MAGGIE LAKE: Hello, welcome to the Real Vision Daily Briefing. It's Monday, December 20th, 2021. I'm Maggie Lake, and here with me today is Jeffrey Schulze from ClearBridge. Hi, Jeff. Welcome to Real Vision.
JEFFREY SCHULZE: Hey, Maggie, happy to be here.
MAGGIE LAKE: Yeah. Great to have you with us, and on a day where there's a lot to talk about. It was pretty volatile for US markets. We saw US equities trade down about 1.5% across the board. We're actually a little bit off our lows. WTI crude prices fell 3% while natural gas jumped 4.5%, all while the 10 Year Yield remained flat anchored at that 1.42%. And overseas, we saw big moves too. China cuts interest rates for the first time in 20 months. That was pretty significant. And Turkey's currency crisis continued with the lira falling to a record low. Weston Nakamura has the latest from Tokyo.
WESTON NAKAMURA: Hey, thanks, guys. Two quick things, PBOC in China made a very small cut to its loan prime rate today, LPR. One-year LPR was cut by only five basis points to 3.8%, so it's more symbolic than anything, but it does mark the first LPR cut since April 2020 coming off of the COVID crash. What they left unchanged, however, was the five-year LPR which is what mortgages reference off of.
In other words, this is not so much to signal support for stronger borrowers as it is to underscore their continued lack of aid for the property sector and their preferences for which sectors they want to stimulate in the economy and more importantly, which ones they do not. Keep your eyes on this policy versus markets here because while markets may have sold off in part due to Senator Manchin's rejecting Joe Biden's bill, during Asia hours, the Nikkei e-minis and of course, the Hang Seng Index, they all sold off on the PBOC LPR cut today, so certainly, it's a global market driver out of Asia.
And then I just need to bring up the Turkish Lira, because it's only been a month since I flagged the lira risk on the Daily Briefing market update. But since then, the lira has gotten slammed 80% in the past month, they're now coming off a fourth consecutive rate cut last week. And while the central bank signal this is it for rate cuts, President Erdogan, the real head of the central bank said otherwise once again this weekend. The lira has now fallen by at least 2% every single day over the past week at 9am local time in Istanbul.
And then last Friday, very alarming turn as the Turkish stock market which had been an enormous rally right alongside dollar lira, that finally cracked and did a 14% cliff dive on the day. Keep your eyes on these two idiosyncratic emerging markets going against the rest of the world's policy tightening, and that's it. Thanks.
MAGGIE LAKE: Jeff, there's an awful lot to digest here and a lot for investors, it would seem, to worry about. What did you make off, let's start with stocks, what do you make of the selling that really have been pretty persistent here for the last week?
JEFFREY SCHULZE: Well, it's interesting to note that the volatility that you saw today was really isolated in the equity markets and also the oil markets. If you look over to fixed income, 10 Year Treasurys were actually up on the day, 30 Year Treasurys were up about five basis points, inflation breakevens were roughly flat, and credit spreads, if you're looking at credit default swaps on the investment grade space, widened about one basis point and in high yield, went up about five basis points. Yes, a little bit of risk-off, but certainly not to the same degree that you saw in equity markets overall.
Obviously, you've had to digest a lot in the last five trading days, you had the hawkish tidbit from the Fed, you also have Omicron and the case counts increasing here, likely disrupting economic activity. JPMorgan Chase released their credit card data today, and if you look at this month versus 2020 and 2019, are actually well below levels that you saw on previous December. It's certainly having a bite in economic activity. You're going to see downgrades for the fourth quarter and the first quarter.
And it may actually reflect on some weaker earnings near term, but the third thing was obviously, Senator Manchin dropping a bomb about the Build Back Better plan likely being on hold or potentially not moving forward at all. A little bit of risk-off profit taking in this type of environment makes sense given the changing dynamics that we witnessed over the last week.
MAGGIE LAKE: Yeah, and you really summed up to three different areas that we're trying to all juggle. Omicron, is that impacting your forecast? How are you factoring this into what you expect?
JEFFREY SCHULZE: The key question with Omicron is whether or not the spending that we're seeing right now is going to be delayed or it's going to be lost altogether. I think obviously, you're going to have some foregone spending that's never going to make its way back into the economic bloodstream, like holiday travel, New Year's Eve travel, for example, and going out and doing things that you'd normally do but nonetheless, I have ratcheted down fourth quarter expectations by 1%, first quarter expectations by a 1.5%.
But nonetheless, if you look out to 2022, I see this as a mild disruption overall. And I do think that we're going to get the peak Omicron cases here relatively soon, maybe by the early part of January, because if you look at South Africa, caseloads have peaked. You've seen all nine provinces peak in their cases, they're now starting to come down. You didn't see a material increase of hospitalizations, ICU, ventilator use, that's really untrained throughout the entire process. And this has been about twice as fast as what you saw during Delta, it took about 55 days to get to Delta's peak.
We're assuming that 25 days is that trend line with Omicron cases picking up a couple of weeks ago, we're potentially looking at early January, maybe mid-January to see that peaking here in the US. And if people aren't going to go to the hospital and the same rates that we saw with other variants, you don't see a big uptick in deaths, again, this disturbance that you're seeing in economic activity is going to be relatively minor.
MAGGIE LAKE: What about the impact from overseas? We know China has a zero tolerance policy, we do see some other countries considering lockdowns again. I don't think most people that I've spoken to over the last week or so on these programs don't think we're going to see any lockdown in the US, but could it exacerbate the supply chain problems that we have?
JEFFREY SCHULZE: It certainly could. The White House is making a pivot, not focusing on cases per se, but obviously, severity, so there really doesn't appear to be any appetite for a lockdown here in the US. I think that's a very unlikely scenario. But again, following these zero tolerance policies in areas like China and a lot of Asian countries, I think this certainly has the potential to create disruption similar to what we saw with Delta back in the third quarter and perpetuating these goods inflation that we're seeing, and making it a little bit more stickier than what I've been anticipating, which is a peaking out of inflation in the first quarter.
And in the second quarter, starting to see inflation move meaningfully down throughout the course of 2022. But this could throw a wrench in that viewpoint, and it certainly could perpetuate the supply chain issues and create a massive supply shock similar to what we've experienced over the last year. Obviously, something that I'm watching. You saw the port in China shut down here recently, but you can't contain Omicron because of its contagiousness.
I'm not sure if governments are going to come to that realization and realize that it's a fight that they can't win, and abandon what they've done in previous sessions. But again, that's something that I think is really going to dictate the near term direction of inflation.
MAGGIE LAKE: And that's going to be really key for the Fed, isn't it?
JEFFREY SCHULZE: It will, it will. Now obviously, if the Build Back Better plan doesn't move forward, that creates less of a growth impetus or an inflation pulse into the economy over the next couple of years. That could be a reason why the Fed remains on the sidelines longer than what people are anticipating. But again, if you have these supply chain issues pop up again and inflation continues to be sticky and moves up to the upside, that could also cause the Fed to move in March, which is what the market's pricing in right now and what's my base case scenario.
But again, the Fed can't really control the supply chain issues. They've talked about that over the last couple of FOMC meetings, but they can have an impact on aggregate demand and inflation is at seven or eight handle in the next couple of months when we get to that March meeting. I think a rate hike is a foregone conclusion.
MAGGIE LAKE: It certainly seems so. If that's the case, what do you make of the action we've seen in the bond market? Because we don't see the 10 Year, we've seen reaction in the frontend, but we haven't seen the 10 Year move, or the long end? Is the bond market telling us something? Are we pricing in too much from the Fed? What do you make of that?
JEFFREY SCHULZE: Well, you haven't seen a lot of movement. I think that's a reason why you haven't seen a lot of movement. It's the Fed is basically cutting off the right tail of inflation right now, so that people were concerned about a policy mistake that they be behind the curve. And they've obviously changed that perception with the FOMC meeting. And I think obviously, that's one reason why you've seen inflation breakevens behave relatively well over the last couple of weeks.
But I think the 10 Year Treasury and the 30 Year Treasury are likely going to rise from here, especially the 10 Year Treasury because if you look at the last 11 hiking cycles, the 10 Year Treasury usually bottoms a little bit before the beginning of that tightening cycle and moves up on average about 111 basis points. Given the fact that the 10 Year Treasury has remained sticky, and it was up a couple basis points today, this can actually be the beginning of that move that you traditionally see at this part of the cycle.
MAGGIE LAKE: What is the impact, if we move back to stocks, a lot of the selling we've seen has been concentrated in technology. Is it going to be a much tougher for that sector if we are facing an environment where we're going to see higher rates here in the US?
JEFFREY SCHULZE: It will. Obviously, part of their valuation is contingent on low interest rates and a low discount rate. If the 10 Year Treasury is going to be rising from here, given the lofty valuations that are ascribed to that space, that's certainly going to be a headwind to overall performance. Interestingly, over the last two or three weeks since Thanksgiving, you've actually seen value outperform growth.
Now, this is not what you would expect with rates actually moving down in this type of environment, there's been a little bit of concern about Omicron, and the growth prospects that it brings along with it. And whenever something isn't acting like it should, it usually gets my antenna up in the fact that value has actually been leading growth by a wide margin, but it's been doing well and holding its own. In my opinion, it's foreshadowing what potential leadership is going to look like once the clouds clear up the variant and the concerns that we have along with it.
I do think that information technology and growth is going to have a little bit of a headwind in its face. But again, a lot of those companies are really rock solid. The ones that I'm really concerned with are those that are the hypergrowth companies that aren't going to have really any meaningful free cash flow for the next four or five years. I'm less concerned with your FANG type of stocks that are great business models, generate a lot of free cash flow and actually thrive in a positive growth environment.
MAGGIE LAKE: Yeah, that's what's hard to wrap your head around is I understand what you're saying about the threat from rates, but you have a situation where some of these companies really seem like they're tied to the future. They dominate every part of our life. And if you look on the other side, I don't know when you were talking about value taking over, I know a lot of people in a higher rate environment are looking to financials, but there's so much disruption happening in that space. How do you counter those larger trends with some of these short term issues in the economy and in the rate forecast?
JEFFREY SCHULZE: Again, I think these growth behemoths, the mega cap stocks are going to do quite well. I think they could be the next bubble that we see when this stock market cycle is all over. It doesn't mean that they are going to go through periodic times where they're going to derate and rerate. But these are excellent companies, and as you say, they're going to disintermediate a lot of areas of the economy and continue to take market share.
Again, given the fact that they have been the only part of the market that really hasn't sold off in a pronounced way, they may be right for, again, some selling over the course of the next year. But again, if you have a long term perspective, I think these are going to be really good stocks to have in your portfolio and you want to buy them on weakness. Now, from a financials perspective, lone end interest rate's being tethered here as really hindered performance even though they've had rock solid earnings over the last 12 months.
I think when you finally get that last piece of the equation of rising rates, even though part of their business models are going to be likely disintermediated or potentially disintermediated, again, they have a lot of avenues of growth to be able to pad their bottom lines. But I do think financials looks really good on a 6- to 12-month basis given my expectation for the economy and the rates backdrop and valuations are quite compelling.
MAGGIE LAKE: When we're looking at the economy, if we potentially have supply chain issues, concerns about inflation are going to have to be balanced against what we're looking at in underlying growth. What is your forecast-- I know, you said you ratchet it down, but what are you expecting in terms of economic growth? And is the market accurately pricing that in?
JEFFREY SCHULZE: I think economic growth next year could probably be around 4% on a real basis. If you obviously include inflation, you're up in 8% levels. That's a really strong nominal GDP growth print. What we found is when nominal GDP growth is over 5%. It really kickstarts operational leverage, which is predominantly found in the value complex. And again, given the fact that valuations are relatively cheap in that area, that's why we think that that's an area that could be attractive over the next 12 months.
But again, if inflation continues to surprise to the upside, and you do see these lock downs in supply chain disruptions, there's only so much that you can pass on to the consumer. So far, even though confidence levels have plummeted for the consumer, because they don't like paying higher prices, there's a difference between not liking and not being able to pay those prices and they've been able to absorb it.
If you look at aggregate weekly payrolls. They're up 9.3%. Wage growth is up 4.8%. Aggregate hours worked are at 4.4%. A 9% handle on what you're taking home is more than enough to offset the inflation that we've seen with of course, the headline CPI being around 6.8%. Now if we get higher inflation, and again, if consumers aren't able to absorb that, that's going to weigh on margins. That could be a headwind to the markets next year, but not my base case.
Again, until we start to see economies go down overseas, I'm still thinking that you're going to see goods deflation likely in the back half of next year into 2023. But again, that calls up in question right now.
MAGGIE LAKE: Yeah. It would make sense you have a recession risk dashboard that if it's not up already, I think we can put up. This was interesting to me, because you're tracking different components of the economy, consumer components, business activity, as well as financial conditions. And certainly, when you're talking about the shape of the consumer's in, it would make sense that some of this, a lot of the arrows are green. Jobs, sentiment, retail sales. Wage growth, I noticed is yellow, though. Why is that a concern? I would think in a really tight labor market, that would be looking good.
JEFFREY SCHULZE: Generally speaking, it is a good thing. But usually, wage growth pops up late in an economic cycle. And wage growth tends to be one of the biggest drivers of inflation, which the Fed has usually reactive to with tightening monetary policy. The good thing about wage growth is one of our longer indicators. Usually, wage growth return red anywhere from two and a half to two years prior to the end of an economic cycle.
The fact that it's yellow isn't a concern to me, but the one thing I will mention on wage growth is that I do think that there's a lot of labor supply that's out there that's going to come back into the labor market once we get to the first and second quarters of next year. A lot of people are out because they had generous unemployment benefits over the last year. And what we found is the median household has accumulated after tax pay of point eight months prior to COVID, so 2.8 months.
People that are unemployed, they've had that cash cushion, but they're rapidly running through that. And I think that ultimately draws them back into the labor market, about 8.5 million people losing those federal unemployment benefits back in September. Also, again, one of the things that we've been watching is people that are scared of coming back because of COVID. If Omicron ends up being more contagious, but less deadly, this effectively puts an end to the pandemic, and it makes it not a pandemic anymore, but endemic.
And these individuals will eventually come back into the labor market as well. Again, wage growth is a little bit higher than what we would normally associate at the early part of an economic cycle. But at 4.8%, I could see this coming down into the low 4% range as we move through 2022 and into 2023.
MAGGIE LAKE: And I guess the good news is I don't see any red signs for recession. Is that completely off the table? And what else should we be keeping an eye on in terms of maybe a lead that would make you concerned?
JEFFREY SCHULZE: Yeah. I would say, it's very unlikely. Nothing is ever completely off the table. We've