Markets React to Powell Testimony, NATO Summit Day One

Published Jul 10, 2024, 1:55 AM

Featuring:

James Demmert, CIO at Main Street Research

Sean Monaghan, Visiting Fellow, Europe, Russia and Eurasia Program, CSIS

Adam Coons, Chief Portfolio Manager at Winthrop Capital Management

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Fedcher Jerome Powell said that officials are wary of potential risks to the labor market from higher interest rates. That's as they seek more evidence that inflation is slowing down.

The most recent inflation readings, however, have shown some modest Further progress and more good data would strengthen our confidence that inflation is moving sustainably toward two percent. We continue to make decisions meeting by meeting. We know that reducing policy restraint too soon or too much could stall or even reverse the progress that we've seen on inflation.

Powell careful not to offer any kind of timeline for interest rate cuts, However, investors are betting that the cuts will begin in September. The US Central Bank is weighing cuts after holding its benchmark at two decade highs for nearly a year. Palal also said that regulators are close to revamping a plan, a plan to force the big banks to hold significantly more capital. We're joined by James Demmer at cio at Main Street Research. James a little bit more on Pale here. It seems like he really wanted to acknowledge that they are fully aware of the challenges of the slowing in the labor market, but he also wanted to make the point quite strongly that the fight against inflation is not yet over, and he was really careful not to talk about the timing. Is that the right balance in your view?

Yeah, they're bending him, but they haven't broken him yet. So it's getting closer to that point where he wants to get and I think he's right. You know, they really want to wait till the data really shows obviously that the inflation boogeyman is gone before they go ahead and they cut rates. And they've got to be careful here, you know, you do see the employment numbers coming down, the inflation numbers are obviously coming down and trending down. They do want to be careful waiting too long, and I think that's why he's sort of like starting the dialogue's changed right from a few quarters ago. He's starting to lean towards it's a question of when, not if. Then we do think it's this year.

So the swaps market right now is projecting about two rate cuts between now and the end of the year. Maybe the first comes in September. Is that possible? Is that pretty much the way you see it.

We do see that. You know, we've been of the thought that earnings are driving this market and the FED might not even need to cut, but the most recent data on inflation employment suggests yes, they're probably going to have to come to it, and I'd say say as early as September. They don't want to get them too close to the election and be viewed as, oh gosh, we're doing this from sort of political stance, so I think they do it sooner then later in September would make would make sense. And that's just another accelerant, if you will, to this rocket launching bow market that we're in. You know, when the FED comes, that's just going to be more fuel, another booster for this rocket.

James, do you go back and forth about being really comfortable with market conditions and being also very worried or are you steadfast in either one of the two.

I am in a constant state of optimism and concern.

Here here join the group.

Thirty five years of this. But I will say this isn't one of the best setups I've seen for equities this year than I've seen in decades. So the optimism definitely overtakes a concern. And you know, we think this is the certainly the first phase of a very powerful ball market, and that's the phase investors don't want to miss. You know, if you look back at any bowl markets the first year and a half, where you get this acceleration like rocket launch like acceleration, then you get to cruising speed, which I think is probably into next year and beyond. But so here where you know, my optimism is overwhelming a concert there are concerns we have. I do think we're going to get a five percent at least seven percent correction between now and the end of the year, even though we do have high target numbers for the end of the year on markets in general.

So in addition to addressing monetary policy today, Powell was talking about new banking regulations, and he indicated that regulators are close to agreeing to some type of modification to that plan to force the big banks to hold more capital, so maybe they'll be required to hold a little bit less. I thought it interesting that the financials actually led the S and P five hundred higher today. It was only up a tenth of one percent. Nonetheless, the entire group looked pretty robust. We've got earnings at the end of the week from some of the money centers. How are you feeling about the big banks these days?

You know, Brian, this is a or Doug, this is a period where investors really want to own the banks. These are historically low pe ratios on the financials, in the banks specifically, and I think the banks even shrugged that off today based on the fact that the earnings are coming. I think the earnias are going to be better than expected. The multiples are low, and the FED is nodding to lowering rates, and that is going to be a boon for the banks, particularly the big ones. So I think investors want to be really careful about avoiding them. I think investors want to step in here or at any weakness and own them.

It's tricky with the banks, obviously, I mean the big banks in particular, JP Morgan's done very well this year. I think the banks generally have done well. They've been one of the sectors that has been putting on gains up there, close to with the tech companies JP Morgan going from one to seventy up to you know, between two hundred and ten. But then you know you've got various segments in there. Regional banks, no, no, you know you've got companies like you know, the credit card companies that have done very well. How do you actually target that area instead of buying buying, say, you know, a big ETF that puts them all in.

Yeah, that's a really good question. I think investors have been way better off this year by by being more selective and not owning let's say a whole sector, because that way you can avoid the regionals really can't get out of their own way, and it makes sense they need they need rates to really come down for sure. There's a lot of commercial real estates attached to them and they don't have the strong balance sheets of the larger banks. So you know, this is the sort of cycle, this phase of it where you want to be a stock selector, and I think think you want to go with Larger is better, right, Bigger market share is better balance sheets in the banks, and then we use that same litmus test across other sectors like tech, you know, in healthcare and industrials. So bigger is better, particularly in the beginning of a new bowl market where investors, you know, haven't even gotten fully invested yet. There's still trillions of dollars of uninvested assets laying around that needs to come into the market, and so people are going to safety trade first. Big is better, better balance sheets.

So if we can agree that there's a little bit of dry powder on the side I heard, I thought, I heard you say a moment ago seven to ten percent correction sometime here in the near term. What is the catalyst for that?

Yeah, First of all, I would say it's way over due, but I think it could be. You know, we got earning season here again, which I think is going to be robust, but it would not take much if you had one tech company kind of come in. You know, expectations have gone up a lot in the tech analyst community, and if they're a little bit too high and one company comes in a little miss here or there, I think it could rattle the market. I'd say more like a five to seven percent correction, which is still more shallow than normal. And that's only because there's so much cash. Every time there's a bit of a pullback, right, all that trillions of dollars in cash is trying to get in on that weakness. But I think it might be an earning type of thing that you see a bit of a pullback, and I tell you investors, if they haven't been in this market, they really need to use that next sort of mini correction to put that money to work towards the end of the year.

Quick question on PCs recovering, What does that tell.

You, Well, you know, the bigger buyer of PCs, you know, there's obviously corporate money spent there, but there's a lot of individuals and consumers doing that. I was really interested to see Apples that was really fantastic. We've been a fan of Apple for quite some time. I think that it shows that the economy is still very resilient.

Yep, all right, James, Thanks, good session. James Demmert there cio at Main Street Research. We are chatting now with Sean Monahan, visiting fellow in Europe, Russia and Eurasia Program at the CSIS, the Center for Strategic and International Studies in Washington, d C. So the NATO meeting today and the speech by President Biden, Biden no doubt made more friends in Europe with the speech today, a strong defense of NATO, strong defense of Europe, strong defense of global institutions. And Biden said Sean that NATO is as strong as ever. Did he get that right?

Yeah?

I love that.

Thanks for having me. Well, I think Biden did. I mean, NATO needs to be as strong as it's ever been, because it's now the most challenging time really that NATO has ever faced. I mean, the Alliance is seventy five years old, created in nineteen forty nine as a bullwork against Soviet aggression in Europe. But now with Russia's war in Ukraine, war raging in Europe, the US, NATO's main ally kind of pivoting to East Asia. NATO really needs to up its game. This is a really dangerous time. And this week in Washington, I think we can expect allies to announce a series of measures that demonstrate that they're really stepping up.

So mister Biden has been on the defensive as I'm sure you're well aware since the debate a couple of weeks back, and he had an interviewer sit down last Friday. One of the things that he was addressing in terms of accomplishments was the expansion of NATO. So during his presidency we have seen the addition of Finland and Sweden. Give us an understanding of Biden's influence on the Alliance in these last three and a half years.

Sure. Well, the first thing that President Biden said, I think when he came into office with something like America is back and alliances are back, and he's really put that into practice. Yeah, the main achievement you mentioned it Finland and Sweden have joined NATO. NATO is now two members, two allies larger. Now, of course that's not just down to President Biden. The real reason that people of Finland and Sweden decided to join the NATO Alliance was because of mister Putin's actions. Mister Putin, if you like, has seen kind of Newton's third law of international politics in action, which is that every action has an equal and opposite reaction, and in reaction to his invasion of Ukraine, Finland as Weeden ad opted to join NATO. But under mister Biden's watch, I mean, spending has gone up in Europe. The perennial complaint from Washington that Europeans weren't pulling their weight. And in the four years mister Biden has been in office, we've seen a drastic increase in defense spending by European allies. Back four years ago and in nine of them spent the two percent of DP on defense. Now twenty three of them do. That's an impressive achievement.

So the action today the air defense systems, five long range air defense systems and F sixteen fighters. This is a show of unity. Does it make a difference, Will it in any way intimidate President Vladimir Putin?

I mean yes and no. The need for more air defense systems and in particular the interceptors, the missiles that are fired from the ground at incoming missiles, was really demonstrated by the horrific, tragic attack really on the children's hospital in Ukraine that we saw a couple of days ago in an incredibly cynical move. That attack came alongside a wealth of other attacks across Ukraine by Russia's missile missile forces. And so you know the US, the West. NATO has been helping supporting Ukraine, providing a wealth of equipment and systems, and air defense has really been top of Kiev's shopping list for some time. They've got some more systems, but they need a lot more. And this is where NATO this week is going to have to announce some measures to commit in more aid in the long term to Ukraine and also to commit to boost NATO allies owned defense industrial basis to produce that equipment in fruture, both for Ukraine and for NATO's own purposes.

Do you think about the rise that we have seen in some far right parties, whether it's Italy or France, as having an impact on NATO at some point?

It's hard to say. Look, NATO is a collection and alliance of democracies. There's thirty two of them now so over seventy five years, and there were twelve nations to beginning with. There's been many elections, many changes in governing parties among NATO allies, and through all of that volatility, NATO has endured, and NATO endures because it offers a clear deal to the allies that are part of it. That strength in numbers together, they are stronger and can deter threats like Russia. NATO is also not just a military alliance, but of course it's a security community of nations with common values, so it endures for those reasons too. So it's celebrating seventy five years. I think we'll see many more years out of NATO.

Yet, Sean, you're there in Washington, d C. I take it, And I'm curious about your perception of the President's performance. It's been so much in the spotlight, given the weakness in the debate a week and a half ago. Did he sound like a commander in chief? Did he look like the president of the United States? Your take?

Yeah, of course. So yeah, I'm here in Washington, DC, and this is a talk of the town at the moment, and of course it's NATO summit. There's lots of functions. I've just actually come from a function following the President's speech, and a lot of people were really saying that he put in an excellent performance as commander in chief. He was very strong and decisive, didn't hesitate, and also the bit of a surprise where he gave current sectory General Jan Stoltenburg the Medal of honor the highestvillion holla, and that was Yen Stoloma looked quite emotional. Actually, it was a bit of a surprise. So that was a nice a nice touch too. So I think Biden. President Biden always saw this week as a really important one. It's even more important for him now he's got the first speech out of the way. He's done really well. So on to the next two days of the summit.

Sean, before we let you go. In the event that there is a second Trump administration, and I'm sure there has been a conversation across European countries, NATO Alliance countries in particular, about the changes that would happen under another Trump administration. Can you shed any perspective on that, what the nature of these conversations may have been or maybe yeah.

Of course, as I said, NATO's and alliance of democracies and a feature of a NIS the democracies, elections happen very often, so particularly when the election is in the biggest, most powerful state in NATO, the US. You know, allies capitals are watching. But I think what they see is if it's Biden or if it's Trump. As I said, NATO presents a kind of very clear argument. It's really in the interest of Europeans and Americans to have a very strong NATO. Deterring war in Europe against NATO allies is far cheaper than fighting it. You know, European security is still American security at the end of the day. We'll learnt that throughout the twentieth century, and depending on the color of the government, I don't think that fundamental coret argument changes and I think the American people kind of seem to realize that too.

Just to the battlefield. One final question on Ukraine in your assessment, does either side look ready for any kind of breakthrough?

Not so much at the minute. I mean, I think mister if he was able to make a breakthrough, he would have done so to spoil the NATO summit. What was clear from the tax this week, which includes the attack on the fieldpil all.

Right, Sean, thanks so much, Sean Monaghan. There from the csis the Center for Strategic and International Studies. We're joined by Adam Kohn's chief portfolio manager at Winthrop Capital Management.

So J.

Powell seems to have laid out this kind of script and it is pretty well scripted. It seems acknowledge a little softness in jobs, prepare the market, now watch the data, then updated jackson Hole, and then finally pull the trigger in September. Does the script need any editing?

You know?

I think that's what the market is saying, is that we're going to get rate cuts in September. But that's dependent on this economic gata continuing to get worse and worse, and I think it has to get fairly bad before the FED is.

Going to cut any rates.

I keep coming back to the fact, you've got to look at the entire site of this FED, and when we go back to the beginning, when we kind of had this transitory talk, inflation was picking up, it was very apparent that inflation was an issue, yet the FED was very slow to act.

Then. I think the reality is they're going to have.

That same stance on the back end of the cycle, where they're going to be slow to respond to one or two data points. I think we're gonna have to see multiple consecutive data points pointing to both inflation decelerating and employment becoming an issue. So their dual mandate needs to be addressed before they're going to cut any rates.

Sounds like a recipe for a policy mistake is that the way you see it.

I think it's it's a setup for a potential because you know, they're they're walking a tight rope.

Over the last year, it's looked pretty good.

They've done a good job maintaining you know, people have used the narrative of soft landing or no landing, and we've seen that the US economy has remained extremely resilient despite higher interest rates.

The problem is if you wait too long, and if you wait until the economy has completely rolled over to change policy, at that point, it's too late, and the policy mistake really would be that you push the US economy into disinflation or even worse, deflation.

So you see that as the main policy mistake because it could be the way too soon or too or too late.

I mean, it's a terrible tough job to have. I do not envy pal, So yeah, I mean that is the potential, right. If you cut too soon, you reignite inflation, and you kind of have some of the things we've seen historically historically where inflation seems to be done, seems to be dead, and then because policy moves too quickly in the other direction, inflation picks back up, So that is a risk. I do think that's a lower risk then the other side of that waiting too long and then seeing us move into disinflation.

So how are you translating what you believe in the macro into an investment strategy? What are you doing these days?

Well, I mean, for us, the conviction call for probably the last twelve months has been high quality long duration bonds. I know it's not exciting, but for us, we look at the asymmetry of whatever investment we're in, and when we look across the universe of potential investments, long duration bonds have the biggest asymmetry, meaning that the potential for interest rates to go much higher is fairly low. So the other two scenarios are one, interest rates stay where they are for a longer period of time, and.

I'm okay with that.

I'm okay clipping you know, five percent coupons for the next you know, twelve months or so. Or The upside of that asymmetry is that interest rates come down. They collapse because either the Fed starts cutting or the market sees that, you know, the economy is rolling over quicker than we expected. And then you're gonna see rates come down, You're gonna see the price of bonds go up, so that that has been the highest conviction call for US.

So for those people worried about recession coming on quickly, today you had Apple, Google, Walmart, and Costco hit all time highs. And that's a pretty good mix of consumer facing companies, right. Doesn't that tell you that recession's not very likely anytime soon?

Well, I mean I think, you know, look, a stock in some ways is going to lead with what we what we see right now. It's not looking out to you know, what a company is going to be doing twelve months from now. And on the other side of that, I would say the companies just listed could probably weather that storm fairly well. I think when you look at the other side of the market, where you've seen you know, things like Tesla and n Video that have had corrections, that's a bigger tell of overvaluation met with a potential for a rolling over of the economy.

And really what I would call what you just described is a flight to quality.

I mean, when you look at those names, those are high quality, large cat names that they're high cash flowing, low debt, with actual earnings growth revenue growth. So when I look at those, I'm looking at a flight to quality, not necessarily just stocks taking off because they're consumer based and because the economy is necessarily waring, it's more of that defensive stance, even though those are some of those names are high growth names.

Very quickly, Adam, as we look to earning season guidance, do you think we're going to get disappointing guidance?

I don't.

I actually think we'll see will continue to see guidance somewhat better than expected.

I think that'll come from margin expansion. You'll continue to see things.

Like job cuts help prop up earnings because margins are expanding.

Hey, Adam, thanks very much for joining us. It's always good. You never know what questions you'll get and you handle them well. Adam Coombs, their chief portfolio Winthrop Capital Management.

This has been the Bloomberg Daybreak Asia podcast, bringing you the stories making news and moving markets in the Asia Pacific. Visit the Bloomberg Podcast channel on YouTube to get more episodes of this and other shows from Bloomberg. Subscribe to the podcast on Apple, Spotify, or anywhere else you listen, and always on Bloomberg Radio. The Bloomberg Terminal and the Bloomberg Business app.