April 4, 2024 • 44 mins
When Savita Subramanian, head of US equity strategy at Bank of America, raised her outlook for stocks at the end of last year, there was a lot of skepticism that equities could go any higher. The S&P 500 had already surged on expectations that the Federal Reserve would start cutting rates in 2024. And investors were very excited about AI. Then, in early March, she increased her year-end target for the S&P 500 even further, going from 5,000 to 5,400. Fast forward to the start of April, and the rally has continued even as markets ratcheted down their expectations for rate cuts this year. Of course, there are questions about whether investors are getting ahead of themselves and whether things are starting to feel a little frothy. In this episode, Subramanian explains why she thinks stocks can go up even further from here, how she's thinking about valuations, and why we shouldn't be too worried just yet about a repeat of the early 2000s internet bubble.
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Speaker 1 (00:02):
Bloomberg Audio Studios, Podcasts, radio News.
Speaker 2 (00:18):
Hello and welcome to another episode of the All Lots podcast.
I'm Tracy Alloway.
Speaker 3 (00:22):
And I'm Joe Wisenthal.
Speaker 2 (00:24):
Joe. For all intents and purposes, we're pretty much at
a record in terms of US stocks totally.
Speaker 3 (00:31):
We're recording this April second, so we're actually down a
little bit today, about a percent. But the story in
my mind of the market for twenty twenty four is
that we went into this year with all sorts of
soft landing optimism. The FED is going to cut rates
a bunch of times, and then all these sort of
rate cut hopes are sort of slowly evaporating, but it's
hardly affected the stock market, and so we're basically at
(00:51):
record highs despite the fact that that first cut keeps
getting pushed out into the future.
Speaker 2 (00:56):
Yeah, And the question is, are stock's going to start
to turn lower again? They are lower today, They've been
kind of vacillating for the past couple of days. Is
the start of a durable drop or are markets basically
catching their breath after a torrid rally and are they
going to continue upward? Is all that excitement over things
like AI and tech just going to keep going. And
(01:17):
speaking of excitement over AI and tech, you do see
some commentary at the moment about bubble territory, so the
idea that, well, maybe we're getting a little bit too optimistic,
or isn't it weird that it was expectations of rate
cuts that drove the move upward, but as the rate
cuts get priced further out, we're not really seeing that
(01:37):
big impact on stocks totally.
Speaker 3 (01:39):
So for a while as the market was doing this
sort of straight line up really since the end of
October when rates peaked, part of this sort of I
don't know, bear crowd or skepticism or people trying to
poke holes in the rally is like, oh, it's all tech,
it's all the mag seven, these gigantic tech stocks, etc.
What's interesting about lately is that actually a lot of
(02:00):
these high flyers, like in video, they've like sort of
been flat for the last month or so, and even
that doesn't seem to be holding water. There actually are
big rallies in many parts of the market. So the
question is like why, I mean, you could say, oh,
like the story maybe made sense, it's like, oh, there's
these handful of mega giants. They're capturing all of the gains,
(02:20):
and so what these new all time highs don't really
reflect what the broader market is doing. The broader market's
doing fine.
Speaker 2 (02:27):
Yeah, and again against expectation. Yes, it's actually broadening out yeow,
rather than becoming more narrow, which is the kind of
thing that you would be worried about if you are
in a bubble or about to test a bubble. But
all right, I am very pleased to say that we do,
in fact have the perfect guests to discuss markets and
whether or not we are closing in on bubble territory.
We're going to be speaking with Cevita Supermanian, head of
(02:50):
US equity strategy at Bank of America, and she recently
raised her target for the S and P five hundred
from five thousand to five four hundred. I think this
was done about a month ago, and we're already at
like five thousand, two hundred. Yeah, So yeah, good call, Savita.
Welcome to the show.
Speaker 4 (03:09):
Hi, it's great to be here. Thanks for having me.
Speaker 2 (03:12):
It's I feel kind of bad. I feel like we
should have had you on way way earlier, because you know,
you are sort of a stalwart of the cell side
research on the stocks, and yet we haven't made it happen.
Kind of weird, that is weird, but we're correcting for
past mistakes. Yes, this is good, a good type of correction.
(03:33):
All right, SMP five hundred pretty much at record highs.
What's driving it?
Speaker 4 (03:38):
Yeah, So it's interesting when we launched our twenty twenty
four outlook in November with our year ahead report, and
we launched our SMP market call with a five thousand
year end target, and I remember having to repeat that
number like people would literally say, did you just say
(03:59):
five thousand? Like it was way too high? And now
here we are at fifty two whatever, and a couple
of months ago, the market basically breezed right through that
five thousand target. And you know, there's no perfect way
to forecast a point in time target impact. I think
it's kind of a silly number. But the question that
(04:21):
we asked ourselves was, Okay, now, what does the market
go higher or lower? Because we're kind of where we
thought we would be by your end in January, and
everything we looked at said higher, So you know, I
can delve into it, but I think where we are
now is still we're sort of climbing that wall of worry.
We're still in an environment where I don't know, it's
interesting if you look at the average target for the
(04:44):
S and P, I think it's lower than where the
market is today, which is unusual because I think the
SU side is usually skewed to being more optimistic. When
you look at even analysts earnings expectations, there are still
relatively low outside of this so called you know, Magnificent
seven or the you know, the megacap tech companies that
(05:04):
have been driving the market. So I still think we're
in an environment where allocation to stocks is just starting
to increase, Bolishness is just starting to percolate, and as
you rightly point out, the market is just starting to
broaden out a bit.
Speaker 3 (05:20):
Let's go back to the initial call that you made
for S and P five thousand. What was the reasoning
then in terms of like, let's just start with that question.
Speaker 4 (05:29):
So the reasoning then and it was basically putting the
smp at around it. I think it was like a
ten percent year or thereabouts. Was the idea was, Okay,
where are we now versus where we were a couple
of years ago, And I think there's a lot of
good news that we should be happy about. We should
be happy that the FED has actually moved interest rates
from zero to five because now we have a lot
(05:51):
of latitude with which to ease our way out of
the next crisis. We should also be happy that the
SMP itself is pretty different today than what it was
a couple of years ago. And I think you know
what I find interesting is that the SMP five hundred
has basically managed out a lot of its own risk
over the last couple of years by attrition. So if
(06:12):
you look at a lot of the companies that were
in the S and P five hundred in twenty twenty two,
you know when the big surprise was the FED was
about to hike interest rates by the largest amount ever
in the fastest period of time. You know, the constituents
that were bigger weights in the market are now smaller
weights and maybe have even drifted out. And in particular,
(06:33):
the ones that have drifted out are those with refinancing
risk or companies that might not be able to hack
it in a five percent rate world. So I almost
feel like the beginning of this year was a good
start in terms of the health of the index. We
also saw that despite this megacap tech dominance. These companies
(06:53):
they got expensive, but they didn't get as expensive as
we saw, you know, nonprofitable tech during the tech bubble
of ninety nine two thousand. Moreover, I think what's really
exciting from a corporate finance perspective is that when you
look at the risks around the S and P five
hundred based on higher interest rates. One of the things
(07:15):
that worried us a couple of years ago was that
the SMP itself was a very long duration instrument, i e.
You were buying today for like great growth, but it
was way out in the future and you were getting
no cash return. Today, I think a lot of that
has resolved itself because many of the less profitable growth
companies have either drifted lower in market cap or have
(07:39):
become profitable and are now returning that cash to shareholders. So,
you know, when we looked at companies in the big
tech sector in early twenty twenty three, we started to
see really encouraging signs. These big companies, these megacap tech
companies basically acknowledged that they were too big to grow
as quickly as they had in a zero percent interest
(08:02):
rate world. And they were also just going to grow
a little bit more slowly, and you saw these growth
stocks actually cut capacity, cut costs. Meta did the biggest
share buyback that we've ever seen in the history of
share buybacks. And you know, these companies were able to
lower their duration by pulling earnings earlier, in returning cash
(08:27):
to shareholders, et cetera. I mean, the unthinkable happened earlier
this year with Meta paying a dividend or initiating a dividend.
So I think, you know, the idea here is we're
at a point where the market actually looks a lot
healthier and much better able to navigate a higher rate
environment than it did a couple of years ago.
Speaker 2 (08:47):
So this is really interesting because you hear a lot
of people say, well, stocks look expensive at the moment,
and I think Bank of America has a bunch of
different metrics that you look at, and I think in
one of your notes you said that the SMP five
hundred is statistically expensive on nineteen of twenty metrics. Yes,
but the argument is that we've gone through this period
(09:09):
of adjustment of higher rates and the mix of the index,
its composition has shifted such that well, maybe those valuations
are well deserved.
Speaker 4 (09:20):
Well, to some extent, it's the question should we ever
be comparing the market multiple to a prior market multiple, right,
because it's a different animal. And I think today, as
you said, you know, we're looking at an S and
P five hundred index that barely resembles the market in
nineteen eighty or even nineteen ninety. We've gone from a
(09:43):
market that was you know, seventy percent manufacturing back in
the eighties to an index that's fifty percent asset light growth, healthcare,
tech innovation. We've gone from a benchmark that had much
higher debt to x equity ratios ten years ago to
a benchmark that's paid down a lot of it's debt
(10:05):
and now has fixed strate you know, kind of long term,
less leverage risk and less free financing risk than it
has had in prior cycles. I mean, seventy percent of
debt sitting on SMP balance sheets is long term fixed
rate debt versus back in two thousand and seven it
was you know, something like forty percent. So it's almost
(10:27):
like comparing apples to oranges by saying the market today
looks expensive versus the market of two thousand, or you know,
nineteen eighty or thereabouts, So I think that's part of
the problem. And then the other part of the problem
is when you look at the S and P five hundred,
it's made up of a whole bunch of different stocks.
We all know this, but right now there is a
skew where, you know, the growth companies that really benefited
(10:50):
from this sort of free capital environment are bigger proportions
of the benchmark and are potentially more expensive than the
rest of the SMP. So it's kind of like if
you peel back the onion and you take out, you know,
five of the megacap companies, the market multiple drops from
twenty to fifteen or something pretty pretty extreme. So I
(11:11):
think there are a lot of problems with just looking
at a snapshot multiple and saying, Yep, the SMP's at
twenty five times and it's historically been at fifteen times,
you want to sell it. That's not the call we're making.
Speaker 3 (11:23):
So I'll just give my full disclosure here, which is
that I am an investor in an S and P
five hundred index fund. So I want to thank the
active managers at SMP who have successfully gotten rid of
some of the more rate sensitive stocks out of the industry.
Speaker 2 (11:40):
If de risk your portfolio.
Speaker 3 (11:41):
Yes, thank you for the excellent active manager of my
passive vehicle. You've already raised a number of really interesting points.
Speaker 4 (11:49):
But I want to go back.
Speaker 3 (11:49):
To something you said in the first answer about sentiment,
because capturing whatever the sentiment is at the moment is
an inherently difficult task. You can look at market measures,
what's happening with call options, you can do surveys. Bank
of America does a survey of fund managers and they
talk about their allocation. When you say that, like we're
just getting into bullishness, it sounds weird when stocks are
(12:12):
at all time hies. What are you looking at when
you say something like that, And when you say, okay,
we're just getting people are just getting more into stocks. Now,
what is the data that.
Speaker 1 (12:21):
Backs that up?
Speaker 4 (12:22):
Yeah, there's a lot of data, And you can basically
get data to say whatever you wanted to if you
isolate your frame of reference to certain subsets. So I
guess it's a complicated question, and nobody really ever has
a full kind of up to date look at what
everybody in the world is holding. And also, I mean,
for whoever is buying equities, somebody is selling equities, So
(12:44):
it's kind of like, why does positioning even matter? So
one of the things we look at is is sort
of who are the arbiters of inflows over the next
like let's call it three to six months, right, Individual
investors are obviously part of the pie, But then there's
the asset owners themselves, the pension funds, the sovereign wealth funds,
(13:05):
like the biggies that kind of engage in asset allocation decisions.
And I think what's interesting there is that you would
think that asset allocators would be maxed out on equity
exposure today, given how well the asset class has done,
how well stocks have done relative to other asset classes.
But if you look at the average US pension fund,
(13:26):
their exposure to public equity to stocks is actually the
lowest we've seen since the nineteen late nineteen nineties. And
the reason is that a lot of these pension funds
have supplanted their exposure to equities with exposure to private
equity or alternative asset classes or you know, kind of
(13:49):
less liquid ways to buy growth. And I think that's
important because where we are today is an environment where
pension funds have basically supplanted to their exposure to active
equity like mutual funds and hedge funds with an index fund.
(14:09):
But they've actually replaced a lot of that equity exposure
with other asset classes in this search for growth, and
I think that's potentially more problematic for ill liquid asset
classes like private credit and private equity, and asset classes
that haven't necessarily been marked to this current environment of
a little bit higher rates and inflation than it is
(14:31):
for public equities. So that's one measure of positioning. The
other measure of positioning that I've followed my entire career
at Bank of America, and I inherited this from my
former boss, Rich Bernstein, who was our strategist at Merrill
Lynch for many many years, and I think he may
have inherited it from somebody before him. Is it's called
the Cell side Indicator, and it's the reason I always
(14:54):
go back to this model is that it has been
the most predictive market timing model for the S and
P five hundred over a twelve month time horizon, more
predictive than anything else I've been able to find. And
what we do in this cell side indicator is we
look at our peers and ourselves, and we say how
(15:15):
bullish or bearish are we by virtue of one number,
which is our recommended allocation to equities in a balanced portfolio.
So when you talk to your broker and he or
she tells you we think you should put sixty percent
into stocks and you know, thirty percent into bonds and
ten percent into cash. We take that stock allocation, we
average it together across the entire Wall Street bulge bracket firms,
(15:39):
and we look at what that average allocation is, and
it has waxed and waned between something like forty percent
and seventy percent. It's been all over the place over
the last thirty or forty years. But what we found
is that when it's at very bearish or bullish extremes,
you should do the opposite of what we're all telling
you to do. And I think what's interesting is that
(15:59):
we're not at a bullish extreme. We're at a point
where your average market strategist is recommending that you put
about fifty five percent of your assets into equities, which
is kind of surprising given that we've seen dramatic outperformance
of equities relative to other asset classes over the last
couple of years surprise gains in the SMP versus other indices,
(16:23):
it's a little bit surprising to see that there is
still this very tepid allocation to stocks. I mean, the
benchmark for years has been sixty percent stocks, and we're
still shy of that. So it's not to say that
folks out there are bearish and under the table and
hiding and putting all their money in cash and gold
and under the mattress. But I think we're at a
(16:44):
point where we're far from that euphoric level on equities
that typically heralds the end of a bull market.
Speaker 2 (17:08):
How much of the rise in stocks is an interest
rates story? Going back to the beginning of this discussion,
because part of the idea here is that, all right, well,
the FED might cut interest rates, but the reason it
would be cutting interest rates is because economic growth is deteriorating, like,
maybe not substantially, but it's weakening a little bit, and
(17:30):
so it's trying to get ahead of a potential recession
or something like that. Is that perhaps why there's some
reticence on the cell side to jump into stocks wholeheartedly
at this point.
Speaker 4 (17:43):
You mean, because of the fact that we're likely moving
into a lower growth environment.
Speaker 2 (17:48):
Yes, exactly.
Speaker 4 (17:49):
Yeah, I think that is really the underpinnings of this caution.
And I mean, if you think about it, since the
beginning of twenty twenty two, we had economists bracing us
for this recession that was going to happen and it
was going to be in two quarters, and it kept
getting kind of pushed out. So we've been in this
(18:11):
environment where we've been sort of waiting for this recession
that hasn't happened, and it's hard to really pound the
table on equities if you're expecting an economic recession, right,
this is the wall of worry, basically the wall of warry. Yeah.
And then I think on top of that, we've had healthy,
attractive returns in the risk free rate. So you know,
(18:34):
this is the Tina argument is now sort of debunked
because you can get great returns and you know, in
money market accounts and you don't have to take any risk.
So I think that that's the other problem with allocating
too aggressively to stocks. But you know, what's what's interesting
is that if you go back over time and you
look at allocations during periods when cash yields were this high,
(19:00):
allocation to stocks, we're actually higher than where they are today.
I think we're just in an environment where we're all
so surprised that you can actually make any money off
of bonds and cash after getting nothing for a decade,
that it's almost made those asset classes that much more attractive,
(19:20):
or surprisingly attractive. And I think there's very little acknowledgment
that rates can actually continue to move higher rather than
come down. So if you're bearish on stocks because you
can get better yield in cash, I get it. But
if the FED is about to start cutting interest rates
and most of the assets sitting on balance sheets of
individual investors are in money market funds and retirey accounts,
(19:43):
where they're looking for investments they can live off of,
my sense is that as we start to see short
rates come down, if that happens this year, they'll be
forced to look for other areas of higher yield, which
basically pushes them a little bit higher up the risk spectrum,
back into good old bast equity income or utilities and
financials and even real estate companies. So I think those
(20:06):
are some of the considerations that we're thinking about in
terms of what is keeping investors on the sidelines when
it comes to equities, but what could push them back
into equities?
Speaker 3 (20:16):
So I want to press a little bit further on
this idea of maybe it's not a contradiction, but that
stocks have been fined even with the rate move up
and even with the higher for longer becoming consensus. So
I take your point that over long periods of time
or medium periods of time, the S and P five
hundred is just not as rate sensitive as it might
(20:37):
have been times in the past when companies had more
dead had more assets, had more rollover risk. What about though,
just the last two months, which is like if someone
asks you, why haven't stocks gone down over the last
two months, after we keep getting these warmer than expected
inflation prints, after we keep that rate expectation keeps getting
pushed out. This week we saw the odds of a
(20:59):
June cut has now fallen below fifty percent. Talk about
that ongoing resilience.
Speaker 4 (21:04):
I mean, I think it's really thinking about why the
Fed's not cutting, And it's the idea that the Fed's
not cutting because the economy is still running too hot, right,
And again I think that's not a bad environment for stocks, right,
I mean, so far we've sort of seen this proof
(21:25):
of concept, if you will. So when you think about
the last couple of years, I, along with many was
expecting to see margins getting hit harder by the fact
that we went from you know, negative inflation to nine
percent and then to five and you know, now we're
a little bit lower. But it's kind of remarkable that
(21:46):
margins remained relatively intact and healthy during that entire period
of massive volatility around costs of everything, labor inputs, you know, lumber,
every thing. Saw a lot more volatility around costs than
what we were expecting and the what we thought margins
could actually withstand. So I think that proof of concept
(22:09):
that you can have the corporate sector navigate that environment,
you know, still be able to price in many areas
of the economy. The consumer hasn't slowed down meaningfully. I mean,
there's been pockets of a slowdown, but in fact, the
average US consumer is potentially benefiting a bit from higher
short rates by that spread between their assets and liabilities.
(22:32):
I mean, I think all of this, we've had two
years of seeing the fallout of a massive move in
short rates, and it hasn't necessarily derailed a lot of
the equity market. It's certainly derailed parts of the spectrum.
It's derailed you know, commercial real estate. It's derailed parts
of the private markets and the less liquid areas. But
we haven't necessarily seen it play through to you know,
(22:55):
your average cash rich company sitting on the S and P.
Five hundred caps haven't done particularly well, but I think
they're perhaps a bit more refinancing or credit sensitive than
large caps. But I do think that you know, we've
had enough time to see that corporates can actually handle
five percent cash shields. Some companies are benefiting, some consumers
(23:17):
are benefiting. Consumers aren't necessarily slowing down. We're still all
gainfully employed for the most part. We haven't seen massive layoffs.
We're still in a very tight labor market in fact,
in many areas of the economy. So I think those
are some of the reasons that the market is remaining
where it is. Then I think the other kind of
I guess harder to prove or harder to bear out,
(23:39):
And the data reason is that we are seeing some
seeds sown for potentially a very strong productivity cycle, and
I think that is the bulkhase from here, and we
need to really all be paying attention to how that's materializing.
But you know, I said earlier, we should be happy
that the FED has gotten us off of ground zero
on interest rates. And the truth is, we're now at
(24:01):
a point where there's a lot more certainty around earnings
than there was a couple of years ago. A couple
of years ago, a lot of companies were generating earnings
growth per share, earnings growth by borrowing money to buy
back stocks. That's not a great, high quality source of
earnings growth. And then even before that, we had globalization
driving a lot of the earnings for the SMP, and
(24:22):
you had cost arbitrage, tax arbitrage, basically global arbitrage. You know,
if something was expensive in the US, you could move
somewhere else. And that was just this frictionless, great story
for earnings for you know, for twenty years. But that
is also risky, and we're now starting to see that
because you know, we're no longer friends with everybody, and
(24:43):
you know, this whole globalization story seems like it's at
least hit pause, if not reverse. So I think today
we're also at a point where we can be a
little bit more what's the word confident about company's ability
to continue to generate earnings given that all of these easy,
(25:06):
kind of lower quality maneuvers are behind us. They've reversed,
and we've still seen companies able to adapt. So I
think that's another part of this story that's you know,
companies are now focusing on productivity. They're spending money on AI.
We'll see if it works or not, but you know,
there is this promise that a lot of the more
labor intensive companies in the S and P five hundred
(25:29):
can become labor light very quickly, and we've seen this happen.
I mean, I think what's remarkable is like when you
look at certain business models, they have vaporized overnight, Like
that idea of a call center has basically gone away
after generative AI was put out there. We've seen, you know,
the need for Python programming completely evaporate because you can
(25:52):
get you know, you can get AI to write your
code for you. So it's kind of an interesting, very
fast moving theme that's already disrupted some industries and has
the potential to really make a lot of these service sectors,
like it services, financial services, legal services that much more efficient.
Speaker 2 (26:14):
One thing I always wondered, if you are a stock
strategist looking at something like that SMP five hundred, and
you think we are on the verge or in the
early stages of a big secular trend. So for instance,
the Internet in the late nineteen nineties, early two thousands,
or the AI revolution right now, how do you start
(26:34):
incorporating something like that into your forecast. Yeah, it feels
like it could be so transformative. And there's no historical parallels,
not a perfect one.
Speaker 4 (26:44):
Yes, it's hard. I mean we've been trying to think
about you know, well, there's a few angles. One is
the revenue angle, which is already in play, and that's
the idea of the capex takers. So if you have
some theme, be it the PC revolution or industrial automation,
there's a company that benefits. And if you look at
(27:07):
robotics companies or you know, nvideo or chip makers, those
are the capex takers and we've seen those stocks do
tremendously well. If you think about the next leg, which
is probably a longer leg, it's the first movers in
industries that buy the stuff and get it right. So
(27:30):
you know, it's it's basically the first company that buys
the right chips and implements them successfully to replace a
big chunk of their expensive workforce, and that company could
see margin expansion and bump up in there. Multiple I
would argue that margin expansion might be short lived if
(27:52):
the process can be replicated across the industry. So I
think we move from the capex takers to the first movers,
to the process being commoditized and priced in across the industry.
But at the end of the day, when you look
at the companies that have used these tools to transform themselves,
the entire sector should trade at a lower risk premium
(28:16):
because those earnings are potentially stickier and easier to predict
than they would be if you had to worry about
this very cost intensive and risky labor force. Like people
are risky, processes are less risky. So I think that's
the sort of the evolution of this the way I
see it. And then what we did was we looked
at at prior cycles, like we looked at the nineteen
(28:38):
eighties and nineties to see, you know, how automation benefited companies.
And what was interesting to see is that over that
entire time period, within sectors, the peers that became labor
light versus the peers that didn't become more efficient. The
labor light companies outperformed their labor intensive peers. So our
(28:59):
view is, okay, okay, we've got this opportunity for big
chunks of the S and P five hundred to become
less labor intensive, and based on our performance data, labor
intensity and improvements in that metric have actually translated into alpha.
So long kind of convoluted argument for how you track this,
(29:19):
But I think right now all anybody's focused on are
the capex takers and the chip makers and the tech companies.
Maybe now we've moved on to power and grid, but
I think at some point we're going to start acknowledging
that there are these industries that are likely to be transformed.
There are some industries that are going to go away,
other industries that are going to pop up. You know,
(29:40):
like any tech revolution, this is going to take away
some jobs, but is also going to create jobs, and
we're seeing that real time with Python. I mean, you know,
it's interesting if you talk to a graduate and an
engineering program, well, I don't know, maybe it's different now,
but you know, maybe six months ago I was talking
to some recent grads in a program that I'm affiliated
with and they were saying that, you know, the software
(30:02):
and the coders were not getting jobs, but the hardware
folks were getting jobs. So that was just a big,
big transformation right away that was disrupting jobs but creating
like tightness and jobs and other sectors. And I think
that's just what we have to kind of think about
and try to anticipate in a smart way. So we're
listening to our fundamental analysts on every sector. And what's
(30:24):
fascinating to me is when we have calls on AI
and it's use cases, it's not just tech analysts that
participate in these calls, it's healthcare analysts, insurance analysts, you know,
really old economy businesses where there are potential transformative measures
in place.
Speaker 3 (30:59):
I mentioned before investing in an S and P five
hundred index fund. And in the investment industry there's always
this preaching of diversification, and you mentioned that, you know,
right now maybe people are at fifty five percent, or
people are in various alternatives, or from time to time
they're like go international by international stocks, or rotates to
small caps or whatever. But for the last fifteen years,
(31:20):
more or less, we really all should have just had
all of our money in QQQ and outside of no
for real, right, Like, that's like we we've almost been
punished for being the good diversifiers that we're supposed to
be and we really shouldn't have. What changes that, What
kind of regime shift would you want to see such
that it's not always just like this sort of inexorable
(31:41):
sucking of value towards a handful of leading edge.
Speaker 4 (31:45):
Yeah, it's such a good point. I mean, I suppose
I would argue we're seeing that now, and maybe by now,
I mean, you know, March, but not any time earlier
than that. But it's it's really the idea that we
are starting to see earnings broaden out beyond just these
(32:06):
thematic stories. So you know, it felt like last year
we were just jumping from theme to themes. So it was,
you know, AI was doing well, in financials were doing poorly.
Then it was GLP one and you know, kind of
anti obesity, and you know, it's different theme, different months.
You know, this month there's a lot of interest in
power and utilities has actually outperformed on some of those themes.
(32:30):
So I think that where we're starting to see that
idea that diversification is important is when you look at
just within the S and P five hundred, which is
what I know best, we have seen this sort of
broadening of the market occur. So in March, I think
something like sixty percent of S and P companies outperformed
(32:52):
the index, versus less than fifty percent in prior months,
you know, going back to December. So we're at a
point where we are starting to see the average stock
outperform the index, rather than the index outperform the average stock.
And I think that's a change, and that is actually
more normal than unusual. So historically we've seen the breadth
(33:15):
of the S and P five hundred remain a little
bit higher than fifty percent rather than below fifty percent,
And I think that's something we can point to as
a sign that diversification is starting to pay off again.
But you know, I think one of the reasons that
diversification didn't pay off over the last twenty years or
fifteen years was that you had one single buyer of
US treasury bonds, and that was the FED, and the
(33:36):
FED was pouring trillions and trillions and trillions of dollars
into US treasuries. That's not a diversified investor. That's one theme,
one asset class, and one big, huge, monstrous buyer. And
I think if that environment is behind us, we go
back to a more diverse set of buyers buying different
types of things.
Speaker 2 (33:58):
Similar question, I suppose, but what would give you pause
at this point? What would make you nervous?
Speaker 4 (34:04):
Well, I guess I'm what makes me nervous is you know,
every earning season we're listening for layoffs because I think
the lynch pin of consumption is not necessarily rates or
the cost to borrow. It's really just having a job, right.
I mean, if you have income and you have the
(34:27):
ability to pay off your mortgage, you're not going to
walk away from your house. When you lose your job
and you have no option to pay off your mortgage,
that's when you start to see things really deteriorate. So
I think one kind of bow case for the US
consumer that we've been highlighting is, you know, we're still
in a pretty tight labor market. I mean, we had
(34:49):
this massive resignation during COVID, we had an aging population,
We have fewer workers in manufacturing. Meanwhile, there's this huge
restoring initiative brewing where you know, companies are moving plant
property and equipment back to the US from other parts
of the world. So I think that tightness in the
manufacturing complex and the feed through to small businesses in
(35:12):
those regions has been positive. But if that starts to
slow down, that would be a negative and broadspread job losses,
I think would be what we'd worry about to sort
of end the consumption story. You know, I also worry
about the debt burden carried by the US government, but
I think that's a harder problem to model into your
(35:33):
equity market forecast, right, I mean this is like, this
is like your question earlier on AI and how do
you model these things into your outlook? I think it's
hard to know how the debt to GDP burden of
the US government resolves itself. Does this mean that the
US sovereign you know, tenure treasuries are more risky? Does
(35:54):
this mean that the dollar is at risk of losing
its reserve currency status? Definitely today, because there's no alternative.
But I think those are the more kind of problematic,
longer term risks that make me less polytize about the
world that I might be. Again, though, when I think
about those risks, I don't know if they manifest themselves
(36:17):
in the S and P five hundred and in the
public equity markets. I think they're more impactful to private equity,
liquid assets, real estate, you know, just basically bonds, and
then just sort of the idea of the US as
a high quality sovereign I think is the other kind
of part of this that is harder to really fathom
(36:38):
at this point.
Speaker 3 (36:39):
You know, you mentioned the companies cutting cost layoffs and
changing their cash management. I sort of came away from
that whole period of like, US company operators are really good.
Layoffs aren't good, especially mass layoffs. But the speed with
which companies kind of pivoted it was like many companies
(37:00):
demonstrated a pretty serious sort of like management competence just
sort of like in a few minutes left, Like it
sort of goes in hand in hand with if people
have jobs, they're probably going to spend it. That'll keep
support up. What are you you seeing in terms of
just sort of how EPs, earnings per share or corporate
earnings are tracking versus where you would have thought at
the beginning of the year or six months ago or
(37:21):
at the end of October when this rally really took off.
Speaker 4 (37:24):
Yeah, yeah, it's a great point. So we've seen margins
hang in there, they've actually expanded a little. The big surprise,
like I always feel like kind of surprised when I
look at the data, even though I know it, is
that we had an earnings recession last year, right we
had companies and the overall S and P five hundred,
it had a couple of quarters of negative earnings growth.
(37:44):
And that recession is now behind us, and we're seeing
companies recover. I suppose when I look at earnings trends,
I mean, one reason that I think the market could
start to broaden out even more than just a month
or two is that when you look at just the
differential between high growth tech companies and the rest of
(38:05):
the S and P five hundred, that differential starts to narrow.
Last year, the only companies that were making money were
the Magnificent seven, so it kind of made sense that
they just crushed it. This year, we're starting to see
that differential between growth trends and narrow. We're forecasting about
ten percent earnings growth this year, which is roughly in
line with where I think bottom up consensus is. Maybe
(38:26):
bottom up consensus is a little bit higher we're basically
forecasting a broad based recovery across sectors that we've already seen.
So it's the idea that we've already seen cost cutting
and now maybe we see that operating leverage from demand
coming back from parts of the economy starting to pick
up again. We're seeing a shift from service spending to
(38:48):
good spending, so that's positive for the S and P
five hundred and consumer stocks. Those are some of the
areas that we're looking at from an earnings perspective.
Speaker 2 (38:56):
All right, Savina, I'm so glad we finally had you
on all Laws.
Speaker 4 (39:01):
Having.
Speaker 5 (39:02):
It's great to be here, Joe.
Speaker 2 (39:16):
I'm so glad we could do that episode finally because
Cevita has nailed the upwards trend in the S and
P five hundred at a time when a lot of
people were still very nervous about the outlook for stocks.
The one thing that had me thinking, and I think
we spoke about this before, but like the one recession
path that I kind of worry about is the idea
(39:39):
of like I guess, lofty EPs expectations kind of coming
back to haunt the market in the sense that companies
had pricing power in recent years, they raised their prices.
That helped pad margins. But if inflation is starting to
go down, or if consumers are starting to push back,
or if there is pressure on household balance sheets or whatever,
(40:00):
then maybe one of the levers they pull is on
the job front, and then we get layoffs, and then
we see consumer powers start to go down, and then
we see profit margins start to go down, and that
would be bad. I'm not saying we're there yet, but
that's the one kind of path that I worry about totally.
Speaker 3 (40:17):
That makes a ton of sense to me. And also
just this idea that like, you know, there's this on
the service puzzle, why haven't stocked affected by higher rates?
Speaker 4 (40:24):
Yeah?
Speaker 3 (40:25):
Well, rates are high because demand is strong and the
economy continues to grow at a robust clip. And if
people continue have jobs, they'll continue to spend. And if
they continue to spend and earnings hold up, and then
you don't necessarily need those higher rates. So it's interesting
that already this year, you know, rather than the scenario
that you describe, which seems very plausible to me so far,
(40:46):
at least, we're seeing the opposite, that broadening out of.
Speaker 2 (40:48):
Virtuous Yeah, it's a virtuous cycle. At the moment, it
could go in the other direction, but for now it
seems to be feeding on itself in a positive manner.
The one other thing I thought was really good to
emphasize is that index composition yes, yes, and the idea
that like, okay, you could look at historical pees and
comparing contrast with the nineteen eighties or the early two
thousands steering the tech bubble or whatever, but there are
(41:11):
actual changes in the S and P five hundred that
might make that comparison less useful. And especially that point
about companies terming out their balance sheets and the duration
changes that we've seen. I think if you had a
good handle on the degree to which companies had actually
refinanced their balance sheets over the past couple of years,
(41:32):
you probably would have nailed a lot of the resilience
that we've seen in markets.
Speaker 3 (41:35):
Totally. I think it's really important this idea of like
sort of earnings durability quality, and so you can imagine
that a company that has to hold a lot of inventory,
or a company that has to from time to time
engage in huge capital expenditure cycles, like, yeah, you probably
don't want to pay as much for those earnings as
you do a company that doesn't have to manage those
(41:58):
risks the same way, and so I think, like I'm
always a little bit scared of like, oh, here's why
the index is not doesn't matter, and that these like yeah,
you know, percentiles in ninety fifth is not as scary.
But it does make sense that there are certain types
of earning streams that the nature of the business models sucks,
where you can be confident that they'll be more durable
than another type of company.
Speaker 2 (42:19):
This has gone back to being a value bashing show.
Speaker 3 (42:22):
Yes, can I say the one other thing I really
like is that, you know, it is really hard to measure,
as Savida said, like how much allocation different types of
investors have to stocks any given moment. That's why there's
all these surveys. I love that the one measure that
seems to have some historical validity is to just measure
the analysts themselves. And when the analysts are really bullish
(42:45):
or super bullish, that's maybe time to sell. Like that,
you just do the survey, look what people are recommending,
and see if how out of whack they are.
Speaker 2 (42:52):
I'm looking at the cell side indicator that Savita mentioned
right now and It is kind of crazy how much
bollishness there was in Sale two thousand and one. Yeah,
it seems to work anyway. Shall we leave it there?
Speaker 4 (43:04):
Let's leave it there, all right?
Speaker 2 (43:06):
This has been another episode of the Oudlots podcast. I'm
Tracy Alloway. You can follow me at Tracy Alloway.
Speaker 3 (43:12):
And I'm Joe Wisenthal. You can follow me at the Stalwart.
Follow our producers Carmen Rodriguez at Carman Arman dash Ol
Bennett at Dashbot and Kelbrooks at Kelbrooks. Thank you to
our producer Moses onm. For more Oddlogs content, go to
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(43:33):
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Bloomberg Audio Studios, Podcasts, radio News.
Speaker 2 (00:18):
Hello and welcome to another episode of the All Lots podcast.
I'm Tracy Alloway.
Speaker 3 (00:22):
And I'm Joe Wisenthal.
Speaker 2 (00:24):
Joe. For all intents and purposes, we're pretty much at
a record in terms of US stocks totally.
Speaker 3 (00:31):
We're recording this April second, so we're actually down a
little bit today, about a percent. But the story in
my mind of the market for twenty twenty four is
that we went into this year with all sorts of
soft landing optimism. The FED is going to cut rates
a bunch of times, and then all these sort of
rate cut hopes are sort of slowly evaporating, but it's
hardly affected the stock market, and so we're basically at
(00:51):
record highs despite the fact that that first cut keeps
getting pushed out into the future.
Speaker 2 (00:56):
Yeah, And the question is, are stock's going to start
to turn lower again? They are lower today, They've been
kind of vacillating for the past couple of days. Is
the start of a durable drop or are markets basically
catching their breath after a torrid rally and are they
going to continue upward? Is all that excitement over things
like AI and tech just going to keep going. And
(01:17):
speaking of excitement over AI and tech, you do see
some commentary at the moment about bubble territory, so the
idea that, well, maybe we're getting a little bit too optimistic,
or isn't it weird that it was expectations of rate
cuts that drove the move upward, but as the rate
cuts get priced further out, we're not really seeing that
(01:37):
big impact on stocks totally.
Speaker 3 (01:39):
So for a while as the market was doing this
sort of straight line up really since the end of
October when rates peaked, part of this sort of I
don't know, bear crowd or skepticism or people trying to
poke holes in the rally is like, oh, it's all tech,
it's all the mag seven, these gigantic tech stocks, etc.
What's interesting about lately is that actually a lot of
(02:00):
these high flyers, like in video, they've like sort of
been flat for the last month or so, and even
that doesn't seem to be holding water. There actually are
big rallies in many parts of the market. So the
question is like why, I mean, you could say, oh,
like the story maybe made sense, it's like, oh, there's
these handful of mega giants. They're capturing all of the gains,
(02:20):
and so what these new all time highs don't really
reflect what the broader market is doing. The broader market's
doing fine.
Speaker 2 (02:27):
Yeah, and again against expectation. Yes, it's actually broadening out yeow,
rather than becoming more narrow, which is the kind of
thing that you would be worried about if you are
in a bubble or about to test a bubble. But
all right, I am very pleased to say that we do,
in fact have the perfect guests to discuss markets and
whether or not we are closing in on bubble territory.
We're going to be speaking with Cevita Supermanian, head of
(02:50):
US equity strategy at Bank of America, and she recently
raised her target for the S and P five hundred
from five thousand to five four hundred. I think this
was done about a month ago, and we're already at
like five thousand, two hundred. Yeah, So yeah, good call, Savita.
Welcome to the show.
Speaker 4 (03:09):
Hi, it's great to be here. Thanks for having me.
Speaker 2 (03:12):
It's I feel kind of bad. I feel like we
should have had you on way way earlier, because you know,
you are sort of a stalwart of the cell side
research on the stocks, and yet we haven't made it happen.
Kind of weird, that is weird, but we're correcting for
past mistakes. Yes, this is good, a good type of correction.
(03:33):
All right, SMP five hundred pretty much at record highs.
What's driving it?
Speaker 4 (03:38):
Yeah, So it's interesting when we launched our twenty twenty
four outlook in November with our year ahead report, and
we launched our SMP market call with a five thousand
year end target, and I remember having to repeat that
number like people would literally say, did you just say
(03:59):
five thousand? Like it was way too high? And now
here we are at fifty two whatever, and a couple
of months ago, the market basically breezed right through that
five thousand target. And you know, there's no perfect way
to forecast a point in time target impact. I think
it's kind of a silly number. But the question that
(04:21):
we asked ourselves was, Okay, now, what does the market
go higher or lower? Because we're kind of where we
thought we would be by your end in January, and
everything we looked at said higher, So you know, I
can delve into it, but I think where we are
now is still we're sort of climbing that wall of worry.
We're still in an environment where I don't know, it's
interesting if you look at the average target for the
(04:44):
S and P, I think it's lower than where the
market is today, which is unusual because I think the
SU side is usually skewed to being more optimistic. When
you look at even analysts earnings expectations, there are still
relatively low outside of this so called you know, Magnificent
seven or the you know, the megacap tech companies that
(05:04):
have been driving the market. So I still think we're
in an environment where allocation to stocks is just starting
to increase, Bolishness is just starting to percolate, and as
you rightly point out, the market is just starting to
broaden out a bit.
Speaker 3 (05:20):
Let's go back to the initial call that you made
for S and P five thousand. What was the reasoning
then in terms of like, let's just start with that question.
Speaker 4 (05:29):
So the reasoning then and it was basically putting the
smp at around it. I think it was like a
ten percent year or thereabouts. Was the idea was, Okay,
where are we now versus where we were a couple
of years ago, And I think there's a lot of
good news that we should be happy about. We should
be happy that the FED has actually moved interest rates
from zero to five because now we have a lot
(05:51):
of latitude with which to ease our way out of
the next crisis. We should also be happy that the
SMP itself is pretty different today than what it was
a couple of years ago. And I think you know
what I find interesting is that the SMP five hundred
has basically managed out a lot of its own risk
over the last couple of years by attrition. So if
(06:12):
you look at a lot of the companies that were
in the S and P five hundred in twenty twenty two,
you know when the big surprise was the FED was
about to hike interest rates by the largest amount ever
in the fastest period of time. You know, the constituents
that were bigger weights in the market are now smaller
weights and maybe have even drifted out. And in particular,
(06:33):
the ones that have drifted out are those with refinancing
risk or companies that might not be able to hack
it in a five percent rate world. So I almost
feel like the beginning of this year was a good
start in terms of the health of the index. We
also saw that despite this megacap tech dominance. These companies
(06:53):
they got expensive, but they didn't get as expensive as
we saw, you know, nonprofitable tech during the tech bubble
of ninety nine two thousand. Moreover, I think what's really
exciting from a corporate finance perspective is that when you
look at the risks around the S and P five
hundred based on higher interest rates. One of the things
(07:15):
that worried us a couple of years ago was that
the SMP itself was a very long duration instrument, i e.
You were buying today for like great growth, but it
was way out in the future and you were getting
no cash return. Today, I think a lot of that
has resolved itself because many of the less profitable growth
companies have either drifted lower in market cap or have
(07:39):
become profitable and are now returning that cash to shareholders. So,
you know, when we looked at companies in the big
tech sector in early twenty twenty three, we started to
see really encouraging signs. These big companies, these megacap tech
companies basically acknowledged that they were too big to grow
as quickly as they had in a zero percent interest
(08:02):
rate world. And they were also just going to grow
a little bit more slowly, and you saw these growth
stocks actually cut capacity, cut costs. Meta did the biggest
share buyback that we've ever seen in the history of
share buybacks. And you know, these companies were able to
lower their duration by pulling earnings earlier, in returning cash
(08:27):
to shareholders, et cetera. I mean, the unthinkable happened earlier
this year with Meta paying a dividend or initiating a dividend.
So I think, you know, the idea here is we're
at a point where the market actually looks a lot
healthier and much better able to navigate a higher rate
environment than it did a couple of years ago.
Speaker 2 (08:47):
So this is really interesting because you hear a lot
of people say, well, stocks look expensive at the moment,
and I think Bank of America has a bunch of
different metrics that you look at, and I think in
one of your notes you said that the SMP five
hundred is statistically expensive on nineteen of twenty metrics. Yes,
but the argument is that we've gone through this period
(09:09):
of adjustment of higher rates and the mix of the index,
its composition has shifted such that well, maybe those valuations
are well deserved.
Speaker 4 (09:20):
Well, to some extent, it's the question should we ever
be comparing the market multiple to a prior market multiple, right,
because it's a different animal. And I think today, as
you said, you know, we're looking at an S and
P five hundred index that barely resembles the market in
nineteen eighty or even nineteen ninety. We've gone from a
(09:43):
market that was you know, seventy percent manufacturing back in
the eighties to an index that's fifty percent asset light growth, healthcare,
tech innovation. We've gone from a benchmark that had much
higher debt to x equity ratios ten years ago to
a benchmark that's paid down a lot of it's debt
(10:05):
and now has fixed strate you know, kind of long term,
less leverage risk and less free financing risk than it
has had in prior cycles. I mean, seventy percent of
debt sitting on SMP balance sheets is long term fixed
rate debt versus back in two thousand and seven it
was you know, something like forty percent. So it's almost
(10:27):
like comparing apples to oranges by saying the market today
looks expensive versus the market of two thousand, or you know,
nineteen eighty or thereabouts, So I think that's part of
the problem. And then the other part of the problem
is when you look at the S and P five hundred,
it's made up of a whole bunch of different stocks.
We all know this, but right now there is a
skew where, you know, the growth companies that really benefited
(10:50):
from this sort of free capital environment are bigger proportions
of the benchmark and are potentially more expensive than the
rest of the SMP. So it's kind of like if
you peel back the onion and you take out, you know,
five of the megacap companies, the market multiple drops from
twenty to fifteen or something pretty pretty extreme. So I
(11:11):
think there are a lot of problems with just looking
at a snapshot multiple and saying, Yep, the SMP's at
twenty five times and it's historically been at fifteen times,
you want to sell it. That's not the call we're making.
Speaker 3 (11:23):
So I'll just give my full disclosure here, which is
that I am an investor in an S and P
five hundred index fund. So I want to thank the
active managers at SMP who have successfully gotten rid of
some of the more rate sensitive stocks out of the industry.
Speaker 2 (11:40):
If de risk your portfolio.
Speaker 3 (11:41):
Yes, thank you for the excellent active manager of my
passive vehicle. You've already raised a number of really interesting points.
Speaker 4 (11:49):
But I want to go back.
Speaker 3 (11:49):
To something you said in the first answer about sentiment,
because capturing whatever the sentiment is at the moment is
an inherently difficult task. You can look at market measures,
what's happening with call options, you can do surveys. Bank
of America does a survey of fund managers and they
talk about their allocation. When you say that, like we're
just getting into bullishness, it sounds weird when stocks are
(12:12):
at all time hies. What are you looking at when
you say something like that, And when you say, okay,
we're just getting people are just getting more into stocks. Now,
what is the data that.
Speaker 1 (12:21):
Backs that up?
Speaker 4 (12:22):
Yeah, there's a lot of data, And you can basically
get data to say whatever you wanted to if you
isolate your frame of reference to certain subsets. So I
guess it's a complicated question, and nobody really ever has
a full kind of up to date look at what
everybody in the world is holding. And also, I mean,
for whoever is buying equities, somebody is selling equities, So
(12:44):
it's kind of like, why does positioning even matter? So
one of the things we look at is is sort
of who are the arbiters of inflows over the next
like let's call it three to six months, right, Individual
investors are obviously part of the pie, But then there's
the asset owners themselves, the pension funds, the sovereign wealth funds,
(13:05):
like the biggies that kind of engage in asset allocation decisions.
And I think what's interesting there is that you would
think that asset allocators would be maxed out on equity
exposure today, given how well the asset class has done,
how well stocks have done relative to other asset classes.
But if you look at the average US pension fund,
(13:26):
their exposure to public equity to stocks is actually the
lowest we've seen since the nineteen late nineteen nineties. And
the reason is that a lot of these pension funds
have supplanted their exposure to equities with exposure to private
equity or alternative asset classes or you know, kind of
(13:49):
less liquid ways to buy growth. And I think that's
important because where we are today is an environment where
pension funds have basically supplanted to their exposure to active
equity like mutual funds and hedge funds with an index fund.
(14:09):
But they've actually replaced a lot of that equity exposure
with other asset classes in this search for growth, and
I think that's potentially more problematic for ill liquid asset
classes like private credit and private equity, and asset classes
that haven't necessarily been marked to this current environment of
a little bit higher rates and inflation than it is
(14:31):
for public equities. So that's one measure of positioning. The
other measure of positioning that I've followed my entire career
at Bank of America, and I inherited this from my
former boss, Rich Bernstein, who was our strategist at Merrill
Lynch for many many years, and I think he may
have inherited it from somebody before him. Is it's called
the Cell side Indicator, and it's the reason I always
(14:54):
go back to this model is that it has been
the most predictive market timing model for the S and
P five hundred over a twelve month time horizon, more
predictive than anything else I've been able to find. And
what we do in this cell side indicator is we
look at our peers and ourselves, and we say how
(15:15):
bullish or bearish are we by virtue of one number,
which is our recommended allocation to equities in a balanced portfolio.
So when you talk to your broker and he or
she tells you we think you should put sixty percent
into stocks and you know, thirty percent into bonds and
ten percent into cash. We take that stock allocation, we
average it together across the entire Wall Street bulge bracket firms,
(15:39):
and we look at what that average allocation is, and
it has waxed and waned between something like forty percent
and seventy percent. It's been all over the place over
the last thirty or forty years. But what we found
is that when it's at very bearish or bullish extremes,
you should do the opposite of what we're all telling
you to do. And I think what's interesting is that
(15:59):
we're not at a bullish extreme. We're at a point
where your average market strategist is recommending that you put
about fifty five percent of your assets into equities, which
is kind of surprising given that we've seen dramatic outperformance
of equities relative to other asset classes over the last
couple of years surprise gains in the SMP versus other indices,
(16:23):
it's a little bit surprising to see that there is
still this very tepid allocation to stocks. I mean, the
benchmark for years has been sixty percent stocks, and we're
still shy of that. So it's not to say that
folks out there are bearish and under the table and
hiding and putting all their money in cash and gold
and under the mattress. But I think we're at a
(16:44):
point where we're far from that euphoric level on equities
that typically heralds the end of a bull market.
Speaker 2 (17:08):
How much of the rise in stocks is an interest
rates story? Going back to the beginning of this discussion,
because part of the idea here is that, all right, well,
the FED might cut interest rates, but the reason it
would be cutting interest rates is because economic growth is deteriorating, like,
maybe not substantially, but it's weakening a little bit, and
(17:30):
so it's trying to get ahead of a potential recession
or something like that. Is that perhaps why there's some
reticence on the cell side to jump into stocks wholeheartedly
at this point.
Speaker 4 (17:43):
You mean, because of the fact that we're likely moving
into a lower growth environment.
Speaker 2 (17:48):
Yes, exactly.
Speaker 4 (17:49):
Yeah, I think that is really the underpinnings of this caution.
And I mean, if you think about it, since the
beginning of twenty twenty two, we had economists bracing us
for this recession that was going to happen and it
was going to be in two quarters, and it kept
getting kind of pushed out. So we've been in this
(18:11):
environment where we've been sort of waiting for this recession
that hasn't happened, and it's hard to really pound the
table on equities if you're expecting an economic recession, right,
this is the wall of worry, basically the wall of warry. Yeah.
And then I think on top of that, we've had healthy,
attractive returns in the risk free rate. So you know,
(18:34):
this is the Tina argument is now sort of debunked
because you can get great returns and you know, in
money market accounts and you don't have to take any risk.
So I think that that's the other problem with allocating
too aggressively to stocks. But you know, what's what's interesting
is that if you go back over time and you
look at allocations during periods when cash yields were this high,
(19:00):
allocation to stocks, we're actually higher than where they are today.
I think we're just in an environment where we're all
so surprised that you can actually make any money off
of bonds and cash after getting nothing for a decade,
that it's almost made those asset classes that much more attractive,
(19:20):
or surprisingly attractive. And I think there's very little acknowledgment
that rates can actually continue to move higher rather than
come down. So if you're bearish on stocks because you
can get better yield in cash, I get it. But
if the FED is about to start cutting interest rates
and most of the assets sitting on balance sheets of
individual investors are in money market funds and retirey accounts,
(19:43):
where they're looking for investments they can live off of,
my sense is that as we start to see short
rates come down, if that happens this year, they'll be
forced to look for other areas of higher yield, which
basically pushes them a little bit higher up the risk spectrum,
back into good old bast equity income or utilities and
financials and even real estate companies. So I think those
(20:06):
are some of the considerations that we're thinking about in
terms of what is keeping investors on the sidelines when
it comes to equities, but what could push them back
into equities?
Speaker 3 (20:16):
So I want to press a little bit further on
this idea of maybe it's not a contradiction, but that
stocks have been fined even with the rate move up
and even with the higher for longer becoming consensus. So
I take your point that over long periods of time
or medium periods of time, the S and P five
hundred is just not as rate sensitive as it might
(20:37):
have been times in the past when companies had more
dead had more assets, had more rollover risk. What about though,
just the last two months, which is like if someone
asks you, why haven't stocks gone down over the last
two months, after we keep getting these warmer than expected
inflation prints, after we keep that rate expectation keeps getting
pushed out. This week we saw the odds of a
(20:59):
June cut has now fallen below fifty percent. Talk about
that ongoing resilience.
Speaker 4 (21:04):
I mean, I think it's really thinking about why the
Fed's not cutting, And it's the idea that the Fed's
not cutting because the economy is still running too hot, right,
And again I think that's not a bad environment for stocks, right,
I mean, so far we've sort of seen this proof
(21:25):
of concept, if you will. So when you think about
the last couple of years, I, along with many was
expecting to see margins getting hit harder by the fact
that we went from you know, negative inflation to nine
percent and then to five and you know, now we're
a little bit lower. But it's kind of remarkable that
(21:46):
margins remained relatively intact and healthy during that entire period
of massive volatility around costs of everything, labor inputs, you know, lumber,
every thing. Saw a lot more volatility around costs than
what we were expecting and the what we thought margins
could actually withstand. So I think that proof of concept
(22:09):
that you can have the corporate sector navigate that environment,
you know, still be able to price in many areas
of the economy. The consumer hasn't slowed down meaningfully. I mean,
there's been pockets of a slowdown, but in fact, the
average US consumer is potentially benefiting a bit from higher
short rates by that spread between their assets and liabilities.
(22:32):
I mean, I think all of this, we've had two
years of seeing the fallout of a massive move in
short rates, and it hasn't necessarily derailed a lot of
the equity market. It's certainly derailed parts of the spectrum.
It's derailed you know, commercial real estate. It's derailed parts
of the private markets and the less liquid areas. But
we haven't necessarily seen it play through to you know,
(22:55):
your average cash rich company sitting on the S and P.
Five hundred caps haven't done particularly well, but I think
they're perhaps a bit more refinancing or credit sensitive than
large caps. But I do think that you know, we've
had enough time to see that corporates can actually handle
five percent cash shields. Some companies are benefiting, some consumers
(23:17):
are benefiting. Consumers aren't necessarily slowing down. We're still all
gainfully employed for the most part. We haven't seen massive layoffs.
We're still in a very tight labor market in fact,
in many areas of the economy. So I think those
are some of the reasons that the market is remaining
where it is. Then I think the other kind of
I guess harder to prove or harder to bear out,
(23:39):
And the data reason is that we are seeing some
seeds sown for potentially a very strong productivity cycle, and
I think that is the bulkhase from here, and we
need to really all be paying attention to how that's materializing.
But you know, I said earlier, we should be happy
that the FED has gotten us off of ground zero
on interest rates. And the truth is, we're now at
(24:01):
a point where there's a lot more certainty around earnings
than there was a couple of years ago. A couple
of years ago, a lot of companies were generating earnings
growth per share, earnings growth by borrowing money to buy
back stocks. That's not a great, high quality source of
earnings growth. And then even before that, we had globalization
driving a lot of the earnings for the SMP, and
(24:22):
you had cost arbitrage, tax arbitrage, basically global arbitrage. You know,
if something was expensive in the US, you could move
somewhere else. And that was just this frictionless, great story
for earnings for you know, for twenty years. But that
is also risky, and we're now starting to see that
because you know, we're no longer friends with everybody, and
(24:43):
you know, this whole globalization story seems like it's at
least hit pause, if not reverse. So I think today
we're also at a point where we can be a
little bit more what's the word confident about company's ability
to continue to generate earnings given that all of these easy,
(25:06):
kind of lower quality maneuvers are behind us. They've reversed,
and we've still seen companies able to adapt. So I
think that's another part of this story that's you know,
companies are now focusing on productivity. They're spending money on AI.
We'll see if it works or not, but you know,
there is this promise that a lot of the more
labor intensive companies in the S and P five hundred
(25:29):
can become labor light very quickly, and we've seen this happen.
I mean, I think what's remarkable is like when you
look at certain business models, they have vaporized overnight, Like
that idea of a call center has basically gone away
after generative AI was put out there. We've seen, you know,
the need for Python programming completely evaporate because you can
(25:52):
get you know, you can get AI to write your
code for you. So it's kind of an interesting, very
fast moving theme that's already disrupted some industries and has
the potential to really make a lot of these service sectors,
like it services, financial services, legal services that much more efficient.
Speaker 2 (26:14):
One thing I always wondered, if you are a stock
strategist looking at something like that SMP five hundred, and
you think we are on the verge or in the
early stages of a big secular trend. So for instance,
the Internet in the late nineteen nineties, early two thousands,
or the AI revolution right now, how do you start
(26:34):
incorporating something like that into your forecast. Yeah, it feels
like it could be so transformative. And there's no historical parallels,
not a perfect one.
Speaker 4 (26:44):
Yes, it's hard. I mean we've been trying to think
about you know, well, there's a few angles. One is
the revenue angle, which is already in play, and that's
the idea of the capex takers. So if you have
some theme, be it the PC revolution or industrial automation,
there's a company that benefits. And if you look at
(27:07):
robotics companies or you know, nvideo or chip makers, those
are the capex takers and we've seen those stocks do
tremendously well. If you think about the next leg, which
is probably a longer leg, it's the first movers in
industries that buy the stuff and get it right. So
(27:30):
you know, it's it's basically the first company that buys
the right chips and implements them successfully to replace a
big chunk of their expensive workforce, and that company could
see margin expansion and bump up in there. Multiple I
would argue that margin expansion might be short lived if
(27:52):
the process can be replicated across the industry. So I
think we move from the capex takers to the first movers,
to the process being commoditized and priced in across the industry.
But at the end of the day, when you look
at the companies that have used these tools to transform themselves,
the entire sector should trade at a lower risk premium
(28:16):
because those earnings are potentially stickier and easier to predict
than they would be if you had to worry about
this very cost intensive and risky labor force. Like people
are risky, processes are less risky. So I think that's
the sort of the evolution of this the way I
see it. And then what we did was we looked
at at prior cycles, like we looked at the nineteen
(28:38):
eighties and nineties to see, you know, how automation benefited companies.
And what was interesting to see is that over that
entire time period, within sectors, the peers that became labor
light versus the peers that didn't become more efficient. The
labor light companies outperformed their labor intensive peers. So our
(28:59):
view is, okay, okay, we've got this opportunity for big
chunks of the S and P five hundred to become
less labor intensive, and based on our performance data, labor
intensity and improvements in that metric have actually translated into alpha.
So long kind of convoluted argument for how you track this,
(29:19):
But I think right now all anybody's focused on are
the capex takers and the chip makers and the tech companies.
Maybe now we've moved on to power and grid, but
I think at some point we're going to start acknowledging
that there are these industries that are likely to be transformed.
There are some industries that are going to go away,
other industries that are going to pop up. You know,
(29:40):
like any tech revolution, this is going to take away
some jobs, but is also going to create jobs, and
we're seeing that real time with Python. I mean, you know,
it's interesting if you talk to a graduate and an
engineering program, well, I don't know, maybe it's different now,
but you know, maybe six months ago I was talking
to some recent grads in a program that I'm affiliated
with and they were saying that, you know, the software
(30:02):
and the coders were not getting jobs, but the hardware
folks were getting jobs. So that was just a big,
big transformation right away that was disrupting jobs but creating
like tightness and jobs and other sectors. And I think
that's just what we have to kind of think about
and try to anticipate in a smart way. So we're
listening to our fundamental analysts on every sector. And what's
(30:24):
fascinating to me is when we have calls on AI
and it's use cases, it's not just tech analysts that
participate in these calls, it's healthcare analysts, insurance analysts, you know,
really old economy businesses where there are potential transformative measures
in place.
Speaker 3 (30:59):
I mentioned before investing in an S and P five
hundred index fund. And in the investment industry there's always
this preaching of diversification, and you mentioned that, you know,
right now maybe people are at fifty five percent, or
people are in various alternatives, or from time to time
they're like go international by international stocks, or rotates to
small caps or whatever. But for the last fifteen years,
(31:20):
more or less, we really all should have just had
all of our money in QQQ and outside of no
for real, right, Like, that's like we we've almost been
punished for being the good diversifiers that we're supposed to
be and we really shouldn't have. What changes that, What
kind of regime shift would you want to see such
that it's not always just like this sort of inexorable
(31:41):
sucking of value towards a handful of leading edge.
Speaker 4 (31:45):
Yeah, it's such a good point. I mean, I suppose
I would argue we're seeing that now, and maybe by now,
I mean, you know, March, but not any time earlier
than that. But it's it's really the idea that we
are starting to see earnings broaden out beyond just these
(32:06):
thematic stories. So you know, it felt like last year
we were just jumping from theme to themes. So it was,
you know, AI was doing well, in financials were doing poorly.
Then it was GLP one and you know, kind of
anti obesity, and you know, it's different theme, different months.
You know, this month there's a lot of interest in
power and utilities has actually outperformed on some of those themes.
(32:30):
So I think that where we're starting to see that
idea that diversification is important is when you look at
just within the S and P five hundred, which is
what I know best, we have seen this sort of
broadening of the market occur. So in March, I think
something like sixty percent of S and P companies outperformed
(32:52):
the index, versus less than fifty percent in prior months,
you know, going back to December. So we're at a
point where we are starting to see the average stock
outperform the index, rather than the index outperform the average stock.
And I think that's a change, and that is actually
more normal than unusual. So historically we've seen the breadth
(33:15):
of the S and P five hundred remain a little
bit higher than fifty percent rather than below fifty percent,
And I think that's something we can point to as
a sign that diversification is starting to pay off again.
But you know, I think one of the reasons that
diversification didn't pay off over the last twenty years or
fifteen years was that you had one single buyer of
US treasury bonds, and that was the FED, and the
(33:36):
FED was pouring trillions and trillions and trillions of dollars
into US treasuries. That's not a diversified investor. That's one theme,
one asset class, and one big, huge, monstrous buyer. And
I think if that environment is behind us, we go
back to a more diverse set of buyers buying different
types of things.
Speaker 2 (33:58):
Similar question, I suppose, but what would give you pause
at this point? What would make you nervous?
Speaker 4 (34:04):
Well, I guess I'm what makes me nervous is you know,
every earning season we're listening for layoffs because I think
the lynch pin of consumption is not necessarily rates or
the cost to borrow. It's really just having a job, right.
I mean, if you have income and you have the
(34:27):
ability to pay off your mortgage, you're not going to
walk away from your house. When you lose your job
and you have no option to pay off your mortgage,
that's when you start to see things really deteriorate. So
I think one kind of bow case for the US
consumer that we've been highlighting is, you know, we're still
in a pretty tight labor market. I mean, we had
(34:49):
this massive resignation during COVID, we had an aging population,
We have fewer workers in manufacturing. Meanwhile, there's this huge
restoring initiative brewing where you know, companies are moving plant
property and equipment back to the US from other parts
of the world. So I think that tightness in the
manufacturing complex and the feed through to small businesses in
(35:12):
those regions has been positive. But if that starts to
slow down, that would be a negative and broadspread job losses,
I think would be what we'd worry about to sort
of end the consumption story. You know, I also worry
about the debt burden carried by the US government, but
I think that's a harder problem to model into your
(35:33):
equity market forecast, right, I mean this is like, this
is like your question earlier on AI and how do
you model these things into your outlook? I think it's
hard to know how the debt to GDP burden of
the US government resolves itself. Does this mean that the
US sovereign you know, tenure treasuries are more risky? Does
(35:54):
this mean that the dollar is at risk of losing
its reserve currency status? Definitely today, because there's no alternative.
But I think those are the more kind of problematic,
longer term risks that make me less polytize about the
world that I might be. Again, though, when I think
about those risks, I don't know if they manifest themselves
(36:17):
in the S and P five hundred and in the
public equity markets. I think they're more impactful to private equity,
liquid assets, real estate, you know, just basically bonds, and
then just sort of the idea of the US as
a high quality sovereign I think is the other kind
of part of this that is harder to really fathom
(36:38):
at this point.
Speaker 3 (36:39):
You know, you mentioned the companies cutting cost layoffs and
changing their cash management. I sort of came away from
that whole period of like, US company operators are really good.
Layoffs aren't good, especially mass layoffs. But the speed with
which companies kind of pivoted it was like many companies
(37:00):
demonstrated a pretty serious sort of like management competence just
sort of like in a few minutes left, Like it
sort of goes in hand in hand with if people
have jobs, they're probably going to spend it. That'll keep
support up. What are you you seeing in terms of
just sort of how EPs, earnings per share or corporate
earnings are tracking versus where you would have thought at
the beginning of the year or six months ago or
(37:21):
at the end of October when this rally really took off.
Speaker 4 (37:24):
Yeah, yeah, it's a great point. So we've seen margins
hang in there, they've actually expanded a little. The big surprise,
like I always feel like kind of surprised when I
look at the data, even though I know it, is
that we had an earnings recession last year, right we
had companies and the overall S and P five hundred,
it had a couple of quarters of negative earnings growth.
(37:44):
And that recession is now behind us, and we're seeing
companies recover. I suppose when I look at earnings trends,
I mean, one reason that I think the market could
start to broaden out even more than just a month
or two is that when you look at just the
differential between high growth tech companies and the rest of
(38:05):
the S and P five hundred, that differential starts to narrow.
Last year, the only companies that were making money were
the Magnificent seven, so it kind of made sense that
they just crushed it. This year, we're starting to see
that differential between growth trends and narrow. We're forecasting about
ten percent earnings growth this year, which is roughly in
line with where I think bottom up consensus is. Maybe
(38:26):
bottom up consensus is a little bit higher we're basically
forecasting a broad based recovery across sectors that we've already seen.
So it's the idea that we've already seen cost cutting
and now maybe we see that operating leverage from demand
coming back from parts of the economy starting to pick
up again. We're seeing a shift from service spending to
(38:48):
good spending, so that's positive for the S and P
five hundred and consumer stocks. Those are some of the
areas that we're looking at from an earnings perspective.
Speaker 2 (38:56):
All right, Savina, I'm so glad we finally had you
on all Laws.
Speaker 4 (39:01):
Having.
Speaker 5 (39:02):
It's great to be here, Joe.
Speaker 2 (39:16):
I'm so glad we could do that episode finally because
Cevita has nailed the upwards trend in the S and
P five hundred at a time when a lot of
people were still very nervous about the outlook for stocks.
The one thing that had me thinking, and I think
we spoke about this before, but like the one recession
path that I kind of worry about is the idea
(39:39):
of like I guess, lofty EPs expectations kind of coming
back to haunt the market in the sense that companies
had pricing power in recent years, they raised their prices.
That helped pad margins. But if inflation is starting to
go down, or if consumers are starting to push back,
or if there is pressure on household balance sheets or whatever,
(40:00):
then maybe one of the levers they pull is on
the job front, and then we get layoffs, and then
we see consumer powers start to go down, and then
we see profit margins start to go down, and that
would be bad. I'm not saying we're there yet, but
that's the one kind of path that I worry about totally.
Speaker 3 (40:17):
That makes a ton of sense to me. And also
just this idea that like, you know, there's this on
the service puzzle, why haven't stocked affected by higher rates?
Speaker 4 (40:24):
Yeah?
Speaker 3 (40:25):
Well, rates are high because demand is strong and the
economy continues to grow at a robust clip. And if
people continue have jobs, they'll continue to spend. And if
they continue to spend and earnings hold up, and then
you don't necessarily need those higher rates. So it's interesting
that already this year, you know, rather than the scenario
that you describe, which seems very plausible to me so far,
(40:46):
at least, we're seeing the opposite, that broadening out of.
Speaker 2 (40:48):
Virtuous Yeah, it's a virtuous cycle. At the moment, it
could go in the other direction, but for now it
seems to be feeding on itself in a positive manner.
The one other thing I thought was really good to
emphasize is that index composition yes, yes, and the idea
that like, okay, you could look at historical pees and
comparing contrast with the nineteen eighties or the early two
thousands steering the tech bubble or whatever, but there are
(41:11):
actual changes in the S and P five hundred that
might make that comparison less useful. And especially that point
about companies terming out their balance sheets and the duration
changes that we've seen. I think if you had a
good handle on the degree to which companies had actually
refinanced their balance sheets over the past couple of years,
(41:32):
you probably would have nailed a lot of the resilience
that we've seen in markets.
Speaker 3 (41:35):
Totally. I think it's really important this idea of like
sort of earnings durability quality, and so you can imagine
that a company that has to hold a lot of inventory,
or a company that has to from time to time
engage in huge capital expenditure cycles, like, yeah, you probably
don't want to pay as much for those earnings as
you do a company that doesn't have to manage those
(41:58):
risks the same way, and so I think, like I'm
always a little bit scared of like, oh, here's why
the index is not doesn't matter, and that these like yeah,
you know, percentiles in ninety fifth is not as scary.
But it does make sense that there are certain types
of earning streams that the nature of the business models sucks,
where you can be confident that they'll be more durable
than another type of company.
Speaker 2 (42:19):
This has gone back to being a value bashing show.
Speaker 3 (42:22):
Yes, can I say the one other thing I really
like is that, you know, it is really hard to measure,
as Savida said, like how much allocation different types of
investors have to stocks any given moment. That's why there's
all these surveys. I love that the one measure that
seems to have some historical validity is to just measure
the analysts themselves. And when the analysts are really bullish
(42:45):
or super bullish, that's maybe time to sell. Like that,
you just do the survey, look what people are recommending,
and see if how out of whack they are.
Speaker 2 (42:52):
I'm looking at the cell side indicator that Savita mentioned
right now and It is kind of crazy how much
bollishness there was in Sale two thousand and one. Yeah,
it seems to work anyway. Shall we leave it there?
Speaker 4 (43:04):
Let's leave it there, all right?
Speaker 2 (43:06):
This has been another episode of the Oudlots podcast. I'm
Tracy Alloway. You can follow me at Tracy Alloway.
Speaker 3 (43:12):
And I'm Joe Wisenthal. You can follow me at the Stalwart.
Follow our producers Carmen Rodriguez at Carman Arman dash Ol
Bennett at Dashbot and Kelbrooks at Kelbrooks. Thank you to
our producer Moses onm. For more Oddlogs content, go to
Bloomberg dot com slash odd Lots, where we have transcripts,
a blog, and a newsletter, and you can chat with
fellow listeners twenty four to seven in the discord discord
(43:33):
dot gg slash odd Lots. We have a markets room
where people talk about stocks all day. Go check it out.
Speaker 2 (43:39):
And if you enjoy ad lots, if you like it
when we take a look at what's going on with stocks,
then please leave us a positive review on your favorite
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with Apple Podcasts. Thanks for listening in
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