What if It’s Still Early? With Denise Chisholm

15:09There is good growth. There is good job growth. But when you study history, the equity market doesn't always reflect good times. In fact, if you had to say, if you dropped a quant onto it, and I'm kind of a quant, and you said, is the equity market reflective of good times or is it a hedge against bad times? You'd almost say that it's more often the hedge against bad times. I mean, think of all the things that have gone wrong over the last five years, and the equity market is 70 % higher. So this is the trick, I think, of investing, that when you study history, like you understand all the risks, all the headlines, like all the problems that can go wrong.

15:40And your downside risk is, well, what if they don't go wrong in the way that you think that they will? Then you give up on average returns of 8 % a year, which is one of the few asset classes that can actually keep pace with inflation. So I think that's the tug of the riddle with equity investing.

15:59Downtown Josh Brown:I think there are investors also who politically are just on the other side of the administration. And that's perfectly fine. They'll have their time in the sun someday too, we assume. Like it goes back and forth. Oh, it always goes back and forth. But there are people that when they don't like the direction the country seems to be headed in, they don't like who's in the White House or they disagree with the way like certain things are happening in the culture. It's like a cognitive dissonance that they almost can't bear. They can't process why is the stock market higher? Isn't A so bad and B so bad and C so bad?

16:38Downtown Josh Brown:this surely this is wrong because i don't feel good right now about what i'm seeing and but the problem is i don't think anyone's like fully immune to that hence the need for quantitative okay i think that that's what what's helpful right if you say like consumer confidence is at all time lows like is that a problem and you go well wait a minute you'd actually be rather be buying equities when consumer confidence is low relative to high i stopped paying attention to that a long time ago right i mean same thing with uncertainty like we we got this with tariffs originally, you know, last year when people were like, and I had a lot of diversified portfolio managers come to me and say, Denise, this is a very uncertain environment and an uncertain environment.

17:14Corporate America is not going to spend. If they don't spend, jobs aren't going to grow. And you say, OK, well, we can measure all of those things and we can see if that's true. And the interesting part is when you quartile out uncertainty, the more uncertain the environment, the higher the odds of the stock market advancing and the higher the odds that corporate America hires and the higher the odds that there's capital spending.

17:33Downtown Josh Brown:Nobody thinks that way intuitively. But it's like the Baron's head, like the covers. It's by the time it is so visible, it is more likely than not already discounted. Corporate America has already not spent. Corporate America has already not hired. The stock market has already worried about all the things that you're very visibly worrying about. And I mean, to put a fine point, I don't remember if we talked about it last time, but remember, I mean, the low in the market between like 1976 and 1985 was 1978 before either of the recessions happened. So if you said like, hey, Denise, I know what's going to happen.

18:05We're going to have two back-to-back recessions and rates are going to go to 15%. Nobody buys that. But then if you said like, I'm going to sell in 78, I'm going to get this right. I'm going to nail the risks. I'm going to get the risks right. And I'm going to buy back at the end of 82 when jobs finally started to recover. You lost 40 % cumulative nominal returns.

18:23Michael Batnick:So we saw a lot of worries in the first quarter of the year. Yeah. Where the market didn't really seem to react to the news immediately. And there was a lot of people thinking like, how is this happening? The closure of the Shredder Hormuz was supposed to be a black swan type of event where oil goes up to$150 a barrel, S &P closes limit down. Like that's a black swan type of outcome. And the market seemed to be sort of yawning past it. And you had this weird dynamic where earnings estimates were rising and prices were coming down a little bit. And so you saw the valuation compress in a big way.

18:59Michael Batnick:Yes. So you went through history and you looked at this, Daniel, chart one, please, of the valuation compression over a six-month period. What were you saying during this period of the multiple coming down with this weird dynamic of earnings skyrocketing? Yeah, so it's an interesting dynamic. This is rare that you have this kind of multiple compression. But if you go like reverse to when we started the year, I had a lot of people, you know, asking me just even even from an institutional perspective, like, how can you be bullish on the market when the market is up so much over the last three years and stocks are expensive?

19:32And the problem is, again, quantitatively, neither of those things bend your odds for underperformance of equities, right? So the more the equity market goes up, you guys know, like, momentum usually begets momentum, which is not to say that it's 100 % of the time, but it is to say that if you bet on that, if you want to take the other side of stocks going up, you have to accept the fact that it's a lower likelihood, not a higher likelihood, and you know something that the stocks don't know. Second, same thing for, you know, valuations. Like, there's no quartile difference in terms of the odds of an equity market advance.

20:01Coming into the year, for me, what has been different since 2022 is the equity market is just persistently fearful. You can measure it in valuation spreads on a rolling measure of the VIX, right? I mean, during the tariff tantrum, you know, you saw the VIX spike to 50. I think during this tantrum, we saw it spike to 30. When you sort of roll it out through time, when you look at the fear in the equity market that has been persistent relative to the fear in the credit market, that's where you start to get this linear relationship that you potentially want to take the other side. and the market has more likelihood to climb the wall of worry.

20:33Michael Batnick:I'm so glad you said that because people point to the stock market and say, what an all-time high. What do you mean there's fear in the market? Even last week or two weeks ago when the S &P fell 2%, it was nothing. The pull call ratio spikes immediately. There is a lot of fear. And it's really hard to have both of those thoughts in your head at the same time. I know. Because you think like, oh, this is a bubble everybody's in. No. And that is why it keeps grinding higher. Correct. I completely. What would be your signal though for that?

20:57Downtown Josh Brown:Unwant. Like what would have to happen for you to say there's not enough fear in the market, multiple expansion again? Yeah. So the 15 % down sort of confirmed that whole thing. Think about how hard though it is to have 29 % earnings growth and outrun that with price. Yeah. We would have to have like a 70 % rally in the market in order to get multiple expansion. Well, thank God we didn't have that happen. Right. Exactly. That would have been scary. Well, that's exactly. So when people say like, what could be the problem? Something like that, where you see very little fear in the equity market or a bubble like that in terms of that price advance or something like that looks more like that.

21:32And good economic times, top quartile, you know, GDP growth, which we're still grinding it out at like two, two and a half. And we'll see where earnings growth ends up. But, you know, for the most part, it's been between 10 and 15.

21:44Michael Batnick:So don't you think it's easy to make the case that investors as a whole are being sober right now, even though we're about to get to some of the crazy shit that's happening, because there is obviously crazy shit happening. But I've said this to Josh a million times. in today's modern digital markets. Yeah. In a bull market, there will always be maniacal behavior. Like that's just, that will never not happen again. Yeah. And sideshows. Yeah, of course. But in the aggregate, the fact that we are not outpacing earnings growth, I think the market is being pretty sober. Completely agree. All right.

22:13Michael Batnick:Right. So rewind back to, I guess earlier in the year. I don't know when we made this chart, but remember the forward PE of tech, next chart please, Daniel, and the forward PE of the S &P 500. converged. Yep. Yeah, yeah. And we were like, is this good? Is this bad? This seems weird. All right. Well, that was the fat pitch. Yep. We got it. Yep. Literally the faux pee of tech and the whole market converged for a minute.

22:37Downtown Josh Brown:So you had a chance to buy all of these quote-unquote high flyers at the same multiple as the overall market.

22:41Michael Batnick:So we made this last week. I forgot to put it in the deck, but even better. We saved a few, Denise. Yeah. The rolling 38-day performance since we made this chart or since those lines converged. Look at that fat pitch. Look at that home run. I know.

22:52Downtown Josh Brown:Was that plus 16 %?

22:53Michael Batnick:So it's a performance, but I've tech versus the S &P over the time period. I figured. Yeah, no, there's, and we have the data going back to the 60s, right? I have to go back to the 30s. That's all. I don't really have technology data. I was like, wow, you'll have to share that with me. There is, there's a relationship. The cheaper technology stocks have been relative to the S &P 500, the higher the odds. The tech in the 30s was brooms.

23:13Downtown Josh Brown:Brooms were very big. So in many ways, the multiple compression is justified because the companies themselves are undergoing a transformation. Going from CapEx Lite, predominantly software businesses with crazy high margins, a little bit of R &D, a little bit of CapEx, but nothing crazy, to 120 % cash flow going into long-term infrastructure projects. Can't say they're Capita Lite anymore. Right. Um, maybe with the exception of, uh, I mean, even Apple would be a stretch. They're the only one not engaging in this CapEx frenzy. Their CapEx actually is down versus last year, at least so far. But like these stocks should not be trading at 35 times earnings anymore.

24:01Downtown Josh Brown:They are industrial. They're very modern industrials. What do you think about that? It's a great point. Well, I think it depends on their ultimate margin structure, which we don't know the answer to yet. I think to your point, like— In this transition period while they build, they look more like heavy industrial companies today. With a much higher margin structure and return structure. So far, yeah. Currently. That's what I mean. So what we know is to date, that has not been true in the sense that they have spent more in terms of CapEx, and yet they have retained this margin structure. Now, we will see where it ends up.

24:32Again, like all estimates don't always come to fruition. What they will spend, maybe there will be bottlenecks. Maybe, in fact, technology will do what technology always does, which is make something very expensive and scarce and that will make it cheaper and abundant. Right. So maybe this CapEx ends up not being as egregious as we think and doesn't weigh on free cash flow as much. So there are all kinds of possibilities. I think that what was the debate in the bubble was that all of the spending was very clearly not associated with any margin or any earnings. And to date, the spending that we're seeing has been associated with.

25:06Downtown Josh Brown:So we've made that point before, and we've also made the sort of parallel point that the equity-funded bubble of 2000 is very different than the cash flow-funded bubble of today. Yes. So that may not stay true. I think half the backlog for AI CapEx is open AI Anthropic, and that money very obviously has to come from IPOs or raised assets. So that's sort of equity issuance funded spending. But like the CapEx itself is coming directly from the companies that are most capitalized to actually do the spending.

25:45Michael Batnick:And also look at Meta. So they've obviously spent a lot of money on AI and Reels, which is a three-year-old product is now doing$50 billion in annualized revenue. That's more than Netflix. And that is a direct result of the AI spend. Right.

26:00Downtown Josh Brown:Reels has become the world's most addictive product. It's literal heroin. If you walk through an airport and just look to the left, look to the right, walk through a terminal, you will see eight out of 10 people are staring at their rectangle. Eight out of 10. If it's kids, it's 10 out of 10. And that's reels. It's a little bit TikTok, but a lot of reels. And they've used AI to essentially rewire our brains. We can't stand on an elevator and not look down at the phone. Right? It's like it's captivated. So AI has enabled just an incredible step change in how addictive meta is and how good they are at serving ads, most importantly.

26:43Right, which is how they generate ROI.

26:45Michael Batnick:So the biggest beneficiary of all this spend in the market today and the area where if somebody said, Michael, what do you mean the market is sober? Have you not looked at semiconductors? Yeah. Okay, fine. Point taken. So chart three, Daniel, please. The Sox index is 69 % above its 200-day moving average, which is unlike anything going back to, so I guess we only have data going back to 2002 here. But we've never seen anything in the last 25 years like this. It is going straight up. We spoke, Josh and I were talking about Micron, how it just joined the trillion dollar club. It's the 11th stock, and I guess Anthropica is on its way.

27:21Michael Batnick:So on Tuesday, UBS raised its chart for Daniel, please. UBS raised its price target for Micron to$1 ,625 from$535, more than double its closing price on Friday of$751.

27:38Downtown Josh Brown:Without commenting specifically on Micron, you would agree this recent development of these memory stocks and Korean stock market and some semiconductors that Denise is not specifically talking about. But you would agree this is an area that's causing portfolio managers and market watchers to be like, wait a minute, what's going on? I'm getting shades of Cisco, Lucent, JDS Uniphase. Like I'm getting those feelings back from 25 years ago. You would agree there's some element to that. Yeah. So that's where I think the data is really interesting. Should we short Micron? I'm just teasing you. I know you're teasing me.

28:18I won't answer. It doesn't matter. So, no, I think that's a really interesting point in terms of like when you aggregate it together, forget Mike Griner and the individual stock and just aggregate all the semiconductors together. You go, OK, well, what's happened over the last six months, right? They're up 70 percent. What's happened over the last year? They're up 100 percent. And now let's look at the data. Let's just pretend again, back to sort of all the charts, like let's pretend we don't know the answer and let's be open minded. Now you look at that and you can say, OK, well, it's been up 100 percent before over the last year.

28:45And two things. One, it's exactly in line with its earnings growth. And two - That's important. Yeah. And it gets more important in a second. And two, if I bought it every time it was up 100%, clearly the bubbles was one instance that was negative. But more often than not, like 55 % of the time, it goes on to outperform again the next year. The interesting part is, let's forget semiconductors for a second. Let's take all of the industries going back to the 60s for anything in any GIC sector and say, well, what if I bought them when they were up 70 % to 100 %? Any sector that's up 70 % to 100%.

29:17Any sector, any industry. Industry. Industry. So one click down. So that'll be, it's only happened like 2 % of the time, you know, historically. But every sector kind of has some participants. 65 % of the time, they go on to outperform. That's a lot. Right? Surprising, too. Which is sort of to the point of, wait a minute, is there something the market is not - But investors aren't stupid.

29:37Michael Batnick:Like, there's a reason why this happened. They're not doing this randomly. Because what the anomaly is, has been earnings growth. So over the last two years, the price performance is less than the earnings growth have been for semiconductors as an industry over the last two years. That's the anomaly. They've never compounded earnings like this without being down 100 % or not 100 % and then up 100%. But now this up trajectory, up let's call it more than 50%, has lasted more than two years. That's the difference in history. I think the average investor, they see the price. Right. So they see like the Wall Street Journal had this great chart.

30:12Downtown Josh Brown:They're not looking at the earnings.

30:12Michael Batnick:The Washington Journal had this great graphic showing the time between reaching$500 billion and a trillion dollar valuation. And Berkshire, I mean, you know, whatever. It was a long time ago. But Micron, it happened in how many trading days? Is that like, I don't know. I can't, it doesn't say, but.

30:25Downtown Josh Brown:Yeah. 20.

30:26Michael Batnick:I mean, it's ridiculous. The speed at which just happened. So we made a chart showing that Micron, we're showing its path in the S &P 500 over time. And a year ago, like not a year ago, it was the 127th largest stock in the S &P. It was less than$100 billion market cap just a year ago. And it's now number 11.

30:46Downtown Josh Brown:10 years ago, it was number 381.

30:48Michael Batnick:The speed is amazing. So Denise, you have a chart showing the relative forward PE of semis. Yep. And they tend to trade at a, I don't know, discount. But investors don't give them the premium multiple. Right. So I had a friend of mine who, credit to him, he's been in Micron for a while. He's made a lot of money. and I was saying like, hey, listen, I'm not like calling a top of my gun or anything like that, but like when something goes up 5 % a day, set some sort of exit plan just while you're sober and maybe he's drunk on the gains, but like, because if and when this thing falls, it's just going to be disoriented for your brain.

31:27Michael Batnick:Like I'm not making a short term call, but just having this conversation with him.

31:29Downtown Josh Brown:It won't fall 5 % a day. It'll fall 20 % a week.

31:32Michael Batnick:Well, it just fell 30%. Like after earnings, it just did. So anyway, the point is this. He said, well, it's sold out for a year. Is it still a cyclical business? And I would say yes, but you know a lot more about this than I do. Well, I would say, so the trick with cyclical businesses, if they're cheap, right, that could be the peak in earnings, right? So that's to your point. Like if this is still a cyclical business, then valuation doesn't look from a probability perspective the way it currently looks for semiconductors, meaning that I have this linear relationship. The cheaper the stocks are right now over the last 10 years, the more likely the stocks are to outperform.

32:08So I think some of what we're seeing right now is a changing business. We just talked about that in terms of earnings. They've never compounded like this. Now, whether or not earnings is a peak, that part, I don't know. But what I can say is that the valuation compression that we just saw, again, that two-year stack in terms of the earnings growth, it's almost like a catch-up trade. And some of this valuation multiple is saying, look, I understand that there's a lot of fear in the market about what this might mean. Some of that's in the stocks, right, which seems absurd to your point, like back to the point of like, yeah, there's fear in the stock.

32:39It's only it's only 8x. Exactly. So, again, it's sort of you have to sort of put the case of, yes, anything that goes up that much can also go down. But when you think about measuring fear quantitatively and measuring valuation support, there's 70 % odds are not 100 % odds. But when you see a pattern like that, I think you have to be a little bit more open-minded that price might be understanding something that you don't quite yet.

33:03Michael Batnick:What's that 70 % that you just mentioned? So the odds of semiconductor outperformance over the next 12 months when your starting point is in that bottom quartile of valuation. But do you still think they're cyclical?

33:14Downtown Josh Brown:Yeah, but the nature of the cycle itself is probably changing. so maybe the cycle used to be three years and now it's seven and we won't know until we get to eight and look back and say oh yeah that was the peak of cycle one of the things that distinguishes this from the 2000 bubble micron in particular so i'm old enough to remember two years ago when they were comparing nvidia to cisco um we don't talk that uh nvidia nvidia like basically has become Taylor Swift and Micron is Olivia Rodrigo. And like the young, younger girls don't care about Taylor Swift anymore. Okay. Okay. So, um, so now we're not saying, we're not saying NVIDIA, Cisco, maybe we're saying Micron.

33:58Downtown Josh Brown:So people are pointing back to like the, um, the telecom fiber optic boom and how like they laid all this fiber and then nobody needed it. And all those companies went bankrupt. And then it wasn't until five years later that YouTube came along and all that fiber that they thought was worthless. And I, I was in these stocks like MFNX and like, I owned all of these things. Um, I don't love that comparison or that analog because Micron's memory is not being installed in a data center and then collecting cobwebs. Like the stuff that they're selling is put into use immediately. Now, you could argue whether or not that will continue, but that's not a great comparison to Cisco and fiber optic cable in the year 2000.

34:49Downtown Josh Brown:This is not CapEx with the expectation that maybe somebody will need it. They're literally saying we're short compute based on today's demand. Forget about what we think demand is going to be in three years. Do you think that that point is made enough on the bull side? Do people understand it really? Or? I mean, I think it goes back to the like idiosyncratic versus, you know, systemic in terms of like how you add it up. So yes, are there individual stocks where you could sort of make this comparison? But the problem was in the 90s into that bubble, it was everybody, right? So the median technology stock, their earnings peaked in 1996.

35:25Michael Batnick:Whoa. Right. That was the disconnect. Yeah. Right. I mean, this like, Could we get there? Sure. But we're a very far cry from there. The median tech stock is profitable. Obviously, the cap-weighted tech stocks are profitable. Operating margins are still increasing. Could we look back at some point and say, this is the peak? But again, back to that, okay, let's pretend that this is the peak. What if then it's 1996?

35:50Downtown Josh Brown:Okay. Do you think if Anthropic and OpenAI were public companies reporting financials on a quarterly basis, holding conference calls and had ticker symbols that people could see. They, the visibility of where the spending is going and where the revenue is coming from would be, what would be a better source of comfort to people. Because I think one of the issues right now is a lot of this CapEx is going into projects being paid for by Anthropic and OpenAI and they don't have tickers. The circle door. And they don't talk to the public unless they want to promote something on TV. But it's not the same as seeing a public company spending and then being like, okay, I get it, though.

36:34Downtown Josh Brown:They're also generating revenue. We're getting rumors of revenue about these companies. They're like casually mentioning their revenue at the Milken conference. Like we don't have the data at our fingertips. And maybe that's why all the CapEx spending, it's harder to tie it to revenue that we can actually see. You think that's an issue for investors? Is that maybe why there's so much suspicion? Yes, but I'm not sure transparency would solve the suspicion, to your point. Like, I think there are skeptics out there. I think the skeptics will probably continue. And in some ways, like, I don't know.

37:09Do we want comfort? Because so far, it's been a decent investing setup. So do we need people to be more comfortable? I'm not sure the answer. That's a good question. Do we need that as a driver?

37:22Downtown Josh Brown:Well, the people who are long right now don't need that. They're fine.

37:25Michael Batnick:What are the areas of the market where there might be too much enthusiasm? And this is hard to say what's priced it or not, but it might be the analysts. So this is from BC Alpha Research. They grabbed this data from Faxit. We're looking at net profit margin for every sector. and they're expected, I mean, they're at all time highs and they're expecting even more gains. Yeah. What happens if this doesn't come to fruition? I think you keep saying like the diffusion and the breadth of companies benefiting from this. Do you think that this is more likely than not that margins are going to keep going up?

38:01Michael Batnick:Because this to me is the, this is it. This is the whole game. Right. Yeah. So I would say, let's look at the forward indicators in terms of what's correlated to margins. And the biggest correlation to margins is unit labor costs. So labor, especially when you sort of compound it for productivity, that's, you know, corporate America's biggest, for the most part, cost. Which is not to say that there's not other input costs, but that's the main, I would say that the main corollary. And so when you look at unit labor costs over time. Every sector? Yeah. So most sectors, the vast majority of sectors, and then when you aggregate it up for the market overall, without a doubt.

38:34Okay. So I think you have this unique combination of unit labor costs are in the bottom quartile of history, right? So that is very rare relative to like 3 % inflation. So it's partly because wage pressure has been continued, I would say, in conjunction with productivity advancements. So that has the correlation to profit margins. So the lower unit labor costs have been, direct relationship, the higher corporate profit margins usually are.

39:01Michael Batnick:Do you have to put token spend back into the labor costs? Why? Because a lot of the money that would be spent on humans is being spent on the robots. Already? Or the machines. Not yet. I would say from a proportion perspective, not yet. Maybe that will change, but I don't think we're there yet.

39:19Downtown Josh Brown:Oh, so like we're saving money by hiring people, but we're just reinvesting that money into compute? Like that ornament? We might be, yeah. Yeah. But I don't think that that's where the productivity is coming from quite yet. But I do think that wage growth has been restrained. productivity is on the uptrend and that usually makes corporate America more profitable. Again, back to just relationships, right? And then you add in that fact too. So you go, okay, so then these are the expectations, you know, they continue, but yet we're seeing this, you know, persistent fear in the equity market and this multiple compression saying that some people are already pricing in the fact that it won't continue, meaning that there's already the fear that there are these risks.

39:57So you end up in the same situation where the forward drivers do suggest that it's more likely than not the profit margins are higher rather than lower and the market doesn't believe it let's talk about the diffusion

40:08Downtown Josh Brown:that you spoke of yeah um i think this is one of the most unsung aspects of the bull market this year last year we talked about it a lot the financials had a great year yeah there's a lot of money to be made in things other than tech last year this year i feel like the focus has gone back to AI CapEx being the only game in town. But here's a chart, 11. This is the S &P 493. Yeah. The earnings revisions for the first quarter. And I feel like this is trending in the direction that you'd want it for the overall market. Right. So it's like more upside from more companies that are not Mag 7. That's correct.

40:52I think it's a unique setup in the sense that there's been a big divergence between cap-weighted earnings growth and equal-weighted earnings growth. And while cap-weighted earnings growth has been, you know, fine and good for the last three years, equal-weighted earnings growth has actually been contractionary. From a duration perspective—

41:09Downtown Josh Brown:Smaller companies have not had the same earnings boost. Correct. And I would say not only the same earnings boost, we're actually seeing earnings decline. Yeah. From not a magnitude perspective like we saw in other recessions, but from a duration perspective, it was as long as those recessions. So that's why like 2022 was kind of recessionary from a corporate America profit perspective. It was a full employment recession, and this is a full employment recovery. But this is just now getting back to a situation where equal weighted earnings growth can grow and be durable. And from a pattern perspective, you see the symmetry between the duration of the decline and the duration of the support.

41:50Downtown Josh Brown:How long was the duration of the decline? Three years. Three years? Three years. So where are we in this earnings recovery for the 493? Like we're four months. Yeah. Four months. Yeah. Yeah. I mean, I started writing about it in the beginning of the year that we're just really getting started.

42:05Michael Batnick:So the MAG-7, the MAG-7 are up 6.6 % year to date. Yep. Which is underperforming the market. XMAG is up 10.25%. So I thought this is really a welcome sight. Daniel, chart five, please. The top 10 stocks in the S &P 500 in terms of what's contributing to the overall gain. Google's number one. The fact that Micron is number two is so insane. It started the year at$100 billion and it's the number two contributor. It's added 100 plus basis points to the overall index. It's remarkable. After that, you've got NVIDIA, Apple, AMD, Amazon, Intel, Broadcom, SanDisk, and Lam Research. So we're noticing a theme here, okay?

42:50Michael Batnick:Obviously. But they all add up to 2.3%. Guess what? The index is up 10%. Pretty damn good. Yeah. Well, that's why it's interesting when you talk about people saying, oh, the market's dependent on the Mag-7. The Mag-7 underperformed for the better part of the last 18 months.

43:05Downtown Josh Brown:And they themselves are diverging from each other. Correct. Which I love. Correct. Maybe we'll have to come up with another acronym or something. Well, we're going to have to add SpaceX to that, to MAG-7. It's going to be MAG-8. Tough acronym. Okay. Right. But it's definitely going that direction. Do you want to do this one? Which one? Margins Outside Tech. All right.

43:23Michael Batnick:So this is also very welcome. Margins Outside Tech. Is this AI basically is the question? Yeah. So what do you think?

43:32Downtown Josh Brown:Why are margins expanding at this rate outside of technology companies? because they're the users of AI and they're expanding their margins? Or is it too early for that story? I think it's too early. I mean, you're definitely seeing productivity advancements specifically in software, but I don't think it's diffuse relative to the rest of corporate America. And again, I would go back to the, if you ask me what's sort of the driver behind that, I would go back to the pattern of unit labor costs, right? And that's sort of the driver, at least the corollary, the tightest corollary that I've ever seen with corporate profit margins.

44:03Michael Batnick:So I want to get your take on this and sticking with the rest of the market. So small cap earnings, I forget what the overall estimate is, but it's like 30%. It's like a number that you're like, wait, what, how? So one of our guys, Chartkin Matt, compared the small cap earnings, the Russell 2000 versus the S &P 500, the expected earnings over the next four quarters. And the spread amongst the two is gigantic. Energy and materials, I think we sort of know what the story is there, at least in the energy side. But what's happening with financials? How are they expecting 66 % earnings growth for small cap financials and just 7 % for large cap?

44:40Michael Batnick:And similar things with real estate and discretionary, the spread is gigantic. Do you feel like it's the calculation in terms of the non-earners and how you calculate that from people? Because at the end of the day, like Russell's 2000, what we went from, we're close to at least 20 % of more non-earners.

44:57Downtown Josh Brown:Oh, so a company's losing 5 cents and now they're going to earn 5 cents. That's a huge difference. Are they in? Are they out? I think that's the issue.

45:02Michael Batnick:I think with the 600, it's directional in the same. Yeah, yeah, directionally the same, but I think from a magnitude perspective. So let's just say that we overstated it. But what do you think is driving this? Do you think it's, because it's not the expectation of Fed cuts, which we're going to talk about. No. Because that is going the opposite direction. So what do you think? Correct. What do you think it is? Because you're right, like the equal in a small cap, earnings have not broken out yet. Correct. No, I mean, I think it's all the beginning of a recovery, right? So, and you're all seeing this together.

45:27It's the manufacturing recovery that they're, you know, linked to. So the same thing, like when you look at ISM, right? ISM new orders inflected higher for the first time in three years. It's very rare that the manufacturing economy is in, I would call it maybe recessions, overstating it, but a malaise for three years. The last time you saw that was like in the 80s. And you see a big corollary to smaller businesses and productive capacity in the U.S. So it is just starting to emerge to what normal growth actually looks like. And that's where I think you get from a non-earner perspective to a flip to earner perspective.

46:00This is the beginning. Right. This is exactly where it starts. So it's all linked to that median earnings growth is finally emerging from what I would call a recession that's lasted the better part of three years.

46:11Downtown Josh Brown:What do we do with inflation? And what do you mean? Buy it, sell it. It's not trending in the right direction. It's changing the story of what we thought the Trump appointed new Fed chair would be able to do, would want to do. They just pushed the first rate cut of 2026 into December in terms of the probability based on trading. That's probably my guess. I don't think we get any kind of relief on the inflation numbers next month, the month after. I'm guessing they'll push that 26 cut completely off the table and maybe start talking more about a hike. What do we do with this as investors? Yeah, so I have a lot of thoughts on inflation.

46:53So the interesting part is as an investor, right, do we get any relief? Do we need relief? Do we need it? As equity market investors?

47:01Downtown Josh Brown:Does CPI have to cool off to two and a half or can we just bluster through the year? The sweet spot for the equity market is between three and four, right? Inflation. Yes. So I actually have a chart of that. I know it's ironic. Chart 15? Yeah. I don't think you have it. Oh, no, this is small. Yeah, this goes back. Yeah, yeah. So, I mean, so that's one irony, right? Which is what you know, like equities act like an inflation hedge, right? The times when you don't want to own equities are when it's top quartile. Inflation is top quartile and rising. That's 4.5%. We can debate whether or not we're going to get to 4.5 % from a core CPI perspective.

47:30I don't think we will. And we'll talk about that next. But that's the area that you don't want to own equities. Anything sort of like in this inflationary dynamic, which we're a part of, I would call it the middle quartiles. It's not the driver, right? Earnings growth is the driver. And again, if earnings growth is the driver, equities can be a valid inflation hedge. So there's an interesting pattern there as it relates to overall inflation. So this is again, this is I don't want to say controversial, but so if you look at core CPI and you take out shelter, if you say, let's call shelter a supply shock this time around, because that's exactly what happened, right?

48:05Interest rates went up. Everybody was locked in their mortgages. So nobody wanted to sell. So it's acting like a supply shock. If you look at core CPI x shelter, do you know what it was last quarter or last month? 2.3%.

48:16Downtown Josh Brown:Oh, right. The shelter component is what's making it look like it's way worse than it is. Well, people really do care about shelter, though. No, but I understand that they should care. It's not about what the consumer feels. This is about how the Fed should manage. Well, that's a good point. Those are different. So the reason why you look at Core CPI, and we'll get into energy in a second, but the reason why you look at Core CPI is because if you're the Federal Reserve, you don't want to double down on supply shock, meaning that if oil acts like a tax hike, The last thing you want to do is add rates to mitigate something that you can't control anyway and make it worse.

48:51Downtown Josh Brown:Sorry about the gasoline prices. Here's higher interest rates. Correct. So that's why— That always made no sense to me. That's why they look for CPI. And the interesting part is, so when people are worried about higher rates this time and you say, well, okay, we can observe that rates are going higher. But again, let's assume. We don't know why. So when you look at oil specifically and you chart it out—we have a great chart of this. I don't know if you have it up or if you have it, but when you sort of quartile out the oil, like advances that you see over time, 10%, 20%, all the way up to 60%, you say, is there a pattern between what has happened to oil over six months and what the Federal Reserve will do over the next 12 months?

49:29There's a negative pattern. Meaning they're not reacting to it. The bigger the shock in oil, the lower the probability that the Fed hike. 25 % is not zero, but even when oil is up 60%, what you see is only a 25 % chance that the Federal Reserve hikes. Why? Because most of the time, since the 1980s, you don't see a pass through to core inflation. And by most, I mean 48%. Let me quote you. So it's not never.

49:50Michael Batnick:Let me quote you to yourself. You said many investors, and Denise, you write on LinkedIn weekly. Yes. Okay. Many investors see higher oil prices as the factor that's increasing the odds of a Fed hike. But when you examine the data, oil-driven shocks have historically made the Fed less likely to tighten, not more, functioning more like a tax on the consumer. Love that. That's great news. Then a catalyst for broad-based price increases. And by contrast, what clear pattern emerges? Yeah, growth. Growth is the clear pattern. And the funny thing is, like when you look at, I wrote a lot about the manufacturing recovery earlier on in the year, durable goods orders are actually in the top quartile of their range.

50:27Michael Batnick:Chart 14, Daniel. Yeah, so that's chart 14. And then you do see this pattern, right, between core capital goods, right? So the strongest core capital goods, that's the quartile we're in. You see that relationship, you know, that monotonic relationship between the higher the growth is in terms of durable goods orders, the more likely the Fed is to hike. And which quartile are we in right now? We're in the top quartile of capital goods, yeah. So you think they're going to do it? I don't know. I mean, it increases your odds to 65%. I would say that, again, you got to go with the base cases. Okay, so something changed in terms of the probabilities.

51:00Let's be open-minded to the probabilities. Then the question becomes, okay, let's say they're going to hike. Do I care as an equity market investor? And that's the unique data set, which is you find out really quickly. Chart 15, Daniel. Which is, it's not about, oh, we're going right to magnitude? This is so important.

51:17Downtown Josh Brown:So I don't know if you know this. I am a television star. And we spend so much time on TV talking in binary terms about hikes versus cuts, what's good, what's bad. There's very little discussion of magnitude. Yeah. So let's talk. I'll sign an autograph after this, but let's get into your chart. I think it's interesting. So if there is growth, you usually see in these middle two quintiles or quartiles of the Federal Reserve hiking interest rates. So these two quintiles are zero to 100, right? So if you're hiking like 25 basis points and maybe 100 basis points over the course of four meetings over the course of a year, those are your market odds, right?

51:56And there are higher odds of a market advance than baseline, right? So baseline 75%. And you would say, if I knew everything about what the Fed is going to do, whether they're cutting or hiking, what's my best probabilities? It's the Fed hiking by just a little.

52:11Downtown Josh Brown:A small hike and a stock market that is not disturbed by it. Correct. Because it's a reflection of growth, not deterred to it. Right. And it's more like it's indicative of the fact that, you know, rates confirm the cycle, that rates or the Fed follow the cycle rather than potentially create it. And if rates are a reflection of growth, the market's got no problem with it because they're focused on growth.

52:33Michael Batnick:How often do new Fed chair people come in and hike? I know there's not been like a million examples, but. I actually don't know.

52:40Downtown Josh Brown:Well, it ain't going to be this guy. I can tell you right now. It reminds me of the O. Henry story, The Gift of the Magi, where there's a husband and wife. What a show off. I don't know. Right? What is he talking about? There's a husband and wife. They each want to buy each other a gift and surprise each other. Oh, I do know this story. Right? Yeah. Yeah. But they don't have money and there's a whole thing that goes on. It's not important. But in the end, he buys her this beautiful hairbrush. I don't know if it's like ivory or something. She cuts off all her hair for the money to get him a gift.

53:12Yes.

53:13Downtown Josh Brown:So there's some element to that where it's like, all right, oil price spike, definitely uncomfortable for the consumer, for business, high gasoline, very real. and then the reaction to that is, well, we're worried about the reaction to that is that is going to make its way into other prices in the economy, which I understand. But then the reaction is going to be, well, we're going to raise rates. Well, first of all, you ain't going to change the price of oil by raising rates. So what are you really doing? You're just exacerbating the high prices that you were worried about in the first place. I think that's correct.

53:47Downtown Josh Brown:Okay. So, but they, I mean, I'm not a PhD. Surely they understand this. Right. I do think that they - If I understand this, they must. I would say that - I hope. It's clear in the data, right? When you see in history, the fact that the Federal Reserve is less likely to hike the bigger the spike in oil, I think that they see it exactly the same way, that oil is like a tax hike on the consumer. And the interesting part, again, since the 80s, I mean, this doesn't include the 70s and like the big inflation spike, which is different because of unit labor costs. But if you say like, what are the odds that it does get passed through?

54:17I would say less than 50-50. And I think that we saw this movie with tariffs, right? In some ways, corporate America doesn't get to decide what it can pass through. The U.S. consumer decides what it's going to absorb. And that's, I think, what's very different. So if real incomes aren't excessive or, you know, we're not getting rained down in terms of 15 percent GDP coming out of COVID or something like that, if you have to spend more money at the pump or from a tariff perspective, more money on watching machines, then your marginal propensity to consume goes down in other areas and their marginal ability to price goes down with it.

54:49So you saw, again, I think over the last 12 months, corporate America like try and increase prices and then quantity demand fell. And so what did they do? They cut prices, right, to increase quantity demand. So I think -

55:02Downtown Josh Brown:Where did we see that? Autos? I think airline tickets? Yes. You saw that in some consumer goods. Yes. Right.

55:08Michael Batnick:So forget about Fed funds rates for a second. And let's talk about the 10-year. Yeah. And the longer end of the curve, which people have been nervous about over the last couple of weeks. do you think that's appropriately priced given how strong demand and growth are and therefore it's not necessarily something to be worried about yeah i would say it's not anomalous at all like when you look at yeah when you look at it relative to growth i mean again it goes back to the like would we like it lower from an accommodation perspective not clear in terms of the data lower rates are often a reflection of lower growth so no and when you sort of quartile it out and you say, okay, where we are relative to where GDP is or where it would be, you would say there's really nothing to see here from a pattern perspective.

55:51Michael Batnick:And where was the 10-year in the 90s? It was like 5%, 6%. Exactly. Exactly. Exactly. All right. So the IPOs are coming. SpaceX is looking like sometime in June. Who knows about the frontier models, OpenAI and and Anthropic, but let's just assume that at some point. So we have a chart showing the actual money raised, and we did not inflation adjust this, okay? But in 1998 and 99 and 2000, which was a legitimate IPO boom. Obviously the numbers were smaller, okay? Not inflation adjusted.

56:24Downtown Josh Brown:You could say mania.

56:25Michael Batnick:But it was a legit full-blown mania.

56:27Downtown Josh Brown:Yeah. And it's possible that at some point

56:30Michael Batnick:over the next year or whatever, we're going to have as much supply coming to the market from SpaceX, OpenAI, and Anthropic I mean, this is the big one. Do you think there is enough liquidity, enough willing buyers? Can the market take on this much new equity? For the people listening and not,

56:47Downtown Josh Brown:before you answer, for the people listening, so Michael's chart is like, you look at 1998, 99, and 2000, you had 34 billion worth of IPOs, then 65, then 65. That's 164 billion in three years of new equity issuance. contrast that with this year, if we were to get SpaceX, OpenAI, Anthropic, those three deals, we think, would add up to something like$170 billion would have to be raised.

57:16Michael Batnick:And these numbers look light. And these numbers are going up every minute.

57:20Downtown Josh Brown:Yeah. But so has the market cap. So three companies versus, I don't know how many IPOs are we thinking in the 98 to 2000 period. Hundreds. But don't we need to rebase it in terms of market cap? Yeah, of course. But if we rebased it in terms of market cap, wouldn't that look 25 % of that?

57:34Michael Batnick:Yeah, probably. Right. All right, but whatever. Let's just, it's a lot of money. Delete that portion from the show. No, but this is something that people are worried about. Yeah, no, I understand. You guys know more than me about like IPOs. And clearly you can look back in history and say IPO booms are at least correlated with some potential busts in the sense that they usually correlate to euphoria in the stock market, which is usually around boom conditions in the economy, boom condition in earnings. It's very diffuse. So they all tend to happen together. You know, bullish sentiment, you know, exorbitant earnings.

58:06And by exorbitant, I mean like top quartile, right? All of these top quartile indicators. We're not there in any other indicator.

58:13Downtown Josh Brown:You talk, but you talk to portfolio managers. Is anyone talking about what they, the fact that they might have to sell things to participate in some of these, like, there's a certain amount of money you have under management. Yeah, yeah. All right. So now you have a company that you already know. if you're being benchmarked to the S &P or a growth index or a NASDAQ, you must own. You literally must either own SpaceX or it crashes and you look like a genius or something in the middle. But like you have to do something. It's a rebalance challenge. I mean, I think that we've seen this over and over again with the Russell value and growth indices.

58:52Downtown Josh Brown:And the market handle 80s. We had a guest on our show a couple of days ago, his math, let's assume it's the case. he's saying it's like 74 billion uh they'll raise and then if the green shoe is exercised which of course it will be be like 86 billion dollars okay that money has to come from somewhere especially if you think they're going to engineer a pop like they're it's going to open it's going to open up like not down you probably need like 2x that in order to get a pop in the stock somebody has to sell something that money doesn't just come from like another planet so like is that a concern in the near term for investors in other tech stocks because i'm assuming that's where the money will come from yeah i mean we'll see in the near term anything can happen right so in the long term and by long term i mean again over the course of a year which is generally my time horizon it will be what will matter the most will be earnings right so you will get i'm sure you'll get more volatility or at least idiosyncratic volatility, maybe not at the highest level of the market for a time from an absorption perspective.

1:00:03But I think that that might be more short term than you think, which is, like I said, go back to the rebounds that we have. Again, this is a little bit of a different issue, but we've seen rebalances like that that are sizable before in Russell versus growth in 2000, going to sort of the mid cap. And all of that, yes, there are absorption issues over the short term, but over the long term, and again, just a one your time horizon, earnings is going to be the driver. And that will ultimately be the determinant.

1:00:27Downtown Josh Brown:So we'll get through this level of new equity issuance because the earnings will bring people back in as buyers. Correct. This would be a good time for buybacks to kick back in. Yeah, we're going to get all this equity issuance. Yeah, yeah.

1:00:39Michael Batnick:Sticking with like the speculative stuff, does the speculation worry you at all? Is it a total sideshow? So like the meme ETF from Roundhill is at an all-time high. It's a relatively new-ish ETF. Like they issued it, I don't know, in the last 12 months, I think. It came out in October 25. Okay. It's at an all-time high in terms of price. All-time high. October 25. What does it own? So the, but my point is like, the main names are working. Yeah. Non-profitable tech. Yeah, Redwire, AST, Space Mobile. So, all right, Space, Applied Opto Electronics. I don't know what that is. IREN. So a lot of the quantum stuff, Applied Digital, Rocket Lab.

1:01:15Michael Batnick:The junk is working. So, yeah, I did an interesting piece on this for Risky Tech. And because there's a lot of charts making the rounds, If you do like towards top quartile beta, right, or highest beta stocks within S &P technology, they were hitting all-time highs. And like the inflection was very similar to what we saw in 2000. The interesting part about that is when you sort of rebase it for relative to the S &P 500, they've actually lagged broader tech. And the funny part is – and I had this chart. So if you look at – if you just look at high beta tech versus tech, it's been in a downtrend since the 90s.

1:01:48Yeah. Like you generally don't want to own risk. And it sort of oscillated right back to the top of the range. So you'd say it worked in the way that it's worked other cycles. And you would say there's nothing anomalous to see here relative to the rest of technology. You could certainly say that because it's rallied so much, it's fairly expensive. And there are better portions to own in tech that are not high volatile. But you also wouldn't say that you would sell technology as a sector, meaning that even if risky tech underperforms, forms, you still see the less volatile tech actually outperformed to the tune of 75%.

1:02:23So it doesn't look, when you start to normalize things in terms of risky tech relative to tech, and you sort of look at it relative to other cycles, nothing looks particularly anomalous. And then if you layer on the fact that, you know, sort of let's just get, you know, let's think that the median earnings recovery that I was talking about is right. That's exactly what you should see, a junk rally in the beginning that you generally speaking don't want to chase.

1:02:45Downtown Josh Brown:So I want to, first of all, you're amazing. You know that. I want to sum up for the people that are listening, watching, but maybe didn't absorb every one of these very important things. The number one thing for me from this conversation is that we could be relatively early in the earnings growth cycle for the 493. Yeah. Is that right? That's correct. So we're all assuming like we're at the end of something because stocks have been going up for years. It feels like uninterrupted. I know it has been interrupted. But this concept that all of a sudden margins are expanding for small caps, the equal weight is seeing faster earnings growth than the MAG-7.

1:03:31Downtown Josh Brown:The 493 is a better earnings story for this year. I don't think the average investor is aware of that or understands the meaning of that. And you're talking about this sort of symmetrical where we had three years of these companies' earnings being under pressure. And so what if we had three years of earnings expansion, margin expansion for everything that's not a MAC-7? Yep. That might be the most underappreciated aspect of the market. The second – do I have all that right? Yes. Okay. Absolutely. The second big takeaway is the multiple compression. And that's sort of a favorable setup so long as it's not coming as a result of earnings falling.

1:04:11Correct.

1:04:11Downtown Josh Brown:And the stock market's falling faster. That's not what's going on. Correct. What's going on is people almost don't believe the growth can last. So we're seeing, okay, that's not a negative. And the more skepticism there is, the more you can climb the wall away. Yes. And then the third big point that I took from this is you don't really see the Fed as being a major issue in the second half of this year. Did I miss anything? No, you summarized very well. Very good at this. Thank you. Yeah. Professional podcast host. He is too. I know. Certified. That's why I'm here. Did you have fun? I did. I always have fun.

1:04:42Downtown Josh Brown:What's your favorite part about living in, what's your favorite thing about living in Boston? Is Boston nice in the summer? No. Okay. Not to me. So I would say the fall. The fall is my favorite. What do you, so besides like you go to Duncan and like Matt Damon standing there, like what else do you like about, what's like the best Boston life thing? The seafood. Because when we went up to see you. Yeah.

1:05:07Michael Batnick:We loved it. Like what's that neighborhood that we stayed in? Oh, we said, where do we stay? Right by your offices. What is that called? Oh, 245? The ladder? Yeah. Oh, you're in the seaport. Oh, that's a fancy area. It's all like new buildings. It's totally new. It used to be parking lots.

1:05:22Downtown Josh Brown:Okay. So the seafood. When I was going to school. So say more. I think, yeah. No, the seafood. And I would say the seafood purveyors. I'd say the restaurants. Like, I think Boston is. You don't strike me as a lobster roll person. No, I'm not a lobster roll person. Okay, are you? Why don't I strike you as a lobster roll person?

1:05:37Michael Batnick:What do lobster roll people look like? Yeah, we just met. I love the pistachio cannolis of the North. Oh, yeah. Is it Mike's? No, absolutely. Mike's pastry. Yeah, yeah. The Italian food's great.

1:05:49Downtown Josh Brown:What's the best seafood dinner in Boston? Oh, in Boston. No, I would have to say my husband's cooking. I have to say. Yeah, yeah. Yeah, good to him. Good answer. Good. All right. We loved having you here. Thank you so much. I want to let people know that you are doing research for Fidelity. A lot of the stuff that you do makes it out into the public eye. Tell people where they can find more Denise Chisholm. Yeah, you can find it on LinkedIn. So I do share charts of the week and you can subscribe to the newsletter. That way it comes right into your email box as opposed to sort of filtering it through.

1:06:24I also write a monthly white paper. I also do my own, not like you all do, but a podcast called Market Insights at Fidelity. They let you do that? They let me talk. They let me talk. But it's just me talking. Like a hostage situation? It is a hostage situation.

1:06:38Downtown Josh Brown:But it's good though. But no video. So just me talking. So for those who don't consume my research from a, not everybody likes to read. So for people who like to listen, and I also do a quarterly webcast for clients that is the quarterly sector and investment research. So Fidelity clients can get access to that. Okay. Well, we think you're magnificent. You can come on our podcast anytime you want. You can do video with us. Thank you so much. Guys, follow Denise Chisholm on LinkedIn and check with your Fidelity rep for why you're not getting her research. It's very good. All right. We had an awesome time on the show this week.

1:07:15Downtown Josh Brown:We did it all. Right? All right. Guys, thank you so much for listening. Thank you for watching. We'll see you soon.

1:07:35All right.

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