September 19, 2024 • 43 mins
Ryan talks with Bob Carey about the implications of a falling interest rate environment for equity markets.
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Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Ryan (00:17):
Hi, welcome to the First Trust ROI podcast.
I'm Ryan Isakainen, etsstrategist at First Trust.
For today's episode, I'm joinedby Bob Carey, chief Market
Strategist at First Trust.
Bob and I are going to discusswhat's likely to happen down the
road as the Fed begins cuttingrates, which sectors may benefit
and what sorts of investmentsfinancial professionals should
(00:38):
consider.
Thank you for joining us onthis episode of the First Trust
ROI Podcast.
So, bob, this is your thirdappearance on the podcast.
You were my first podcast guest, so I'm glad you're willing and
able to come back for a thirdtime.
Bob (00:57):
Absolutely.
It was fun, let's do it again.
Ryan (01:01):
We'll definitely do it again.
So since you were on the firsttime, believe it or not, there
have been people that havewatched this podcast in 73
different countries.
Really, isn't that crazy?
That is Like the reach ofpodcasts is like.
I'm shocked when I look at someof the underlying stats.
Bob (01:19):
That's really cool, that's 73 countries 73 countries.
Is there a country that we havenot reached that you would like
you have as a goal?
Ryan (01:28):
I haven't really looked at where we have and haven't been.
Some of them are just one ortwo views, so I guess okay, we
don't have a big following.
Bob (01:35):
Your ancestors are from finland.
It'd be fun to see if somebodyin finland actually watched.
Ryan (01:40):
They saw your last name and they're all probably related
to me that have watched fromFinland, but that's okay.
Bob (01:47):
Exactly.
Ryan (01:49):
So you and I spent some time together driving cars
recently, and one thing I didn'trealize about you after having
worked with you for 20-someyears is that you are kind of a
maniac behind the wheel of arace car.
Bob (02:07):
Where did that come?
Ryan (02:09):
from.
Do I have to answer this?
Yes?
Bob (02:10):
you're on camera.
I don't know what it is, butI've always enjoyed being around
fast cars and I've always beenaround cars.
My dad was in the car businessand after school when I was a
kid, I used to walk to thedealership where my dad worked.
My dad worked there, mygrandfather worked there, my
(02:30):
dad's cousin worked there, andthen we had two dirt tracks
reasonably close to the townthat I lived in when I was
really young, so I was alwaysaround race cars and cars and
we'd go to car shows and went totracks all the time, so I grew
up with it.
I don't know what I'd do if Icouldn't do that.
Ryan (02:48):
You know I was going to ask you, and maybe this helps
answer it If you weren't chiefmarket strategist at First Trust
, if you didn't go into thefinancial industry, what would
you have ended up doing, youthink?
Bob (03:00):
That's a good question.
My degree is in physics andI've always had an interest in
audio and music and I probablywould have done something in
that field or I would have goneinto some sort of automotive
engineering type of discipline.
Yeah, you're very much a sortof analytical engineer kind of
(03:23):
guy, it seems, and then I getbehind the wheel.
Ryan (03:24):
You get behind the wheel.
No, no, but there's a lot ofthere's a lot of thinking,
though.
Bob (03:27):
You know.
It's true, there's a lot ofadrenaline, but there's a lot of
thinking about how am I goingto make it through that turn
without crashing.
Ryan (03:33):
Yeah, you know there's a lot of calculations going on
yeah, well, it was, uh, it wasgreat fun hanging out with you,
uh, in some fast cars.
So, uh, we'll have to do thatagain sometime, absolutely Okay.
So, speaking of fast cars, Iwant to get this clear, because
you asked me before we wererecording.
(03:54):
Last time we were on thepodcast together, I told you I
was planning on getting aCybertruck, the Tesla Cybertruck
.
It didn't actually happen, andit's not that I dislike the
Cybertruck or the amazingtechnology behind it, but I
found the Ram Charger, whichhasn't yet debuted.
I reached my spot on theCybertruck list and I decided to
(04:17):
go with the extended 650-milerange Ram Charger, which is
supposed to make its debut earlynext year.
Is that a good or a baddecision?
Bob (04:25):
Oh, I love Ram pickup trucks.
They're amazing.
Ryan (04:28):
They are.
Bob (04:29):
They're absolutely fantastic.
I think they're the best pickuptruck in the market from
everything that I've seen andjust driven myself.
Ryan (04:36):
Yeah, very comfortable.
Probably not quite as fast asthe Cybertruck, which is
probably not a terrible thingfor me.
Bob (04:44):
Especially living in New York, speed limits are not very
high.
No, in fact.
Sammy Hagar wrote I can't drive55 after getting a speeding
ticket in New York State.
You know.
Ryan (04:54):
Is that right?
Bob (04:55):
Yeah, true story, true story.
Ryan (04:57):
I did not realize that.
Absolutely so, bob, there'sbeen a lot that's happened in
markets and the economy sincethe last time you joined me.
We're recording this onSeptember 12th 2024.
We're basically around a weekbefore the Fed is going to meet
again and the market isexpecting them to start cutting
(05:20):
rates.
Do you expect that to happen?
Bob (05:22):
Oh yeah, I think it's pretty much a foregone thing
that they'll cut rates.
Really, the big question is isthis the first of many rate cuts
or are they going to cut ratesonce or twice maybe, and just
see whether or not inflationcontinues to come down?
We printed a 2.5% inflationrate last month, which is closer
(05:44):
to 2% than it's been in a very,very long time.
So the trend is good.
The Fed definitely is lookingat that trend and I'm sure
they're expecting it to persist.
But at the same time we stillhave core inflation above 3%.
So I think the Fed feltpressure to cut rates.
They felt like they could cutrates given the trend in
inflation.
But it's going to beinteresting to see how far they
(06:06):
go.
The bond market clearly hasmany rate cuts already priced in
.
I mean the 10-year Treasury at3.6%, I think this morning 3.7%.
That implies going forward,that we're going to get a lot of
rate cuts.
Ryan (06:19):
Yeah.
So do you think that the marketis too aggressive in its
expectations or do you err onthe other side?
Bob (06:28):
It's interesting.
The Fed's 2% inflation targethas not been met very often
historically.
It has, more often than not thelast 15 years or so, with the
exception of what we saw duringthe pandemic.
But the reality is thatinflation has averaged closer to
3% 3.5%, depending on how farback you go.
(06:49):
So I think the Fed you knowthey do have a dual mandate and
I think the reality is that theytypically keep the Fed funds
rate about 1% above theinflation rate.
That's been the average overdecades.
Now they got away from that inthe years coming out of the
(07:10):
financial crisis With rates atzero.
We did have low inflation.
But there was a long period oftime where if you had money
sitting in money market fundsand anything short-term in
nature T-bills and whatnot youweren't earning the inflation
rate.
Inflation wasn't all that high.
So we've been above thatinflation rate recently for a
while, but the amount of timethat we were below the inflation
(07:33):
rate is many, many years longerthan what we've seen on the
other side with rates above theinflation rate.
So I think Powell is probablymore in the camp that he would
like to keep rates above theinflation rate and if inflation
does go down to 2%.
That tells me that they'll cutit to about 3% and declare
victory and then see how theeconomic data comes out.
Ryan (07:57):
So the yield curve has been inverted for quite some
time the 2s and the 10s, as wellas shorter term in the 10s, and
it recently normalized, ordisinverted I'm not sure what
the right word is for that.
So when the Fed does startcutting rates, it's likely to be
even more normalized and thathas historically often been a
(08:20):
precursor to a recession.
Do you think that that is likea cause and effect sort of
relationship, or is it just acoincidence?
I mean, there's really not thatmany instances we look back.
It's happened quite a bit, butit doesn't always follow that it
will continue to.
But do you have an opinion onthat?
Bob (08:36):
Yeah, I think a lot depends on why the Fed's cutting rates.
I mean, when that happens, thatmeans the market is
anticipating the Fed cuttingrates, and so the question is,
why is the Fed cutting rates?
We've had two cycles in thelast 20, 25 years where they cut
rates and it was because wewere in a bad situation.
All of a sudden, we've got 9-11, we've got the pandemic, or
(09:02):
we've got the financial crisis,got the pandemic or we've got
the financial crisis.
That's been typically thereason the Fed has cut rates in
recent times is something badhappens and they're reacting to
it by cutting interest rates.
In a more normal economic cycle,we've been in a recession for a
while and the Fed is holdingrates, holding rates high until
(09:24):
they see that the recession hasin fact given us lower inflation
and then they begin to cutinterest rates and we haven't
had a recession.
There's certainly been a lot ofexpectations that we would have
a recession the last couple ofyears, but you know, whether or
not we've had a recession orthere's been a recession, this
cycle seems more like what wewould have seen prior, to say
(09:46):
9-11, you know, many years ago,where we'd have an economy that
was overheated, the Fed wouldraise rates, we'd have a
recession, and the Fed wouldhold rates, and hold rates, and
hold rates until they saw thatthe economy was finally giving
the inflation numbers that theywanted to see, sometimes even
having disinflation, and thenthey would start to cut interest
rates.
Ryan (10:07):
And I think that Do you think that the Fed should wait
to cut rates until we?
I mean, does the Fed reallywant there to be?
I know they want inflation tocome down, but do they need to
wait until there is actually arecession that emerges before
they cut rates in order toactually get rid of the
(10:28):
inflation that they're trying toget rid of?
In other words, you know, inthe 1970s we all remember
looking at the charts that havethat double spike of inflation,
right, right.
So is that a risk?
What do you think that theyshould do?
Bob (10:43):
I think we have a lot more productivity today in the
economy globally than we hadback in the 70s.
I grew up in the 70s and I justsee how the world operates
today and how businesses areable to be so much more
productive.
You know, goods and servicesare done on a much larger scale
(11:03):
with higher levels ofproductivity, which in theory,
should keep inflation down.
So I think, if I'm the Fed, I'ma little bit more confident
that cutting interest rates isnot going to reignite inflation
than I would have years ago.
We've seen massive changes inthe way the economy functions.
However, if we have policiesgoing forward from a regulatory
(11:29):
perspective, from a fiscalperspective, that are not good
for inflation coming down andthey're anti-productivity
basically, then it's a differentdiscussion, but we're not there
yet.
Ryan (11:41):
So do you think the Fed believes that they're out of the
woods when it comes toinflation?
Bob (11:47):
I don't know if they actually will ever admit it.
Powell, even if he cuts ratesall the way to say 3%, I think
he's going to be pretty cautiousabout suggesting, hey, we've
succeeded.
Ryan (12:00):
Mission accomplished, yeah , mission accomplished.
Bob (12:02):
I don't see him spiking the football sort of analogy.
That just doesn't seem like hispersonality.
Ryan (12:07):
I think the conventional wisdom is once they start
cutting rates, they can'treverse course and raise rates
in response to emerging data.
Once you go down that path, youhave to continue down that path
.
Do you think that's true?
Bob (12:20):
That's very true.
That's been true historicallytoo.
I think the Fed, I thinkthey'll cut rates 25 basis
points and I think Bob Stein hasbeen, I think, on the money
with his idea that they just cutrates 25 basis points on a
regular basis here until theysettle, I mean.
(12:42):
And where the plane landsreally is the question when do
they, you know, do they cut itdown to three and stop and then
see what happens?
Or I think so much of it'sgoing to depend on the economy
and the data they get that theyhave to look at.
Ryan (12:53):
One of the things I was wondering about the other day is
, I think, so much of it's goingto depend on the economy and
the data they get that they haveto look at.
One of the things I waswondering about the other day is
, I think, about the Fedsystematically cutting rates
over a long period of time.
Is that if I'm looking tofinance some sort of debt, I
might want to put that off untilthe end of next year?
If I'm confident they're goingto continue to lower rates, why
not put off my economic activityuntil then, which could then
(13:13):
slow the economy, not put off myeconomic activity until then,
which could then slow theeconomy, which maybe that would
argue for cutting rates faster,just so there doesn't have to be
that lag.
Bob (13:20):
They tend to cut rates or they tend to raise rates more
slowly and, historically, if theeconomy really does start to go
into a bad place, then theyusually cut rates rather rapidly
, and that's what we've seenmore often than not.
I think.
So much of this is we just wehaven't seen this sort of
typical economic cycle in a longtime where we have inflation,
(13:43):
the Fed raises rates.
Brian's talked about thisextensively Brian Westbury, the
Fed the way they conduct policyis different today than they did
prior to the financial crisis.
So we don't we really don'tknow whether or not even these
rate increases actually didreduce inflation.
Probably, but you know, there'ssome arguments to be made that
(14:04):
it was just.
You know, we went through apandemic and productivity
collapsed because of that, andproductivity has just come back.
And you know, you just, all youhave to do is go to a store and
you just, you just see a lotmore inventory these days and
where things were we wereclearly in a scarcity situation
here three years ago.
Ryan (14:23):
Let's assume for a second that rates do continue to come
down, as our expectationssuggest, and the Fed continues
to cut rates.
Do you think that at the longerend of the yield curve we see a
similar pattern, that the10-year kind of moves along with
the federal funds rate, or doyou think it's going to move
somewhat independently ofshort-term rates?
Bob (14:43):
I think it will move, it'll correlate, but I think most of
the change in interest rates isgoing to be more on the very
short end of the curve.
Clearly, I think that you knowwe've got inflation at 2.5, a
little over 3 on the core.
A 3.7 percent inflation or 3.7percent rate on the 10-year is
(15:04):
anchored right about where itshould be given, where inflation
is at, I think.
So I think most of the changein rates is going to be on the
short end of the curve.
I'm not expecting the yield onthe 10-year to go back down to
3%.
Maybe it does, but I think we'dhave to see 2% inflation, I
think for an extended period oftime for that to happen.
Ryan (15:25):
Now, does that have an effect or an impact on the way
that you view opportunities invarious sectors, on the way that
you view opportunities invarious sectors?
Are there certain sectors thatyou think do better or will do
better if we've got a certainrate-cutting environment?
Bob (15:41):
or rates moving lower.
Yeah, I think there's onereally obvious sector that would
benefit from the yield curvegetting back to normal, where
we've got the twos and tensdoing what they do where they
should be and where they've beenhistorically, but the short end
of the curve below the two,just a classic, you know shape
yield curve, and I think it'sthe financial services sector.
Not necessarily every bank ornecessarily every stock in the
(16:06):
financial services sector, butyou think about the nature of
lending and banking.
Most funding is done at theshort end of the curve with
deposits, you know savingsaccounts, checking accounts,
short-term CDs.
That's the funding engine forbank loans and most loans have a
longer duration, if you want tothink of it that way.
(16:27):
And so getting that yield curveback to normal, I think is
going to benefit the financialservices sector more than any of
the sector.
Ryan (16:35):
Yeah, that margin between the very short end and the
higher yielding longer end isimportant.
Bob (16:41):
Now there are a lot of banks that are, I would argue,
overcapitalized, that when youlook at their deposits and you
look at their assets, they havemassive assets compared to their
deposits and so they haveexcess reserves, if you will,
and they have parked thosereserves at the Fed in huge
numbers and they have made very,very good interest on that and
(17:04):
funding costs for a lot of thatstill very, very low.
So there are some financialinstitutions that are probably
not real happy with the Fedcutting interest rates.
They would probably like tokeep this ability to earn
without taking any risk at all,just parking money at the Fed,
but I think the vast majority ofbanks are not in that position.
(17:25):
There are very few of those andthey typically are the very
largest financial institutions.
You start getting into theregional banks and the community
banks, they tend to lend outpretty much all that they can
lend out, so they are trulybanking institutions that don't
have a lot of wealth management,capital markets activity,
things like that.
(17:45):
They're usually traditionallenders.
Ryan (17:49):
Turning to other sectors of the economy, you know the
technology sector has reallydominated recently.
When we look at fund flows intoETFs, the technology sector is
at the top of the list.
When we look at where theinnovation is happening and the
enthusiasm is happening, it'sthe technology sector Right.
And even you know, when rateswere before the Fed pivoted or,
(18:13):
you know, started talking thatway, the technology sector was
doing pretty well.
Yep, do you think that, as theFed does pivot, or maybe even
setting aside the Fed, becausewe're always talking about the
Fed what's the opportunity inthe technology sector?
Bob (18:28):
Yeah, I think that the tech sector there are trends in tech
that really have nothing to donecessarily with economic cycles
and the reality is thecompanies in the tech sector,
from a stock market perspective,are companies that generate
just such high returns on theirbusiness.
I mean just very, very highROIs ROEs, however you want to
(18:50):
calculate returns.
These are businesses that don'treally need a lot of external
capital, so they, for the mostpart, generate capital
themselves.
They're self-funding, and Ithink that's one reason why the
sector has done so well the lastcouple of years because they
really don't care what theFederal Reserve is doing.
(19:10):
They don't care whether ratesare 0% or 5%.
When you're generating 25%, 30%, 40, even 50% returns on
capital, do you care whetherrates are 5%?
On the short end of the curve,5.5%?
If you're looking at the Fedfunds rate, they're not going to
slow down, they're going tokeep on going.
The biggest impact from the Fedcutting rates from, say, 5%
(19:31):
down to closer to three, it'sgoing to be companies that have
lower returns on their businessthat need external capital.
And since Chairman Powell'sspeech on July 9th, where he
finally came out and said,without saying it directly, that
the Fed was about to embark onrate cuts.
(19:52):
We've seen a pretty significantshift in leadership in the
markets.
So you know small capsinitially had a big surge.
You know, when you look at thesmall cap space, mid caps, a lot
of companies that might be inthe S&P 500, but they're not
necessarily huge.
You know weightings in theindex or high return businesses.
You know that shift in policybenefited those stocks
(20:15):
significantly and the market, tome, is sending out a very clear
message that their cost ofcapital is about to come down,
and not only that, which is goodfor valuations, but it's also
good for them to expand and growtheir balance sheets, going
forward and making investmentsin their businesses.
Ultimately and that's kind of aclassic thing we tend to see as
(20:39):
we come out of a recession, wetypically see small caps,
mid-caps, do pretty well in theearly stages of an economic
cycle when this change in policyhappens.
Ryan (20:51):
So it makes a lot of sense that capital-intensive
businesses would be impactedwith lower costs of capital.
Bob (20:58):
Absolutely, absolutely Assuming these are businesses
that don't have high returnbusinesses.
You know, you think aboutcompanies that are more
classically cyclical businesses.
You know manufacturing, youknow industries like that
construction, home building,automotive, the automotive
(21:19):
sector, things like that.
These companies, they need alot of external capital from
time to time and especially whenthe economy's been slow, they
tend not to have a lot ofcapital sitting on their balance
sheet looking for a place.
They usually need that externalcapital.
And then you have a lot ofsmaller companies.
They're small and they want toget bigger one day, and so the
(21:40):
only way that happens is you'vegot to make investments in your
business.
So it's kind of a life cyclething.
Big companies tend to get biguntil they hit a wall and they
just can't grow anymore andeventually some of them fall
into decline.
And then you have all theseother companies that are earlier
in their life cycle that needcapital.
Some of these companies areburning capital.
(22:00):
You think about the biotechsector and whatnot.
They don't have a business yet,but they need capital and
investors, I would argue, areprobably going to be a little
bit more inclined to look atsome of those companies that are
in need of capital with thecost of capital coming down.
Ryan (22:20):
Yeah, I was thinking about the biotech industry in
particular the other day, aboutthe relationship between
interest rates and the returnsof that industry in particular,
and it seems like they're pretty.
I mean there's a pretty strongrelationship recently, but even
longer term.
Bob (22:35):
No question about it.
You know you've got all thesecompanies that you know they've
got clinical trials going on.
They've got.
You know they're makinginvestments.
They don't have anything toshow for it yet there's no
business there.
There's no there there yet, andyet there's.
You know the marketcapitalization reflects the
anticipation that at some pointthose investments they've made
(22:55):
will generate cash flow down theroad.
Ryan (22:57):
Yeah, the duration of those cash flows is very long,
oh big time.
Bob (23:00):
You think about how long it takes to bring a product to
market and the clinical trialsand all those sorts of things
that need to happen, and we'vebeen in an environment where
mergers have been discouraged, Ithink from a regulatory
perspective as well.
So that's another sector that Ithink will benefit a little bit
from shifting policies.
Ryan (23:20):
To your point with M&A, I would think that lower rates
would also maybe be at least oneinput to potentially spurring
on some more M&A.
If you're going to finance anacquisition, having lower rates
could actually be important forthat as well.
Bob (23:34):
Yeah, especially when you're buying a business that
has high future returnspotentially, but low returns
right now.
That could be all thedifference between a company
having enough capital to make itto the finish line and actually
having these investments payoff.
And that's always the questionthese investments pay off?
(23:56):
And that's always the questionDo these companies have enough
capital to stay in the gameuntil they actually have a
product in the marketplace?
And that's a balancing act fora lot of these companies.
Ryan (24:03):
What are your thoughts about artificial intelligence?
This is an area, especially intechnology, where there's just
been so much enthusiasm.
There's been incredible amountsof revenue that have been
generated by some of the chipcompanies, NVIDIA in particular,
but others, and the forecastsare pretty impressive as well.
(24:24):
Is this something that is?
I mean, where are we in thecycle?
I guess?
Is this something that you'reexpecting to continue along the
same pace, or are we nearing thepeak of the enthusiasm or the
hype cycle?
Bob (24:40):
I do think that there has been a lot of.
There have been some factorsthat have driven valuations
higher for these stocks, and Ithink the so-called carry trade,
for example, is that the Bobcarry trade.
It's C-A-R-R-Y not C-A-R-E-YExactly.
I've had to mention that to afew people, especially when the
(25:01):
market was getting volatile andthese stocks were blaming the
carry trade Folks.
It wasn't me, I had nothing todo with it, but a lot of hedge
funds, primarily, have borrowedmoney in yen and they've turned
around and they've bought otherassets.
Now they can buy anything theywant.
They could buy treasuries, theycould buy real estate, whatever
(25:24):
the case may be.
But it's pretty clear, basedupon the recent surge in the yen
against the dollar, as themarket began to price in the Fed
cutting interest rates that wasseen initially in the currency
markets the dollar did weakenagainst the yen.
The yen surged a little bit andboy, all of a sudden, we had a
(25:46):
lot of pain in those AI-relatedstocks.
And so that tells me that a lotof the advance that we've seen,
especially this year, probablylast year as well, was fueled by
investors who were essentiallybuying these things on margin,
if you want to think of it thatway.
And so anything that wouldcause that margin trade to
(26:09):
unwind is going to have aneffect on the shares of those
companies, and clearly thevaluations are very, very high
for a lot of those companies.
But when you take a look at theearnings and the forecast for
earnings for the rest of theyear and for next year, it's
like you kind of understand, infact you do understand why these
stocks are doing so well.
These companies are growinglike crazy, and so it gets down
(26:30):
to one thing Are theseinvestments in AI ultimately
going to pay off?
The people who are benefitingfrom all that spending right now
the chip companies and whatnot.
They are clearly making a lotof money because a lot of
companies are spending a lot ofmoney as they migrate into this
(26:51):
space, and so the question isare there going to be new
businesses that come out of this?
Are there going to be newsources of revenue for some of
these companies?
And so far, I would argue thatwe haven't really seen a lot of
that yet.
It's really, I think, probablyway too early to know whether or
not these are going to pay off,so we'll see how this plays out
(27:12):
.
This reminds me this whole cyclereminds me of the late 90s.
We were seeing a lot ofenthusiasm about the Internet
and e-commerce and all thesedifferent things back in the day
, and then we hit like an airpocket.
We were expecting thatbroadband Internet services were
(27:33):
going to be rolled out muchfaster than they ended up
getting rolled out.
I remember back in 98, 99, alot of people were in many
places.
They were seeing their streetstorn up because they were laying
fiber optic cable and there wasa lot of enthusiasm about
getting rid of these dial-upmodems, which were really slow,
and that process took five orsix years instead of taking one
(27:57):
to two years.
And that's when we got thismassive correction in these
dot-com stocks and a lot of thatair pocket was the result of
policy changes.
There was a lot of concernsabout, well, who's going to own
these Internet service providers, and there were a lot of things
that were going on inWashington that caused that
(28:20):
process to slow down.
And so you know, unless we havesome sort of crazy thing that
we're not expecting from apolicy standpoint, regulations
and whatnot If this is truly anorganic change and doesn't have,
we don't throw a wrench intothis from a policy standpoint.
I do think that we are going tosee a lot of things come about
(28:41):
as a result of this.
I think a lot of businesseswill emerge.
I think clearly it'll helpproductivity in the economy
longer term, as well, yeah,that's what's important for
these sorts of investments.
Yeah, and at the same time, thetechnology based upon the stuff
that I've messed with.
In some ways, it's very good.
In other ways, you can tell wehave a long way to go before
(29:04):
this is truly a revolution inthe way we do things.
Ryan (29:08):
Yeah, the Internet, I think, is a great analogy
because it's with the benefit ofhindsight.
Looking back, a lot of it waskind of a second order effect
after you had the build out.
Right Apple and its iPhonewouldn't exist without the
internet, but that didn't happenfor five, six, seven years.
Right Right Amazon.
(29:29):
It's a huge company.
It's got a lot of differenttypes of ways to earn money, but
initially it was a bookselleronline and that wouldn't have
existed Losing money like crazy.
Google or Alphabet, theywouldn't be able to advertise
Meta, they wouldn't have socialmedia.
All of that kind of came downthe road from the internet.
So I wonder the same thing whatare the companies in these
(29:50):
amazing revenue-generatingmachines and efficiency and
productivity that comes out ofAI?
Bob (29:57):
I think the market's initial assessment is that it's
going to be companies involvedin building data centers.
It's going to be the chipcompanies.
That's where probably the mostsecure bets that you can make
are going to be in that sort ofthing.
To me, it's the next generationof products and services we
haven't seen yet.
(30:18):
I think it's going to be fiveto ten years down the road when,
all of a sudden, there aregoing to be things that we take
for granted in our daily livesthat we can't even see right now
.
And that's the way technologyhas always been.
Ryan (30:30):
It's interesting Data centers, the amount of
electricity that they areactually going to consume
because of artificialintelligence and cloud computing
and all these high-demandsources that didn't exist just a
few years ago and electricvehicles and the electrification
(30:51):
of appliances, and all thesethings happening at once Ram
superchargers or ram chargers.
There's exactly there's anestimate that I saw I think it's
from the IEA that by 2026,that's two years away data
centers are going to consume athousand terawatt hours of
electricity per year, which isabout the same as the nation of
Japan, right?
(31:11):
Which is incredible, yep.
And at the same time, there's,you know, bitcoin mining, which
is consuming a tremendous amountof electricity, and all those
other things, right?
It just seems like we're goingto have to build out that
infrastructure pretty quickly.
Bob (31:26):
What is well.
At least this was true as of aof a couple days ago.
What was the best performingsector in the stock market year
to date?
It was the utility sector.
Yeah, that's which we haven'tseen that sector perform all
that well, that's so recently.
I do think interest rates arepart of that and there's no
question these stocks are.
From a valuation perspective,they are sensitive to interest
(31:49):
rates.
They're very bond like in termsof their businesses.
You know, low returns, steadyreturns, and so they're.
You know these are kind of longduration plays.
So that's that's certainlyhelped, I would argue.
But when I look at the, theearnings estimates for this year
compared to last year, Ibelieve earnings this year will
(32:09):
be up 10% for the utility sectorin 2024.
If the estimates for Q3 and Q4are correct, we haven't seen
that sector grow 10% in a yearin a long time.
I don't remember ever seeingthat sector actually have that
kind of an increase in earnings.
So I think a lot of it is whatyou just mentioned.
Ryan (32:28):
Yeah, and as they build out their infrastructure they
actually get to pass all thatcost along to you and I and all
the consumers.
Bob (32:36):
So it really is an interesting time to be a utility
company, in comparison to maybethe last several decades
stories about some of theutilities or some of these, you
know, nuclear power plants thathave been offline for many, many
years, bringing those back andso forth.
So it's an interesting timewatching this.
This is a sector that has beenhasn't really interested me in a
(33:01):
long time.
I've had a lot of concernsabout different things.
Part of it is just you can't Ican't get excited about the
growth rates when other sectorsare growing much faster.
Historically, that's been asector that you like.
When we are actually in arecession or about to head into
recession, the stocks aredefensive in nature, and that's
(33:23):
still going to be true goingforward, I'm sure of it.
But now you've got thepossibility, these companies
will actually start to increasetheir businesses.
They'll actually see moreprojects and more ways to make
money, and so I would expectthat we'll see some merger
activity and things like that aswell.
These are huge capitalinvestments when you have to
(33:45):
supply more power to these datacenters, and a lot of these
companies are actually buildingtheir own.
A lot of these data centercompanies are actually building
their own power plants too.
They're actually, you know.
So companies that make theequipment that go into that are
also, as you say kind of asecond order.
That's another area of themarket that I think is
(34:06):
interesting yeah, absolutely.
Ryan (34:10):
Market, that I think is interesting yeah, absolutely.
And that is another interestingtrend, as we're seeing, you
know, the reshoring ofmanufacturing and some of the
building of factories and thingsin the US, and part of that
makes me think about what'sgoing on in other parts of the
world, because this is aquestion that I've asked you
several times in the past.
Obviously, we've had a greatperforming equity market in the
(34:37):
US this year surprisingly so butsometimes our focus is pretty
myopic and narrow.
What's going on overseas?
Do you think there's anyopportunity yet in?
Bob (34:44):
some of those markets.
Yeah, I don't think things havechanged all that much.
I'm a numbers guy and when Ilook at the stock markets of the
world and I look at the UnitedStates and I look at, say, for
example, the S&P 500, and I seewhat these companies have done,
looking at earnings estimates,what they might do over the next
(35:05):
year or so, a couple of years,I don't see any other region of
the world or any other countryin the world that has anything
like what we have here in the US.
Now, the reality is those bigcompanies in the S&P are global
in nature they do business allover the world.
So I have been in the camp thatyou're better off letting those
(35:28):
companies navigate the globaleconomy.
The US companies are better atcreating shareholder value than
companies in Europe, companiesin Japan.
Not that you should completelyavoid markets overseas, but I
think it's I would argue it'smore important to be selective
when having those allocationsoverseas.
You know we are a lot of peopleargue well, hey, we're only 25%
(35:51):
of the world's GDP Only.
The reality is we're 4% of theworld's population but we're 25%
of the world's GDP.
When that's when you have thosekind of metrics, that means
you've got a lot of wealth beingcreated, a lot of economic
activity being created, and Ithink our companies are just
simply better than companiesoverseas.
I know valuations are betterwhen you look at Europe.
(36:14):
I mean, pes are quite a bitlower, but I would argue that
difference can be completelyexplained by the differences in
returns on capital.
Ryan (36:23):
Obviously, one of the things happening here between
now and November is thepolitical season.
We've got election day comingup.
I think if you were to ask mostof the pundits they'd say it's
kind of a coin flip.
At this point we don't reallyknow who the eventual winner
will be for the presidency andyou know the houses of both
houses of Congress are up forgrabs to some extent.
(36:45):
Maybe Bob Stein would tell usthat the Senate favors the
Republicans.
How important do you think thatis for investors to pay
attention to?
Should they tailor theirinvestment decisions based on
who the eventual winners will be?
Bob (37:01):
History says you shouldn't.
That doesn't really matter allthat much.
I think that the biggestfactors impacting the stock
market and what investors reallyshould care about are proposals
on the tax side, and if weraise taxes on dividends and
capital gains and whatnot evenestate taxes going up, that is
(37:27):
going to have an impact onvaluations.
It won't be the only factorimpacting the market, but
clearly those are factors thatwe plug into our models.
You know what is in, and whenwe start hearing talk about
taxing unrealized capital gainsand things like that, then you
know my antenna goes up.
I'm like, ooh, how's that goingto work?
If you have success in themarket and you've made some
(37:50):
money, now you may be in asituation where you have to sell
some of your shares in order topay taxes.
So you're effectively forcing aliquidation, potentially if
you've got some gains.
But then the market you wouldthink would adjust for that If
it knows that a founder of acompany that's been successful
(38:11):
that has to pay taxes more on anongoing basis.
That could affect the value ofthe stock because the market
knows that somebody's going tobe in the market selling to pay
taxes.
So it's kind of a you know thatwould be on.
We've never seen that before.
So those kind of proposals, youknow I doubt that they actually
would become law.
I think that would be verydifficult to pass into law, but
(38:33):
all of a sudden you start towonder whether or not that would
be the case.
So I think in the end, I thinkultimately, the stock market
likes when there's a sharing ofpower, because nothing crazy
happens at that point.
In other words, we don't havemassive shifts of policy as a
result of that, and when we'vehad one party control everything
(38:56):
, it's usually very, very shortterm.
We've only had a couple ofyears here and there in my
lifetime where the Democratshave run everything or the
Republicans run everything.
For the most part it's, youknow, both parties sharing power
.
Ryan (39:08):
Yeah, it's interesting because we're coming up to I
believe next year is when theindividual tax rates that were
part of the original tax packagethat was passed by the
Republicans when Trump was inoffice.
That's when those individualtax rates expire.
The corporate tax rates weremore permanent.
Bob (39:26):
Yeah, the only thing about taxes going up.
If that happens next year, whatdo we have the year after that?
We have another election.
Ryan (39:34):
We've got midterms.
That's when midterms come.
Bob (39:36):
And so that's the one kind of.
The beauty of our system isthat, even if they don't vote
for tax increases and we seetaxes going up, you know you
just don't want to be the partyin power and you just raise
taxes potentially, so you don'tcare.
If you're in the White House,probably you wouldn't care, but
if you're in Congress you'reprobably I don't know if I want
(39:59):
to vote for these taxes going upwhen.
I have to face the electoratenext year.
Ryan (40:04):
So that's an incentive to actually get something done to
extend some sort of maybe makeit so it's not as bad as it
would be.
Bob (40:13):
Right exactly Whether you keep it at this level and
selling it as such.
Yeah, it's an increase, butit's not all that bad.
This is your medicine.
It tastes good, doesn't it?
Ryan (40:25):
Great question for Bob Stein, and Bob was on just a
couple episodes ago.
Bob (40:29):
I've got.
Ryan (40:30):
Bob coming on once more before the election to give his
perspectives.
Bob (40:33):
I thoroughly enjoyed your conversation with him.
Ryan (40:36):
Yeah, it's always great to talk with Bob Stein.
Bob (40:38):
Whenever a Georgetown alum gets to visit with a Syracuse
fan, you never know what mightcome of that.
That's true.
But that was good.
Ryan (40:48):
We brawled off camera.
You never know what might comeof that, that's true, but that
was good, we brawled off camera,okay.
So my final question for you,bob, is and I've asked this, I
think I've asked you this before, but I'm going to ask you for
another recommendation what's onthe Bob Carey book list?
Is there anything that you'veread recently that you're
considering reading, or thatmaybe even a classic that you
(41:10):
would recommend?
I know you're into music.
Bob (41:13):
I have a book about the Beatles lyrics and Paul
McCartney did a book a coupleyears ago and it's thick and
there's a lot of information.
But a Princeton professorcollaborated on this and it just
has all the Beatles lyrics inthe book and there's a whole
discussion about what the lyricsmean and what they were
(41:34):
thinking at the time.
That's just the whole creativeprocess.
It's just amazing to me.
It is, as you know, I play theguitar and I've never written a
lyric in my life, I've neverwritten a song in my life, and
I'm just trying to figure outthe music of what these people
wrote over the years.
And why does that sound so good?
(41:54):
And then you throw the wholestorytelling and the lyrics and
all that into it.
It's like that's a great topicfor sure to dive into.
Ryan (42:03):
It's also interesting because everyone has their own
story of how they got to besuccessful.
You know what they went throughto get to where they ended up.
It's really fascinating becauseI think it's applicable to any
industry.
Any sort of success story has asimilar kind of trajectory.
It's very interesting.
Bob (42:23):
Yeah, it's interesting seeing bands.
I don't know if this so muchhappens anymore, but you think
about bands coming along.
They have ideas.
Bands I don't know if this somuch happens anymore, but you
think about bands coming along.
They have ideas.
A lot of bands start offcovering other band songs and
that's kind of how they maketheir mark, or at least they try
to.
That's what maybe pays the bills.
And then that process of goingokay, I want to create my own
thing, or we want to create ourown thing.
(42:45):
A lot of bands, they hit thatwall and they don't succeed, and
for every band that's made it,there's thousands of bands that
just hit that wall and theynever make it.
Yeah, maybe they release onealbum or two albums if they're
fortunate.
Yeah, and then they're gone.
Ryan (43:01):
Well, thank you once again for coming on the podcast, bob.
It's always interesting.
We'll have to get together anddrive some race cars again
sometime soon.
Bob (43:08):
Bob, it's always interesting, we'll have to get
together and drive some racecars again sometime soon.
Ryan (43:10):
I love that, but always great speaking with you.
Thanks to all of you as wellfor joining us on this episode
of the First Trust ROI Podcast.
We'll see you next time.
Hi, welcome to the First Trust ROI podcast.
I'm Ryan Isakainen, etsstrategist at First Trust.
For today's episode, I'm joinedby Bob Carey, chief Market
Strategist at First Trust.
Bob and I are going to discusswhat's likely to happen down the
road as the Fed begins cuttingrates, which sectors may benefit
and what sorts of investmentsfinancial professionals should
(00:38):
consider.
Thank you for joining us onthis episode of the First Trust
ROI Podcast.
So, bob, this is your thirdappearance on the podcast.
You were my first podcast guest, so I'm glad you're willing and
able to come back for a thirdtime.
Bob (00:57):
Absolutely.
It was fun, let's do it again.
Ryan (01:01):
We'll definitely do it again.
So since you were on the firsttime, believe it or not, there
have been people that havewatched this podcast in 73
different countries.
Really, isn't that crazy?
That is Like the reach ofpodcasts is like.
I'm shocked when I look at someof the underlying stats.
Bob (01:19):
That's really cool, that's 73 countries 73 countries.
Is there a country that we havenot reached that you would like
you have as a goal?
Ryan (01:28):
I haven't really looked at where we have and haven't been.
Some of them are just one ortwo views, so I guess okay, we
don't have a big following.
Bob (01:35):
Your ancestors are from finland.
It'd be fun to see if somebodyin finland actually watched.
Ryan (01:40):
They saw your last name and they're all probably related
to me that have watched fromFinland, but that's okay.
Bob (01:47):
Exactly.
Ryan (01:49):
So you and I spent some time together driving cars
recently, and one thing I didn'trealize about you after having
worked with you for 20-someyears is that you are kind of a
maniac behind the wheel of arace car.
Bob (02:07):
Where did that come?
Ryan (02:09):
from.
Do I have to answer this?
Yes?
Bob (02:10):
you're on camera.
I don't know what it is, butI've always enjoyed being around
fast cars and I've always beenaround cars.
My dad was in the car businessand after school when I was a
kid, I used to walk to thedealership where my dad worked.
My dad worked there, mygrandfather worked there, my
(02:30):
dad's cousin worked there, andthen we had two dirt tracks
reasonably close to the townthat I lived in when I was
really young, so I was alwaysaround race cars and cars and
we'd go to car shows and went totracks all the time, so I grew
up with it.
I don't know what I'd do if Icouldn't do that.
Ryan (02:48):
You know I was going to ask you, and maybe this helps
answer it If you weren't chiefmarket strategist at First Trust
, if you didn't go into thefinancial industry, what would
you have ended up doing, youthink?
Bob (03:00):
That's a good question.
My degree is in physics andI've always had an interest in
audio and music and I probablywould have done something in
that field or I would have goneinto some sort of automotive
engineering type of discipline.
Yeah, you're very much a sortof analytical engineer kind of
(03:23):
guy, it seems, and then I getbehind the wheel.
Ryan (03:24):
You get behind the wheel.
No, no, but there's a lot ofthere's a lot of thinking,
though.
Bob (03:27):
You know.
It's true, there's a lot ofadrenaline, but there's a lot of
thinking about how am I goingto make it through that turn
without crashing.
Ryan (03:33):
Yeah, you know there's a lot of calculations going on
yeah, well, it was, uh, it wasgreat fun hanging out with you,
uh, in some fast cars.
So, uh, we'll have to do thatagain sometime, absolutely Okay.
So, speaking of fast cars, Iwant to get this clear, because
you asked me before we wererecording.
(03:54):
Last time we were on thepodcast together, I told you I
was planning on getting aCybertruck, the Tesla Cybertruck
.
It didn't actually happen, andit's not that I dislike the
Cybertruck or the amazingtechnology behind it, but I
found the Ram Charger, whichhasn't yet debuted.
I reached my spot on theCybertruck list and I decided to
(04:17):
go with the extended 650-milerange Ram Charger, which is
supposed to make its debut earlynext year.
Is that a good or a baddecision?
Bob (04:25):
Oh, I love Ram pickup trucks.
They're amazing.
Ryan (04:28):
They are.
Bob (04:29):
They're absolutely fantastic.
I think they're the best pickuptruck in the market from
everything that I've seen andjust driven myself.
Ryan (04:36):
Yeah, very comfortable.
Probably not quite as fast asthe Cybertruck, which is
probably not a terrible thingfor me.
Bob (04:44):
Especially living in New York, speed limits are not very
high.
No, in fact.
Sammy Hagar wrote I can't drive55 after getting a speeding
ticket in New York State.
You know.
Ryan (04:54):
Is that right?
Bob (04:55):
Yeah, true story, true story.
Ryan (04:57):
I did not realize that.
Absolutely so, bob, there'sbeen a lot that's happened in
markets and the economy sincethe last time you joined me.
We're recording this onSeptember 12th 2024.
We're basically around a weekbefore the Fed is going to meet
again and the market isexpecting them to start cutting
(05:20):
rates.
Do you expect that to happen?
Bob (05:22):
Oh yeah, I think it's pretty much a foregone thing
that they'll cut rates.
Really, the big question is isthis the first of many rate cuts
or are they going to cut ratesonce or twice maybe, and just
see whether or not inflationcontinues to come down?
We printed a 2.5% inflationrate last month, which is closer
(05:44):
to 2% than it's been in a very,very long time.
So the trend is good.
The Fed definitely is lookingat that trend and I'm sure
they're expecting it to persist.
But at the same time we stillhave core inflation above 3%.
So I think the Fed feltpressure to cut rates.
They felt like they could cutrates given the trend in
inflation.
But it's going to beinteresting to see how far they
(06:06):
go.
The bond market clearly hasmany rate cuts already priced in
.
I mean the 10-year Treasury at3.6%, I think this morning 3.7%.
That implies going forward,that we're going to get a lot of
rate cuts.
Ryan (06:19):
Yeah.
So do you think that the marketis too aggressive in its
expectations or do you err onthe other side?
Bob (06:28):
It's interesting.
The Fed's 2% inflation targethas not been met very often
historically.
It has, more often than not thelast 15 years or so, with the
exception of what we saw duringthe pandemic.
But the reality is thatinflation has averaged closer to
3% 3.5%, depending on how farback you go.
(06:49):
So I think the Fed you knowthey do have a dual mandate and
I think the reality is that theytypically keep the Fed funds
rate about 1% above theinflation rate.
That's been the average overdecades.
Now they got away from that inthe years coming out of the
(07:10):
financial crisis With rates atzero.
We did have low inflation.
But there was a long period oftime where if you had money
sitting in money market fundsand anything short-term in
nature T-bills and whatnot youweren't earning the inflation
rate.
Inflation wasn't all that high.
So we've been above thatinflation rate recently for a
while, but the amount of timethat we were below the inflation
(07:33):
rate is many, many years longerthan what we've seen on the
other side with rates above theinflation rate.
So I think Powell is probablymore in the camp that he would
like to keep rates above theinflation rate and if inflation
does go down to 2%.
That tells me that they'll cutit to about 3% and declare
victory and then see how theeconomic data comes out.
Ryan (07:57):
So the yield curve has been inverted for quite some
time the 2s and the 10s, as wellas shorter term in the 10s, and
it recently normalized, ordisinverted I'm not sure what
the right word is for that.
So when the Fed does startcutting rates, it's likely to be
even more normalized and thathas historically often been a
(08:20):
precursor to a recession.
Do you think that that is likea cause and effect sort of
relationship, or is it just acoincidence?
I mean, there's really not thatmany instances we look back.
It's happened quite a bit, butit doesn't always follow that it
will continue to.
But do you have an opinion onthat?
Bob (08:36):
Yeah, I think a lot depends on why the Fed's cutting rates.
I mean, when that happens, thatmeans the market is
anticipating the Fed cuttingrates, and so the question is,
why is the Fed cutting rates?
We've had two cycles in thelast 20, 25 years where they cut
rates and it was because wewere in a bad situation.
All of a sudden, we've got 9-11, we've got the pandemic, or
(09:02):
we've got the financial crisis,got the pandemic or we've got
the financial crisis.
That's been typically thereason the Fed has cut rates in
recent times is something badhappens and they're reacting to
it by cutting interest rates.
In a more normal economic cycle,we've been in a recession for a
while and the Fed is holdingrates, holding rates high until
(09:24):
they see that the recession hasin fact given us lower inflation
and then they begin to cutinterest rates and we haven't
had a recession.
There's certainly been a lot ofexpectations that we would have
a recession the last couple ofyears, but you know, whether or
not we've had a recession orthere's been a recession, this
cycle seems more like what wewould have seen prior, to say
(09:46):
9-11, you know, many years ago,where we'd have an economy that
was overheated, the Fed wouldraise rates, we'd have a
recession, and the Fed wouldhold rates, and hold rates, and
hold rates until they saw thatthe economy was finally giving
the inflation numbers that theywanted to see, sometimes even
having disinflation, and thenthey would start to cut interest
rates.
Ryan (10:07):
And I think that Do you think that the Fed should wait
to cut rates until we?
I mean, does the Fed reallywant there to be?
I know they want inflation tocome down, but do they need to
wait until there is actually arecession that emerges before
they cut rates in order toactually get rid of the
(10:28):
inflation that they're trying toget rid of?
In other words, you know, inthe 1970s we all remember
looking at the charts that havethat double spike of inflation,
right, right.
So is that a risk?
What do you think that theyshould do?
Bob (10:43):
I think we have a lot more productivity today in the
economy globally than we hadback in the 70s.
I grew up in the 70s and I justsee how the world operates
today and how businesses areable to be so much more
productive.
You know, goods and servicesare done on a much larger scale
(11:03):
with higher levels ofproductivity, which in theory,
should keep inflation down.
So I think, if I'm the Fed, I'ma little bit more confident
that cutting interest rates isnot going to reignite inflation
than I would have years ago.
We've seen massive changes inthe way the economy functions.
However, if we have policiesgoing forward from a regulatory
(11:29):
perspective, from a fiscalperspective, that are not good
for inflation coming down andthey're anti-productivity
basically, then it's a differentdiscussion, but we're not there
yet.
Ryan (11:41):
So do you think the Fed believes that they're out of the
woods when it comes toinflation?
Bob (11:47):
I don't know if they actually will ever admit it.
Powell, even if he cuts ratesall the way to say 3%, I think
he's going to be pretty cautiousabout suggesting, hey, we've
succeeded.
Ryan (12:00):
Mission accomplished, yeah , mission accomplished.
Bob (12:02):
I don't see him spiking the football sort of analogy.
That just doesn't seem like hispersonality.
Ryan (12:07):
I think the conventional wisdom is once they start
cutting rates, they can'treverse course and raise rates
in response to emerging data.
Once you go down that path, youhave to continue down that path
.
Do you think that's true?
Bob (12:20):
That's very true.
That's been true historicallytoo.
I think the Fed, I thinkthey'll cut rates 25 basis
points and I think Bob Stein hasbeen, I think, on the money
with his idea that they just cutrates 25 basis points on a
regular basis here until theysettle, I mean.
(12:42):
And where the plane landsreally is the question when do
they, you know, do they cut itdown to three and stop and then
see what happens?
Or I think so much of it'sgoing to depend on the economy
and the data they get that theyhave to look at.
Ryan (12:53):
One of the things I was wondering about the other day is
, I think, so much of it's goingto depend on the economy and
the data they get that they haveto look at.
One of the things I waswondering about the other day is
, I think, about the Fedsystematically cutting rates
over a long period of time.
Is that if I'm looking tofinance some sort of debt, I
might want to put that off untilthe end of next year?
If I'm confident they're goingto continue to lower rates, why
not put off my economic activityuntil then, which could then
(13:13):
slow the economy, not put off myeconomic activity until then,
which could then slow theeconomy, which maybe that would
argue for cutting rates faster,just so there doesn't have to be
that lag.
Bob (13:20):
They tend to cut rates or they tend to raise rates more
slowly and, historically, if theeconomy really does start to go
into a bad place, then theyusually cut rates rather rapidly
, and that's what we've seenmore often than not.
I think.
So much of this is we just wehaven't seen this sort of
typical economic cycle in a longtime where we have inflation,
(13:43):
the Fed raises rates.
Brian's talked about thisextensively Brian Westbury, the
Fed the way they conduct policyis different today than they did
prior to the financial crisis.
So we don't we really don'tknow whether or not even these
rate increases actually didreduce inflation.
Probably, but you know, there'ssome arguments to be made that
(14:04):
it was just.
You know, we went through apandemic and productivity
collapsed because of that, andproductivity has just come back.
And you know, you just, all youhave to do is go to a store and
you just, you just see a lotmore inventory these days and
where things were we wereclearly in a scarcity situation
here three years ago.
Ryan (14:23):
Let's assume for a second that rates do continue to come
down, as our expectationssuggest, and the Fed continues
to cut rates.
Do you think that at the longerend of the yield curve we see a
similar pattern, that the10-year kind of moves along with
the federal funds rate, or doyou think it's going to move
somewhat independently ofshort-term rates?
Bob (14:43):
I think it will move, it'll correlate, but I think most of
the change in interest rates isgoing to be more on the very
short end of the curve.
Clearly, I think that you knowwe've got inflation at 2.5, a
little over 3 on the core.
A 3.7 percent inflation or 3.7percent rate on the 10-year is
(15:04):
anchored right about where itshould be given, where inflation
is at, I think.
So I think most of the changein rates is going to be on the
short end of the curve.
I'm not expecting the yield onthe 10-year to go back down to
3%.
Maybe it does, but I think we'dhave to see 2% inflation, I
think for an extended period oftime for that to happen.
Ryan (15:25):
Now, does that have an effect or an impact on the way
that you view opportunities invarious sectors, on the way that
you view opportunities invarious sectors?
Are there certain sectors thatyou think do better or will do
better if we've got a certainrate-cutting environment?
Bob (15:41):
or rates moving lower.
Yeah, I think there's onereally obvious sector that would
benefit from the yield curvegetting back to normal, where
we've got the twos and tensdoing what they do where they
should be and where they've beenhistorically, but the short end
of the curve below the two,just a classic, you know shape
yield curve, and I think it'sthe financial services sector.
Not necessarily every bank ornecessarily every stock in the
(16:06):
financial services sector, butyou think about the nature of
lending and banking.
Most funding is done at theshort end of the curve with
deposits, you know savingsaccounts, checking accounts,
short-term CDs.
That's the funding engine forbank loans and most loans have a
longer duration, if you want tothink of it that way.
(16:27):
And so getting that yield curveback to normal, I think is
going to benefit the financialservices sector more than any of
the sector.
Ryan (16:35):
Yeah, that margin between the very short end and the
higher yielding longer end isimportant.
Bob (16:41):
Now there are a lot of banks that are, I would argue,
overcapitalized, that when youlook at their deposits and you
look at their assets, they havemassive assets compared to their
deposits and so they haveexcess reserves, if you will,
and they have parked thosereserves at the Fed in huge
numbers and they have made very,very good interest on that and
(17:04):
funding costs for a lot of thatstill very, very low.
So there are some financialinstitutions that are probably
not real happy with the Fedcutting interest rates.
They would probably like tokeep this ability to earn
without taking any risk at all,just parking money at the Fed,
but I think the vast majority ofbanks are not in that position.
(17:25):
There are very few of those andthey typically are the very
largest financial institutions.
You start getting into theregional banks and the community
banks, they tend to lend outpretty much all that they can
lend out, so they are trulybanking institutions that don't
have a lot of wealth management,capital markets activity,
things like that.
(17:45):
They're usually traditionallenders.
Ryan (17:49):
Turning to other sectors of the economy, you know the
technology sector has reallydominated recently.
When we look at fund flows intoETFs, the technology sector is
at the top of the list.
When we look at where theinnovation is happening and the
enthusiasm is happening, it'sthe technology sector Right.
And even you know, when rateswere before the Fed pivoted or,
(18:13):
you know, started talking thatway, the technology sector was
doing pretty well.
Yep, do you think that, as theFed does pivot, or maybe even
setting aside the Fed, becausewe're always talking about the
Fed what's the opportunity inthe technology sector?
Bob (18:28):
Yeah, I think that the tech sector there are trends in tech
that really have nothing to donecessarily with economic cycles
and the reality is thecompanies in the tech sector,
from a stock market perspective,are companies that generate
just such high returns on theirbusiness.
I mean just very, very highROIs ROEs, however you want to
(18:50):
calculate returns.
These are businesses that don'treally need a lot of external
capital, so they, for the mostpart, generate capital
themselves.
They're self-funding, and Ithink that's one reason why the
sector has done so well the lastcouple of years because they
really don't care what theFederal Reserve is doing.
(19:10):
They don't care whether ratesare 0% or 5%.
When you're generating 25%, 30%, 40, even 50% returns on
capital, do you care whetherrates are 5%?
On the short end of the curve,5.5%?
If you're looking at the Fedfunds rate, they're not going to
slow down, they're going tokeep on going.
The biggest impact from the Fedcutting rates from, say, 5%
(19:31):
down to closer to three, it'sgoing to be companies that have
lower returns on their businessthat need external capital.
And since Chairman Powell'sspeech on July 9th, where he
finally came out and said,without saying it directly, that
the Fed was about to embark onrate cuts.
(19:52):
We've seen a pretty significantshift in leadership in the
markets.
So you know small capsinitially had a big surge.
You know, when you look at thesmall cap space, mid caps, a lot
of companies that might be inthe S&P 500, but they're not
necessarily huge.
You know weightings in theindex or high return businesses.
You know that shift in policybenefited those stocks
(20:15):
significantly and the market, tome, is sending out a very clear
message that their cost ofcapital is about to come down,
and not only that, which is goodfor valuations, but it's also
good for them to expand and growtheir balance sheets, going
forward and making investmentsin their businesses.
Ultimately and that's kind of aclassic thing we tend to see as
(20:39):
we come out of a recession, wetypically see small caps,
mid-caps, do pretty well in theearly stages of an economic
cycle when this change in policyhappens.
Ryan (20:51):
So it makes a lot of sense that capital-intensive
businesses would be impactedwith lower costs of capital.
Bob (20:58):
Absolutely, absolutely Assuming these are businesses
that don't have high returnbusinesses.
You know, you think aboutcompanies that are more
classically cyclical businesses.
You know manufacturing, youknow industries like that
construction, home building,automotive, the automotive
(21:19):
sector, things like that.
These companies, they need alot of external capital from
time to time and especially whenthe economy's been slow, they
tend not to have a lot ofcapital sitting on their balance
sheet looking for a place.
They usually need that externalcapital.
And then you have a lot ofsmaller companies.
They're small and they want toget bigger one day, and so the
(21:40):
only way that happens is you'vegot to make investments in your
business.
So it's kind of a life cyclething.
Big companies tend to get biguntil they hit a wall and they
just can't grow anymore andeventually some of them fall
into decline.
And then you have all theseother companies that are earlier
in their life cycle that needcapital.
Some of these companies areburning capital.
(22:00):
You think about the biotechsector and whatnot.
They don't have a business yet,but they need capital and
investors, I would argue, areprobably going to be a little
bit more inclined to look atsome of those companies that are
in need of capital with thecost of capital coming down.
Ryan (22:20):
Yeah, I was thinking about the biotech industry in
particular the other day, aboutthe relationship between
interest rates and the returnsof that industry in particular,
and it seems like they're pretty.
I mean there's a pretty strongrelationship recently, but even
longer term.
Bob (22:35):
No question about it.
You know you've got all thesecompanies that you know they've
got clinical trials going on.
They've got.
You know they're makinginvestments.
They don't have anything toshow for it yet there's no
business there.
There's no there there yet, andyet there's.
You know the marketcapitalization reflects the
anticipation that at some pointthose investments they've made
(22:55):
will generate cash flow down theroad.
Ryan (22:57):
Yeah, the duration of those cash flows is very long,
oh big time.
Bob (23:00):
You think about how long it takes to bring a product to
market and the clinical trialsand all those sorts of things
that need to happen, and we'vebeen in an environment where
mergers have been discouraged, Ithink from a regulatory
perspective as well.
So that's another sector that Ithink will benefit a little bit
from shifting policies.
Ryan (23:20):
To your point with M&A, I would think that lower rates
would also maybe be at least oneinput to potentially spurring
on some more M&A.
If you're going to finance anacquisition, having lower rates
could actually be important forthat as well.
Bob (23:34):
Yeah, especially when you're buying a business that
has high future returnspotentially, but low returns
right now.
That could be all thedifference between a company
having enough capital to make itto the finish line and actually
having these investments payoff.
And that's always the questionthese investments pay off?
(23:56):
And that's always the questionDo these companies have enough
capital to stay in the gameuntil they actually have a
product in the marketplace?
And that's a balancing act fora lot of these companies.
Ryan (24:03):
What are your thoughts about artificial intelligence?
This is an area, especially intechnology, where there's just
been so much enthusiasm.
There's been incredible amountsof revenue that have been
generated by some of the chipcompanies, NVIDIA in particular,
but others, and the forecastsare pretty impressive as well.
(24:24):
Is this something that is?
I mean, where are we in thecycle?
I guess?
Is this something that you'reexpecting to continue along the
same pace, or are we nearing thepeak of the enthusiasm or the
hype cycle?
Bob (24:40):
I do think that there has been a lot of.
There have been some factorsthat have driven valuations
higher for these stocks, and Ithink the so-called carry trade,
for example, is that the Bobcarry trade.
It's C-A-R-R-Y not C-A-R-E-YExactly.
I've had to mention that to afew people, especially when the
(25:01):
market was getting volatile andthese stocks were blaming the
carry trade Folks.
It wasn't me, I had nothing todo with it, but a lot of hedge
funds, primarily, have borrowedmoney in yen and they've turned
around and they've bought otherassets.
Now they can buy anything theywant.
They could buy treasuries, theycould buy real estate, whatever
(25:24):
the case may be.
But it's pretty clear, basedupon the recent surge in the yen
against the dollar, as themarket began to price in the Fed
cutting interest rates that wasseen initially in the currency
markets the dollar did weakenagainst the yen.
The yen surged a little bit andboy, all of a sudden, we had a
(25:46):
lot of pain in those AI-relatedstocks.
And so that tells me that a lotof the advance that we've seen,
especially this year, probablylast year as well, was fueled by
investors who were essentiallybuying these things on margin,
if you want to think of it thatway.
And so anything that wouldcause that margin trade to
(26:09):
unwind is going to have aneffect on the shares of those
companies, and clearly thevaluations are very, very high
for a lot of those companies.
But when you take a look at theearnings and the forecast for
earnings for the rest of theyear and for next year, it's
like you kind of understand, infact you do understand why these
stocks are doing so well.
These companies are growinglike crazy, and so it gets down
(26:30):
to one thing Are theseinvestments in AI ultimately
going to pay off?
The people who are benefitingfrom all that spending right now
the chip companies and whatnot.
They are clearly making a lotof money because a lot of
companies are spending a lot ofmoney as they migrate into this
(26:51):
space, and so the question isare there going to be new
businesses that come out of this?
Are there going to be newsources of revenue for some of
these companies?
And so far, I would argue thatwe haven't really seen a lot of
that yet.
It's really, I think, probablyway too early to know whether or
not these are going to pay off,so we'll see how this plays out
(27:12):
.
This reminds me this whole cyclereminds me of the late 90s.
We were seeing a lot ofenthusiasm about the Internet
and e-commerce and all thesedifferent things back in the day
, and then we hit like an airpocket.
We were expecting thatbroadband Internet services were
(27:33):
going to be rolled out muchfaster than they ended up
getting rolled out.
I remember back in 98, 99, alot of people were in many
places.
They were seeing their streetstorn up because they were laying
fiber optic cable and there wasa lot of enthusiasm about
getting rid of these dial-upmodems, which were really slow,
and that process took five orsix years instead of taking one
(27:57):
to two years.
And that's when we got thismassive correction in these
dot-com stocks and a lot of thatair pocket was the result of
policy changes.
There was a lot of concernsabout, well, who's going to own
these Internet service providers, and there were a lot of things
that were going on inWashington that caused that
(28:20):
process to slow down.
And so you know, unless we havesome sort of crazy thing that
we're not expecting from apolicy standpoint, regulations
and whatnot If this is truly anorganic change and doesn't have,
we don't throw a wrench intothis from a policy standpoint.
I do think that we are going tosee a lot of things come about
(28:41):
as a result of this.
I think a lot of businesseswill emerge.
I think clearly it'll helpproductivity in the economy
longer term, as well, yeah,that's what's important for
these sorts of investments.
Yeah, and at the same time, thetechnology based upon the stuff
that I've messed with.
In some ways, it's very good.
In other ways, you can tell wehave a long way to go before
(29:04):
this is truly a revolution inthe way we do things.
Ryan (29:08):
Yeah, the Internet, I think, is a great analogy
because it's with the benefit ofhindsight.
Looking back, a lot of it waskind of a second order effect
after you had the build out.
Right Apple and its iPhonewouldn't exist without the
internet, but that didn't happenfor five, six, seven years.
Right Right Amazon.
(29:29):
It's a huge company.
It's got a lot of differenttypes of ways to earn money, but
initially it was a bookselleronline and that wouldn't have
existed Losing money like crazy.
Google or Alphabet, theywouldn't be able to advertise
Meta, they wouldn't have socialmedia.
All of that kind of came downthe road from the internet.
So I wonder the same thing whatare the companies in these
(29:50):
amazing revenue-generatingmachines and efficiency and
productivity that comes out ofAI?
Bob (29:57):
I think the market's initial assessment is that it's
going to be companies involvedin building data centers.
It's going to be the chipcompanies.
That's where probably the mostsecure bets that you can make
are going to be in that sort ofthing.
To me, it's the next generationof products and services we
haven't seen yet.
(30:18):
I think it's going to be fiveto ten years down the road when,
all of a sudden, there aregoing to be things that we take
for granted in our daily livesthat we can't even see right now
.
And that's the way technologyhas always been.
Ryan (30:30):
It's interesting Data centers, the amount of
electricity that they areactually going to consume
because of artificialintelligence and cloud computing
and all these high-demandsources that didn't exist just a
few years ago and electricvehicles and the electrification
(30:51):
of appliances, and all thesethings happening at once Ram
superchargers or ram chargers.
There's exactly there's anestimate that I saw I think it's
from the IEA that by 2026,that's two years away data
centers are going to consume athousand terawatt hours of
electricity per year, which isabout the same as the nation of
Japan, right?
(31:11):
Which is incredible, yep.
And at the same time, there's,you know, bitcoin mining, which
is consuming a tremendous amountof electricity, and all those
other things, right?
It just seems like we're goingto have to build out that
infrastructure pretty quickly.
Bob (31:26):
What is well.
At least this was true as of aof a couple days ago.
What was the best performingsector in the stock market year
to date?
It was the utility sector.
Yeah, that's which we haven'tseen that sector perform all
that well, that's so recently.
I do think interest rates arepart of that and there's no
question these stocks are.
From a valuation perspective,they are sensitive to interest
(31:49):
rates.
They're very bond like in termsof their businesses.
You know, low returns, steadyreturns, and so they're.
You know these are kind of longduration plays.
So that's that's certainlyhelped, I would argue.
But when I look at the, theearnings estimates for this year
compared to last year, Ibelieve earnings this year will
(32:09):
be up 10% for the utility sectorin 2024.
If the estimates for Q3 and Q4are correct, we haven't seen
that sector grow 10% in a yearin a long time.
I don't remember ever seeingthat sector actually have that
kind of an increase in earnings.
So I think a lot of it is whatyou just mentioned.
Ryan (32:28):
Yeah, and as they build out their infrastructure they
actually get to pass all thatcost along to you and I and all
the consumers.
Bob (32:36):
So it really is an interesting time to be a utility
company, in comparison to maybethe last several decades
stories about some of theutilities or some of these, you
know, nuclear power plants thathave been offline for many, many
years, bringing those back andso forth.
So it's an interesting timewatching this.
This is a sector that has beenhasn't really interested me in a
(33:01):
long time.
I've had a lot of concernsabout different things.
Part of it is just you can't Ican't get excited about the
growth rates when other sectorsare growing much faster.
Historically, that's been asector that you like.
When we are actually in arecession or about to head into
recession, the stocks aredefensive in nature, and that's
(33:23):
still going to be true goingforward, I'm sure of it.
But now you've got thepossibility, these companies
will actually start to increasetheir businesses.
They'll actually see moreprojects and more ways to make
money, and so I would expectthat we'll see some merger
activity and things like that aswell.
These are huge capitalinvestments when you have to
(33:45):
supply more power to these datacenters, and a lot of these
companies are actually buildingtheir own.
A lot of these data centercompanies are actually building
their own power plants too.
They're actually, you know.
So companies that make theequipment that go into that are
also, as you say kind of asecond order.
That's another area of themarket that I think is
(34:06):
interesting yeah, absolutely.
Ryan (34:10):
Market, that I think is interesting yeah, absolutely.
And that is another interestingtrend, as we're seeing, you
know, the reshoring ofmanufacturing and some of the
building of factories and thingsin the US, and part of that
makes me think about what'sgoing on in other parts of the
world, because this is aquestion that I've asked you
several times in the past.
Obviously, we've had a greatperforming equity market in the
(34:37):
US this year surprisingly so butsometimes our focus is pretty
myopic and narrow.
What's going on overseas?
Do you think there's anyopportunity yet in?
Bob (34:44):
some of those markets.
Yeah, I don't think things havechanged all that much.
I'm a numbers guy and when Ilook at the stock markets of the
world and I look at the UnitedStates and I look at, say, for
example, the S&P 500, and I seewhat these companies have done,
looking at earnings estimates,what they might do over the next
(35:05):
year or so, a couple of years,I don't see any other region of
the world or any other countryin the world that has anything
like what we have here in the US.
Now, the reality is those bigcompanies in the S&P are global
in nature they do business allover the world.
So I have been in the camp thatyou're better off letting those
(35:28):
companies navigate the globaleconomy.
The US companies are better atcreating shareholder value than
companies in Europe, companiesin Japan.
Not that you should completelyavoid markets overseas, but I
think it's I would argue it'smore important to be selective
when having those allocationsoverseas.
You know we are a lot of peopleargue well, hey, we're only 25%
(35:51):
of the world's GDP Only.
The reality is we're 4% of theworld's population but we're 25%
of the world's GDP.
When that's when you have thosekind of metrics, that means
you've got a lot of wealth beingcreated, a lot of economic
activity being created, and Ithink our companies are just
simply better than companiesoverseas.
I know valuations are betterwhen you look at Europe.
(36:14):
I mean, pes are quite a bitlower, but I would argue that
difference can be completelyexplained by the differences in
returns on capital.
Ryan (36:23):
Obviously, one of the things happening here between
now and November is thepolitical season.
We've got election day comingup.
I think if you were to ask mostof the pundits they'd say it's
kind of a coin flip.
At this point we don't reallyknow who the eventual winner
will be for the presidency andyou know the houses of both
houses of Congress are up forgrabs to some extent.
(36:45):
Maybe Bob Stein would tell usthat the Senate favors the
Republicans.
How important do you think thatis for investors to pay
attention to?
Should they tailor theirinvestment decisions based on
who the eventual winners will be?
Bob (37:01):
History says you shouldn't.
That doesn't really matter allthat much.
I think that the biggestfactors impacting the stock
market and what investors reallyshould care about are proposals
on the tax side, and if weraise taxes on dividends and
capital gains and whatnot evenestate taxes going up, that is
(37:27):
going to have an impact onvaluations.
It won't be the only factorimpacting the market, but
clearly those are factors thatwe plug into our models.
You know what is in, and whenwe start hearing talk about
taxing unrealized capital gainsand things like that, then you
know my antenna goes up.
I'm like, ooh, how's that goingto work?
If you have success in themarket and you've made some
(37:50):
money, now you may be in asituation where you have to sell
some of your shares in order topay taxes.
So you're effectively forcing aliquidation, potentially if
you've got some gains.
But then the market you wouldthink would adjust for that If
it knows that a founder of acompany that's been successful
(38:11):
that has to pay taxes more on anongoing basis.
That could affect the value ofthe stock because the market
knows that somebody's going tobe in the market selling to pay
taxes.
So it's kind of a you know thatwould be on.
We've never seen that before.
So those kind of proposals, youknow I doubt that they actually
would become law.
I think that would be verydifficult to pass into law, but
(38:33):
all of a sudden you start towonder whether or not that would
be the case.
So I think in the end, I thinkultimately, the stock market
likes when there's a sharing ofpower, because nothing crazy
happens at that point.
In other words, we don't havemassive shifts of policy as a
result of that, and when we'vehad one party control everything
(38:56):
, it's usually very, very shortterm.
We've only had a couple ofyears here and there in my
lifetime where the Democratshave run everything or the
Republicans run everything.
For the most part it's, youknow, both parties sharing power
.
Ryan (39:08):
Yeah, it's interesting because we're coming up to I
believe next year is when theindividual tax rates that were
part of the original tax packagethat was passed by the
Republicans when Trump was inoffice.
That's when those individualtax rates expire.
The corporate tax rates weremore permanent.
Bob (39:26):
Yeah, the only thing about taxes going up.
If that happens next year, whatdo we have the year after that?
We have another election.
Ryan (39:34):
We've got midterms.
That's when midterms come.
Bob (39:36):
And so that's the one kind of.
The beauty of our system isthat, even if they don't vote
for tax increases and we seetaxes going up, you know you
just don't want to be the partyin power and you just raise
taxes potentially, so you don'tcare.
If you're in the White House,probably you wouldn't care, but
if you're in Congress you'reprobably I don't know if I want
(39:59):
to vote for these taxes going upwhen.
I have to face the electoratenext year.
Ryan (40:04):
So that's an incentive to actually get something done to
extend some sort of maybe makeit so it's not as bad as it
would be.
Bob (40:13):
Right exactly Whether you keep it at this level and
selling it as such.
Yeah, it's an increase, butit's not all that bad.
This is your medicine.
It tastes good, doesn't it?
Ryan (40:25):
Great question for Bob Stein, and Bob was on just a
couple episodes ago.
Bob (40:29):
I've got.
Ryan (40:30):
Bob coming on once more before the election to give his
perspectives.
Bob (40:33):
I thoroughly enjoyed your conversation with him.
Ryan (40:36):
Yeah, it's always great to talk with Bob Stein.
Bob (40:38):
Whenever a Georgetown alum gets to visit with a Syracuse
fan, you never know what mightcome of that.
That's true.
But that was good.
Ryan (40:48):
We brawled off camera.
You never know what might comeof that, that's true, but that
was good, we brawled off camera,okay.
So my final question for you,bob, is and I've asked this, I
think I've asked you this before, but I'm going to ask you for
another recommendation what's onthe Bob Carey book list?
Is there anything that you'veread recently that you're
considering reading, or thatmaybe even a classic that you
(41:10):
would recommend?
I know you're into music.
Bob (41:13):
I have a book about the Beatles lyrics and Paul
McCartney did a book a coupleyears ago and it's thick and
there's a lot of information.
But a Princeton professorcollaborated on this and it just
has all the Beatles lyrics inthe book and there's a whole
discussion about what the lyricsmean and what they were
(41:34):
thinking at the time.
That's just the whole creativeprocess.
It's just amazing to me.
It is, as you know, I play theguitar and I've never written a
lyric in my life, I've neverwritten a song in my life, and
I'm just trying to figure outthe music of what these people
wrote over the years.
And why does that sound so good?
(41:54):
And then you throw the wholestorytelling and the lyrics and
all that into it.
It's like that's a great topicfor sure to dive into.
Ryan (42:03):
It's also interesting because everyone has their own
story of how they got to besuccessful.
You know what they went throughto get to where they ended up.
It's really fascinating becauseI think it's applicable to any
industry.
Any sort of success story has asimilar kind of trajectory.
It's very interesting.
Bob (42:23):
Yeah, it's interesting seeing bands.
I don't know if this so muchhappens anymore, but you think
about bands coming along.
They have ideas.
Bands I don't know if this somuch happens anymore, but you
think about bands coming along.
They have ideas.
A lot of bands start offcovering other band songs and
that's kind of how they maketheir mark, or at least they try
to.
That's what maybe pays the bills.
And then that process of goingokay, I want to create my own
thing, or we want to create ourown thing.
(42:45):
A lot of bands, they hit thatwall and they don't succeed, and
for every band that's made it,there's thousands of bands that
just hit that wall and theynever make it.
Yeah, maybe they release onealbum or two albums if they're
fortunate.
Yeah, and then they're gone.
Ryan (43:01):
Well, thank you once again for coming on the podcast, bob.
It's always interesting.
We'll have to get together anddrive some race cars again
sometime soon.
Bob (43:08):
Bob, it's always interesting, we'll have to get
together and drive some racecars again sometime soon.
Ryan (43:10):
I love that, but always great speaking with you.
Thanks to all of you as wellfor joining us on this episode
of the First Trust ROI Podcast.
We'll see you next time.
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