ANDREAS STENO LARSEN: Hi, everyone and welcome to the Real Vision Daily Briefing. I'm Andreas Steno Larsen, sending to you live from Copenhagen, Denmark, Wednesday, August 3rd. It's been another crazy day in markets. We have equities rallying once again, and I am pleased to be joined by Peter Boockvar, the CIO of Bleakley Advisory Group. Peter, it's good to have you back on the show. Welcome.
PETER BOOCKVAR: It's good to be back. Thanks.
ANDREAS STENO LARSEN: Peter, I wanted to start with a tweet from earlier today from our friend, Ed Harrison, he basically quoted you and now I'm reading out loud. For decades, the Fed always gave the markets more candy, especially when the kids cried out for it. Now, the kids are going to have to do without. Please elaborate.
PETER BOOCKVAR: Yeah, I wrote that in my daily Boock Report. And I was really referring to a lot of the Fed speak that we got yesterday that resulted in the sharp jump in interest rates across the curve, but particularly on the short end, where the 2Y went up about 15 basis points, because the markets have this belief and Powell fed into it at their last press conference, that the Fed was almost done raising interest rates and they're at neutral, even though they're not.
And I think that they got a reminder that the Fed is still intent on raising interest rates that was reiterated today by Bullard, who was on CNBC, who wants 3.5% plus Fed funds rate by the end of the year. And when you look at last couple of decades, it was always the markets that were given the candy that they wanted from the Fed. And every time the kid whined, the parent gave the kid more candy.
And because of high inflation, even though it's probably peaking out and is going to start to slow down, there's still the belief that the Fed is going to give us more candy, but that inflation is why they're not going to. And I think that that is something that the central bankers have tried to reiterate, reinforce last couple of days. The markets are still whistling past that. Thinking that, okay, well, maybe so but if we go into recession, you can be sure you're going to stop. And that's all we're looking for on the buy side.
ANDREAS STENO LARSEN: So Peter, if we look at various sentiment scores at the moment, they look extremely downbeat. And at the same time, we have the Federal Reserve now pushing back on markets again with these hawkish comments. How can equities rally in such an environment? What's your take on that?
PETER BOOCKVAR: Well, I think the center for the rally over the past month was firstly, the contrarian setup where you had in multiple sentiment gauges, extreme bearishness, particularly investors' intelligence, the AAII where bears were swamping the number of bulls, and so in other metrics as well.
And that was a good setup for this, then you throw in, of course, as I mentioned about hopes that the Fed is almost done, or at least is slowing down the pace of the rate increases, because they'll most likely hike 50 in September from the 75 basis point case that they accelerated to over the prior two meetings, and earnings that are beating lowered expectations, and still the hope that we are going to have, even if it's a recession, a mild one, that won't be a big deal, and everything will be just fine. I think that's a setup for this.
But in any bear market, which I still firmly believe that we're in, you're going to have these hope rallies, and with everyone thinking that the worst is over. But if you just look at a chart in particularly the NASDAQ, where tech is obviously a big driver of this rally, all it is just a rally into the down trending line from the January peak, so I wouldn't be lulled into this. I also want to remind investors that in four weeks, September 1st, QT ramps up to 95 billion a month. So good luck rallying in the teeth of that.
ANDREAS STENO LARSEN: Peter, no one's talking about quantitative tightening at the moment. It's like everybody's centered on these interest rate hikes. But beneath the surface, this balance sheet withdrawal will basically continue throughout the course of the second half of the year. Would you consider the balance sheet shrinkage from the Federal Reserve, more important facet of markets start the discussion on interest rates?
PETER BOOCKVAR: I think that QE in its purpose, stated purpose by Bernanke who created the US version of it, compared to how the Bank of Japan did it. His stated purpose was to ease financial conditions and with stock prices. So, well, if you're consistent and symmetric with that, it should do the exact opposite when we're in the middle of it. Now, we're obviously doing it right now, but on a pretty small scale. Doubling it will, I think, at some point, get the market's attention.
On the rates side, I think the rates side and the actual movement in interest rates has more of an impact on actual economic activity. Yes, it does flow through to valuation models, it does flow through into pricing of credit spreads and valuations and stocks, no question. But in terms of a direct impact, I would say QE has a direct impact on stocks, where shifting the Fed funds rate and its distribution effect on the rest of the yield curve has more of an impact on firstly, in the interest rate sensitive parts of the economy, like housing and autos, and more so indirectly, in terms of the cost of capital, generally speaking.
ANDREAS STENO LARSEN: Peter, we've received a bunch of data today, and as we know by now, the Fed is now clearly data dependent, looking at interest rates from meeting to meeting. One of the key gauges out today was the ISM services gauge, and it actually jumped to a three-month high. But if we look beneath the surface, the message is probably a little less upbeat. Do you think the Fed will take comfort in this ISM report from today?
PETER BOOCKVAR: The Fed will take comfort in any economic datapoint that doesn't badly deteriorate. Because they'll feel like it buys them time to continue this rate hiking and buys them time to eventually, inflation does start to recede. So that gets into their tolerance of a softer economy. It's when things start to accelerate in the situation that they start to get worried when you start to see a notable increase in the unemployment rate.
But the ISM, just for context, the bounce came off the lowest levels since 2020. And the market, IHS market, the US services for July, came in at 47.3. So that was firmly below 50. And the IHS market number is broader in its survey. It includes a lot of small and medium sized businesses as well, whereas ISM is more focused on bigger companies. And you're seeing that bifurcation generally in the economy.
You have higher income people that are managing this inflation situation better than lower income people, you're going to have bigger companies that are going to outperform smaller companies, just because they have the resources, they have the buying power, they have the leverage in terms of its supply chain. Just think that if you're going to try to get a container, well, you're in the back of the line compared to a Walmart if you're just a local retailer.
So that's my point there. But we have to also understand that the economy doesn't all grow at once, all contract at once. It has its own internal cycles in a broader cycle. And as we've talked about before this interview, it's not a light switch you just turn on and off, do the recession or expansion. There's a dimmer, there's a lot of in between.
And I think we're beginning to see, obviously, putting aside the two negative prints and GDP, and I know in the world of COVID, it's fair to use the word virus, but let's use the word virus here is that the COVID didn't infect the whole world all at once. It was something that spread and metastasized.
And we have that going on and the economy. It's starting out in certain pockets, starting out in weakness in housing, as I mentioned, in lower income spending, smaller businesses are getting impacted, but it's going to start to metastasize because then that flows into capital spending decisions, which is beginning to weaken. We saw very poor prints in some of the regional manufacturing numbers in terms of their six-month outlook.
And then we have to see, okay, once it start impacting the higher end consumer, when does it start impacting broader business flow? It is impacting broader business flow, we've seen the advertising businesses getting clipped as companies use that labor force to cut costs and readjust their budgets. So it is beginning to spread, and that's why this whole debate about there is a recession, not a recession technical. It's all semantics, the trajectory of growth is down, and it is spreading. And how you want to define it, and how you want to time it, I think is right now irrelevant.
ANDREAS STENO LARSEN: Peter, if we look at the current growth pace in Q3, I wanted to play a soundbite for you. From a debate I had with David Woo, the former head of strategy at Bank of America earlier today. He's arguing that Q3 will be a strong quarter. So let's listen to his argumentation and get back to that debate.
DAVID WOO: So if you look across the market, I will argue the market doesn't understand the world has changed. The market doesn't want to think about these longer-term issues. Okay. Yeah, I realize that the earning season so far has been pretty good. And by the way, the earnings season, the fact it's been pretty good overall, tells me that we are not okay, that we're not in the recession.
I was the first one to say there was going to be a recession in the US before Thanksgiving. I said this already back in basically, March. But my view, the recession has already ended. The recession started in Q1, continued to Q2, has already ended. I think Q3, the economy is going to do okay. Okay, because the price shock associated with energy and food would have dissipated in Q3, which means the moderation of inflation, which means you're going to actually see a pickup in real GDP growth, because you're going to see actually a pickup in real, basically income growth.
But that would only strengthen the need for the Fed to keep going. So that's why for me, Q4 is when the reckoning is really going to come.
ANDREAS STENO LARSEN: The entire discussion between David Woo and I will be available on Monday on the Real Vision platform for Plus, Pro and Essential subscribers. A lot of good stuff also on the current situation in Taiwan. Peter, back to you and your take on the Q3 growth pace. If we take the ISM report today at face value, it looks as if the economy is still growing. Are we in a recession or not? What's your take?
PETER BOOCKVAR: Well, I think inventories are a key swing factor for-- and so inventories in the first second quarters [?] breadth. And I think yeah, whereas in Europe, we haven't seen any inventory build. So if that shows up in Q3, maybe that gives us a lift. The question is, is what the offsets were going to be in terms of consumer spending on a real basis? Obviously, everything's on a real basis when looking at that, and how capital spending is.
Housing is obviously going to be shrinking still. I think we're already seeing broader capital spending within some of the regional manufacturing surveys that are looking squishy. And to me, consumer spending, maybe it's going to get a lift and travel and leisure just as we saw it in the second quarter number with Europe. But if we do see a plus number in Q3, I expect it to be barely, and then we'll start to resume the fourth quarter contraction after we run down this jump in inventories, because I think companies are going to be pretty good at clearing out some of their excess inventories.
Because keep in mind, a lot of this excess inventories was just they were making the assumption that COVID spending trends will continue. And that was obviously not the case. But in an inflationary environment, you put a for sale sign in front of something, it's going to sell pretty quickly. But I still think that the general trajectory of economic activity is slowing. And also, and I've argued this for a while is that we have credit cycles now.
We don't have normal economic cycles. And these credit cycles are driven by the cost of capital, and what the Fed does. And when rates go up, it squeezes things and growth slows. And when the Fed eases, it eases things and things grow.
So to think that we're going to somehow growth through the most aggressive rate hiking cycle in 40 years, and a pretty rapid increase just generally in market rates, I just think it's such wishful thinking. We all hope we do. We don't want to see a recession. We don't want to see this downturn, but in a very interest rate sensitive, easy money sensitive economy, I don't see how we just coast right through what's going on here.
ANDREAS STENO LARSEN: The Fed probably now tracks the most lagging of lagging indicators, namely the unemployment rate, and also, the spot inflation from month to month. If we get a decent Q3, will that allow the Fed to hike interest rates into Q4 and maybe into Q1 next year?
PETER BOOCKVAR: I think the Fed wants to get the Fed funds rate to about 3.5%. Well, they're going to get it to 3% in September, and then they'll play it by ear from there. And this ties into what they think with the neutral rate is, even though the neutral rate is just some made up cockamamie econometric model number that they spit out. And people have to understand that a 2.5% neutral rate is under the assumption of 2% inflation and 4% unemployment rate.
If you have the unemployment rate below 4% and you have inflation much higher, then the neutral rate is clearly well above 2.5%. I think the Fed in terms of what will guide them on when they stop raising interest rates will not be GDP, it will be the unemployment rate. And if the unemployment rate goes from 3.6%, we'll obviously see the updated number on Friday, if all of a sudden it goes to 4.5% rather quickly, that will ring alarm bells there.
Now 4.5% historically is very low, but when you have the participation rate as low as it is, that helps to explain that you're not going to need necessarily high unemployment rate, historically speaking, in order to see a notable decline in the jobs market. You're already seeing, speaking of the labor market and this lagging type data, initial jobless claims are at the highest level since November. And yes, on an absolute basis, the pace of firings is relatively modest, but the trajectory in that is also clear.
Again, the highest level, actually came off its highest level since November. So the pace of firings is clearly going up. And just keep in mind, the mentality of a business and getting to your point about lagging is that if I'm running a local business, and my business starts to slow on, I don't just start firing people, I take a step back, I try to cut some costs, I try to maybe delay some of my capital spending plans. And then at some point, things don't get better, maybe I limit hiring.
And then after going through that exercise, and things aren't getting better, and if they're getting worse, only then do I start to fire people. And the reverse is true on the flip side when you decide to hire. So that's why it's very much a lagging indicator. And it just amazes me how the Federal Reserve and all these trained economists continue to conduct policy based on what they see, but what they see is behind them.
And all you have to do is look at a chart since the 1950s and see that recessions begin soon after a bottom in the unemployment rate. So it was a Fed Governor Chris Waller, who maybe it was three weeks ago, who was like scratching his head in an interview, like, I can't foresee a recession with the unemployment rate only at 3.6%. I'm thinking, Chris, just look at the chart. Look at the history of this stuff. You shouldn't be scratching your head. These are the times when you should be preparing for one, not wondering and thinking that it's not possible.
ANDREAS STENO LARSEN: Peter, if I allow myself to play the devil's advocate here, for a short while, we have a bunch of job openings still in the US, we got the latest number from June, was it, yesterday, albeit with a drop compared to May, but still at extremely elevated levels when we look at job openings. Could this be a game changer for the labor market compared to earlier cycles?
PETER BOOCKVAR: Yeah, there are a lot of unique characteristics to what's going on in the economy, where you have tech companies that are either limiting hiring or firing the excessive number of workers they took on in this expansion. But at the same time, you have restaurants and hotels, and airports and airlines that can't find enough people. So there is some strange dynamics within the labor market. But also, there's strange dynamics when it comes to the inventory situation.
So you have Target and Walmart and other retailers that over ordered what they thought was going to be a continuation of trend of spending on all these goods, and they got stocked with excess stuff. But then you have some purposeful increases in inventory, because people don't want to get stuck again with a lack of inventory, particularly like you look at the balance sheet inventory numbers with Mattel and Hasbro, they've gone up sharply because they don't want to play a game with Christmas again.
They don't want stuff showing up in January. They want their toys on the shelves in September and October, early November the latest for that Christmas holiday. So they pulled forward a lot of their inventory build because of this more different environment that we're in. So there are definite crosscurrents here, and I think that's also what's making it somewhat confusing in trying to figure out where the economy goes from here. You listen to the CEO of Starbucks last night in their conference call, oh yeah, everything's fine.
We're not seeing any trade down behavior or consumers are still spending as is. And then you hear from Verizon and ATT and consumers are delaying paying their cell phone bills and McDonald's acknowledging that people are trading down. So there is a lot of mixed signals here, but that also gets to my point that it doesn't go from expansion to contraction just like that. It starts to show up in different areas, and then starts to spread. And I think that we have to be prepared for more spreading.
ANDREAS STENO LARSEN: David Woo also mentioned a potential day of reckoning during Q4 as a consequence of the Fed false flagging interest rates through Q3. Would you concur with such a