00:00Is it a little bit of a concern that we've seen such a gain, particularly in the belly and the
00:05back end?
00:08The flip side of rising yields is durable income, which is becoming a more important theme for portfolios.
00:15But certainly rising rates is a concern for risk assets more broadly.
00:21So what we have seen so far this year really has been a tug of war between how quickly earnings
00:29on the one hand can grow versus how quickly rates are rising if earnings can outrun rates.
00:36So this is a key consideration for equities and the fact that equities so far this year have held up
00:43really well and continue to push new highs through summer despite rising rates is because of strong earnings.
00:49But on the other hand, as some of these large companies, hyperscalers, they run down on their free cash piles,
00:56cash piles and free cash flow.
00:58They become more sensitive for rates, which is why we're having a more nervous start to September as we get
01:05back to school.
01:06Yeah, lots of ripple and knock-on effects.
01:09Wei, what woke yields up?
01:11Because this was before we were looking forward to Jackson Hole.
01:14You know, it was there for some time, but we really sort of had that big reaction before Scott Besant
01:22intervened.
01:23I mean, there was a, you know, a massive move at the back end of the curve that really became
01:27quite concerning.
01:31Absolutely.
01:31So what we have seen is that Walsh's speech at Jackson Hole was interpreted as a bit more hawkish, which
01:40is also why September rate hike probability has gone up from previously almost 50-50 to now just shy of
01:4770%.
01:48But the big picture is that long rates are binding, how governments fund themselves and the interest rates that it
01:56pays, which is why, you know, as we think about what drives long rates, term premier drives long rates and
02:03feds credibility drives term premier.
02:05So Walsh needs to have credibility first and foremost before he can do anything, which is also why his speech,
02:13somewhat hawkish interpreted last Friday, needs to be also read in that context.
02:18And you talked about Besant.
02:20So the rising long end is a key focus for the Treasury as well.
02:25So the yen intervention and doubling of buyback need to be read in that context as well.
02:31And to that end, if you look at dollar-yen, is heating 160 again, which is a key thing to
02:37focus.
02:38But heading into September FOMC, you know, obviously we have NFP this Friday, which is going to be critical.
02:44But we actually think that they are going to try to stay put if they can to have some optionality
02:49on the table.
02:51Will the bond market be quiescent if they do hold pat in September?
02:55I mean, it really feels like the pressure is building and even more so after Jackson Hole, you know, how
03:01much longer can the Fed chair tease us about being committed, Wei?
03:07Well, he is really trying to gain credibility from his speech, which is why he came across a little hawkish,
03:17because if markets are expecting that anything leans against that, actually term premier would reprice.
03:23Yes, right. So that's important context.
03:25But as we think about September, non-farm payroll happens before that.
03:30And that's probably the most important non-farm payroll in a very, very long time.
03:35So July, we had negative headline growth and also negative revision to previous month payroll as well.
03:44Yes, unemployment rate had fallen, but that is also because of falling participation.
03:49So actually, the drop market may give out enough ambiguous kind of cover for the Fed to stay put.
03:59But obviously, this Friday's non-farm payroll is going to be critical and decisive.
04:04And not to forget, inflation is not on target.
04:07So there is a pent-up pressure for sure, which is reflecting the supply constraints that we face in this
04:14new regime.
04:15But again, as it translates to investment, high for longer, durable income as a portfolio theme is going to be
04:21such an important anchor as we face all this uncertainty from the macro picture.
04:26When you talk about term premia needing to go higher with all of this uncertainty and inflation risk, Scott Best
04:34and the Treasury Secretary obviously suggested that the bond market was not reflecting reality or that it was, quote unquote,
04:41mispriced somehow or that maybe the term premia shouldn't be so high.
04:46What do you make of his sentiments and how accurate they were?
04:52I mean, what is this bond market pricing if it's not reality?
04:57Well, right now, term premia for 10 years is about 80 basis points if you look at the ACM model.
05:04It has come a long way from minus 1% around four or five years ago.
05:10But if we look at historical levels, term premia 1%, 1.5%, those are not terribly high levels.
05:21So in a historical context, current term premia over 80 basis points is not high.
05:26One might even argue, given fiscal trajectory, given inflation uncertainty, and also given international investors' appetite for holding government bonds,
05:37U.S. treasuries in portfolios, term premia is low.
05:40Which is why in our longer term capital market assumptions, we're looking at term premia north of 125 basis points
05:48to 150 basis points to actually reflect where we're heading towards in terms of the indebtedness.
05:55But I have to acknowledge as well that term premia repricing has come a long way from recent low.
06:01But recent low is extraordinary by historical standards.
06:04Well, actually, so you point out that the average yield in your strategic portfolio is now 5.6% and
06:12five years ago that was 2.3%.
06:14So that is a fascinating move.
06:16But are bond investors in any way incentivized to own duration risk or credit risk at this point?
06:26Right now, from a total portfolio perspective, we prefer equities over credit over government bonds because of the dynamics of
06:37insurance, but also because of the risks around term premia needing to reprice.
06:42Having said that, there are good income opportunities within fixed income that we do want to lean into.
06:51So specifically, a preference for front and belly of the curve over long end of the treasury market and also
06:59preferring quality income in credit space.
07:02And we also have an overweight in emerging market debt as well.
07:05And I must also say that income is not to only come from fixed income.
07:10There are option type of strategies that extract income for equities to an income within private market, such as infrastructure
07:19debt, private credit, are interesting in this whole portfolio context.
07:24Yes, you mentioned that and also that investors are, select investors at least, are looking at derivative strategies to hedge
07:31some of this risk so they don't have to be overexposed to something like utilities, right?
07:35Or what have you.
07:37You say you still prefer US equities over everything else, though.
07:41And I'm curious, you know, is that just the broad index?
07:45And at some point, won't these rising term premia impact those indices and have stocks sell off?
07:54Well, US equities right now, by recent year standards, are not stretched in valuations.
08:02So S&P 500 is 22 times forward P just above and Magnificent 7 below 20 times forward P, which
08:10is a recent year low.
08:11So from a valuation perspective, yes, versus the long history average, it is stretched, but versus recent year average since
08:20the launch of ChadGPT, it is not stretched.
08:23So valuation is not that stretched.
08:25That's point number one.
08:26Rising rates is a concern.
08:28We talked about earlier on how higher rates ought to correspond to a lower multiple.
08:33So this is a tug of war between earnings and rates and also as hyperscalers, they run down on their
08:38cash power.
08:39They become more rate sensitive.
08:41There is a concern.
08:42But the reality is that earnings momentum continue to be very, very positive.
08:47The positive and application cases for AI is broadening out.
08:52Adoption is broadening out.
08:55What we have seen over summer, commoditization risk from cheaper Chinese models have not impacted valuation of these companies, including
09:04private companies looking to go public.
09:08So implicitly speaks to really significant addressable market, which is the whole bet of AI.
09:14So we still stay invested in this overall theme.
09:18All right.
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