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This is the Bloomberg Surveillance Podcast. I'm Jonathan Ferro, along with Lisa Abramowicz and Amory 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.
We begin this hour with stocks mixed as the banks set the tone for earnings season. Mike Wilson of Morgan Stanley writing, 'Look to financials' relative performance and bond volatility for signs the worst is over.' Mike joins us now for more. Mike, good morning. Good to see you.
Are you seeing signs the worst is over?
Yeah, well, we've seen the breadth. I mean, everybody's talked about this now, but you know, I want to go back to June. You know, that's really when this correction started, I would say, in the broader equity complex, and it was an internal correction at first. We called it the transition to midcycle. Some of the early cycle stocks have really been hammered, like semiconductors, which now are having a second leg lower. Financials is another early cycle group. So the market's on to this. I mean, it understands that financial conditions have really been tightening quite significantly, and the weaker parts of the market have underperformed. So I like that. I mean, and by the way, the market understands all this. So, it's digesting. The question that we don't know the answer to yet is, do we need a final kind of catch down in the S&P 500 to kind of finish this correction? And I would say it's sort of 50/50, but that would be something we would really embrace because we don't see any issues with growth.
What would suggest that we need that final catch down?
Well, as we wrote in our note this week, I mean, the two things I'm really focused on — I'm focused on a lot of things, but those are two that stick out to me — is financials' relative performance because that's a leading indicator, and then bond volatility because equity vol really has been suppressed, hasn't really caught up. So maybe we just need equity vol to catch up to where bond volatility has been, and then that's your final sort of cleanout. I mean, I'm a trader by trade, right? So I mean, that's how I look at the markets. I'm probably different than some strategists. I'm kind of in the weeds on this, and so I like what I see. I like that setup, but I'm not convinced that it's time to really just come in with a big hand and say, 'Okay, everything's clear.'
I'm picking up on a couple of words you used. For one, markets aren't digesting this. Some people might say markets haven't been digesting what's happening in the bond market. You push back against that beneath the surface. Where do you see that process going on?
Oh, well, I mean, small cap stocks, you know, low-quality stocks, which has been our call since June. You know, the early cycle groups have really underperformed, and even with the AI complex, I think this is healthy. We've gone from sort of the enablers outperforming to more of the adopters, and we are seeing that in our work that companies are now using this technology to expand margins. So that to me is encouraging. That doesn't mean we're not going to have bumps along the way, and you know, most recently we've had more concerns about AI safety or some of the, you know, NIMBYism concerns around the election. And let's not forget we still have the midterm election in three weeks, and there's all this anxiety around that, and markets tend to, you know, get the most anxious before the results. So I actually view the midterm elections, no matter who wins or what the outcome is, as a clearing event. So the market can kind of look forward.
You don't think it's a catalyst for more potential policy volatility?
I don't, because I don't think that there's going to be that big of a sweep or any real policy changes occur.
I'm talking about the executive branch, not Congress.
Well, I mean, that's definitely not going to happen because, I mean, you know, and that's the thing — like even if the Democrats were to sweep Congress on both houses, I mean, Trump has veto power, and so it's going to be really hard to change policy in the short term.
You mentioned there could potentially be a catalyst for catch down. What would that be? Could it be something political like the midterms?
Well, I think it's happening. I mean, the market again is this cauldron of, you know, digestion, and so it's happening right now. And this is why people have gravitated to the S&P 500 because it is the highest quality index in the world. And so there's a reason for why this is all happening. Typically, okay, when you get these corrections where the breadth is this bad, you eventually get to the generals, as they call them, or the highest quality parts of the market. I like to use the analogy of a flood coming in. You go to the high ground, and eventually the flood gets to the top room, and then, you know, those come down. But to me, that would be positive. I mean, that I would embrace that because once again, I don't see any real, you know, concern about growth. Okay, we don't have a growth issue from an earnings standpoint. I don't think over the next six or 12 months.
Is a growth scare emerging in some of the parts of the market that might tap the brakes on economic activity?
Yeah, but that's what we want. I mean, like the economy's been booming, right? I think we grew eight and a half percent in the third quarter. Nominal...
Is that things are too hot?
Yeah, they ran it too hot. That was our call last year. The market figured that out. Multiples went up. Now the multiples come down because financial conditions are tightening, and it's probably a good time to talk about, you know, what's going on with the Fed. So, you know, Powell, I think, has had this view that, you know, I want the market to do the tightening for me. So what has he done? They've raised rates 25 basis points. He hasn't told us what they're going to do. He's allowed the market to go to where the neutral rate is, but it's done it in a pretty orderly way. Now, bond vol, you could say, has gotten a little disorderly, you know, but not in a way where it's going to cause a growth problem. The last thing I'll say about this is for all the consternation around Treasuries, okay, your friends in Europe, I think, have a bigger issue. So it's like the old hiker analogy, right? You only got to be faster than the slowest hiker in the market. And so I'm not worried about the U.S. fiscal sustainability issue when you have other problems around the world that are much more acute. Number one, and I still think the U.S. economy, if we choose, has the most flexibility in funding our deficit.
We heard something similar from John Gray earlier on this morning.
But when you're talking about it, it sounds like, well, the U.S. is good because everyone else is bad right now. That's a reason why you potentially like America.
Well, what else are you going to buy?
And that was my next question for George Saravellos at Deutsche Bank, to make the point that maybe people won't buy Treasuries. What are you going to buy? Going to buy Europe right now? European debt with the difficulties that some of those countries have got? That's a big ask.
No, absolutely not. Especially as they have a presidential election, and we've seen this time and time again with a place like France. They cannot get their house in order when it comes to fiscal discipline.
For the Federal Reserve, you mentioned it, Mike. We've heard repeatedly on this program that interest rates don't matter to the tech trade because so much of this stuff is rate insensitive. The stuff started to get me a little bit nervous, and Emanuel's call was talking about that earlier on this morning. Where do you come down on that? How rate sensitive is this buildout?
Well, I think it's actually starting to happen now. So remember, it's not just about the rate level of Treasuries, but actually credit spreads are now widening in some of these hyperscaler bonds. Okay, and so that's more of a supply issue in my view than a true credit issue because these data centers haven't even been stood up yet. So it can't be a credit issue yet because they're not even making interest payments. Now there are some that are weaker than others, but my point is that a combination of rates and spreads widening — we're just like the Fed chair said, I'm going to let the market go to where it needs to go to calm things down. And that has so far been a pretty orderly process. We have seen supply slow down a little bit because of that. Okay, so that's a good outcome for now. I anticipate there's going to be weak links though. There will be credit issues within the buildout of this, you know, incredible capex cycle, but not to the point where it stops it. I mean, that's not where we are right now.
