Seema Shah Makes the Case for a Short-Lived Recession

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I'm Valdana Hirek, a market's reporter at Bloomberg. And I'm Emily Grafeo, a cross-asset reporter at Bloomberg. Mike Regan is out this week. And this week on the show, our stock's in a new bull market or not. There's a raging debate on Wall Street as both the S&P 500 and the Nasek 100 continue to surge. We'll get into it with the chief global strategist for a major asset manager. But first, Emily, welcome back to the show. We're so happy to have you. Thank you. Thank you for having me, Mike Regan. On last week's show, Katie Filden, and she told us one of her deepest arc secrets, which is what she's very, very deathly afraid of. The dark. The dark. So that can't be your answer, too. This isn't really a secret, but I'm very afraid of birds. Flying birds out of control birds. How do you live life? So it's, when I went to a conference a few months ago in Miami for ETFs. I was having a business lunch with the source, and I was trying to be really serious and professional. And there was a bird, and it kept flying towards us, and I was being really spastic and freaking out. But the source was very kind about it, and he would chew it off. But it's a big fear of mine. I don't get it, though, because there's so many birds everywhere. The New York City pigeons are different. Harmless. They mind their own business. It's other birds. I see. Yeah, I don't see. Our guest this week is laughing. So I do want to bring her in. It's Cima Shaw, Chief Global Strategist for Principal Asset Management. Cima, I'm so happy to have you back on the show. Oh, it's great to be here. Thank you. Yeah, we have you here in person, which is really great. Yeah, it's fun to be here. Although it's just 24 hours. Maybe let's just start with some of your views on what you're expecting from the economy and from markets. You said that a recession is not imminent, but you're still forecasting one. So maybe just tell us about your projections. Yeah, so we are still expecting a recession. We're maybe increasingly in the minority and actually expecting a full recession to come through. But we are expecting it starting Q4. I know a lot of people out there who are expecting recession to expect it to come in Q3. I look at the labor market, the strength of it, and I say that that's almost impossible. But Q4, we would expect fairly mild negative growth. And then in Q1, a deeper downturn. But then by Q2, this is back to recovery. So this is historically a very short recession and historically a very, very mild recession. So unlike some strategists on the street that have been pushing out their expectations for when this recession is finally going to get here, it seems like for a while you have been thinking that it's not going to come. It's not going to be an imminent recession. How is your view, though, shifted from the beginning of the year to now? Yeah, so we have had this expectation for recession in the second half of 2023 since the early part of 2022. So this is a long-held view for a recession. I'm really based on this idea of the long and variable lags. All based around Fed policy is going to trigger a recession. But since the beginning of this year, I should actually, even in the last two or three months, with this continued out-performance strength of the labor market, the one thing that we have changed is that we have reduced the duration of recession from three quarters to two quarters. I almost wonder if this is even going to feel like a recession. If you look around, are you going to say, wow, the EOSism recession probably not because of that mild? So I think maybe the more important part of this, at least from an asset allocation perspective, is what the impact on earnings is going to be. And you can already see that down with trend, you get into recession, earnings will continue to come down, and that's really what's going to weigh on asset prices. But certainly, if you look at the labor market and what we're expecting, we're projecting unemployment to rise to 4.1% by year end, that is still essentially full employment. So it's not, I don't think, going to be a very, very tough recession for the population. OK, but that's super interesting. The thing you said about, is it going to feel like a recession? So what will it feel like for the everyday American? I wonder if it's going to feel any different to when, you know, almost over the last year, with living costs being quite oppressive. Maybe you find out more and more people around you are losing their jobs, but then that will be a very much of a rolling recession. I mean, I do buy into this idea that some sectors will continue to be very strong. Other sectors will be really feeling the pain, and almost a continuation of what you've seen since last year. When housing was struggling, now it's manufacturing energy, struggling at least in the earnings side. And you're probably going to see rolling sectors, which are struggling, but maybe just a few more of them are feeling the effects by year end. What does that mean for what it's going to feel like for investors, equity investors? Well, as we've seen already, I mean, for equity investors, it's confusing now. It's pretty going to become even more confusing. And it becomes a very, very important case. If you have to pick your sector very wisely, you have to think about your styles very carefully as well. And just having a blanket view of the poor equity market is simply not going to be enough. I want to make the plug for active management. I mean, this is really the environment active management should start to thrive when you have specific sectors, which are struggling. And can you say more about what's behind your calculation for your projections? Is it that you're just thinking about how strong the labor market is or are there other factors at play too? Yes, so there's a couple of things at play. So I mean, one of the reasons that we expect this to be fairly mild, and actually not coming through in fact till, you know, towards the end of this year, is back to that consumer, back to that ex-assaving story. I think we are all very familiar with that story. But I think at some point last year there was an expectation that at least for some of the households, lower income households, ex-assavings had been completely exhausted already. But if you look at the data now, and we've just done a kind of a rejuvenation of those numbers, and it looks like they're still half a trillion to go, and that should sustain households at least until year end, potentially even longer if they start to change their behavior a little bit. So that is what really continues to support the broader economy. The thing is with the labor market is it is very tight today, but it is typically the most lagging indicator of any recession. So it's a strong, it's a strong, and then suddenly it drops, and then it spirals fairly quickly. So although it looks good today, it doesn't mean it's going to stay like this forever, which I think a lot of people are making that mistake. So we are anticipating Q4s when you start to see job losses. And it does spiral. You've also seen actually the interest rate sensitivity of the US economy is considerably lower than it was previously, partly because actually debt levels for consumers, households, businesses is lower than in previous times. So those are the kind of the key factors which are driving this not imminent recession, but also mild recession. That was really interesting in your note about the interest rate sensitivity. Could you talk a little bit more about why in this current cycle were a little bit less sensitive to higher interest rates than prior downturns? Yeah, so one of the interesting things, and I said it's coming from the UK, where actually interest rate sensitivity there is a lot higher than the US. And one of the reasons is back to the housing market, and back to mortgages. So for example, in the United Kingdom, you have a majority of mortgages are on the variable right side. So it's rates have gone up. People have really started to see their mortgage cost, their full ability Q4. Whereas in the US, there's a greater percentage of fixed rate mortgages. So the implication is, is that people just simply don't feel that pain of these fed rate hikes, which have been incredibly aggressive. But if you're not feeling it, then at least it almost doesn't exist. So that's one thing. And then once you start to look at the corporate debt imbalances, they are lower than what you've seen, certainly during the GFC, but also during previous recessions. So as interest rates rise, that debt servicing cost is not as oppressive as maybe it had been in previous times. So that is really the key reason. And I think that has actually been a process of, I guess, of understanding for a lot of economists out there, that history, of course, we look to it as a guide, but it cannot be the rule for us, we look forward. So what does that mean for the FOMC meeting next week? If we get another rate hike, does it even matter that much? It's a very good point. I would say, look, once you're getting into just additional 25 bips, no, no, I don't think it's a thing that's, it's not like it's going to suddenly push the economy over. I think the interesting part of that 25 basis point hike is the implications for market expectations. And that's really where you're seeing liquidity conditions, or I should say financial conditions, have been very easy, actually, have eased, in fact, over the last couple of months, because markets have been so certain that the Fed is going to stop hiking, that there's going to be rate cuts. But once you start to introduce another rate hike, well, potentially that could reverse a lot of this easy and financial conditions. And alongside that increase in rate hike, potentially in June, potentially in July, alongside that you should see a continued pressing out of rate cuts. And if I think about the broad equity market, one of the reasons I think, why there is some optimism, still is just this idea that the Fed will come to the rescue. So the more and more they intervene, then I think the less that becomes a truth. Income is back, and Vanack has you covered with VETFs to bring income to your portfolio. 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Bloomberg publishes over 5,000 data-driven stories a day across multiple platforms, so you can gain insight and act with confidence, ready to dive deeper, start at Bloomberg.com slash think bigger. Okay, before we talk more about what you're expecting down the line, what do you think we do get from the Fed? Because the market is anticipating the pause in June, potentially I can July, what are you foresee happening? So we have had a forecast, I think since last October, when Powell had come up with a fairly hawkish commentary, that the Fed would peak at 5.25 to 5.50. That for us means that there is one more rate hike. I would have said June, suddenly looking at the labor market data from April, suddenly there is another rate hike to come, which is going by the commentary, the kind of words that are coming out from so many of the FOMC members, they are very reluctant and quite rightly so in wanting to look for the evidence of economic slowdown. Now we talk about this long and verbal lags, well that means that they need to take the time to see how the economy is responding to the hikes so far. So I think from that perspective, it's more likely that they stop and June, and then they start again in July. The one thing that concerns me though, to be honest, is this is now becoming another consensus forecast for one more rate hike. When this are consensus, there's always a little bit of a concern around it because if you do get a continuation of hikes, maybe another one in September, that is where you start to see some negative surprises and when you've got a market which is doing so well, that is where the risks really come from. What is behind the June pods? Is it also some of the banking sector turmoil that we've seen that they are really needing to still figure out and think about? Yeah, absolutely. So as well as as you said, as well as just looking at the broader economy, how is the unemployment rate and how is, of course, how is inflation behaving? One of the key things that we've heard the FOMC talk about repeatedly over the last couple of months is what the impact of the banking crisis is going to be. And the difficulty with the banking crisis is it's actually a lot of it is down to behavioural, behavioural economics, almost how do people respond? How do businesses respond? And how do banks respond? So one of those things is very, very difficult to model. For us, but also for the Fed too. So they are having to track the data and see how lending behaviour is continuing. Up till this point actually has been fairly healthy. So that shouldn't really stand in their way, but I think they are looking for as much evidence as they can gather before they do a hike which could really unsettle by national markets. What about inflation? There's a lot of people that doubt we can get to the 2% target for quite some time. Do you think the Fed would ever redefine the 2% target? Well, first thing is they cannot redefine a 2% target until they've hit 2%. Because otherwise they lose complete credibility. So would they do it this year? Absolutely not, because I am studying the count that they cannot hit 2% in 2023. If you get a recession, well that's probably going to be your process which brings it down to 2%. And then maybe at that point they can say right, looking at the broader set of features, looking at the next 10 years or the various structural secular inflationary forces, maybe we want to shift it maybe a little bit more flexible to an half to 3%. But certainly until they've hit 2%, I think that they really risk losing quite ability. We've had a slew of strategists come on in the last couple weeks and they've been upping their S&P targets. Obviously the market's been rallying quite a bit, text talks and the broader market as well. But what do you foresee? It sounds like you would foresee a very choppy path for stocks through the end of the year. Well, so this is where I think the picture becomes extremely confusing because this recession forecast, even if you don't expect recession, but you just anticipate slowdown, that should suggest that the S&P 500 is going to be under downward pressure, right? The broad equity market is under downward pressure. That makes sense. But then you throw in the tech side and actually everything goes completely out the wind up because the math just doesn't add up. So if you believe in the strength of AI and study, maybe there's a bit of froth in the market, but if you believe that AI can continue to push tech companies forward, it's actually very difficult to see how you get the S&P 500 like below 4,000 and suddenly down to the previous 10 October lows. So I think that has been one of the reasons why you have seen so many strategists upping their S&P 500 forecasts. Just because of the tech side, the math just doesn't add up. So many for us, we are believers in the tech story. Last year we were in an underweight because of the fed hiking cycle February this year. We raised our exposure mainly for cyclical reasons. Timely. Very timely. I can't pretend to have known that Nvidia would do what it's doing. But we had a cyclical view on it in terms of there's a slowdown coming. The fed is nearing the end of its hiking path. And the broader global economies can do better than the US, and typically large cap has a greater international revenue exposure than the middle small caps. So that was the reason why we went overweight in February. But now you've got of course this amazing secular discussion around AI and the potential profits for the sector. I have to say I think it's very difficult to see this completely collapse back to what it was last year. What is the ball case on AI? Is it that companies have a bunch of cash on their balance sheets and they're going to be spending it towards AI developments? Or is it and I've seen this slightly gloomier view which is that people are thinking about AI as replacing a lot of jobs. So they're jumping into the market because they want to at least take advantage of the market upside. They want to be part of the rally even if it means that AI is potentially displacing tons of jobs. Yeah AI could be the emotional hedge. So I think it's a little bit of both. I think the rationale for having that especially to companies which are investing in AI is you know I think it's it's not just like you have in the dot-com boom. I think it's almost a fundamental change in and I guess that the way people live their lives do business is that AI is probably something which is here to stay. It's not like the metaverse. Right this is something which is a lot more meaningful and these companies have the cash on their balance sheets and I have the same kind of leverage they have brand. I mean there's so many reasons to have a positive view for AI. But I also I mean one of my lingering concerns for the broader market is you know one of the consensus views is that the next 10 years is going to be a lot more inflationary than the past 10 years and that people point to de-globalization aging the shift degree in energy. But what about AI? I mean AI and the potential job loss and we've already heard from places like IBM and the United Kingdom we heard from British Telecom which is saying that they could I think almost like a third of their workforce within the next few years. That is deflationary and that could potentially turn that whole discussion of the next 10 years and how you really want to invest from it as a strategic perspective upside down. But at least for the near term I think AI technology you need to have some kind of exposure to that in your portfolios. How resilient are these AI-linked stocks for the next six months from you know an impending recession and earnings downturn? I think they are fairly resilient to the broader economic story simply because they are typically the companies that should thrive when things get a little more challenging. It's not like they're going to completely avoid the downflow that you see for the border economy but I would expect them to outperform. The reason I'm hesitating is because there is clearly a little froth in the market. You know valuations I've just gone to extreme levels. We would anticipate that there's going to be a bit of a pullback. Once you get the pullback increase your exposure because I think this is a long-term trade but I do think that maybe the next six months could be very very choppy for a lot of things in the market. The other thing is is that if you don't see a pullback in the market at least pullback in the AI side does it drag the rest of the market up with it? Do you get this kind of melt off, this momentum, this improved investor sentiment? I think that would be dangerous because all that happens then is that you get liquidity financial conditions continuing to ease. You get a new re-bursts of inflation kind of like what you saw in the 1970s. You have new Fed hikes to come and then you essentially get a deeper downturn. So from a recession standpoint you want to get out this way sooner. The later it comes the deeper is going to be. I'm really interested in your super long-term view which is you're expecting lower returns and higher volatility. I think over the next decade maybe we can say like can you talk about that very long term view? So if we think about the last 10 years you've had an environment of very low volatility and high rates and one of the key reasons for that was because it was a low rate environment. You had low inflation, you had central banks not just a Fed but around the world keeping liquidity conditions extremely easy and as a result if you're an investor it wasn't too hard to make a positive return your portfolio. But now if you look at the next 10 years and for the reasons of the globalization, aging society, shift of degree in energy you're probably looking at a time where inflation is going to be I mean not meaningfully higher than what you've had over the last 10 years but maybe if you think that for the US inflation is average about 1.2% over the last 10 year period maybe goes up to about 2.5 to 3% over the next 10 years. That is an environment where you are moving away from quantitative easings you haven't got zero rate environment anymore and as long as you have that and it's actually more expensive for companies well then you need to make harder decisions you need to have better analysis but ultimately that is an environment where you have lower returns and higher volatility. You need to be a little bit more exotic I think in terms of how you're thinking about investing. Can you just stick to the traditional asset classes or do you need to start thinking a little bit outside of the box? So I think that the next 10 years is going to be harder but potentially more interesting as well. I like that word exotic. What's your highest conviction exotic? That for the long term. Yeah okay now this is not going to sound exotic at all but Treasury bills. Cash. If you want to get any kind of strong returns in your portfolio beyond beyond I think study what you can make on any kind of traditional equities public equities public fixed income then you have to start considering about considering privates and ideally you're going to combine two things together. That's emerging markets and privates and I think there is a lot of potential there but you have to look beyond the next year or so because there will I think be a lot of cyclical concerns as maybe the public witness catches up with the private, catches up for the private market but then you're taking a 10 year perspective. So do you want to have a position in some new found companies which are going to be benefiting from a growing middle class, a catch up economy and ideally based something on technology? Income is back and Vanack has you covered with VETFs to bring income to your portfolio. Find the yield, duration and credit exposure you're looking for from Vanack's range of income focused ETFs which includes municipal bonds, corporate bonds, international bonds, equity income, floating rate instruments and multi-asset income. With Vanack's income investing yield monitor at thinkyield.com you can easily track Vanack's ETF yields as well as the monthly flows and performance of each income ETF category. Take advantage of the back to income play. Explore Vanack's income ETFs at thinkyield.com and find the right ETF for you. Investing risk includes principal loss. Pass performance is no guarantee of future results. Visit Vanack.com to view a prospectus that includes investment objectives, risks, fees, expenses and other information that you should read and consider carefully. Vanack ETFs are distributed by Vanack Securities Corporation, a wholly owned subsidiary of Vanack Associates Corporation. The race to shape Africa's future is a contest for influence, access and alliances across a continent. Rich in culture, abundant in natural resources and bursting with human potential, Africa is primed to become the next hub of global industry. On June 13th and 14th, Bloomberg New Economy gathers leaders to confront the pressing issues facing Africa's economy, rising food and energy prices, supply chain shocks and financial constraints. Watch the event live from Morocco at BloombergNewEconomy.com. Well, I was going to ask you to give us your overview of what you are seeing internationally as well and maybe what areas you're concerned about or what you are currently liking. So at the moment, we have had, I think, a generally constructive view on China. We are disappointed, of course, by the economic story in the last couple of months is really being quite disappointing. And yet, if you look out over a longer term perspective, again, maybe the next six months are tough, but if you're looking out maybe over two, three and obviously a longer term horizon, I actually think the China story is quite a constructive one again. And the reason is is that what we've learned from the Chinese government over, I think the last five years, but it's kind of gone a little bit behind the scenes because of COVID and the various lockdowns, is that they are aiming for a more stable economy. They don't want to have the boom bus cycle. They don't want to have an economy which is addicted to leverage. And as a result, their stimulus policies are not going to be driving incredible growth rates and then sharp drops. So we are not anticipating very significant stimulus in the second half of this year. This is a government which is aiming for fairly stable and I guess a little bit boring growth. But the benefit for an investor over the next over a year, longer term horizon is that this is a more stable economy, which avoids a lot of the pitfalls that I think investors have fallen into previous years. So we do like China, I guess, from a longer term perspective. Well, Sima Shah, Chief Global Strategist for Principal Asset Management. We want to thank you for coming in, but you're not free to go yet. I call this the taking our guests for hostage part of the show because we're going to be playing some games. I think games. Yeah, I have a game for us. Take time. Yes. But first, I think both of you have come very well prepared for crazy things we saw in markets. Emily, I'll have you go first. Okay. So the relatively new Amazon CEO, Andy Jassy, is cutting a number of projects, side projects that Amazon during the Jeff Bezos era came up with. Bloomberg had an article last week about 37 of the projects that they have cut over the last few years. The craziest one I saw was Amazon Books. It was a physical bookstore by Amazon. I think I remember this. So they closed this last year. So I'm a little late to it, but I didn't see it until the article last week. But how ironic is that that Amazon? Were there any actual physical bookstores? They had, they were just planning. They had 24 physical bookstores. And then closed them down. Were any of them in New York? I'm not sure about that. I know one was in Seattle, I believe. I think that was the first one. I've still never been to one of those stores where you just grab stuff and leave. You just steal it in the morning. Yeah, you just steal. Is that what you do? Just bring a big bag. I don't think I've ever been in one of those either. There's one across the street from us, actually, from the office, and I've never been. We should go. See my word about you. Okay, so this one is maybe it's a little bit concerning, I think. So we know that Europe is ahead, I think, with regards to the ESG discussion. Maybe taking a bit of a back foot in the US. But so recently, and I saw this on the Bloomberg terminal, it was, I did a bit of a double take for my saw this and I'm clicking on it. And it turns out that one of the German states, one of the richer states, has decided that under its new ESG legislation, they are putting US treasuries on the investing blacklist. Oh, because of America's failure to ratify a number of treaties, ending like women's rights, controversial weapons, and probably down to the ESG perspective. Which state was it? I wish I could pronounce it. Now, you put in me on the spot. This is why I did, yeah, button word to bug with an English accent. That's really interesting. I think Sima says better than yours. Sorry. I liked mine. It was a ironic business, you know, business is coming full circle. Okay, it's time to play the price is precise, which I have such a hard time pronouncing. The rules are exactly the same as a little game called the price is right, but we can't call it that. So we call it the price is precise. Okay, we all know Taylor Swift has been on tour for a couple months now. I didn't get tickets, super hard to get. Did you get tickets? You're not a big Taylor Swift fan. But I want to play, I want to ask both of you to guess how much she, the concert is expected to gross, and then how much she of that gross amount actually gets to keep. Emily, you go first. Oh my gosh. I have no idea. The whole like the whole tour or one single concert? The whole tour. Crickets. I don't know. 500 million. And then how much she makes? How much she keeps? 50 million. Sima. So I should do what I used to do with my brother. I just go like $1. Or no, if you go over, then you lose. Oh, you lose. You're supposed to go $1 lower, I think. Maybe, what if it's more like so? Unless you're super sure. Now you made it more complicated. I'm re-strategizing everything with my brother. Okay, I'm going to go with 450 million. And I reckon she makes more of it because didn't tell us we've taken back control of all of her records. So I'm going to say she made like 50%. That's aggressive. Maybe 30%. Is she a big deal in the UK? Oh, yes. Yeah, absolutely. Yeah. Okay. Alexa is very much accustomed to playing tennis. Oh, that's nice. For you, she gets a lot. For you, right? Yeah, for my daughter. Okay, you were both actually very close. It's expected to grow $620 million. I tricked you a little. You did. Sorry. I couldn't want. I had to spice it up a little. You helped me a lot. However, she's keeping 500 million of it. Oh, wow. Good for her. But you guessed 10 billion at first. It's her all day. 10 billion. Well, I know some people have been paying a lot for the ticket. 10 billion. I can't eat it last week because saying the ice cream was going to cost like $500,000. Oh, my God. Okay. Seema, thank you so much for coming in. It's been great to have you. Oh, thank you. Have a back on. And actually see you in person too. Thank you very much. What goes up will be back next week until then you can find us on the Bloomberg Terminal website and app or wherever you get your podcasts. We love it if you took the time to rate and review the show on Apple podcasts. So more listeners can find us. And you can find us on Twitter. Follow me at Reganonymous. Valdana Hierarch is at Valdana Hierarch. You can also follow Bloomberg podcasts at podcasts. What goes up is produced by Stacy Wong. Thanks for listening. See you next time. The race to shape Africa's future is a contest for influence, access, and alliances across the continent. Rich in culture, abundant in natural resources, and bursting with human potential, Africa is primed to become the next hub of global industry. On June 13th and 14th, Bloomberg New Economy gathers leaders to confront the pressing issues facing Africa's economy, rising food and energy prices, supply chain shocks, and financial constraints. Watch the event live from Morocco at BloombergNewEconomy.com.