Amid a sharp drawdown in US equities, Dave McGarel highlights the risks and opportunities that may lie on the horizon.
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Episode Transcript
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Ryan (00:12):
Hi, welcome to this episode of the First Trust ROI
podcast.
I'm Ryan Isakainen, etfstrategist at First Trust.
Today I'm joined by DaveMcGarrel, chief Investment
Officer at First Trust.
Dave and I are going to talkabout what's going on in the
stock market.
This year.
We've seen a bit of a softeningin equity returns and we're
going to unpack some of thereasons why we're going to talk
(00:32):
about will the market broadenthis year?
And we're going to talk alittle bit about what investors
should consider doing in themidst of the sell-off and maybe
the opportunities that mightfollow.
Thanks for joining us on thisepisode.
All right, dave, so we'rerecording this on March 20th.
It's going to air on March 24th, so the viewers and listeners
(00:53):
can kind of keep that in mind.
Maybe extend you a little graceif there's a rally or if the
market melts down on Friday.
Hopefully we don't see that.
But one of the things I reallywanted to ask you about has to
do a little bit with politics,but not really.
From election day throughinauguration day, the equity
(01:14):
markets and risk assets reallydid well.
They rallied, the S&P was upsomething like 4% and since
inauguration day things havesold off.
How do you explain that?
Is that political or is theresomething else going on there?
Dave (01:29):
Sure, that's the buy, the rumor, sell, the news, right,
and that's kind of what themarket did.
Essentially, we're back towhere we were November 4th 57.70
, I believe that day on the S&P500.
President Trump wins, themarket takes off.
We hit 61.44, I believe, onFebruary 19th 4.6% on our way to
(01:50):
another 25% year, and then fromthat day, then maybe the last
19, 20 trading days, we've seenthe market revert.
Now, instead of being up 4.5%year to date, we're down 3% year
to date as we sit here, and themarket's exactly where it was
pre-election and there's allkinds of excuses.
We got deep seek and AI.
(02:11):
Maybe Microsoft doesn't need tospend 80 billion dollars every
single year on capitalexpenditures and the rest of
that.
You know, hyperscaler cohorts,or maybe it's tariffs, or maybe
it's inflation.
Maybe it's tariffs or maybeit's inflation.
Maybe it's the Fed saying, hey,we're not going to cut rates as
fast as maybe the market wouldhope.
(02:32):
Geopolitical events not settledyet, even though there's been a
lot of noise there.
So there's all kinds of issues,but those issues materialize in
the market when you startlooking at how much you're
paying for those risk assets.
And essentially we had anexpensive basket of stocks,
especially if you look at theS&P market cap weighted when we
started November, the day beforethe election, and we're right
(02:54):
back to it, so it's still notinexpensive.
There's not a valuation supportunderneath this market at these
levels, but we're not at 61.44,which put us at about a 24
times multiple for this year'searnings if we have 10 or 11
percent earnings growth.
So so the market just had goneup so much it needed to correct
(03:17):
and we got a little bit of acorrection here.
We'll see if that's just are-rating and saying, okay, we
need to see some proof thatwe're going to make these
earnings and things are going toactually materialize like the
market expected when we startedthe year for that 10% earnings
growth.
Ryan (03:32):
So the S&P 500 equal weight relative to the market
cap weighted version thetraditional version of the S&P
500, the equal weight versionhas outperformed this year and
that seems to be early evidenceof some level of broadening for
markets.
Do you think that thatcontinues throughout the year or
is that something that we'regonna see the the mega caps
(03:52):
rally again?
Maybe I can guess your answerbased on what you're saying
about valuations.
But what do you think?
Dave (03:57):
yeah, I think it's a multi-year story.
Okay, we had 70% of the S&P 500return in 2023 come from the MAG
7.
Last year it was over 50% camefrom the MAG 7.
Think about it there's 500stocks in seven companies in
consecutive years where wereturned 26% on the S&P 500,
with dividends in 2023, 25% in2024, and half of that return
(04:24):
more than half of that return,more than half their turn just
came from seven companies andthose seven companies didn't see
their earnings grow anywherenear as fast as their stock
prices.
So we've added a lot ofmultiple at the very tippy top
of the SP 500.
A ton of weight in that topbasket of stocks at the SP 500,
maybe 36%, sitting in just 10names at the top of a massive
(04:49):
$52 trillion index.
But they traded 29 or 30 timesearnings.
So it's historically incrediblyexpensive and maybe a harbinger
of looking backwards instead oflooking forwards at where the
future growth is coming from,because when you do look at
earnings growth going forward,it's much more spread out than
it's been the last couple ofyears.
Ryan (05:10):
So a lot of people will cite the uncertainty that's
crept into the market.
Some of it related to what theFed is going to do with interest
rates, some of it to do withother government policies,
especially tariffs.
I wanna talk a little bit abouttariffs and their impact on
stocks, because I think that iswhat is on the mind of a lot of
investors.
I guess my question for you,then, is do you have any
(05:33):
thoughts on what's happeningwith some of the tariff policies
, and will they ultimatelyimpact corporate profits and
stock prices?
Dave (05:40):
Sure, absolutely.
I mean, tariffs across theboard are unhelpful to faster
growth and unhelpful to lowerprices for consumers.
It's that simple.
You have less choices.
If we put a 200% tax onchampagne from France, nobody's
going to buy French champagnehere, so that doesn't, and the
(06:01):
cost of champagne from somewhereelse is going to be more
expensive for consumers herebecause there's going to be less
competition, right?
So it's pretty simple at theend of the day.
Again, I think the marketsgenerally has perceived that
most of any tariffs that are outthere will be short-lived and
(06:21):
mostly a negotiated tool.
Perhaps the market got a littledoubtful of that over the last
couple of months, but but I'mnot sure tariffs is the
underlying root cause here.
We just have a very expensivestock market and you need to
look for value other than thisplace where we've seen the
performance come in the lastcouple of years, and that's
(06:41):
really, I think, what's changingthings.
You had companies at the verytop, the best companies in the
world, kind of hitting theirhead on the ceiling.
All of a sudden, you got tospend a lot of money on AI,
infrastructure, asset-heavybusinesses for businesses that
we love, that we asset-lightwhether that's Microsoft or some
of the other big names, thehyperscalers and Google and Meta
(07:04):
.
And all of a sudden they'resaying we have to spend a ton of
money on capital expenditures.
And investors are saying wait, Iloved your business because
you're not building newfactories.
And now you're building newfactories and you're taking all
of your profits in building newfactories and you're not telling
us that it's not gonna be acontinuum.
Year after year after year withthis build out and we don't
(07:25):
have enough proof yet that AI isgoing to actually goose your
earnings much faster than theforecasts sit today.
So, that's some of theconsternation that's sitting out
there.
I think of broader than justthe tariff story.
I think it's a whole conundrumof factors that concern
investors today, and stocks werejust too expensive with all
(07:47):
this uncertainty out there.
And stocks were just tooexpensive with all this
uncertainty out there.
Ryan (07:49):
So, dave, to your point, when you look at sectors of the
S&P 500, I looked a couple daysago and eight out of the 11
sectors actually had positivereturns this year and the ones
that didn't were those sectorsinvolving the companies that
you're mentioning.
That are technology companiesor tech plus companies that are
spending all this money likethey're an industrial firm or an
(08:10):
energy company or somethinglike that.
So I think that's reallyinteresting, because you haven't
historically thought oftechnology companies as being
heavy spenders making bigcapital expenditures.
Do you think that that willcontinue going forward, or are
they going to have to getcapital discipline, like we've
talked about with the energysector, at some point?
Dave (08:30):
Sure, at some point you can't.
Microsoft, I think, made $85billion last year.
They say they're going to spend$80 billion on capital
expenditures.
Well, just two or three yearsago they spent about $25 billion
, $28 billion, and slowly theywere already spending 11%, 12%,
13% of their revenue on capitalexpenditures and this past year
(08:51):
or this year they're expected tospend closer to 22 or 23% of
their capital expenditures tosales.
So a massive increase.
And there's no different atMeta, it's no different at
Google, it's no different atAmazon.
And you start looking at thecash flow the best cash flow
companies in the world, don'tget me wrong.
But all of a sudden there's allthese other needs for cash
(09:13):
where investors are just sayingwe can just buy back stock, you
can reward me with dividendincreases, whatever it might be,
that's great.
Or you can make an acquisition,like Microsoft bought LinkedIn
and all kinds of uses to grow.
And now you're telling me it'sgonna be really capital
intensive.
Well, when you have capitalintensive businesses, those
assets depreciate and need to bereplaced.
(09:34):
So nobody knows the chips thatare going to come in 27, 28, 29.
Are we talking about justrecycling and having this 20%
plus capital expenditure torevenue ratio for the rest of
this decade, and that is givingjust some consternation to
shareholders about where do Iget the returns that I expected?
(09:54):
And that's where theuncertainty comes in in that
trade, in our view at least,when we look at all this data.
Ryan (10:00):
Yeah, I hadn't really thought about the depreciation
of some of those assets.
And especially when you'redealing with technology and
these really advanced chips andyou hear N hear Nvidia talking
about their new generation ofchips and you just wonder how
quickly, if those chips get muchbetter and continue to get much
better, you're gonna have toreplace them and that's a whole,
you could have a pretty fastdepreciation of those existing
(10:23):
assets if that's the case.
Dave (10:24):
Exactly and if you need to replace them, unless these
costs really come down, it'sgonna be a continued big
investment that didn't existjust a couple years ago for
those companies.
Ryan (10:38):
So I think a lot of the focus at least the narrative
focus this year has been as riskassets have begun to sell off
and people have gotten a littlebit anxious and nervous.
The narrative has been focusedon some of those things like
tariffs, whether they're thecause of the sell off or not,
but it doesn't seem like there'sbeen as much focus on some of
(10:58):
the things that could be comingdown the road, like extending
the tax cuts or maybe extendingthe tax cuts or potential
benefits of deregulation orthose sorts of things.
Do you think investors arepaying too much attention to
some of the near-term kind ofuncertainty, and when will they
(11:18):
start to give more credit tosome of the more optimistic
things that could be coming downthe road?
Dave (11:24):
Again.
I think a lot of that has beenbaked into stock prices.
Now we have come off the highsbut again at the S&P 500, you're
close.
Let's do it this way.
We're at 5,700 today.
Earnings forecast are for $261this year.
May that hold.
That'd be about 11% growth fromlast year's 235.
But next year's forecast is for$300.
(11:45):
That's another 12% or 13%growth.
Those are above-averageearnings.
That's another 12 or 13 percentgrowth.
Those are above averageearnings In a period of time.
We're not forecasting aboveaverage GDP growth here and yet
we have this forecast.
So maybe companies will beproductive that say they make
the $300.
Well, $5,700 today divided by$300 is 19 times the 25-year
(12:05):
multiple on the S&P 500, lookingforward is 17 times.
So if we may have two greatyears of earnings growth and
stocks don't go up from here atall, stay flat, you would have a
multiple of 19 times at the endof 2026.
So if you look at the marketcap weighted index, there's no
(12:26):
way to say, hey, we have somevaluation support here.
But the top heaviness of thisis the reason that we're seeing
this broadening out, becausethere is valuation support once
you get through stocks 200through 500 in the S&P 500.
Much cheaper basket of stocksthan the 29 or 30 times you're
(12:47):
paying for the top third of themarket, versus 17 times when you
get to the bottom 300 companiesthat make up a very small
percentage of the S&P 500 weight.
Ryan (12:58):
So for those podcast viewers who haven't seen the
Market Minute with McGarrel,it's something that you publish
once a month.
It's a short, one-page kind ofsnapshot of what your views are
on opportunities in the market.
And so this year you've beentalking a lot about momentum and
quality and those are kind ofthe best factors over the last
(13:19):
couple of years, and you saidsomething like you know,
three-peats are rare when itcomes to factors.
So when you look at all thedifferent factors that you know
our research team uses to buildportfolios, where do you see
opportunities?
Dave (13:33):
Sure, when you think about 2023, quality was the best
factor.
The reason is because in 2022,when the market got routed down
18 percent, growth stocks down30 percent a lot of good quality
growth stocks fell hard thatyear we got.
The worst factor in 2022 wasquality.
(13:54):
The best factor in 23 was thisrebound Things were better than
expected, higher rates didn'thurt the market and its earnings
growth significantly and we sawquality rebound and be the best
factor.
Then last year, quality was thesecond best factor.
And so you look this year andthen you look back at a jelly
bean chart to say let me see allthese factors low volume value
(14:14):
and a smaller size in momentumand you look at those factors
and you do not see anythree-peats Nobody.
Three years in a row, like 98,99, momentum was the best factor
.
Everybody was invested inmomentum and how did momentum do
in 2001?
The worst factor both years.
So it's very difficult tothree-peat.
(14:37):
You know the joke is askPatrick Mahomes, right, ask the
Kansas City Chiefs.
It is not an easy feat.
And the deal with quality isbecause at the end of 2022, the
quality factor is because at theend of 2022, the quality factor
, which typically trades at aslight premium to the S&P 500,
actually fell to a 12% discount.
(14:57):
Quality the easiest thing topurchase a quality basket of
stocks was at its biggestdiscount since 2000 on the chart
that we have, and even earlierthan that I had never seen a 12%
discount on quality stocks.
And so what did we do?
We took those quality stocks,we drove them to a premium of 9%
on February 19th and now we'reback to about a 4% premium.
(15:18):
So quality isn't on sale.
It's not as expensive as it wasjust a few weeks ago.
You can buy a quality basket ofstocks, but you don't want the
concentration risk in some ofthe names that are very
expensive and still qualify asquality stocks.
We're going to see differentfactors value, perhaps, maybe
low volatility.
(15:39):
Although they work as a bondproxy, we don't really need a
bond proxy today where rates are.
But you've seen healthcare,you've seen staples, financials
at the top.
I think if we avoid a recessionhere, even if we slow growth
down, that you're going to seethe cyclical sectors hold up
financials and industrials.
They have a lot of avenues forgrowth with the AI build-out on
(16:01):
the industrial side.
Financials one of the crownjewels of our economy are our
big banks and our insurancecompanies.
Those are USA crown jewels.
They have massive amounts ofcapital, they have phenomenal
businesses worldwide and they'rejust dominant companies and
(16:24):
they have a bunch of differentavenues for growth.
If you're the big banks, youhave investment banking.
It's slow because of theuncertainty, but at the same
time, think about the volatilityof the last 20 trading days and
what that does for all thetrading desks at a JP Morgan, a
Morgan Stanley, goldman Sachs.
They're going to have aphenomenal quarter when it comes
to that and invariably, everytime something isn't working say
(16:47):
mortgage underwriting,something else is working for
those banks and when everythingcomes together, that's when they
make just a massive amount ofmoney.
Ryan (16:55):
So you like the cyclicals, the financials, the industrials
.
When you think about what theFed is doing and where we are
with interest rate policy, whatimpact will that have on stocks,
whether it's the sectors thatyou mentioned or just overall?
Do you think that rates areabout where they're going to
(17:16):
stay?
Are we going to be in kind of ahigher for longer environment,
and what are some of theimplications?
Dave (17:21):
Sure, I certainly think higher for longer.
We're not going to see zero,hopefully anytime soon.
I think in a very long time, ifever we're going to see that
zero interest rate policy.
The market maybe three, four,five months ago was thinking the
Fed had cut two or three times.
I think right here, with thenext move still viewed by the
(17:43):
market as lower than today iswhat's most critical.
If the Fed indicates in any way,shape or form and the market
gets in it, the Fed might haveto raise rates, mostly because
of inflation, and in our viewthe market's gonna get creeped.
Okay, that is not beneficial tohousing, which is a huge part
of the economy.
It's not better for individualsto go out and get debt to
(18:06):
purchase cars or any otherdurable goods, and higher
interest rates, or the threat ofhigher interest rates will take
this market down significantly.
On the other side of things, ifthings do get weak and even if
we don't go into a recession andwe see GDP growth slow and the
economy struggle a little bit,the beauty of where the Fed is
(18:30):
today is if inflation is undercontrol, not getting worse,
coming down, the Fed's got 450basis points at their disposal
so they could cut 25 basispoints, signal that they'll cut
if they see continued weaknessand that will spoil the market
and give the market anopportunity to go higher here.
I don't think we're going to seea 20% market.
(18:51):
If we ended this year and wewere close to 6,000 from 5,700
today and you get your 1.5%dividend rate or whatever in the
S&P 500, I think that would bea pretty good year after two
fantastic years in the equitymarkets.
And if rates are still expectedto stay here or go lower, I
don't think that'll be animpediment to the market going a
(19:14):
little bit higher from here.
Ryan (19:16):
Yeah, it's interesting because it doesn't seem to me
that businesses are going toreally change the way that they
do anything if they expect ratesto drop 25 basis points, 50
basis points by the end of theyear or something like that.
That doesn't seem like it wouldinfluence the economy or
decision making in any real way.
Dave (19:33):
Yeah, I'd agree.
I don't believe there's.
We have massive profitabilityin the S&P 500 today.
Better profitability if we missearnings and don't do 261 this
year, we'll do 250.
It'll be the best earnings inthe S&P 500 history and it will
be about 60% or 70% higher than2019, which had been the best
(19:56):
year before four consecutiveyears of putting over $200 in
earnings in the S&P 500.
So it's pretty amazing theprofitability.
Maybe there's some relation toCOVID and what companies learned
then at the expense level.
Maybe it's fiscal monetary toCOVID and what companies learned
then at the expense level.
Maybe it's fiscal monetarystimulus and it's sticking
(20:16):
around for a really long time.
That's probably some of it.
But we've seen massive earningsand companies just have the
wherewithal to do a lot withthose earnings if we hit
anywhere close to the expectednumber this year.
So we've got a really good setof companies and a really
significant earnings profile outthere and if we see earnings
(20:37):
keep going up, you know stockscan actually, you know, make
slight gains this year, evenwhere the valuation is.
Ryan (20:46):
So Westbury talks about the embers of inflation and you
know the possibility thatinflation does kind of roar back
to life and you mentioned thatif the market perceives that the
Fed is going to have to raiserates, that we could have some
level of sell-off.
Where is the tipping point, Iguess, in your view?
(21:09):
What level of inflation is theFed really going to sit up and
pay attention like, oh boy, webetter shift our stance, because
it seems to me that they wouldbe very hesitant to want to
change any stance at this point.
Dave (21:24):
Oh, absolutely.
It would have to be data-drivenand they would have to see an
uptick in inflation.
It's as simple as that.
It would have to start going.
I think if it plateaus or sitshere and just moves around a
tiny bit right around where itis today, in the 2, 2.8,
wherever it is, they'll assumethat with rates where they are,
(21:45):
with some of that stimulus stillcoming off, that we'll see a
continued decline, even if ittakes a lot longer than they
might have hoped.
But if we get some prints thatstart seeing higher numbers and
they might say it's temporaryagain.
But they're gonna be very, verycautious there when it comes to
lowering rates from here.
(22:06):
But also to your point, man, dothey not want to raise rates?
It means they cut them too much.
It's that simple.
Ryan (22:16):
The other thing that I've noticed this year and maybe it
goes hand in hand with thebroadening trade or the
broadening market is that theinternational equity markets
have done better, and some ofthat might have to do with
movements in currency orsomething like that.
But how do you look atinternational stocks this year?
Is that an opportunity?
They are historically cheap,but maybe that's because of some
(22:39):
level of risk.
How do you look atinternational stocks?
Dave (22:41):
Sure, you could see that Europe is having a great year so
far in the first two and a halfmonths I don't know depending
on which market somewherebetween 8 and 14 or 15 percent.
Is it because they're going togrow faster in Europe than the
US?
No, we're still expected to goGDP growth generally below 1
percent.
But you know, their bankingsystem has been atrocious and
(23:04):
maybe that catalyst for whyEurope is doing better in some
regard in that sector is theCredit Suisse acquisition by UBS
.
And, all of a sudden, if youlook at a basket of European
stocks, they've been fantasticover the last year.
They've outperformed the MAG7over the last year.
European financials, and theyhave some really good financial
(23:27):
companies that finally, 15 yearsafter the 08-09 crisis, have
gotten their balance sheets inorder, their capital in order,
and there's this little bit of agroundswell that you can see
and that's with those financialssaying we can compete with some
of those big American banks.
And it's the energy companiessaying we've been left behind
(23:49):
with moving into, you know,green energy too quickly.
We always kind of knew thatfossil fuels were going to be
around for a long time, but wetook our foot off the gas and
now Shell and BP.
They're talking about puttingtheir foot back on the gas and
realize this is a longtransition.
So they're getting the messagefrom their shareholders that the
reason our stocks are doing sopoorly is because your earnings
(24:10):
growth is not good, getting themessage from their shareholders
that the reason our stocks aredoing so poorly is because your
earnings growth is not good.
And the way you get earningsgrowth is give the consumer what
they want, and right now it'sstill fossil fuels.
The banks have recovered, soEurope is not in a better
position than the US.
However, to your point, usuallywe enjoy a 15 to 20 percent
(24:36):
premium to European equities,international equities in the US
.
American exceptionalism, bettermargins, better regulations,
typically.
Ryan (24:48):
Different mix of industries as well, Of course
yeah, we have a much widerspread.
Dave (24:52):
We have the technology footprint.
We deserve that premium, but ithad gotten outlandish.
It was absurd how cheap therest of the world is versus the
US and I always kind of take astep back and realize we hit way
above our weight.
We got 4% of the world'spopulation, 24% of the world's
(25:13):
GDP, but 76% is somewhere elseand they're trying to improve
their lives every day and growtheir net worth and better lives
for themselves.
And I think, at these prices,investors just woke up and said
if we're going to get a marketthat's not just led by seven
stocks, it's going to be broader, it's going to be small, mid
(25:34):
value growth and eveninternational at this point
where there's some pretty goodopportunities.
Ryan (25:40):
Germany just made an announcement that they were
going to increase spending quitea bit.
I think they have somethinglike a 500 billion euro or
dollar I'm not sure whichspending package where they're
going to increase spending ondefense and on infrastructure
and on some other things.
Do you think and I've noticedthat you know the German equity
market has done fairly well asthat announcement has come out,
(26:03):
but do you think that that hassome level of I don't know
stimulus that will maybe helpsome of the equities related to
that?
Dave (26:12):
I do.
I think it is Europe waking upand saying how do we compete?
And the way we compete is toinvest.
You know they're actuallycutting rates over there.
The ECB's cut, I think, acouple of times this year in the
last six months or so and we'vebeen stagnant on our interest
rates at the Fed level.
So there's some I thinkeverybody's too scared because
(26:34):
of all the false alarms over thelast five to 10 years of oh,
there's little green shootscoming up in Europe and they
never materialize and maybe,knowing that our administration
is going to deregulate, they'regoing to be pro-growth.
Now, whether it works or not,that's their intent and Europe
is gonna get left further behindif they don't have some of that
(26:54):
approach going forward.
And I think you've seen kind ofthe new US administration
spurring the rest of the worldsaying to compete, we're going
to have to actually step up ourgame and I think that's what the
market saw, has seen, with thisdouble-digit rise in European
equities in the first two and ahalf months of the year.
Ryan (27:19):
Yeah, it seems to me that most investors that have
allocated to internationalstocks, unless they're
rebalancing on a consistentbasis and I suspect that those
that are using a financialprofessional to help them manage
their money, yes, they're mayberebalancing, but there's a lot
of people that don't rebalanceand I think there's a lot that
are underweight, probablyinternational stocks.
They're probably underweight alot of things apart from US
growth, and so that seems likewould be a source of funds to
(27:43):
maybe buy some of these areasthat we've been talking about.
Dave (27:46):
Yeah, it really speaks to diversification right Again.
This year, you know, in thefirst two months, health care is
the number one sector.
After the prior two years itwas right at the bottom.
Energy is near the top.
It was lousy the last couple ofyears.
Consumer staples are doing finethis year.
Financials are doing prettywell the first couple of months
(28:09):
of the year, and sodiversification is perhaps
boring to too many investorswho've just seen this rise in
tech or tech-related names andgenerating returns on an Nvidia
that goes from $500 billion to$3 trillion.
Ryan (28:25):
That's not normal.
Dave (28:26):
Normal is a much lower rate of return than what we
enjoyed in 23 and 24.
And risk positioning is going tobecome more prevalent in
portfolios.
There's a lot of portfolios.
When you do an x-ray, a lot ofinvestors would say, wow, I
(28:47):
can't believe I have a beta of1.2.
That was never my intent, butwhat's happened in the markets
is everything skews towards thetop.
Remember, if there's 36% and 10names at the top of the S&P 500
, there's only 100%.
So if we put more at the top,where's it coming from From all
the other companies that aretowards the bottom of that S&P
(29:07):
500.
So companies that might havehad a 10 or 12 basis point
weight in the S&P 500 10 yearsago might only have a 5 or 6
basis point weight, even iftheir stock's done fine.
We just put so much multipleand so much weight at the top of
the index.
It doesn't mean those aren'tstill really good opportunities.
Ryan (29:25):
Well, dave, I'm looking at the clock and time once again,
has flown by.
My final question for you iskind of a retrospective
philosophical question for DaveMcGarrel, as you manage a big
department of research at FirstTrust, as you're talking to
younger analysts and portfoliomanagers just coming up, what's
(29:47):
the most important piece ofadvice that you would give them?
Dave (29:50):
Sure, I'll talk to old people who've experienced a
market that is different than, Iwould say, the last 15 years.
Covid was a hiccup.
08-09 was devastating, and so Imean 08-09 was as tough as you
can experience.
98-99 was just a valuationstory.
(30:11):
That's certainly caused bearmarkets and people lose a lot of
money, but 08-09 and the powerof leverage was in full view at
that point in time and marks onassets liquidity were big issues
.
We have not seen any eventslike this.
(30:32):
Liquidity were big issues.
We have not seen any eventslike this.
I'm not asking for one, buteverything is easy when the
market's going up like it's beengoing the last couple of years,
when there's that muchliquidity, when anybody can
raise capital regardless of whatthe asset looks like, when
people are willing to take riskeven if it might not be a great
(30:54):
risk-reward scenario and we'veseen all of that and I think
we're just in for a differentmarket.
And compound interest over time.
That's how you make a lot ofmoney.
Timing the market seems reallyeasy, and when it goes the other
way, when you break stride,it's really hard to win the race
(31:15):
.
We broke stride here the last20 trading days.
I think we're in for a differentmarket Doesn't mean we need to
get creamed.
Earnings got to hold up for themarket to make small gains.
But the way you make, howperform in a market that gives
you small gains, is gettingdiversified and owning, at
points in time, internationalstocks or small cap value stocks
(31:38):
when they hadn't done anythingfor a long time and you get it
really concentrated in a briefperiod of time.
And if you don't have any ofthat, if you're way underweight,
then you have to make adecision.
Do I chase that?
Is it real?
And that's a really harddecision to make.
It's much easier, thinkingabout where we sit today,
thinking about the rest of thisdecade, to say, if we get 8% per
(32:01):
year on average through the endof 2029, 2030, that'd be a
great return for equities fromwhere we start, especially if we
just look at the SP 500, tooutperform that.
You can use some other toolstoday to de-risk your portfolio
from the concentration in theS&P 500, but also to outperform
(32:21):
that index if we don't see thesame exact story we've seen,
which we don't expect to see, in2023 and 2024.
Ryan (32:28):
All right, Dave, thank you for that perspective Overcoming
recency bias is how I wouldencapsulate a lot of your
comments there.
Dave (32:33):
But, as always, thank you for that perspective Overcoming
recency bias is how I wouldencapsulate a lot of your
comments there.
There you go, sure.
Ryan (32:35):
But, as always, thank you for joining us on the podcast.
We'll look forward to havingyou on at some point later this
year, hopefully.
But again, thank you forjoining us and for your insights
.
And thanks to all of you forjoining us for this episode of
the First Trust ROI Podcast.
We'll see you next time.
Hi, welcome to this episode of the First Trust ROI
podcast.
I'm Ryan Isakainen, etfstrategist at First Trust.
Today I'm joined by DaveMcGarrel, chief Investment
Officer at First Trust.
Dave and I are going to talkabout what's going on in the
stock market.
This year.
We've seen a bit of a softeningin equity returns and we're
going to unpack some of thereasons why we're going to talk
(00:32):
about will the market broadenthis year?
And we're going to talk alittle bit about what investors
should consider doing in themidst of the sell-off and maybe
the opportunities that mightfollow.
Thanks for joining us on thisepisode.
All right, dave, so we'rerecording this on March 20th.
It's going to air on March 24th, so the viewers and listeners
(00:53):
can kind of keep that in mind.
Maybe extend you a little graceif there's a rally or if the
market melts down on Friday.
Hopefully we don't see that.
But one of the things I reallywanted to ask you about has to
do a little bit with politics,but not really.
From election day throughinauguration day, the equity
(01:14):
markets and risk assets reallydid well.
They rallied, the S&P was upsomething like 4% and since
inauguration day things havesold off.
How do you explain that?
Is that political or is theresomething else going on there?
Dave (01:29):
Sure, that's the buy, the rumor, sell, the news, right,
and that's kind of what themarket did.
Essentially, we're back towhere we were November 4th 57.70
, I believe that day on the S&P500.
President Trump wins, themarket takes off.
We hit 61.44, I believe, onFebruary 19th 4.6% on our way to
(01:50):
another 25% year, and then fromthat day, then maybe the last
19, 20 trading days, we've seenthe market revert.
Now, instead of being up 4.5%year to date, we're down 3% year
to date as we sit here, and themarket's exactly where it was
pre-election and there's allkinds of excuses.
We got deep seek and AI.
(02:11):
Maybe Microsoft doesn't need tospend 80 billion dollars every
single year on capitalexpenditures and the rest of
that.
You know, hyperscaler cohorts,or maybe it's tariffs, or maybe
it's inflation.
Maybe it's tariffs or maybeit's inflation.
Maybe it's the Fed saying, hey,we're not going to cut rates as
fast as maybe the market wouldhope.
(02:32):
Geopolitical events not settledyet, even though there's been a
lot of noise there.
So there's all kinds of issues,but those issues materialize in
the market when you startlooking at how much you're
paying for those risk assets.
And essentially we had anexpensive basket of stocks,
especially if you look at theS&P market cap weighted when we
started November, the day beforethe election, and we're right
(02:54):
back to it, so it's still notinexpensive.
There's not a valuation supportunderneath this market at these
levels, but we're not at 61.44,which put us at about a 24
times multiple for this year'searnings if we have 10 or 11
percent earnings growth.
So so the market just had goneup so much it needed to correct
(03:17):
and we got a little bit of acorrection here.
We'll see if that's just are-rating and saying, okay, we
need to see some proof thatwe're going to make these
earnings and things are going toactually materialize like the
market expected when we startedthe year for that 10% earnings
growth.
Ryan (03:32):
So the S&P 500 equal weight relative to the market
cap weighted version thetraditional version of the S&P
500, the equal weight versionhas outperformed this year and
that seems to be early evidenceof some level of broadening for
markets.
Do you think that thatcontinues throughout the year or
is that something that we'regonna see the the mega caps
(03:52):
rally again?
Maybe I can guess your answerbased on what you're saying
about valuations.
But what do you think?
Dave (03:57):
yeah, I think it's a multi-year story.
Okay, we had 70% of the S&P 500return in 2023 come from the MAG
7.
Last year it was over 50% camefrom the MAG 7.
Think about it there's 500stocks in seven companies in
consecutive years where wereturned 26% on the S&P 500,
with dividends in 2023, 25% in2024, and half of that return
(04:24):
more than half of that return,more than half their turn just
came from seven companies andthose seven companies didn't see
their earnings grow anywherenear as fast as their stock
prices.
So we've added a lot ofmultiple at the very tippy top
of the SP 500.
A ton of weight in that topbasket of stocks at the SP 500,
maybe 36%, sitting in just 10names at the top of a massive
(04:49):
$52 trillion index.
But they traded 29 or 30 timesearnings.
So it's historically incrediblyexpensive and maybe a harbinger
of looking backwards instead oflooking forwards at where the
future growth is coming from,because when you do look at
earnings growth going forward,it's much more spread out than
it's been the last couple ofyears.
Ryan (05:10):
So a lot of people will cite the uncertainty that's
crept into the market.
Some of it related to what theFed is going to do with interest
rates, some of it to do withother government policies,
especially tariffs.
I wanna talk a little bit abouttariffs and their impact on
stocks, because I think that iswhat is on the mind of a lot of
investors.
I guess my question for you,then, is do you have any
(05:33):
thoughts on what's happeningwith some of the tariff policies
, and will they ultimatelyimpact corporate profits and
stock prices?
Dave (05:40):
Sure, absolutely.
I mean, tariffs across theboard are unhelpful to faster
growth and unhelpful to lowerprices for consumers.
It's that simple.
You have less choices.
If we put a 200% tax onchampagne from France, nobody's
going to buy French champagnehere, so that doesn't, and the
(06:01):
cost of champagne from somewhereelse is going to be more
expensive for consumers herebecause there's going to be less
competition, right?
So it's pretty simple at theend of the day.
Again, I think the marketsgenerally has perceived that
most of any tariffs that are outthere will be short-lived and
(06:21):
mostly a negotiated tool.
Perhaps the market got a littledoubtful of that over the last
couple of months, but but I'mnot sure tariffs is the
underlying root cause here.
We just have a very expensivestock market and you need to
look for value other than thisplace where we've seen the
performance come in the lastcouple of years, and that's
(06:41):
really, I think, what's changingthings.
You had companies at the verytop, the best companies in the
world, kind of hitting theirhead on the ceiling.
All of a sudden, you got tospend a lot of money on AI,
infrastructure, asset-heavybusinesses for businesses that
we love, that we asset-lightwhether that's Microsoft or some
of the other big names, thehyperscalers and Google and Meta
(07:04):
.
And all of a sudden they'resaying we have to spend a ton of
money on capital expenditures.
And investors are saying wait, Iloved your business because
you're not building newfactories.
And now you're building newfactories and you're taking all
of your profits in building newfactories and you're not telling
us that it's not gonna be acontinuum.
Year after year after year withthis build out and we don't
(07:25):
have enough proof yet that AI isgoing to actually goose your
earnings much faster than theforecasts sit today.
So, that's some of theconsternation that's sitting out
there.
I think of broader than justthe tariff story.
I think it's a whole conundrumof factors that concern
investors today, and stocks werejust too expensive with all
(07:47):
this uncertainty out there.
And stocks were just tooexpensive with all this
uncertainty out there.
Ryan (07:49):
So, dave, to your point, when you look at sectors of the
S&P 500, I looked a couple daysago and eight out of the 11
sectors actually had positivereturns this year and the ones
that didn't were those sectorsinvolving the companies that
you're mentioning.
That are technology companiesor tech plus companies that are
spending all this money likethey're an industrial firm or an
(08:10):
energy company or somethinglike that.
So I think that's reallyinteresting, because you haven't
historically thought oftechnology companies as being
heavy spenders making bigcapital expenditures.
Do you think that that willcontinue going forward, or are
they going to have to getcapital discipline, like we've
talked about with the energysector, at some point?
Dave (08:30):
Sure, at some point you can't.
Microsoft, I think, made $85billion last year.
They say they're going to spend$80 billion on capital
expenditures.
Well, just two or three yearsago they spent about $25 billion
, $28 billion, and slowly theywere already spending 11%, 12%,
13% of their revenue on capitalexpenditures and this past year
(08:51):
or this year they're expected tospend closer to 22 or 23% of
their capital expenditures tosales.
So a massive increase.
And there's no different atMeta, it's no different at
Google, it's no different atAmazon.
And you start looking at thecash flow the best cash flow
companies in the world, don'tget me wrong.
But all of a sudden there's allthese other needs for cash
(09:13):
where investors are just sayingwe can just buy back stock, you
can reward me with dividendincreases, whatever it might be,
that's great.
Or you can make an acquisition,like Microsoft bought LinkedIn
and all kinds of uses to grow.
And now you're telling me it'sgonna be really capital
intensive.
Well, when you have capitalintensive businesses, those
assets depreciate and need to bereplaced.
(09:34):
So nobody knows the chips thatare going to come in 27, 28, 29.
Are we talking about justrecycling and having this 20%
plus capital expenditure torevenue ratio for the rest of
this decade, and that is givingjust some consternation to
shareholders about where do Iget the returns that I expected?
(09:54):
And that's where theuncertainty comes in in that
trade, in our view at least,when we look at all this data.
Ryan (10:00):
Yeah, I hadn't really thought about the depreciation
of some of those assets.
And especially when you'redealing with technology and
these really advanced chips andyou hear N hear Nvidia talking
about their new generation ofchips and you just wonder how
quickly, if those chips get muchbetter and continue to get much
better, you're gonna have toreplace them and that's a whole,
you could have a pretty fastdepreciation of those existing
(10:23):
assets if that's the case.
Dave (10:24):
Exactly and if you need to replace them, unless these
costs really come down, it'sgonna be a continued big
investment that didn't existjust a couple years ago for
those companies.
Ryan (10:38):
So I think a lot of the focus at least the narrative
focus this year has been as riskassets have begun to sell off
and people have gotten a littlebit anxious and nervous.
The narrative has been focusedon some of those things like
tariffs, whether they're thecause of the sell off or not,
but it doesn't seem like there'sbeen as much focus on some of
(10:58):
the things that could be comingdown the road, like extending
the tax cuts or maybe extendingthe tax cuts or potential
benefits of deregulation orthose sorts of things.
Do you think investors arepaying too much attention to
some of the near-term kind ofuncertainty, and when will they
(11:18):
start to give more credit tosome of the more optimistic
things that could be coming downthe road?
Dave (11:24):
Again.
I think a lot of that has beenbaked into stock prices.
Now we have come off the highsbut again at the S&P 500, you're
close.
Let's do it this way.
We're at 5,700 today.
Earnings forecast are for $261this year.
May that hold.
That'd be about 11% growth fromlast year's 235.
But next year's forecast is for$300.
(11:45):
That's another 12% or 13%growth.
Those are above-averageearnings.
That's another 12 or 13 percentgrowth.
Those are above averageearnings In a period of time.
We're not forecasting aboveaverage GDP growth here and yet
we have this forecast.
So maybe companies will beproductive that say they make
the $300.
Well, $5,700 today divided by$300 is 19 times the 25-year
(12:05):
multiple on the S&P 500, lookingforward is 17 times.
So if we may have two greatyears of earnings growth and
stocks don't go up from here atall, stay flat, you would have a
multiple of 19 times at the endof 2026.
So if you look at the marketcap weighted index, there's no
(12:26):
way to say, hey, we have somevaluation support here.
But the top heaviness of thisis the reason that we're seeing
this broadening out, becausethere is valuation support once
you get through stocks 200through 500 in the S&P 500.
Much cheaper basket of stocksthan the 29 or 30 times you're
(12:47):
paying for the top third of themarket, versus 17 times when you
get to the bottom 300 companiesthat make up a very small
percentage of the S&P 500 weight.
Ryan (12:58):
So for those podcast viewers who haven't seen the
Market Minute with McGarrel,it's something that you publish
once a month.
It's a short, one-page kind ofsnapshot of what your views are
on opportunities in the market.
And so this year you've beentalking a lot about momentum and
quality and those are kind ofthe best factors over the last
(13:19):
couple of years, and you saidsomething like you know,
three-peats are rare when itcomes to factors.
So when you look at all thedifferent factors that you know
our research team uses to buildportfolios, where do you see
opportunities?
Dave (13:33):
Sure, when you think about 2023, quality was the best
factor.
The reason is because in 2022,when the market got routed down
18 percent, growth stocks down30 percent a lot of good quality
growth stocks fell hard thatyear we got.
The worst factor in 2022 wasquality.
(13:54):
The best factor in 23 was thisrebound Things were better than
expected, higher rates didn'thurt the market and its earnings
growth significantly and we sawquality rebound and be the best
factor.
Then last year, quality was thesecond best factor.
And so you look this year andthen you look back at a jelly
bean chart to say let me see allthese factors low volume value
(14:14):
and a smaller size in momentumand you look at those factors
and you do not see anythree-peats Nobody.
Three years in a row, like 98,99, momentum was the best factor
.
Everybody was invested inmomentum and how did momentum do
in 2001?
The worst factor both years.
So it's very difficult tothree-peat.
(14:37):
You know the joke is askPatrick Mahomes, right, ask the
Kansas City Chiefs.
It is not an easy feat.
And the deal with quality isbecause at the end of 2022, the
quality factor is because at theend of 2022, the quality factor
, which typically trades at aslight premium to the S&P 500,
actually fell to a 12% discount.
(14:57):
Quality the easiest thing topurchase a quality basket of
stocks was at its biggestdiscount since 2000 on the chart
that we have, and even earlierthan that I had never seen a 12%
discount on quality stocks.
And so what did we do?
We took those quality stocks,we drove them to a premium of 9%
on February 19th and now we'reback to about a 4% premium.
(15:18):
So quality isn't on sale.
It's not as expensive as it wasjust a few weeks ago.
You can buy a quality basket ofstocks, but you don't want the
concentration risk in some ofthe names that are very
expensive and still qualify asquality stocks.
We're going to see differentfactors value, perhaps, maybe
low volatility.
(15:39):
Although they work as a bondproxy, we don't really need a
bond proxy today where rates are.
But you've seen healthcare,you've seen staples, financials
at the top.
I think if we avoid a recessionhere, even if we slow growth
down, that you're going to seethe cyclical sectors hold up
financials and industrials.
They have a lot of avenues forgrowth with the AI build-out on
(16:01):
the industrial side.
Financials one of the crownjewels of our economy are our
big banks and our insurancecompanies.
Those are USA crown jewels.
They have massive amounts ofcapital, they have phenomenal
businesses worldwide and they'rejust dominant companies and
(16:24):
they have a bunch of differentavenues for growth.
If you're the big banks, youhave investment banking.
It's slow because of theuncertainty, but at the same
time, think about the volatilityof the last 20 trading days and
what that does for all thetrading desks at a JP Morgan, a
Morgan Stanley, goldman Sachs.
They're going to have aphenomenal quarter when it comes
to that and invariably, everytime something isn't working say
(16:47):
mortgage underwriting,something else is working for
those banks and when everythingcomes together, that's when they
make just a massive amount ofmoney.
Ryan (16:55):
So you like the cyclicals, the financials, the industrials
.
When you think about what theFed is doing and where we are
with interest rate policy, whatimpact will that have on stocks,
whether it's the sectors thatyou mentioned or just overall?
Do you think that rates areabout where they're going to
(17:16):
stay?
Are we going to be in kind of ahigher for longer environment,
and what are some of theimplications?
Dave (17:21):
Sure, I certainly think higher for longer.
We're not going to see zero,hopefully anytime soon.
I think in a very long time, ifever we're going to see that
zero interest rate policy.
The market maybe three, four,five months ago was thinking the
Fed had cut two or three times.
I think right here, with thenext move still viewed by the
(17:43):
market as lower than today iswhat's most critical.
If the Fed indicates in any way,shape or form and the market
gets in it, the Fed might haveto raise rates, mostly because
of inflation, and in our viewthe market's gonna get creeped.
Okay, that is not beneficial tohousing, which is a huge part
of the economy.
It's not better for individualsto go out and get debt to
(18:06):
purchase cars or any otherdurable goods, and higher
interest rates, or the threat ofhigher interest rates will take
this market down significantly.
On the other side of things, ifthings do get weak and even if
we don't go into a recession andwe see GDP growth slow and the
economy struggle a little bit,the beauty of where the Fed is
(18:30):
today is if inflation is undercontrol, not getting worse,
coming down, the Fed's got 450basis points at their disposal
so they could cut 25 basispoints, signal that they'll cut
if they see continued weaknessand that will spoil the market
and give the market anopportunity to go higher here.
I don't think we're going to seea 20% market.
(18:51):
If we ended this year and wewere close to 6,000 from 5,700
today and you get your 1.5%dividend rate or whatever in the
S&P 500, I think that would bea pretty good year after two
fantastic years in the equitymarkets.
And if rates are still expectedto stay here or go lower, I
don't think that'll be animpediment to the market going a
(19:14):
little bit higher from here.
Ryan (19:16):
Yeah, it's interesting because it doesn't seem to me
that businesses are going toreally change the way that they
do anything if they expect ratesto drop 25 basis points, 50
basis points by the end of theyear or something like that.
That doesn't seem like it wouldinfluence the economy or
decision making in any real way.
Dave (19:33):
Yeah, I'd agree.
I don't believe there's.
We have massive profitabilityin the S&P 500 today.
Better profitability if we missearnings and don't do 261 this
year, we'll do 250.
It'll be the best earnings inthe S&P 500 history and it will
be about 60% or 70% higher than2019, which had been the best
(19:56):
year before four consecutiveyears of putting over $200 in
earnings in the S&P 500.
So it's pretty amazing theprofitability.
Maybe there's some relation toCOVID and what companies learned
then at the expense level.
Maybe it's fiscal monetary toCOVID and what companies learned
then at the expense level.
Maybe it's fiscal monetarystimulus and it's sticking
(20:16):
around for a really long time.
That's probably some of it.
But we've seen massive earningsand companies just have the
wherewithal to do a lot withthose earnings if we hit
anywhere close to the expectednumber this year.
So we've got a really good setof companies and a really
significant earnings profile outthere and if we see earnings
(20:37):
keep going up, you know stockscan actually, you know, make
slight gains this year, evenwhere the valuation is.
Ryan (20:46):
So Westbury talks about the embers of inflation and you
know the possibility thatinflation does kind of roar back
to life and you mentioned thatif the market perceives that the
Fed is going to have to raiserates, that we could have some
level of sell-off.
Where is the tipping point, Iguess, in your view?
(21:09):
What level of inflation is theFed really going to sit up and
pay attention like, oh boy, webetter shift our stance, because
it seems to me that they wouldbe very hesitant to want to
change any stance at this point.
Dave (21:24):
Oh, absolutely.
It would have to be data-drivenand they would have to see an
uptick in inflation.
It's as simple as that.
It would have to start going.
I think if it plateaus or sitshere and just moves around a
tiny bit right around where itis today, in the 2, 2.8,
wherever it is, they'll assumethat with rates where they are,
(21:45):
with some of that stimulus stillcoming off, that we'll see a
continued decline, even if ittakes a lot longer than they
might have hoped.
But if we get some prints thatstart seeing higher numbers and
they might say it's temporaryagain.
But they're gonna be very, verycautious there when it comes to
lowering rates from here.
(22:06):
But also to your point, man, dothey not want to raise rates?
It means they cut them too much.
It's that simple.
Ryan (22:16):
The other thing that I've noticed this year and maybe it
goes hand in hand with thebroadening trade or the
broadening market is that theinternational equity markets
have done better, and some ofthat might have to do with
movements in currency orsomething like that.
But how do you look atinternational stocks this year?
Is that an opportunity?
They are historically cheap,but maybe that's because of some
(22:39):
level of risk.
How do you look atinternational stocks?
Dave (22:41):
Sure, you could see that Europe is having a great year so
far in the first two and a halfmonths I don't know depending
on which market somewherebetween 8 and 14 or 15 percent.
Is it because they're going togrow faster in Europe than the
US?
No, we're still expected to goGDP growth generally below 1
percent.
But you know, their bankingsystem has been atrocious and
(23:04):
maybe that catalyst for whyEurope is doing better in some
regard in that sector is theCredit Suisse acquisition by UBS
.
And, all of a sudden, if youlook at a basket of European
stocks, they've been fantasticover the last year.
They've outperformed the MAG7over the last year.
European financials, and theyhave some really good financial
(23:27):
companies that finally, 15 yearsafter the 08-09 crisis, have
gotten their balance sheets inorder, their capital in order,
and there's this little bit of agroundswell that you can see
and that's with those financialssaying we can compete with some
of those big American banks.
And it's the energy companiessaying we've been left behind
(23:49):
with moving into, you know,green energy too quickly.
We always kind of knew thatfossil fuels were going to be
around for a long time, but wetook our foot off the gas and
now Shell and BP.
They're talking about puttingtheir foot back on the gas and
realize this is a longtransition.
So they're getting the messagefrom their shareholders that the
reason our stocks are doing sopoorly is because your earnings
(24:10):
growth is not good, getting themessage from their shareholders
that the reason our stocks aredoing so poorly is because your
earnings growth is not good.
And the way you get earningsgrowth is give the consumer what
they want, and right now it'sstill fossil fuels.
The banks have recovered, soEurope is not in a better
position than the US.
However, to your point, usuallywe enjoy a 15 to 20 percent
(24:36):
premium to European equities,international equities in the US
.
American exceptionalism, bettermargins, better regulations,
typically.
Ryan (24:48):
Different mix of industries as well, Of course
yeah, we have a much widerspread.
Dave (24:52):
We have the technology footprint.
We deserve that premium, but ithad gotten outlandish.
It was absurd how cheap therest of the world is versus the
US and I always kind of take astep back and realize we hit way
above our weight.
We got 4% of the world'spopulation, 24% of the world's
(25:13):
GDP, but 76% is somewhere elseand they're trying to improve
their lives every day and growtheir net worth and better lives
for themselves.
And I think, at these prices,investors just woke up and said
if we're going to get a marketthat's not just led by seven
stocks, it's going to be broader, it's going to be small, mid
(25:34):
value growth and eveninternational at this point
where there's some pretty goodopportunities.
Ryan (25:40):
Germany just made an announcement that they were
going to increase spending quitea bit.
I think they have somethinglike a 500 billion euro or
dollar I'm not sure whichspending package where they're
going to increase spending ondefense and on infrastructure
and on some other things.
Do you think and I've noticedthat you know the German equity
market has done fairly well asthat announcement has come out,
(26:03):
but do you think that that hassome level of I don't know
stimulus that will maybe helpsome of the equities related to
that?
Dave (26:12):
I do.
I think it is Europe waking upand saying how do we compete?
And the way we compete is toinvest.
You know they're actuallycutting rates over there.
The ECB's cut, I think, acouple of times this year in the
last six months or so and we'vebeen stagnant on our interest
rates at the Fed level.
So there's some I thinkeverybody's too scared because
(26:34):
of all the false alarms over thelast five to 10 years of oh,
there's little green shootscoming up in Europe and they
never materialize and maybe,knowing that our administration
is going to deregulate, they'regoing to be pro-growth.
Now, whether it works or not,that's their intent and Europe
is gonna get left further behindif they don't have some of that
(26:54):
approach going forward.
And I think you've seen kind ofthe new US administration
spurring the rest of the worldsaying to compete, we're going
to have to actually step up ourgame and I think that's what the
market saw, has seen, with thisdouble-digit rise in European
equities in the first two and ahalf months of the year.
Ryan (27:19):
Yeah, it seems to me that most investors that have
allocated to internationalstocks, unless they're
rebalancing on a consistentbasis and I suspect that those
that are using a financialprofessional to help them manage
their money, yes, they're mayberebalancing, but there's a lot
of people that don't rebalanceand I think there's a lot that
are underweight, probablyinternational stocks.
They're probably underweight alot of things apart from US
growth, and so that seems likewould be a source of funds to
(27:43):
maybe buy some of these areasthat we've been talking about.
Dave (27:46):
Yeah, it really speaks to diversification right Again.
This year, you know, in thefirst two months, health care is
the number one sector.
After the prior two years itwas right at the bottom.
Energy is near the top.
It was lousy the last couple ofyears.
Consumer staples are doing finethis year.
Financials are doing prettywell the first couple of months
(28:09):
of the year, and sodiversification is perhaps
boring to too many investorswho've just seen this rise in
tech or tech-related names andgenerating returns on an Nvidia
that goes from $500 billion to$3 trillion.
Ryan (28:25):
That's not normal.
Dave (28:26):
Normal is a much lower rate of return than what we
enjoyed in 23 and 24.
And risk positioning is going tobecome more prevalent in
portfolios.
There's a lot of portfolios.
When you do an x-ray, a lot ofinvestors would say, wow, I
(28:47):
can't believe I have a beta of1.2.
That was never my intent, butwhat's happened in the markets
is everything skews towards thetop.
Remember, if there's 36% and 10names at the top of the S&P 500
, there's only 100%.
So if we put more at the top,where's it coming from From all
the other companies that aretowards the bottom of that S&P
(29:07):
500.
So companies that might havehad a 10 or 12 basis point
weight in the S&P 500 10 yearsago might only have a 5 or 6
basis point weight, even iftheir stock's done fine.
We just put so much multipleand so much weight at the top of
the index.
It doesn't mean those aren'tstill really good opportunities.
Ryan (29:25):
Well, dave, I'm looking at the clock and time once again,
has flown by.
My final question for you iskind of a retrospective
philosophical question for DaveMcGarrel, as you manage a big
department of research at FirstTrust, as you're talking to
younger analysts and portfoliomanagers just coming up, what's
(29:47):
the most important piece ofadvice that you would give them?
Dave (29:50):
Sure, I'll talk to old people who've experienced a
market that is different than, Iwould say, the last 15 years.
Covid was a hiccup.
08-09 was devastating, and so Imean 08-09 was as tough as you
can experience.
98-99 was just a valuationstory.
(30:11):
That's certainly caused bearmarkets and people lose a lot of
money, but 08-09 and the powerof leverage was in full view at
that point in time and marks onassets liquidity were big issues
.
We have not seen any eventslike this.
(30:32):
Liquidity were big issues.
We have not seen any eventslike this.
I'm not asking for one, buteverything is easy when the
market's going up like it's beengoing the last couple of years,
when there's that muchliquidity, when anybody can
raise capital regardless of whatthe asset looks like, when
people are willing to take riskeven if it might not be a great
(30:54):
risk-reward scenario and we'veseen all of that and I think
we're just in for a differentmarket.
And compound interest over time.
That's how you make a lot ofmoney.
Timing the market seems reallyeasy, and when it goes the other
way, when you break stride,it's really hard to win the race
(31:15):
.
We broke stride here the last20 trading days.
I think we're in for a differentmarket Doesn't mean we need to
get creamed.
Earnings got to hold up for themarket to make small gains.
But the way you make, howperform in a market that gives
you small gains, is gettingdiversified and owning, at
points in time, internationalstocks or small cap value stocks
(31:38):
when they hadn't done anythingfor a long time and you get it
really concentrated in a briefperiod of time.
And if you don't have any ofthat, if you're way underweight,
then you have to make adecision.
Do I chase that?
Is it real?
And that's a really harddecision to make.
It's much easier, thinkingabout where we sit today,
thinking about the rest of thisdecade, to say, if we get 8% per
(32:01):
year on average through the endof 2029, 2030, that'd be a
great return for equities fromwhere we start, especially if we
just look at the SP 500, tooutperform that.
You can use some other toolstoday to de-risk your portfolio
from the concentration in theS&P 500, but also to outperform
(32:21):
that index if we don't see thesame exact story we've seen,
which we don't expect to see, in2023 and 2024.
Ryan (32:28):
All right, Dave, thank you for that perspective Overcoming
recency bias is how I wouldencapsulate a lot of your
comments there.
Dave (32:33):
But, as always, thank you for that perspective Overcoming
recency bias is how I wouldencapsulate a lot of your
comments there.
There you go, sure.
Ryan (32:35):
But, as always, thank you for joining us on the podcast.
We'll look forward to havingyou on at some point later this
year, hopefully.
But again, thank you forjoining us and for your insights
.
And thanks to all of you forjoining us for this episode of
the First Trust ROI Podcast.
We'll see you next time.
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