Bloomberg Audio Studios podcasts radio news. This is the Bloomberg Surveillance Podcast. I'm Jonathan Ferro along with Lisa Abramowitz and Amarie Hordern. Join us each day for insight from the best in markets, economics, and geopolitics. From our global headquarters in New York City, we are live on Bloomberg Television weekday mornings from 6:00 to 9:00 a.m. Eastern. Subscribe to the podcast on Apple, Spotify, or anywhere else you listen. And as always on the Bloomberg terminal and the Bloomberg Business app.
Mike Wilson of Morgan Stanley writing higher oil and rates remain the main risk to equities in the near term. Mike joins us now for more. Mike, good morning.
It's good to see you. Look, we've dealt with this now for 7 months. We've dealt with it. Okay. Equities have been up and to the right. Does that change?
It's a wall of worry. You know, I mean, look, this is our call for the whole year, which is that earnings were going to be better than people expected. It was even better than we thought, quite frankly. And we've been derating all year. So, it's not as if the market is ignoring all of these risks. It's just been digesting it in a way where it's not as obvious to the casual observer. Hey, the S&P hasn't really corrected. Well, it has corrected in price earnings multiples and then the averages go up because of earnings. So, the broadening out story, I think we were the first ones to talk about that. And to me, that's really the story. It's this transition now. We're going from an early cycle recovery from the recession of a year ago. Okay, we had all the rotation now to the midcycle areas, the quality rotation. That's very typical. So, I don't really see anything that's troubling to say there's some end of cycle calamity that's going on here. The market's dealing with all these risks. But we do worry a little bit in the short term about oil prices. And what Amarie was talking about is what's really important here. It's not about the price of oil. It's about the price of product. Okay? We don't consume oil, okay? We consume gasoline. We consume diesel. We consume heating oil. And those prices are really, really high. The crack spreads on these products are as high as they've ever been. So it just can't even there's no more kinetic energy in this war that's that spread has to narrow and the question is does that narrow from product prices coming down or from oil prices going up and it looks to me like it's going to be oil prices going up because there's no demand destruction right so you got you need demand destruction for that product to come down so that's the risk in the near term I don't think it's insurmountable I think it's another hurdle that we can we can get over okay but it's you know it's probably the next 30 or 40 days where we have to deal with this.
Does it influence your sector exposure, the kind of sectors you want to be in, the kind of sectors you don't want to be in?
Well, we've used energy as a hedge, right? So energy, you know, has had a great year this year. And I think you should continue to own energy stocks as a hedge in your portfolio because we like the quality parts of the market. So that's more of not a sector call, but a factor call. Free cash flow, quality factors have really been working since the beginning of June and fading some of these early cycle lower quality areas. And then owning some energy on the other side as your hedge against oil prices going up.
So when would you know to get back in the second energy comes down?
Well, we're not trading, we're rotating as opposed to reducing our overall equity exposure. I don't think people should be reducing their equity exposure. What they should be doing is upgrading the portfolio, which is what we've been doing, which is S&P over foreign markets. It's, you know, quality stocks over lower quality stocks that are more vulnerable to a rise in rates, a rise in oil prices, and then having some hedges like oil maybe being underweight duration still within fixed income. I think that's probably a good place to be. And then you know gold and crypto are probably good hedges against inflation getting out of bounds.
Because the United States is so much of a bigger energy producer and less vulnerable say to Europe and countries like Japan. Do you want to double down here?
Absolutely. I mean the United States is protected from a lot of these concerns and I would say the United States is still in control of its own narrative more than other countries because you know we have the fiscal policy controls. The administration has been very forceful there. You have a Fed chair and a Treasury Secretary who are very market savvy. Okay, so I feel like this is still the place to be and let's not kid ourselves, S&P 500 is still the highest quality equity market in the world. So if you are nervous Nelly, okay, own the S&P 500, okay, don't own long bonds. I mean like long bonds have been a train wreck for 5 years. I mean we've had that call for pretty consistently and then you know gold and other alternative assets I think are a good part of the portfolio but we're in a bull market. Okay, let's not ignore that factor. We are in a bull market. Okay. The economy is fine. You know policy is a little bit erratic. Sure. Okay. We have a war, a couple wars going on. That's the world. I mean that's the world we live in, been living in for 30 years. And to think that we the four of us can sit here and say oh well the market's not thinking about this. I doubt it. Okay. The market's not aware of this stuff.
You talked about the broadening out trade originally and that was a significant call of yours. What's the nature of the broadening out? Is this the deployment of AI that you're actually seeing getting monetized? Is this just the rest of the economy catching up after essentially being in a recession outside of AI?
Yeah, it's more the latter. So, our call was really predicated on this idea that we did complete a recession a year ago that typically when you come out of a recession, you have massive operating leverage just on a little bit of revenue growth, which is what's happened. So, that's probably 80% of the broadening out story that I think is still not appreciated or not understood. The second part is what you just talked about which is that we are now seeing a transition from the enablers to the adopters. Okay. And that is happening from some of the enablers too. For example, the hyperscalers. One of the calls you made about 2 months ago is hyperscalers got too punished. Hey, these guys are enablers and adopters. And not all of them are good adopters, but the ones who are using the technology to advance their businesses to generate higher returns will do well. And then of course this includes companies across the entire economy. There are winners in the AI race and there are losers in the IRA. We're seeing more winners pop up. So that could be in consumer, that could be in healthcare, it could be in financials. And so it's a pretty broad trade.
Do you think that you could see the broadening out continue even if you see some real declines in not only the hyperscalers but say the valuation or the perceived valuation of the likes of OpenAI and Anthropic that are kind of huge question marks looming over the market ahead of those impending IPOs?
Well, that's a liquidity question which I think could come back into the fore next year. I don't think the Fed chair is going to be really overly tight on balance sheet going into midterms. You know, this is somewhat of a political game. Plus, he's new. He hasn't done his homework yet, but I do think in 2027 we could see a liquidity tightening, some of which is just the massive issuance from corporate and from sovereign. So, that's the 27 issue. I'm not ready to go there yet.
Are you saying that a rate hike would torpedo this?
No, I'm not saying that at all. What I'm saying is a balance sheet tightening could torpedo the absorption of all the issuance that's going on across the entire economy, both equity and fixed income.
When are you ready to start thinking about that 2027 dynamic?
Well, we have to write a report in November.
Of course. Okay. Got to wait for the year ahead.
You know, we could go out to lunch and maybe have, you know, a beer or two and we... No, I'm just... But I mean, in all seriousness, I think it's just premature to be worrying about a situation where we're overtightening. We're aware of it. I mean, we have things to monitor. I do think in the next 30 days, okay, if oil goes to 120, 130, 140, that's a drain on liquidity, okay, and so that will tighten. So, one thing we have to be clear about, the Fed is no longer being abundant with its liquidity. They're being ample. What does that mean? Just enough to kind of keep the thing, you know, on the tracks. If for whatever reason we start to see things tighten in the next 30 days because of oil prices or because there's even more issuance, which by the way the corporate calendar looks pretty full for the next 30 or 40 days and there's some other, you know, just sort of apprehension to buy securities, then we could... that's another reason why I think we could have a correction next 30 days but it's a correction, it's not the end of the...
You'll get a ton of supply on the debt side, high grade issuance this month could be another record. We had a record in June, July, and August on that front. Equity issuance as well, equity supply. How well prepared are we to take down another monster IPO and maybe another one after that?
Well, we're very prepared at Morgan Stanley.
And I mean, but I mean Wall Street as a body is very prepared for issuance right now. We, I mean this has been the best year since 2021. I don't see any real unwinding of that machinery yet. I mean we're, these deals are being absorbed whether it's in credit or now what I would say is that the quality of the deal matters. Okay. So we are seeing a little bit deterioration in the lower quality issuers but whether it be fixed income or equity. So I don't think it's as wide open perhaps as it was 6, 8, 12 months ago but I do think we still have quite a bit of buying demand for new issuance.
Mike, appreciate it. Mike Wilson there of Morgan Stanley.
Stay with us, more Bloomberg Surveillance coming up after this.
The Citizens Financial Group CEO Bruce Van Saun is offering a different perspective, writing, 'Despite ongoing geopolitical tensions and a fluid macro backdrop, the US economy has remained remarkably resilient. Consumers continue to benefit from a generally healthy labor market.' Bruce joins us now for more. Bruce, good morning.
There's a lot to worry about this morning, sir. There always is. Can you give us the glass half full view on this economy right now?
Yes, I'm certainly in the half full camp. So if you look at GDP growth, I think it's starting to tick up actually and we'll see maybe closer to two and a half growth for the next four quarters. Unemployment has stayed very steady in the low fours. Inflation while there's concerns about it I think is slowly on a gradual declining trajectory. Business conditions are excellent. The capital markets are wide open. People are going to market, the kind of hyperscalers and people who need funding to play the AI and the data center compute game. It's creating a lot of business opportunity. It's also lifting other companies who are suppliers along with it. And the most interesting thing is we're starting to see the broader market and demand for funding and capex spend broaden out a bit. So, it's not just the AI and data center engine that's pulling. It's now in kind of August and September starting to broaden out.
Can we build on some of that? The distribution of the benefits across income groups. Are you seeing that catch up with all income groups? Are you seeing the benefits go from higher income down to low-income groups as well?
Well, certainly the folks at the upper end of the wealth spectrum are doing exceptionally well. Stock market's been strong. Housing values high. So, they're spending money at a kind of good clip. As you get lower, the good news is people are still resilient. They may have spent down some of the excess savings they had during COVID, but being a little more selective on where they spend their money, but still spending. And that's bolstered by the strong labor market. They have jobs, they're employed, they're not worried really about what comes next. But we're in this low higher low fire environment. People are staying put generally speaking and they kind of have one eye over their shoulder looking to see what AI is potentially going to do to their positions.
Have you seen the higher price of gasoline really pressure any of the businesses that you do business with or consumers?
No, I think people have figured out how to absorb that generally. So it may, if you look at the percentage people spend on filling their gas tank, it's a relatively low percentage. So maybe you eat out one less time during the week to compensate for that, but it hasn't knocked people off their game that much.
If I were a member of the Federal Reserve and I was sitting here listening to this, I would think to myself, wow, this just highlights why the inflationary pressures could be persistent, why they could widen out because the ambition for faster growth is much greater than the concern about some of the restraints on the US economy. Would one or two rate hikes make a difference to your world?
Yeah, I personally, I'm not sure that there will be rate hikes even though the market is saying there could be. There's really no new evidence yet that inflation is accelerating since the last meeting they had and that's what they're looking for. So we'll see, the CPI print is going to be quite telling. But at this point just because the economy is picking up a little steam doesn't mean that the reflex is that we need to have a hike. We don't have to choke off a good economy.
Would it choke off a good economy?
I think if you're in a plus one or plus two or minus one or minus two, it doesn't change the baseline a whole hell of a lot. It's more of a signaling mechanism.
