, but it's largely
Speaker 4: been the near term price section is the near term
Speaker 4: action from the FED has been priced. I do think
Speaker 4: there's a risk, though, that the bond market is very
Speaker 4: convinced that this is not a pause. It's just a
Speaker 4: short term pause that leads to a series of cuts
Speaker 4: and we do see that sort of infiltrating equity market
Speaker 4: psychology through valuations for long duration versus loaduration stocks. So
Speaker 4: high duration equities are much more sensitive interest rates. Higdration
Speaker 4: equities are still trading and increasingly trading at a premium
Speaker 4: to low duration equities, which would substantiate that bond market forecast.
Speaker 4: So I think later this year you do have some
Speaker 4: risk if the economy does not comply, we don't ultimately
Speaker 4: fall into that growth malaise or recession. If we don't
Speaker 4: see inflation really viciously come down to more normalized levels,
Speaker 4: then the bond market has to adjust, and that will
Speaker 4: have impacts on the equity market. It won't be as
Speaker 4: negative as the last year's impacts because you have the offset. Right.
Speaker 4: If the bond market is having to adjust to an
Speaker 4: outlook where the Fed Funds rate doesn't have to come
Speaker 4: down and instead stays stable for longer, that only impacts
Speaker 4: valuations because that only happens in an environment where economic
Speaker 4: growth is actually still stronger than anybody had hoped, right,
Speaker 4: and inflation is coming down, And so that offset that
Speaker 4: stronger economic growth than anybody had hoped with a decelerating
Speaker 4: inflation is very good for the earning stream, and it
Speaker 4: really substantiates twenty twenty four forecasts for earnings, which should
Speaker 4: help the equity market sustain that movement, but it will
Speaker 4: create volatility and equities, probably for longer duration equities more
Speaker 4: than short duration equities. That's what I'm worried about with
Speaker 4: respect to the FED. That longer term.
Speaker 2: I remember it was just a couple of weeks ago,
Speaker 2: I think when people some people were suggesting the FED
Speaker 2: was going to start cutting in July.
Speaker 4: Yeah, yeah, now, yeah, But.
Speaker 2: I want to ask you just to go back to
Speaker 2: the AI theme, just broadly speaking, what you make of
Speaker 2: it in terms of it being such a big driver
Speaker 2: for the rally for companies spending on AI, and what
Speaker 2: the possibilities are of it driving not just spending with
Speaker 2: the big megacaps, but also with I don't know, smaller
Speaker 2: companies that might start utilizing AI in different ways, and
Speaker 2: how that might be beneficial or even underpin the ball case.
Speaker 4: Yeah, I think it's really early to say what the
Speaker 4: potential of this is long term, and certainly we'll go
Speaker 4: through the process of trying to price that over the
Speaker 4: next six to twelve months. That said, every cycle starts
Speaker 4: with some new innovation, some new catalyst for growth. And
Speaker 4: what you do tend to find is that if you
Speaker 4: get this catalyst for growth, it emanates throughout and tends
Speaker 4: to broaden in terms of its impact on industries, companies
Speaker 4: and sectors at large. And think about this. If we're
Speaker 4: able to accelerate the utilization of AI and tech, there's
Speaker 4: no reason why that ultimately would not also benefit the
Speaker 4: margins of even consumer staples companies long term. Right, So
Speaker 4: this is right now really being implemented as a driver
Speaker 4: of revenue growth, right and I think that's the psychology
Speaker 4: right now, is that this will help drive revenue growth
Speaker 4: long term for tech. What we haven't thought through and
Speaker 4: probably the second derivative impact of this is Okay, it'll
Speaker 4: help drive revenue growth for tech, and companies will spend
Speaker 4: a little bit more on this. They'll probably shift spending
Speaker 4: so it's not a net net margin drag in that capacity.
Speaker 4: Instead of spending on other capital investments, they'll spend on AI.
Speaker 4: Presumably in that sense, if they're spending the same amount,
Speaker 4: they're elevating the value of revenue or they're elevating revenue
Speaker 4: growth potential for the tech space, which are the producers
Speaker 4: of AI, but then they also are implementing these technologies
Speaker 4: which should reduce their margin pressures or reduce margins longer
Speaker 4: term make their companies much more efficient. And that efficiency
Speaker 4: improvement is the long term, big, big benefit that I
Speaker 4: think we have yet to really price because we just
Speaker 4: don't know how fast can it be implemented, how quickly
Speaker 4: can it actually improve efficiency and drive productivity gains. We
Speaker 4: all have read all the articles about how horribly unproductive
Speaker 4: the US economy is. This is a potential big game changer.
Speaker 4: I don't think that it's at all in the consensus
Speaker 4: forecast right now. I think most people are saying, look,
Speaker 4: you know that we're still going to struggle with this,
Speaker 4: these labor dynamics and very low productivity rates and whatnot.
Speaker 4: So it's a potentially very big game changer longer term,
Speaker 4: but it's going to take us a while to work
Speaker 4: that out. For now, it is very much a driver
Speaker 4: of revenue optimism in tech.
Speaker 3: Yeah.
Speaker 1: Well, I hear efficiency gains and I interpret that as
Speaker 1: job layoffs, which obviously feeds back into your economic models.
Speaker 3: How big of a risk is that, do you think?
Speaker 4: I think it's limited in the short run, mostly because
Speaker 4: we have record levels of available jobs open in the economy.
Speaker 4: As it is, the way that I see the job market,
Speaker 4: I think it's a little different than the way that
Speaker 4: many people have characterized the job market. The way that
Speaker 4: I see it is in twenty twenty, we had a
Speaker 4: mass mass layoff experience, I mean, the worst layoff experience
Speaker 4: that any of us hopefully will ever face in our lives,
Speaker 4: with the unemployment rate just shooting higher, layoffs throughout all
Speaker 4: industries except for tech and to a lesser extent, financials.
Speaker 4: It is therefore no surprise that come twenty twenty two,
Speaker 4: the sectors that did not lay off in twenty twenty
Speaker 4: suddenly had to lay off workers. And so it was
Speaker 4: just this sort of twenty twenty two was kind of
Speaker 4: this mini to me, mini layoff experience, mini recession, whatever
Speaker 4: it might be, however you want to characterize it, reflecting
Speaker 4: the twenty twenty experience. And now we've gotten to the
Speaker 4: point of presum close to stable labor market conditions. And
Speaker 4: I derive this expectation really through an analysis of Challenger layoffs.
Speaker 4: It's not the most popular economic series, but if you
Speaker 4: look at Challenger layoffs, Challenger layoffs really peaked with the
Speaker 4: fourth quarter layoffs in the tech space, they started to descelerate.
Speaker 4: As of the first quarter, they're continuing to decelerate. Can
Speaker 4: that's very consistent with what we're getting out of earnings
Speaker 4: call sentiment and the announcements of layoffs in earnings calls.
Speaker 4: Earnings layoffs announced by US companies in earnings reports peaked
Speaker 4: in the fourth quarter. They decelerated to a lower level
Speaker 4: in the first quarter, and I anticipate that to continue
Speaker 4: in the second quarter. So so far, it looks like
Speaker 4: the labor market weakness is really minimal ultimately long term,
Speaker 4: Do you have some layoffs affiliated with AI or is
Speaker 4: your growth so much faster that those jobs all come
Speaker 4: back even faster, right? I don't know how much transfer
Speaker 4: of labor there is between the layoff worker, the laidoff
Speaker 4: workers and communications and technology industries into AI sorts of positions. Yeah,
Speaker 4: but it is a question. But I don't think we're
Speaker 4: going to face major labor constraints as a result or
Speaker 4: major labor weaknesses as a result of AI for quite
Speaker 4: some time, and.
Speaker 1: It seems like it'll be you know, while the revenue
Speaker 1: lines are moving higher for the chip makers and the
Speaker 1: cloud companies. For companies actually trying to utilize AI to
Speaker 1: boost their own efficiencies, it feels like we're just only
Speaker 1: in the R and D phase for all of that.
Speaker 1: It's not immediately going to be a needle mover for anything.
Speaker 4: From that side of it, it does seem very very
Speaker 4: early in the game. The equity market moves so far
Speaker 4: in advance in so much faster than the economy that
Speaker 4: will feel the economic impacts for five years. In the
Speaker 4: equity market will price itent in six months. So I
Speaker 4: think we do need to respect that dynamic. But nonetheless,
Speaker 4: I do think it's still very very early. And the
Speaker 4: degree to which this took the consensus by surprise was
Speaker 4: quite shocking.
Speaker 1: Well, does that notion of the benefits of AI broadening
Speaker 1: out beyond big tech affect at all?
Speaker 3: How you're thinking about?
Speaker 1: Magnificent seven is the latest new buzzword for the top
Speaker 1: seven weights in the SMP your big megacap alphabets and
Speaker 1: in videos.
Speaker 4: Your team had Magma, we did, we had a few.
Speaker 4: We've tried a Fab five for the Big five. We
Speaker 4: have done the Magnificent seven as well. I've gotten into
Speaker 4: this game and none of them have really taken off.
Speaker 2: So you need to get one that sticks.
Speaker 4: I know I need to find one that sticks. The
Speaker 4: problem is also the market cap concentration shifts are pretty significant.
Speaker 4: So sometimes Tesla's in there, Sometimes Berkshire Hasay, Hathaway is
Speaker 4: in there, Berkshire Hathaway with a bunch of tech companies.
Speaker 4: How do I describe this?
Speaker 3: How are you thinking of that concentration?
Speaker 1: I've heard sort of different arguments from different people that
Speaker 1: a lot of people think, well, the rest of the
Speaker 1: market's bound the catch up eventually, but it's hard to
Speaker 1: see a correction in megacap tech without a really nasty
Speaker 1: s and P.
Speaker 3: Five hundred.
Speaker 1: Have you done any thinking about this type of top
Speaker 1: heavy rally and what we should think will come next?
Speaker 4: Yeah, we actually dedicated a note to it a couple
Speaker 4: of weeks ago. I really looked at concentration risk and
Speaker 4: what it may or may not mean. We are historically
Speaker 4: concentrated in terms of gains, but what it actually means
Speaker 4: going forward as gains might slow. Let me just start there. Yeah,
Speaker 4: but there are two experiences in our past in which
Speaker 4: we have had extraordinary concentration in similar fashion to the
Speaker 4: concentration that we have today. And twenty twenty, and the
Speaker 4: outcome of both of those was totally different. In two thousand,
Speaker 4: the concentrated gains and died in tears right, all of
Speaker 4: the biggest names really crashed. In twenty twenty, the rest
Speaker 4: of the market caught up, and the difference there was
Speaker 4: earning strengths. In two thousand, earnings for the rest of
Speaker 4: the market just kept crashing along with the tech stocks.
Speaker 4: Tech earnings fell. In twenty twenty, the rest of them
Speaker 4: market started experiencing in earnings recovery. So I believe that
Speaker 4: earnings are going to make the difference now when I
Speaker 4: look at the earnings outlook for tech and the rest
Speaker 4: of the sectors, I actually see some justification for this
Speaker 4: concentration risk in earnings as well, because the biggest stocks
Speaker 4: in the index had a magnificent earnings recession in twenty
Speaker 4: twenty two. We're talking twenty twenty five in some cases
Speaker 4: thirty percent declines in EPs. They have started to show
Speaker 4: some signs of stabilization and recovery earlier than the rest
Speaker 4: of the market, which has enabled this rotation. So right
Speaker 4: now they have an earning's edge on the rest of
Speaker 4: the market, if you will. They're the only stocks that
Speaker 4: you know, people feel confident that their earnings recovery is
Speaker 4: already emerging, that they have a longer term outlook for
Speaker 4: earnings growth that is emerging. The rest of the market
Speaker 4: will have to prove the case that they too can
Speaker 4: participate in this. But unless they start failing on that
Speaker 4: earnings recovery, there's no reason to fade it, and I
Speaker 4: think that's important to consider. Maybe they'll start failing on
Speaker 4: the earnings recovery, and that would be a very good
Speaker 4: reason to fade that rally. I'm working on the presumption
Speaker 4: that the rest of the market will broaden out and
Speaker 4: start to catch up to tech in terms of earnings,
Speaker 4: mostly because of the inflation dynamic that we talked about
Speaker 4: the pig and the python at the very beginning, But
Speaker 4: it's important. The other thing I'll say about concentration risk
Speaker 4: that I think nobody talks about is twenty twenty three's
Speaker 4: gains first are not historically unprecedented. They're too short to
Speaker 4: be historically unprecedented. We had a longer period of concentrated
Speaker 4: gains in both twenty two thousand as well as twenty twenty.
Speaker 4: But secondly, they do come off of unprecedented historic losses
Speaker 4: in twenty twenty two. That's the one thing that makes
Speaker 4: this story very different than twenty twenty or two thousand.
Speaker 4: Tech had a horrible year twenty twenty two. This space
Speaker 4: underperformed the market for twelve straight months last year, and
Speaker 4: I think that's really important for setting the background for
Speaker 4: why they're outperforming now, different characteristic than has existed in
Speaker 4: past experiences.
Speaker 2: I want to ask you about one other hot topic,
Speaker 2: which is cash, which basically became its own acid class
Speaker 2: last year because so many people were putting we're going
Speaker 2: into cash. I think in June money market funds saw
Speaker 2: a record high level. There's all these different ways to
Speaker 2: measure people favoring cash over the last year or so.
Speaker 2: But if we're thinking about five percent yields on cash,
Speaker 2: how does that compare now seeing a fourteen percent rise
Speaker 2: in the S and P five hundred thirty seven percent
Speaker 2: rise and then Nazak one hundred and what is the
Speaker 2: possibility of some of that cash actually starting to move
Speaker 2: into the equities market.
Speaker 1: Yeah.
Speaker 4: I think this is a great question, and this is
Speaker 4: one area where I have had a minor amount of
Speaker 4: success and creating a shortcut description. I call this Tara
Speaker 4: instead of Tina. We all remember Tina. There are there
Speaker 4: is no alternative in tarra is. There are reasonable alternatives,
Speaker 4: and some people are adopting this one, so we'll go
Speaker 4: with that.
Speaker 2: Let's make it happen. Yeah, let's make Tara.
Speaker 4: Tara has definitely changed the game for equities. And it's
Speaker 4: not just cash, but it's also bond yields are much
Speaker 4: much higher, So the relative value of equities in a
Speaker 4: multi asset portfolio is quite different than it was for
Speaker 4: much or the last cycle. The way that I think
Speaker 4: about this, the equity risk premium in comparison to bonds
Speaker 4: is probably the most relevant. I think cash is and
Speaker 4: is not competitive with equities. I think people save in
Speaker 4: cash with a different outlook than they save inequities. First
Speaker 4: of all, I think most people think of equities as
Speaker 4: a long term asset for savings, whereas putting money in
Speaker 4: a money market pun fund still makes it quite accessible
Speaker 4: to you for you to utilize. It's kind of a
Speaker 4: different savings mechanism, but nonetheless, yield across the border higher.
Speaker 4: And that's the story which makes the equity risk premium
Speaker 4: much lower than it used to be and equities much
Speaker 4: less attractive relative to bonds than they have been at
Speaker 4: least for the most of the last cycle from two
Speaker 4: thousand and nine to twenty nineteen. Most of that period
Speaker 4: of time, equities were in the fourth quintile of history
Speaker 4: in terms of the equity risk premium relative to bonds.
Speaker 4: That meant you were really getting pushed into equities as
Speaker 4: an asset class. Your expected returns in that kind of
Speaker 4: climate for equities are eleven percent annualized. It's fantastic. It
Speaker 4: was just one of the best periods of time ever
Speaker 4: to be an equity investor, justified by very, very low
Speaker 4: relative yields. You were just forced in. Now equities risk
Speaker 4: premium is closer to the third quintile of history, which
Speaker 4: implies your return expectations for equities are much more limited.
Speaker 4: Your average return per year in that environment, on average,
Speaker 4: would anticipate closer to six percent annualized returns to equities.
Speaker 4: And it really is just a function of math. You know,
Speaker 4: when you're thinking about allocating assets, you can consider now
Speaker 4: yield oriented investments. As a long term investor, you can
Speaker 4: yield actually contributes to your portfolio, and equities have very
Speaker 4: little yield. Even if you look at the dividend yield
Speaker 4: relative to the tenure treasury, it's just not particularly fun.
Speaker 4: It's two percent on the S and P five hundred.
Speaker 4: You're just not going to get a lot. So add
Speaker 4: that to the earnings yield and that's your all out yield.
Speaker 4: You could get really stretchy and add buy back yield
Speaker 4: to it too, and it's still Equities are not that
Speaker 4: attractive relative to bonds anymore.
Speaker 1: Gina, you do all these great models, this great quantitative work.
Speaker 1: I want to take you out of that comfort zone
Speaker 1: a little bit and talk about the things that really
Speaker 1: I think cause a sharp correction in equities is when
Speaker 1: there's something unforeseen, something non predicted or very few predicted.
Speaker 3: And I get go back.
Speaker 1: To the notion of the FED. We have seen this
Speaker 1: aggressive tightening from the FED. We did see the shoes
Speaker 1: with Silicon Valley Bank and a few other First republic
Speaker 1: that duration risk problem they all had. I just wonder,
Speaker 1: the way you look at the universe, is there a
Speaker 1: way to sort of model kind of a black Swan
Speaker 1: thing or something from the FED tightening that's yet to come.
Speaker 1: I think even Jerome Pow this week said there's a
Speaker 1: lot of tightening that still has to work. Its way
Speaker 1: through the economy and the financial system. Is that work
Speaker 1: you can do? I mean, is there another shoe to
Speaker 1: drop from this aggressive rate height campaign? Is there any
Speaker 1: way to predict that or at least prepare for it
Speaker 1: and sort of viewer the way you look at the world.
Speaker 4: I don't think there's a way to model it. I
Speaker 4: think there's a way to think it through. And the
Speaker 4: way to think it through is identify the sectors or
Speaker 4: the space in the economy that benefit most from interest
Speaker 4: rates at zero percent and acknowledge that there probably are
Speaker 4: segments of that group or industry or investment or whatever
Speaker 4: it might be, that are built upon a foundation of
Speaker 4: interest rates remaining low forever and therefore when interest rates
Speaker 4: go higher, will experience some degree of distress and default.
Speaker 4: And so it's not a modeled approach, it's just more logical.
Speaker 4: The question you have to ask yourself as an investor
Speaker 4: is when interest rates were for a very short period
Speaker 4: of time at zero percent in twenty twenty and twenty
Speaker 4: twenty one, where did that money go? Where was the
Speaker 4: most borrowing, How did that manifest itself? And did that
Speaker 4: borrowing result in excess supply of something that is going
Speaker 4: to be subject to a shortfall of demand, like did
Speaker 4: we plan too much for these low interest rates to
Speaker 4: persist in perpetuity? This cycle is particularly difficult on this
Speaker 4: I think that the most frequently presented sort of areas
Speaker 4: of risk are the least likely to be the candidates
Speaker 4: to create the downdraft. And I say that because everyone,
Speaker 4: I think, is looking at things like office and commercial
Speaker 4: real estate. They're looking at residential real estate. They're looking
Speaker 4: at the perpetuators of the last crisis because that's the
Speaker 4: easy spot, and they're thinking, Okay, I live through the
Speaker 4: Great Financial Crisis, and therefore I know what happens when
Speaker 4: interest rates go higher and squeeze off growth, and therefore
Speaker 4: I know that it's going to be residential and commercial
Speaker 4: real estate that are the areas of most risk. I think,
Speaker 4: because we went through the Great Financial Crisis, those are
Speaker 4: the areas of most likely, not the areas of greatest
Speaker 4: risk in the economy. Instead, it's somewhere else that low
Speaker 4: interest rates we're fueling excess borrowing, fueling excess investment that
Speaker 4: was unsustainable. And if there's one area where I think
Speaker 4: that was the case, it probably is private credit, private equity.
Speaker 4: And I don't know how this ultimately works its way
Speaker 4: through the financial markets, how it ultimately works its way
Speaker 4: through the economic to me, because I just don't know
Speaker 4: if those losses will forever be paper losses or will
Speaker 4: be real losses. I think some of them will be.
Speaker 3: I think they're there.
Speaker 4: Yeah, exactly, I just don't. I don't know how this
Speaker 4: is going to work itself out. But there was not
Speaker 4: a ton of housing activity when it creates for zero percent,
Speaker 4: So why would we point our finger there? There wasn't
Speaker 4: We weren't building offices like crazy in twenty twenty. We
Speaker 4: have a shortage of demand of offices for sure, and
Speaker 4: probably it's some excess supply that will ultimately go into
Speaker 4: distress and default. But this is not a phenomenon like
Speaker 4: two thousand and seven, two thousand and eight. So that's
Speaker 4: the way that I think about it. Long story short,
Speaker 4: find those areas of excess, because those are the areas
Speaker 4: that are most in.
Speaker 3: Yeah, yeah, no, that makes a lot of sense.
Speaker 1: Well, Gina Martin Adams, chief equity strategist at Bloomberg Intelligence,
Speaker 1: So great to have you on the show. We can't
Speaker 1: let you go just yet, though we do have the
Speaker 1: tradition on the show to discuss the craziest things we've
Speaker 1: seen in markets. But Donna, what do you have?
Speaker 2: Okay, this is a Bloomberg Store worry. It's about an
Speaker 2: apartment that's listed for sale in New York City. It's
Speaker 2: listed for sale for four million dollars, which apparently is
Speaker 2: a bargain because it comes with a huge catch. There's
Speaker 2: somebody already living in the apartment, has been living there
Speaker 2: for decades, and I don't think has plans to leave.
Speaker 2: And so this tenant pays two three hundred and forty
Speaker 2: six dollars a month and can continue renewing their lease
Speaker 2: even if you know the apartment gets new ownership. It's
Speaker 2: a five thousand, eight hundred square foot apartment oh Manhattan.
Speaker 2: It's rents stabilized, and until the tenant leaves, if you
Speaker 2: own the apartment, you're actually operating at a huge loss
Speaker 2: because just the taxes alone, the monthly taxes are five
Speaker 2: five hundred dollars, and there's common charges of two eight
Speaker 2: hundred dollars, which is more than the tenant pays to
Speaker 2: live there.
Speaker 3: That is wild, but apparently.
Speaker 2: So like in that same building, another apartment went for
Speaker 2: almost eleven million. Another one went for nine point four
Speaker 2: seven five million in February, so you'd be getting a bargain.
Speaker 4: Wow.
Speaker 1: Well yeah, you got to eat those that loss for
Speaker 1: however many years. But that is pretty fascinating. All right,
Speaker 1: that's a good one, Bill, don I'll give you that.
Speaker 1: Mine is has to do with the IPO market, which Gina,
Speaker 1: as you know, has not exactly been the hottest market
Speaker 1: this year. This was not an IPO of a company.
Speaker 1: It was an IPO of a painting, so three courtesy
Speaker 1: of Quartz, and I think they've done this in crypto
Speaker 1: fractional ownership of paintings, but this is more of a
Speaker 1: regular traditional approach to it. It's Francis Bacon's masterpiece, three
Speaker 1: Studies for a Portrait of George Dyer, finished in nineteen
Speaker 1: sixty three, going IPO, I think in a few weeks
Speaker 1: at a specialty exchange that was just created Liechtenstein, of
Speaker 1: all places, Liechtenstein, Liechtenstein. One hundred dollars a share is
Speaker 1: the offering price. I'm not going to tell you how
Speaker 1: many shares are being offered though, because it's time to play.
Speaker 1: The price is precise. Your favorite game show, what do
Speaker 1: you think the total value of Francis Bacon's masterpiece Three
Speaker 1: Studies of a Portrait of George Dyer, the first ever
Speaker 1: painting to be ip oed. And the way this will
Speaker 1: work is you'll buy your share in the painting, but
Speaker 1: then it's going to go be hung in a museum somewhere.
Speaker 3: They don't know which museum yet.
Speaker 1: And basically what you're hoping for is a takeover, a
Speaker 1: hostile takeover of it at a higher level than the
Speaker 1: market cap.
Speaker 3: And as they always say, art.
Speaker 1: Has a pretty reliable fine art has a pretty reliable
Speaker 1: return profile if you believe all these art hucksters.
Speaker 3: I don't know, but name that price.
Speaker 1: What do you think the total market cap is of
Speaker 1: three Studies for a Portrait of George Dyer. I'll tell
Speaker 1: you this, it's not going to make it into the
Speaker 1: magnificant Magnificent seven as far as market cap.
Speaker 3: That's the only hint I'll give you.
Speaker 2: Okay, that's not a very good hint because would billions.
Speaker 3: Right, it's not gonna be a trillion dollars trillions?
Speaker 2: Okay, So you don't even get to own this painting.
Speaker 2: You can't take it home, No, you can.
Speaker 1: Go visit it in the museum, so you own a
Speaker 1: share of it, so that if the hope I guess
Speaker 1: is that some private collector says, wait a minute, this
Speaker 1: thing's a bargain.
Speaker 3: I'm going to go. But you can share.
Speaker 1: If there's a frenzy for the shares in this painting,
Speaker 1: they'll trade like a stock.
Speaker 3: So I see the value will go up and down.
Speaker 1: You could you could unload your shares at a profit, presumably,
Speaker 1: And I got to say, I bet you, I bet you.
Speaker 1: These shares do pretty well, just for the novelty of it.
Speaker 1: Be kind of cool to own ten shares in a masterpiece.
Speaker 2: I'm gonna go with twenty eight million.
Speaker 3: Twenty eight million, all right, Gina, how about you.
Speaker 4: I have no idea how to value art. I'll say
Speaker 4: one hundred million.
Speaker 3: One hundred million, actually fifty five million.
Speaker 2: I thought I was so close. I really thought I
Speaker 2: was so close. Wait, but I still win went over.
Speaker 4: Yeah, I'm sorry, Gina, what I'm talking about. I'm fully
Speaker 4: willing to admit it.
Speaker 1: All right, Well, I think that is all the time
Speaker 1: we have. Unless, Gina, you have a crazy thing you
Speaker 1: want to share.
Speaker 3: I don't know.
Speaker 4: I do not I don't have a really crazy thing.
Speaker 4: The only thing that I think is really crazy right
Speaker 4: now that's actually an investible theme is the heat. I'm
Speaker 4: blown away by the fact that we are going to
Speaker 4: face terrible air quality conditions again in the Northeast as
Speaker 4: a result of these wildfires that we've got. Yeah, people
Speaker 4: actually dying in Texas of overheating. And it's only June.
Speaker 4: So I think this summer is going to be interesting.
Speaker 1: I was wondering if that at some point this smoke
Speaker 1: starts to become macro influential, if it starts having an
Speaker 1: impact on something. I don't know, whether it be crap
Speaker 1: or travel, I don't know. Do you think that's there's
Speaker 1: a potential for that, Well.
Speaker 4: I think it's possible. Remember when the volcano erupted in
Speaker 4: Iceland and all of that volcanic ash in the air
Speaker 4: shut down European travel for a while. It's definitely possible
Speaker 4: because all of this terrible sediment in the air can
Speaker 4: create really big problems. And remember they did have to
Speaker 4: very short term on that terrible air quality day in
Speaker 4: New York, they did have to shut down the airports.
Speaker 3: Yeah, just a short.
Speaker 4: Period of time, but it's so it's certainly possible.
Speaker 1: Yeah, or even that the health effects, you know, if
Speaker 1: there's an uptick in asthma, you know that sort of thing.
Speaker 1: That's something to keep an eye on, for sure. I'm
Speaker 1: surprised it hasn't, you know, started influencing some prices somewhere
Speaker 1: on something.
Speaker 3: I'm sure it has, I just haven't noticed.
Speaker 4: I think it has. I think it will continue to
Speaker 4: influence for sure.
Speaker 2: Or even if people getting getting lunch being too afraid
Speaker 2: to step outside to buy lunch.
Speaker 1: Yeah, yeah, well that's a good crazy thing off the
Speaker 1: top of your head.
Speaker 4: I don't know. I don't know. I'm going to read
Speaker 4: up next time for crazy things before I come.
Speaker 2: I thought you meant the Miami Heat since you're from Florida.
Speaker 4: Oh yeah, I know. You know, I wasn't talking about Miami.
Speaker 1: That after that that last finals performance. They're short shirt
Speaker 1: that team anyway. Gina Martin Adams, chief equity strategist at
Speaker 1: Bloomberg Intelligence. Always such a treat to catch up with
Speaker 1: you and hear how you're thinking about things. I encourage
Speaker 1: all Terminal subscribers go out and read that mid year outlook.
Speaker 1: It's chock full of really a lot of interesting studies
Speaker 1: and outlook for the rest of the year.
Speaker 3: Thank you so much to thank you, Thank.
Speaker 2: You, Gina. What Goes Up. We'll be back next week.
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