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Speaker 1: Bloomberg Audio Studios. Podcasts Radio News. This is the Bloomberg Surveillance Podcast. I'm Jonathan Farrow, along with Lisa Abramowitz and Anne-Marie Hordern. Join us each day for insight from the best in markets, economics and geopolitics. From our global headquarters in New York City, we are live on Bloomberg Television weekday mornings from 6 to 9 a.m. Eastern. Subscribe to the podcast on Apple, Spotify or anywhere else you listen. And as always, on the Bloomberg Terminal and the Bloomberg Business App. We begin this hour with stocks holding steady, heading into results from Bank of America and Morgan Stanley. Cam Dawson of New Edge Wealth writing, seasonality and earnings season is likely to spark a rebound in breadth, but softness in market leaders, mainly semis, is a red flag for the outlook into 27. Cam joins us now for more. Cameron, good morning.
00:00:53
Speaker 2: Good morning.
00:00:54
Speaker 1: Five days of weakness for semis. What is the signal?
00:00:56
Speaker 3: Yeah, well, I think that it makes us have to question the outlook for 2027 earnings and maybe 28 earnings for semis. We always have seared into our brain price leads data. So the fact that you have semiconductors trading at 19 times forward earnings, this is the low end of their range. You're still seeing earnings estimates somewhat ratchet up. But what you see is a big expectation for further margin expansion for semis next year.
00:01:21
Speaker 2: I think it's important to sink in.
00:01:23
Speaker 3: Margins on the EBIT line for semiconductors have gone from 16% in 25% to 42% in 2026. They're expected to go to 49% next year. And I think the question, given this weakness, is how sustainable are those margins as we look into the out years?
00:01:40
Speaker 1: What do you believe is a threat to those margins, the outlook for CapEx or the competition?
00:01:44
Speaker 2: I think it's competition.
00:01:45
Speaker 3: I think it's certainly competition because if you look at the weakness, it's concentrated within the memory names. Look at the KOSPI, which is effectively a two-stock index, given the fact that it's mostly memory in that market. That's breaking down microns a lot weaker than NVIDIA. You look at ASML this morning. That's holding up well, but that's a monopoly business. That's a very different kind of market structure than what we're seeing within the memory side of things. But the margin expansion has all come from the membrane names.
00:02:12
Speaker 2: And that's very important.
00:02:13
Speaker 3: For the S & P 500 because the semiconductors are a 19% weight in that index. And this year, semiconductors have been 35% of overall earnings growth. So, so go semi-margins, so go S & P 500 margins.
00:02:25
Speaker 1: One-fifth of the index. Where does the leadership come from outside of those names? Where can it come from?
00:02:29
Speaker 3: Well, I think in the very near term, we can see a bounce in the everything else. Just because it got oversold, September seasonality wasn't bad for the market on the surface, but we saw stealth corrections under the surface.
00:02:41
Speaker 2: 38% of the names.
00:02:42
Speaker 3: In the S & P 500 are still down 20% or more from their all-time highs. So as we move through earnings season, potentially that's a catalyst to see a rebound in those names. I would say though, the bank's reaction yesterday to earnings results that were okay, they were fine. Yes, you had some misses within some of the trading, that's to be expected, but the core businesses were fine and you saw big, huge reversals during the day on a group of stocks that already was oversold, down 12% from the mid-August highs. That's not necessarily encouraging for a rebound in the everything else.
00:03:15
Speaker 1: They're lapping some really tough comps, clearly. There are some questions, though, about that capital market's activity and whether it returns or not. How do you see things? How much visibility do you have on the so-called pipeline for the investment banking fees, all those kind of things that we're looking to potentially bounce into next year?
00:03:29
Speaker 3: Well, I think breaking investment banking into the credit side and certainly into the equity side of things, we saw a lot of.
00:03:35
Speaker 2: Debt issuance at the beginning of the year. The question is, at.
00:03:38
Speaker 3: Higher rates, will we see that degree of debt refinancing, debt issuance?
00:03:42
Speaker 2: That'll be a question for 27%.
00:03:44
Speaker 3: And then on the equity market side, we've seen this bifurcation where, yes, the amount of capital raised within IPOs is at a new record, but the number of IPOs is actually down from 2025 because it's all been concentrated really just in SpaceX. So now we have to ask the question of, will we get Anthropic?
00:04:01
Speaker 2: Will we get OpenAI? When do those names come out?
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Speaker 3: And does that create the tough comps where you effectively won't be able to make up for that difference in 2027?
00:04:10
Speaker 4: Well, if we are going to be on pause for Anthropic and OpenAI, what does that do to the broader market?
00:04:14
Speaker 2: Can we get to your price target?
00:04:16
Speaker 3: Well, I think that that raises the question about potential hyperscaler CapEx forecasts because we know that these frontier labs, you look at a name like Microsoft, 40% of their backlog is OpenAI. How much of OpenAI's ability to continue to spend and grow their cloud demand is dependent on their ability to raise incremental capital? So when we think about the hyperscaler capex forecast, yes, we can look at a name like Google and say, hey, higher interest rates really doesn't impact Google.
00:04:45
Speaker 2: It's interesting.
00:04:46
Speaker 3: Their net interest expense is still negative. Even though their interest cost has gone up so much, they still have net debt that is negative. They have more cash than they have debt. So they can
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continue to spend, but we can't ignore the fact that you need these IPOs in order to be able to create the capital for the frontier labs to be able to continue to spend.
00:05:05
Speaker 4: You headlined your note, how do we get to 8,000 by year end? Simply don't change a thing. But by year end, we could potentially have one more hike. At the same time, we have oil prices still elevated.
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Speaker 3: Yeah, that implies 8,000 is effectively today's valuation at 19 times on $ 420 a share, which is the current consensus for 2027 earnings. So that raises, is 420 the right number? We've seen that number get ratcheted up by 16% as we've moved here today.
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Speaker 2: Is there much more upside to that number?
00:05:35
Speaker 3: And then on the 19 times, you have to ask the question of, to your point, interest rates, certainly moving higher would be a headwind, but.
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Speaker 2: Also financial conditions.
00:05:44
Speaker 3: If we continue to see things like high-yield credit spreads, weaker credit spreads like triple Cs broaden out, it's really hard to make the argument that equity valuation should go up from here.
00:05:54
Speaker 2: So it really comes down.
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Speaker 3: To, if we just don't change a thing, we get to 8,000, but that might be actually more complicated than it looks.
00:06:01
Speaker 1: On the surface. You sound bearish going into next year. Is that fair?
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Speaker 3: Can you really be bearish when you have overall earnings growth that is going to.
00:06:10
Speaker 2: Be probably mid-teens?
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Speaker 1: Double digits.
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Speaker 2: Double digits. I think that that's hard to do.
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Speaker 3: I think that we've had to be optimistic that you continue to see earnings revisions to the upside. But we think that the big bulk of that is likely behind us. So we wouldn't be surprised if Ford returns in 27 or lower. But we have to counter that with the idea that if you look at institutional positioning, it still is relatively light. households are very much all in on this market but hedge fund positioning is light so we could see some kind of rally blow off top certainly as people chase into.
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Speaker 1: The market we're going into outlook season a lot of people are waiting to put pen to paper they're waiting for the midterms how crucial is that to you the outlook for policy down in washington is it relevant.
00:06:53
Speaker 3: At all I think it's relevant to the bond market, and that certainly matters. If you have a takeaway where the outcome from the midterms means more fiscal profligacy and effectively no reining in on budgets, I wouldn't expect that to be the outcome from the midterms anyway, though, because no candidate is running on any kind of austerity or balanced budget policy. So I think we have to accept the fact that deficits are high and they'll continue to go higher, which just means that the midterms likely cement this idea that the bond market will continue to be concerned about supply of bonds entering the market.
00:07:26
Speaker 4: How do you think about next year in terms of this specifically when it comes to debt? Because the debt ceiling fight is going to mean everyone gets a piece of the pie.
00:07:33
Speaker 1: We could see a lot of spending.
00:07:34
Speaker 3: You see a lot of spending and then you also have to raise the questions about what Treasury is potentially talking about shifting more issuance to the front end. I would note that bills issuance is 23% of debt outstanding. That's slightly below the COVID peaks, but that's certainly well above where it used to be. And so we really ask the question, if you want to cut back on 30, 20, 10-year bond issuance, do you really have the room to be able to cut back on or increase bills that much more?
00:08:02
Speaker 1: Stay with us. More Bloomberg surveillance coming up after this. Under surveillance this morning, growing fears of conflict, contagion.
00:08:19
Speaker 4: They're behaving very badly.
00:08:21
Speaker 1: I mean, if I told you I made a decision, that would.
00:08:25
Speaker 3: The Hooties have.
00:08:25
Speaker 1: Acted very badly. I did, yeah.
00:08:27
Speaker 2: I can't judge you, man.
00:08:27
Speaker 1: Do you really think I can judge you, man? So here's the latest this morning. The President Donald Trump speaking with the Saudi Crown Prince as the Iranian-backed Houthis expand attacks across the kingdom, launching more missile strikes and striking the Aramco headquarters. Let's build on this story with General Karen Gibson of Academy Securities writing, although Iran's threat perceptions might be heightened right now, it's worth noting that its rebuilding and re-fortification programs have continued throughout the conflict. General Gibson joins us now for more. General, welcome back to the program. Do you see U.S. involvement on the horizon here? Well, if you mean U.S.
00:09:09
Speaker 5: Involvement against the Houthis, there are some reasons that I would understand that the administration might be reluctant to do that. One, opening another front on this theater would be a draw on resources, although there is a third carrier strike group headed to the region. Two, there's some question as to whether airstrikes alone would be enough to compel the Houthis to change their attacks or alter their methods against the Saudis. Saudi Arabia has a tremendous infrastructure that spans from the Red Sea all the way to the Gulf and then things in the center of the country like Riyadh.
00:09:45
Speaker 2: It's a lot to defend.
00:09:46
Speaker 5: And I think, frankly, there's probably some reluctance to get involved against the Houthis as long as the Houthis are only targeting Saudi-related vessels in the Bab al-Mandeb. And a thought that perhaps if we get engaged as well, that the restrictions or the targeting of vessels may expand to include more nations, particularly those associated with the U.S.
00:10:08
Speaker 4: General, the Houthis
are designated a terrorist organization.
00:10:12
Speaker 2: They went after airports.
00:10:13
Speaker 4: They obviously went after Saudi Aramco last night, one of their key logistic areas at their headquarters, not production, but still a strong signal.
00:10:21
Speaker 2: What does it say basically.
00:10:23
Speaker 4: That the international community is accepting what I think a lot of people thought were red lines are no longer red lines.
00:10:29
Speaker 2: They feel like they're pink.
00:10:32
Speaker 5: Well, I think something I would point out, and we've seen this in Ukraine and certainly with Iran on the other side of the Arabian Peninsula, is that the economics of attack have really changed. So through the ability of a terrorist organization, not an internationally recognized government, to conduct such precise and lethal attacks against Saudi critical infrastructure, the cost and ability for organizations like the Houthis to do that, the threshold has really lowered significantly. And it's incredible the kind of strikes they're conducting that used to only be the province of advanced nation states. On the flip side, the expense of defending that across the entire nation of Saudi Arabia is much higher. And so we're on the wrong side of that cost curve. And work needs to be done both to limit the Houthis' ability to conduct these precise and lethal strikes, but to defend the vast entirety of Saudi critical infrastructure.
00:11:28
Speaker 2: What more does the kingdom need from the U.S. in terms of the defensive posture?
00:11:33
Speaker 5: Well, you know, again, I think Saudi Arabia has one of the toughest defensive measures. They face threats from three directions, from the Houthis, from Iranian-aligned militant groups in Iraq, and from Iran itself. So three directions, you know, a country that's, I think, about 20 percent the size of the continental U.S., and critical infrastructure scattered all over. The money that's spent on Patriot missiles or theater high-altitude air defense, the THAAD systems— and the joint strike fighters. That's important, but it's not proved enough. I think the Houthis are following tactics that we've seen in the Russia-Ukraine conflict, where you overwhelm those defenses by sending both cruise missiles and drones. They really need, as does the entire Middle East, a more layered air defense system that also comprised of some cheaper counter drone technologies, that the high-end material, as important as it is, is not proving sufficient to defend their sites.
00:12:29
Speaker 4: When it comes to the diplomatic route, we did have Oman this morning talk about how they've concluded these discussions with Iran regarding the Strait of Hormuz Pact, but they can't do any more until the U.S. and Iran get to some agreement. It feels like the market has just sort of felt numb to these diplomatic talks.
00:12:45
Speaker 2: Where do they stand?
00:12:48
Speaker 5: You know, I don't have good insight into the diplomatic talks. For one, they tend to occur in back rooms, and it's not as easy to measure as ships that go through or missiles that are launched. There just aren't the same kinds of signals. I do think that the Strait itself, its leverage has lessened somewhat. on the Iranian side because of the ability to get oil out, whether that's dark transits, military escorts over land or through these alternate routes. And I think that's part of what the market has responded to is that we are, in fact, as I understand, shipping close to pre-war volumes out of the area. But the diplomatic talks, I'm not sure that we've budged the needle on Iran's willingness to make significant concessions, or certainly the ones that we seek.
00:13:38
Speaker 1: Stay with us. More Bloomberg surveillance coming up after this. Ascent of the Federal Reserve, New York Fed President John Williams signaling a dovish outlook ahead of today's CPI print. Williams telling Bloomberg the following, I haven't changed my view that it may be appropriate to have one more rate hike. I don't think at this time I have any reason to believe that we would need to do more. We can catch up with the former St. Louis Fed President Jim Bullard. He joins us now for more. Jim, good morning. Good to see you. Great to be here. Whenever we catch up, I often say this, you know, I imagine you're happy you're no longer on this committee because they've got some hard work to do. There's a big gap right now between the policy rate and the market rate. How do you see things playing out in the next year?
00:14:23
Speaker 6: I think that the September meeting is the meeting that has the most forward guidance because they give a dot plot that only goes to the end of the year. So you're basically saying what you're going to do over the next two meetings. And the dot plot came out with, okay, we'll raise in September, and we'll do one more by the end of the year. So the speakers have come out, in particular Chris Waller and John Williams, and they said that's what they see happening. I think that's where the center of the committee is, and I think they want to wait and see for 2027. And so they've got a flat outlook for 2027. You know, rates are up a lot. Longer-term rates are up a lot. I think that probably does help the committee. Policy has changed dramatically from where it was earlier this year. where the market was expecting rates to go down further. That's all reversed now, and obviously we're in a very different situation. So I think that committee feels comfortable that they can wait and see. They still have conviction around the idea that a lot of inflation will naturally dissipate as they get into the first half of 2027. They have been telling that story for a long time, but they still have conviction around that, I think. And so we'll see what the CPI report comes out today.
00:15:39
Speaker 1: Do you think one hike in Hope is a good strategy? Is it good enough? Well, I think it's two hikes in Hope. I think
they're planning to move it. One more hike in Hope.
00:15:50
Speaker 6: Well, you know, it just might work. And I think that's where the center of the committee is because the market has moved a lot. And so, you know, I think that the market reaction was kind of overdone in some sense to September that the committee might move several times in a row and very aggressively, but they probably don't have to do that with this level of inflation.
00:16:14
Speaker 1: There was a belief, I think, stemmed actually not from just the meeting in September, but also that PMI. We had this red-hot PMI, and the market shifted to this idea that maybe things were getting away.
00:16:23
Speaker 6: The economy's strong, and I've been saying that.
00:16:28
Speaker 1: The market.
00:16:29
Speaker 4: in the.
00:16:29
Speaker 6: Spring, overemphasized what would happen from the oil shock. I think the U.S. is a very different country than it was. Oil shocks are, you know, let's not be too harsh, but they're kind of beneficial for the U.S.
00:16:42
Speaker 1: The U.S.
00:16:43
Speaker 6: Is a producer, you know, more than a consumer. I'm not sure everybody has really fully taken that on board. So for the real side of the economy, I don't think you're at that much risk from oil gyrations. And, you know, that's why the committee is focused mostly on the inflation implications.
00:17:01
Speaker 4: But what about record diesel prices that feed into the manufacturing sector and the agricultural sector?
00:17:06
Speaker 6: Yeah, and those, you know, and that is a factor. And, you know, but that's not coming directly, I would say, from the Middle East. That's also coming from, you know, tax in Russia and also, obviously, it's been discussed a lot. And the committee wants to watch that and see that.
00:17:24
Speaker 4: We, Tom Sparkin had this to say, it's not some unicorn in the forest. It's actually something that you can hit. He was talking about the 2% inflation target. And I laugh because then why didn't they hit it for five years? We were actually cutting rates where CPI was higher than where CPI was going into the September meeting. Do you believe that the Fed truly believes that 2% is a target or is that something they say? But really it's 2, 2.3, 2.5.
00:17:51
Speaker 6: No, that inflation target has been enormously valuable. They definitely do believe it. But the question is, you know, how much inertia is there in inflation movements? And, you know, to what extent do they really have to take action? So I think there's no question that they're committed to the 2 percent target. I thought that Chair Warsh did a great job at Jackson Hole emphasizing that point.
00:18:15
Speaker 4: But to get there, will they have to crush part of the lower end of the economy?
00:18:21
Speaker 6: Well, the lesson from 2022 and 2023 is that if you act aggressively and with purpose, you can get a lot of reduction in inflation without damaging the economy. And so, you know, hopefully they can
get that again here. It doesn't have to lead to a recession every time, but you have to be aggressive enough to get inflation back to target.
00:18:42
Speaker 1: Can we talk about a dominant source of inflation at the moment, and that's the CapEx build-out in this country? How difficult is it to get at that?
00:18:52
Speaker 6: I think that's moving independently, and I think one of the biggest risks for the economy is if the AI bubble bursts in some way, and this has gone a long ways here. There's a lot of physical investment and much more planned ahead, and there's not really a product on the table and a revenue stream on the table that's justifying that except for the hope that that AI is going to be radical change. Surely it is going to be radical change, but is it a trillion-dollar radical change or a $ 10 trillion radical change?
00:19:28
Speaker 1: You called it a bubble, Jim. You believe it's a bubble? I think it's a bubble.
00:19:32
Speaker 6: I think it will burst at some point. Sometimes the air can come out slowly, so we'll see if that's what happens. But you shouldn't kid yourself. This is a feeding frenzy. And this is bigger than any capital build-out that the U.S.
00:19:47
Speaker 1: Has ever seen, ever. How should the Fed manage that?
00:19:50
Speaker 6: Think of the build-outs that have occurred in the past. Build the freeway system, build the railroads, build canals, all kinds of things. This is bigger than all those. So it is a feeding frenzy, and I think it will come to an end. But you never know quite how these things proceed. I think you've got these open weight models sitting on the sidelines. You've got probably... 80% of the answers that are given by AI are probably done with 20% of the computation. You've got chips that are going to depreciate going forward, being stuffed into physical capital. There's just a lot of flags here about what's going to happen.
00:20:35
Speaker 1: Do you think the Fed's got a role to play to do something about it?
00:20:39
Speaker 6: Yeah, I think it'd be, well, I don't think it has that much effect because this is emanating from Silicon Valley. And obviously, the Valley has made tremendous amounts of money in the last few decades. And so it's a battle for who's going to control those revenue streams going forward. So I'm not sure they're too worried about interest rates.
00:21:00
Speaker 1: The spending, though, has shifted to the debt market. A lot of people share that view. They're not too worried about interest rates. But everyone's got a buy point. at some point does become a problem. And I'm trying to work out whether the Federal Reserve does have a role to play here.
00:21:14
Speaker 6: It's certainly true on the margin. But if you look, I think the best analogy is the internet boom.
00:21:19
Speaker 1: It was a good.
00:21:20
Speaker 6: Bubble in the end. I think AI will be a good bubble in the end. Great technology. It will diffuse all the way through the economy.
00:21:27
Speaker 1: It will improve productivity.
00:21:28
Speaker 6: All that will happen. But if you look at the Internet boom, rates were actually quite high toward the end of the Internet boom compared to today. And people said at the time, well, I don't think that has any effect until it does. So I guess slowly and then suddenly is the answer.
00:21:48
Speaker 1: This is the Bloomberg Surveillance Podcast, bringing you the best in markets, economics and geopolitics. You can watch the show live on Bloomberg TV, weekday mornings from 6am to 9am Eastern. Subscribe to the podcast on Apple, Spotify or anywhere else you listen. And as always, on the Bloomberg Terminal and the Bloomberg Business Hour.