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Beyond The Mag 7 – Positioning For Earnings Peaking and Yields Rising – Liz Ann Sonders — Transcript

by The Master Investor Podcast with Wilfred Frost · 9,469 words · 1,391 segments · language en · Watch on YouTube

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0:00But I think the combination of the
0:02Nvidias, the microns, the Broadcoms of
0:05the [music] world, they do continue to
0:08bring forth numbers that we're looking
0:10for, the capex spend [music] numbers
0:11that we're looking for. It's hard to
0:14extrapolate that with an infinity sign
0:17[music] and at some point there's going
0:19to be some sort of miss. At some point,
0:22it becomes math where the the base
0:24effects [music] work to the disadvantage
0:27of the growth rate in in earnings. I'm
0:29not sure we're at some imminent
0:31inflection point [music] here, but I
0:34think we have to start thinking about
0:36the point at which growth starts to
0:38slow, particularly earnings growth, and
0:40how that feeds into the bigger picture
0:43uh backdrop. So, caveat, I I've known
0:47Kevin Worsh for 23 [music]
0:49years. He has always been seen as on the
0:52more hawkish end of the the spectrum. I
0:55don't worry
0:56>> [music]
0:56>> um about some give up of those inflation
0:59fighting credentials. My best guess
1:00[music] is that they're going to pike
1:03rates 25 basis points. Ultimately, I
1:05think what matters in terms of the
1:07equity market is the speed of of any Fed
1:11moves. Are they going to take the
1:13escalator or are they going to take the
1:14elevator [music] is uh historically has
1:17been a key determinant of how well the
1:19market does.
1:22Welcome to the Master Investor podcast
1:24with me, Wilfred Frost, where we
1:26celebrate and learn from the success of
1:28the greatest investors, business
1:30leaders, and politicians in the world,
1:31giving you, our listeners, the edge. The
1:34Master Investor podcast is sponsored by
1:37Else, Interactive Brokers, the World
1:40Gold Council, and BMY Investments.
1:43Please do remember the views expressed
1:45in this podcast are for general
1:47information purposes only. Nothing in
1:50the podcast constitutes a financial
1:52promotion, investment advice, or a
1:54personal recommendation. More on that in
1:57the show notes.
1:59My guest today is the chief investment
2:02strategist of Charles Schwab, Lisanne
2:04Saunders. Schwab is a firm with, wait
2:07for it, $13.4 4 trillion in client
2:11assets, making her the key source of
2:15investment advice to their 40 million
2:19customers. They are a Goliath. Lzanne is
2:22joining us for the second time on the
2:24podcast and I am delighted to welcome
2:26her back. Lisanne, great to see you.
2:28Thanks for joining us again.
2:30>> Oh, thanks so much for having me. I love
2:31our conversations, uh, Wolf, and and
2:34sorry for the very generic, uh,
2:36background, but I'm in a hotel ballroom
2:38doing this. [laughter]
2:40>> Well,
2:40>> life on the road.
2:42>> We, uh, we appreciate your time even
2:44more given how clearly busy you must be,
2:46but it's great to see maybe a slightly
2:48bland background, but the very green
2:50positive top you're wearing.
2:53>> Yeah, might as well bring a little color
2:54in that way.
2:55>> Yeah. Well, also, our branding for the
2:57podcast is green as well on purpose
2:59because we all want markets to go
3:00higher. So there markets yeah go in that
3:03direction.
3:03>> Sadly though if we're looking at the
3:05futures we're recording this obviously
3:06Tuesday uh Tuesday morning um your time
3:09eastern time through Tuesday afternoon
3:11UK time markets futures are down today
3:14and I think the story we've got to start
3:15with if it's all right is is what's
3:17causing that which is the yield picture.
3:19Um and uh clearly been on the rise
3:22globally it's not just a US phenomenon
3:24but the moment we're looking at the US
3:2610ear up to sort of 4.8% 8% the 30-year
3:29up to close to 5.3%. And I I guess my
3:33first question on that that they are big
3:35levels relative to anything in the last
3:38month or anything in the last decade
3:40really whichever time frame we look at
3:42it. Are you surprised that those levels
3:46highs of yields haven't actually hit
3:48stocks more so far?
3:51>> Well, no. I'm not terribly surprised.
3:54And and if you just peel even one layer
3:56of the onion back, you do see that uh
3:59whether you go back to the late June
4:01recent low in yields or you just look at
4:04over the past month or so where the
4:06increase in concern about the Treasury
4:09Secretary Besson's plan to double the
4:11buybacks of the long end and what that
4:13says about confidence. Really what we've
4:16done is continue a move toward
4:18normalization in in yields. Whether you
4:21track it against nominal GDP growth,
4:23whether you track it against the level
4:25of inflation, yields are um not only
4:29just about where they should be, but
4:31arguably relative to nominal GDP growth
4:33probably have more upside. You can look
4:36under the hood of the stock market and
4:38see the more interest sensitive segments
4:41like utilities, like real estate. Those
4:43sectors have had the worst performance
4:46over that two-month period of time since
4:48we've seen the move up. So you do see an
4:50impact. It's just sub the index level.
4:53It's just been the latest reason why
4:55you've seen rotation in this case more
4:57recently into energy for obvious reasons
5:00into financials. So it doesn't surprise
5:03me. And frankly I this normalization is
5:08not a not a bad thing. I I I think we're
5:10better off in a more normal yield
5:12environment relative to the financial
5:15repression that came in the aftermath of
5:16the pandemic and the aftermath of the
5:18global financial crisis when you had the
5:1910-year bottom at half of 1%. I don't
5:23think anybody should be wishing to go
5:25back to that environment. I think it's
5:27the orderly component of it though that
5:29has kept the overall market from more
5:33volatility. I think if this were to
5:34become more disorderly or the speed of
5:37the move higher were to accelerate, then
5:39I think you probably see that filter
5:41into equity market volatility to a more
5:43significant degree.
5:44>> So So what what would qualify as
5:46disorderly if we're at 4.8 on the
5:4810-year? What level? How quickly would
5:52would worry you? Well, you know, level I
5:55think comes into play into the
5:56psychology and how investors react more
5:59so than some level that represents a
6:01turning point in terms of the economic
6:03impact. 475 has been considered one of
6:06those initial psychological levels and
6:09and to your point me mentioning where
6:12things are this morning as we're uh
6:14recording this, we're there now at 480.
6:17I think probably the next somewhat
6:19obvious point from a round number
6:22perspective would be uh 5%. I think it
6:25would be speed of move and maybe a
6:28pickup in the volatility on the bond
6:30market side of things. So the move index
6:32which is akin to the volatility index
6:34the VIX on the equity side the move
6:35index tracks that on the fixed income
6:38side on the treasury side and that has
6:40been relatively calm. So I I think it
6:42would be a combination of maybe
6:44breaching that 5% level with a pick up
6:47in volatility or moving very very
6:50quickly from where we are now at 48, you
6:53know, through 5%. So speed is a a factor
6:56too that I think could could filter into
6:59more equity market volatility. And I'm
7:01interested though in the overall
7:03relationship then because you know I I
7:05would think certainly how I think about
7:07it and buying shortterm guilts UK
7:10government bonds can be attractive at
7:13certain levels I would say if it's
7:15higher than inflation it's it's a you
7:17know risk-free real real return. Do do
7:20you not think that the levels alter how
7:23most investors think about the
7:25riskreward of owning stocks or not? do
7:27they not think as clearly using a sort
7:29of discounted cash flow to to the
7:31risk-free rate like that?
7:32>> Um I I what really matters to the equity
7:35market aside from in the short term
7:37mentioning the speed of a move or the
7:39volatility associated whether it's
7:40orderly or not. I think what's maybe
7:42most important and this is a more
7:45secular discussion as opposed to what's
7:47going to happen in the next month or
7:49week or in you know in the leadin to the
7:51September FOMC meeting is the fact that
7:54we're now back in pretty deep negative
7:56correlation territory between bond
7:58yields and stock prices. And there's a a
8:02variety of reasons for that but let me
8:04put it in a really long-term context. So
8:07we had the great moderation era which
8:09was the era that spanned from the late
8:121990s up until the 2022 inflation spike
8:15driven by the pandemic. And that great
8:18moderation era had a lot of facets to
8:20it. It was uh there was sort of moderate
8:23inflation risk very not much inflation
8:25volatility generally a disinflationary
8:28backdrop with the exception of of a
8:30spike in inflation in 2008. generally a
8:33benign
8:35interest rate environment where interest
8:36rates were generally trending uh lower.
8:39You had massive globalization that was
8:42part of the reason why we kept inflation
8:44relatively uh contained. China joining
8:46the WTO in in 2001 and flooding the
8:49world with cheap and abundant access to
8:52goods and labor.
8:54And throughout that entire 20 plus year
8:58span, with the exception of 2008, bond
9:01yields and stock prices were positively
9:03correlated. And that's because what bond
9:05yields were keying off of during that 20
9:07plus year period of time was the growth
9:10side of the equation, wasn't so much the
9:13inflation side of the equation. So if
9:15you if you have yields going up because
9:16growth is improving without the attended
9:18concern about a risk of inflation,
9:20that's sort of nirvana for the equity
9:22market. and vice versa when yields were
9:24moving down. Well, go further back to
9:27the 30 plus year period. From the mid to
9:29late60s up until the late 1990s, it was
9:32the complete opposite. Almost the
9:35entirety of that 30 plus year period,
9:37bond yields and stock prices moved in
9:39the opposite direction because bond
9:41yields were keying off of the inflation
9:43side of the equation. There was much
9:45more inflation volatility. There was
9:46more economic volatility. You had
9:48shorter cycles, more frequent
9:50recessions. the growth phases were much
9:52stronger but you had more frequent
9:54recessions. Now of course when bond
9:56yields and stock prices move in the
9:59opposite direction it means bond prices
10:02and stock prices were moving in the same
10:04direction. So that temperamental era as
10:06we've been calling it from the mid to
10:08late60s to the late 1990s
10:11it was a bit more difficult to get
10:15diversification through just a simple
10:17stocks bonds mix in the great moderation
10:20era which gave rise to the simplicity of
10:23models like 6040 because you had that
10:26inverse price relationship. We're back
10:29now in an environment that I think looks
10:31more like that mid to late60s to mid to
10:34late 90s. And that I think is what's
10:36most important for investors in terms of
10:38thinking how do I navigate this? Not so
10:40much just how speedy the move is in the
10:44in the 10ear. Is there some level that
10:45is a a tipping point? It's that
10:48relationship between bond yields and
10:51stock prices and in turn bond prices and
10:53stock prices. The good news is is we're
10:55in an environment now where we've seen
10:58continued democratization of access to
11:00other asset classes, non-correlated
11:02asset classes. So I think individual
11:04investors in particular are in a better
11:06position than they were back in that
11:09period of time for a lot of reasons, not
11:10just the correlation piece of it. So
11:13that I think is the bigger picture most
11:16important issue that we're facing as we
11:17have already transitioned to what I
11:19think is in a very different era than
11:20the great moderation.
11:22>> That that's really really interesting. I
11:23mean, I guess implicit in that for bonds
11:26to be able to do badly, but stocks still
11:29do well, is the expectation of uh of
11:33higher and persistent inflation. Um,
11:36which maybe we'll come to and what that
11:37should mean for your portfolio in a
11:39little bit. But just to to dwell a
11:41little longer on recent events and and
11:44the yield picture, I mean, what what do
11:45you make of the the Bessant
11:48intervention? uh the attempt to to cap
11:51longer term yields. Is that something
11:53that is sort of understandable? You
11:55know, if longerterm yields are rising
11:59then issue more at the short end while
12:01currently yields are a bit lower. Is
12:03that a sort of normal course of action
12:05or is there a sort of different risk
12:07factor that's emerging of losing
12:09credibility uh that that comes with
12:12those sorts of tampering in the market
12:14type place? You know, it's normal in the
12:18sense that they were already doing this.
12:20Besson just announced a doubling of the
12:22buybacks of the the long end. Now, the
12:25the couple of problems. One, it's a bit
12:28at odds with Kevin Worsh's Fed given
12:32that, you know, Kevin's desire is to
12:34shrink the balance sheet and or let the
12:38long end do some of the Fed's job for it
12:40by tightening financial conditions. And
12:42then you've got Treasury to some degree
12:44working at odds with that. So that's one
12:46issue. But I also think that the
12:48probably the most important issue is
12:50that what Treasury is trying to do here
12:54is they're focused on the symptom, not
12:57the cause. Um not the disease. The
12:59disease in part is fiscal profleacy and
13:03runaway deficits and runaway debt and
13:06investors now requiring a higher level
13:10of compensation to take the risk
13:12associated with financing that debt. You
13:15also have massive massive issuance now
13:18relative to AI coming on the corporate
13:20bond side. So there's now kind of a
13:22shiny new object in the corporate bond
13:24market related to AI that may be pulling
13:27some investors attention away from the
13:30traditional treasury market into the uh
13:33the corporate bond market particularly
13:35in investment grade which is a little
13:36bit more of that apples to apples
13:38relative to treasuries versus say the
13:40junk bond uh market. So, I think those
13:43are are two of the forces at play and a
13:46concern that inflation is is not a
13:50short-term problem that can just be
13:52tackled by the Fed. You know, the the
13:54Fed can only do so much, especially when
13:57an inflation problem is more of a supply
14:00side problem versus a demand side
14:02problem. The Fed has a better ability to
14:05kind of, you know, move the needle with
14:07monetary policy if it's a demand side
14:10problem. But but this is certainly the
14:12energy side of things is a is a supply
14:14problem. It's not really a demand
14:16problem. Um even the the tariff impact
14:19on inflation, that's a bit of a supply
14:23uh problem. Um so I I think we're
14:26there's an attempt again to tackle the
14:29symptom but not really the uh the
14:31disease.
14:36This episode is brought to you by Else,
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15:14Did does that not then somewhat create
15:17the environment that you just said we've
15:18moved out of that the sort of actions
15:21that we saw for example in in the
15:23reaction to COVID even going back the
15:25reaction to the financial crisis which
15:27is they're just trying to inflate the
15:29debt away
15:30>> right yeah well you know they might be
15:34on the Treasury Department side but if
15:35if what brings what comes along with
15:38that is inflation that goes beyond the
15:41fiveyear span of it being above the
15:43Fed's target, then again, you're at that
15:46point where you're at odds uh with one
15:49another. And it's just a question of
15:51what the tolerance is going to be on the
15:53part of the Fed, which of course spans
15:54well beyond Worsh. It's it's still
15:56amazing to me how often I get questions
15:59um whether it's tied to any sort of
16:02political influence. Couldn't the
16:05administration just put pressure on
16:08Worsh to not raise rates? Maybe not to
16:11lower rates, but not raise rates. But
16:13you know the CN FOMC is committee. It's
16:15not chair. And you have uh there have to
16:18be seven people that decide on moving
16:20the monetary policy lever whether it's a
16:23change in the Fed funds rate or balance
16:25sheet uh policy. And even though Wars
16:29himself has been a little bit more quiet
16:31than past Fed heads, um there's still a
16:35cacophony of speakers out there among
16:37the other uh the governors and voting
16:39members. And I think this is going to be
16:42an interesting time between now and the
16:44the September FOMC meeting.
16:46>> Um I I agree. I think it's going to be a
16:48fascinating time. And by the way on the
16:50yield outlook, clearly it's not just the
16:52the US in in focus. Everyone's kind of
16:55in similar positions.
16:56>> Um ju just then finally on your
16:59assessment of I guess the collective uh
17:02actions of Treasury and the Fed albeit I
17:05understand that the importance of the
17:06Fed between the two. I'd say the market
17:09over the last, you know, step back from
17:12it being Bessent and Walsh specifically,
17:13but the market over the last 5 10 years
17:15has has always felt comfort in the buy
17:18the dip kind of tactic because they
17:21think authorities as a whole will step
17:23in if if uh if problems really persist.
17:27Is that still your view uh overall or do
17:30you think they're going to put inflation
17:31first and allow things uh to to hurt in
17:36the short term if necessary?
17:39So caveat, I I've known Kevin Worsh for
17:4323 years. Um I'm not in touch with him
17:46on a day-to-day basis. We're not texting
17:48each other. He's not asking me what I
17:50think about what they should do from a
17:52monetary policy, but you know, I've
17:53known him for a long time. And I, you
17:56know, he he he has always been seen as
17:59on the more hawkish end of the the
18:01spectrum. It was only when we were in
18:04the the the appointment process, the
18:06decision on the part of of President
18:08Trump of who he wanted to nominate for
18:11that position, the concerns, you know,
18:13the whole sock puppet concerns that
18:15existed during the leadin to the
18:18confirmation process. But I I I don't
18:20worry um about some give up of those
18:24inflation fighting credentials. I think
18:26he he at least tried to make that really
18:29really clear during the Jackson Hole
18:31speech. Um
18:33not only specifically saying 2% is still
18:36our target. We're not going to raise
18:37that. The core PCE is still the mandate.
18:39We're not going to change that.
18:40Inflation is too high. It's not coming
18:42down quickly enough. But also starting
18:46the speech with references to two
18:49different kind of hikes. Now he was
18:51talking ostensibly about actual hikes.
18:54that there was there was more than a
18:56subliminal message in there. So, I I
18:59think and there was there was there was
19:01a mention of the labor market side of
19:03the Fed's mandate, but I certainly get
19:06the impression that fighting this in
19:09this inflation boogeyman that has not
19:11disappeared in the last 5 years, I think
19:14is going to take precedent over um maybe
19:18what the Treasury Department is is
19:20trying to do, which is more directly
19:22influenced by the goals of the uh the
19:25administration. I mean that's absolutely
19:27as you say it's going to create a
19:29fascinating couple of months as we lead
19:30up to the next meeting if if we're going
19:32to see a hike um and and and we'll see
19:34the political reaction to that. I I
19:37guess you know part of the rotation
19:41we've seen which we'll get into in more
19:42detail in a bit has been in reaction
19:45therefore to a steepening yield curve.
19:47Is is that overdone then? Do do you
19:49think the yield curve won't keep
19:51steepening?
19:53Um, you know, the short answer and the
19:55honest answer is, uh, I don't know. Uh,
19:58it's a question of of how active
20:00Treasury decides to be, whether it's in
20:03line with what they've already announced
20:04or beyond that. Um, and the upcoming
20:07data that we uh, see, I I think both
20:11labor market data and inflation data is
20:13important, but I think the burden of
20:15proof is more on the inflation side.
20:18Now, I think it would have to take
20:20probably something really, really
20:22significant in terms of weakness on the
20:23labor market side for the Fed to veer
20:26away from what I'm guessing is a
20:28probably a bias toward hiking. That's
20:30what the market is priced in in
20:32September. So, uh I my my best guess is
20:37that they are they are going to pike
20:40rates 25 basis points. Ultimately, I
20:42think what matters in terms of the
20:44equity market beyond the long-term
20:46secular great moderation exit to
20:48temperamental era entry um is the speed
20:52of of any Fed move. So if you look at
20:56one year subsequent performance of the
20:58equity market once the Fed starts a
21:00hiking cycle
21:03the aggregate performance is about 4 and
21:05a.5% positive performance for the equity
21:08market over the subsequent one year
21:09which is sub your sort of average annual
21:12performance. Um but if you look at fast
21:16hiking cycles that actually is where you
21:19get negative performance. So about -4%
21:23or so in the subsequent one year. You
21:25look at slow tightening cycles and the
21:28performance in that subsequent year is
21:31more than 10% positive. So
21:33>> it's you know are they going to take the
21:35escalator or are they going to take the
21:37elevator is uh historically has been a
21:40key determinant of how well the market
21:42does.
21:43>> Hi guys, it's Wilf. I hope you're
21:45enjoying this episode. Just a quick
21:47reminder to please hit follow or
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21:59It really helps other people find the
22:00podcast too. Now back to the episode.
22:03That's very interesting. And I guess the
22:05other key factor which can solve all
22:07problems is is the pace of economic
22:09growth. What what do you think the
22:11market is pricing in at the moment? and
22:13and where do you stand as to as to
22:15whether the US is likely to to beat or
22:18disappoint?
22:20>> So it you don't tend to see published
22:23forward estimates for nominal growth. Um
22:27but I think you probably need nominal
22:31growth to be pretty high, you know, mid
22:32to high single digits. um to be
22:35supportive of the sort of overall
22:38economic backdrop, the relationship
22:40between bond yields and stock prices and
22:43the idea that you can sort of grow your
22:47way out of the problem. I mean, that
22:48really is mathematically the solution to
22:51this problem, this problem of runaway
22:53deficits and and high rate of uh debt
22:56growth is have economic growth be higher
23:01than the rate of uh inflation. um and
23:05higher than the rate of debt growth. So
23:08if you've got economic growth moving
23:11fast at a faster rate than debt growth,
23:13then you mathematically start chipping
23:15away at the problem.
23:16>> We're not there. That's ideally the the
23:19goal is to get to that level of nominal
23:22growth that we can start to grow our way
23:25out of this problem. The problem is if
23:26inflation keeps creeping higher, then
23:29you've got real growth that is uh that
23:31is subpar. So I I think you know mid to
23:34high singledigit nominal growth with
23:37profit margins uh being maintained or
23:40you know at least stable not declining
23:43um earnings growth I think is is is set
23:46to ease from just the blistering pace
23:49that we saw in second quarter. Again at
23:53some point it becomes math where where
23:55the the base effects work to the
23:57disadvantage of the growth rate in in
24:00earnings. I'm not sure we're at some
24:02imminent inflection point here, but I
24:05think we have to start thinking about
24:07the point at which growth starts to
24:10slow, particularly earnings growth, and
24:12how that feeds into uh the bigger
24:15picture uh backdrop and whether that's
24:18sufficient to help bring down uh
24:20inflation.
24:21>> So, so that's are you less constructive
24:25on the outlook for the overall market
24:26than you have been in the last couple of
24:28years? Um,
24:31not necessarily. I I I think the market
24:34environment is going to uh persist as
24:36one defined by pretty rapid fire
24:39rotations. I've been saying that
24:40rotation is the new momentum trade. And
24:44I I think it's a function of the unique
24:46economic cycle we've been in since CO
24:49where we have these rolling expansions
24:52and rolling recessions at the sectoral
24:54level. And this time I'm talking about
24:55economic sectors where you don't have
24:58this big aggregate expansion or big
25:00aggregate contraction which often comes
25:03in a more linear cycle where you have a
25:06recession, you come out of a recession,
25:08you have that recovery phase, then you
25:10have the expansion phase, then things
25:12start to slow, the Fed has to step in,
25:14tighten policy. Worst case scenario, you
25:17get some sort of financial system
25:19problem. um massive constraints in terms
25:22of credit access that brings on a
25:24recession and then you start the cycle
25:26all over again. This has been an
25:27entirely different cycle because of the
25:30pandemic and its aftermath. You had you
25:32know a boom in manufacturing in the good
25:34side of the economy when we were in the
25:36early period of the pandemic because
25:39services were completely shut down. So
25:41when we had the stimulus it could it had
25:43to be funneled into the good side of the
25:44economy because there was no access to
25:46services. That gave rise to the
25:48inflation problem with which we're still
25:50dealing. But ultimately when the economy
25:52started to open back up, vaccines were
25:54created. You had pent down demand on the
25:57good side. You had pent-up demand on the
25:58services side. Manufacturing went into a
26:00recession, but services, which is a
26:02larger share of the economy, its
26:05strength was more than an offset. So we
26:07just sort of overall rode through it. I
26:10think that's the environment we stay in.
26:12And that in turn helps to explain the
26:15rotations we're seeing in the market.
26:18And I think that sort of rolling nature
26:20to the economy, rotational nature to the
26:23market.
26:25I think my base case is that that
26:28persists for some time, barring some
26:31black swan kind of event or real problem
26:34within the financial system, a major
26:36credit crunch. um that's not a near-term
26:38based case, but um that some sort of
26:42credit crunch or black swan event or
26:46something that becomes really disorderly
26:48in the Treasury market where it becomes
26:51unanchored from what either the Fed
26:54andor the Treasury could do to try to
26:56contain that. And I guess the other
26:59factor will be if the bigger market cap
27:01stocks are the ones people are rotating
27:03out of it, it might still have a net
27:05effect to the downside. On which note,
27:07let let's just touch on some of those
27:09mega cap tech names. And you know, as
27:12much as you rightly point out already
27:14how the base effects can make it harder
27:17to keep growing fast. We just had Nvidia
27:19late last week with their numbers. I
27:20mean, they do keep delivering in a quite
27:24remarkable way.
27:25>> Mhm. They they do. And you know, clearly
27:28that's a that's a bell weather for the
27:30whole AI movement. Um, and you know,
27:35spelled a different way, the weather
27:38forecast is pretty good uh per Nvidia.
27:41Um, you know, you've got Broadcoming up,
27:44Broadcom coming up tomorrow as we're uh
27:47taping this, less of a bell weather than
27:49Nvidia, but I think the combination of
27:51the Nvidia, the microns, the Broadcoms
27:54of the world, they do continue to
27:59bring forth numbers that we're looking
28:00for, the capex spend numbers that we're
28:02looking for. It's hard to extrapolate
28:06that with an infinity sign. And at some
28:09point
28:10>> there's going to be some sort of miss.
28:12And I I think what's interesting these
28:15days in this environment of just
28:17unbelievably strong earnings growth is
28:20number one, when do we actually hit the
28:22inflection point? Because I'm fond of
28:24saying and have for my 40 years doing
28:26this, better or worse often matters more
28:28than good or bad. We can talk about
28:30whether it's the mag 7 or the neural 9
28:32or the tech sector or the com
28:34communication services sector or
28:36combination or some AI basket. Lots of
28:38ways to slice and dice it. You could say
28:41okay that the growth rate was 60% it's
28:44dropping to 30%. But man 30% is still
28:47phenomenal but often it's the it's the
28:49inflection point. It's the rate of
28:51change. It's the direction of travel
28:52that can have an impact. And to some
28:54degree we are seeing some impact already
28:57come into the the mix. I think the early
29:00poster child of this um many weeks ago
29:04now was when Samsung reported they
29:07reported better numbers than the
29:09consensus the sellside consensus
29:12estimate both on topline growth and
29:14bottom line growth but they arguably
29:17undersshot the buyside sort of whisper
29:21number or expectation. they fell in
29:23between those two and it caused a route
29:25in the stock um because of how big a
29:28weight both Samsung and SKHEX are on in
29:31the Cosby the Korean stock market that
29:33had a draw down to the tune of about
29:3540%.
29:37Um, we've since seen a recovery there,
29:39but that's what I think probably the
29:42next step will be. And I'm not
29:45suggesting it comes as soon as third
29:46quarter reporting season, but the next
29:48step would be dislocations that you
29:51start to see that are a little bit more
29:53at the individual stock level and you
29:56start to see more dispersion. We're
29:57already seeing that in a group like the
29:59MAG 7 right now. And I added Micron and
30:02Broadcon. I've been calling a slightly
30:04expanded group the Neural 9. and I post
30:06about it on my X feed every day and that
30:09again includes Micron and Broadcom plus
30:12all seven of the MAG 7. And from a
30:14contribution to S&P returns standpoint,
30:18not just simple price performance, but
30:20contribution to returns, which is price
30:21performance multiplied by cap size
30:24equals your contribution. you know, you
30:26range from Micron, which is the third
30:29best contributor to uh uh overall S&P
30:35returns this year. I don't even I'm not
30:36sure what one and two are, but it's not
30:38any of the neural N. But you've got then
30:41Tesla, which is the 503rd ranked
30:44contributor to S&P returns this year. So
30:48almost the best to the worst in an array
30:51of nine stocks. Mhm.
30:53>> So some of that dispersion we're already
30:55seeing and that's why this desire to
30:58invest in all things AI has expanded
31:02well beyond that core aggregate group
31:04like the MAG 7 and it's part of the
31:06reason why you're seeing the Russell
31:092000 has double the performance of the
31:11S&P year to date and actually is
31:14outperforming the S&P in the past two
31:15years. It's not just a 2026
31:18phenomenon. So, I I think we're already
31:21seeing more dispersion even though the
31:25interest is still in the AI uh story.
31:28There's there's a lot of money now
31:30looking for different shiny new objects.
31:34It's it's such an important point and uh
31:36an episode we did in in July, Jim Melon
31:38kind of was talking about a similar
31:40point which is actually MAG seven share
31:42price performance might might underwhelm
31:44you when you pause and look at it year
31:46to date um relative to the to the
31:48headline numbers
31:50they still I guess or the neural nine I
31:53like that
31:54>> still contribute such a huge amount to
31:57the overall earnings though and I guess
32:01I guess if that does roll over. Um, as
32:03you said, no signs of it yet from
32:05Nvidia, but but it can't go on forever.
32:07The base effects will take effect at
32:09some point. Does that not spook the
32:12broader market at some point?
32:14>> Uh, probably does. Yes. So, let let me
32:16put some numbers on on that. Um, if you
32:19look at expectations for calendar year
32:232026, so second half is still not in the
32:27books yet. So we're talking about
32:30existing numbers that have come in for
32:32the first two quarters and then
32:33consensus estimates for the second two
32:36quarters. And you look at the growth
32:37rate for the o for overall S&P earnings
32:40calendar year 26 relative to calendar
32:42year 25. Um Nvidia just that company
32:46alone is 18% of that expected earnings
32:49growth. You add Micron which is another
32:5114% that gets you to 32%. So you're
32:54talking about onethird of all S&P
32:57expected earnings growth in 2026 is a
33:00function of two uh companies. If you go
33:03out to the top 10 in terms of top 10
33:06earnings growth rate companies and that
33:08brings in uh Chevron and Exxon as I
33:11think number nine and 10 on that list.
33:14Um they represent twothirds of S&P
33:18earnings growth. So yeah, you have some
33:21sort of high-profile miss,
33:24not not just what that does in terms of
33:26the psychology of the the market, but
33:29mathematically you would see a
33:31ratcheting down of estimates. Now
33:33there's another somewhat positive side
33:36of this and that is that the the big
33:39surge in earnings and in turn forward
33:42expectations that occurred throughout
33:44second quarter reporting season
33:4710 out of the 11 sectors have seen an
33:50improving earnings profile. So at least
33:53we have some momentum in areas other
33:57than just the sort of tech AI AI
34:01adjacent uh space. It's just not meaty
34:05enough when you do the math for a cap
34:09weighted index. So um we have less of a
34:13concentration problem in terms of
34:17>> the stature of these companies as it
34:19relates to concentration from a market
34:21cap perspective. We still very much have
34:24a concentration problem uh on the
34:26earnings growth side of things.
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35:19So, before we get to to the breakdown,
35:21the rotation we're seeing in sector
35:23picks, where are we now on the headline
35:25valuation for the index?
35:27Well, the good news is is that the
35:30denominator in the PE equation has been
35:32rising to at a faster pace than the
35:35numerator in the PE equation. So, we've
35:37seen the forward PE and there's going to
35:41be a variety of sources for a forward PE
35:43depending on whether you know the the
35:45the denominator is fact set based
35:47earnings information or LSG IBES based
35:52information. So, there's not some clean
35:55this is the number. It really depends on
35:57what the plug is for the denominator,
35:59but based on the data that we look at,
36:02you were you were at about a 22 multiple
36:04earlier in the year and you're at about
36:06a 19 multiple right now. That's not
36:09that's not so bad. Now, rising inflation
36:12or inflation that is not coming down,
36:14maybe that's a better way to uh state
36:16it. All else L equal
36:19suggests you probably don't have a lot
36:22of upside from a multiple perspective.
36:26But it's not a bad backdrop.
36:29>> I probably should have applied a caveat
36:33though right in the beginning.
36:35>> I look at every variety of valuation
36:37metric forward PE, trailing PE, you
36:39know, Schiller's adjusted cyclally
36:41adjusted PE, Tobin's Q and the Fed model
36:44and equity risk premiums and the Buffett
36:46model and rule of 20, etc., etc.
36:50um valuation is in interesting to look
36:52at, but it only has relevance to what
36:54the market's going to do if you're
36:56talking about say a subsequent 10-year
36:59forward look. Um there is zero
37:01correlation between,
37:04let's use forward PE because that's what
37:06we're talking about, forward PE and
37:08subsequent one-year performance in the
37:10S&P 500. It basically rounds to no
37:12correlation. If you do a scattergram
37:14version of it, the dots are all over the
37:16map. There have been plenty times where
37:18the market is cheap and the market
37:20continues to do really poorly. There are
37:22plenty times where the market's
37:23expensive, market continues to do well,
37:24gets more expensive, continues to do
37:26well. So, we can talk about valuation.
37:29It's part of the toolbox of what a
37:31strategist looks at. But I would never
37:34sort of adjust a market view solely
37:37because of where valuation is because
37:38valuation is really an indicator of
37:41sentiment
37:42>> um more so than some you know timing uh
37:46tool. Well, there's no good timing tool
37:48but valuation is definitely not one of
37:50them.
37:50>> No. And I remember when you joined us
37:52last time you're talking about how
37:53sentiment is is perhaps focused on too
37:56often as well by by uh investors as well
37:59trying to gauge uh short-term
38:01decision-making. Maybe we'll come to
38:02that in a moment, but let's talk about
38:03the the rotation. I mean, you've already
38:05alluded it to across a number of
38:07answers, but there has been a big
38:10rotation during the course of calendar
38:13year 2026 already that perhaps is not
38:16talked about as much as it should be.
38:19>> So, well, by far the best performing
38:21sector this year is the energy sector.
38:23Uh, people are generally not that aware
38:25of it because it's it's such a small
38:27representation in the S&P 500. though
38:30its stellar performance doesn't prevent
38:32the S&P at times from from chopping
38:35around because it only represents about
38:363 and a half% of the uh index but you
38:40know about double the performance of the
38:42the tech sector and then you have the
38:44lagards particularly more recently as I
38:47mentioned which are those more interests
38:50segments like utilities like uh real
38:53estate very widespread and the other the
38:57other thing to understand about this
38:59environment when when people talk to me
39:02about how the market just seems to be
39:04whistling past all of these geopolitical
39:07and and macro concerns with very little
39:10if any downside. But what happens via
39:12rotation is you see it more at the
39:15individual stock level. So here again
39:18are some numbers. So S&P at the index
39:21level didn't even hit 10% correction
39:24territory this year. its maximum draw
39:27down in that post Iran war period of
39:30time was 9% in change. So just shy of of
39:3310%. But the average member if you look
39:36at all it's actually 504 members because
39:40two companies have two shares of service
39:42uh two classes of service uh of shares.
39:45Um, if you go at each individual stock
39:49in the S&P 500, look at their individual
39:51maximum draw downs and then take an
39:53average of those, that average member
39:55maximum draw down for the S&P is
39:57negative - 255%. If you do that for the
40:00NASDAQ at the index level, the NASDAQ
40:02did have a correction. It's maximum draw
40:05down at the index level was 13% over
40:07that same post Iran war start initiation
40:10of the Iran war period. But the average
40:12member within the NASDAQ has had a 45%
40:15draw down on a year-to- date basis. It's
40:17just happened via process of rotation.
40:19So you actually can see a process where
40:23you ease excesses whether it's valuation
40:26excess or concerns thereof whether it's
40:28sentiment excess whether it's you know
40:30the earnings expectations bar having
40:32gotten set too high whether it's a
40:34narrative change in terms of macro
40:37drivers whether it's a function of
40:39monetary policy and interest rates going
40:40up and maybe we want to uh move away
40:43from the interest sensitive areas and
40:45and go into a sector like financials
40:47that as long as the yield curve is steep
40:49their beneficiaries. So that's not a bad
40:52way to sort of ease some of these
40:55excesses is through a process of
40:57rotation. I think we would all choose to
41:00have this experience versus the S&P and
41:03the aggregate dropping by 25% all at
41:05once. Uh so it's not a bad way to to go
41:08through via rotation. And that's my base
41:12case that that's the environment we stay
41:14in. save for something that is a bit
41:16more exogenous and a bit more extreme
41:18than what we've seen so far
41:20>> and and obviously the rotation as you're
41:22alluding to is already started and
41:24certainly taken place to some extent
41:26which are the sectors where you think
41:29[snorts] there is much further to go
41:30that that there's more rotation to come
41:32out of and into.
41:36So I I I think we're going to still see
41:38bouts where there's sort of exit from
41:41the megga cap tech names, but there's
41:43going there's still a buy the dip
41:45mentality. So
41:47for for as many times as we've seen this
41:49year where there's sort of a move out,
41:51there's that money again looking for the
41:53shiny new object. I still think that
41:56we're going to have times where we move
41:57back in, especially when you get into
41:59earning season and you get the
42:00enthusiasm associated with the
42:02eyepopping uh numbers that you see. um
42:06we we do have sort of favorable to
42:10unfavorable scale for sectors. we we
42:13don't sort of have the maybe traditional
42:16overweight underweight labeling um
42:19because we think you want to be more
42:20subtle and we also believe that
42:23factor-based investing maybe not instead
42:26of sector-based investing but as a
42:29overlay to sector-based investing and
42:32factor-based in investing is just you
42:34know factor is another word for
42:35characteristics so factors like you know
42:38there's growth factors like forwardings
42:40uh estimates being positive
42:42stability or strength in profit margins.
42:45Um positive earnings surprises. You have
42:47more valueoriented factors. Everything
42:49from traditional PE ratio to price to
42:51book, price to sales. You've got balance
42:53sheet oriented factors, strong free cash
42:55flow, high interest coverage. And
42:58there's been more consistency
43:02in outperformance and underperformance
43:04when you look at the factor level than
43:07there has been at the sector level,
43:09which is much more monolithic. So, so we
43:12do have a a bit of a cyclical bias in
43:15terms of the sectors that we have more
43:17favorable ratings on uh industrials,
43:21materials, financials. We also little
43:25bit more from a valuation perspective
43:27are on the more favorable end of the
43:28spectrum on healthcare and then on the
43:31less favorable end of the spectrum would
43:34be areas like I already mentioned uh you
43:37know utilities and and real estate. So,
43:40but we think applying that factor
43:42overlay because even within sectors,
43:46you're seeing much more dispersion and
43:48the the key to figuring out, you know,
43:51what's going to be on the better end of
43:52that uh dispersion of performance,
43:54what's going to be on the worse end. I
43:56think that's where that factor screening
43:58or analysis comes into play.
44:01>> Um, a few other sort of different
44:03factors I wanted to touch on, Lausanne.
44:05The first is the midterms. Is it is that
44:07something that the market actually
44:09doesn't care about or historically is
44:11there is there a reaction leading in and
44:13afterwards depending on the result?
44:15>> Yeah. No, the market often does uh care
44:17about the midterms. You know, it's the
44:19worst year overall on average for the
44:23four-year uh election cycle. And the
44:27volatility tends to pick up at around
44:30this point in time, sort of the summer
44:32and the the lead in and then you you
44:34sort of tend to see a rally. And I I do
44:36air quotes around tend because there
44:39there are exceptions. There's exceptions
44:40to every average around the election
44:42cycle. Um you know I I I would if you
44:47could gauge what the market is pricing
44:51in or probably should be pricing in is
44:56pretty high likelihood of the house
44:59changing hands.
45:01maybe not quite
45:0350/50 or more in favor of the Senate
45:07changing hands. So, that seems to be the
45:10consensus and and our team in Washington
45:13led by um our my fabulous colleague Mike
45:15Townsen, he puts it I think his odds are
45:20um 75% that the House turns for I think
45:23it's 40 or 45% that the Senate turns. Um
45:28the then it's a question it you know
45:30that there's very little likelihood that
45:32the that the we go back to sort of pre
45:37one big beautiful bill which would in
45:39turn be pre say the 2017 tax cut. So
45:43don't worry about some sort of imminent
45:45change to tax policy. Um but
45:49investigations would undoubtedly uh pick
45:52up. uh there would be fewer executive
45:54orders or or fewer decisions that are
45:57made that arguably do require Congress.
46:01Um so I think it could bring some
46:03volatility into the mix. But it's if say
46:08the House does turn and the Senate
46:10doesn't and people are shocked by that
46:12and there's a big market reaction, I
46:14would say what rock have you been living
46:17under um for the last year? that that is
46:21that is that's would not be a terribly
46:23surprising outcome. Um the other kind of
46:26longerterm factor I'm interested in your
46:28take on and Charles Schwab you you guys
46:30have great insight into this but is is
46:33the wealth effect and and how much
46:35>> this very long rising uh period of of
46:39rising equities has had on the US
46:42economy as a whole and in that terms of
46:44virtuous cycle then on the stock market
46:46too and and whether that alters the
46:50potential riskreward from here that if
46:55that gets derailed.
46:57And I guess on that question, we're
46:58asking not not so much about just the
47:01size of a a market pullback, but the
47:03persistence of one and how long it
47:05lasts.
47:06>> Is the downside more pronounced uh if
47:10that probability arises than than over
47:12most of this sort of century?
47:15>> Um probably. Yes. And I we we've never
47:20seen a higher share of household assets
47:23invested in the equity market. You can
47:25look at sed fed data related to that. Um
47:28you can look at data around different
47:31percentages
47:32of that exposure to equities and look
47:36out subsequent 10 years. And the outlook
47:38from a an equity return standpoint is on
47:41the lower end of the spectrum given that
47:43we're at all-time highs in terms of
47:44exposure. Um, I do think there is the
47:48the carry into economic performance that
47:51is probably even greater than what
47:53existed in the late 1990s into the the
47:57internet bubble bursting in early 2000.
47:59So to go back to that period of time to
48:02illustrate this, we had the bursting of
48:04the internet bubble that started in
48:06early 2000. You saw them the equity
48:08market peak in March of 2000. Ultimately
48:12didn't bottom until October of 2022. We
48:14had an economic recession in 2001. It
48:17was not a terribly severe one in terms
48:19of the contraction in GDP and I think it
48:22only lasted nine or 10 months. My view
48:25is we would not have had a recession at
48:27all if it weren't for the problems in
48:30the equity market because we it wasn't a
48:33story of a major tightening in financial
48:35conditions or monetary policy. It was
48:37not a major credit crunch. It wasn't
48:39some sort of plumbing system problem
48:41within the financial system. It was a
48:44bursting of an equity bubble and the
48:47wealth effect filtered its way into the
48:49economy. I I I think you have to think
48:52in those terms this time too. But
48:54there's a there's also some circular
48:55logic that needs to come into it and
48:57maybe an unanswerable as of yet question
49:01is sort of chicken and egg. So I I think
49:03it's easy to connect the dots if we were
49:05to see something more significant occur
49:08in the the equity market, something
49:11more severe than the kind of mini
49:14corrective phases we've had uh in the
49:16past year or two. Um something a little
49:19bit more lasting than say what happened
49:20during the the COVID related uh bare
49:23market. It's hard not to think that that
49:26filters into the equity market side of
49:29things. And in turn, if we were to see
49:32more weakness in the economy develop
49:35than what is built into expectations, if
49:38you really were at risk of an aggregate,
49:41you know, actual recession, how much
49:44does that feed into the equity market
49:46beyond what it might have in the the
49:48past where where you can sometimes point
49:50to periods where you disconnect the
49:52economy and the market? So yeah, I I
49:54think that that is something that that
49:56we all should worry about without having
49:58any real sense of when and if that
50:01tipping point might occur, at least in
50:02the near term.
50:03>> And and look, I totally get what you
50:06said throughout this conversation about
50:07timing the market. It's a it's a fool's
50:09errand. It's impossible. It's impossible
50:11to do. And I totally get what what your
50:14CEO said to us when he joined us, Rick
50:16Worester, about it's about time in the
50:18markets, not not timing the markets.
50:21Right. That said, there's been quite a
50:22lot of
50:25sort of negative factors we've discussed
50:26over the last 45 minutes. I just kind of
50:29wanted to go back to a question I I said
50:31earlier, which is, you know, not not in
50:33changing that fundamental piece of
50:35advice, which is time in the markets is
50:38is worthwhile. I mean, that's what this
50:40podcast is all about. Um, but compared
50:43to the last three or four years when
50:45we've we've chatted a lot either on this
50:47podcast or before on CNBC, are you less
50:50constructive than than you were in
50:51moments during those last three, four,
50:54five years?
50:55>> Um,
50:57no. I I think we have to be maybe a bit
50:59more mindful of of the risks right now.
51:03But I think there are there are
51:05traditional disciplines that I think can
51:07help investors continue to participate
51:09in what has been a pretty healthy market
51:12backdrop without adding undue risk and
51:15portfolio. So be mindful of
51:16concentration.
51:18It's boring to talk about on on this or
51:20on CNBC, but diversification across and
51:23within asset classes matters so much in
51:25this environment. be mindful of
51:27concentration, take advantage of
51:28rebalancing. And for a lot of investors,
51:30we've been saying a lot of the
51:32rebalancing programs, certainly on the
51:34institutional side, you know,
51:35traditional mutual funds do their
51:36rebalancing typically the last week of
51:39each calendar quarter. A lot of other
51:41programmatic structures that have
51:44automatic rebalancing. They'll do it
51:46based on the calendar. It might be
51:47semiannual. It might be uh at the end of
51:50the the year. One of the things we've
51:52been saying to investors is consider
51:54portfolio-based rebalancing where your
51:56actual portfolio tells you when it's
51:58time to trim back an asset class or even
52:01a stock or a group of stocks that have
52:03had outsized performance on the upside
52:05and in turn let your portfolio tell you
52:07when maybe you want to add to
52:09underperforming areas. So assuming you
52:11have some sort of strategic asset
52:13allocation that makes sense for you as
52:15an investor, your time horizon and your
52:16risk tolerance, your need for income,
52:19past experiences, whether your financial
52:22risk tolerance and your emotional risk
52:23tolerance are two entirely different
52:25things, which often happens and
52:26sometimes we learn that the hard way
52:29that those are the disciplines that
52:31matter. And what I fear maybe is that
52:35there is a bit more of a gambling
52:37mentality certainly for younger
52:39investors. Um, we have been a big voice
52:42on this. Um, I wrote a piece back in in
52:44April with my colleague Kevin Gordon.
52:47Um, up titled Gamblers Blues. It's still
52:49on the website. Schwab made it into a
52:51commercial because it's such an
52:53important message about the blurring of
52:55the lines between investing and
52:58gambling. And we're seeing that. We're
53:00we're we're seeing it in all the surveys
53:02done of the younger generations and they
53:05view gambling, whether it's sports
53:07betting or in the prediction markets or
53:10a really short-term get in, get out or
53:13gamble on the stock market. You're
53:15seeing it in terms of options activity.
53:18To me, that has the potential to be a
53:22crisis at some point, almost a sort of a
53:24financial literacy crisis in the making.
53:27And our message around that has been
53:31investing is about owning. You are a
53:33participant. You are you are a
53:35participant in wealth creation. You are
53:38owning a stake say in a company and its
53:40future cash flows. And you're a
53:42participant in that. You know, your
53:45approach to investing is about gambling.
53:47You're not a participant. You're a
53:49spectator. And gambling is about hoping,
53:52not about owning.
53:54>> You place a bet. you step back as a
53:57spectator, you hope it's a windfall.
53:59More likely than not, you lose the
54:02entire investment. And we also know that
54:05over any reasonably long time period,
54:07the odds are in your favor as an
54:09investor. Anyone that's ever gambled,
54:12anyone that's ever stepped foot in Las
54:14Vegas knows the odds are against you.
54:16And that to me is the thing that has
54:19changed and I worry most about. And you
54:22you see it in in day-to-day action in
54:24the in the market and single stock ETFs
54:26and all the leveraged inverse and it it
54:29does bring back shades of 2021 when it
54:32was the meme stock craze and it was the
54:35spat craze and we're seeing a bit of
54:37that again. So
54:38>> I find that there are pockets of
54:41sentiment froth
54:43>> um and a mentality of get in get out
54:46which neither of those are an investing
54:48strategy. That's again that's just
54:49gambling on two moments in in time. So
54:51that specifically is something I worry
54:54more about than some, you know, '08
54:57crisis uh ahead of us and a and a deep
55:01longlasting bare market.
55:02>> Well, listen, I totally totally agree
55:04with that, Lisan. Very much uh against
55:07gambling versus uh in favor of long-term
55:10investment. The house and the maths are
55:12against you in one and they're behind
55:14you in the other, which uh is
55:15>> nothing wrong with, you know, placing a
55:17a sports bet or going to Vegas. I mean,
55:20but we shouldn't we shouldn't blur the
55:22lines.
55:23>> I was just talking with my wife that we
55:25need we need to get back to Vegas. It's
55:27been too long. But as you say, once
55:29every few years only. Um, Lzanne, it's
55:31it's been a pleasure. Thank you so much
55:33for joining us again on the Master
55:35Investor podcast and and u hopefully
55:37we'll do this again in person at some
55:39point next time you're you're in London
55:41or
55:41>> I hope so too. Wolf. I love our
55:44conversations and really appreciate you
55:45having me again. Uh Lisanne Saunders
55:48from Charles Schwab there. Great to have
55:50her back on the podcast. Next week on
55:53the Master Investor podcast, we'll be
55:54joined by Jeff Curry of Real Macro, a
55:58company he's founded on his own since
56:00leaving uh Goldman Sachs after 30 years
56:02where he was head of commodities. Lots
56:04to discuss with Jeff that's coming up
56:06next week. So, please do hit follow or
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