SHOCKWAVE: Market divergences keep DRAWING attention

[00:00:00] Speaker 1: I'm going to bring you now, Gabriela Santos, she's the chief market strategist for Americas at J.P. Morgan Asset Management. So this, your mid-year outlook, what does this mean, the divergence is everywhere? What exactly does that mean? [00:00:12] Gabriela Santos: So take your manufacturing PMI survey, which on the surface, absolutely nicely above 50, accelerating and improving over the past few months. But if you look beneath the hood within manufacturing, if it's not AI CapEx, there's nothing going on. The rest of manufacturing is kind of moving sideways, residential, still soggy. So huge divergence within manufacturing and investment spending. [00:00:37] Speaker 1: And even in this number, employment was at a record six-month low. And I'm seeing other side articles talking about robots and bringing in the technology. Could that also be part of what you're talking about with this big technology slash AI divergence, you know, sort of changing all the story? [00:00:55] Gabriela Santos: At the moment, we see it primarily affecting the real economy on the CapEx side. So AI CapEx, boom, showing up in the numbers and lifting overall GDP. We think here re-acceleration in the middle of the year of around 3%, second and third quarter. When it comes to the labor market, it still seems to us a bit frozen. It's still low-hire, low-fire, but we're watching to see if there are more sectors picking up. [00:01:21] Speaker 1: High-income consumers, you know, there's a political side to that. You know, when the top 20% do X amount, 50, 60%, depending on 40% for, okay. You know, some people, but at the same token, they're keeping us afloat. And the tax refunds, you say, have had to sort of offset gasoline prices. [00:01:39] Gabriela Santos: Yeah, so we were expecting more of an improvement from the consumer this year because of the tax refunds. So you were supposed to see a broadening from the high-income lift to the other parts of the household area. However, you haven't seen that because below the top 20%, the refunds were fully offset by the increase in gas prices. [00:01:59] Speaker 1: Is it too late now? Let's just say we started with that crude oil chart. We're 72. We get a six-handle. Let's say gasoline comes out dramatically in the second half of the year. Is it too late for the average consumer to benefit from that? [00:02:10] Gabriela Santos: I think if we get below where we were, where we started the year, something a little bit closer to $60 or below, or meaning, you know, a low three-handle of gasoline, I think that would be helpful again. If not, you're still up about 30% year over year. But it certainly is helpful that we seem to be stabilizing here. [00:02:30] Speaker 1: Having a job kind of offsets that too, right? I mean, it's painful. We've got a 2.6% savings rate. So it's pretty clear. People are spending, even if it's at the detriment of savings. [00:02:40] Gabriela Santos: They are. And one of the things that's caught our eye for the broader consumer, that divergence, high income, and the rest, are real wages. Because inflation has now picked up, real wages have been negative for two months in a row. So consumers, okay, it's not booming. [00:02:57] Speaker 1: On inflation, and I'm going to ask you about bond yields, pulling back a little bit, under 4.5. Are bonds attractive to you here? You know, it's more and more folks are saying maybe they like the risk reward at this level. [00:03:12] Gabriela Santos: Yes, we do. But on the short end of the curve, that's where you've seen the biggest move higher. Take the two-year, it's up 75 basis points this year. And it's actually 60 basis points above your cash rate, the Fed funds rate. So it's already priced a big change from the Fed to dovish to hawkish. Now, when we do look at the labor market, we don't see that strength. So we don't see demand-side inflation pressure. Right, right. We think inflation likely peaked in May, and we won't see those rate hikes. So we do see opportunity on the short end of the curve. [00:03:44] Speaker 1: So, I mean, I came away, I was shocked at the narrative and also a lot of the experts on Wall Street thinking that Warsh is a hawk. You know, I think he's working within the parameters of the rules they have now. But he's making it clear he's going to remake the Fed. And I think when he comes through after all of these committees and all of these, you know, all these committees get together, that they'll be working from a different sort of set of principles, you know. And they'll read inflation differently. They'll read the data differently. I think he'll be accommodative. [00:04:12] Gabriela Santos: I think investors may be overextrapolated the hawkishness of the Fed. And I think part of it is because we didn't get forward guidance or much of a discussion of the Fed's reaction function from this chair Warsh. And as a result, it got filled in by the hawkish change in the dots. Nine out of 18 seen hikes. But what we care about are the 12 voting members. [00:04:34] Speaker 1: Right. [00:04:35] Gabriela Santos: And those might actually be happy just staying on hold. [00:04:37] Speaker 1: I actually think the SEP set us up for positive surprises. [00:04:40] Gabriela Santos: I think so. Yeah. [00:04:41] Speaker 1: Real quick, two things I want to ask you about. Private credit, some Apollo headlines, redemptions are going through the roof. First quarter, second quarter. How concerned are you about a contagion effect from private equity? [00:04:53] Gabriela Santos: So I think there's something very specific happening in these outflows from private credit and private equity because they're very retail driven. And I think it's about a fundamental misread of what these strategies are about. So they're meant to be long-term strategies. They're semi-liquid funds. Right. So these gatings that we hear about are a feature, not a bug. [00:05:14] Speaker 1: We've got it, but everyone's going to have to consider that. If you want to promote these to Main Street, you've got to understand this audience that doesn't want to hear like, hey, I need my cash today. Well, you've got to wait, you know, like. [00:05:24] Gabriela Santos: Yeah, you've got to know what you're getting into. You've got to know. [00:05:27] Speaker 1: I hope there's some onus, though, on the industry and not just buyer beware because a lot of folks have never dealt with this before. [00:05:33] Gabriela Santos: Exactly. You've got to know what you're getting. [00:05:35] Speaker 1: I can't let you go because without asking you first about international stocks. You're saying, listen, you're not bearish in America, but you see opportunities outside of the U.S. [00:05:42] Gabriela Santos: Yeah, being bullish international is not about being bearish the U.S. We are very bullish the U.S. You have emerging markets, for example, which is another side of the AI coin. Currently very concentrated on three semiconductor stocks you were discussing in South Korea and Taiwan. But there's more than that. Asia is really leading physical AI robotics. That's where you actually see it being implemented. And then I would also spare a thought for Japan and Europe that those are different themes. And actually, it's kind of good to have non-AI themes in the mix. Yeah. They're much more related to defense, to banks, more to the value side. So a good complement for the AI piece with the U.S. and emerging market Asia. [00:06:22] Speaker 1: Great stuff.