00:00You've dived things back just a bit, slightly less bullish.
00:02What's weighing on you heading into year end?
00:05Yeah, well, the key point in terms of what I've changed is I'm thinking it's going to take a little
00:11longer to get to 8,400.
00:14I don't think it's likely to happen by the end of the year now.
00:17I think it's more likely to happen by the middle of next year.
00:197,900 is still obviously above where we are now, so it would still give us an awfully good year
00:25of returns.
00:25But the issue for me is geopolitical developments have deteriorated.
00:31The war in the Middle East has escalated, and we're looking at higher for longer oil prices and higher for
00:38longer oil prices.
00:39Increase the odds that some of that inflationary pressures from energy will spill over into core prices, as Bill Dudley,
00:49your interview with Bill Dudley, excellent interview, indicated.
00:52And then, in turn, we have not a one-and-done situation here with the Fed.
00:59We've got a situation where we're likely to have another one or two increases this year.
01:06And then the bond market is concerning.
01:09My friends, the bond vigilantes, have kind of gone wild all around the world.
01:13And I'm particularly concerned about the unwinding of the carry trade in Japan.
01:19The U.S. officials keep putting pressure on the Japanese to increase their interest rates at a faster rate, which
01:28makes sense from a macroeconomic standpoint.
01:30But, unfortunately, we may find out that this leads to more unwinding of the carry trade, which means hedge funds
01:38that borrowed in Japan at very low interest rates, when the yen was getting weaker, now we'll flip around and
01:47say, you know, that financing is just too expensive now, too risky.
01:51So, Ed, you gave us three things to think about there.
01:53Let's unpack them all.
01:54So, you said geopolitics and what happened with oil.
01:56You talked about what it means for monetary policy and the spillover to the bond market.
02:00Can we just stand on the first one?
02:01Does the first one inform the other two?
02:04How dominant is the situation in the Middle East?
02:06And to the people watching this at home that have become desensitized because it's gone on for seven months and
02:11they don't think it matters anymore, what's your message to them?
02:13Well, look, we're back at 100 and everything was just hunky dory when we came back down to about 80
02:22or so a few weeks ago.
02:24But the problem is that everybody thought that this war in the Middle East would be over pretty quickly, especially
02:31at the beginning of the war when the leadership of Iran was decapitated.
02:36I thought the same thing for about one day.
02:39Then I thought about it again and I said, well, wait a second, the IRGC are professional terrorists that are
02:44basically running a country and they've got praxies all over that neighborhood.
02:50They're not going to give up just because they're getting bombed from the air.
02:54Military history shows that that just doesn't work.
02:57You need boots on the ground.
02:59And so here we are in a situation where we're approaching the midterms and the Iran has a great incentive
03:08to create more havoc to keep the price of oil up because they obviously would like Trump to lose his
03:15majorities, Republican majorities in the House and in the Senate.
03:19Do you think that stocks are going to take longer to get to some of your loftier goals because of
03:24oil prices or because of rate hikes?
03:27Well, I think it's a combination of everything.
03:29You know, the nice thing about being a strategist is it's pretty simple.
03:34It's P-E times E.
03:35It's the valuation multiple times earnings.
03:38That's easy to do.
03:40Getting it right is the tricky part.
03:42I think the E, the earnings side, looks great.
03:44I mean, the economy is doing great.
03:46You know, I remain fundamentally bullish, but even more bullish have been the analysts because the companies have been reporting
03:54great earnings.
03:55So it's all about the valuation multiple.
03:58And as you know, as earnings expectations have increased, and I call a FIMO, a fabulous earnings momentum, the valuation
04:07multiple has actually gone down because investors are getting a little bit shy about paying for this remarkable outlook for
04:15earnings.
04:15And oh, by the way, the whole AI story has become a little bit more questionable.
04:20That's also sort of being delayed, if you will, or pushed out.
04:24And I think that also affects the valuation multiple because a lot of these AI stocks have very high valuation
04:29multiples.
04:30I want to pick up on something else that you were talking about with John, which is the unwind of
04:35the yen carry trade.
04:36And you're concerned that it could get kind of messy if you see the Bank of Japan hiking more significantly
04:42or responding to pressure from around the world.
04:44What does that look like?
04:45What gets penalized the most in that type of scenario?
04:48Well, I think actually we've been seeing it.
04:50When you look at the global bond route, when you look at how bond yields have gone up just about
04:56everywhere except maybe in China, what I think we are in fact seeing is a significant unwinding of that carry
05:04trade.
05:05Hedge funds, as I mentioned before, they went and borrowed at close to zero in Japan, got the proceeds in
05:13yen, converted them to other currencies and bought government bonds and other assets around the world.
05:18And I think that's probably one of the best explanations for why this has been a global route, because the
05:25hedge funds took the money and invested it all over the world in areas where they thought they'd get a
05:31good carry trade opportunity.
05:34And that's unwind may not necessarily be over.
05:38What are the pockets of vulnerability that you can identify this morning for us, Ed?
05:42Heading into the BRJ.
05:43Where do you see pockets of vulnerability in the market as you unwind that carry trade?
05:47Where do you still see them?
05:48Well, I think the clear tracks or fingerprints of the unwind would be in a coordinated increase in bond yields
06:01around the world.
06:02That's what we've seen.
06:04So, I mean, I think the BOJ decision up ahead here and what they do, will do.
06:12If they only do a quarter, then I think maybe that'll keep the carry trade from unwinding faster.
06:19But if they go and surprise and do 50, that might be more of a shock.
06:23So, I think the reaction to the BOJ report will be very important.
06:28So, Ed, just to get this clear, the more hawkish this BOJ is, you believe the more vulnerable the global
06:33bond market is?
06:35Yes.
06:36Yes.
06:36Yeah.
06:37And the ironic thing is our officials, especially Treasury Secretary Scott Besson, is pushing them to be more aggressive.
06:46More aggressive means they'll be raising interest rates more, their short-term rate more aggressively.
06:50And that would obviously strengthen the yen, two things that clearly stimulate the unwind.
06:58So, clearly, just to sort of put a pin in this, Ed, you don't think that this is a good
07:03time to be applying long-term bonds ahead of that Bank of Japan decision?
07:07I wouldn't do it right ahead of the Bank of Japan decision, no.
07:11But I think, let's see what happens after that.
07:14I do think that looking out six, 12 months or 10 years on a 10-year bond, 5% is
07:21going to turn out to be a very good return.
07:23But for now, I'd like to sit on the fence the way the 10-year is sitting on the fence,
07:29which is kind of sitting in that 5% fence.
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