How to Pick Stocks Like Morgan Stanley With Dan Skelly

20:46Google's issuance ahead of the big SpaceX deal bought up immediately.

20:50Michael Batnick:I think that's really impacting the economy and the market in an underappreciated way. No, I think that's absolutely right. And that's like the residual benefit of a 15-year bull market, which started out as FANG, then went to MAG7, then went to AI CapEx. And now, I agree with you, the most healthy thing I would argue in terms of the duration of this cycle is the rotation we just saw. It's as if you really needed the semis in June and some of the other first order AI CapEx winners to roll over. Here, healthcare, take it. To get the healthcare sector, to get - Materials. Mathematically, get the Mag7 working.

21:21Right. And we saw that in, you know, selectives.

21:24Downtown Josh Brown:Financial stocks working all year and all year last year for the most part. Healthcare this year, small caps coming out of nowhere. Yeah, small caps has really been a surprise.

21:34Michael Batnick:I know they've pulled back, but they had a big run. kudos to Mike Wilson, our other friend and partner, you know, of many years, whom used to be my direct boss 10 years ago, who had a small caps call earlier this year, late last year. So yeah, I think that's been one of the surprises as well.

21:49Downtown Josh Brown:Okay. Are we going to see the dramatic earnings growth gains that have now spread from the S &P into the mid caps and the small caps? Is that sustainable? So I feel like that space is a lot trickier. Yeah. Because on the one hand, And you would argue like the sectors that are disproportionately overweighted to small and mid industrials, financials have a lot of, as I've mentioned so far, a lot of idiosyncratic positives like capital market cycle, rates, building, production, no doubt, Josh. FOMO. FOMO, for sure. That risk taking liquidity you mentioned.

22:25Michael Batnick:All the M &A leads to more M &A. And it should. And look at how the biotech sector is acting of late as an example. So here, all of that can be true on the one hand. And then on the other hand, I think it can be true that rates backing up, particularly for that lower quality cohort of small caps, should be an issue, right? And we've talked about this phenomena as of the last 15 years. We went through this massive monetization cycle in privates. And something like 80 % of the companies in the U.S. today that generate$100 million plus revenue are private. So basically, your small cap allocation as a retail investor could have just been in the private market and not in Russell.

23:01Downtown Josh Brown:It's an off now. Totally. And so that you've had like almost this negative selection bias in the public in the Russell 2000, which is like whatever the status, 40 % of that index isn't profitable. And so like I think on the one hand, you have positive drivers. But on the other hand, beware rates, number one. And beware AI. Look, let's face it. I think AI, we've talked about it earlier in terms of the big caps and when does that show up in earnings. But I think AI could be really tricky for small caps in the sense that, number one, in some of these industries, AI is going to disintermediate certain industries completely, and they may be more small cap in nature.

23:38Number two, I would argue that the AI adoption wave we're going to experience, which is going to be a decade experience, may not also be felt in terms of the right tail from the small caps. Because in many of the cases, those less profitable small caps don't have the capital to invest in AI. So they might have a left tail risk, disintermediation. They may have a right tail risk in terms of not participating in the AI adoption.

24:02Downtown Josh Brown:So small caps will do what small caps do, which is periodic moments of inspiration followed by disappointment. And then when you're so disappointed, all of a sudden they start to rally again. Very different return profile than large caps. I think that's well said. I think it's like catching a Friday morning flight to Tampa. You're going to have a lot of periods of calm and you're going to have a couple seconds of turbulence. I like that. I like the pop-up ad metaphor even better though. That's a good one. Thank you. Where, yeah, we see it. It's peripheral. Can't wait to close that window and not think about it.

24:36Downtown Josh Brown:So I'm that way with the midterms. I have no opinion of what's going to happen because I'm paying as little attention as possible. I think that's wise. So maybe the House turns over, the Senate doesn't, and nobody really does anything differently. the one big thing that might change is all these astroturfed data center protests might very quickly go away because there's no longer a political opportunity to say how much you hate Microsoft. Like all of a sudden we were talking about it, talking about it. Then the election comes and goes and nobody's talking about it anymore. I could picture that.

25:06I think that's spot on. I was at a client dinner earlier this week out on the island with Brian Nowak, who's our leader, thought leadership, thought leading, industry leading internet analysis, you well know. And we were talking about really the midterms, but also 28. And this idea that the midterms, like you just said, are going to come and go, and then people are going to focus on 28. And what you might feel, right, is just a very fast pull forward in terms of data centers.

25:31Downtown Josh Brown:We may have a presidential election in 28. Yeah, every four years or so, they seem to come back. Okay, go on. What I was just saying is Brian's view, and it's intuitive to me, is past the midterms, Right. And keep in mind that AI CapEx and momentum implosion in June, which has struggled technically to come back to the 50 day if you're like memory stocks or I think it's very interesting when you get past the midterms that you have maybe almost a pull forward ahead of 28 in terms of the data center trying to get as much done ahead of that. So that would be a negative catalyst eventually. In terms of the hangover?

26:09Downtown Josh Brown:Well, so the last CapEx cycle that became a pull forward was Y2K. And the hangover from that started to be felt in the second quarter of 2000. So wait, wait, wait. People are not going to buy this many Intel chips every quarter. Oh, that's not good. So that's the thing that I most worry about. The amount of the earnings growth that's expected to come from the hyperscalers, the 50 largest semis and memory companies, and then the Dell computers of the world. It's a large, it's not all of the earnings growth. It's a large amount of it. And if it goes into reverse, I don't know that the market's going to treat that well from 21 times earnings.

26:53Michael Batnick:And also Broadcom today, what are they, 90 % growth, whatever it was, and the stock fell 5%.

26:58Downtown Josh Brown:It wasn't 91%. Same with NVIDIA recently, which blew out the guidance and even said guidance amid capacity constrained backdrop. and the stock worked well on the day and then really hasn't followed through.

27:11Michael Batnick:So what does this tell you about where the stock market is today? Now, the environment could change, but people are simultaneously worried that their earnings are too high, the earnings estimates are too high. And even when companies destroy earnings to the tune that we've never seen before, the stocks still aren't working. Is that bullish? It doesn't really sound it. I think it's, in my opinion, it's good for the duration again. Like it comes back to this idea of, I think we're in a longer cycle. And like secular, here's the good news. The way the capitalism works, the secular bulls last a very long time.

27:43Like they last 20, 25 years on average. And the good news is also that the secular bears tend to be half that duration. So we had a nasty bear market, as you well know, coming out of the 2000 internet bus. And really since 09, 010, it depends if you adjust it for inflation and S &P price and gold terms or not, which I know which is one popular way to look at it, but we think we bottomed in 10 or 11 in real terms. And so, you know, whatever, we're 15 years into that cycle. I think the factors that are going to matter, right? To Josh's point a minute ago, 60 % of 2Q earnings, 28 % headline came from AI infrastructure.

28:21So I think we're money good on that particular contribution, 27. That was then. I think we're money good, 27, 28. Talk to Brian, who I saw two nights ago. His numbers for AI CapEx in 27 are 1.5 trillion. The street is at like 1.2. So the street is still low. And that's been, there's been a catch up, we all know for the last 18 months or so. On our team, we call it the quarterly tradition. Like every quarter, you can bank on the numbers going higher. Why? Because it's a generational competitive risk among the US players, zooming out among China as well. We can talk about it. Secondly, on a more technical basis, the scaling laws continue to work.

28:57Meaning every time we train new levels or new AI models on higher levels of compute, the outputs and the results continue to get better. So what is the technical incentive for drawing down the CapEx at this moment? So I agree that -

29:12Downtown Josh Brown:One other thing to add to that that I've been talking about that I think is maybe underappreciated, it's not as sexy as new data centers and it's not as sexy as new GPU sales to new customers. But when you build these data centers, you are embedding guaranteed purchases of servers and chips as far as the eye can see. We could argue about the depreciation schedule and is a GPU produced in 2026, a five-year asset, a three-year asset. I don't know the answer. I'll be the last person that will know that answer. But the point is, it's not a 20-year asset. Correct. It's not the same as Toyota building a plant that's going to make RAV4s for the next 20 years.

29:54Downtown Josh Brown:You're going to need new chips all the time. and there's a story there for NVIDIA, story there for Dell, which just had a blowout earnings report this week. Like that's a big part of the story that I think people underappreciate. Like now that you built these data centers, even if that slows down the pace of new construction, we still have to feed all of this existing infrastructure with tons of technology. So I think that's the most important point that anyone's made so far on the pod. And the reason I say that is - I told you I'm good at this. is that tennis clap yes the reason i say that is because of the following we wrote a note back on june 1st and i love writing i wish i had more time to write but i write you know fairly infrequently but i wrote a note on june 1st which i'll share with you cautioning the semis momentum and our takeaway was you hear all about demand constraints to your good point i think in under the hood in reality, it's more about deployment constraints.

30:52You are ordering servers and chips and all these electrical components and industrial components ahead of 40 gigawatts, 50 gigawatts of projected data center construction in the next two to three years. Are all those buildings going to get built, unless you're Elon, are all those buildings going to get built on time? And do you have a risk of double ordering in the supply chain of semis of service? Absolutely. Is it a risk today? No. But is a risk from here for now?

31:19Michael Batnick:Could be. This is one of the most bearish charts that I've seen. I accidentally was like this. I'll hold it up because it's not in the doc. This is a chart of Sienna. And as you know, Sienna was around during the dot-com bubble for the fiber optic build out straight up, straight down. And it looks eerily similar. It doesn't look great. Yeah. And that's so that's a perfectly reasonable analog. I think a couple of things I would argue, right? So one is when we look at our prime brokerage book and we're the biggest wealth manager in the industry. And I like to, I'll say the best, we're the biggest prime broker in the industry on the institutional side.

31:53All right. So if you look at the net and gross exposures of our hedge fund book and our hedge fund clients, a lot of our hedge fund clients have not regrossed in memory. And a lot of the first half winners in AI CapEx, they've been waiting. And we are paying very close.

32:08Downtown Josh Brown:So the stocks came down and they didn't get back into them, or at least not of the same size. Correct. Not even close. And where they rotated, they've rotated a tad to Mag7, somewhat to software, picking the bottom in some of those areas. But it's been healthcare. It's been some of these other parts of the market. So the reason I mentioned that, number one, is number one, I think that's healthy. I think the idea that everyone didn't jump back on the train is a positive. They're kind of waiting to see how things go in terms of pricing, in terms of midterm political football and data center. But again, I think the healthiest thing that has happened in terms of this cycle vis-a-vis 2000 is the rotation that's happening.

32:49And lastly, let's not also forget, as Brian and I spoke about on Tuesday night, that all the major hyperscalers are in the early innings still of a cloud transition. And yes, the cloud business is being in effect supercharged by the AI intersection today, But how many big Fortune 500 and beyond companies have fully transitioned to the cloud? You're not in the ninth inning. You're not in the sixth inning. You're probably in the fourth or fifth inning. So here's the key takeaway. The way this kind of differs from 2000 is when you laid all this fiber, you had no alternative for the fiber. It just went dark.

33:26And it was dark for 10 years until Amazon became Amazon. So did it eventually matter for creating U.S. exceptionalism? Yes. but not for 10 years.

33:35Downtown Josh Brown:Yeah, but we had to live through a 90 % NASDAQ decline on the way to somebody inventing YouTube. Like we had to wait, we had to wait from first quarter of 2000 to 2013, I think for the NASDAQ. On the NASDAQ to fully make a new high. Very great. Something like that. Very good point. And so where I'll just put a fine point just to end that comment is keep in mind that taking both of our, I think, I think we're on the same page, well-founded risk factors around data center deployment and double ordering, a lot of those chips can be reverted back to cloud. And so do we have dark GPUs the way we had dark fiber?

34:13Probably not. Maybe not as likely.

34:14Downtown Josh Brown:I like what you said about the duration of the bull. So not having a bubble. So when Michael brings up like NVIDIA blowout numbers, a week later, Broadcom blowout numbers, why are these stocks flat down? It makes no sense. I agree with what he's saying, but I also like what you said. if we don't rocket those two stocks up 70 % right after earnings, it gives you more potential upside over time. And so those stocks can rally, but we don't have to have the rise and fall all take place inside of two weeks. 100%. I like that it's in slow motion.

34:52Michael Batnick:Well, the glass half-fold version is we're building the wall of worry. You need that. You need disbelief. You need the wall of worry. Thank you, Michael. And by the way, the wall of worry was like the Empire State Building in 22 and 23. Remember, when everyone predicted, and I'll give kudos to Ellen Zentner, our colleague, who at the time had the economics call. Remember that in 2022, 2023, we'd just gone through the most aggressive Fed cycle in 40 years. And the consensus was predicting this big, bad recession that never arrived. Why? Back to our earlier conversation, we have paradigm shifted away from goods to services, away from a normalized income scale to a hyper-K-shaped income scale where the 10 % is driving 40 % and is less elastic to monthly changes in gas and food prices.

35:36And last but not least, of course, post-23, the AI super cycle. And so my point being is, I agree with you, Josh. I like the fact that you have, and Michael, I like the fact that you have these clouds hanging over the kind of Uber euphoria from happening, number one. But number two, I just want to come back to, and I know I'm doing a little bit of a weave, so I apologize. I just want to come back to your comment about the earnings growth risk, because here's where the onus on that baton being handoff from AI infrastructure to AI adopters is really crucial. In the next two years, does the margin productivity boost from the AI adopters more than offset what could be a deceleration in the AI infrastructure spending?

36:18That is the key handoff. Well, I hope it happens that way. It better. And by the way, let me just say this because a lot of our retail clients often – everyone thinks and talks and invests, unfortunately, at times with their generational bias and their memory. And a lot of our average retail clients are still stung with the memory of 08, with 2000, et cetera, for good reason. And a lot of people are talking about, is this 99 over and over again? And one of the things I would just argue is, in terms of how it's different, is number one, the quality of the spenders today is so much different from back then.

36:52Downtown Josh Brown:That's such a great point. And yes, we are talking about leverage now. But don't forget, these were all MAG7, formerly FANG. the industry group formerly known as FANG was once upon a time net cash balance sheets. And so if I'm an, as an investor, when I see a generational technology investment, I want to see more CapEx. I don't want to see just buybacks for buyback's sake, which is what they had done for 10 years. FANG was capital light. They generated excess cash. They bought back stock. They did that to the tune of a trillion dollars a year. The same people who hated the buybacks though now hate the CapEx too.

37:26Downtown Josh Brown:I don't know if you'd be surprised by that. It makes for the duration. So I want to double-click on what you just said because in 1999, in order for Cisco to hit its growth targets and Lucent and Dell and Sun Microsystems and Sienna and Juniper and I can go on and on, in order for those companies to hold up, they were reliant upon selling to a customer that had gone public a week prior. like literally like our enterprise customers are pets.com e toys cd now dlj direct and all these things that didn't exist a year later the customers today are amazon buying on behalf of its 30 million cloud customers who represent every sector of the economy a little different hospitals, insurance companies, manufacturers, government.

38:20Downtown Josh Brown:So it is not the same as, I hope we get the next 100 IPOs so we can sell these people some Sun Micro products or some servers. EMC needs to sell some stuff. So let's hope we get another 500 IPOs next year. That is not. Now, the asterisk is the two biggest players in the ecosystem on the buy side are not public yet, correct, not profitable, not particularly transparent yet because they don't have to be and not proven through any sort of economic cycle. That's the wild card that takes everything I just said and invalidates it a little bit. 100. I think it's really well said. And I think I'm somewhat limited, as you know, on what I can say on the privates or not.

39:05But what I would say in terms of what we've publicly written about and talked about is like the growth rates when you track what they're doing. Some of these companies on the privates were printing$10 billion ARRs end of last year. Now they're last month$60,$70 billion. So the growth rates are still astronomical. And that's what ultimately what you need is the demand versus supply dynamic to still be at our favor. And we think it is. Let me just say two things quickly because I want to get them in. So one is the quality of the spenders is different. Secondly, I don't think what gets discussed enough is the credibility of the spenders.

39:40And this is also in vast contrast to the pets.com analog. Look at I'm not I'm a fundamental investor, but look at the technicals of tech relative to the S &P over 30 years. It always makes higher highs. I think that is an incredibly profound technical signal. Why do I say that? we go through our warts, whether it was internet bus, whether it was 08, whether it was COVID, whether it was 22 duration sell-off, et cetera, et cetera, et cetera, but we always recover to new highs. What does that remind me of? The U.S., despite some of our political pitfalls and despite some of our issues, of which there are several, is still the single best allocator of capital to new innovative technologies and enterprises anywhere in the world.

40:21American exceptionalism lives. The historical analog, however, is that while we always figure out the next big thing and allocate to it appropriately, we almost always boom bust on the CapEx. So that was true of internet fiber. It was true of shale 2000 to 2015. Railroads, canals. Going even back to my, blowing off my history books, going back to rails. No doubt. Here's where this could be different once again. It goes back to our comment about NVIDIA and Broadcom are not screaming after phenomenal earnings. I also like that. I like the fact that the market is signaling, one, that they're treating those companies with rationality.

40:59And frankly, a lot of it's law of large numbers. And lastly, there's other games in town. There are private companies out there that are going to be coming out.

41:06Downtown Josh Brown:So I like that argument, that it's not that they are not impressed by NVIDIA. It's that they know they're not going to do 100 % earnings growth next year. But in the meanwhile, there are snowflakes. out there. Like there are other companies that do have that sort of potential that the world is waking up to. That don't trade at a$5 trillion market cap. And the money is shifting from one to the next. All right. I would buy that as a great reason for the rotation and for why it's so healthy. By the way, last point is 40X mutual funds. Think about the mechanical ceiling or the issue with a lot of those funds have on being relatively in absolute overweight nvidia right like they get kept out at a certain level they can't go to 10 they can't go overweight who's the incremental buyer a lot of our wealth clients and and frankly to their great um uh intuition have bought the dip when you look at the trading uh patterns and the statistics in the last year five years 15 years they've been better buyers on the dip and a lot of them have gone back to nvidia but at a certain point if you're a retail investor how much of your overall wealth can being NVIDIA.

42:13Michael Batnick:So all of this hinges on the hyperscaler's ability to make an ROI on all these investments. Sembalist, a former guest of the show, I watched the program.

42:23Downtown Josh Brown:It was excellent. Michael's great.

42:26Michael Batnick:Hyperscaler's and NVIDIA, new investment-grade debt and SPVs, it's $320 billion in 2026. This is from his note. So he argues that perhaps there's so much money. I mean, this is dramatic. There's so much money here that this has helped pushing up government bond yields. is this going to work? So at the moment, the demand we're seeing and even the terms and the spreads we're seeing for a lot of this issuance is still relatively benign. And again, it goes back to my point that these, the names you all cite on this chart were all net cash balance sheets. And is there dispersion between the Oracles of the world and the Microsofts?

43:05Absolutely. Microsoft and J &J are the only two triple rated, triple A rated names in the market left. Oracle's CDS spreads trade at very wide levels. So is the market, in my opinion, vis-a-vis that example, pricing in some of the risk in a dispersed manner as it should? Yes. So the market is fully aware of this. But Michael, you made the point earlier in terms of just how much liquidity is out there and what types, I'll also add, what types of new buyers are out there, including the insurance community, which I think has been another source of major demand for this paper.

43:38Michael Batnick:That's such a good point. Getting back to the point I made earlier, God forbid the price on these come down, the yields, the yields go up a tidal wave of money waiting to buy these. Agreed.

43:47Downtown Josh Brown:Agreed. The world wants this paper. Otherwise it wouldn't be issued. Absolutely. And it's not being issued out of desperation. They're calling up Alphabet and saying, Hey guys, like there's an opportunity here, you know, given your credit rating and your cash flows, there's an opportunity to do something that's potentially better than equity financing if you don't want to just keep doing it. They're going to spend anyway. Yeah. So, OK. How do you handle people asking about the circular financing question? Because that's, I would say, five days a week on CNBC. That's being debated. It's not going away.

44:22Downtown Josh Brown:There are some great answers for it. I'd love to hear your answer for it. So if you listen to Jensen's comment on the October call of 25 on that same risk or that same feedback. It was, hey, we have a really unique line of sight in terms of some of our supply chains and some of our partners' future growth. And he's talking about the private labs. And he said, given that line of sight, given our net cash balance sheet as an investor, wouldn't you want me to take some type of leverage or take some type of skin in the game in terms of some of our partners? And frankly, I thought it was a really convincing statement.

44:58Wouldn't who want him?

44:59Downtown Josh Brown:His own shareholders? His own balance sheet. Because I know the shareholders of these other things love him doing that. No doubt. No doubt. And look, to your earlier point, does it create a risk factor? Absolutely. And so, you know, what I would say is I think it goes back to, you know, it's more of a qualitative answer, but it goes back to my comment about 2000 to 2026. look at how all these companies have managed through every technology wave, whether it was internet, yes, social, e-commerce, online ads, streaming entertainment, cloud, now AI. And oh, by the way, the next round, which doesn't get talked about enough, Adam Jonas talks about it quite a bit, robotics, space, quantum, and autonomous.

45:40And by the way, the MAG-7 is going to dominate in a lot of those sectors as well. And so my opinion is, he's saying we have a really unique line of sight in terms of how all these businesses are being allocated, how they're being allocated in the enterprise, I meant to say. And we have the net cash balance sheet. So wouldn't as a shareholder of our stock, wouldn't you want us to take that opportunity?

46:03Downtown Josh Brown:So vendor financing was a big issue during the dot com boom bust. And people remember, like this is one when the equipment suppliers are giving money to the buyer who's then going to buy their equipment, that's usually closer to an end than a beginning. That's the thing that people are worried about. So watch the spreads, right? So the debt market, just like in 98, 99, when you had the Fed raising and you started to see the bond spreads on the tech names starting to widen out, we're watching that too, right? And so look, I mean, that was go back to the fall of 25, Oracle CDS really was the predictor of Oracle stock in the coming year.

46:43Michael Batnick:Dan, this is weird. So we're looking at, in red, is the high-yield corporate bond spread, okay? And in black or gray is the triple C, so really junky junk. And they go in the same direction almost all the time. And there's been a very, very notable divergence where high-yield corporate spreads haven't budged, good, but the shittier stuff is ticking up in a pretty meaningful way.

47:10Downtown Josh Brown:What's in triple C? Is that like private equity that companies?

47:16Michael Batnick:Even worse rated stuff. So take it with a grain of salt from the equity guy. But my extrapolation of this data series is when I look at the underlyings of high yield, I look at energy. I look at materials. I look at chemicals. I look at industrials. One, a lot of those industries are benefiting fundamentally from the geopolitical issue in the Middle East right now. Second, if you just stick with energy for a minute, right, pre the 2015 shale bust, CapEx bust, a lot of executive compensation frameworks were incentivized towards production growth. So commodity prices would scream higher. What would all the EMPs do?

47:55They put on extra production growth. What changed dramatically post the 15 implosion? A lot of the executive compensation structures today are more balanced in terms of capital return. And so what have a lot of energy names become today? They've become higher dividend payers. they become higher buybacks. Secondly, let's go downstream to materials and some of the industrials components. Okay. Well, we just talked about the AI data center build out. They're fundamentally benefiting from that build out. So maybe there's more of an idiosyncratic - Steel, copper, like you named chemicals. 100%. I feel like this series is diverging because in part because of AI and because of some of the compositional and fundamental changes in the energy sector.

48:34Michael Batnick:I think that's right, especially on the energy side. We were talking earlier about the wall of worry and how there does seem to be a persistent level of disbelief, which in the short term is maybe something to pay attention to, but longer term, that's healthy for the continued secular bull market. John, chart six, please. So this is from Goldman. Leverage funds versus the Nasdaq 100. Never heard of them. Bears are piling into Nasdaq 100 futures. Short positions have surged 35 % since mid-June and are now near record levels. So I want to share another chart that we made. John, chart seven. So, ChartKid Matt made this, and we're looking at the median S &P 500 stock short interest as a percentage of market cap going up and to the right in a pretty steep way.

49:20Michael Batnick:And on the right side, you have the bottom decile. So, these are the ones that are least shorted. And even the ones that are the least shorted are going up in a material way. Is there anything going on in here? Like, my first reaction was, well, maybe dismiss this because there's a lot of other different hedging instruments.

49:36Downtown Josh Brown:It's a 30-year chart. So there is something going on.

49:39Michael Batnick:But they're moving.

49:41Downtown Josh Brown:Wait, did you just get bearish now? I just got very pensive. So let me, let me, let me. So I've got. I have to take this all in. This is a lot.

49:48Michael Batnick:So while you're thinking, I've got the stocks that are. This is not a squawk box exercise. Hold on. You can think. So the stocks that are in the bottom. So the least shorted stocks. Makes sense.

49:58Downtown Josh Brown:This 99th percentile?

50:00Michael Batnick:Yes. Yes. So what's in that basket is Google.

50:04Downtown Josh Brown:Probably like Apple.

50:05Michael Batnick:Google and Berkshire, because who the hell is short Berkshire? Morgan Stanley, number three. Let's hear it. Morgan Stanley, number three. General Dynamics.

50:13Downtown Josh Brown:Who would short Dan Skelly?

50:14Michael Batnick:Walmart, Amazon, Wells Fargo, Eli Lilly, Apple, Anet, and Chevron. So these are stocks that nobody wants to short in. Even them. It's at the highest it's been since 94. But could this be mechanical? People hedging even bigger long positions? So the only way, this is fascinating, and I'll come back to you with a fuller answer. Ask your quants. Because I want to study this. Well, Chris Metley is our leader on the Quantitatum Derivative Strategy Desk in IED. Boston's been around forever. It's phenomenal. When you introduce him, do you say, this is my quant? This is my quant. Okay. Chris. All right.

50:45From Boston. Here's the only thing I could say, because I'm just still focused on this left-hand side chart on the median stock. Remember that as of late second half 25 until June 22nd, when the semis locally topped, we had this really hyper-concentrated market in AI CapEx. So year to date through June, we had 90 % of S &P's attribution come from three industry subgroups, semis, IT hardware, and power, all tethered to data centers. And so if I think about like what's going on the left-hand side of the chart, simply put is I think you have people rotating out of those names and also shorting the median stock as a counter to that.

51:33Michael Batnick:There's interesting shit happening. It's hard to, so, all right, the top decile, so the most shorted, by the way, look at the y-axis. Obviously the bottom decile, nobody's short, okay? It's at an all-time high, but it's 1.2%. If you look at the top desk, I saw the most shorted, it's 9.8%, which is in the 70th percentile. And these are the names, the most shorted stocks. Reddit, 13%. I don't even know a lot of these names. KMB, Akamai. This is helpful to see that. Okay. Charter, SMCI. I don't know. I don't know all these names. Trade desk, I know. So I know almost - This feels like a rates move.

52:07So like the curve, we were priced for three rate cuts from Jan till Iran, March, April. and now that's completely flipped. And I didn't see what happened this morning, but I think we're now 50-50 price for this month in terms of rate. So if I look at this cohort on the left-hand side, it's super low quality, less balance sheet strength. On the right-hand side, it's much higher quality. So to me, it feels like the short interest and the lower quality things has re-rated as rates have re-rated. So maybe the debt-to-equity ratio looks terrible. That's what it feels like. Profit margins, cash flow.

52:38Downtown Josh Brown:There's idiosyncratic stories in here that like the trade desk has been an abomination in a very good tech sector, not representative of anything else. SMCI is accounting scandals. Charter is cable. Like Reddit has the Google algorithm change. Right, Reddit has to contend with the source of all its traffic changing how it sends people. Like you can, Echo is competing with SpaceX. Have fun with that. Like you can go through this and come up with, a reason why this is not a market story. It's an idiosyncratic story. So, Dan, you'll like this. The only, not to interrupt, Michael, the only outlier on the right-hand side, Charles, I'm not sure why Microsoft wouldn't be there.

53:23Because I think what was really crucial to their narrative in the last month was how they tempered the CapEx comments on the earnings call a month ago. And the stock reacted so positively towards that. And it feels like people are now siphoning out within the group, maybe Microsoft, Amazon, Apple's in a different category, but they are in a different group at the moment than Meta, Oracle, etc. It's funny that you say that.

53:47Downtown Josh Brown:I don't think that's at all behind the rally in Microsoft. I think what people really liked was the public divorce with Sam Altman and the end of exclusivity with OpenAI. I think people felt that Microsoft was not getting the best end of that deal and that they might be better off using cheaper open-weight models to fulfill those AI software product commitments to their users. and I think that that's probably where Microsoft gets its mojo back. Some combination. Absolutely. No, that's a great point. I think they went 180 from being tip of the spear investing in Frontier to now being more rational.

54:21I think that's a great point.

54:22Michael Batnick:I want to introduce two charts to present evidence that the stock market is functioning pretty well, I think. Fundamentally, I think it's responding appropriately to stocks that are doing well and stocks that are doing less well. John, let's start with chart four. So this is a CNBC chart, three-month interest stock correlations. Is that basically as low as it's been in almost 40 years? Like each stock is marching to the beat of its own drum.

54:48Downtown Josh Brown:But Michael, I thought index funds were ruining the market. Is that not true?

54:53Michael Batnick:So Adam Parker, your friend, our friend, John, let's jump to chart nine, has an awesome, awesome, awesome chart that shows the mean 12-month industry group relative return of companies with year-over-year growth margin contractions of more than 1%, okay? And these stocks are getting the shit kick out of them relative to the index. And what he's saying is basically, if your gross margins are missing, you are in big, big, big trouble. And we're seeing that over and over and over again with these earnings reports. So I'll jump in on - Oh, Broadcom today, by the way, their gross margins fell 200 basis points.

55:27Michael Batnick:Blowout numbers, yeah, their margins weren't great. And the stock was on 25 % going to the print. Crucial, crucial point, Michael. So let me jump in on two things. I think the reason why this particular vector is compounded at the moment, one, goes back to what I said earlier in terms of this synthetic tariff-related cloud in first half of last year being now synthetically boosted by pricing. So if you're not getting the gross margin benefit from that pricing right now, you're in this camp. And secondly, maybe a little bit of this on the gross margin line even is on the AI productivity as well.

56:01And so like if your peer group is experiencing some modicum of AI adoption productivity and you're not, I think that's why you're getting triple dinged on this particular data series. Okay.

56:12Downtown Josh Brown:You know what's in this? In this, the stocks that are missing on gross margins, it's a lot of food service. Okay. It's a lot of QSR restaurants. It's your Shake Shacks, your Chipotles. The K working in reverse, which is a thing now. It's just, right. It's just not a, it's not a lot of fun to be in that business right now. Like Shake Shack is not supplying French fries to data centers. You know what I mean? Like they have less to look forward to. They had an earnings blow up a couple of months back. They blamed paper goods, the price of beef, and it was all Iran war oil related, whatever. but they don't have that offsetting.

56:49Downtown Josh Brown:Yeah, but look how much money we're making from AI. Like they don't, there's probably a thousand stocks like that in the US market of 3 ,800 stocks. They're small. They don't actually matter to the returns of the index. It's 100%. And it's helpful, Josh, to your point, to see it through the lens of which business models, because like, let's just drill down for a minute on food staples, which are going through two massive headwinds at the moment. But cyclically, you've got the backup in rates and the volatility mostly to the higher side of the chart on oil. So the K-shape, which has been incredibly resilient on the lower rung.

57:26I mean we talk about – everyone folks on the upper rung. Let's talk about the lower rung for a minute, which I mean I could argue and I think there's been this debate around. Does the official data capture all of the gig economy and all of the ways people are making money off balance?

57:40Downtown Josh Brown:No, because the data comes from the 1950s. We didn't have that. Right. We could use an update there. Yeah. So I think on the one hand, the data is skewed. But on the other hand, let's face it, like the middle lower income cohort has been, I think, more resilient than most have perceived or anticipated until now. I think now you are seeing some degradation on the middle income worker, maybe vis-a-vis AI in the beginning stages. But just the macro factors and then just drilling down into food staples because as a generalist, I could talk to all these sector experts. I think the GLP thing is real.

58:15I think when you look at Pepsi going back five years ago, I think they were incredibly convicted that they were going to sail through the issue. And when you look at Frito-Lay and some of the food businesses missing their organic revenue growth targets for like two to three years running, I think it's a very real thing.

58:35Downtown Josh Brown:The mistake is to look at McDonald's earnings and try to extrapolate something about the economy. Because it's just not, it's not the way that.

58:44Michael Batnick:Look at the stock of Hershey.

58:46Downtown Josh Brown:Horrible. That's years. Now, Dan, I am a salt of the earth person. And I am equally likely to be shopping at Americana, Manhattan. Or Dollar Tree. As I am to be at Roosevelt Field. And Michael and I have been harping on this for like three years. Every time the banks report earnings, less so Morgan Stanley. the banks that issue credit cards, it's almost like the audience is clamoring for them to say the bottom decile, the bottom quintile is breaking. And now they don't even wait for the question anymore. Like JP Morgan, they lead with it. They're like, before anyone asks us, everyone's paying their bills.

59:25Downtown Josh Brown:Delinquencies are well within norms and at historic lows and car loans are being paid off. And just anecdotally, like who is filling up all these flights? The movie theaters are packed again. Like you walk through the mall. It doesn't matter which mall. There are people in it. So even if you don't know the data, if you're a normal person and you talk to the people in your life and you look around and see what they're doing, they're leasing new cars. They're going to work. They're paying their bills. and then for some reason there's like this internet component that is insisting that it's all fake and nobody is paying their bills and it's about to collapse and that's the hardest part for me because the arguments are so seductive that we're at some sort of peak something and it's being hollowed out from the bottom and you up there on wall street you don't see it yet have fun with your micron earnings, but you'll see it soon.

1:00:23Downtown Josh Brown:Or when? I keep waiting. Do you feel that maybe we get to a point where we're ignoring that risk too much? Or am I ignoring it just about the right amount? It's really an important comment and I think super well said. And I'll say a couple things. First is, number one, I think it goes back to my statement, which is unproven at the moment a minute ago about the gig economy. It goes back to COVID, which, you know, a crisis doesn't usually create new trends, but it certainly can accelerate things that were already in place. And I think the, whatever you want to call it, social media influencer economy vis-a-vis COVID got supercharged and it's still going forward.

1:01:04Downtown Josh Brown:People starting businesses. New business. I was going there next. The entrepreneurial spirit. Absolutely. I was going there right now. So we're on the same page. So new business formations that are two decade high is part of that vis-a-vis AI I absolutely think so. AI in many ways is lowering the barriers to entry to being an entrepreneur if you have a good idea. Now, does everyone have a good idea? No. But do I have more scale in advertising and marketing and process and technology if I have AI? Yes. And so what are those new businesses doing, Josh? They're hiring people. And maybe it's not all counted on the official monthly payrolls, but they're hiring people.

1:01:38And so my point is, I know your comment about the big bank's earnings transcripts so well, because we see the same thing. and it's true. Like the data is too diverse and too rich and too widespread to try to poke holes in it, right? It's travel, it's eating out. It's all these different parts of the economy. And so in my opinion, it's not a kind of one-off phenomenon. There's something underpinning it. And I think these comments are underpinning it. Don't you think one day there will be a Bank of America

1:02:06Downtown Josh Brown:or a Capital One financial conference call where they actually do say, okay, we're seeing an uptick in delinquencies or bills past due, like 30 days past due, whatever. But by the time they do that, we will all be like, yeah, no duh. I was just going to say, look at the earnings. Wouldn't it be obvious to all of us? Right. How unlikely would it be that earnings prior to that moment - Hold up. How unlikely would it be that earnings continue to trend quarter over quarter, not year over year, in the short term? How unlikely would it be that they continue to accelerate? Very unlikely. So we've talked a lot about idiosyncratic nuances, which I think today this cycle is unlike any other cycle.

1:02:47It's been an underlying thread of all of our comments. But to be fair, Economics 101 just goes back to earnings and job growth. And it's very unlikely in this earnings picture to have that future B of A moment.

1:02:59Michael Batnick:The lower shape of the K. I was looking at a firm's delinquency rate. Which customer do they serve? A firm? It's not Amex. No. Buy now, pay later. Yeah, so lower FICO. Oh, they're 20. Okay. Yeah. The delinquency rate is nowhere. It's nowhere. It's 2.3%, whatever it is.

1:03:16Downtown Josh Brown:Because that's the pay later part. You don't understand. You just don't understand economics. I'll add to that. I don't know if it's - They say pay later. You don't know how much later. I don't know if it's GOPs at the 25-year-old cohort level, but what I do understand from a lot of our clients and our partners' anecdotal comments about their children and the next generation is that people aren't going out as much, maybe to bars, maybe drinking, but they are gambling. They are making wages, wagers. And maybe on average, they're doing better than we would have anticipated. So maybe they have this excess capital from this proliferation in the gamification of betting and gambling, all these other things going on.

1:03:55Downtown Josh Brown:So instead of overeating, they're betting. They're overbetting. So it's so funny, like the next generation, they're just going to do the GLP-1 right into the womb. Like in vitro GLP-1. I'm going to be the last fat person left in this world. Yeah, less of a copay. Okay. All right. I want to make sure we get to a couple of more things. Stock selection. You're managing money. You're also advising other people who manage money. You're on the committee. You're in all these conversations. What are you telling people about the end of year run? Hopefully it's a run. And into 27. Like, I don't know if it's your opinion, the house opinion.

1:04:33Downtown Josh Brown:I don't know where one ends where. But talk about our audience are investors, right? They love the stock market. People listen to Compounded Friends, love the stock market. So talk about stock selection, what you guys are excited about, what you're looking at, and maybe what you're leaving behind from the first half of 26. Yeah, all of the above. So let me bifurcate it between my asset allocation hat and my day-to-day PM equity hat. So on the asset allocation front, Josh, we've been overweight U.S. equities for well over a year. And I would say, while that has certainly served us well, we've also no doubt experienced this AI spending, AI highly correlated, concentrated phenomena as well.

1:05:15And so at the asset allocation level, we've also told people, allocate towards real assets. Allocate towards long, short hedge funds. That's a counterbalance. No doubt. And in some instances, allocate towards EM. And we saw what happened when AI caught a cold this summer. We saw what happened in the US. rotation was the outcome. Peak to trough drawdown, the S &P was 3%. Because of that concept I alluded to earlier, semis went to mag seven. And mathematically, mag seven might be 35, 40 % of the market. Semis are much bigger, but they're 18%. If I add in healthcare at 10 % and financials at 15%, that's what really offset that cold metastasizing for the US, not so for the KOSPI.

1:05:58So the Kospi had a truly concentrated two stock. So we've told people to be selective in EM. So what I'm trying to outline, Josh, at the broad level is asset allocation. We've been overweight U.S. and are sticking to that for a lot of the reasons we've talked about. Resilient economy, accelerating earnings growth. But we've also tried to plug and play through diversified asset classes. On the stock level, again, the healthiest thing I would say, because I'm most focused on long-term investing. You know, my team originated in 1995 under Byron Wien in the equity research department. And Byron, who is truly a visionary, thought of investing in a concentrated portfolio along a continuum.

1:06:40And we run 40 to 50 stock portfolios. And the idea being in a 50 stock portfolio, you want to have the majority of your names, 40 names, 45 names be core holding-esque, plus or minus the market in any given year. And they're going to be 2-ish percent. 2-ish percent. Correct. So not super big absolute sized, but I also want to build in maybe five, six positions that are big ideas. And this was truly Byron's philosophy. If I can get big ideas right over a cycle, be it NVIDIA 10 years ago, Visa, MasterCard, and processing, be it Thermo Fisher and the proliferation of life science, if I can get a lot of the big ideas right over a cycle, they can now offset the average over a longer period of time.

1:07:23So what we're telling clients today through our portfolio process. I like that approach. What we're telling clients today through our portfolio process to conclude is, yes, you wanted to be cautious AI and semis in June. I think there's a lot more interesting ideas there today. But coming back to our overall thesis, this adoption wave is going to be a decade long. And so we want to own a lot of those Fortune 100 companies that are quality oriented. And I know it's a offsided cliche to be quality oriented. Quality has not worked this year. It has not worked in several years. But when I think about the rotation as of the last three months, what's working again?

1:08:01Again, kudos to Mike Wilson. Quality has been coming back in vogue. Rates are higher. The onus on whether or not you can make money and outcompete your peer set on AI adoption is higher. And I think this really augurs for a quality, diversified equity portfolio across healthcare, no doubt. AI, in many instances, is taking a six to seven year timeline in terms of phase one drug discovery to like less than 12 months.

1:08:25Downtown Josh Brown:One of the things I'm most excited about is seeing that play out and seeing drugs in our lifetime. Safer drugs come to market faster, I think, is a phenomenal outgrowth of all this spend. And the downstream winners beyond that, the life science tools, the consumables, the lab and clinical trial managers. Keep in mind, health care couldn't comp the COVID comp. Then it had a deal with the 22 rate cycle. Then it had a deal with everyone who had growth equity capital going to tech. So healthcare used to have growth equity capital. So that's one sector we like on the AI adoption theme, capital markets.

1:09:00Downtown Josh Brown:But are you top down on this 50 stock portfolio? Are you saying we're really bullish on healthcare, so let's find healthcare stocks that fit our thesis? Or are you arriving at that top down because from the bottom up, these are the best earnings growers? How are you doing that? It's more of the latter. For 30 years, in a 50-stock context, we've been bottom-up focused. So do we make sector calls? Yes. But our sector calls are modest in nature, two to four points over underweight any given sector as a way of controlling tracking error and risk. So to your good question, Josh, if we like a stock from the bottom-up thesis, we might overwrite the sector call.

1:09:37But at the same time, as our old strategist and our friend Henry McVeigh has always said, who started out as a financial analyst, now at KKR, great friend of Morgan Stanley, you got to have a view. And so we think you no doubt have to marry the bottom-up selection effect with the sector calls.

1:09:53Downtown Josh Brown:Are there scenarios where you did get, you got the sector right. You got the, you thought you got the stock right, but then there's an execution misfire on the part of management. And you say, we're still bullish on this theme. We're riding the wrong horse. You must have to do that all the time. Let's talk about software. How hard is that? Oh, that's the hardest part. That's gotta be the hardest part. Hardest part. Hardest part. Because in a, you know, going back to the process. Right horse, wrong jockey. No doubt. Or right race, wrong horse or whatever. No doubt. I was supposed to get on a flight to the Derby, and I ended up at Belmont.

1:10:27So what I would argue is in a 50-stock portfolio with a 2 % to 3 % tracking error, which is our process, you live and die by concentration. And so we try to temper the sector bets as a function of controlling that risk factor. But the stock selection effect drives really everything at the end of the day. And so you asked the right question, which was, got the sector call right or wrong? What happened to the stock selection? No doubt software has been, I think, the most acute realization of that question in the last seven or eight months. So I told you earlier, I don't write often. But when I do, I've actually been fairly, you know, directly correct this year.

1:11:03I cautioned on Semi's June 1st. I said software is oversold in mid-February. And my conclusion in software— Little early. My conclusion in software, it was at the time, if you look at IGV, the new Claude plugin had just come out in mid-Feb. And the whole sector was being priced for obsolescence. It freaked everybody out. My statement was, I think it's very unlikely that as private entities, the business plan for these labs pitching Wall Street future investors is our plan over the long term is to put a lot of corporate America out of business. I think that would be a very futile business plan to the street.

1:11:39More likely, in my opinion, back in February was, forget about obsolescence. You're going to see chronic interdependence between AI and software. What's going to be most likely is dispersion of outcomes across the spectrum. And so I'd like to say across the holdings we had, we had 100 % hit rate across that outcome. We were right on the concept, but there's been so much variation in terms of -

1:12:01Downtown Josh Brown:Yeah, like if you take the bet on Adobe based on what you just said versus take the bet on CrowdStrike, it's like, okay, we were right. Software was oversold, but we didn't get the full benefit. And that's got to be when you're doing 50 stocks, that's got to be the thing that's like, oh man, I hope this is the right one. It's hard for everybody. We had puts and takes. For us, Microsoft's rebound, ServiceNow's rebound. We were out of Adobe over a year ago. We were in Palo Alto as of the last two years, but it got to 70 times. And in the last two or three months, we said it's the top end of the PE range.

1:12:36The market has correctly discounted. It's an AI winner. but we run a 50 stock portfolio at 70 times. It was a high tracking error winner. So let's take it out.

1:12:46Downtown Josh Brown:What's the stock in that portfolio that you are most convinced the market misunderstands? In the software space or just overall? Just period. Like what, I have mine in my own portfolio. I think the market - I think the market is Uber wrong, personally. You look like you're short. You look like you're bears. I'm long only. Okay. So I've been in and out of Uber over the years. So let me put it this way. What's your version of that where I'm saying to people - Can I give you two names? Yeah, no, you can give me as many as you want. I'll give you two names. So back in, go back to February. So it seemed like every other week, a big liquid part of the market was being priced for Absolus.

1:13:20We talked about software. At one point, it was insurance brokerage. At one point, it was wealth management. CBRE. Michael, we're also on the same page. SPGI. So Morningstar. That's where I was going to go. Okay. The idea that data, forget about software at the moment. The idea that data-centric businesses were also being priced for obsolescence. And in many instances have not rebounded. So S &P, as an example, in one of our full disclosure, one of our holdings does multiple things. It has the issuance business, but it has the data business, what they just started talking about potential alternatives.

1:13:52But I don't think the issuance business is frankly getting enough bid in a world of going back to your debt charts, in a world of massive financing.

1:14:01Downtown Josh Brown:Yes, bond investors need ratings. They don't, they're not going to take Claude's word for it. Thank you. It's regulated. It's regulated. They have to be regulated. Go back to healthcare. Okay, I'm with you on that. So it's highly regulated, data-centric businesses. And last one is NASDAQ. Because when I think about that business, I have these future franchise IPOs on the rise. That's at highs. NASDAQ for the year, it might be at highs, but for the year, point to point is flattish. The last time I looked at it, you should be up more. It looks like it's about to break out. The earnings continue to grow, mid-teens to high-teens.

1:14:35The multiple has stayed really flattish. And to me, again, it was caught up in that February, March sell-off of data's going out

1:14:43Downtown Josh Brown:of business. So NASDAQ has three businesses. They have a small fintech business. They have a data business, which is the crown jewel. And then they have the exchange business, which it is what it is. All three of those things feed each other. So they're not really three distinct businesses, but that's how they report. Right. I remember thinking NASDAQ is the bet because all of this IPO activity, listings, great for the exchange. Then you think about the data business, which is— And AI optimization on the data. And the market said, Joshua, I got stopped out of NASDAQ. I think I made money on it, but I had been in it for a while.

1:15:17Downtown Josh Brown:And it's been a great name for a long time. Yes. The market told me this spring, to your point, that I was wrong. and I couldn't process, wait, we're saying there's this whole wave of AI disruptors coming along and NASDAQ's not going to capture its share of that upside? It makes no sense. It doesn't make sense. Highly regulated industry data, the cyclical tailwind from the capital market cycle. And look, our analyst, Mike Cypress, who's a great partner and friend of our business, has been positive on the stock. And as the last two to three quarters of evidence shows, they continue to generate AI strong evidence of AI utilization in their business and the market is just not roaring so that was the example around here

1:15:59Michael Batnick:we don't believe in triple tops that's gonna go right Josh

1:16:02Downtown Josh Brown:everybody loves a trilogy when do you know when do you know you're wrong on a stock and it's time to take action but it's too late I know it's always different but what are like the big picture things that you think about so before I answer that just to also reference having a hard and fast stop loss in a context of 50 stocks where we try to generate 30 to 40 % turnover a year with a tax-sensitive retail type client, I think is too rigid. And so to your question, we've adopted quantitative and quantum mental, to use Adam's phrasing, quantum mental inputs, but it's also just at the end of the day, a decision tree, usually binary.

1:16:41Did you see Adam's piece on stop losses this weekend? We just, we had a call the other day on it. Yeah, yeah. Okay, go on. And so look, I would argue that there's the good news and the bad news. I told you Palo Alto earlier. When I have something in the high tracking error bucket that we've taken a idiosyncratic risk on and it re-rates and we've owned it for our time horizon one and a half, two years, and it's everything that's worked out, it becomes my 40th idea isn't as good as my 41st potential idea. It's friction and opportunity cost in the portfolio.

1:17:12Downtown Josh Brown:Because if that's still in the portfolio, it doesn't matter that it just doubled. you're allocating fresh cash to the portfolio. Every day. Do you really want to buy that stock now? Opportunity cost. So that's the good scenario. Let's talk about the much more difficult conversation, which is when something goes against you. And it goes back to, in our world, the original thesis. So we build out, every time we write up a new idea, it's a 20-page proprietary note that my team builds. I have a seven-person PM team. Yes, we use Morgan Stanley's research and have used them for 25 years. And we really benefit from that relationship.

1:17:46We use street research. And since I took over the team 12 years ago, I realized, hey, we have all these asset managers on our platform trying to talk to our wealth management audience. Why don't we talk to their PMs? So we talked to a lot of the buy side as of the last 12 years and have established great relationships there. That's a great filter. Those people are putting risk on in those stocks. Absolutely. And in some cases, they look like me in terms of process. In some cases, they have a shorter horizon or a riskier horizon. But I love the mosaic of all the input there, and we have great relationships there.

1:18:18And I can recommend some friends for the pod. But what I would just say is when I look at that second scenario, it comes back to the original thesis. Did something unforeseen happen in terms of competition, regulation, management, governance? And is the earnings power temporarily impaired or permanently impaired? Is the competitive moat temporarily in question or permanently impaired? And you have to make that tradeoff. So two things I will tell you, one on the stop loss front and one on just my 20 years deducing kind of qualitative signals on the stop loss. Cut your cyclical losers faster. Give your secular faster than the growth faster because because correct, because the cyclical momentum almost always begets more cyclical downside momentum.

1:19:07almost always, whether it was oil rigs in 2014, 2015, whether it was banks in 07, 08. And like when the earnings drop out on the cyclicals, you're not talking about an earnings haircut of 10 % or 20%.

1:19:20Downtown Josh Brown:Less likely for a V-shaped recovery in a material stock, for example. 1 ,000%. And so let me give you the counter to that. That's a good one. Are you writing these down? Okay. The counter to that is on the secular names. And I'm going to bring in my second comment a segue here, on the secular names, maybe manage them down, maybe risk manage them as they beget negative momentum. But if they're really those Byron Ween, big idea, secular winners, you know, Mike Durbin, Durbin Amendment 2010, Visa, MasterCard, they were down 30 % in a six month period. They're 10 baggers since then. You know, Apple were worried about advertising, worried about Samsung, you know, 10 and 20.

1:20:01So if they're really the secular winners, it can almost always come back. Whereas the cyclicals, different story.

1:20:08Downtown Josh Brown:So you're treating different types of stocks differently in the risk management process. There's no, I wish there was, there's no formula, but it's one of those experience judgment things we've learned over 20 years. And the second comment, I'll come back really quickly to end, two types of risk factors. You're not getting out of here. On this topic, on the risk factors, competitive risk versus government and regulatory risk. Here's where I've also extrapolated a lot of signal over time. On the government regulatory front, it's almost always temporary and overkill in nature. And there's exceptions to that.

1:20:43But Durban Amendment 2010, as a case in point I just mentioned, it's almost always more fear and more quickly discounted incorrectly by the market than not.

1:20:53Downtown Josh Brown:I learn that lesson every six months. I'm a shareholder in Live Nation. So I know. Oh, great. New highs soon. as soon as people start freaking out about the next attorney general is suing them. And we've talked about this a little bit in terms of the macro, but oftentimes you need a wall of worry for a stock fat call to work too. Last comment on this topic, by contrast, the competitive risk is so vastly different. And this is where it's more nebulous by nature and just harder to discern. When companies are losing market share, when a brand is starting to fade in terms of its relevance. That is almost always the death knell of many businesses.

1:21:30And here's the hardest part for me, because we only fish in the ascendant and high quality cohorts. It happens to everyone. It even happens to high quality.

1:21:38Michael Batnick:Nike. Yeah.

1:21:40Downtown Josh Brown:Lululemon was a quality stock at one point. Right. And then things go in and out of favor.

1:21:47Michael Batnick:But Abercrombie is back, interestingly. That stock is on fire. The competitive dynamic in terms of brand and market share brand equity, and really just governance, management change over time. One of my first managers, when I started on the team 18 years ago, first exercise he had me do as a first-year associate, fresh out of the analyst program, and I was a liberal arts major, Dan, do a study of executive compensation across all of our 50 holdings, and tell me about the correlation between compensation in pay and shareholder return, and try to find outliers. And he had me do that exercise as probably 11 or 12 different times.

1:22:27And so I mentioned governance earlier before. Changes in governance, lack of credibility, lack of capital allocation, consistency. Those are some of the qualitative things that we pay attention to.

1:22:39Downtown Josh Brown:You know, it's so funny because the way that you do things lines up so much better with my actual lived experience in the stock market. But when I started, and maybe you experienced a version of this, this was not the way things were done. it was much more about metrics and it was much more about math and it was much more about well this p e ratio is lower than that p e ratio remember when valuation mattered right but so so but that's that was like everybody coming out of wharton that's what they were taught and so they would look at like the steel sector and they would say bethlehem steel is the lowest P.E.

1:23:16Downtown Josh Brown:ratio. Yes, it's got the highest debt, but, you know, we're buying a dollar for 50 cents rather than Ishpat's deal, which is, you know, a dollar for 80 cents. And that was just the way people thought about the market. I don't think anyone thinks about the market. I think more people now think about it the way you and I do, which is that the price is behaving in whatever way it's behaving relative to valuation because the market is smart. The market has figured out that this stock should be an elevated valuation. That's not a negative. I'm not saying it's a positive and we only want to buy expensive stocks, but oh my God, are we saying it's expensive by accident?

1:23:58Downtown Josh Brown:We can't be saying that. It's amazing how many people were trained thinking that expensive stocks relative to their peers were accidentally, they'd call it a mispricing. What do you mean a mispricing? No, it's not mispriced. They want to own Dell because Dell is better than Compaq. What part of that don't you understand? So I think people have come along to that. Well said. And I think the two things I would just add to that, Josh, are number one is the access to information, the speed of information, and the proliferation of information has helped that efficiency in nature. And secondly, it's the microstructure of who's invested in the markets.

1:24:37Think about the proliferation of CTAs and quant funds on the institutional side. Think about all the liquidity on the retail side. You know, I didn't mention it earlier, but I meant to. I made a mental note of it. But something like 40 % of homes in the US are owned outright, no mortgage. So think about an aging population with excess capital on hand, and maybe from the other part of the spectrum, from the younger cohort who has more access to investing, gambling tools, and just think about the momentum and trend followers in the market versus classically trained Wharton MBAs doing valuation work.

1:25:11The microstructure has changed, the technology and the speed of information has changed, making momentum one of the single most important factors in markets this year through June 22 and the last five years. And so what we say is, look, it can be true on the one hand that we're quality oriented, we're diversified, we're long-term investors. We have one client in mind who's wealth management and we manage the tails. That can be true on the one hand, but on the other hand, don't pay attention to the technicals and the momentum at your own risk.

1:25:40Downtown Josh Brown:That's right. It's nice to be able to punch into Google, what is the PE ratio in this stock? But everybody knows that already. So the momentum is the actual story. The stock is under accumulation or it's not. and watch for one momentum changes. We are at a crucial inflection right now, whereas the aforementioned semis, hardware, and power names have either traded sideways since June, failed to recover the 50-day, not had the PB hedge fund guys regross back up. That's going on on the one hand, and we've talked about it. Healthcare's working. Parts of software's working. Financials are working. Energy's working.

1:26:14You know, one of our very simple tools this year has been every time we've had a ceasefire is to buy more energy in the book. because every ceasefire deal has been pretty short-lasting. And so, yes, you have to pay attention to the momentum. You have to also try to exploit some of the anomalies out there too. Last thing, you think the year-end setup is favorable

1:26:36Downtown Josh Brown:given the earnings growth and all these tailwinds we talked about? You're feeling pretty good about like, I mean, most years we go out close to the highs. So it wouldn't be surprising. Yeah, it's been tough to bet against seasonality the last several years. So I would say per our pop-up ad exchange earlier, I think at best we trade sideways into the midterm. As you stated, Josh, earlier, I don't think there's any real profound outcome from the midterm. But then I think it's all about, you know, in terms of October earnings season, I think all of the trends and data we're seeing suggests – and the conference season this September should also predict pretty solid acceleration there.

1:27:12And then it becomes what happens in 27. So let me leave you with my 27 thought, which is in my mind, 27 could look a lot like 23, where it's a return of more monolithic MAG-7 outperformance. I think the average company is going to have trouble comping that synthetic tariff operating leverage. So if I were to make a more of a thematic call for next year, it could be one of these ideas where it's -

1:27:38Downtown Josh Brown:Bigger is better again. Bigger is better. Quality is back. And it could be a broader market, but you definitely want to be in kind of the 23 kind of AI enabler Mag 7 names and maybe some of the healthcare adopters. And maybe it's not as good a year for small caps or the average stock. I love it. Good stuff. Did you have fun on the show today? It was really fun. Thank you. Okay. You're happy on your end? Okay. We're going to take a brief recess and then we're going to do some Israel-Palestine stuff. Is that okay? Is that good? All right. You were awesome on the show today. Put the headphones back on.

1:28:10Downtown Josh Brown:We're going to give you your flowers. I want to tell people where they can learn more and get more of your insights. So you're going to do Squawk from time to time. Do you guys publish anything anywhere? Are you on LinkedIn? Tell us where we do. And thanks for that. Of course. That heads up. So Josh, I'm on LinkedIn and the firm, Morning Stanley's on LinkedIn. So we are available through those channels. And then, yes, we publish through the Global Investment Committee. I publish a quarterly letter, which I'll share with you both in terms of my fund. the SMA. And then at times, as per the software and semis comments, we'll write more tactical ad hoc client facing material.

1:28:44So we'll share all those with you. That's great.

1:28:45Downtown Josh Brown:And I know the audience definitely is going to want to hear more from you. Thank you so much for joining us. Thank you for having me. A lot of fun. Really appreciate it. Guys, great job this week. John, Duncan, Nicole, the whole team. Appreciate it. Thank you so much for watching. Thank you for listening. We'll see you next week. Thanks again.

1:29:19Downtown Josh Brown:This episode is brought to you by ChatGPT. Hey, it's Bill Simmons from the Bill Simmons Podcast. Have you guys heard about ChatGPT work? It's the new way to use ChatGPT for bigger multi-step projects. And when you need more than just answers, give ChatGPT work access to your apps and files, and it can create real work documents like spreadsheets, slides, and structured reports. Get started at ChatGPT.com by selecting work mode available on Plus and Pro plans.