#1042 - Can Tech Lead the Market Higher? w/ Liz Ann Sonders

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0:59Can tech lead the market? Hi, everyone. Welcome to the Real Vision Daily Briefing. I'm Maggie Lake. With me today is Lizanne Saunders, Managing Director and Chief Investment Strategist at Charles Schwab. Hi, Lizanne. It's great to have you. Hi. I'm also apparently the recipient of the pink memo. Yes. I know. We did not plan this before. No, we did not plan it. Slightly different shades, but for somebody who almost never wears pink, this is ironic. But a little levity in our afternoon. That's what I said. We're bringing the happy. That's right. Right. And we needed a little bit today, maybe. I don't know.

1:32It was a little bit of a down day for stocks. Investors keeping an eye on, it seemed like two things really. Certainly, everyone's on the edge of their chair for NVIDIA earnings, which are going to be hitting the tape any moment now. And I was surprised about the number of people who were like, this is the biggest thing in macro right now, but NVIDIA has been. But we also had Fed minutes, which seemed to cause some ripples. So let's tackle the Fed first. And just tell me what your thoughts are. We had them drop the minutes. Obviously, they're backward looking. But it came on a day that we also had a surprise drop in existing home sales.

2:05That seemed at odds with maybe some of the concerns in the Fed minutes. How are you thinking about that policy? Yeah, so I was surprised. It seemed to be a bit of a knee-jerk move on the part of markets, given that the minutes covered the meeting that was on April 30th and May 1st, which at that point, the only data that was in hand were the three months in a row of hotter than expected inflation. And then the prior month at that point of a hotter than expected jobs report. But then subsequent to the May 1st meeting, we had the even PPI was more benign because it was only seemingly hot on the headline level because of downward revisions to the prior month.

2:43And then you got a little bit cooler CPI reading. You got the pretty much cooler across every component metric in the April jobs report. So I was surprised to see that reaction. Other than all-time highs, there's been a tremendous amount of momentum. Sometimes you get to that overbought condition that just triggers some profit-taking, even if the news, if you dissected it, didn't specifically point to a reason for the market to sell off. So I think that's what happened today. That seems really reasonable because it did seem kind of out of sync, especially on a day when you're getting yet more weak economic data.

3:18It's not like it came on a day when things are running hot. But does it seem, so what are you expecting from the Fed? Because they have been sort of talking out of both sides of their mouth a little bit, right? Like we know that rate cuts are getting put in and partially because, you know, when there's a meeting and Jay Powell seems to try to walk that line. And then you have some of the Fed presidents trying to sound like they're going to be tough on inflation. So it's a little bit mixed. What do you think is the most reasonable course of action in terms of what we should be expecting from the Fed?

3:48I think it depends on the data. And I think, you know, during the hiking part of the cycle, somewhat obviously, the Fed was almost solely focused on the inflation side of their mandate. Now they have both of the dual parts of the dual mandate very much in focus. And pretty much every speaker now, including Powell, is saying that there certainly could be circumstances under which the labor market weakens enough that that can represent the green light for easing policy absent a move in inflation, whatever metric, down to the target. So it's not necessarily that we have to wait for poor PCE to hit that magical 2 % point.

4:30That's a stretch just from a math perspective because we're starting to drop out in the April through August period of last year. That was a big deceleration in inflation because the comp then was the nine handle in the case of CPI the year before. We're dropping those numbers out. And if you just track on an average basis of what the monthly readings are, PCE is actually set to hook back up. But if there's meaningful deterioration in the labor market, the Fed has suggested they could use that as a reason to start easing policy. We know their desire is to want to cut rates. The market has priced in a September start with one to two cuts, but that could change.

5:14And I think it's almost a silly parlor game of all the prognosticators out there saying, I think it's going to be July. I think it's going to be September without any there there in terms of, well, this is based on here's what I expect to happen to claims or the unemployment rate. Or we're going to see a real big move down in the month over month readings on core PCE. Absent that, we're all at the mercy of the data. Yeah. What is it? Where does the where is the economy right now? What should we expect from the labor market? So we've been using the term rolling to describe this cycle, rolling recessions.

5:49Going back to the early part of the pandemic, the initial surge driven by stimulus was funneled into the good side of the economy because, of course, we had no access to services, not just here, but globally. And then we had the rolling over as you reached that pent-up demand and you went into recessions for housing and housing-related and manufacturing and a lot of consumer-oriented goods that were big beneficiaries of the stay-at-home era. You just have the offsetting strength on the services side. The weakness was enough that, remember, we had the entire first half of 2022 was negative GDP.

6:22We just had the larger portion of the economy services offer that offset. And now that we're starting to see services falter a little bit, there had been some hope that we were finding stabilization in manufacturing. You had that slight move back up to above 50 in the ISM manufacturing index that, for now anyways, seems to be a one-month phenomenon that ticked back down again. But now I think another way to think about the economy is there's lots of bifurcations. You know, much healthier large company sentiment and balance sheets and earnings profiles versus small companies, high-end consumer versus low-end consumer, even within the inflation data.

7:04If you break out any of the inflation metrics, CPI or PCE, into the non-discretionary components and the discretionary components, non-discretionary is running at more than 6%. Discretionary is running flat. So that's another. So it's sort of a bunch of these kind of K-shapes that make this yet again another reason to think of this cycle so unique. And it's today's orange compared to history's apples. Hey, everyone, we're going to take a quick break right now to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing. Have you ever wanted to trade Bitcoin but haven't dared try?

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8:42yeah i love that idea of a rolling recession because it helps explain some of the confusion confusing headlines right depending on who you talk to i mean and and also by the way the polls right there's just an interesting poll uh out today 56 of america percent of americans believe the u.s is in a recession this is the same economy where some people are screaming it's a you know There's no landing. This thing's on fire. The Fed has to hike rates. The perspective is so, the range of perspectives on whether it's the economy or the labor market or inflation is so wide ranging. It really depends on your own personal set of circumstances.

9:23I mean, it's always the case that everybody's personal inflation rate is different. You know, I always use my parents as an example. They're 86 and almost 94, and they live in a senior apartment, and their costs are basically fixed. They're not driving anymore. They're not going out to the grocery store. So their personal inflation is almost nil. where somebody who's commuting an hour in a car and has to shop for groceries and pay auto insurance and homeowner's insurance. So it's part of the reason for this bifurcation. And not only that, another problem in this cycle is that a lot of the data that comes in via surveys, even things like the BLS establishment survey that generates payrolls, the response rate has come way down.

10:14The response rate has been cut in half for jolts. It's been almost cut to that same proportion for the establishment survey. And what that leads to is a greater number of big revisions because the data is not as robust in the initial print because response rates have come down. And that may have something to do with the pandemic as well. That's so interesting. And it's really important, right? Because that kind of skews everything. if you're not getting that intel that you used to? Does it seem like a temporary thing or is this maybe - I don't know. I think the last time I looked at a chart of the response rate for the establishment survey out of the BLS, I believe it may have started to hook higher, but I haven't seen any concrete data as to the why behind the response rate being down and whether that's just something cyclical, something pandemic-related, or more of a secular thing.

11:12If it's more of a secular thing for whatever reason, it just means that in the case of things like monthly jobs reports, when you get that headline of payrolls, whatever the payrolls number was, you've got to spend as much time focusing on the revisions, not just the revisions that come out each month with the jobs report of the prior two months, but those annual benchmark revisions. That's got to be in the collection as you try to assess the labor market. So it's also why I say be careful about knee-jerk reactions to initial readings on anything these days, because there is just that greater amount of uncertainty.

11:50That's super important. And we know from all of you that you want to put together a trend, right? I remember at least three months before, but now this is different if even that. But as you say, we're all data dependent. So this becomes really sort of murky when you're trying to figure out what's going on. By the way, you tweeted out another something today, a great map that shows just how uneven. We've talked about income, depending where you are, depending what your personal inflation is. It's even geographically, right, where you're sitting. That was fascinating to me. Yeah. So whether it's unemployment rates across the 50 states, whether it's inflation rates, whether it's wage growth, huge, huge spread from the high end to the low end, depending on where you are.

12:39And that obviously has to do with whether what the industry is that drives your regional area, your metropolitan area, your state economy. And so these days, whether you're an analyst of the overall economy and markets like I am, or even an analyst of individual companies, probably the most important tool you have is your fine tooth comb to go through all this stuff. Yeah. And I know at Schwab, you touch so many individuals and so many people who are thinking about their well-being, their retirement. So it's a great sentiment gauge as well. Where is the consumer? Because we know, speaking of those surveys, even if they are a bit unreliable, we know that consumers are still hot and bothered about inflation, right?

13:25It came up in University of Michigan. We saw Target's earnings disappointing today. How's the consumer holding up and what does that mean for consumer-facing businesses? So one thing I think we can't look at the consumer through a monolithic lens anymore. That might have been an okay thing to do during the stimulus part where you saw savings rate overall jump to more than 30 percent and it accrued to the benefit of everybody. And arguably, when we came down on the other side of that for a while, you could look at the consumer monolithically. That's not the case anymore. In terms of the excess savings thesis, it's hard to know what the accurate numbers are.

14:00San Francisco Fed has done some work on it, most recently saying that it's basically gone. But there's other data that shows at the high end. there still is some excess savings. It's pretty much gone for sure on the low end. And that's why you're seeing delinquencies really accelerate in the subprime categories, especially for autos and credit cards. You are seeing it in some of these retailers. And it's not just the lower end that is paring back on purchases and really digging their heels in against the inflation problem. But there's even been kind of a mix shift happening up the income spectrum and just a change in spending habits.

14:36You know, the other thing I would say is this idea that consumption has been booming in dollar terms. Yes, you could argue that. So we had about$19 trillion of consumer spending in calendar year 2023, which is a big number. It's a record. But that data is not population adjusted. If you population adjust consumer spending and you do it per capita, It's actually been in a somewhat flat range since 2021. And that's because we've had a huge surge of immigration, which let's not get into the political side of that. I deal in facts and data and math, and that has been to the benefit of labor force participation rate, the demand side of the economy, but it also skews things like consumption numbers that are expressed in just aggregate dollar terms.

15:32That's fascinating. And this is why it's so important to get down in the weeds in this data like you do, because it can be very confusing in the headline, especially when you're in this interesting transition coming out of a pandemic and trying to figure out, you know, what's temporary, what's now structurally changed. Let's talk a little bit about tech, because everyone is waiting for the NVIDIA earnings out after the bell. How are you feeling about the tech sector at this juncture? So overall, the sector we have rated what would generically be thought of as neutral. You know, our lingo is market perform, our outperform ratings, our materials, energy and financial.

16:11So it's not a it's not an anti tech. It's just, you know, it doesn't screen well in terms of the quantitative part of the work that's done on sectors. Maybe no surprise on things like, you know, valuation and sentiment. But as it relates to NVIDIA today, and as you know, Maggie, I don't cover any individual stocks. I'm not an analyst. I don't cover NVIDIA. But to just put some math as to why there's just so much focus on this stock, if you look at, we're almost at the end of earnings season, obviously, right now. And the tech sector is expected to have about 24 % earnings growth for the first quarter.

16:47You X out NVIDIA based on what the current expectation is for the quarter, and that drops down to 11%. NVIDIA is now the third largest contributor to overall S &P earnings. Apple and Microsoft are still larger as a contribution percentage, but NVIDIA's growth rate expectations are much higher, which is why you see that big depression happen if you X NVIDIA out. So it matters more than just psychologically. It matters in terms of the math and the power of those earnings. So, you know, we'll have to see. And there are a lot of whisper numbers out today that were higher, both on the top line and bottom line.

17:28And that, I think, sometimes gets troubling just overall. I'm not speaking specifically about that stock. When the expectation bar gets too high, you have that risk of people extrapolating strong growth. The last thing I'd say is that if you look at the Magnificent Seven or the Mega Cap Eight, the peak in the aggregate growth rate for those stocks was fourth quarter of last year when you had low single-digit earnings growth for the rest of the S &P and more than 60 % earnings growth for the Magnificent Seven. By the third quarter of this year, and this is consensus expectation, those are going to converge.

18:07The other 493 catch up to about 14 % or 15 % growth with the Magnificent 7 catching down. Now, NVIDIA could go a long way in making that process a little bit more elongated, but just some math around why there's so much focus on this particular stock. Yeah. We really have seen, well, we've seen everything underperform those mega cap, right? It's been tough. All the flows are going that way, and you can have lots of conversations, whether it's passive or an active decision to do that. But are you surprised that we've seen such underperformance, especially if you look at something like the Russell?

18:42I mean, everything's just been dead in the water except for that small basket of stocks. You've had some short-lived periods kind of in the sun for equal weight relative to cap weight or Russell 2000. If I was to point to one particular thing that I think has defined whether small caps and equal weight kind of lose any hope of meaningful gains is the bond market and the yield environment. So if you think about the point at which yields peaked out at 5%, and I'm using the 10-year as an example of that at the end of October of last year, and then ultimately came all the way down to below 3.8%, that initially provided a huge tailwind for the market, but specifically down the cap spectrum.

19:27because, of course, smaller companies tend to have more leverage. They tend to have more floating rate debt. So the influence of big moves up and down in yields has felt much greater down the cap spectrum. And then when we had that recent bottom down at 3.8 and we ultimately went back up to 4.7, that really caused a hammering again down the cap spectrum. And you can be more granular, too, and look at the strength of the balance sheet and interest coverage as a particular factor that has really kind of moved in and out of favor, depending on what yields are doing. So I continue to think if there's sort of one thing that's in the driver's seat for the equity market and the nuances within, it's the bond market.

20:10Yeah, all roads lead back to rates. It's been that way for the last year and a half, almost two, and it's been difficult because everyone's been, we've seen these swings and a lot of people have been caught off guard by them. So you like energy, you said. That's one of the sectors you like. What's attractive about that right now? Yeah. So all three of the sectors on which we have outperform ratings screen really well in terms of value. Energy also screens well in terms of quality and sentiment. It's also a sector that institutionally and amongst the retail crowd is pretty significantly under-owned.

20:49And you can't say that about a lot of sectors, but broadly with those three sectors, it represents the cyclical side of the economy and what looks to be improving growth outside the United States in places like China, Europe seemingly having come out of what was a fairly mild recession. And some of the pushback that we get on that is, well, fine, it may be improving, but global growth isn't strong. But one of the things I've always said for my almost entire 38 years doing this is when it comes to market movements and understanding why at times a move in a stock or a sector or an asset class doesn't seem to make sense when the level of the data is not supportive, it's the rate of change.

21:38It's better or worse can often matter more than good or bad. And it's just that inflection point that I think has been fundamentally behind why you have these traditional cyclical areas performing fairly well and why you're seeing some improvement in terms of overseas market performance. We're going to take another quick break to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily briefing.

22:09You mentioned financials, which is interesting because we know there's still a lot of pain in real estate. Some people are worried about private credit and any sort of, I don't want to say black swan, but maybe that's where the cracks are. And if things go wrong, that's going to be and the threat of contagion. Is it broadly bullish financials or are you being particular about what type of financials? Well, when we have our ratings on the sectors are S &P sectors. So they're inherently the larger cap companies and particularly within a sector like financials, the big boys, which dominate financials within the S &P 500, have somewhat de minimis exposure to commercial real estate and the problem pockets they're in.

22:56Most of the exposure is down in the regional and smaller banks. And given that an index like the Russell 2000, I think has a 24 % financials, that's where you're feeling the pain points. That said, you know, commercial real estate is a very broad category. It's not all office there. There's, there's healthcare and there's senior facilities and there's warehouses and there's retail and there's hotels. So it's really just the office component of it that is most beleaguered. But But even there, you've got regional differences, urban area differences. You've got class A versus class B, not to mention a maturity schedule that is very extensive.

23:33So maybe the best way to think of this is it's sort of a slow motion train wreck or a simmering problem over time as opposed to being something Lehman-esque in nature. You're right to point out the private side because so much credit has been provided in the private markets. I don't have any more color than anybody else. First of all, I'm not an expert on the private markets. But of course, we do know that that's where a lot of lending has occurred. And it's more opaque with less liquidity. So yeah, there could be some bombshells happening within that space. But again, I think it's more of a simmering problem over time as opposed to some moment in time, some straw is going to break the camel's back a la Lehman.

24:21Yeah. And a lot of those big cap financials banks have had to go through stress tests and a lot has changed. So their balance sheets are pretty fortress when it comes to having to sort of navigate some volatile waters, for sure. Absolutely. We have a question back to the Fed. And NVIDIA earnings are, oh, wow, they announced a 10 for one stock split. So it could be a lot of action after hours, I'm sure. As if it wasn't already appealing enough to retail investors. Exactly, exactly. There's like, you know, so it's going to be wild. But as always, folks, you want to listen to that conference call, too, because there's always a lot of stuff and people get caught up in just trading the headlines.

25:03So but this is going to be really fun for a couple of hours. But I want to switch back to the Fed because we have a question from Raymond. And that is, Liz, what's your view in time horizon of tech with the Fed reducing QT from$60 billion to about$25 billion? I think he's getting at this argument that if there's going to be liquidity coming into the system, it's going to just funnel to risk assets and particularly the tech sector. Does that change your mind? No, in fact, what's funny about QT, and I heard this analogy and I thought, that's a really interesting way to describe going from QE to QT.

25:39And it had to do with a fire in a building, a burning building. And QE, with the fire being an analogy for whatever the crisis is, so the Fed comes in with the QE fire hoses and finally extinguishes the flames, puts out the fire, there's no more embers. When they leave, that doesn't mean the fire is going to ignite again. So I think we have to think distinctly about what happens when you're in QE mode and what happens when you're in QT mode. There is clearly still plenty of liquidity out there. And that's why, yes, a lot of that liquidity has continued to find its way within the equity market in the momentum areas like tech, but it's found its way into other areas too, not to mention other asset classes, commodities and precious metals.