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Bloomberg Audio Studios. Podcasts, radio, news. Ed Yardeni of Ed Yardeni Research is lowering his year-end target for the S&P 500 to 7,900 from 8,400 , the highest estimate in the market, noting that downside risk has increased. We increase the probability of a " bearish" scenario from 20% to 30%. Ed joins us now to tell us more.
Ed, welcome to our program. You have changed your forecasts a little , becoming a little less optimistic. What worries you as the end of the year approaches? Yes, the main thing I changed in my views is the idea that it will take a little longer to reach the 8,400 mark. I don't think that's likely to happen before the end of this year.
I believe this will most likely happen by the middle of next year. 7,900—that's still significantly above the current level, so the year still promises to be quite profitable. But for me, the problem is the worsening geopolitical situation. The war in the Middle East has escalated and we expect higher oil prices for an extended period of time.
Prolonged high oil prices increase the likelihood that energy inflation will feed through to core prices, as Bill Dudley pointed out in his excellent interview. Accordingly, we have a situation where the Fed's actions will not be limited to one step; it is likely that we will see one or two more rate hikes this year.
Additionally, bond markets, which my bond avengers friends worry about , have become quite volatile around the world, and I am particularly concerned about the winding down of carry trades in Japan. US officials continue to pressure the Japanese to raise interest rates more quickly, which makes sense from a macroeconomic perspective, but unfortunately we can see that this will lead to a further contraction of the carry trade.
This means that hedge funds that borrowed money in Japan at low interest rates while the yen was weakening are now turning around and saying, "You know, this kind of financing has become too expensive and risky." So, Ed, you've outlined three topics for us to think about. Let's take them one by one.
You mentioned geopolitics and events surrounding oil. You talked about the impact of this on monetary policy and the implications for the bond market. Can we stop at the first point? Does the first factor affect the other two? How dominant is the situation in the Middle East? And what would you say to people who are watching us at home and have already lost their sharpness of perception, because all this has been going on for seven months and it seems to them that it no longer matters?
What is your message to them? Well, look, we're back to hundreds, and everything was great when the price dropped to about 80 a few weeks ago; but the problem is that everyone thought this war in the Middle East would end pretty quickly, especially at the beginning when the Iranian leadership was beheaded.
I thought the same thing for about a day, and then I changed my mind and said to myself: "Wait, the IRGC are professional terrorists who actually run the country, and they have puppets all over the region. They won't surrender just because they're being bombed from the air. Military history shows that it just doesn't work.
We need troops on the ground." So we're in a situation where the midterm elections are coming up , and Iran has a huge incentive to create more chaos to support oil prices because they obviously would like Trump to lose his majority, the Republican majority in the House of Representatives and in the Senate.
Do you think it will take longer for stocks to reach your more ambitious targets because of oil prices or because of rate hikes? Well, I think it's a combination of everything together. You know, the nice thing about being a strategist is it's pretty simple. This is P/ E, i.e. valuation multiplier multiplied by earnings.
This is easy to do. But doing it right is the hard part. I think from the "E" side, meaning earnings, everything looks great. I mean, the economy is doing great. You know, I remain fundamentally bullish on growth, but analysts are even more bullish as companies report excellent earnings. So it all boils down to the valuation multiple, and as you know, as earnings expectations have gone up—I call it FEMO, fantastic earnings momentum—the multiple itself has actually come down because investors are becoming a little more cautious about paying for these great earnings prospects.
And, by the way, the whole story with artificial intelligence has become a little more dubious. It also seems to be postponed, if you will, or pushed back in time. And I think that also affects the valuation multiple, because many of these AI stocks have very high multiples. I want to touch on another issue that you talked about with John, which is the unwinding of the yen carry trade, and you're concerned that things could get quite chaotic if the Bank of Japan starts raising rates more substantially or reacting to pressure from around the world.
What might this look like? What would suffer the most losses in such a scenario? Well, I think we actually see that when we look at the global bond sell-off, when we see bond yields rise almost everywhere except maybe China. What we are actually seeing is a significant reduction in carry trade operations .
Hedge funds, as I mentioned, borrowed money in Japan at almost zero interest rates, received it in yen, converted it into other currencies, and bought government bonds and other assets around the world. And I think that's probably one of the best explanations for why it became a global sell-off, because hedge funds took money and invested it around the world where they saw good carry trade opportunities.
And this rollback is not necessarily complete. What vulnerabilities can you tell us this morning, Ed, ahead of this period? again . Where do you see vulnerabilities in the market in the process of winding down the carry trade? Where do you see them now? Well, I think the clear traces or signs of this rollback are the coordinated rise in bond yields around the world.
And this is what we observe. So I think the upcoming decision of the Bank of Japan and their actions...if they raise the rate by just a quarter , that might hold back the rapid rollback of the carry trade, but if they surprise and raise it by 50, that could be a bigger shock. Therefore, I believe that the reaction to the Bank of Japan report will be very important.
So, Ede, to clarify: you believe that the more hawkish the Bank of Japan becomes, the more vulnerable the global bond market will be. Yes. Yes, and the irony is that our officials, particularly Treasury Secretary Scott Bessant, are pushing them to take more aggressive action. More aggressive action means they will raise interest rates, their short-term rate, more decisively, and that will obviously strengthen the yen.
Two things that clearly stimulate clotting . So, to sum up: you think now is not the best time to buy long-term bonds before the Bank of Japan's decision. I wouldn't do it right before the Bank of Japan's decision, no. But I think let's see what happens after that. I do believe that over the next 6–12 months or 10 years, 5% for 10-year bonds will be a very good return, but for now I prefer to take a wait-and-see approach, just like the 10- year bonds themselves.
They just hang around the 5% mark. Ed, thank you. It was nice to chat. Always instructive. There is something to think about before tomorrow's Bank of Japan meeting, according to J.P. Research. Morgan.
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