The Open Full Show
Know top stocks down life in New York City this morning. Good morning. Good morning. The S&P trying to recover, gone into the opening bell. The countdown to the open starts right now.
Everything you need to get set for the start of us trading. This is Bloomberg, the open with Jonathan Ferro. Live from New York. We begin with a big issue.
Markets on edge. We worry about recession fighting, inflation and financial stability. Some major macro headwinds. It's a difficult trinity. The Fed has been very explicit. Until we see concrete signs of inflation peaking, until we see a change in what's happening in the labor market, they are going to be tone deaf to slowing in the economy. The markets have been looking for any window of change and pivot, and I just don't think it's there.
There is no pivot. The Fed has got it has got to keep going. It's all about the Fed. It's all about central banks. We kind of can see this train wreck in motion, in slow motion, so to speak. The difficulty of balancing growth, inflation and financial stability. We know that the labor market is going
to continue to slow and at the same time, the Fed is going to continue to hike. Navigating through this is going to be going to be a bumpy months ago. The IMF with a warning that the worst is yet to come with more as my NIKKEI. Mike. It's a train wreck in slow motion. Why is that happening and sees chances
of avoiding it as declining, the chief economist at the IMF PR, Olivier Grinch, is saying, in short, the worst is yet to come. For many people, 2023 is going to look like and feel like a recession, and that is for the world. For a lot of countries, it's going to be worse. The IMF sees unusually large risks this year. Russia, of course, with the Ukraine war continues to power to destabilize the global economy.
They say inflation, it should peak by the end of the year. But it's going to remain higher for longer, slower to come down. China's Covid lockdowns and a weakening property sector. There are ongoing risks and monetary policy, as your guest said, at the top there. The ever stronger dollar and the risk of
mis calibration keep the world on edge. Their latest forecasts show that they expect slower growth and higher inflation for longer. The U.S. going to grow one point six percent this year, which is a seven tenths decline from their last forecast in July.
Only 1 percent next year. The eurozone barely avoids recession, as does the UK next year. And China going to grow extremely slowly. A little bit of a comeback, but not very much compared to what they usually do. Inflation going to come down dramatically in the US with the Fed tightening from eight point one to three point five percent. But in the eurozone, it stays strong.
In the U.K., it barely moves. And China is comes down just a little bit, remains high. So a gloomy forecast from the IMF and it's summed up by the chief economists saying the worst is yet to come as world leaders and bankers and investors gather here in Washington for the annual meetings of the IMF, World Bank and IMF. It is a doer outlook from pretty much
everybody in mind. We caught up with Mohamed El-Erian a little bit earlier this morning. I want you to reflect on what he had to say. Take a listen. The economy is starting to grow through the windshield.
The financial system has started going through the windshield. This is not stepping on the brakes. This is slamming the brakes. It didn't need to be this this this is the tragedy of a train. It didn't need to be this way. This is a self-inflicted wound by
central banks. This is going to be a reminder, a little bit of October 2008 when people gather in Washington and realize we have a global problem and it needs global global solutions. Mike, I love your response to that final line from Mohammed. Just that. Yeah, I think it's a little much to say it's parallel to 2008 because then you did have Lehman Brothers going down about the time the IMF and World Bank were meeting and that set off a chain reaction in global markets that couldn't be contained.
We do have a declining economy and higher inflation now and a lot of individual problems, but nothing is systemic as that. Yet his analogy to a car, though, is interesting because I did a panel yesterday at the IMF and one of the members there, one of the members of my panel said, you know, what's happened is the Fed and other central banks missed the stop sign and now they're going straight downhill trying to step on the brakes and stopped. But the brakes may not work. I'm NIKKEI. Thank you, sir. That's problematic, to say the least. Mike, great coverage, as always. Looking forward to it through the week and through today as well. JP Morgan's boss, Michael Stipe. This is the guy we complain.
He said the following When the central bank steps on the brakes, something goes through the windshield. The cost of financing has gone up and it will create tension in the system. Joining us now is Blackbox Wiley, J.P. Morgan's Clinton, Warren Whaley. First to you. What's going through the windshield here? Well, in our assessment, we are in a new regime characterized by much tougher trade offs facing central banks because of the supply constrained environment that we're in. So in order to fight inflation, which is the sole focus for central banks at this juncture, it's going to carry much higher cost to the economy, but also financial stability. So in our assessment to bring inflation down to targets quickly enough, actually it would require a two percent shot to the US economy next year and also an additional three million people out of a job pushing unemployment rates to 5 percent. So these are the sort of bravery have
you caused facing central banks, which is why we believe that in the near term they will fight inflation that caused at some point early next year. First half of next year, they would pause this very aggressive rate hikes as the damages from going very, very aggressively becomes clear both to the economy as well as to financial markets. CLINTON This is the policymakers try Lemma right now. How do you support growth, get inflation down and at the same time preserve financial stability? What gives? Yes, it's really tough out there.
Every Monday, I joined a volunteer organization we usually talk about helping the kids or special projects and anything that everyone wanted to talk about yesterday was the recession, inflation, Jamie comments, etc. And I said, Hey, guys like Alix Steel, you guys what I told the fellows, I said, listen, we are going through a lot. We've had two negative quarters of GDP. There's an inverted yield curve to last time I check to the tens or 42 bits, inverted inflation's over 8 percent.
The Fed is behind the curve. Earning revisions are coming down. Sentiments bad. There is a war. Like what? Of course, a recession probability increases that every day that goes on, every fed hike that that increases into everyone's confidence. The Fed is behind the curve. They they they thought inflation was inflation and transitory. They didn't move quick enough. And that's all focus is how do we get
inflation down? Unfortunately, it's not coming down. Quick, quick, quick. As quick as they want. As quick as market needs to. Well, equities are meant to be the anticipatory asset class. So let's talk about what they're
anticipating Clinton and how long they've been doing it for. The IMF is warning about something this market has been fearing for months. When you start to lean the other way. Well, I mean, I was looking at some data here recently and got you've got to look at what happens in previous recessions.
Certainly no previous recession happens. Earnings come down about 30 percent. You. The consensus for 2023 earnings are around 230. You haircut that by 30 percent. That gets you to earnings around 160. Apply multiple to that. That gets you down to like a 28 hundred. So if the recession is likely and
history is any indication, there could be downside. I think at 10 percent below from here, I'd start leaning in and start lighting and end it all once again becomes back to someone's time horizon if you have 3, 5, 7 years. You know, now could look interesting. If your time horizon is a little bit shorter, you may want to sit on the sidelines because it's going to be a bumpy ride over the next 12 months. Lightly. What are the three conditions for you to
lean in? Part of it is around understanding when central banks could pull up stakes. Aggressive rate hike cycle and he has two steps. Number one, central banks, specifically the Fed needs to acknowledge debris, tough trades, exceptionally tough trade off right now facing them. And number two, choosing to leave was inflation, recognizing that hiking rates aggressively does not solve for supply bottlenecks. So this two step process is what we're looking for, for a sustained kind of pause in the aggressive rate hike cycle.
Now, having said that, everything has a price. Yes, risks of recession have increased. We are expecting a recession and also risks of policy over tightening, slamming the brakes.
Have the facts become the base case? The equities have also corrected a lot. So there is a level at which point we can say that actually a recession is in the price. So our estimate is about another 7 percent actually down from here and reflecting both the higher cash path as well as earnings recession that we expect.
And at that point, we can say while there is a lot of bad news out there, but also a lot of bad news. All right. The price of catch up with my in a book, Stanley in about twenty one minutes time took a quote from his research to kick off the week. And this is what the quote read like. Markets often meet the engraved invitation from a higher power to tell them what's going on for the bond markets. It's the Fed and fish stocks.
Clinton It's company management teams. Clinton Do you expect management teams this earning season to kitchen sink it with guidance? For me, it's something that we've been watching very closely, and you have seen numerous reports from C Suite executives talking about controlling discretionary spending. So what were we focused on is what does that mean to the margins that the consumer is still spending at a high level? And corporations are cutting down expenses. There be a room for four increases to increase earnings. Our forecast for now is that Q3 earnings
come in about 2 percent higher than than last quarter. But yeah, I mean, it's something that we're watching very closely is not only the numbers, but more importantly, the guidance that the CEOs and CEOs those get us this DAX next. Couples clients are just out of interest because you brought it up and I did. And so this is your fault, not mine.
If you pay our complaints, how do you deal with questions when you'll see ISE starts talking about an extra 20 percent downside? Yeah, I mean, I think one of the benefits of working at a firm like ours is our CEO calls it exactly how he sees it. And it's it's it's it's made it a good place to be. As we've been the safe baring of banks and financial assets through through most crises and recessions. But it's a it's a probability.
It's not the base case, but it is something that people should be should be aware of. I do think that something that's going to be a silver lining is the job position. Usually when you think of recessions, you think of lost work, layoffs, the consumer not being able to spend. But we all know the data doesn't show that right now, two million open jobs, one point eight open jobs for people looking at it. Unemployment. People are still creating jobs. So the job thing is really what I think is going to make this a shallow recession and something that will make deep, long recession that some people are forecasting diplomatic fantastically executed. Clinton Warren, that sticking with us
along side. Why are they coming up on this program? Markets feeling the pain as Fed hikes work their way through the economy. It's going to take some time for that cumulative tightening to transmit throughout the economy and for inflation to come down. A conversation coming up next. We're starting to see the effect on some sectors, but it's going to take some time for that cumulative tightening to transmit throughout the economy and for inflation to come down. And of course, uncertainty is high. So I'm paying close attention to global risk.
I was a Fed vice chair offering a case for caution, pointing out aggressive rate hikes have yet to work their way through the economy. This coming as the global bond rout deepens. Mohamed El-Erian warning of the implications for financial stability. Once the bond vigilantes are unleashed, they tend to find tipping points. So central banks and governments have to be very aware that we are getting close to a situation where financial instability is the tail that wags the dog of the economy. Same coverage starts right now with
Lindbergh's Michael McKee alongside CAC lights there in New York. My NIKKEI, first to you, sir. A warning from Mohammed. A warning from Mohammed, but an answer from Lael Brainard, although the answer came first, some hearts on Wall Street went pitter patter yesterday when she said that because they thought maybe it means the Fed is about to back off.
But really, I think what she's saying is the Fed is aware of the potential for problems that Mohamed is talking about and is taking that into its calculations when it's thinking about how far to go. But it doesn't mean they're stopping. You look at what New York Fed President John Williams said this past week, that the Fed's commitment to achieve and sustain 2 percent inflation is now a bedrock principle. His comments are important because the vice chair by tradition, never dissents. So he's seen it as a bellwether for Chairman Jay Powell. The Fed is not close to its target for the year yet. Their median forecast, which they made
just three weeks ago, has rates going up another hundred twenty five basis points by the end of the year. So even though Brainard sounded maybe a hair more dovish, the markets are still projecting a 75 basis point move on November 2nd. And that bet could be cemented on Thursday when we get the September CPI headline forecast forecast to rise, core forecast to rise a tad slower, but still very strong. So the dollar goes up. The world still has to worry about the things breaking aspect of Mohammed's comment, particularly in the bond market. Kailey Leinz again, the Treasury market
all over the place. Yeah. And of course, the Treasury market is playing a little bit of catch up to what we saw in places like the U.K. yesterday as the bond market here in the U.S. was closed for the holiday.
And in the U.K., they're really trying to deal with what you could probably call bond vigilantes. What Mohamed was likely referring to, the Bank of England announcing even further steps today to try to rein things in in the bond market. And yet you're seeing once again the 30 year yield in the U.K. pushing higher by about 4 basis points, of course, were pushing higher here in the U.S.
as well, although that has up about 4 basis points on the 10 year war, essentially unchanged at the short end. But just on the point of where the 10 year is now, where the two year is now, for that matter, remember just a few weeks ago when we hit about 4 percent on the 10 year, about four point three on the two year, and everybody said, oh, that was at the peak is now in. We're now retesting those levels. It seems time and again we are too early to call the peak. Now, the same is also true on the 10
year real yield, which right now is at the highest level since April up to 2010, up about one hundred and eleven basis points over the last 30 days or around one point six six percent. All of this as the market is still pricing in cuts over the next year. Mike was just running through where the Fed is seen getting to by the end of this year. But this market is still expecting that by the end of 2023, we will have seen a rate cut more to come in 2024. Even though the Fed has tried to push back against that narrative, the markets seem to think that they are right and the Fed is wrong. And the inflation data we get this week probably going to make a big difference in that narrative John.
Kelly, thank you. Kelly, nice there. And Mike McKay, Teddy's right. We've placed the Fed pivot. The Fed pause, peak rates, peak inflation 50 different ways over the last twelve months. Vice chair Brian, it talked about how much they've already done and we know they've done 300 basis points in the last six months. She talked about a two year, three, four percent for the first time since 2007, a 10 year near decade highs, mortgage rates doubling more than doubling this year. And the Fed's broad dollar index appreciating 11 percent year to date.
Wiley, I'd love your view on how much tightening you think is in the pipeline that's yet to be realized in this economy. Well, I think this long and variable lag of the transmission mechanism is also precisely why we could see over a tightening May, so our expectations for peak rates for the Fed is actually 5 percent, which is even higher than the current market pricing of some offer of peak rate. I would say one thing though, also as we head into the CPI this week, ISA, we have an upside surprise. It could reinforce the results of the Fed to over tighten. Maybe if we have a downside surprise, one data point is not going to sway them from that.
So there is a bit of an asymmetrical kind of the risks as we're entering into this very, very important data prints. But one more thing I would say when it comes to investment implications of this is that as we head into recession, typically investors may want to hide in government bonds because that's when central banks will start cutting rates. But in this recession that we're entering into in, the U.S. is likely going to be engineered by central bank over tightening. So government bonds is not where we would want to hide. Long duration is actually not a safe place to hide. So whilst we see kind of the
opportunities on the front end of the curve because of the income and carry, we don't want to own the long end of the curve for this precise reason. Since you agree with that, what can you hide? I mean, I think in these circumstances where there's so many divergent views amongst economists, analysts, researchers, etc., you have to do and you have to take with what you're getting, which are given to what do we know right now? One, we know that volatilities increase, too. We know that rates are higher and are moving higher. And 3, we know that inflation is here and probably here a lot longer than any of us like.
So with those with that as a backdrop, we are telling clients to look at structured products where you can use option packages to express a view, give you some downside protection and some upside participation, too. We kind of like core bonds here. I mean, they've been borrowing for such a long time, but getting 4 or five, 5 and 8 percent on some of your core bond exposure seems like an interesting trade to us. And in third, you got to look at real assets to fight inflation, whether it's infrastructure or transportation, vehicle solutions, etc. real estate. I do think those two things.
So look at the structured notes to play the ball and interest rate game, lock in longer rates with core bonds and then look at real assets to fight inflation. Can I wrap things up by just asking you both the same question? Ray Dalio of Bridgewater just caught up with my colleague and friend David Westin over the Greenwich Economic Forum, and he said that he says a negative for poor real return for perhaps even five years. Wait, can I get your response to that? I think return expectations needs to be adjusted to reflect the higher macro uncertainty, as was the higher market uncertainty. Now, having said that, if you have that
long investment horizon. Actually a recent market volatility, public market and private markets to some extent create that longer term opportunity is right. So if you have that long term horizon, we actually are more constructive over the long term than we are tactically.
So I would say, yes, we have to adjust our return expectations to reflect the cautious assessment of the macro environment. But there are value and we want to lean into that. We are conditioned by market history. Clinton to believe that any five year
period should be a positive one, at least is likely to be one. Write down your questioning that. Can you give me a final word on it? Yeah, I mean, I think everyone has to remember we're still dealing with the hangover from all the stimulus that was pumped to save the market and the economy from the pandemic. So we've had great returns in 2020 21 and we're feeling some of those pains and we're paying back some of that now. That was a once in a generation event, a pandemic, all the stimulation that was pumped. So we're paying for that now.
But if you worked out three to five years, I believe in the US economy. I believe in U.S. corporations, I believe in the US people, I believe in the US consumer. And my optimism is that we will be up higher three to five years from now. We'll check em before we finish that five year period. No doubt, Clinton. It's good to hear from you, sir. Vincent Warren alongside Wiley, Vincent
Warren at J.P. Morgan Private Bank and Wiley, of course, of BlackRock. That line from. Right. A French freshwater alongside David Westin. He says a negative or poor real return for five years. Something we talk about through the next
couple of days. Coming up the morning calls. That's next. And later. What a way to close out the program in the back half.
Morgan Stanley's Mike Wilson expecting the fair market to continue until there's further downgrades to earnings. That conversation just around the corner. And we'll catch up with Globe Capital CEO Lawrence Scala from the Greenwich Economic Forum. We'll talk to Lisa about that conversation a little bit later from New York City this morning. Good morning. Well, off session lows were down by more than 1 percent early this morning on the S&P 500. Now futures negative. Sixteen were down four tenths of one percent this year pulling back.
Twenty three seconds away from the area about this morning. Good morning, full day losing streak on the S&P 500 coming in. See today we're down by another six tenths of one percent right now on S&P 500 teaches on the Nasdaq, down about six tenths of one percent. We were much lower than this a little bit earlier in the session. And that's because of what was happening in the bond market. Take a look at bonds right now. Treasury yields off session highs
briefly to 4 percent, but picking up again now up 40 basis points, three ninety two point forty five. Thanks, Mark. You are trying to show some strength. Euro dollar up a tenth of one percent. Ninety 716 crude negative, two point one per cent to eighty nine twenty five. That's the cross asset price section. This case and move us is up. Hey, John. Well, between rising yields and U.S. China, tech tensions continuing to increase, escalate.
We, of course, have the tech wreck, continuing chips in particular. This is nothing new. We've seen this kind of action day after day between the preannouncements and the Asian session after those fresh U.S. curbs on China technology or China's ability to gain access to U.S.
technology. We see big, big declines in the Asian session. Taiwan Semiconductor plunge a record eight point three percent right now, down four point eight percent here. The ADR and it is fearing, sparking fears of retaliation. So you can see just again, continued weakness. Kayleigh, tank core these in my cap equipment company down about 4 percent.
Skyworks Solutions, the Apple supplier, broad based declines here, John. Of course, the stocks closed at a fresh low yesterday for the year, its lowest since November 20 20. NAB down 44 percent. The big question is, what does this mean for the rest of the index's chips, of course. A tell using everything that we use. Probably not the rosiest picture John. Abbi, thank you. We're down about a half of 1 percent on a S&P 500 1 minute in about 30 seconds into the session. Pretty defensive stuff. The relative outperformance from Staples, Healthcare, Utilities, technology. Here's a line for you.
The S&P 500 tech sector lagging the broader index this year by the most since 2002 with more his tied to rig sites. That's not a good year that you want to be mentioning as well. John, when you mentioned technology, let's dive into it.
When you think about now the Nasdaq and the Nasdaq 100, the biggest of the big tech now down for five straight days, that is the longest losing streak matching it of this year, said highlights. Of course, some of the recent pressure is we've been continuing to track the path of the Federal Reserve and rates higher. Take a look. And John, I think what was interesting,
you talked about different sectors within tech. We've been talking a lot about the stocks, some of the chip makers lately, given the extra curbs that the Biden administration has put on some of the chip makers and how they're doing business with China. But it's also been software. So it's been hardware technology. It's really been all different facets. And it hasn't sort of been that traditional software is recurring revenue when it's a potential safe haven. That narrative, this change and it's been a little bit more of a broad based sell off that mainly was that with a killer note this morning. If you take a look at where we are with
the technicals highlighting the S&P, as well as the NASDAQ 100 hitting some key technical levels, the NASDAQ here, just the general composite, also looking at some major support levels. When you think about where you are for the lows of the year and trying to hold on to what has been at least some support levels as of late, we'll be watching that into the closing bell. Looking forward to the coverage starting with you a little bit later. As always, this market's been hammered by REITs this week. We turn to earnings. James RTS of Aberdeen has this to say.
I'm expecting more cautious and negative guidance on the basis of broad economic weakness and uncertainty and tighter monetary policy. CAC nine cents more. Hi, Kate. Hey, John. Yeah, it doesn't sound great.
We're just days away now from JP Morgan, unofficially kicking off the start of third quarter in earnings season. And the closer we have gotten to that, the more expectations have deteriorated. Back in mid August, analysts were expecting on average earnings growth for S&P companies and about four point three percent. That estimate is now down at two point six percent. A significant slowdown compared to the eight point four percent we saw in Q2, for example, which by and large was a better than feared reporting season. The question is whether we'll see a repeat performance of that. And if you look at the share of S&P
members that have topped profit estimates, the trend has been a slow down where we have fewer companies beating expectations. And although J.P. Morgan is the unofficial start of earnings season, it's worth noting we've gotten 21 reports from S&P members already and the average earnings surprise is negative, three point two percent. So more companies are actually coming up short of the bar. It raises a question of whether the bar is still too high, which is what we've heard from a lot of voices here on Bloomberg TV. What a lot of the research on the sell side says is that essentially we have seen downward earnings revisions.
That is true. That is what we're looking here on this chart, not just the U.S., but globally. It's about 17 weeks in a row here in the U.S. that downward revisions have outpaced
upward one. But the narrative is that we still have farther to go, that you need to see more deterioration in expectations as these companies face so many headwinds, including the stronger dollar, tighter monetary policy. And just a slowing growth environment that could hit demand and the ability to pass on higher input costs that remain John. Candy, thank you. Voting on what Candy just said, that what we get the kitchen sink this. Tax season in the guidance. My version of Morgan Stanley says this.
Markets often need the engraved invitation from a higher power to tell them what's going on for bond markets as the Fed. And for stocks, it's company management teams. Mike Wilson, I'm pleased to say, joins us right now. Hey, Mike, do we get the kitchen sink that from management teams this earning season? Well, like this is the question we don't know the answer to, right? We think we know the answer to where earnings are going. We've done a lot of work on that.
That's where we have the highest conviction. I think that's where most of a consensus is that 2020 will disappoint. But of course, for Mark, is the path in which you get there is always the question. And we think that there's plenty of
evidence from a top down perspective to do our analysis, say, hey, why don't we just cut the numbers? But as we said in this week's note, somewhat jokingly, but this is the way it works. You know, the numbers are sticky until companies throw in the towel. You know, people say, well, what's the consensus? You know, earnings for next year. Basically, what they're saying is what are what is what is what is the company management team guidance for next year? And they haven't really given us guidance.
So that's why the numbers are always stale until, you know, they have they're forced to make those cuts. And so this is a time of year where companies can decide the kitchen, sink it. As I said in the note, or they just throw in the towel, they cut costs and a lowered the bar, or they wait until January when they have to give formal guidance for that for the full year, for next year. So it's between here and there. I guess you'll get some of it now. We're seeing at the individual stock level where you're seeing that as as Kelly was saying, you know, we're seeing some pretty bad earnings already from those who have reported and they've thrown in the towel. So it's going to be a mixed bag. Our confidence on where we're going is
high. Our confidence on the path as well might just gone off that line against the bond markets since the Fed. And for stocks, it's company management teams.
Does that imply that you and the team believe there is a part of this market that is further along in the adjustment process? Absolutely. And, you know, particularly for bonds. Right. So I would say a year ago, the most mispriced market was the bond market. And that's why stocks overshot to the
upside because rates were artificially too low. And we find it somewhat amusing. You know, fixed income investors in particular are the most critical of the Fed. This is what we hear. Yes, they hang on every word. So which is it? Do you don't think they're credible or you think they're so credible that you have to trade off her every word? Really, with your dynamic. And I would say that your bond markets have been chasing the Fed all year. The Fed has done their job.
They've aggressively pivoted to a very hawkish regime, even more hawkish than we expected. At the end of last year, we were probably one of the more negative folks in the bond market. So, you know, look best. I think the bond markets probably there. And but unfortunately, kind of like stocks, the bond market needs to be told by the Fed that they're done. Right. And that's just the dance we're in right now.
It's the hardest part of the cycle to trade. We think we know we're going in equities. We think yields are probably close to topping. But we've got to go through the earnings revision still, which is why you can't say that that stock's about let's talk about margins then. Once in the bond market has been pricing over the last several months, is the prospect of inflation rolling over? And I'll see it now.
I think what matters to margins and Mike, you've written about this a million times is the pocket if the inflation story, the sticks and the pocket of the fight. So when you think about what's going to fight him, Mike, from an inflation perspective and what's going to stake, what does it mean for margins? Yeah, that's exactly right. We want a pretty detailed note this week, in addition to our weekly around inventory where we worked collectively with our analyst teams and I mean like this submit a story that we've been talking about for nine months. We said that it's likely that the bottlenecks get relieved and then we'll see too much inventory. And I think where that's most evident is in some of the apparel stocks or retailers where consumer goods kind of across the board. And it's likely that we're going to see outright deflation in a lot of those products as companies have to discount to move the extra product. I think areas where it's going to be
tougher to get negative prices is going to be in, say, housing and ranch at least on a year on a sequential basis. But maybe on a year over year basis, we get them a flat. And then, of course, labor you know, labor now does have the upper hand a bit because of the pandemic. And I think we've moved into a different regime here where we're seeing a shift from capital to labor. So I don't think you're going to see labor costs come down. You may see them flatten out, but that
could be one of the more defining features of this cycle, John. That actually makes margins worse. And what I mean by that is, you know, U.S. based companies are very good at cutting
costs when they need to and particularly labor costs. And because of the pandemic and the shortage of labor that may be here for a while, companies may not be in a position to do that as aggressively as they have historically. And that's the case that we probably see more margin degradation than even what we're modeling. And I'll just leave you with this. I think that the area of the market that a lot of clients are perhaps underestimating is negative operating leverage. Inflation increases operating leverage. However, operating leverage can cut both ways.
It was positive in the lock down during the pandemic and now it's in a negative cycle. And we think that's where even we could be underestimating the downside to margin pressure, because that negative operating level story in labor is part of that. Mike, that is a very different market regime than what we've experienced recently. And he has before as well. What does that mean for leadership within the equity market? Might what does it come from? Yeah. It's more the same. What we've been saying all year, John. And you know this well, which is we're very focused on companies that have what we call operational efficiency. They have their hands on cost working
capital, that eating up the cash flow is another feature. What we're seeing right now there, they're very good at running their businesses and that's idiosyncratic features that a sector feature per say. Now, some sectors that can defend their margin position or operational efficiency better or those tend to be the more defensive areas like health care as an example. Some of the managed care businesses look quite good in that regard for the trees. Well, I would say clearly some of the staples and beverages, you know, that's you know, that's where we are. And then, of course, when we get to the trough, we're going to want to flip it exactly the other direction because we're not in the camp.
I think you were saying a minute ago we have negative returns or flat returns for next five years. That could be true. Point a point. I'll put it in a real basis after inflation. But there's got to be tremendous trading
opportunity on the upside, just like there wasn't 20 or 21. However, we're still in the down cycle right now. So we're thinking about the next five years, John, which probably different than most is we're in this boom bust period and we're in a bust period right now. We'll get through it and there could be another boom. So, you know, as soon as you get your head around on the bus, it's probably time to start thinking about the upside. That could be within the next three to five months.
Well, Mike, this is the perfect time to have this conversation then, because right now on my screen, we're making new lows for the yet the new life for the year 35. And take on the S&P 500. You send in the next few months, Mike, you could change course. And I think we should build on that a little bit more, because the risk is always, as you know, is to become married to a world view. Since the bearish commentary to the position, you can't make the trends come back into the market. Mike, I know that you haven't done that
over the last company is you were super bullish out of the pandemic. And then you tend what's going to make you turn, Mike? What's going to make you a little bit more bullish to have that rip that you're looking for? Well, the same thing we did in 2020 or there we get in 2017, you know, when we find ourselves out of consensus, it's, you know, you're you really are sold out. We could argue we are now, but then our fundamental metrics are telling us that we're at a rate of change low. So we've been we're pretty disciplined around that. We don't get everything right.
But, you know, one thing we tend to not Wynton. We tend to be early. We're usually that late force right now being early to be quite painful. You know, I don't wanna get too bullish
here because we will they will construe my words as AAA. You know, here it's time to go. And that's now what we're saying. We're saying there's still the last couple innings.
This bear market could be quite painful. OK, but you've got to be ready for when that price gets to an attractive level. If it was 5 percent away, John, I would say fine. But we still think, you know, kind of low, three thousands, even three thousand is really where we're probably going. And so, you know, as we go through thirty four hundred thirty three hundred towards a low of three thousands, we've heard other people throw those numbers out to kind of nonchalantly. It's like that's a big move, you know. So you do want to be too early in sort
of getting your head around that. But the things we're looking for the most is rate of change on earnings growth, revisions. Valuation could be the other way we get there, which is how we got there during the pandemic. No equity risk premium really blows out. And then, of course, we'll we'll start to see the whites of the eyes in terms of, say, economic growth, which will pick which will actually cause the Fed to pivot. They're not there yet. OK. So those are three things that we're very focused on. And it's just the cake is just not baked
yet. Going told you before that. Take us banks, I'm sure. Mike, thank you, sir. As always, Mike Wolfson from Morgan Stanley on this equity market went down for a fifth straight session on the S&P with down three quarters of 1 percent. And we have new lows for 2022. Up next, gulp capital CEO Lawrence, Ghana joining Lisa Abramowicz from the Greenwich Economic Forum. Looking forward to that from New York. This is, in fact.
This is Bloomberg's The Open. I'm Lisa Mateo, live in the principal room. Coming up here, Olivia go Grinch. IMF chief economist. That conversation at ten thirty a.m. Eastern, three thirty p.m. in London. This is Bloomberg. A fifth day of losses on the S&P 500 17 minutes into the session, a new low for 2022. That low is thirty five eighty two on
the markets on this story. Picking taking things out now is Lisa. Hi, Lisa. Hey, John. Thanks so much. We are right now speaking with someone who has a real feeling and entrenched in the economic fibers, particularly smaller and mid-sized companies. Lawrence Golub, CEO of Gallup Capital. Joining us here in Greenwich, Connecticut, from the Greenwich Economic Forum. And I'm curious for you, from your standpoint, with a credit focus on smaller companies, as you hear about all of the fear in markets, are you getting more aggressive or less aggressive in your investments? Thanks, Lisa.
It's great to be here with you. Right now is an increasingly good time in our business. Lending business is cyclical. You want to land not against the frothy top of performance and you want to lend not at the most extremely high leverage levels. You want to lend money when companies that are borrowing the money can put it to excellent use and become economy right now really is pretty good.
You can't have a bad economy and three and a half percent unemployment. Interest rate sensitive sectors, which are not where we really invest are having having some struggles. But we're trying to be especially active problem solving for our private equity firm clients as they have, especially as they have portfolio companies that are growing by acquisition. And I was speaking about this with Jim Seltzer. The complication comes when you're lending for five years at a time when the economy is moving very quickly. And I'm wondering from your perspective
whether that duration has shrunk, whether you're less willing to invest for a longer period of time as the ambiguity of perhaps 3 1/2 percent unemployment now could turn into something vastly different a year or two from now? Well, for us, it's all about margin of safety. It's it's about margin of safety in terms of how high can floating rates rise before you have interest coverage problems. It's about how many mistakes a management team can make or how many unlucky things can happen. We certainly don't know what inflation is going to be four years from now.
We run all the models, we do the sensitivities, the margin of safety and loans we make today given the wider range of possible outcomes. We try to make bigger than than we would in some other times. That margin of safety course, a lender's margin of safety is a borrower's problem potentially. So there's always give and take. Well, that's in fact, what I was going to actually ask, how high are yields? I mean, if you're looking at public markets, the 10 percent average yields for speculative grade credit, how are yields in private markets? So a typical loan that we would a new loan that we would make now would have interest rate margin. So four plus six and a half percent.
So four on a forward curve can be for four and a half percent next year. So you're talking about an 11 percent floating rate yield in our asset class, which is super attractive because it's firstly senior secured and floating rate. So for goes to five and a half that eleven goes to twelve. So you have built in protection against inflation. The private credit markets are pretty
attractive on a risk adjusted return basis right now. You raised the issue of if yields go to high, it becomes a problem for the borrower, which is the reason why when yields go way too high, it can become a problem. Based on what you're seeing just in the nuts and bolts and you put out a big marker for it, you start to look and strip away the large storylines and actually look at the details how well or how not well our company is doing. And this very quickly moving cycle where
we're seeing greater dispersion and we're seeing greater dispersion between industries. We're seeing greater dispersion among companies within industries. I think one of the things that our business is based on is lending to private equity backed businesses, which helps a little bit because private equity firms are very good at noticing issues and intervening in issues. But for sure, at so four approaches, four and a half percent, there's less room to maneuver, especially if a company has borrowed a very high multiple of adjusted EBITDA. Not all those adjustments have come to pass and all of a sudden they're looking at an 11 percent interest rate on what was six or seven times adjusted EBITDA, but might be eight times really. But I mean, fortunately, this is when your skill as a credit underwriter comes into play.
You don't want to have made those loans. Are there certain areas you will not touch right now because the industry is just flat on its back in a way that people might not appreciate. So we we really stay away from businesses that rely on consumer case and consumer preferences. So, for example, we do a lot of mission critical business to business software, but we won't do business to consumer software.
And there are parts of business, clever software. They're booming there, some that have hit some bumps. We're just not smart enough to pick the winners and losers. And back to the. Years, even if we were smart enough, pick winners and losers for not smart enough to pick five years where other industries where traditionally you have liked them occasionally would have seen deterioration, that is so dramatic that it has you concerned.
Well, the specialty retailers who are all based businesses that have very high demands on lower skilled labor content. You know, we would have, for example, probably considered a loan to a franchise or who had a lot of operations in California with California's minimum wage increases. You've got to worry about the health of the franchisees. So something like that we'd be more conservative about right now. And what are you concerned about going
forward in terms of this default cycle? Right. I mean, a lot of people talk about where we are, where are we in terms of the pricing, let alone a company is actually running into trouble. So we're we're expecting modelling growth.
If we have modelling growth, we're not going to have a massive default cycle like we did in the financial crisis. I think what we're looking at are companies specific issues where their early intervention can really make a big difference by figuring out do they need more capital? Should the company be sold to an industry player? I think that we have to keep our eye on inflation because inflation correlates with what so far is going to be in the future. I mean, we're all very concerned about interest rates going up, but so far still negative in real terms. If you look historically at Fed funds, the historical average of Fed funds before the financial crisis was 5 percent. We're not even up to average yet. You said that you work with a lot of companies that have private equity backed. Yes.
Those that are not. Do you find that they have a harder time getting equity investments are turning to debt more frequently or getting better terms and they are having a better claim on a company simply because private equity perhaps isn't that much more of a world of hurt? I wish, but not the case. Private equity bars are so tough and smart they don't let us get away with anything. We have great relationships and we've done multiple deals with over 200 private equity firms, but they're looking for a reliable partner who helps the portfolio companies grow. They're not giving anything away and private equity firms don't don't have a shortage of that capital. I think one of the interesting trends
that will play out over the next 12 months is the pace of new deals by private equity firms. Right now, the S&P is approaching new session lows. We are seeing the sell off accelerate as yields continue to climb. At what point will you move away from floating rate loans and start to want to have fixed rate instruments? Again, we won't worry in the floating rate business.
We have at fund. We take the inflation issue. We take the interest rate risk off the table as traditional senior secured lenders. So we won't do that. I think that that the degree to which we take some junior capital risk, whether that's floating rate or fixed rate, is a little bit cyclical. And to us, that's less about what
interest rates are doing and more about our own thinking about forward profit growth in our middle market report. We had very robust growth in revenue, but the growth in profit was not was really not that great. And that's comparing to a year ago, which were boom times.
But we're having an economy now where the economy is growing. GDP is growing. Interest rates are going up, but it's getting harder and harder to cheat profit growth. Yeah, another way of saying margin compression. Lawrence Globe, thank you so much of Gala Capital.
John, back to you. Lisa. Thank you. Great work this morning. Thank you very much. New lows for 2022 when the S&P 500 35
78. Just off those lows right now, the S&P down by nine tenths of one percent. From New York City, thank you for choosing Bloomberg TV. This was the countdown to the open. This is Bloomberg.
2022-10-14 15:18
