Euro and Oil Contagion Risks

SPEAKER_1 (0:02)

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Tom Keene (0:27)

We start Beyond Strong today. This is really with all the reading I did. There was a reading week in Alexis.

Paul Sweeney (0:32)

It really was. You were immersed, Tom.

Tom Keene (0:34)

I was immersed with that bill on the couch in the kennel. I think it was just great. Steve Chiavarone is the right person to speak to right now. Long ago and far away, Steve, you and I looked at an equation that's too long and has too many Greek letters.

The answer is, Rho squared is the summation of Omega squared, Rho squared, summation, summation. Yeah, yeah, yeah. The math of diversification just seems to be thrown out the window right now. What is the to-do list for Americans shell shocked in bonds, currencies, commodities as they try to maintain an equity ownership?

Steve Chiavarone (1:15)

Yeah, I'd say, as long as you're in an environment, if you want to simplify it, Tom, as long as you're in an environment where the risk to upside inflation is greater than the risk to downside growth, that is a profoundly equity healthy bond unhealthy setup. And that's been the setup we've been in really for the last six years. Now, it's accelerated this year, but I think that's the story that you have to be in the asset that can pass along the inflation and that eats nominal earnings.

And those are equities and they're the only game in town right now.

Tom Keene (1:50)

And folks, I know you're bored by it. And Michael Darter with a brilliant note this weekend on nominal GDP and nominal revenue down the income statement as we see Pepsi this week and JP Morgan the 13th. Okay, to me, your world at Federated Hermes is the idea that earnings and revenue and all that's coming up is endogenous, is in the side of the system. And we're treating all these shocks in the stock market is outside the system, bonds, currencies, oil, all that. They're just exogenous to what the earnings revenue picture looks like.

Steve Chiavarone (2:29)

A couple of things. Step back. This is the biggest infrastructure build in the history of the United States. We say since the railroad, but it's bigger. What we're living through right now is the earnings story of our lifetime. It's the margin expansion story of our lifetime. That's not an opinion. That's a verifiable fact.

The market's gotten cheaper while you've posted these earnings this year.

Paul Sweeney (2:51)

Relative to earnings?

Steve Chiavarone (2:53)

Yeah, relative to earnings. We've gone from a 23 times multiple to something sub 20 When you're sitting here, the only question you have to ask yourself is, do any of the risks that we're getting scared about really derail that story? The answer is no, because the rising rates don't really derail the drivers of growth. The MAG-7, the hyperscalers are relatively rate insensitive. So is the high-end consumer. And the thing about rising rates, and I think we're making more of this than we should, we lived for 20 years in an environment where growth was sub 2%, inflation was sub 2%, real yields were negative, policy rates were zero, and market rates were 2-3%.

We all agree it's no longer sub 2% growth, it's no longer sub 2% inflation, real rates are not zero, policy rates are 3-4%, so why are we shocked and clutching our pearls that long-term bond yields have to reflect that and be 5% plus? And by the way, there's a name for that terrible environment, it's called the 90s and it wasn't so terrible.

Paul Sweeney (3:54)

So you're not afraid of bond market contagion at all, Europe somehow moving, spreading further throughout Europe and then impacting us here in the US, you're not that concerned.

Steve Chiavarone (4:02)

We're underweight Europe because Europe has now chosen, for whatever reason, to miss the second major economic transformation of the last 25 years, right?

They produced no magnificent name to join the Magnificent Seven, right? Asia did with Samsung and Hynix and Taiwan Semi. And now with AI, you know, they're long on regulation and non-existent on innovation or participation. And so they're dealing with this kind of repricing higher of debt, just like we are in the United States. The difference is in the US, you've got earnings growth that's 25, 30 percent and margins that are able to deal with it. In Europe, they don't have that.