Speaker 1: Bloomberg Audio Studios, Podcasts, radio News.
Speaker 2: Hello and welcome to another episode of the All Lots podcast.
Speaker 2: I'm Tracy Alloway.
Speaker 3: And I'm Joe Wisenthal.
Speaker 2: Joe. For all intents and purposes, we're pretty much at
Speaker 2: a record in terms of US stocks totally.
Speaker 3: We're recording this April second, so we're actually down a
Speaker 3: little bit today, about a percent. But the story in
Speaker 3: my mind of the market for twenty twenty four is
Speaker 3: that we went into this year with all sorts of
Speaker 3: soft landing optimism. The FED is going to cut rates
Speaker 3: a bunch of times, and then all these sort of
Speaker 3: rate cut hopes are sort of slowly evaporating, but it's
Speaker 3: hardly affected the stock market, and so we're basically at
Speaker 3: record highs despite the fact that that first cut keeps
Speaker 3: getting pushed out into the future.
Speaker 2: Yeah, And the question is, are stock's going to start
Speaker 2: to turn lower again? They are lower today, They've been
Speaker 2: kind of vacillating for the past couple of days. Is
Speaker 2: the start of a durable drop or are markets basically
Speaker 2: catching their breath after a torrid rally and are they
Speaker 2: going to continue upward? Is all that excitement over things
Speaker 2: like AI and tech just going to keep going. And
Speaker 2: speaking of excitement over AI and tech, you do see
Speaker 2: some commentary at the moment about bubble territory, so the
Speaker 2: idea that, well, maybe we're getting a little bit too optimistic,
Speaker 2: or isn't it weird that it was expectations of rate
Speaker 2: cuts that drove the move upward, but as the rate
Speaker 2: cuts get priced further out, we're not really seeing that
Speaker 2: big impact on stocks totally.
Speaker 3: So for a while as the market was doing this
Speaker 3: sort of straight line up really since the end of
Speaker 3: October when rates peaked, part of this sort of I
Speaker 3: don't know, bear crowd or skepticism or people trying to
Speaker 3: poke holes in the rally is like, oh, it's all tech,
Speaker 3: it's all the mag seven, these gigantic tech stocks, etc.
Speaker 3: What's interesting about lately is that actually a lot of
Speaker 3: these high flyers, like in video, they've like sort of
Speaker 3: been flat for the last month or so, and even
Speaker 3: that doesn't seem to be holding water. There actually are
Speaker 3: big rallies in many parts of the market. So the
Speaker 3: question is like why, I mean, you could say, oh,
Speaker 3: like the story maybe made sense, it's like, oh, there's
Speaker 3: these handful of mega giants. They're capturing all of the gains,
Speaker 3: and so what these new all time highs don't really
Speaker 3: reflect what the broader market is doing. The broader market's
Speaker 3: doing fine.
Speaker 2: Yeah, and again against expectation. Yes, it's actually broadening out yeow,
Speaker 2: rather than becoming more narrow, which is the kind of
Speaker 2: thing that you would be worried about if you are
Speaker 2: in a bubble or about to test a bubble. But
Speaker 2: all right, I am very pleased to say that we do,
Speaker 2: in fact have the perfect guests to discuss markets and
Speaker 2: whether or not we are closing in on bubble territory.
Speaker 2: We're going to be speaking with Cevita Supermanian, head of
Speaker 2: US equity strategy at Bank of America, and she recently
Speaker 2: raised her target for the S and P five hundred
Speaker 2: from five thousand to five four hundred. I think this
Speaker 2: was done about a month ago, and we're already at
Speaker 2: like five thousand, two hundred. Yeah, So yeah, good call, Savita.
Speaker 2: Welcome to the show.
Speaker 4: Hi, it's great to be here. Thanks for having me.
Speaker 2: It's I feel kind of bad. I feel like we
Speaker 2: should have had you on way way earlier, because you know,
Speaker 2: you are sort of a stalwart of the cell side
Speaker 2: research on the stocks, and yet we haven't made it happen.
Speaker 2: Kind of weird, that is weird, but we're correcting for
Speaker 2: past mistakes. Yes, this is good, a good type of correction.
Speaker 2: All right, SMP five hundred pretty much at record highs.
Speaker 2: What's driving it?
Speaker 4: Yeah, So it's interesting when we launched our twenty twenty
Speaker 4: four outlook in November with our year ahead report, and
Speaker 4: we launched our SMP market call with a five thousand
Speaker 4: year end target, and I remember having to repeat that
Speaker 4: number like people would literally say, did you just say
Speaker 4: five thousand? Like it was way too high? And now
Speaker 4: here we are at fifty two whatever, and a couple
Speaker 4: of months ago, the market basically breezed right through that
Speaker 4: five thousand target. And you know, there's no perfect way
Speaker 4: to forecast a point in time target impact. I think
Speaker 4: it's kind of a silly number. But the question that
Speaker 4: we asked ourselves was, Okay, now, what does the market
Speaker 4: go higher or lower? Because we're kind of where we
Speaker 4: thought we would be by your end in January, and
Speaker 4: everything we looked at said higher, So you know, I
Speaker 4: can delve into it, but I think where we are
Speaker 4: now is still we're sort of climbing that wall of worry.
Speaker 4: We're still in an environment where I don't know, it's
Speaker 4: interesting if you look at the average target for the
Speaker 4: S and P, I think it's lower than where the
Speaker 4: market is today, which is unusual because I think the
Speaker 4: SU side is usually skewed to being more optimistic. When
Speaker 4: you look at even analysts earnings expectations, there are still
Speaker 4: relatively low outside of this so called you know, Magnificent
Speaker 4: seven or the you know, the megacap tech companies that
Speaker 4: have been driving the market. So I still think we're
Speaker 4: in an environment where allocation to stocks is just starting
Speaker 4: to increase, Bolishness is just starting to percolate, and as
Speaker 4: you rightly point out, the market is just starting to
Speaker 4: broaden out a bit.
Speaker 3: Let's go back to the initial call that you made
Speaker 3: for S and P five thousand. What was the reasoning
Speaker 3: then in terms of like, let's just start with that question.
Speaker 4: So the reasoning then and it was basically putting the
Speaker 4: smp at around it. I think it was like a
Speaker 4: ten percent year or thereabouts. Was the idea was, Okay,
Speaker 4: where are we now versus where we were a couple
Speaker 4: of years ago, And I think there's a lot of
Speaker 4: good news that we should be happy about. We should
Speaker 4: be happy that the FED has actually moved interest rates
Speaker 4: from zero to five because now we have a lot
Speaker 4: of latitude with which to ease our way out of
Speaker 4: the next crisis. We should also be happy that the
Speaker 4: SMP itself is pretty different today than what it was
Speaker 4: a couple of years ago. And I think you know
Speaker 4: what I find interesting is that the SMP five hundred
Speaker 4: has basically managed out a lot of its own risk
Speaker 4: over the last couple of years by attrition. So if
Speaker 4: you look at a lot of the companies that were
Speaker 4: in the S and P five hundred in twenty twenty two,
Speaker 4: you know when the big surprise was the FED was
Speaker 4: about to hike interest rates by the largest amount ever
Speaker 4: in the fastest period of time. You know, the constituents
Speaker 4: that were bigger weights in the market are now smaller
Speaker 4: weights and maybe have even drifted out. And in particular,
Speaker 4: the ones that have drifted out are those with refinancing
Speaker 4: risk or companies that might not be able to hack
Speaker 4: it in a five percent rate world. So I almost
Speaker 4: feel like the beginning of this year was a good
Speaker 4: start in terms of the health of the index. We
Speaker 4: also saw that despite this megacap tech dominance. These companies
Speaker 4: they got expensive, but they didn't get as expensive as
Speaker 4: we saw, you know, nonprofitable tech during the tech bubble
Speaker 4: of ninety nine two thousand. Moreover, I think what's really
Speaker 4: exciting from a corporate finance perspective is that when you
Speaker 4: look at the risks around the S and P five
Speaker 4: hundred based on higher interest rates. One of the things
Speaker 4: that worried us a couple of years ago was that
Speaker 4: the SMP itself was a very long duration instrument, i e.
Speaker 4: You were buying today for like great growth, but it
Speaker 4: was way out in the future and you were getting
Speaker 4: no cash return. Today, I think a lot of that
Speaker 4: has resolved itself because many of the less profitable growth
Speaker 4: companies have either drifted lower in market cap or have
Speaker 4: become profitable and are now returning that cash to shareholders. So,
Speaker 4: you know, when we looked at companies in the big
Speaker 4: tech sector in early twenty twenty three, we started to
Speaker 4: see really encouraging signs. These big companies, these megacap tech
Speaker 4: companies basically acknowledged that they were too big to grow
Speaker 4: as quickly as they had in a zero percent interest
Speaker 4: rate world. And they were also just going to grow
Speaker 4: a little bit more slowly, and you saw these growth
Speaker 4: stocks actually cut capacity, cut costs. Meta did the biggest
Speaker 4: share buyback that we've ever seen in the history of
Speaker 4: share buybacks. And you know, these companies were able to
Speaker 4: lower their duration by pulling earnings earlier, in returning cash
Speaker 4: to shareholders, et cetera. I mean, the unthinkable happened earlier
Speaker 4: this year with Meta paying a dividend or initiating a dividend.
Speaker 4: So I think, you know, the idea here is we're
Speaker 4: at a point where the market actually looks a lot
Speaker 4: healthier and much better able to navigate a higher rate
Speaker 4: environment than it did a couple of years ago.
Speaker 2: So this is really interesting because you hear a lot
Speaker 2: of people say, well, stocks look expensive at the moment,
Speaker 2: and I think Bank of America has a bunch of
Speaker 2: different metrics that you look at, and I think in
Speaker 2: one of your notes you said that the SMP five
Speaker 2: hundred is statistically expensive on nineteen of twenty metrics. Yes,
Speaker 2: but the argument is that we've gone through this period
Speaker 2: of adjustment of higher rates and the mix of the index,
Speaker 2: its composition has shifted such that well, maybe those valuations
Speaker 2: are well deserved.
Speaker 4: Well, to some extent, it's the question should we ever
Speaker 4: be comparing the market multiple to a prior market multiple, right,
Speaker 4: because it's a different animal. And I think today, as
Speaker 4: you said, you know, we're looking at an S and
Speaker 4: P five hundred index that barely resembles the market in
Speaker 4: nineteen eighty or even nineteen ninety. We've gone from a
Speaker 4: market that was you know, seventy percent manufacturing back in
Speaker 4: the eighties to an index that's fifty percent asset light growth, healthcare,
Speaker 4: tech innovation. We've gone from a benchmark that had much
Speaker 4: higher debt to x equity ratios ten years ago to
Speaker 4: a benchmark that's paid down a lot of it's debt
Speaker 4: and now has fixed strate you know, kind of long term,
Speaker 4: less leverage risk and less free financing risk than it
Speaker 4: has had in prior cycles. I mean, seventy percent of
Speaker 4: debt sitting on SMP balance sheets is long term fixed
Speaker 4: rate debt versus back in two thousand and seven it
Speaker 4: was you know, something like forty percent. So it's almost
Speaker 4: like comparing apples to oranges by saying the market today
Speaker 4: looks expensive versus the market of two thousand, or you know,
Speaker 4: nineteen eighty or thereabouts, So I think that's part of
Speaker 4: the problem. And then the other part of the problem
Speaker 4: is when you look at the S and P five hundred,
Speaker 4: it's made up of a whole bunch of different stocks.
Speaker 4: We all know this, but right now there is a
Speaker 4: skew where, you know, the growth companies that really benefited
Speaker 4: from this sort of free capital environment are bigger proportions
Speaker 4: of the benchmark and are potentially more expensive than the
Speaker 4: rest of the SMP. So it's kind of like if
Speaker 4: you peel back the onion and you take out, you know,
Speaker 4: five of the megacap companies, the market multiple drops from
Speaker 4: twenty to fifteen or something pretty pretty extreme. So I
Speaker 4: think there are a lot of problems with just looking
Speaker 4: at a snapshot multiple and saying, Yep, the SMP's at
Speaker 4: twenty five times and it's historically been at fifteen times,
Speaker 4: you want to sell it. That's not the call we're making.
Speaker 3: So I'll just give my full disclosure here, which is
Speaker 3: that I am an investor in an S and P
Speaker 3: five hundred index fund. So I want to thank the
Speaker 3: active managers at SMP who have successfully gotten rid of
Speaker 3: some of the more rate sensitive stocks out of the industry.
Speaker 2: If de risk your portfolio.
Speaker 3: Yes, thank you for the excellent active manager of my
Speaker 3: passive vehicle. You've already raised a number of really interesting points.
Speaker 4: But I want to go back.
Speaker 3: To something you said in the first answer about sentiment,
Speaker 3: because capturing whatever the sentiment is at the moment is
Speaker 3: an inherently difficult task. You can look at market measures,
Speaker 3: what's happening with call options, you can do surveys. Bank
Speaker 3: of America does a survey of fund managers and they
Speaker 3: talk about their allocation. When you say that, like we're
Speaker 3: just getting into bullishness, it sounds weird when stocks are
Speaker 3: at all time hies. What are you looking at when
Speaker 3: you say something like that, And when you say, okay,
Speaker 3: we're just getting people are just getting more into stocks. Now,
Speaker 3: what is the data that.
Speaker 1: Backs that up?
Speaker 4: Yeah, there's a lot of data, And you can basically
Speaker 4: get data to say whatever you wanted to if you
Speaker 4: isolate your frame of reference to certain subsets. So I
Speaker 4: guess it's a complicated question, and nobody really ever has
Speaker 4: a full kind of up to date look at what
Speaker 4: everybody in the world is holding. And also, I mean,
Speaker 4: for whoever is buying equities, somebody is selling equities, So
Speaker 4: it's kind of like, why does positioning even matter? So
Speaker 4: one of the things we look at is is sort
Speaker 4: of who are the arbiters of inflows over the next
Speaker 4: like let's call it three to six months, right, Individual
Speaker 4: investors are obviously part of the pie, But then there's
Speaker 4: the asset owners themselves, the pension funds, the sovereign wealth funds,
Speaker 4: like the biggies that kind of engage in asset allocation decisions.
Speaker 4: And I think what's interesting there is that you would
Speaker 4: think that asset allocators would be maxed out on equity
Speaker 4: exposure today, given how well the asset class has done,
Speaker 4: how well stocks have done relative to other asset classes.
Speaker 4: But if you look at the average US pension fund,
Speaker 4: their exposure to public equity to stocks is actually the
Speaker 4: lowest we've seen since the nineteen late nineteen nineties. And
Speaker 4: the reason is that a lot of these pension funds
Speaker 4: have supplanted their exposure to equities with exposure to private
Speaker 4: equity or alternative asset classes or you know, kind of
Speaker 4: less liquid ways to buy growth. And I think that's
Speaker 4: important because where we are today is an environment where
Speaker 4: pension funds have basically supplanted to their exposure to active
Speaker 4: equity like mutual funds and hedge funds with an index fund.
Speaker 4: But they've actually replaced a lot of that equity exposure
Speaker 4: with other asset classes in this search for growth, and
Speaker 4: I think that's potentially more problematic for ill liquid asset
Speaker 4: classes like private credit and private equity, and asset classes
Speaker 4: that haven't necessarily been marked to this current environment of
Speaker 4: a little bit higher rates and inflation than it is
Speaker 4: for public equities. So that's one measure of positioning. The
Speaker 4: other measure of positioning that I've followed my entire career
Speaker 4: at Bank of America, and I inherited this from my
Speaker 4: former boss, Rich Bernstein, who was our strategist at Merrill
Speaker 4: Lynch for many many years, and I think he may
Speaker 4: have inherited it from somebody before him. Is it's called
Speaker 4: the Cell side Indicator, and it's the reason I always
Speaker 4: go back to this model is that it has been
Speaker 4: the most predictive market timing model for the S and
Speaker 4: P five hundred over a twelve month time horizon, more
Speaker 4: predictive than anything else I've been able to find. And
Speaker 4: what we do in this cell side indicator is we
Speaker 4: look at our peers and ourselves, and we say how
Speaker 4: bullish or bearish are we by virtue of one number,
Speaker 4: which is our recommended allocation to equities in a balanced portfolio.
Speaker 4: So when you talk to your broker and he or
Speaker 4: she tells you we think you should put sixty percent
Speaker 4: into stocks and you know, thirty percent into bonds and
Speaker 4: ten percent into cash. We take that stock allocation, we
Speaker 4: average it together across the entire Wall Street bulge bracket firms,
Speaker 4: and we look at what that average allocation is, and
Speaker 4: it has waxed and waned between something like forty percent
Speaker 4: and seventy percent. It's been all over the place over
Speaker 4: the last thirty or forty years. But what we found
Speaker 4: is that when it's at very bearish or bullish extremes,
Speaker 4: you should do the opposite of what we're all telling
Speaker 4: you to do. And I think what's interesting is that
Speaker 4: we're not at a bullish extreme. We're at a point
Speaker 4: where your average market strategist is recommending that you put
Speaker 4: about fifty five percent of your assets into equities, which
Speaker 4: is kind of surprising given that we've seen dramatic outperformance
Speaker 4: of equities relative to other asset classes over the last
Speaker 4: couple of years surprise gains in the SMP versus other indices,
Speaker 4: it's a little bit surprising to see that there is
Speaker 4: still this very tepid allocation to stocks. I mean, the
Speaker 4: benchmark for years has been sixty percent stocks, and we're
Speaker 4: still shy of that. So it's not to say that
Speaker 4: folks out there are bearish and under the table and
Speaker 4: hiding and putting all their money in cash and gold
Speaker 4: and under the mattress. But I think we're at a
Speaker 4: point where we're far from that euphoric level on equities
Speaker 4: that typically heralds the end of a bull market.
Speaker 2: How much of the rise in stocks is an interest
Speaker 2: rates story? Going back to the beginning of this discussion,
Speaker 2: because part of the idea here is that, all right, well,
Speaker 2: the FED might cut interest rates, but the reason it
Speaker 2: would be cutting interest rates is because economic growth is deteriorating, like,
Speaker 2: maybe not substantially, but it's weakening a little bit, and
Speaker 2: so it's trying to get ahead of a potential recession
Speaker 2: or something like that. Is that perhaps why there's some
Speaker 2: reticence on the cell side to jump into stocks wholeheartedly
Speaker 2: at this point.
Speaker 4: You mean, because of the fact that we're likely moving
Speaker 4: into a lower growth environment.
Speaker 2: Yes, exactly.
Speaker 4: Yeah, I think that is really the underpinnings of this caution.
Speaker 4: And I mean, if you think about it, since the
Speaker 4: beginning of twenty twenty two, we had economists bracing us
Speaker 4: for this recession that was going to happen and it
Speaker 4: was going to be in two quarters, and it kept
Speaker 4: getting kind of pushed out. So we've been in this
Speaker 4: environment where we've been sort of waiting for this recession
Speaker 4: that hasn't happened, and it's hard to really pound the
Speaker 4: table on equities if you're expecting an economic recession, right,
Speaker 4: this is the wall of worry, basically the wall of warry. Yeah.
Speaker 4: And then I think on top of that, we've had healthy,
Speaker 4: attractive returns in the risk free rate. So you know,
Speaker 4: this is the Tina argument is now sort of debunked
Speaker 4: because you can get great returns and you know, in
Speaker 4: money market accounts and you don't have to take any risk.
Speaker 4: So I think that that's the other problem with allocating
Speaker 4: too aggressively to stocks. But you know, what's what's interesting
Speaker 4: is that if you go back over time and you
Speaker 4: look at allocations during periods when cash yields were this high,
Speaker 4: allocation to stocks, we're actually higher than where they are today.
Speaker 4: I think we're just in an environment where we're all
Speaker 4: so surprised that you can actually make any money off
Speaker 4: of bonds and cash after getting nothing for a decade,
Speaker 4: that it's almost made those asset classes that much more attractive,
Speaker 4: or surprisingly attractive. And I think there's very little acknowledgment
Speaker 4: that rates can actually continue to move higher rather than
Speaker 4: come down. So if you're bearish on stocks because you
Speaker 4: can get better yield in cash, I get it. But
Speaker 4: if the FED is about to start cutting interest rates
Speaker 4: and most of the assets sitting on balance sheets of
Speaker 4: individual investors are in money market funds and retirey accounts,
Speaker 4: where they're looking for investments they can live off of,
Speaker 4: my sense is that as we start to see short
Speaker 4: rates come down, if that happens this year, they'll be
Speaker 4: forced to look for other areas of higher yield, which
Speaker 4: basically pushes them a little bit higher up the risk spectrum,
Speaker 4: back into good old bast equity income or utilities and
Speaker 4: financials and even real estate companies. So I think those
Speaker 4: are some of the considerations that we're thinking about in
Speaker 4: terms of what is keeping investors on the sidelines when
Speaker 4: it comes to equities, but what could push them back
Speaker 4: into equities?
Speaker 3: So I want to press a little bit further on
Speaker 3: this idea of maybe it's not a contradiction, but that
Speaker 3: stocks have been fined even with the rate move up
Speaker 3: and even with the higher for longer becoming consensus. So
Speaker 3: I take your point that over long periods of time
Speaker 3: or medium periods of time, the S and P five
Speaker 3: hundred is just not as rate sensitive as it might
Speaker 3: have been times in the past when companies had more
Speaker 3: dead had more assets, had more rollover risk. What about though,
Speaker 3: just the last two months, which is like if someone
Speaker 3: asks you, why haven't stocks gone down over the last
Speaker 3: two months, after we keep getting these warmer than expected
Speaker 3: inflation prints, after we keep that rate expectation keeps getting
Speaker 3: pushed out. This week we saw the odds of a
Speaker 3: June cut has now fallen below fifty percent. Talk about
Speaker 3: that ongoing resilience.
Speaker 4: I mean, I think it's really thinking about why the
Speaker 4: Fed's not cutting, And it's the idea that the Fed's
Speaker 4: not cutting because the economy is still running too hot, right,
Speaker 4: And again I think that's not a bad environment for stocks, right,
Speaker 4: I mean, so far we've sort of seen this proof
Speaker 4: of concept, if you will. So when you think about
Speaker 4: the last couple of years, I, along with many was
Speaker 4: expecting to see margins getting hit harder by the fact
Speaker 4: that we went from you know, negative inflation to nine
Speaker 4: percent and then to five and you know, now we're
Speaker 4: a little bit lower. But it's kind of remarkable that
Speaker 4: margins remained relatively intact and healthy during that entire period
Speaker 4: of massive volatility around costs of everything, labor inputs, you know, lumber,
Speaker 4: every thing. Saw a lot more volatility around costs than
Speaker 4: what we were expecting and the what we thought margins
Speaker 4: could actually withstand. So I think that proof of concept
Speaker 4: that you can have the corporate sector navigate that environment,
Speaker 4: you know, still be able to price in many areas
Speaker 4: of the economy. The consumer hasn't slowed down meaningfully. I mean,
Speaker 4: there's been pockets of a slowdown, but in fact, the
Speaker 4: average US consumer is potentially benefiting a bit from higher
Speaker 4: short rates by that spread between their assets and liabilities.
Speaker 4: I mean, I think all of this, we've had two
Speaker 4: years of seeing the fallout of a massive move in
Speaker 4: short rates, and it hasn't necessarily derailed a lot of
Speaker 4: the equity market. It's certainly derailed parts of the spectrum.
Speaker 4: It's derailed you know, commercial real estate. It's derailed parts
Speaker 4: of the private markets and the less liquid areas. But
Speaker 4: we haven't necessarily seen it play through to you know,
Speaker 4: your average cash rich company sitting on the S and P.
Speaker 4: Five hundred caps haven't done particularly well, but I think
Speaker 4: they're perhaps a bit more refinancing or credit sensitive than
Speaker 4: large caps. But I do think that you know, we've
Speaker 4: had enough time to see that corporates can actually handle
Speaker 4: five percent cash shields. Some companies are benefiting, some consumers
Speaker 4: are benefiting. Consumers aren't necessarily slowing down. We're still all
Speaker 4: gainfully employed for the most part. We haven't seen massive layoffs.
Speaker 4: We're still in a very tight labor market in fact,
Speaker 4: in many areas of the economy. So I think those
Speaker 4: are some of the reasons that the market is remaining
Speaker 4: where it is. Then I think the other kind of
Speaker 4: I guess harder to prove or harder to bear out,
Speaker 4: And the data reason is that we are seeing some
Speaker 4: seeds sown for potentially a very strong productivity cycle, and
Speaker 4: I think that is the bulkhase from here, and we
Speaker 4: need to really all be paying attention to how that's materializing.
Speaker 4: But you know, I said earlier, we should be happy
Speaker 4: that the FED has gotten us off of ground zero
Speaker 4: on interest rates. And the truth is, we're now at
Speaker 4: a point where there's a lot more certainty around earnings
Speaker 4: than there was a couple of years ago. A couple
Speaker 4: of years ago, a lot of companies were generating earnings
Speaker 4: growth per share, earnings growth by borrowing money to buy
Speaker 4: back stocks. That's not a great, high quality source of
Speaker 4: earnings growth. And then even before that, we had globalization
Speaker 4: driving a lot of the earnings for the SMP, and
Speaker 4: you had cost arbitrage, tax arbitrage, basically global arbitrage. You know,
Speaker 4: if something was expensive in the US, you could move
Speaker 4: somewhere else. And that was just this frictionless, great story
Speaker 4: for earnings for you know, for twenty years. But that
Speaker 4: is also risky, and we're now starting to see that
Speaker 4: because you know, we're no longer friends with everybody, and
Speaker 4: you know, this whole globalization story seems like it's at
Speaker 4: least hit pause, if not reverse. So I think today
Speaker 4: we're also at a point where we can be a
Speaker 4: little bit more what's the word confident about company's ability
Speaker 4: to continue to generate earnings given that all of these easy,
Speaker 4: kind of lower quality maneuvers are behind us. They've reversed,
Speaker 4: and we've still seen companies able to adapt. So I
Speaker 4: think that's another part of this story that's you know,
Speaker 4: companies are now focusing on productivity. They're spending money on AI.
Speaker 4: We'll see if it works or not, but you know,
Speaker 4: there is this promise that a lot of the more
Speaker 4: labor intensive companies in the S and P five hundred
Speaker 4: can become labor light very quickly, and we've seen this happen.
Speaker 4: I mean, I think what's remarkable is like when you
Speaker 4: look at certain business models, they have vaporized overnight, Like
Speaker 4: that idea of a call center has basically gone away
Speaker 4: after generative AI was put out there. We've seen, you know,
Speaker 4: the need for Python programming completely evaporate because you can
Speaker 4: get you know, you can get AI to write your
Speaker 4: code for you. So it's kind of an interesting, very
Speaker 4: fast moving theme that's already disrupted some industries and has
Speaker 4: the potential to really make a lot of these service sectors,
Speaker 4: like it services, financial services, legal services that much more efficient.
Speaker 2: One thing I always wondered, if you are a stock
Speaker 2: strategist looking at something like that SMP five hundred, and
Speaker 2: you think we are on the verge or in the
Speaker 2: early stages of a big secular trend. So for instance,
Speaker 2: the Internet in the late nineteen nineties, early two thousands,
Speaker 2: or the AI revolution right now, how do you start
Speaker 2: incorporating something like that into your forecast. Yeah, it feels
Speaker 2: like it could be so transformative. And there's no historical parallels,
Speaker 2: not a perfect one.
Speaker 4: Yes, it's hard. I mean we've been trying to think
Speaker 4: about you know, well, there's a few angles. One is
Speaker 4: the revenue angle, which is already in play, and that's
Speaker 4: the idea of the capex takers. So if you have
Speaker 4: some theme, be it the PC revolution or industrial automation,
Speaker 4: there's a company that benefits. And if you look at
Speaker 4: robotics companies or you know, nvideo or chip makers, those
Speaker 4: are the capex takers and we've seen those stocks do
Speaker 4: tremendously well. If you think about the next leg, which
Speaker 4: is probably a longer leg, it's the first movers in
Speaker 4: industries that buy the stuff and get it right. So
Speaker 4: you know, it's it's basically the first company that buys
Speaker 4: the right chips and implements them successfully to replace a
Speaker 4: big chunk of their expensive workforce, and that company could
Speaker 4: see margin expansion and bump up in there. Multiple I
Speaker 4: would argue that margin expansion might be short lived if
Speaker 4: the process can be replicated across the industry. So I
Speaker 4: think we move from the capex takers to the first movers,
Speaker 4: to the process being commoditized and priced in across the industry.
Speaker 4: But at the end of the day, when you look
Speaker 4: at the companies that have used these tools to transform themselves,
Speaker 4: the entire sector should trade at a lower risk premium
Speaker 4: because those earnings are potentially stickier and easier to predict
Speaker 4: than they would be if you had to worry about
Speaker 4: this very cost intensive and risky labor force. Like people
Speaker 4: are risky, processes are less risky. So I think that's
Speaker 4: the sort of the evolution of this the way I
Speaker 4: see it. And then what we did was we looked
Speaker 4: at at prior cycles, like we looked at the nineteen
Speaker 4: eighties and nineties to see, you know, how automation benefited companies.
Speaker 4: And what was interesting to see is that over that
Speaker 4: entire time period, within sectors, the peers that became labor
Speaker 4: light versus the peers that didn't become more efficient. The
Speaker 4: labor light companies outperformed their labor intensive peers. So our
Speaker 4: view is, okay, okay, we've got this opportunity for big
Speaker 4: chunks of the S and P five hundred to become
Speaker 4: less labor intensive, and based on our performance data, labor
Speaker 4: intensity and improvements in that metric have actually translated into alpha.
Speaker 4: So long kind of convoluted argument for how you track this,
Speaker 4: But I think right now all anybody's focused on are
Speaker 4: the capex takers and the chip makers and the tech companies.
Speaker 4: Maybe now we've moved on to power and grid, but
Speaker 4: I think at some point we're going to start acknowledging
Speaker 4: that there are these industries that are likely to be transformed.
Speaker 4: There are some industries that are going to go away,
Speaker 4: other industries that are going to pop up. You know,
Speaker 4: like any tech revolution, this is going to take away
Speaker 4: some jobs, but is also going to create jobs, and
Speaker 4: we're seeing that real time with Python. I mean, you know,
Speaker 4: it's interesting if you talk to a graduate and an
Speaker 4: engineering program, well, I don't know, maybe it's different now,
Speaker 4: but you know, maybe six months ago I was talking
Speaker 4: to some recent grads in a program that I'm affiliated
Speaker 4: with and they were saying that, you know, the software
Speaker 4: and the coders were not getting jobs, but the hardware
Speaker 4: folks were getting jobs. So that was just a big,
Speaker 4: big transformation right away that was disrupting jobs but creating
Speaker 4: like tightness and jobs and other sectors. And I think
Speaker 4: that's just what we have to kind of think about
Speaker 4: and try to anticipate in a smart way. So we're
Speaker 4: listening to our fundamental analysts on every sector. And what's
Speaker 4: fascinating to me is when we have calls on AI
Speaker 4: and it's use cases, it's not just tech analysts that
Speaker 4: participate in these calls, it's healthcare analysts, insurance analysts, you know,
Speaker 4: really old economy businesses where there are potential transformative measures
Speaker 4: in place.
Speaker 3: I mentioned before investing in an S and P five
Speaker 3: hundred index fund. And in the investment industry there's always
Speaker 3: this preaching of diversification, and you mentioned that, you know,
Speaker 3: right now maybe people are at fifty five percent, or
Speaker 3: people are in various alternatives, or from time to time
Speaker 3: they're like go international by international stocks, or rotates to
Speaker 3: small caps or whatever. But for the last fifteen years,
Speaker 3: more or less, we really all should have just had
Speaker 3: all of our money in QQQ and outside of no
Speaker 3: for real, right, Like, that's like we we've almost been
Speaker 3: punished for being the good diversifiers that we're supposed to
Speaker 3: be and we really shouldn't have. What changes that, What
Speaker 3: kind of regime shift would you want to see such
Speaker 3: that it's not always just like this sort of inexorable
Speaker 3: sucking of value towards a handful of leading edge.
Speaker 4: Yeah, it's such a good point. I mean, I suppose
Speaker 4: I would argue we're seeing that now, and maybe by now,
Speaker 4: I mean, you know, March, but not any time earlier
Speaker 4: than that. But it's it's really the idea that we
Speaker 4: are starting to see earnings broaden out beyond just these
Speaker 4: thematic stories. So you know, it felt like last year
Speaker 4: we were just jumping from theme to themes. So it was,
Speaker 4: you know, AI was doing well, in financials were doing poorly.
Speaker 4: Then it was GLP one and you know, kind of
Speaker 4: anti obesity, and you know, it's different theme, different months.
Speaker 4: You know, this month there's a lot of interest in
Speaker 4: power and utilities has actually outperformed on some of those themes.
Speaker 4: So I think that where we're starting to see that
Speaker 4: idea that diversification is important is when you look at
Speaker 4: just within the S and P five hundred, which is
Speaker 4: what I know best, we have seen this sort of
Speaker 4: broadening of the market occur. So in March, I think
Speaker 4: something like sixty percent of S and P companies outperformed
Speaker 4: the index, versus less than fifty percent in prior months,
Speaker 4: you know, going back to December. So we're at a
Speaker 4: point where we are starting to see the average stock
Speaker 4: outperform the index, rather than the index outperform the average stock.
Speaker 4: And I think that's a change, and that is actually
Speaker 4: more normal than unusual. So historically we've seen the breadth
Speaker 4: of the S and P five hundred remain a little
Speaker 4: bit higher than fifty percent rather than below fifty percent,
Speaker 4: And I think that's something we can point to as
Speaker 4: a sign that diversification is starting to pay off again.
Speaker 4: But you know, I think one of the reasons that
Speaker 4: diversification didn't pay off over the last twenty years or
Speaker 4: fifteen years was that you had one single buyer of
Speaker 4: US treasury bonds, and that was the FED, and the
Speaker 4: FED was pouring trillions and trillions and trillions of dollars
Speaker 4: into US treasuries. That's not a diversified investor. That's one theme,
Speaker 4: one asset class, and one big, huge, monstrous buyer. And
Speaker 4: I think if that environment is behind us, we go
Speaker 4: back to a more diverse set of buyers buying different
Speaker 4: types of things.
Speaker 2: Similar question, I suppose, but what would give you pause
Speaker 2: at this point? What would make you nervous?
Speaker 4: Well, I guess I'm what makes me nervous is you know,
Speaker 4: every earning season we're listening for layoffs because I think
Speaker 4: the lynch pin of consumption is not necessarily rates or
Speaker 4: the cost to borrow. It's really just having a job, right.
Speaker 4: I mean, if you have income and you have the
Speaker 4: ability to pay off your mortgage, you're not going to
Speaker 4: walk away from your house. When you lose your job
Speaker 4: and you have no option to pay off your mortgage,
Speaker 4: that's when you start to see things really deteriorate. So
Speaker 4: I think one kind of bow case for the US
Speaker 4: consumer that we've been highlighting is, you know, we're still
Speaker 4: in a pretty tight labor market. I mean, we had
Speaker 4: this massive resignation during COVID, we had an aging population,
Speaker 4: We have fewer workers in manufacturing. Meanwhile, there's this huge
Speaker 4: restoring initiative brewing where you know, companies are moving plant
Speaker 4: property and equipment back to the US from other parts
Speaker 4: of the world. So I think that tightness in the
Speaker 4: manufacturing complex and the feed through to small businesses in
Speaker 4: those regions has been positive. But if that starts to
Speaker 4: slow down, that would be a negative and broadspread job losses,
Speaker 4: I think would be what we'd worry about to sort
Speaker 4: of end the consumption story. You know, I also worry
Speaker 4: about the debt burden carried by the US government, but
Speaker 4: I think that's a harder problem to model into your
Speaker 4: equity market forecast, right, I mean this is like, this
Speaker 4: is like your question earlier on AI and how do
Speaker 4: you model these things into your outlook? I think it's
Speaker 4: hard to know how the debt to GDP burden of
Speaker 4: the US government resolves itself. Does this mean that the
Speaker 4: US sovereign you know, tenure treasuries are more risky? Does
Speaker 4: this mean that the dollar is at risk of losing
Speaker 4: its reserve currency status? Definitely today, because there's no alternative.
Speaker 4: But I think those are the more kind of problematic,
Speaker 4: longer term risks that make me less polytize about the
Speaker 4: world that I might be. Again, though, when I think
Speaker 4: about those risks, I don't know if they manifest themselves
Speaker 4: in the S and P five hundred and in the
Speaker 4: public equity markets. I think they're more impactful to private equity,
Speaker 4: liquid assets, real estate, you know, just basically bonds, and
Speaker 4: then just sort of the idea of the US as
Speaker 4: a high quality sovereign I think is the other kind
Speaker 4: of part of this that is harder to really fathom
Speaker 4: at this point.
Speaker 3: You know, you mentioned the companies cutting cost layoffs and
Speaker 3: changing their cash management. I sort of came away from
Speaker 3: that whole period of like, US company operators are really good.
Speaker 3: Layoffs aren't good, especially mass layoffs. But the speed with
Speaker 3: which companies kind of pivoted it was like many companies
Speaker 3: demonstrated a pretty serious sort of like management competence just
Speaker 3: sort of like in a few minutes left, Like it
Speaker 3: sort of goes in hand in hand with if people
Speaker 3: have jobs, they're probably going to spend it. That'll keep
Speaker 3: support up. What are you you seeing in terms of
Speaker 3: just sort of how EPs, earnings per share or corporate
Speaker 3: earnings are tracking versus where you would have thought at
Speaker 3: the beginning of the year or six months ago or
Speaker 3: at the end of October when this rally really took off.
Speaker 4: Yeah, yeah, it's a great point. So we've seen margins
Speaker 4: hang in there, they've actually expanded a little. The big surprise,
Speaker 4: like I always feel like kind of surprised when I
Speaker 4: look at the data, even though I know it, is
Speaker 4: that we had an earnings recession last year, right we
Speaker 4: had companies and the overall S and P five hundred,
Speaker 4: it had a couple of quarters of negative earnings growth.
Speaker 4: And that recession is now behind us, and we're seeing
Speaker 4: companies recover. I suppose when I look at earnings trends,
Speaker 4: I mean, one reason that I think the market could
Speaker 4: start to broaden out even more than just a month
Speaker 4: or two is that when you look at just the
Speaker 4: differential between high growth tech companies and the rest of
Speaker 4: the S and P five hundred, that differential starts to narrow.
Speaker 4: Last year, the only companies that were making money were
Speaker 4: the Magnificent seven, so it kind of made sense that
Speaker 4: they just crushed it. This year, we're starting to see
Speaker 4: that differential between growth trends and narrow. We're forecasting about
Speaker 4: ten percent earnings growth this year, which is roughly in
Speaker 4: line with where I think bottom up consensus is. Maybe
Speaker 4: bottom up consensus is a little bit higher we're basically
Speaker 4: forecasting a broad based recovery across sectors that we've already seen.
Speaker 4: So it's the idea that we've already seen cost cutting
Speaker 4: and now maybe we see that operating leverage from demand
Speaker 4: coming back from parts of the economy starting to pick
Speaker 4: up again. We're seeing a shift from service spending to
Speaker 4: good spending, so that's positive for the S and P
Speaker 4: five hundred and consumer stocks. Those are some of the
Speaker 4: areas that we're looking at from an earnings perspective.
Speaker 2: All right, Savina, I'm so glad we finally had you
Speaker 2: on all Laws.
Speaker 4: Having.
Speaker 5: It's great to be here, Joe.
Speaker 2: I'm so glad we could do that episode finally because
Speaker 2: Cevita has nailed the upwards trend in the S and
Speaker 2: P five hundred at a time when a lot of
Speaker 2: people were still very nervous about the outlook for stocks.
Speaker 2: The one thing that had me thinking, and I think
Speaker 2: we spoke about this before, but like the one recession
Speaker 2: path that I kind of worry about is the idea
Speaker 2: of like I guess, lofty EPs expectations kind of coming
Speaker 2: back to haunt the market in the sense that companies
Speaker 2: had pricing power in recent years, they raised their prices.
Speaker 2: That helped pad margins. But if inflation is starting to
Speaker 2: go down, or if consumers are starting to push back,
Speaker 2: or if there is pressure on household balance sheets or whatever,
Speaker 2: then maybe one of the levers they pull is on
Speaker 2: the job front, and then we get layoffs, and then
Speaker 2: we see consumer powers start to go down, and then
Speaker 2: we see profit margins start to go down, and that
Speaker 2: would be bad. I'm not saying we're there yet, but
Speaker 2: that's the one kind of path that I worry about totally.
Speaker 3: That makes a ton of sense to me. And also
Speaker 3: just this idea that like, you know, there's this on
Speaker 3: the service puzzle, why haven't stocked affected by higher rates?
Speaker 4: Yeah?
Speaker 3: Well, rates are high because demand is strong and the
Speaker 3: economy continues to grow at a robust clip. And if
Speaker 3: people continue have jobs, they'll continue to spend. And if
Speaker 3: they continue to spend and earnings hold up, and then
Speaker 3: you don't necessarily need those higher rates. So it's interesting
Speaker 3: that already this year, you know, rather than the scenario
Speaker 3: that you describe, which seems very plausible to me so far,
Speaker 3: at least, we're seeing the opposite, that broadening out of.
Speaker 2: Virtuous Yeah, it's a virtuous cycle. At the moment, it
Speaker 2: could go in the other direction, but for now it
Speaker 2: seems to be feeding on itself in a positive manner.
Speaker 2: The one other thing I thought was really good to
Speaker 2: emphasize is that index composition yes, yes, and the idea
Speaker 2: that like, okay, you could look at historical pees and
Speaker 2: comparing contrast with the nineteen eighties or the early two
Speaker 2: thousands steering the tech bubble or whatever, but there are
Speaker 2: actual changes in the S and P five hundred that
Speaker 2: might make that comparison less useful. And especially that point
Speaker 2: about companies terming out their balance sheets and the duration
Speaker 2: changes that we've seen. I think if you had a
Speaker 2: good handle on the degree to which companies had actually
Speaker 2: refinanced their balance sheets over the past couple of years,
Speaker 2: you probably would have nailed a lot of the resilience
Speaker 2: that we've seen in markets.
Speaker 3: Totally. I think it's really important this idea of like
Speaker 3: sort of earnings durability quality, and so you can imagine
Speaker 3: that a company that has to hold a lot of inventory,
Speaker 3: or a company that has to from time to time
Speaker 3: engage in huge capital expenditure cycles, like, yeah, you probably
Speaker 3: don't want to pay as much for those earnings as
Speaker 3: you do a company that doesn't have to manage those
Speaker 3: risks the same way, and so I think, like I'm
Speaker 3: always a little bit scared of like, oh, here's why
Speaker 3: the index is not doesn't matter, and that these like yeah,
Speaker 3: you know, percentiles in ninety fifth is not as scary.
Speaker 3: But it does make sense that there are certain types
Speaker 3: of earning streams that the nature of the business models sucks,
Speaker 3: where you can be confident that they'll be more durable
Speaker 3: than another type of company.
Speaker 2: This has gone back to being a value bashing show.
Speaker 3: Yes, can I say the one other thing I really
Speaker 3: like is that, you know, it is really hard to measure,
Speaker 3: as Savida said, like how much allocation different types of
Speaker 3: investors have to stocks any given moment. That's why there's
Speaker 3: all these surveys. I love that the one measure that
Speaker 3: seems to have some historical validity is to just measure
Speaker 3: the analysts themselves. And when the analysts are really bullish
Speaker 3: or super bullish, that's maybe time to sell. Like that,
Speaker 3: you just do the survey, look what people are recommending,
Speaker 3: and see if how out of whack they are.
Speaker 2: I'm looking at the cell side indicator that Savita mentioned
Speaker 2: right now and It is kind of crazy how much
Speaker 2: bollishness there was in Sale two thousand and one. Yeah,
Speaker 2: it seems to work anyway. Shall we leave it there?
Speaker 4: Let's leave it there, all right?
Speaker 2: This has been another episode of the Oudlots podcast. I'm
Speaker 2: Tracy Alloway. You can follow me at Tracy Alloway.
Speaker 3: And I'm Joe Wisenthal. You can follow me at the Stalwart.
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