WEBVTT - Savita Subramanian's Earnings-Season Reality Check 0:00:13.880 --> 0:00:17.119 Hello, and welcome to What Goes Up, a weekly markets podcast. 0:00:17.200 --> 0:00:19.160 My name is Mike Reagan. I'm a senior editor at 0:00:19.160 --> 0:00:22.400 Bloomberg and then mal Donna Hark across Acid reporter with Bloomberg. 0:00:22.800 --> 0:00:25.319 This week on the show, Well, in case you missed it, 0:00:25.560 --> 0:00:27.800 there's a little bit of tension brewing on Wall Street. 0:00:27.920 --> 0:00:31.920 Many economists and macro oriented investors are bracing for a 0:00:31.960 --> 0:00:36.240 recession in and with that would likely come a nasty 0:00:36.320 --> 0:00:41.000 drop in corporate profits. But analysts who study individual companies 0:00:41.040 --> 0:00:44.240 haven't reduced their profit estimates enough yet to signal and 0:00:44.360 --> 0:00:47.519 earnings recession is on the way. So what exactly is 0:00:47.640 --> 0:00:50.320 up with this disconnect between the top down and the 0:00:50.360 --> 0:00:52.680 bottom up views of the market and what does it 0:00:52.720 --> 0:00:56.160 mean for your investments in We'll get into it with 0:00:56.200 --> 0:00:59.720 one of Wall Street's best known strategists. But first of all, Donna, 0:00:59.800 --> 0:01:01.720 I gotta tell you, I'm freaking out about something, but 0:01:02.120 --> 0:01:04.000 you're freaking out about a lot of I'm freaking out 0:01:04.040 --> 0:01:06.360 about something. Yeah, what is it? What do you cook 0:01:06.440 --> 0:01:09.039 your cauliflower with? What type of stove do you have? 0:01:09.520 --> 0:01:11.760 Oh my god, this is a sore subject for me. 0:01:11.920 --> 0:01:14.679 Our gas is out in our building. I'm not cooking 0:01:14.720 --> 0:01:19.040 anything that's good, that's good. Why these gas stoves are 0:01:19.120 --> 0:01:21.880 killing us all? Do you realize that they're they're banning 0:01:21.880 --> 0:01:24.720 them right, They're going to ban them all nowhere. I'm 0:01:24.840 --> 0:01:27.760 very alarmed that news came out the same day that 0:01:27.800 --> 0:01:30.360 they turned my gas off, well in my entire building. 0:01:30.520 --> 0:01:34.080 So I'm not I'm just not going to eat. Yeah, 0:01:34.160 --> 0:01:35.760 I'm just not going to eat for the next like 0:01:36.000 --> 0:01:38.920 three months. Probably. I think this is a scheme by 0:01:38.959 --> 0:01:41.399 door dash. I think they want you to go along door. 0:01:42.160 --> 0:01:44.000 What do you think we should check how much they're 0:01:44.000 --> 0:01:49.040 paying lobbyists to kill gas ovens? All right, Well, maybe 0:01:49.040 --> 0:01:51.960 our guest has some thoughts on doordas. She might, she 0:01:52.080 --> 0:01:57.440 might not. Probably not, I'll spoil it, probably not. But 0:01:57.480 --> 0:02:00.800 who doesn't like delivery? Everybody likes celebrity, including our guests. 0:02:00.840 --> 0:02:03.600 Probably I want to bring in Sevita Subramanian. She's the 0:02:03.600 --> 0:02:07.400 head of US equity strategy at Bank of America. Savita, 0:02:07.560 --> 0:02:09.840 welcome to the show. Thanks for having me. B Donna, 0:02:10.000 --> 0:02:15.800 and I do love delivery. Who doesn't. I wish my 0:02:15.919 --> 0:02:17.799 guest stove was out so that I had a good 0:02:17.840 --> 0:02:21.160 excuse not to cook. It is a very good excuse 0:02:21.200 --> 0:02:24.280 to get take out. I always thought my guest stove 0:02:24.400 --> 0:02:26.239 was gonna kill me because the kids always leave the 0:02:26.240 --> 0:02:28.240 pizza box on top of it, and I'm afraid the 0:02:28.280 --> 0:02:32.200 dog's gonna sniff the pizza and go and turn. These 0:02:32.200 --> 0:02:37.440 are some crazy it won't happen. It won't happen. Um 0:02:37.440 --> 0:02:40.400 but sevida so so. Mike mentioned in the introduction, you're 0:02:40.400 --> 0:02:44.000 one of our best known strategies on Wall Street, and 0:02:44.040 --> 0:02:46.560 so I wanted maybe to just start out having you 0:02:46.639 --> 0:02:48.680 tell us about your year and price target for the 0:02:48.800 --> 0:02:51.600 SMP five hundred, and I believe that you guys also 0:02:52.080 --> 0:02:56.040 have different variables and scenes playing out for the year. 0:02:56.080 --> 0:02:58.720 Maybe you can talk about those as well. Yeah. Absolutely, 0:02:58.760 --> 0:03:01.680 it's um so so our official year in target. You know, 0:03:01.720 --> 0:03:04.120 it's it's kind of a point in time forecast where 0:03:04.120 --> 0:03:07.760 we we think the market will close around four thousand 0:03:08.000 --> 0:03:11.600 the SMP five hundred, which is really limited upside from here. 0:03:11.960 --> 0:03:14.480 Um but we think there's a lot of moves within 0:03:14.560 --> 0:03:17.400 the year. So let's talk about a range. I think 0:03:17.400 --> 0:03:20.959 our book case, like, if everything goes right, we think 0:03:21.000 --> 0:03:24.320 the market could go as high as forty hundred, which 0:03:24.320 --> 0:03:27.320 would be a pretty great year, and then our bear 0:03:27.400 --> 0:03:30.440 case and what we think is a reasonable floor for 0:03:30.520 --> 0:03:34.280 the market is three thousand, which would be quite a 0:03:34.280 --> 0:03:37.120 big drop from here. So, you know, I think our 0:03:37.200 --> 0:03:40.160 views are in two thousand twenty three, it might be 0:03:40.480 --> 0:03:43.680 a less than stellar year for the index, for the 0:03:43.760 --> 0:03:46.800 market index, but we think there are gonna be a 0:03:46.800 --> 0:03:51.040 lot of great opportunities within the SMP five hundred. And 0:03:51.080 --> 0:03:54.120 you know, I think that's where we're really focused with 0:03:54.120 --> 0:03:57.640 with our views is what sectors, what themes, you know, 0:03:57.680 --> 0:04:01.080 what areas within the SMP five hundred can actually do 0:04:01.160 --> 0:04:04.680 pretty well this year, you know, amidst a backdrop of 0:04:04.680 --> 0:04:08.960 of relatively muted returns for the overall market. I want 0:04:08.960 --> 0:04:12.640 to get into those themes and sectors sevida. But like 0:04:12.680 --> 0:04:16.440 I said in the introduction, I'm fascinated by this notion 0:04:16.680 --> 0:04:20.760 that pretty much everyone assumes all these earnings estimates from 0:04:20.760 --> 0:04:23.240 the analysts right now or wrong, you know, all the 0:04:23.279 --> 0:04:25.320 top down view of the market is that what are 0:04:25.360 --> 0:04:28.400 they thinking, Uh, these estimates have to be cut? What 0:04:28.440 --> 0:04:31.080 do you think explains that? I mean, our our analysts 0:04:31.120 --> 0:04:34.040 just sort of waiting for the companies themselves to lower guidance. 0:04:34.120 --> 0:04:37.039 You know, is this four fourth quarter reporting season really 0:04:37.080 --> 0:04:40.480 gonna pull that out from all the conference calls. You know, 0:04:40.560 --> 0:04:43.159 how do you see this unfolding? I think you're right. 0:04:43.200 --> 0:04:46.640 I think that analysts are in sort of weight and 0:04:46.720 --> 0:04:49.159 C mode, and maybe even companies are in weight and 0:04:49.279 --> 0:04:53.800 C mode, because you know, the real positive surprise over 0:04:53.839 --> 0:04:59.480 the last few years is that despite rampant inflation, cost 0:04:59.560 --> 0:05:04.000 pressure or wage pressure, you know, everything going up to 0:05:04.760 --> 0:05:07.680 you know, pretty high levels in terms of you know, 0:05:07.760 --> 0:05:11.920 kind of margin pressure, companies have managed to navigate this 0:05:12.080 --> 0:05:17.240 by either you know, pricing products more aggressively or by uh, 0:05:17.279 --> 0:05:20.240 you know, cutting costs. And I think on top of that, 0:05:20.279 --> 0:05:23.919 we're seeing corporates very nimble in terms of cutting costs. 0:05:23.960 --> 0:05:26.360 A lot of the headlines recently have been around megacap 0:05:26.440 --> 0:05:30.440 tech companies, you know, uh, kind of reducing their compensation 0:05:30.839 --> 0:05:35.000 cost structure by by layoffs, you know, not necessarily great 0:05:35.040 --> 0:05:38.000 for the economy, but good for their bottom line. So 0:05:38.000 --> 0:05:40.880 so I think that analysts and you know, in corporates 0:05:40.920 --> 0:05:46.200 are are probably a little less convicted in terms of 0:05:46.640 --> 0:05:50.480 margins and cost pressure and pricing power going forward. Our 0:05:50.560 --> 0:05:55.640 view is that we are likely to see some downward revisions, 0:05:55.800 --> 0:05:59.800 and you know, our forecast for profits growth for three 0:06:00.160 --> 0:06:03.200 is you know, two hundred bucks for the SMP five hundred, 0:06:03.880 --> 0:06:06.320 and that would mean about a ten percent decline in 0:06:06.400 --> 0:06:10.599 earnings peak to trough. Now, you know, I think that 0:06:10.640 --> 0:06:15.520 makes sense to us amidst UH forecasts for a recession. 0:06:15.800 --> 0:06:18.680 This is, you know, one of the most widely telegraphed 0:06:18.720 --> 0:06:21.880 recessions of of all time. I think we're all just 0:06:21.920 --> 0:06:25.560 sitting here bracing ourselves for it. UM, a teen percent 0:06:25.600 --> 0:06:28.200 drop in earnings would actually be half of the typical 0:06:28.320 --> 0:06:32.000 recessionary corporate earnings drop. So so we think that we 0:06:32.040 --> 0:06:34.360 are going to see those estimates come down, and it's 0:06:34.520 --> 0:06:40.040 likely to happen after companies guide more aggressively lower around 0:06:40.400 --> 0:06:43.000 three earnings UM. But you know, I think where we're 0:06:43.000 --> 0:06:47.240 going to see pressures are in companies with more labor intensity, 0:06:47.279 --> 0:06:52.479 like services companies, companies where you're really seeing cost pressure 0:06:52.600 --> 0:06:55.359 remain high. Those are the areas where we think that 0:06:55.400 --> 0:06:58.839 we're going to see some downward guides on on margins 0:07:00.200 --> 0:07:02.479 and savita. I want to ask you about what specifically 0:07:02.480 --> 0:07:06.039 you'll be looking for this earning season, and I think 0:07:06.080 --> 0:07:08.880 you guys have you guys have really great UM daily 0:07:08.880 --> 0:07:13.440 and weekly research. I remember from past earning seasons that 0:07:13.520 --> 0:07:16.200 you have Maybe it's sort of like an AI driven 0:07:16.240 --> 0:07:19.080 model or something along those lines, where you sift through 0:07:19.120 --> 0:07:21.680 all the earnings reports and you look for keywords and 0:07:21.720 --> 0:07:24.360 some of the things that are mentioned the most number 0:07:24.360 --> 0:07:27.239 of times. So if we're behind, if we have peak 0:07:27.440 --> 0:07:30.920 inflation behind us, UM, what will you be looking for? 0:07:31.000 --> 0:07:34.040 What keywords, what trends and and and UM will you 0:07:34.160 --> 0:07:38.560 be sort of cluing into as these earnings reports roll out? Yeah, 0:07:38.560 --> 0:07:41.760 thanks for that question, and thanks for reading our research. 0:07:42.440 --> 0:07:46.440 Always read it. We do a lot of kind of 0:07:46.520 --> 0:07:50.320 text analysis, and you know, some of the things that 0:07:50.360 --> 0:07:53.640 we've been able to unearth UM during different periods are 0:07:54.000 --> 0:07:59.800 you know, kind of inventory pressures, UM, demand destruction, UM 0:08:00.240 --> 0:08:03.400 inability to price. So this quarter what we are laser 0:08:03.440 --> 0:08:06.360 focused on our couple of things. As I mentioned, we 0:08:06.440 --> 0:08:09.560 want to hear more from companies around whether the tightness 0:08:09.600 --> 0:08:12.320 in the labor market is alleviating, because that has been 0:08:12.360 --> 0:08:16.160 the theme for the last you know, almost eight quarters now, 0:08:16.280 --> 0:08:19.680 is just the inability of companies to source labor unless 0:08:19.680 --> 0:08:24.720 they dramatically increase prices, especially at the lower income end. UM. 0:08:24.760 --> 0:08:29.480 We're also listening for more news around layoffs in services sectors. 0:08:29.520 --> 0:08:31.560 So you know, so far we've really heard it only 0:08:31.600 --> 0:08:34.600 from you know, megacab tech companies. We're waiting to see 0:08:34.640 --> 0:08:38.800 whether that spreads to a broader array of companies. UM, 0:08:38.920 --> 0:08:43.079 we're also listening for thoughts around you know, kind of 0:08:43.080 --> 0:08:46.319 this inventory mismatch. So we've seen some of the supply 0:08:46.480 --> 0:08:50.680 chain frictions alleviate, and now we're wondering how much inventory 0:08:50.760 --> 0:08:53.640 companies have to work off, and that could be another 0:08:53.800 --> 0:08:59.600 drag on on pricing, power, demand, earnings pressure, etcetera. We're 0:08:59.600 --> 0:09:01.560 all you I think some of the other factors that 0:09:01.559 --> 0:09:03.880 we're paying attention to from a from an earnings for 0:09:03.960 --> 0:09:07.640 share perspective are buy backs. So you know, the last 0:09:07.760 --> 0:09:11.840 five years we've seen buy backs contribute about ten percentage 0:09:11.840 --> 0:09:15.280 points of SMP profits growth. That's a huge amount and 0:09:15.360 --> 0:09:20.840 it's really unusual versus prior cycles. So if that buy 0:09:20.880 --> 0:09:24.400 back trend also decelerates, and there are good reasons to 0:09:24.440 --> 0:09:27.439 believe it does, I mean, the government is now taxing 0:09:27.559 --> 0:09:30.760 corporate buy backs. You know, companies might be more likely 0:09:30.880 --> 0:09:33.840 to hold cash rather than spend it on buy backs 0:09:33.840 --> 0:09:36.280 if we are worried about a downturn. So that's another 0:09:36.320 --> 0:09:39.319 trend we're listening for um and our view is again 0:09:39.760 --> 0:09:42.840 for share earnings growth has been really juiced up over 0:09:42.880 --> 0:09:46.240 the last five plus years by just um you know, 0:09:46.400 --> 0:09:50.439 rampant buy back activity, and if that cools, that will 0:09:50.480 --> 0:09:55.360 be another source of potential risk to two earnings going forward. 0:09:56.080 --> 0:09:58.840 You know, Sevita, you've mentioned some of the layoffs among 0:09:58.880 --> 0:10:00.960 the big tech company ease. I think a lot of 0:10:00.960 --> 0:10:03.760 people are bracing for perhaps a wave of layoffs in 0:10:03.800 --> 0:10:06.559 the financial sector, you know, which I'm assuming a lot 0:10:06.559 --> 0:10:10.160 of our listeners are employed in our layoffs. Automatically good 0:10:10.160 --> 0:10:12.880 news for the share price this year is as just 0:10:12.920 --> 0:10:15.360 to be blunt and say it out front. If if 0:10:15.360 --> 0:10:19.280 I see a headline such and such is cutting x percent, 0:10:19.520 --> 0:10:21.840 is that automatically good news for the stock price or 0:10:21.880 --> 0:10:24.079 is it is there more nuanced? Do you think, well, 0:10:24.120 --> 0:10:25.959 you know, it's good news and that the company is 0:10:26.000 --> 0:10:29.080 being nimble and addressing this issue of you know, bloated 0:10:29.520 --> 0:10:34.520 compensation costs and maybe you know, rationalizing capacity. But I 0:10:34.600 --> 0:10:38.720 do think that the the signal it's giving us is 0:10:38.720 --> 0:10:41.840 that this company is in workout mode. So yes, they're 0:10:41.840 --> 0:10:46.000 being nimble, they're addressing these issues. But First of all, 0:10:46.080 --> 0:10:49.600 it means that they you know, sort of misallocated capital 0:10:50.240 --> 0:10:53.679 um in in in a better period of time. And 0:10:53.920 --> 0:10:59.360 second of all, it means that from an economic perspective, especially, 0:10:59.360 --> 0:11:01.880 I think in this getting into this recession, what could 0:11:01.880 --> 0:11:03.880 be different this time is that a lot of the 0:11:03.960 --> 0:11:06.640 layoffs are really happening at the higher income end or 0:11:06.679 --> 0:11:09.680 the skilled labor end. And what that means is that, 0:11:09.760 --> 0:11:12.880 you know, typically in a recession, luxury goods are more 0:11:12.920 --> 0:11:18.280 defensive than lower, lower price point products. But in this recession, 0:11:18.320 --> 0:11:21.319 maybe luxury isn't as defensive because a lot of the 0:11:21.400 --> 0:11:24.360 layoffs are really much more acute at that kind of 0:11:24.400 --> 0:11:28.400 skilled services and tech level. UM. So those are some 0:11:28.480 --> 0:11:31.240 of the things that we're watching from a company perspective. 0:11:31.280 --> 0:11:34.240 For the most part, we've found that investors have lauded 0:11:34.840 --> 0:11:39.280 the news around layoffs um you know, as a source 0:11:39.440 --> 0:11:43.840 of alleviation of margin pressure. But I think that you know, 0:11:44.240 --> 0:11:48.880 whether or not that's enough to offset the Also, deteriorating 0:11:48.960 --> 0:11:53.559 demand is the big question, so top line becomes important. Yes, 0:11:53.640 --> 0:11:57.800 companies are being very nimble at managing costs, but they're 0:11:57.840 --> 0:12:00.720 doing this because they're seeing less demand and and less 0:12:00.760 --> 0:12:04.520 ability to um, you know, continue operations with their current 0:12:04.920 --> 0:12:08.240 labor setups, so that that votes ill for you know, 0:12:08.360 --> 0:12:11.760 demand in uh in terms of uh, you know, kind 0:12:11.760 --> 0:12:14.640 of top line growth. When we look at tech companies, 0:12:14.960 --> 0:12:16.920 one of the things that worries us, and we're underweight 0:12:17.160 --> 0:12:21.120 information technology as well as communication services, and one of 0:12:21.160 --> 0:12:23.400 the things that worries us is that, you know, kind 0:12:23.400 --> 0:12:26.120 of similar to Y two K back in two thousand, 0:12:26.880 --> 0:12:31.560 we've seen this massive pull forward of demand for tech 0:12:31.840 --> 0:12:36.440 during COVID work from home, um, you know kind of 0:12:36.559 --> 0:12:40.200 you know, all of the telecommuting that we've done, and 0:12:40.280 --> 0:12:43.959 so what we're seeing now is potentially a hit to 0:12:44.880 --> 0:12:50.400 CAPEX on software of companies that already sort of you know, 0:12:50.520 --> 0:12:55.520 really address their software spend over the last couple of years. 0:12:55.600 --> 0:12:57.960 So I think that's what we're worried about for tech 0:12:58.000 --> 0:13:01.720 companies is you know, maybe what they're doing is great 0:13:01.760 --> 0:13:04.440 in terms of managing costs, but how much of their 0:13:04.480 --> 0:13:08.400 demand is really cyclical rather than as sticky as what 0:13:08.480 --> 0:13:11.800 everybody was forecasting, you know, in the in prior years. 0:13:12.400 --> 0:13:15.679 And we mentioned recession a couple of times down how 0:13:15.720 --> 0:13:19.520 this is one of the most well telegraphed recessions ever 0:13:19.920 --> 0:13:22.040 but you actually say that this is not your mom 0:13:22.080 --> 0:13:25.640 and dad's recession. So I'm wondering what you are expecting 0:13:25.679 --> 0:13:28.600 and how you might characterize. I will say that was 0:13:28.640 --> 0:13:31.080 good news when I read that, because my dad was 0:13:31.120 --> 0:13:34.880 born right at the beginning of the Great Depression. So 0:13:35.240 --> 0:13:40.120 for me, that's why you could crowd his life. You 0:13:40.120 --> 0:13:42.520 could put like ten pounds of spaghetti on his plate. 0:13:42.760 --> 0:13:48.520 He'd eat every piece of spaghetti because he yea spaghetti 0:13:48.600 --> 0:13:50.880 is exactly right. I mean, I think that when we 0:13:50.960 --> 0:13:55.959 think about our parents, and you know, prior generations, recessions 0:13:56.120 --> 0:13:59.520 looked really different. And I think I mean, obviously the 0:13:59.559 --> 0:14:03.079 Depression was was one of the most acute recessions we've 0:14:03.120 --> 0:14:05.920 ever seen, I think, even two thousand and eight, when 0:14:05.960 --> 0:14:09.440 when you think about kind of the drama that took 0:14:09.440 --> 0:14:15.320 place within corporate America, within consumers, homeowners, it was really 0:14:15.400 --> 0:14:18.160 broad spread. It was driven by this you know, massive 0:14:18.280 --> 0:14:22.280 credit cycle. And I think the good news is that 0:14:22.760 --> 0:14:28.080 today corporates and consumers actually look pretty well capitalized, at 0:14:28.120 --> 0:14:30.720 least for the time being. And maybe that's just a 0:14:30.720 --> 0:14:33.320 function of really low interest rates, but I think what 0:14:33.400 --> 0:14:36.440 corporates learned in two thousand and eight was that leverage 0:14:36.480 --> 0:14:41.680 is evil, and they have now locked in relatively long 0:14:41.800 --> 0:14:46.760 dated fixed rate obligations on the on the debt side, 0:14:47.360 --> 0:14:50.320 Like to me, the most encouraging number is if you 0:14:50.400 --> 0:14:54.760 compared today's average maturity of debt on SMP balance sheets 0:14:54.880 --> 0:14:58.560 to that in two thousand eight, today debt terms out 0:14:58.600 --> 0:15:01.520 at about on average a eleven years back in a way, 0:15:01.600 --> 0:15:04.320 it was more like seven years. So we've seen this 0:15:04.320 --> 0:15:08.920 this longer duration exposure to to fixed rate debt, which 0:15:08.920 --> 0:15:10.960 I think is good news because that means that higher 0:15:11.000 --> 0:15:13.720 interest rates won't hurt these companies overnight and they have 0:15:13.840 --> 0:15:18.640 time to navigate that that process. Consumers similarly are well. 0:15:18.680 --> 0:15:21.240 They got a big bullus of cash from the government 0:15:21.880 --> 0:15:26.040 in one so you know, balance sheets of consumers and 0:15:26.080 --> 0:15:29.280 corporates look pretty great. The government is holding the bag 0:15:29.320 --> 0:15:32.040 when it comes to debt. So if you look at deficits, 0:15:32.200 --> 0:15:35.000 if you look at FED balance sheets, I think what's 0:15:35.000 --> 0:15:38.840 different today is that the FED has never had this 0:15:38.960 --> 0:15:42.760 type of an asset base. We've seen trillions of dollars 0:15:42.800 --> 0:15:46.320 of you know, kind of bond purchases occur over the 0:15:46.400 --> 0:15:50.280 last ten plus years, which have been great for risk assets, 0:15:50.320 --> 0:15:53.600 but not you know how does the FED navigate unwinding 0:15:53.640 --> 0:15:56.640 all of that debt? I think that's the trillion dollar 0:15:56.800 --> 0:16:01.000 question because we've never seen this movie for and and 0:16:01.040 --> 0:16:03.880 that's what We're a little more worried about the public 0:16:03.920 --> 0:16:12.960 sector than the private sector in this recession. I think 0:16:12.960 --> 0:16:15.560 what blows my mind the most is, you know, we 0:16:15.640 --> 0:16:19.160 are all expecting this recession, and then yet you right 0:16:19.280 --> 0:16:23.400 in your quant models the most attractive sector is financials, 0:16:23.440 --> 0:16:26.040 which you know would not be what you would expect 0:16:26.880 --> 0:16:30.040 ahead of you know, at least these big recessions that 0:16:30.120 --> 0:16:33.000 you know, two thousand and eight, that sort of thing. 0:16:33.120 --> 0:16:35.080 So yeah, I guess to some degree that's just a 0:16:35.080 --> 0:16:38.840 testament to the effectiveness of the of the reforms of 0:16:38.880 --> 0:16:42.320 two thousand and eight, and how what a different economic 0:16:42.440 --> 0:16:45.120 environment it is with the high inflation everything. But walk 0:16:45.200 --> 0:16:49.040 us through what makes financial stick out in your quant 0:16:49.080 --> 0:16:51.760 models to be so attractive? Yeah, I mean it's a 0:16:51.840 --> 0:16:53.840 it's a great question because I think when you think 0:16:53.880 --> 0:16:56.680 about what to own in a recession, financials would probably 0:16:56.680 --> 0:16:58.960 be the last sector you'd want to own. And it's 0:16:59.000 --> 0:17:01.080 because we all think of two thousand and eight, where 0:17:01.120 --> 0:17:04.760 that was the point of maximum pain. Today, I think 0:17:04.800 --> 0:17:08.960 the good news is that financials companies are not necessarily 0:17:09.080 --> 0:17:11.800 holding the credit risk. They haven't really been allowed to 0:17:11.920 --> 0:17:15.520 lend to low quality consumers. They've been you know, kind 0:17:15.520 --> 0:17:19.040 of regulated by the government, um, forced to arguably over 0:17:19.080 --> 0:17:21.800 capitalize balance sheets or you know, today, if you look 0:17:21.840 --> 0:17:26.080 at a chart of leverage for financials, we're at you know, 0:17:26.119 --> 0:17:29.000 a sixth of where we were in terms of leverage 0:17:29.080 --> 0:17:32.520 risk relative to two thousand eight. And we've never seen 0:17:32.640 --> 0:17:36.080 this type of a monstrous drop in leverage going back 0:17:36.119 --> 0:17:39.119 to you know, the nineteen thirties. So I think where 0:17:39.160 --> 0:17:43.960 the lending risk resides is not necessarily in US large 0:17:44.040 --> 0:17:49.520 cap banks or financial companies. It's really outside of the 0:17:49.560 --> 0:17:52.280 financial sector. You know, you've seen a lot of of 0:17:52.400 --> 0:17:57.080 lending through private equity, venture capital UM companies that have 0:17:57.160 --> 0:18:01.000 burgeoned in an environment of zero in trist rates, zero 0:18:01.119 --> 0:18:04.600 hurdle rates, you know, kind of free capital, and I 0:18:04.640 --> 0:18:08.840 think that's where we are more worried about this unwind 0:18:09.040 --> 0:18:12.680 of public sector debt. So yeah, So, like I said, 0:18:12.800 --> 0:18:15.239 it's not your mom and dad's recession and that the 0:18:15.280 --> 0:18:19.159 credit cycle. You know, we are seeing credit conditions tighten, 0:18:19.359 --> 0:18:24.479 but it's not necessarily as threatening. Two banks given that 0:18:24.520 --> 0:18:28.120 they've been regulated to deal with these types of credit 0:18:27.840 --> 0:18:32.600 credit cycles. Um from lessons that we learned in O eight. Uh, 0:18:32.640 --> 0:18:34.600 you know, I think financials is also this sort of 0:18:34.680 --> 0:18:38.000 closet high quality sector. And it feels weird for me 0:18:38.080 --> 0:18:41.760 to say this having lived through the financial crisis, But 0:18:42.320 --> 0:18:45.560 when you look at the earnings variability of financial companies 0:18:45.600 --> 0:18:48.320 relative to the market, you know, tech is a far 0:18:48.400 --> 0:18:52.359 more cyclical sector today than financials is. Financial companies actually 0:18:52.400 --> 0:18:56.680 have lower earnings volatility than the SMP five hundred, which 0:18:56.720 --> 0:18:59.080 is kind of shocking, right, I mean, it's it's almost 0:18:59.119 --> 0:19:04.640 like financial has morphed into the regulated utilities sector because 0:19:04.840 --> 0:19:08.080 of you know, the fact that these companies have been 0:19:08.119 --> 0:19:14.679 so scrutinized and have been so disciplined about capital cushions. Said, 0:19:15.000 --> 0:19:17.119 I also want to ask you about this point that 0:19:17.160 --> 0:19:21.160 you make about how bonds over stocks is now the 0:19:21.240 --> 0:19:23.919 consensus for at least the first half. But then you 0:19:24.000 --> 0:19:27.760 also add, um, given drops in equity sentiment and positioning, 0:19:27.800 --> 0:19:30.520 one of the biggest risks today might be that of 0:19:30.560 --> 0:19:33.480 being under invested in stocks. So how are you thinking 0:19:33.480 --> 0:19:35.760 about this? Because we heard we've also been hearing from 0:19:35.760 --> 0:19:38.520 people I think even gun Luck said it earlier this 0:19:38.600 --> 0:19:43.320 weekest part of his quarterly webcast, that people should be 0:19:43.359 --> 0:19:46.879 positioning six in bonds and stocks, And I'm wondering what 0:19:46.920 --> 0:19:49.440 you think about that. Look. I mean, I think that 0:19:49.720 --> 0:19:54.800 bonds did horrifically last year, so one could argue that 0:19:54.840 --> 0:19:58.800 there is some you know, kind of upside risk to 0:19:58.960 --> 0:20:03.320 fixed income. From a yield perspective, bonds now offer much 0:20:03.320 --> 0:20:06.480 more competitive income than than you know, the dividend yield 0:20:06.520 --> 0:20:08.560 on the S and P five hundred, So a lot 0:20:08.560 --> 0:20:12.359 of things have changed over the last twelve months. But 0:20:12.880 --> 0:20:15.520 I think what worries me is that when you think 0:20:15.560 --> 0:20:21.880 about bonds, the biggest demand for ten year treasuries over 0:20:21.920 --> 0:20:26.480 the last few decades has been from the FED buying 0:20:26.520 --> 0:20:31.080 bonds through quantitative easing and from China buying US treasuries. 0:20:31.720 --> 0:20:36.119 And both of those big sources of demand have left 0:20:36.200 --> 0:20:40.240 the building. So I think that that's something we need 0:20:40.280 --> 0:20:44.520 to think about. Is quantitative tightening is happening real time. 0:20:44.560 --> 0:20:48.600 I mean, it started last year, and basically our our 0:20:48.760 --> 0:20:53.800 rates team thinks that quantitative tightening as projected will basically 0:20:54.359 --> 0:20:58.440 remove about you know, a trillion plus dollars of demand 0:20:58.600 --> 0:21:02.359 for treasuries. Over the next twelve months. That's a lot 0:21:02.400 --> 0:21:05.679 of money, and we don't know who is going to 0:21:05.800 --> 0:21:11.240 step in and fill that void. So our view is okay, Yeah, 0:21:11.320 --> 0:21:14.320 bonds are offering a higher yield than they were last year, 0:21:14.400 --> 0:21:17.320 so from an income perspective, they do look on the 0:21:17.320 --> 0:21:21.080 margin more attractive than a lower dividend yielding equity. But 0:21:21.240 --> 0:21:24.119 if rates continue to rise, and if that demand for 0:21:24.240 --> 0:21:28.320 bonds is continuing to wane rather than wax, that's where 0:21:28.359 --> 0:21:31.280 I worry about the upside risk to interest rates and 0:21:31.320 --> 0:21:35.080 thus downside risk from a price perspective to bonds. I think. 0:21:35.080 --> 0:21:38.240 Also what's shocking to me is that over the last 0:21:38.240 --> 0:21:42.560 twelve months all of the equity bulls have become bond goals. 0:21:42.600 --> 0:21:45.600 And the most one of the most consensus themes that 0:21:45.640 --> 0:21:50.159 we hear is, you know, buy bonds in a recession 0:21:50.320 --> 0:21:53.160 and then move into equities and the recovery. Our view 0:21:53.280 --> 0:21:55.960 is this, like I said before, this might be a 0:21:56.080 --> 0:21:59.840 very different recession where bonds don't necessarily hold up as well. 0:22:00.240 --> 0:22:03.160 And the reason is that, you know, the twin deficits, 0:22:03.160 --> 0:22:07.040 the fact that the public sector is holding the leverage. 0:22:07.560 --> 0:22:10.800 So our view is okay, sure, dividends are lower, but 0:22:11.160 --> 0:22:13.200 there are still a bunch of stocks in the SMP 0:22:13.320 --> 0:22:16.960 five hundreds that offer competitive yields with bonds and with 0:22:17.000 --> 0:22:19.399 the fixed income markets. And the good news is that 0:22:19.480 --> 0:22:23.880 equities can grow their earnings if inflation remains sticky and high. 0:22:24.160 --> 0:22:29.199 So buy companies that have you know, reasonable dividend yields 0:22:29.240 --> 0:22:33.000 and also the ability to navigate an inflationary environment or 0:22:33.080 --> 0:22:36.480 rising interest rate environment and continue to grow those dividends 0:22:36.560 --> 0:22:40.880 and remain competitive with fixed income. So I still think 0:22:40.920 --> 0:22:44.800 that the argument for holding equities in a rising interest 0:22:44.920 --> 0:22:49.679 rate environment remains intact. Companies have the ability to grow earnings, 0:22:49.960 --> 0:22:53.840 whereas fixed income is exactly that fixed income. You can't 0:22:53.840 --> 0:22:57.439 grow your earnings in an environment of rising interest rates. 0:22:57.480 --> 0:23:01.000 And with you know, equity income sort of being a 0:23:01.119 --> 0:23:03.760 much bigger potential source of return, I think than it 0:23:03.840 --> 0:23:06.080 than it has been in the last negade or so. 0:23:06.560 --> 0:23:09.480 To simplify it's to sort of the most simplest terms. 0:23:09.560 --> 0:23:12.240 Is it like by the aristocrats index type of thing, 0:23:12.359 --> 0:23:15.000 do you think? Or that type of company? That type 0:23:15.040 --> 0:23:18.480 of company exactly, these boring kind of steady eddie companies. 0:23:18.640 --> 0:23:21.479 In fact, my favorite screen and I tell my parents 0:23:21.520 --> 0:23:23.919 about this. I tell my friends about this, But my 0:23:24.040 --> 0:23:27.640 favorite quantitative screen is like the easiest thing to do. 0:23:27.840 --> 0:23:31.160 So you take the Russell in thousands stocks like the 0:23:31.200 --> 0:23:34.840 one thousand largest companies in the US equity market. Take 0:23:34.880 --> 0:23:37.359 the largest one thousand stocks in the US equity market. 0:23:37.880 --> 0:23:40.400 You look for the dividend yield. You rank all these 0:23:40.400 --> 0:23:43.560 companies by dividend yield, and then instead of buying the 0:23:43.680 --> 0:23:48.879 highest dividend quintile, you buy quintile two. It's that easy. 0:23:49.240 --> 0:23:52.639 So just by quintile two of the Russell in thousand 0:23:52.960 --> 0:23:55.800 by dividend yield, and what that does is it gives 0:23:55.840 --> 0:23:59.239 you kind of competitive yields with the market. So you're 0:23:59.280 --> 0:24:03.560