September 22, 2025 • 34 mins
Dave McGarel discusses potential winners and losers in the equity market as the Federal Reserve embarks on a new interest rate cutting cycle.
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Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 2 (00:09):
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.
Equities are relativelyexpensive today.
Dave and I are going to lookunder the hood at the US equity
markets to find pockets ofopportunity amidst the risk.
We're also going to talk aboutopportunities amongst factors,
(00:33):
sectors and internationalmarkets.
Thanks for joining us.
All right, dave McGarrel, weare at the beginning of fall.
I can't believe the summer isalready over of fall.
I can't believe the summer isalready over, but I wanted to
get some updates on you, on yourperspective, maybe through the
(00:53):
rest of this year, 2025, andheading into next year.
So one of the things that youwrote about recently was you
talked about valuations in theoverall market and maybe areas
of opportunity as a result ofovervalued stocks versus
undervalued.
What's your take right now?
I mean, obviously the S&P 500is pretty expensive.
Would you agree with thatstatement?
Speaker 1 (01:14):
first off, oh sure, there's no question about it.
We're a standard deviation orso above that, 17 times over the
last 25 years or so.
So at 22 times the next 12months, you could talk about a
market that maybe not overvaluedbut certainly fully valued, but
again with consideration thatit is a market cap weighted
index and you have 10 stocks atthe top of that index that are
(01:37):
highly priced and comprise a bigpercentage of the weight of the
index.
Speaker 2 (01:44):
Well, and there's a lot of stocks in that large cap
basket, in the S&P 500, that arestill pretty cheap.
Those value stocks are prettycheap, but the question is, will
they get more expensive?
Speaker 1 (01:59):
Sure, and we've seen actually some of that.
We've seen some broadening outthis year after two incredibly
narrow years where less than 25%of the S&P 500 stocks
outperformed the index both in23 and in 2024.
And even go back to 1998 and1999, a very narrow market we
did not see that kind ofnarrowness this year.
We're close to 44%.
(02:20):
The longer-term average isabout 46% of the stocks in the
index outperform the index inany particular year.
So we've gotten closer to theaverage this year and you can
see that just in the sector,exposures, technology and
communication services are stillnear the top, but so are
utilities and industrials andfinancials, with double-digit
returns in the first eightmonths of the year.
(02:42):
So you definitely have seen themarket start to broaden out a
little bit and those stocks havebroadened out because they've
had some earnings but alsobecause we have started to
assign some higher multiples tothe rest of the basket, not just
the top 10 stocks in the S&P500.
Speaker 2 (02:57):
Why do you think that is?
Why are we all of a suddenstarting to see some multiple
expansion in the rest of themarket?
Speaker 1 (03:07):
Sure To your first point overvalued market.
Well, let's call it fullyvalued, especially the MAG7 type
of names, and those stocksclearly have benefited from
significant multiple expansionfrom really deep lows in 2022.
But when the S&P is up 75% in 32months and a lot of that's
coming from the big seven stocksat the top we've seen that
(03:28):
multiple expand quite a bit.
This is the first time themarket is starting to consider
the Fed cutting rates, and ifthe Fed does cut interest rates,
then you've got to questionwho's the beneficiary of that.
Well, I don't think it reallymatters to Apple or Nvidia or a
lot of the other names that arecash rich, that don't need debt,
(03:50):
that actually are in a netpositive position when it comes
to interest income or interestexpense, which is unbelievable
when you really think about it,because they carry a lot of debt
but they have so much cash ontheir balance sheets.
But the rest of the market as wemove through the S&P 500 into
mid-cap territory, where capitalis more expensive or they might
have floating rate capital andthe Fed decides they're going to
(04:14):
cut interest rates to spureconomic development.
That's got to be beneficial toa lot of the cyclical stocks
which make up the latter half,if you will, the other 250
stocks at the bottom of theindex that comprise a very small
weight in the index but have amuch better valuation state than
the top of the index.
Speaker 2 (04:32):
So maybe some rotation out of the largest
stocks into the rest of theindex.
You think that's taking place?
Yeah.
Speaker 1 (04:39):
I think there has been some rotation the last year
or so, last 12 months or so,but it's really just been going
away from the MAG-7 a little bit, especially this year, but into
the best names in the world,whether that's JP Morgan look at
their returns Costco, walmartphenomenal, best-in-class
businesses.
But we've taken those multiplesof those top 50 to 100 stocks,
(05:04):
the biggest names in the index,to multiples that are
historically high compared toany time you looked at them in
the past.
A Costco is trading closer to50 times their average over the
last decade is closer to 35times.
Is it the best retailer in theworld?
It's one of the top threeAmazon, walmart and Costco but
(05:24):
keep in mind it's always beenthere.
So why are we paying so muchmore?
And I think it's just investorssaying, well, I want the best
names.
It might not be the bestreturns going forward,
especially if there'sbeneficiaries of interest rate
cuts that are not in the top 50to 100 stocks.
Speaker 2 (05:41):
So earlier this year there were some companies that
maybe suspended guidance orpulled guidance as a result of
the uncertainty related totariffs.
Is that certainty coming backto some of those companies, you
think?
Speaker 1 (05:56):
I'm not sure.
If there's certainty, it's anexcuse for some companies when
they miss their numbers, butthere's certainly their numbers.
But there's certainly, there'sless it's not as new right so
it's not right on top, justbecome accustomed to it.
Yes, and the market hasnavigated it so far.
Most companies have not hasn'tbeen broad A reckoning of.
(06:19):
Tariffs are hurting profitsacross the entire index.
The index earnings profile forthis year is not very different
from where it started the year,so it hasn't had that kind of an
effect.
The market is getting a littlebit neutral towards it and
waiting to see evidence that thetariffs are actually hurting
both revenues and profit margins.
Speaker 2 (06:40):
So I know you're not a policy analyst necessarily,
but you do have to pay attentionto some of these things like
tariffs.
Recently there was a ruling bythe court that said that some of
the tariffs were actually maybeillegal and then maybe you
would have to go to the SupremeCourt.
I just wonder, with that sortof back and forth legal, illegal
(07:03):
, certainty, uncertainty it justseems like it's a really
difficult environment tounderstand what earnings are
going to do and how do you dealwith that as an analyst?
Speaker 1 (07:14):
Sure, I mean.
First of all, you get signalsfrom the market.
The market has, after April 2ndthrough April 8th when we lost
18 or 19 percent on the S&P 500,has reconciled that President
Trump likes the stock market.
He wants the economy to thrive.
We have midterms coming nextyear, so anything he does is not
(07:34):
going to be to impede thateconomic development.
So the market has kind of putthat on the back burner and
effectively, in our view, saidif we don't see direct evidence
that this is going to affectearnings going forward, we're
not going to put that in thestock prices.
Now maybe that's a little bittoo Pollyanna that President
(07:55):
Trump can come to the rescueevery single time something goes
the wrong way and respond tothe market where the market says
thank you, but so far that'sbeen the case and there's no
reason to get in front of thattrade in the market's view right
now or in our view becausethat's what's happened every
single time.
The market has been confused,uncertain.
They've said okay, we know theintentions of this
(08:18):
administration.
At least they think they knowthat it wants a thriving economy
and a thriving stock market.
Speaker 2 (08:24):
Yeah, well, and the other part, I guess, of
valuations and figuring out whatsomething's worth is, what the
discount rate is, what Fedpolicy is, and the
administration has really notbeen shy in trying to nudge the
Fed, if that's the right word,to lower rates.
Where do you think we end up bythe end of the year?
Are we going to see a couplecuts?
Speaker 1 (08:44):
Well, almost certainly in September 1.
You know you could expect maybeone more by the end of the year
.
There's Fed governors variouscoming out and saying maybe
three or four or five throughthe middle of next year or
throughout next year.
We've already seen a 100-basispoint cut from the highs, 550 to
450.
So another 100 basis points toget us to three and a half.
(09:05):
And again, in our view, thebiggest beneficiaries are going
to be companies that benefitmost from lower interest rates
on their bottom line and theiraccess to capital at a cheaper
cost.
And that's as we get into midcaps and small caps and smaller
large caps, not really thecompanies that are so strong at
(09:26):
the very top of the index butpriced at a valuation level that
really doesn't we call ithitting their heads on the
ceiling.
How much more can we pay forthose companies that are the
best in class when we alreadyhave them at historic highs
compared to their earnings andtheir outlooks?
Speaker 2 (09:42):
compared to their earnings and their outlooks.
So the differential between thegrowth of those biggest
companies that really grewpretty well over the last couple
of years compared to thesmaller mid-cap stocks and even
some of the value stocks in themarket, it seems like that
differential in growth is goingto, or at least is expected to,
decline over the next couple ofyears.
Is that still your expectation?
Speaker 1 (10:02):
That's true the expectation for 2025, only a
couple months left, but it'snarrowed between the haves and
have-nots when it comes toearnings growth, and this year
for 2025 is still very extreme.
Cyclical is growing 2% or 3%,tech Plus growing 22%.
But next year, as you look atcyclicals, 13% growth.
(10:22):
And then you look at tech plus18% growth.
So much tighter.
And then when you think about26, I'm sorry, 27, you're tight
as well.
So much less disparity inearnings growth between cyclical
stocks and tech plus stocks.
(10:43):
But the valuation gap is 29times for that tech stack and
closer to 18 or 19 times for thecyclical.
So financials and energy andindustrials those kind of
companies showing much bettergrowth expected next year.
Same thing as we move down insize whether that's mid or small
(11:04):
caps after basically nothing toshow for growth this year,
starting to see small caps haveexpectations of faster growth in
2026.
And that valuation gap is justso extreme.
That's why you feel that youcould broaden out and see those
come closer to each other.
Speaker 2 (11:20):
Are there any specific sectors in the US
markets that you look at and say, okay, the earnings growth is
going to be there, but it'sstill trading at a pretty
reasonable valuation?
I'm sure you have certain otherthings that you look at besides
that, but are there any sectorsthat you think are particularly
attractive?
Speaker 1 (11:39):
Sure.
Again, it does go back to thatcyclical story.
So financials are one,especially when you get into
maybe not the top banks.
They're still relatively modestcompared to the market.
Even the best bank in the worldtrades at 16 times and the
market's at 22 times, butfinancials always traded at a
lower multiple than the entireS&P 500.
But the value stocks in themarket as you move down through
(12:03):
a lot of those industrials, someof those energy companies,
again with really nice balancesheets, and now, if they do show
that kind of growth goingforward, a lot of these
companies in the bottom 250 ofthe S&P 500, in that industrials
, in the financials, regionalbanks, very cheap still, Perhaps
some M&A activity in that space, Certainly better regulation
(12:28):
and again, if that curvesteepens, a little bit
beneficial to those banks aswell as we move forward.
So the financials industrials,maybe even some of the energy
companies.
That's always dependent on OPEC.
But the nice part about energytoday is the quality of the
balance sheets has never beenwhat they are and the technology
to get energy out of the ground, whether that's oil or natural
(12:51):
gas, continues to make them alot more beneficial to their
margins and a lot moreproductive in getting those
assets out of the ground.
Speaker 2 (13:02):
So there's been a lot talked about the CapEx cycle
for those tech plus companies,especially the hyperscalers, who
are investing tens, if nothundreds, of billions of dollars
in their data centers.
Do you think there's a sort ofdownstream effect on the rest of
the economy because of thatspending, maybe in some
(13:22):
industrials or the financialsthat are?
I guess financials aren'tnecessarily financing that.
A lot of these companies have aton of cash that they're able
to spend, but what's thedownstream impact on the rest of
the economy?
Speaker 1 (13:34):
Yeah, Sure, I think it's been massive the last 12
months or so.
We're talking about $350 billionfrom four companies in capital
expenditures, a lot of thatgoing to AI and infrastructure,
and that's everything from airconditioning units to electrical
components, building supplies Imean these are massive, massive
(13:57):
data centers supplies.
I mean these are massive,massive data centers.
So that data center that Ameddais building in Louisiana will
be the same size as Boeing'smain production facility in
Everett, washington over 4million square feet.
Well, that takes all kinds ofdifferent industries to
participate in building abuilding of that size and then
retrofitting that building withall the steel and robotics and
(14:19):
everything else that will comeinto play there, and so that
benefit has really come throughthe rest of the market.
Those companies don't have thebest margins compared to the
tech companies, so you're nottalking about businesses that
have changed forever, and that'swhere I think you got to be a
little bit worried.
If that spending slows down,we're going to see that
(14:41):
infiltrate a lot of thecompanies that have done so well
, both at the very top but alsoin the second derivative, if you
will, of this massive,unprecedented spend that's
primarily directed at AI and AIinfrastructure.
Speaker 2 (14:56):
So the project that you referred to in Louisiana
from Meta, the $10 billion orsomething they're spending have
you seen how they're going topower that?
Speaker 1 (15:06):
They haven't seen how they're going to power it.
Well, what they said?
Speaker 2 (15:09):
the reason they chose Louisiana instead of choosing
Silicon Valley or something likethat, is because they're
building three natural gas firedpower plants in Louisiana, and,
of course, louisiana has gotplenty of natural gas and the
infrastructure is there.
So do you think?
My take is that we'll probablysee more of that with trying to
(15:30):
figure out how to power thesedata centers.
What do you think about that?
Speaker 1 (15:33):
I think that's true.
I mean, obviously, power is theissue with these data centers.
They can build them all daylong.
They do have those cash flows.
They can use all their cashflows.
Those four hyperscalers areprobably using 75% of their cash
flow this year on capitalexpenditures, which is typically
they use about 30%, and theyunderstand that if you're going
to build this kind ofinfrastructure, you need to
(15:55):
power it and right now themarket is most curious about
where all this power is going tocome from.
So finding solutions.
I know Amazon signed a dealwith a utility company, so
they're not naive.
They believe that this is apath forward.
We'll see if this spendactually has the economics
(16:17):
attached to it on the other sideof it, but clearly they're
thinking about everything rightnow as far as building and then
powering these massivefacilities in the latter part of
this decade that should open up.
Speaker 2 (16:34):
I just was reviewing some data from the Energy
Department about powerproduction, where it's planned,
you know, planned capacity overthe next five years and, believe
it or not, there was only oneline.
That was nuclear power, oneproject.
It seems to me that at leastwhat people are talking about is
an expansion of nuclear power.
(16:56):
Maybe it's just because I waslooking at the next five years
and you know, and year six andfollowing it's going to be
nuclear.
What do you think?
Is that likely to happen?
Speaker 1 (17:04):
I think that is likely to happen.
I'm no expert on nuclear.
I do know that that's beencertainly discussed.
It seems to be getting trending, if you will.
It seems to be getting a lotmore notice and the viability of
that, even through much smallernuclear facilities, which is
what's expected.
That may be the way forward fora lot of these companies.
(17:26):
So I would not discount that inany way, shape or form.
Speaker 2 (17:29):
Yeah, you mentioned something a second ago that is a
big question on my mind as well, and that is who benefits from
some of the efficiency gains andthe productivity gains from all
these CapEx investments, allthe money that's pouring into AI
?
Who's actually going to be ableto extract some value and maybe
improve profit margins orproductivity or something like
(17:50):
that?
Any thoughts there?
Any particular sector orindustry that you think will
benefit?
Yeah, I think at the end of theday.
Speaker 1 (17:58):
AI, I think everybody believes, will be spectacular
in so many ways help improve allof our lives and productivity.
There's little doubt about thatin most minds.
The question is, does it havethe same sort of?
There's been iterations here ofquestions about the
(18:18):
profitability and where it sitsat the end of the day, and the
hyperscalers think if they buildthese big warehouses they'll
get all the profitability.
And yet we saw the deep seeknews in January where NVIDIA
fell 17% and company in Chinasaid we have solutions for AI
and the utility of it that don'trequire this kind of capital
spend.
And then there's a recent MITpaper I'll let everybody read it
(18:41):
that says hey, so far wehaven't seen anybody really
benefiting from AI and theproductivity.
And there's other researchreports saying well, ai is
different because there's nonetworking capabilities around
AI like you would have withFacebook, where everybody has to
get on Facebook to communicatewith each other.
But AI might be disparate andall kinds of different companies
(19:01):
might benefit from AI and myhope is that what AI really does
is not just send profits at thetop of the infrastructure of AI
, but down into the businessesthat can actually be much more
productive not necessarily bylowering their headcount
dramatically, but expandingtheir business because they're
(19:22):
getting so much efficiencies todo what they do and doing things
better, whether that's in thehealthcare space, the financial
space, the energy space, andthat's where, if you really
think about going forward four,five, six years out, it appears
that there could be somesolutions there that will be
incredibly valuable to societyand to those businesses.
(19:44):
You know we discount everythingthat's happened because of
something that's exciting goingforward.
But think about all thetechnology and the improvements
are subtle.
But you know I have kids whodrive.
They never get lost becausethey have a map on their phone.
So there's less gas used,they're not in any danger,
they're not confused, they'renot late for an appointment.
(20:06):
We take that for granted.
But think about how fantasticthat's been for a route that
will take a truck driver lesstime to get there, to deliver on
time or to save fuel to deliveron time or to save fuel.
So little pieces of this showup everywhere and it's really
(20:27):
hard to forecast exactly when wewill see a full picture.
It'll be little iterations overtime, just like every other
technology that improve ourlives, and when we look back
we're like, oh, it wasn't alwayslike that, was it?
Speaker 2 (20:33):
Yeah, little changes that you don't notice.
And then you wake up and sayI'm not getting lost in my car
anymore, because I've got GPS.
Speaker 1 (20:40):
Yes, and 30 years ago , when I was driving, I got lost
constantly.
Yeah, exactly.
Speaker 2 (20:46):
Yeah, that's you know .
I think that's how innovationgenerally works.
It makes you more efficient,more productive in something
that you or maybe repetitivetasks that you don't want to
focus on and frees up creativityand innovation to be able to do
things that we haven't eventhought of yet.
Speaker 1 (21:01):
That's every piece of technology we've ever used in
our research group and ourbusiness is being able to
analyze more instead of justtrying to continually import
data, sort that data andunderstand the data.
Make sure we have the rightdata.
So if we can continue toimprove on that, we can be way
more productive in selectingportfolios and understanding
(21:25):
companies without having to doso much legwork ahead of time
before we get to the analysisstage.
Speaker 2 (21:32):
Okay, so one of the things that our research group
at First Trust pays a lot ofattention to is factors, and
factors being things likemomentum, or we've talked a
little bit about value or yieldor quality.
As you think about some of thedifferent factors that we pay
attention to at First Trust, arethere any things that stand out
to you, anything that looksparticularly attractive?
Speaker 1 (21:54):
Sure, one of the reasons that we've had a massive
rally in the last 32 months 75%of the index is because the
quality factor was at thesteepest discount it's been
since 1995.
Quality typically trades socompanies with high ROEs, great
balance sheets.
Those companies typicallytraded a slight premium to the
(22:15):
S&P 500, about 2%, and they gotto a 12% discount at the end of
2022.
A lot of big tech companieswith high returns on their
equity.
22 was just 30% lower on growthstocks.
So that quality factor wasalmost a free lunch.
If you look back, we got to buyquality stocks, the best stocks
in the world at a massivediscount.
(22:37):
In fact, the S&P was at 15.5times.
So you want to know why the S&Pis up 75% in two years and
eight months?
It's because it was reallycheap.
So today, at 22 times, it's notso cheap.
But what is cheap are thosefactors that are not quality.
So lighten, rebalance andlighten a little bit of the
(22:58):
weight and quality.
You can still own them, butwhen it's such a big, big part
of that top-end market cap, lookat a value factor Now.
Value traded at a premium to itslong-term discount to the index
for a dozen years in earlyaughts, the mid-aughts, all the
way through 2012, 2014.
(23:20):
And then it started going to adiscount and it's at this big
discount to where it typicallytrades versus the S&P 500.
That's some of those cyclicalstocks that we talked about.
So value is probably the factorthat has the most upside
potential Dividends same, notquite the discount that you see
in the value side of it.
And then size smaller size,midsize.
(23:44):
That's at a discount to whereit typically trades when you
compare it to the S&P 500.
So if you had to take threefactors and say size, value and
dividends, get more exposure tothose factors, because what
happens is the market.
Long before you see the whitesof the eyes of a change in the
market, what you see is a rally,a re-rating in areas that look
(24:09):
attractive from a valuationstandpoint, trade below their
historical averages and ifevidence starts to show up that
they're going to be thebeneficiary, say, of rate cuts,
of an earnings profile thatlooks much tighter than it's
been the last couple of years,you'll miss a big part of that
rally if you don't get involvedin that sooner rather than later
(24:33):
.
Speaker 2 (24:34):
I think that's a really important point that you
can't wait until you see theimprovements already, because
everyone else in the market ispaying close attention and the
better valuations that you hopedfor will go away before you
have an opportunity to actuallyenter that trade.
Exactly, right, yeah, there'sno doubt.
So cheap stocks are cheap rightnow is what I heard you say.
(24:56):
The typical discount for valuestocks is what.
Speaker 1 (25:02):
It's about 18% to 20% from the S&P 500.
So it's a pretty big discount.
Today we're closer to 40, 35 to40.
Speaker 2 (25:08):
Wow.
So if you think about whatdetermines your returns for any
investment, it's what you buy itfor, what you sell it for and
any income you collect along theway.
So that first part's reallyimportant.
Speaker 1 (25:21):
Exactly.
Look again.
You know people can look backover the last 32 months, say
it's speculative.
Some of these companies whetherit's hype or hope or even some
evidence that they're going tobenefit from AI.
But most of that return wasforecast when we traded at 15.5
times earnings at the end of2022.
Now the market thought that wemight have a recession.
(25:45):
The Fed raised rates in 2022,early 2023, 550 basis points
Quickly, yes, in 13 months.
So the market said we're goingto have a recession.
We took all the stocks downquality stocks, everything else.
In fact, if I look at every100-stock bucket of the S&P 500,
the last 400 stocks all tradedat about 15 or 16 times earnings
(26:09):
.
Now they're closer to 16 or 17times.
They've grown earnings but weput multiples back on as if we
won't have a recession.
That's not our forecast, thatwe're going to say have a
recession imminently.
In fact, the Fed might even getahead of it with some rate cuts
.
But the valuation story nevergets notoriety, never is the
(26:30):
catalyst, but always shows upwhen you look backward and say
how did I get such good returnshere?
And it's from that startingpoint and unfortunately, today
we're in an S&P 500, we'rebuying just the top of the index
, the best stocks in the worldin our view, won't afford you
our performance of the index.
It's looking at the rest of theindex that will respond to a
(26:54):
Fed that's accommodative and avaluation story and an earning
story that is tight on theearning story and still very,
very wide on the valuation story.
So an opportunity there there'salways a reason why things are
cheap.
Speaker 2 (27:09):
There's just no doubt about that.
And one other area that's beencheap at least from a relative
standpoint for the last I don'tknow decade and a half has been
the international equity markets.
Finally, this year we've seensomewhat of a return of the
international stock market.
I think some of that's probablybeen just the dollar weakening
relative to the euro and someother currencies in the basket.
(27:32):
What's your take oninternational?
Do you think that's anopportunity today?
Speaker 1 (27:37):
Sure, there's no question that the dollar
weakness has been a big factorin those fantastic returns in
the international space,particularly in Europe.
I think there's a little bitmore there.
The valuation gap is massive.
Typically trade maybe 18 or 19percent in the US versus the
international.
We're at a premium in the US.
Technology explains a lot ofthat.
(27:59):
I think it can be wider thanthat long-term average of 18%,
simply because we have such aphenomenal technology footprint
which deserve to trade at highermultiples.
But we got to about 40 or 42%discount, which is two and a
half standard deviations belowthat 18% discount for the
international versus the US.
(28:19):
And yet what we saw this year,along with the dollar supporting
that trade, was that discountdeclined to maybe I don't know
38%, 39%.
It's still massively.
It's still two times what ittypically is.
So you can see when you re-ratean area in the market how much
(28:43):
return you can get in such ashort period of time, long
before anybody says, oh, now Imight want to get in Because the
difficulty is OK.
We don't see a better footprintin Europe than we see in the US
.
They don't have a better economythan we do.
They have had the ECB's cutrates I don't know seven or
eight times, so if that's a lag,they're going to start seeing
(29:05):
the benefits of that.
I think what we're doing herein the US, saying we're going to
focus on us, the US, and bemore competitive against the
rest of the world, is waking therest of the world up to saying
(29:26):
we need to step up our game.
And the third thing I would sayabout international, especially
Europe, is if you don't have abanking system, you don't have
anything.
You need capital Now.
The European banks are nowherenear as good as US banks.
Our banking system is a gem ofthe world.
It's the envy of the wholeworld.
It starts at JP Morgan and goesall the way through the
regional banks.
Europe, at least, is not in thesame spot they've been in the
last decade plus, which is abanking system that has no
(29:49):
transparency, not enough capital, no growth and way too many
other initiatives other thangrowing their earnings.
And I think that's been true intheir energy space, in their
industrial space.
And now I think, as you see alot of these CEOs speak, they're
saying, look, we can still dosome things that in our view, or
(30:10):
Europeans' view, is beneficialto the world.
But we need to grow our profitsand we need to make more money
and we need to reward ourshareholders and compete with
the rest of the world.
So even just a little bit ofthat can take that from 38% to
say, to 30.
Now you're talking aboutanother massive increase in the
value of your underlyingsecurity.
(30:31):
So I think it's definitely timeto have some international
exposure.
Speaker 2 (30:35):
So, coming out of the financial crisis, it seems like
a lot of the Europeans embracedmore of an austerity approach.
I mean, they're trying tobalance budgets, things like
maybe we would want to do herebut it seems at least some of
the rhetoric that has come outof places like Germany has been
more focused on okay, we need tospend, we need to invest in
(30:56):
defense and all these otherareas.
Do you think that plays a rolein the long term, or at least
maybe the near term for some ofthese companies?
Speaker 1 (31:02):
Absolutely, I think just what's coming out of the US
administration is you need todo more for yourselves.
We're not going to do as muchas we did in the past.
We're not going to provide allthat security and the financing
of all that security.
And I think they're gettingthat message, whether it's
Germany, whether it's the restof Europe, and if they rally
(31:23):
around that cry and say, okay,we need to produce energy, we
need to produce industrial goods, and we need to do this and
make profits so that we can thenprotect ourselves by spending
more money on defense, then Ithink that can lift that whole
basket and investors see just aslightly brighter outlook.
I don't even know that you needto see green shoots throughout
(31:47):
European economies.
It just needs to go in theright direction.
And that rate of change goingfrom stagnation or going the
wrong way and moving in theright direction I think can
really benefit stock prices muchfurther than they've come
already this year.
Speaker 2 (32:06):
One last question for you, Dave Book recommendations.
Is there anything that you haveread recently or that you would
recommend to the viewers of theROI podcast?
Speaker 1 (32:14):
Actually.
I mean, there's so muchpolitical wrangling everywhere
in the world, if you will, andcertainly in the US.
Mitch Daniels was the governorof Indiana for 10 years.
He served in some previousadministrations.
He had private sectorexperience at Eli Lilly he's
(32:34):
probably closer to 80 years oldtoday but then he became the
president of Purdue Universityand basically starting to
address some of the issues ofschools not delivering,
especially a school like Purdue,a phenomenal engineering school
on delivering students with thetalents to drive us forward in
(32:55):
STEM, and he really that.
So he was the president ofPurdue for 10 years, so he's
written several books.
He's incredibly smart,incredibly talented.
Probably would have been agreat president, frankly, in my
view, and because he's able tobasically bring people together
from both sides of the aisle.
But what he's really done isnever compromise his principles
(33:18):
and he's written all kinds ofarticles, columns at times for
different newspapers and andgiven all kinds of speeches and
they all are positive,optimistic, again, ivy, educated
but drives a motorcycle aroundand he stays at people's houses
throughout Indiana during hiseight years of governor in
(33:41):
Indiana.
And then at Purdue really turnedthe school, turned Indiana
around from deficits to budgetsurpluses, grew that economy
really revered by the citizensof Indiana.
And then at Purdue for 10 yearsdidn't raise tuition for 10
years in a row.
So he was and really got boththe students, the administrators
(34:06):
, the teachers to buy into hisphilosophy of let's teach these
kids STEM.
And again, just a greatAmerican and a lot of wisdom
along with a lot of wit in whathe wrote.
I think the book's calledBoiler Up, but it really
addresses a lot of his time bothas the governor and at Purdue
(34:27):
University.
So I think of him as just agreat American.
Anytime you read something fromgreat Americans, I think you're
a beneficiary of it.
Speaker 2 (34:34):
Well, that is a great recommendation.
Thanks for that.
I'll add that to the readinglist and thanks for coming on
the podcast.
Speaker 1 (34:41):
Absolutely, Thank you .
Speaker 2 (34:42):
Ryan, have you again, hopefully really soon.
Speaker 1 (34:44):
Sounds great Thanks.
Speaker 2 (34:45):
Thanks, and thanks to all of you for joining us on
this episode of the First TrustROI 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.
Equities are relativelyexpensive today.
Dave and I are going to lookunder the hood at the US equity
markets to find pockets ofopportunity amidst the risk.
We're also going to talk aboutopportunities amongst factors,
(00:33):
sectors and internationalmarkets.
Thanks for joining us.
All right, dave McGarrel, weare at the beginning of fall.
I can't believe the summer isalready over of fall.
I can't believe the summer isalready over, but I wanted to
get some updates on you, on yourperspective, maybe through the
(00:53):
rest of this year, 2025, andheading into next year.
So one of the things that youwrote about recently was you
talked about valuations in theoverall market and maybe areas
of opportunity as a result ofovervalued stocks versus
undervalued.
What's your take right now?
I mean, obviously the S&P 500is pretty expensive.
Would you agree with thatstatement?
Speaker 1 (01:14):
first off, oh sure, there's no question about it.
We're a standard deviation orso above that, 17 times over the
last 25 years or so.
So at 22 times the next 12months, you could talk about a
market that maybe not overvaluedbut certainly fully valued, but
again with consideration thatit is a market cap weighted
index and you have 10 stocks atthe top of that index that are
(01:37):
highly priced and comprise a bigpercentage of the weight of the
index.
Speaker 2 (01:44):
Well, and there's a lot of stocks in that large cap
basket, in the S&P 500, that arestill pretty cheap.
Those value stocks are prettycheap, but the question is, will
they get more expensive?
Speaker 1 (01:59):
Sure, and we've seen actually some of that.
We've seen some broadening outthis year after two incredibly
narrow years where less than 25%of the S&P 500 stocks
outperformed the index both in23 and in 2024.
And even go back to 1998 and1999, a very narrow market we
did not see that kind ofnarrowness this year.
We're close to 44%.
(02:20):
The longer-term average isabout 46% of the stocks in the
index outperform the index inany particular year.
So we've gotten closer to theaverage this year and you can
see that just in the sector,exposures, technology and
communication services are stillnear the top, but so are
utilities and industrials andfinancials, with double-digit
returns in the first eightmonths of the year.
(02:42):
So you definitely have seen themarket start to broaden out a
little bit and those stocks havebroadened out because they've
had some earnings but alsobecause we have started to
assign some higher multiples tothe rest of the basket, not just
the top 10 stocks in the S&P500.
Speaker 2 (02:57):
Why do you think that is?
Why are we all of a suddenstarting to see some multiple
expansion in the rest of themarket?
Speaker 1 (03:07):
Sure To your first point overvalued market.
Well, let's call it fullyvalued, especially the MAG7 type
of names, and those stocksclearly have benefited from
significant multiple expansionfrom really deep lows in 2022.
But when the S&P is up 75% in 32months and a lot of that's
coming from the big seven stocksat the top we've seen that
(03:28):
multiple expand quite a bit.
This is the first time themarket is starting to consider
the Fed cutting rates, and ifthe Fed does cut interest rates,
then you've got to questionwho's the beneficiary of that.
Well, I don't think it reallymatters to Apple or Nvidia or a
lot of the other names that arecash rich, that don't need debt,
(03:50):
that actually are in a netpositive position when it comes
to interest income or interestexpense, which is unbelievable
when you really think about it,because they carry a lot of debt
but they have so much cash ontheir balance sheets.
But the rest of the market as wemove through the S&P 500 into
mid-cap territory, where capitalis more expensive or they might
have floating rate capital andthe Fed decides they're going to
(04:14):
cut interest rates to spureconomic development.
That's got to be beneficial toa lot of the cyclical stocks
which make up the latter half,if you will, the other 250
stocks at the bottom of theindex that comprise a very small
weight in the index but have amuch better valuation state than
the top of the index.
Speaker 2 (04:32):
So maybe some rotation out of the largest
stocks into the rest of theindex.
You think that's taking place?
Yeah.
Speaker 1 (04:39):
I think there has been some rotation the last year
or so, last 12 months or so,but it's really just been going
away from the MAG-7 a little bit, especially this year, but into
the best names in the world,whether that's JP Morgan look at
their returns Costco, walmartphenomenal, best-in-class
businesses.
But we've taken those multiplesof those top 50 to 100 stocks,
(05:04):
the biggest names in the index,to multiples that are
historically high compared toany time you looked at them in
the past.
A Costco is trading closer to50 times their average over the
last decade is closer to 35times.
Is it the best retailer in theworld?
It's one of the top threeAmazon, walmart and Costco but
(05:24):
keep in mind it's always beenthere.
So why are we paying so muchmore?
And I think it's just investorssaying, well, I want the best
names.
It might not be the bestreturns going forward,
especially if there'sbeneficiaries of interest rate
cuts that are not in the top 50to 100 stocks.
Speaker 2 (05:41):
So earlier this year there were some companies that
maybe suspended guidance orpulled guidance as a result of
the uncertainty related totariffs.
Is that certainty coming backto some of those companies, you
think?
Speaker 1 (05:56):
I'm not sure.
If there's certainty, it's anexcuse for some companies when
they miss their numbers, butthere's certainly their numbers.
But there's certainly, there'sless it's not as new right so
it's not right on top, justbecome accustomed to it.
Yes, and the market hasnavigated it so far.
Most companies have not hasn'tbeen broad A reckoning of.
(06:19):
Tariffs are hurting profitsacross the entire index.
The index earnings profile forthis year is not very different
from where it started the year,so it hasn't had that kind of an
effect.
The market is getting a littlebit neutral towards it and
waiting to see evidence that thetariffs are actually hurting
both revenues and profit margins.
Speaker 2 (06:40):
So I know you're not a policy analyst necessarily,
but you do have to pay attentionto some of these things like
tariffs.
Recently there was a ruling bythe court that said that some of
the tariffs were actually maybeillegal and then maybe you
would have to go to the SupremeCourt.
I just wonder, with that sortof back and forth legal, illegal
(07:03):
, certainty, uncertainty it justseems like it's a really
difficult environment tounderstand what earnings are
going to do and how do you dealwith that as an analyst?
Speaker 1 (07:14):
Sure, I mean.
First of all, you get signalsfrom the market.
The market has, after April 2ndthrough April 8th when we lost
18 or 19 percent on the S&P 500,has reconciled that President
Trump likes the stock market.
He wants the economy to thrive.
We have midterms coming nextyear, so anything he does is not
(07:34):
going to be to impede thateconomic development.
So the market has kind of putthat on the back burner and
effectively, in our view, saidif we don't see direct evidence
that this is going to affectearnings going forward, we're
not going to put that in thestock prices.
Now maybe that's a little bittoo Pollyanna that President
(07:55):
Trump can come to the rescueevery single time something goes
the wrong way and respond tothe market where the market says
thank you, but so far that'sbeen the case and there's no
reason to get in front of thattrade in the market's view right
now or in our view becausethat's what's happened every
single time.
The market has been confused,uncertain.
They've said okay, we know theintentions of this
(08:18):
administration.
At least they think they knowthat it wants a thriving economy
and a thriving stock market.
Speaker 2 (08:24):
Yeah, well, and the other part, I guess, of
valuations and figuring out whatsomething's worth is, what the
discount rate is, what Fedpolicy is, and the
administration has really notbeen shy in trying to nudge the
Fed, if that's the right word,to lower rates.
Where do you think we end up bythe end of the year?
Are we going to see a couplecuts?
Speaker 1 (08:44):
Well, almost certainly in September 1.
You know you could expect maybeone more by the end of the year
.
There's Fed governors variouscoming out and saying maybe
three or four or five throughthe middle of next year or
throughout next year.
We've already seen a 100-basispoint cut from the highs, 550 to
450.
So another 100 basis points toget us to three and a half.
(09:05):
And again, in our view, thebiggest beneficiaries are going
to be companies that benefitmost from lower interest rates
on their bottom line and theiraccess to capital at a cheaper
cost.
And that's as we get into midcaps and small caps and smaller
large caps, not really thecompanies that are so strong at
(09:26):
the very top of the index butpriced at a valuation level that
really doesn't we call ithitting their heads on the
ceiling.
How much more can we pay forthose companies that are the
best in class when we alreadyhave them at historic highs
compared to their earnings andtheir outlooks?
Speaker 2 (09:42):
compared to their earnings and their outlooks.
So the differential between thegrowth of those biggest
companies that really grewpretty well over the last couple
of years compared to thesmaller mid-cap stocks and even
some of the value stocks in themarket, it seems like that
differential in growth is goingto, or at least is expected to,
decline over the next couple ofyears.
Is that still your expectation?
Speaker 1 (10:02):
That's true the expectation for 2025, only a
couple months left, but it'snarrowed between the haves and
have-nots when it comes toearnings growth, and this year
for 2025 is still very extreme.
Cyclical is growing 2% or 3%,tech Plus growing 22%.
But next year, as you look atcyclicals, 13% growth.
(10:22):
And then you look at tech plus18% growth.
So much tighter.
And then when you think about26, I'm sorry, 27, you're tight
as well.
So much less disparity inearnings growth between cyclical
stocks and tech plus stocks.
(10:43):
But the valuation gap is 29times for that tech stack and
closer to 18 or 19 times for thecyclical.
So financials and energy andindustrials those kind of
companies showing much bettergrowth expected next year.
Same thing as we move down insize whether that's mid or small
(11:04):
caps after basically nothing toshow for growth this year,
starting to see small caps haveexpectations of faster growth in
2026.
And that valuation gap is justso extreme.
That's why you feel that youcould broaden out and see those
come closer to each other.
Speaker 2 (11:20):
Are there any specific sectors in the US
markets that you look at and say, okay, the earnings growth is
going to be there, but it'sstill trading at a pretty
reasonable valuation?
I'm sure you have certain otherthings that you look at besides
that, but are there any sectorsthat you think are particularly
attractive?
Speaker 1 (11:39):
Sure.
Again, it does go back to thatcyclical story.
So financials are one,especially when you get into
maybe not the top banks.
They're still relatively modestcompared to the market.
Even the best bank in the worldtrades at 16 times and the
market's at 22 times, butfinancials always traded at a
lower multiple than the entireS&P 500.
But the value stocks in themarket as you move down through
(12:03):
a lot of those industrials, someof those energy companies,
again with really nice balancesheets, and now, if they do show
that kind of growth goingforward, a lot of these
companies in the bottom 250 ofthe S&P 500, in that industrials
, in the financials, regionalbanks, very cheap still, Perhaps
some M&A activity in that space, Certainly better regulation
(12:28):
and again, if that curvesteepens, a little bit
beneficial to those banks aswell as we move forward.
So the financials industrials,maybe even some of the energy
companies.
That's always dependent on OPEC.
But the nice part about energytoday is the quality of the
balance sheets has never beenwhat they are and the technology
to get energy out of the ground, whether that's oil or natural
(12:51):
gas, continues to make them alot more beneficial to their
margins and a lot moreproductive in getting those
assets out of the ground.
Speaker 2 (13:02):
So there's been a lot talked about the CapEx cycle
for those tech plus companies,especially the hyperscalers, who
are investing tens, if nothundreds, of billions of dollars
in their data centers.
Do you think there's a sort ofdownstream effect on the rest of
the economy because of thatspending, maybe in some
(13:22):
industrials or the financialsthat are?
I guess financials aren'tnecessarily financing that.
A lot of these companies have aton of cash that they're able
to spend, but what's thedownstream impact on the rest of
the economy?
Speaker 1 (13:34):
Yeah, Sure, I think it's been massive the last 12
months or so.
We're talking about $350 billionfrom four companies in capital
expenditures, a lot of thatgoing to AI and infrastructure,
and that's everything from airconditioning units to electrical
components, building supplies Imean these are massive, massive
(13:57):
data centers supplies.
I mean these are massive,massive data centers.
So that data center that Ameddais building in Louisiana will
be the same size as Boeing'smain production facility in
Everett, washington over 4million square feet.
Well, that takes all kinds ofdifferent industries to
participate in building abuilding of that size and then
retrofitting that building withall the steel and robotics and
(14:19):
everything else that will comeinto play there, and so that
benefit has really come throughthe rest of the market.
Those companies don't have thebest margins compared to the
tech companies, so you're nottalking about businesses that
have changed forever, and that'swhere I think you got to be a
little bit worried.
If that spending slows down,we're going to see that
(14:41):
infiltrate a lot of thecompanies that have done so well
, both at the very top but alsoin the second derivative, if you
will, of this massive,unprecedented spend that's
primarily directed at AI and AIinfrastructure.
Speaker 2 (14:56):
So the project that you referred to in Louisiana
from Meta, the $10 billion orsomething they're spending have
you seen how they're going topower that?
Speaker 1 (15:06):
They haven't seen how they're going to power it.
Well, what they said?
Speaker 2 (15:09):
the reason they chose Louisiana instead of choosing
Silicon Valley or something likethat, is because they're
building three natural gas firedpower plants in Louisiana, and,
of course, louisiana has gotplenty of natural gas and the
infrastructure is there.
So do you think?
My take is that we'll probablysee more of that with trying to
(15:30):
figure out how to power thesedata centers.
What do you think about that?
Speaker 1 (15:33):
I think that's true.
I mean, obviously, power is theissue with these data centers.
They can build them all daylong.
They do have those cash flows.
They can use all their cashflows.
Those four hyperscalers areprobably using 75% of their cash
flow this year on capitalexpenditures, which is typically
they use about 30%, and theyunderstand that if you're going
to build this kind ofinfrastructure, you need to
(15:55):
power it and right now themarket is most curious about
where all this power is going tocome from.
So finding solutions.
I know Amazon signed a dealwith a utility company, so
they're not naive.
They believe that this is apath forward.
We'll see if this spendactually has the economics
(16:17):
attached to it on the other sideof it, but clearly they're
thinking about everything rightnow as far as building and then
powering these massivefacilities in the latter part of
this decade that should open up.
Speaker 2 (16:34):
I just was reviewing some data from the Energy
Department about powerproduction, where it's planned,
you know, planned capacity overthe next five years and, believe
it or not, there was only oneline.
That was nuclear power, oneproject.
It seems to me that at leastwhat people are talking about is
an expansion of nuclear power.
(16:56):
Maybe it's just because I waslooking at the next five years
and you know, and year six andfollowing it's going to be
nuclear.
What do you think?
Is that likely to happen?
Speaker 1 (17:04):
I think that is likely to happen.
I'm no expert on nuclear.
I do know that that's beencertainly discussed.
It seems to be getting trending, if you will.
It seems to be getting a lotmore notice and the viability of
that, even through much smallernuclear facilities, which is
what's expected.
That may be the way forward fora lot of these companies.
(17:26):
So I would not discount that inany way, shape or form.
Speaker 2 (17:29):
Yeah, you mentioned something a second ago that is a
big question on my mind as well, and that is who benefits from
some of the efficiency gains andthe productivity gains from all
these CapEx investments, allthe money that's pouring into AI
?
Who's actually going to be ableto extract some value and maybe
improve profit margins orproductivity or something like
(17:50):
that?
Any thoughts there?
Any particular sector orindustry that you think will
benefit?
Yeah, I think at the end of theday.
Speaker 1 (17:58):
AI, I think everybody believes, will be spectacular
in so many ways help improve allof our lives and productivity.
There's little doubt about thatin most minds.
The question is, does it havethe same sort of?
There's been iterations here ofquestions about the
(18:18):
profitability and where it sitsat the end of the day, and the
hyperscalers think if they buildthese big warehouses they'll
get all the profitability.
And yet we saw the deep seeknews in January where NVIDIA
fell 17% and company in Chinasaid we have solutions for AI
and the utility of it that don'trequire this kind of capital
spend.
And then there's a recent MITpaper I'll let everybody read it
(18:41):
that says hey, so far wehaven't seen anybody really
benefiting from AI and theproductivity.
And there's other researchreports saying well, ai is
different because there's nonetworking capabilities around
AI like you would have withFacebook, where everybody has to
get on Facebook to communicatewith each other.
But AI might be disparate andall kinds of different companies
(19:01):
might benefit from AI and myhope is that what AI really does
is not just send profits at thetop of the infrastructure of AI
, but down into the businessesthat can actually be much more
productive not necessarily bylowering their headcount
dramatically, but expandingtheir business because they're
(19:22):
getting so much efficiencies todo what they do and doing things
better, whether that's in thehealthcare space, the financial
space, the energy space, andthat's where, if you really
think about going forward four,five, six years out, it appears
that there could be somesolutions there that will be
incredibly valuable to societyand to those businesses.
(19:44):
You know we discount everythingthat's happened because of
something that's exciting goingforward.
But think about all thetechnology and the improvements
are subtle.
But you know I have kids whodrive.
They never get lost becausethey have a map on their phone.
So there's less gas used,they're not in any danger,
they're not confused, they'renot late for an appointment.
(20:06):
We take that for granted.
But think about how fantasticthat's been for a route that
will take a truck driver lesstime to get there, to deliver on
time or to save fuel to deliveron time or to save fuel.
So little pieces of this showup everywhere and it's really
(20:27):
hard to forecast exactly when wewill see a full picture.
It'll be little iterations overtime, just like every other
technology that improve ourlives, and when we look back
we're like, oh, it wasn't alwayslike that, was it?
Speaker 2 (20:33):
Yeah, little changes that you don't notice.
And then you wake up and sayI'm not getting lost in my car
anymore, because I've got GPS.
Speaker 1 (20:40):
Yes, and 30 years ago , when I was driving, I got lost
constantly.
Yeah, exactly.
Speaker 2 (20:46):
Yeah, that's you know .
I think that's how innovationgenerally works.
It makes you more efficient,more productive in something
that you or maybe repetitivetasks that you don't want to
focus on and frees up creativityand innovation to be able to do
things that we haven't eventhought of yet.
Speaker 1 (21:01):
That's every piece of technology we've ever used in
our research group and ourbusiness is being able to
analyze more instead of justtrying to continually import
data, sort that data andunderstand the data.
Make sure we have the rightdata.
So if we can continue toimprove on that, we can be way
more productive in selectingportfolios and understanding
(21:25):
companies without having to doso much legwork ahead of time
before we get to the analysisstage.
Speaker 2 (21:32):
Okay, so one of the things that our research group
at First Trust pays a lot ofattention to is factors, and
factors being things likemomentum, or we've talked a
little bit about value or yieldor quality.
As you think about some of thedifferent factors that we pay
attention to at First Trust, arethere any things that stand out
to you, anything that looksparticularly attractive?
Speaker 1 (21:54):
Sure, one of the reasons that we've had a massive
rally in the last 32 months 75%of the index is because the
quality factor was at thesteepest discount it's been
since 1995.
Quality typically trades socompanies with high ROEs, great
balance sheets.
Those companies typicallytraded a slight premium to the
(22:15):
S&P 500, about 2%, and they gotto a 12% discount at the end of
2022.
A lot of big tech companieswith high returns on their
equity.
22 was just 30% lower on growthstocks.
So that quality factor wasalmost a free lunch.
If you look back, we got to buyquality stocks, the best stocks
in the world at a massivediscount.
(22:37):
In fact, the S&P was at 15.5times.
So you want to know why the S&Pis up 75% in two years and
eight months?
It's because it was reallycheap.
So today, at 22 times, it's notso cheap.
But what is cheap are thosefactors that are not quality.
So lighten, rebalance andlighten a little bit of the
(22:58):
weight and quality.
You can still own them, butwhen it's such a big, big part
of that top-end market cap, lookat a value factor Now.
Value traded at a premium to itslong-term discount to the index
for a dozen years in earlyaughts, the mid-aughts, all the
way through 2012, 2014.
(23:20):
And then it started going to adiscount and it's at this big
discount to where it typicallytrades versus the S&P 500.
That's some of those cyclicalstocks that we talked about.
So value is probably the factorthat has the most upside
potential Dividends same, notquite the discount that you see
in the value side of it.
And then size smaller size,midsize.
(23:44):
That's at a discount to whereit typically trades when you
compare it to the S&P 500.
So if you had to take threefactors and say size, value and
dividends, get more exposure tothose factors, because what
happens is the market.
Long before you see the whitesof the eyes of a change in the
market, what you see is a rally,a re-rating in areas that look
(24:09):
attractive from a valuationstandpoint, trade below their
historical averages and ifevidence starts to show up that
they're going to be thebeneficiary, say, of rate cuts,
of an earnings profile thatlooks much tighter than it's
been the last couple of years,you'll miss a big part of that
rally if you don't get involvedin that sooner rather than later
(24:33):
.
Speaker 2 (24:34):
I think that's a really important point that you
can't wait until you see theimprovements already, because
everyone else in the market ispaying close attention and the
better valuations that you hopedfor will go away before you
have an opportunity to actuallyenter that trade.
Exactly, right, yeah, there'sno doubt.
So cheap stocks are cheap rightnow is what I heard you say.
(24:56):
The typical discount for valuestocks is what.
Speaker 1 (25:02):
It's about 18% to 20% from the S&P 500.
So it's a pretty big discount.
Today we're closer to 40, 35 to40.
Speaker 2 (25:08):
Wow.
So if you think about whatdetermines your returns for any
investment, it's what you buy itfor, what you sell it for and
any income you collect along theway.
So that first part's reallyimportant.
Speaker 1 (25:21):
Exactly.
Look again.
You know people can look backover the last 32 months, say
it's speculative.
Some of these companies whetherit's hype or hope or even some
evidence that they're going tobenefit from AI.
But most of that return wasforecast when we traded at 15.5
times earnings at the end of2022.
Now the market thought that wemight have a recession.
(25:45):
The Fed raised rates in 2022,early 2023, 550 basis points
Quickly, yes, in 13 months.
So the market said we're goingto have a recession.
We took all the stocks downquality stocks, everything else.
In fact, if I look at every100-stock bucket of the S&P 500,
the last 400 stocks all tradedat about 15 or 16 times earnings
(26:09):
.
Now they're closer to 16 or 17times.
They've grown earnings but weput multiples back on as if we
won't have a recession.
That's not our forecast, thatwe're going to say have a
recession imminently.
In fact, the Fed might even getahead of it with some rate cuts
.
But the valuation story nevergets notoriety, never is the
(26:30):
catalyst, but always shows upwhen you look backward and say
how did I get such good returnshere?
And it's from that startingpoint and unfortunately, today
we're in an S&P 500, we'rebuying just the top of the index
, the best stocks in the worldin our view, won't afford you
our performance of the index.
It's looking at the rest of theindex that will respond to a
(26:54):
Fed that's accommodative and avaluation story and an earning
story that is tight on theearning story and still very,
very wide on the valuation story.
So an opportunity there there'salways a reason why things are
cheap.
Speaker 2 (27:09):
There's just no doubt about that.
And one other area that's beencheap at least from a relative
standpoint for the last I don'tknow decade and a half has been
the international equity markets.
Finally, this year we've seensomewhat of a return of the
international stock market.
I think some of that's probablybeen just the dollar weakening
relative to the euro and someother currencies in the basket.
(27:32):
What's your take oninternational?
Do you think that's anopportunity today?
Speaker 1 (27:37):
Sure, there's no question that the dollar
weakness has been a big factorin those fantastic returns in
the international space,particularly in Europe.
I think there's a little bitmore there.
The valuation gap is massive.
Typically trade maybe 18 or 19percent in the US versus the
international.
We're at a premium in the US.
Technology explains a lot ofthat.
(27:59):
I think it can be wider thanthat long-term average of 18%,
simply because we have such aphenomenal technology footprint
which deserve to trade at highermultiples.
But we got to about 40 or 42%discount, which is two and a
half standard deviations belowthat 18% discount for the
international versus the US.
(28:19):
And yet what we saw this year,along with the dollar supporting
that trade, was that discountdeclined to maybe I don't know
38%, 39%.
It's still massively.
It's still two times what ittypically is.
So you can see when you re-ratean area in the market how much
(28:43):
return you can get in such ashort period of time, long
before anybody says, oh, now Imight want to get in Because the
difficulty is OK.
We don't see a better footprintin Europe than we see in the US
.
They don't have a better economythan we do.
They have had the ECB's cutrates I don't know seven or
eight times, so if that's a lag,they're going to start seeing
(29:05):
the benefits of that.
I think what we're doing herein the US, saying we're going to
focus on us, the US, and bemore competitive against the
rest of the world, is waking therest of the world up to saying
(29:26):
we need to step up our game.
And the third thing I would sayabout international, especially
Europe, is if you don't have abanking system, you don't have
anything.
You need capital Now.
The European banks are nowherenear as good as US banks.
Our banking system is a gem ofthe world.
It's the envy of the wholeworld.
It starts at JP Morgan and goesall the way through the
regional banks.
Europe, at least, is not in thesame spot they've been in the
last decade plus, which is abanking system that has no
(29:49):
transparency, not enough capital, no growth and way too many
other initiatives other thangrowing their earnings.
And I think that's been true intheir energy space, in their
industrial space.
And now I think, as you see alot of these CEOs speak, they're
saying, look, we can still dosome things that in our view, or
(30:10):
Europeans' view, is beneficialto the world.
But we need to grow our profitsand we need to make more money
and we need to reward ourshareholders and compete with
the rest of the world.
So even just a little bit ofthat can take that from 38% to
say, to 30.
Now you're talking aboutanother massive increase in the
value of your underlyingsecurity.
(30:31):
So I think it's definitely timeto have some international
exposure.
Speaker 2 (30:35):
So, coming out of the financial crisis, it seems like
a lot of the Europeans embracedmore of an austerity approach.
I mean, they're trying tobalance budgets, things like
maybe we would want to do herebut it seems at least some of
the rhetoric that has come outof places like Germany has been
more focused on okay, we need tospend, we need to invest in
(30:56):
defense and all these otherareas.
Do you think that plays a rolein the long term, or at least
maybe the near term for some ofthese companies?
Speaker 1 (31:02):
Absolutely, I think just what's coming out of the US
administration is you need todo more for yourselves.
We're not going to do as muchas we did in the past.
We're not going to provide allthat security and the financing
of all that security.
And I think they're gettingthat message, whether it's
Germany, whether it's the restof Europe, and if they rally
(31:23):
around that cry and say, okay,we need to produce energy, we
need to produce industrial goods, and we need to do this and
make profits so that we can thenprotect ourselves by spending
more money on defense, then Ithink that can lift that whole
basket and investors see just aslightly brighter outlook.
I don't even know that you needto see green shoots throughout
(31:47):
European economies.
It just needs to go in theright direction.
And that rate of change goingfrom stagnation or going the
wrong way and moving in theright direction I think can
really benefit stock prices muchfurther than they've come
already this year.
Speaker 2 (32:06):
One last question for you, Dave Book recommendations.
Is there anything that you haveread recently or that you would
recommend to the viewers of theROI podcast?
Speaker 1 (32:14):
Actually.
I mean, there's so muchpolitical wrangling everywhere
in the world, if you will, andcertainly in the US.
Mitch Daniels was the governorof Indiana for 10 years.
He served in some previousadministrations.
He had private sectorexperience at Eli Lilly he's
(32:34):
probably closer to 80 years oldtoday but then he became the
president of Purdue Universityand basically starting to
address some of the issues ofschools not delivering,
especially a school like Purdue,a phenomenal engineering school
on delivering students with thetalents to drive us forward in
(32:55):
STEM, and he really that.
So he was the president ofPurdue for 10 years, so he's
written several books.
He's incredibly smart,incredibly talented.
Probably would have been agreat president, frankly, in my
view, and because he's able tobasically bring people together
from both sides of the aisle.
But what he's really done isnever compromise his principles
(33:18):
and he's written all kinds ofarticles, columns at times for
different newspapers and andgiven all kinds of speeches and
they all are positive,optimistic, again, ivy, educated
but drives a motorcycle aroundand he stays at people's houses
throughout Indiana during hiseight years of governor in
(33:41):
Indiana.
And then at Purdue really turnedthe school, turned Indiana
around from deficits to budgetsurpluses, grew that economy
really revered by the citizensof Indiana.
And then at Purdue for 10 yearsdidn't raise tuition for 10
years in a row.
So he was and really got boththe students, the administrators
(34:06):
, the teachers to buy into hisphilosophy of let's teach these
kids STEM.
And again, just a greatAmerican and a lot of wisdom
along with a lot of wit in whathe wrote.
I think the book's calledBoiler Up, but it really
addresses a lot of his time bothas the governor and at Purdue
(34:27):
University.
So I think of him as just agreat American.
Anytime you read something fromgreat Americans, I think you're
a beneficiary of it.
Speaker 2 (34:34):
Well, that is a great recommendation.
Thanks for that.
I'll add that to the readinglist and thanks for coming on
the podcast.
Speaker 1 (34:41):
Absolutely, Thank you .
Speaker 2 (34:42):
Ryan, have you again, hopefully really soon.
Speaker 1 (34:44):
Sounds great Thanks.
Speaker 2 (34:45):
Thanks, and thanks to all of you for joining us on
this episode of the First TrustROI Podcast.
We'll see you next time.
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