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00:00Chief Market Strategist for America's Gabriela Santos says that the safest areas during these shocks are European equities, treasuries, gold,
00:08and core real estate.
00:09Gabby joins us now. Gabby, great to see you.
00:11Good to see you, Dani.
00:12I wonder, is it time to like dust off this playbook now? Is it the time to hide into maybe
00:17the AI shock, the AI factor basket?
00:19Well, I think what we learned over the summer, we shouldn't forget as summer sooner rather than later comes to
00:25a close,
00:25is that you can be very bullish on all things AI and still need to think really carefully about portfolio
00:32construction.
00:33I think that was the big lesson from July, where we had a big correction in the picks and shovels
00:39that had done really, really well in the second quarter.
00:41You had a 20% sell-off in momentum, 30% in global semis, 40% in Korea.
00:47So position sizing was important, leverage was important, as well as diversification into other non-AI related topics.
00:57And that's where it's getting complicated because you can't just think about traditional factors or sectors or regions or even
01:04asset classes
01:05because that AI tentacle is absolutely everywhere now and that's only going to get worse.
01:09And so really important to stress test portfolios for an AI factor, to understand how your overall portfolio exposure looks.
01:18And areas to diversify away from that are few and far between, but there are some.
01:23And as you mentioned, treasuries, gold, core real estate have different areas of return stream.
01:30And for equities, I would add just European equities, really, besides that, emerging markets, Japanese equities, and of course, U
01:38.S. equities are very much an AI story.
01:40Are clients receptive to that?
01:42Because it feels like after the July sell-off, we just climbed back up to near all-time highs again.
01:47We did, but that is the number one question I'm getting still.
01:51It's how to diversify from the AI factor.
01:54And I think that's because there's a building nervousness that this is really, really good right now.
02:00The earnings is just truly in a massive super cycle right now, especially for all things memory and power.
02:08However, eventually, this is going to turn.
02:11And you can still be bullish AI and still think that eventually these growth rates are going to decelerate
02:17and there will probably be a correction or at least a fatigue with the theme.
02:22And so I think it's wise portfolio construction to think actively about building some diversification.
02:29How do you sort of bridge the divide between what is diversification and what is missing out on this super
02:34cycle?
02:35Because probably there's a reticence to move too far away from the AI trade,
02:40given just the structural changes that the universe is witnessing as AI takes hold.
02:46Oh, absolutely.
02:47And to be clear, we still think the AI build-out is still the most important theme
02:54when we think about investing across capital markets.
02:57And this is public markets, private markets.
03:00I mean, the scale is huge.
03:01Five and a half trillion dollars of CapEx spending to build out all of this compute infrastructure.
03:08So it's real.
03:09And you see it in the profits themselves already, which makes this very, very unique.
03:14However, at the same time, we don't want to be too concentrated in it
03:19because these AI tantrums are a feature of the build-out.
03:22It doesn't mean it's over.
03:24It doesn't mean we don't want to be invested in it.
03:26It just means that this is going to keep happening.
03:28And it's just wise to have some diversification from it,
03:32even if it is the main theme that you're investing in elsewhere.
03:35One of the things that seems to be weighing on the market this morning
03:38is multi-decade highs for bond yields, not just in the U.S., in the U.K., in Germany, in
03:44Japan.
03:44To what level does it suggest that it's something to worry about?
03:48I think it's just a reflection that we're still getting used to this higher
03:52and more volatile yield environment that we hadn't seen really for 20 years, so pre-GFC.
03:59And this is interesting.
04:00This changed over the summer, where actually now higher yields and the volatility is being driven by the long end.
04:07You've had the 10-year move up 27 basis points since the end of June, whereas the two-year actually
04:13fell.
04:14So it moved from being just a Fed repricing story into being something else that's affecting the long end.
04:21And it's not really inflation expectations.
04:22We think it's just a readjustment of the term premium for two major changes, right?
04:27A lot more debt issuance from governments to fund defense spending around the world,
04:32as well as corporations for the AI build-out.
04:35And then the second thing is this big change in central bank-forward guidance
04:39that we've heard a lot from Kevin Warsh, but also other central bankers at Cintra a few weeks ago,
04:45which is just a feature of having a little bit less control and perfect clarity from central banks
04:52and leaving the market a little bit more to its own devices.
04:55So what we've been seeing clients do is focus on the short end of the curve instead.
05:01There, you've created value earlier in the year when you had yields move higher,
05:04and you have a little bit less volatility there than the long end.
05:08The irony of all of this is having a Chair Warsh who, at the last presser,
05:13basically said that the market's following the data finally,
05:15and the data has been more benign inflation, yet long-term yields are going up.
05:19To you, does that mean Jackson Hole is something of a risk event?
05:22Do you expect a Chair Warsh to kind of come out and attempt to clarify, attempt to talk bond yields
05:28down,
05:28even though he's explicitly said that they shouldn't be pricing based on monetary policy or Fed speak?
05:33I think it'll be very interesting to hear the Chair's speech next Friday.
05:37I do think what ended up creating some of this uncertainty and this rise in the term premium
05:43was during the July meeting some confusion around, well, exactly what inflation metric is the Fed targeting,
05:50exactly how do they respond to supply versus demand-side driven inflation,
05:55and exactly what instrument are they using as their primary tool to enact monetary policy changes.
06:03So there's just some confusion there, and I think there's a lot of hope from the market
06:07that there's a teensy bit more clarity coming out of the Jackson Hole speech, although maybe not.
06:13Chair Warsh has talked a lot about just waiting for the task forces to do their thing.
06:17So something, maybe a little bit more information coming in September from some of those,
06:22and then later in December.
06:24You also mentioned what's moving the term premium higher, yields higher on the long end,
06:27is the amount of corporate issuance we've had, and it has been gigantic.
06:31Gabby, how's the feeling of putting the plane together as we're flying it,
06:34of trying to understand what this means for the corporate bond market?
06:36For one, it's just more issuance, and two, durations a lot longer because of these huge, huge notes,
06:43you know, 100-year notes, even in the case of Alphabet, that we're seeing.
06:46How does that change allocation when you not only have to hedge duration,
06:50but also an increasing exposure to tech and corporate bond indexes?
06:54Well, I think if you're a bond investor, right, for a long time you had a lot of exposure to
06:59things like financials.
07:00That was the main concentration that you had in your index.
07:03And now for the first time in a long time, you actually have some tech issuance.
07:08So for a pure bond manager, it's actually interesting to diversify their sector exposure.
07:14And tech is now paying a higher premium than the overall investment grade.
07:19So you're getting about 100 basis points extra in spread pickup.
07:22But if you're a multi-asset investor, that's where it becomes a little bit more concerning
07:28in that you're starting to have, again, more concentration in the AI build-out theme,
07:32not just on your equity side, but also in your fixed-income side.
07:37And what we've been focused a lot on, besides just the idea of diversification of the AI factor,
07:42is also looking at each specific issuance, right?
07:47Because these are being structured in increasingly complex ways.
07:52So exactly who is your counterparty risk?
07:56Exactly what is the asset that's backing this particular issuance?
08:01There's a lot more of a focus on single security issuance now than overall issuance across the board.
08:08And I think that's really, really healthy because it doesn't seem like it's going to slow down.
08:13It's already been the fourth record month for investment grade issuance and probably next month as well.
08:19I was going to say the numbers.
08:20Goldman has IG issuance already exceeding $1.5 trillion so far this year.
08:24I mean, easily putting this year on track to beat the record.
08:27Do you think most investors are that discerning or are they just gobbling up this debt
08:31and perhaps not looking at things like collateral or the different terms on some of this?
08:36I think, as always, it depends on the investor.
08:40But that's something that we've been advising our clients to do is not look at it as,
08:45oh, this is just hyperscaler debt as one monolith, but to think really carefully.
08:50First off, just what hyperscaler, right?
08:52Are these the super massive tech, super high quality companies,
08:57or are these your more frontier, neocloud, high yield kind of issuers?
09:05So exactly who is doing the issuing and then what is the structure of it?
09:09And I think it is getting more and more attention that these are being created as special purpose vehicles
09:14in partnership with private managers, having leases as the collateral.
09:21So I think it is appropriately getting more attention that they are becoming increasingly complex.
09:26On a different note, I do just want to mention that the president is currently posting on TruthSocial about the
09:31war in Iran,
09:32saying that no talks are happening or scheduled with Iran,
09:34also saying that all mines were removed or detonated in the Hormuz Strait.
09:39So take with that about what you will.
09:41Brent Crude is still above $90 a barrel with those two different stories.
09:44Gabby, at this point, how are you thinking about geopolitical risk?
09:48How are you pricing it in when the headline volatility continues to be quite remarkable?
09:52It is.
09:53And we have a really great center for geopolitics at JPMorgan Chase at Firm Level.
09:59And really, they've been talking about this as just as a new normal, unfortunately,
10:03where you have just more elevated geopolitical uncertainty.
10:07You have several hot conflicts ongoing at the same time.
10:10And I think this is what's driving the second other massive secular theme.
10:16So it's the AI build-out.
10:18And then it's just security and resilience.
10:20So governments really beefing up their defense spending, their infrastructure spending,
10:25and driving this big increase in debt issuance and this volatility that we were talking about in the long end.
10:31And when it comes to the Middle East, I think investors have learned this summer
10:34that there's probably not going to be a return to normal in the Strait of Hormuz and the relationship with
10:40Iran.
10:41And as a result, that's another choke point that different countries and companies need to reduce their reliance on.
10:48So more infrastructure spending in the Middle East and more reorganizing of energy supply chains.
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