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