This is an audio transcript of the Unhedged podcast episode: ‘Cool markets, hot takes

Ethan Wu
US markets finished December with a bang and are starting January with a whimper. Stocks are down just about 1 per cent in the few trading days we’ve had so far in 2024, with Big Tech leading the way down. Apple, for one, is down 5 per cent after getting downgraded by some analysts. And the bond market is falling too. Yields have risen 12 basis points on the long end so far. Today on the show, we’ve got thoughts. This is Unhedged, the markets and finance show from the Financial Times and Pushkin. I’m reporter Ethan Wu here in my mother’s closet in Sacramento, California. And on the other end of the line, all the way from New York, which I missed dearly, one financial commentator, Robert Armstrong.

Robert Armstrong
What are you looking at right now? What you got in the closet, Ethan? Is it like linen? Is it like sheets or is it women’s clothing or . . . What are you looking at?

Ethan Wu
It’s mostly women’s clothing. My mom likes reds and blacks, I think, just judging by the colour spectrum in the closet.

Robert Armstrong
Right on. I’m sure she’s a woman of immaculate taste.

Ethan Wu
Absolutely. Absolutely. I am, I think, contractually and cosmically obligated to agree with that. How was your New Year’s?

Robert Armstrong
I had the most New York possible New Year’s Day.

Ethan Wu
Is that right?

Robert Armstrong
Yeah. I went to Coney Island. I did the polar plunge with my kids, and then I went to Nathan’s Hotdogs and consumed a chilli cheese dog. And then I rode the cyclone rollercoaster. Then you get your official I’m a New Yorker card after you do that trifecta.

Ethan Wu
Wow. Did you have any moments where you felt like you were gonna throw up on the rollercoaster?

Robert Armstrong
Almost the entire time in all three steps, but that’s irrelevant. It was a good kind of nausea.

Ethan Wu
Speaking of things that are plunging and/or puking, stocks, Rob . . . 

Robert Armstrong
(Laughter) Yes, stocks!

Ethan Wu
It’s been just over two trading days here in the US and stocks are down. Yesterday, it looked like they were going to be down about 2 per cent. Today, they’ve gone up a bit, more like 1 per cent. But, you know, I think any way you cut it, it’s been a bit of a damp squib so far this year, led especially by some of the Big Tech stocks. Apple so far this year, down more than 5 per cent. Not a great showing for Apple and for Big Tech.

At the same time, you know, bond yields nudging up a bit. We closed out 2023 with the 10-year yield falling. Now we’re closer to 4 per cent, up about 12 pips so far this year. I don’t think it’s quite the start that market participants were expecting. You know, it’s got us thinking about, you know, what should we be looking for in these markets to try to answer some of the questions we were left with in 2023?

Robert Armstrong
OK. So a little tightening in the cost of long-term money. And I think that’s gonna be a huge theme for the year. Obviously, it’s come down from its kind of near-5 per cent highs. And while much of our attention and the attention of the market has been on the short end of the curve, on what the Fed is going to do with its official policy rate, I think a lot of what happens in weeks to come and indeed for the rest of 2024 is gonna revolve around what we see at the long end, at 10 years and longer.

Ethan Wu
Yeah, I mean, there was a period last year where I felt like most market participants had like a co-ordinated long-term yields freakout where everyone was talking about look at the deficit, look how huge it is. Inflation, it’s not coming down easily. And then, you know, we crossed 5 per cent one day on the 10-year yield, which was like a holy shit moment, right? And you know, we’ve retraced more than a full percentage point from that, you know, point-crossing 5 per cent.

Robert Armstrong
I hear you. But the other thing to remember, though, is how far we are. So inflation, and I say this with mild exaggeration, is now back at its target-ish, right? The 10-year yield is still 2-3 per cent higher than it was in the pre-pandemic period, the post-financial crisis pre-pandemic period. So part of what is going on there at the long end is not captured in the discussion of inflation and the Fed’s policy rate. There’s something else there that we have to talk about.

Ethan Wu
That’s a really important point, that if we continued to get good inflation news for the rest of the year and the Fed declares victory and starts cutting, it’s not clear that the 10-year has that much more to fall. Maybe a little bit, but we’re pretty close to target here. The latest inflation report, I think, had a lot of people looking at soft landing on a six-month annualised basis. Core PCE inflation, which is the Fed’s kind of preferred target, is at 1.9 per cent. That’s quite good. I mean, that’s on target, essentially.

Robert Armstrong
More and more people are just saying this is the soft landing. You know, a month ago people were saying, it looks like we’re there. Now, I’m talking to more and more people who say like, here we are, soft landing, done. It’s in. Which makes the higher 10-year all the more interesting.

Ethan Wu
There’s another factor that goes into long yields, which got a lot of discussion last year, which is the fiscal outlook, right? What is government spending doing? Obviously, you know, bonds are issued by the government. They’re pretty sensitive to what’s going on with tax policy and government spending. And as the US government is borrowing more and more, these kind of like record peacetime fiscal deficits that some argue has pushed the long year up as investors, you know, demand more return for investing in government debt that’s kind of swelling in supply.

Robert Armstrong
Yeah. I mean, I think that’s the right way. Supply is the key term here, the prosaic way to understand this, I think the correct way to understand this in terms of supply and demand. Higher government deficits equals more issuance of government bonds versus what all else being equal is a stable demand for said bonds. The price has to fall for those two to match, as it were. And that means yields have to rise because as we often have to write in our business, prices and yields move in opposite directions.

Ethan Wu
But here’s the weird thing that I don’t know if I totally get, Rob, is, you know, last year, again, it’s kind of peak moment of fiscal freakout. There was a big increase in what’s called the term premium, which is, you know, how much additional yield does a long-term bond have to pay versus maybe a shorter-term bond. And that grew pretty large a couple of months ago. Last year, again, when we were all talking about deficits, but the term premium has basically totally vanished. And it’s been so remarkable that it actually got mentioned in the Federal Reserve meeting minutes that were published just the other day, you know, because all the Fed governors were like writing and talking about this again mere months ago. And now it’s totally vanished.

Robert Armstrong
I’ll give you a theory which we heard yesterday. We spoke with Bob Michele, who’s the co-CIO of JPMorgan Asset Management, and he is kind of the biggest fixed income guru there at JPMorgan. And his view is everybody is in a complete panic because the government spent a lot of money during the pandemic, as it should have, by the way.

But if you think back to prior historical episodes, the ability of the US government to get back on solid fiscal footing is pretty impressive. He’s been in the business for a long time. And he was talking about when he came in in the early ’80s, he came into the business. Everybody said the US government is never gonna pay single-digit yields on its debt ever again because the fiscal situation is a disaster. We’re never gonna have another balanced budget. Cats and dogs living together — it is chaos.

But 10 years later or 15 years later, yields had collapsed. It was the Clinton administration, and by God, we had a balanced budget. So all the gloom and doom about the US fiscal situation and the attendant hysteria about long-term bond yields may be a bit overstated.

Ethan Wu
Rob, in this vein, talking about the fiscal picture and inflation affecting long-term yields, there’s a related question that I think is very much live in these markets, which is the correlation between bonds and equities. And this is, I think, as close to a fundamental market relationship as you can get. Do bonds and equities travel together or do they travel in the opposite direction?

Robert Armstrong
And importantly, we want them to travel in opposite directions, right? Because then the two parts of our portfolio, the bond part and the equity part, hedge each other nicely so we can sleep well at night knowing that if our equity portfolio stinks, our bond portfolio will be doing well and vice versa. And so it helps us reach the efficient frontier and maximise returns over time and lets us sleep better.

Ethan Wu
Exactly. And if it’s not true, if the correlation is positive, that entire investment formula is kind of defunct. And that’s what we saw in 2022 when bond-equity correlation started to trend in a positive direction. And you know, over the span of ’23, we saw some concerning correlations pop up. There’s like a million measures of this, and we can argue about which one to look at. But, you know, one that we looked at in the Unhedged newsletter was rolling two-year returns between the S&P 500 and long-dated Treasuries. So that’s a very slow measure of correlation. It takes, you know, 500 trading days into account. And that turned positive for the first time in November ’22 and stayed positive for most of ’23. And again, the concern there is if you had the returns on your bonds are doing badly at the same time returns on stocks are, that’s not great.

Robert Armstrong
Nobody had very much fun in 2022. I think it’s important to emphasise that the key factor in this relationship usually — and there’s always confounding factors — but usually, the key factor is inflation. And to simplify, neither bonds nor stocks particularly like high inflation. So when inflation is high or the risk of inflation is at the forefront of investors’ minds, the probability that neither asset class will perform well rises dramatically. So the question we’re facing right now is inflation at or close to target again. Are we going to see that correlation go negative again in the way we want it to?

One thing we’ve learned in the last year, right, is that when we were thinking about inflation and what it was gonna do and how long it was gonna last, we thought way too much about the ’70s and early ’80s and how inflation was very persistent then and how it was very unstable then and went up and down and hung around. And it may just be that the pandemic-related inflationary incident is not like that huge inflationary incident in the ’70s and early ’80s that captures so much of our imagination, right, that we think about so constantly. Maybe we ought to get rid of that model and realise this was a burp, as you put it, and inflation anxiety is gonna die down. Bond-stock correlation is gonna go negative and we can be happy with our 60/40 or 70/30 portfolio again.

Ethan Wu
Yeah. That’s the optimistic view anyway. And it’s something we’ll definitely be looking at in these markets. So far, though, to begin the year, stocks down, bonds down. Pretty simple. Well, I did mention at the top, Apple’s been one of the big losers so far in the few trading days we’ve had this year.

Robert Armstrong
Mag Seven generally, right? They’ve all, they haven’t behaved well at all.

Ethan Wu
No, it’s not been a great start to the year for most of the Mag Seven. And I think there’s, you know, we came into 2024 having in recent years seen kind of both sides of the Mag Seven. We saw in 2020 and 2021 during the kind of, you know, the go-go mania of the immediate lockdown era where everyone’s at home and has stimulus checks, the Mag Seven went absolutely crazy alongside most of the market. But it was led very much by these tech stocks. Then the second that interest rates started to go up or that threat began to materialise, they got absolutely crushed. Like, Meta was down like 70 per cent at the absolute worst.

And then, you know, we entered kind of a weirder era. As inflation and interest rates begin to level off a bit, Big Tech became kind of defensive. It became, you know, the place that you would go when you weren’t totally sure about things. And that was clearest after, you know, Silicon Valley Bank failed. Big Tech outperformed the market and continue to do so for some amount of time despite the uncertainty in the broader economy. I mean, these were all kind of very different profiles for these stocks.

Robert Armstrong
I mean, I think a great question for the year to come is this: what exactly are the Magnificent Seven? Not thinking about them individually, what their businesses are, what differentiating factors there are among them but as an asset class, which is clearly how Wall Street treats them at this point, what are they? Growth stocks? Are they a momentum play? Are they defensive? Are they an interest rate play? We all know these stocks are tremendously important. We all know they delivered a disproportionate amount of returns of the total stock market return over recent years. But what are these things? What are they in their essence, I want to ask, hearkening back to my training in graduate school in philosophy. What are they in themselves? And I really don’t know the answer to that question.

Ethan Wu
I mean, the weird thing about them, right, is that like in general, the stocks that have a lot of like growth potential in 10 years are not supposed to be very profitable today. And that is not the case with most of the Mag Seven. These stocks have the one-two punch of being both ridiculously, absurdly profitable right now and also having totally plausible double-digit growth potential for years and years to come. That is just like a feature you don’t see in most stocks.

Robert Armstrong
Although we’ve had a couple of analyst downgrades of Apple this week, people saying maybe the growth picture isn’t so rosy.

Ethan Wu
On the other hand, though, to channel our colleague Elaine Moore, how many times have people predicted, you know, peak smartphone saturation and it just never comes and Apple’s rolling out the, you know, sexy new VR headsets.

Robert Armstrong
If Apple smartphone sales finally peak and start to roll over, my prediction from about 2014 will finally be correct and I will be vindicated.

Ethan Wu
(Laughter) Not wrong. Not really.

Robert Armstrong
(Laughter) Just early. I was just 10 years early.

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Ethan Wu
On the Unhedged podcast, we aim to be both wrong and early. (Robert laughs) It’s the hardest thing to do, actually. It’s harder than being right. On that note, we’ll be back in just a second with Long/Short.

Welcome back. This is Long/Short, that part of the show where we go long a thing we love, short a thing we hate. Rob, I’m feeling short commercial real estate. And, you know, unlike most of the market . . . 

Robert Armstrong
That call was late. You should have been short commercial real estate three years ago. You would have made a bundle.

Ethan Wu
I know, I know. And here’s how I feel, right? In 2023, the market, I would say, was like drastically, drastically short commercial real estate. A bunch of, you know, real estate ETFs sold off like crazy. People were freaking out and some people thought it could be a potential crisis catalyst.

And, you know, we were really in the camp that this doesn’t look like a crisis in the making. There’s a lot of structural features that insulate the broader economy from problems in commercial real estate.

And in the meantime, the market has kind of changed its tune and you’re seeing regional banks and real estate ETFs kind of bounce back. I think that may be overdone potentially and there could be a kind of, you know, market correction in the wrong direction at this point because the problems in commercial real estate are they’re not catastrophic. It’s not going to bring down the economy, I think.

But they’re real problems, right? Remote work remains a feature of the way that we do business. Higher interest rates are still around. We’re not going back to zero or 4 per cent on the 10-year. And people built way too many apartments in certain markets right after the Covid boom, especially in places like Miami and the Sun Belt. Those are gonna come home to roost and there’re going to be investors taking losses. I think you’re gonna see more of that start to materialise this year, even, again, if it’s not a catastrophe for the whole economy.

Robert Armstrong
Yeah. Well, I have an extremely tentative long. I looked yesterday for yesterday’s newsletter. I looked at Alibaba, which for a long time was a, you know, a darling global company. It was the leader in Chinese ecommerce, a bit like China’s Amazon, although their business models are slightly different.

And it has had a horrible couple of years, the stock price falling like 75 per cent. They had a reorganisation plan to simplify what had become an extremely sprawling business that seems to have come off the rails. Of course, we know that the Chinese Communist party has not taken a very friendly attitude towards tech companies within China. The story of Jack Ma, the founder’s sort of public shaming, is well known at this point.

But I wonder if now it’s all been a bit overdone, if the company operationally can’t get back on the rails. And perhaps equally importantly, the party softens its view towards the tech industry a little bit in the year to come. Is it possible that it is the exact moment of maximum darkness for Alibaba and a tiny bit of light about its future might come through? And at those moments, stocks can really move.

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Ethan Wu
Yeah, for sure. Well, Rob, thanks for being here. We’ll have you back very soon. And listeners, we’ll be back in your feed on Tuesday with another episode of Unhedged. Catch you then.

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Unhedged is produced by Jake Harper and edited by Bryant Urstadt. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhecz. Cheryl Brumley is the FT’s global head of audio. Special thanks to Laura Clarke, Alastair Mackie, Jacob Weisberg and Jess Truglia. FT Premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to FT.com/unhedgedoffer. I’m Ethan Wu. Thanks for listening.

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