Macro investing insights

JACK JANASIEWICZ: I'm Jack Janasiewicz.

BRIAN HESS: I'm Brian Hess, and this is Tactical Take.

Here we are again, Jack, and it's feeling like Groundhog Day. The stocks continue to march higher. Another strong month for risk assets. And it's been an unrelenting rally since April. It's continuing through middle of October when we're recording. Large cap growth still leading. AI theme still dominant. Any changes to your views on the US stock market?

JACK JANASIEWICZ: We thought maybe we'd get a little bit of a pullback in here, some profit taking. From a seasonal perspective, we tend to get a little bit of chop in this month. Maybe a couple Fridays ago with the concerns on renewed tariff concerns. We got a little bit of a correction in the marketplace, but it seems like—

BRIAN HESS: One day wonder for now.

JACK JANASIEWICZ: Buy the dip is in full throttle here, and that's exactly what we're seeing. So to us, it looks like we're going to continue to grind up into the end of the year. So still risk on for us.

BRIAN HESS: OK. Sounds good. I mean, we have the Fed cutting rates. That tends to provide support. No signs of recession. So these are insurance cuts, which could help with the stock market.

JACK JANASIEWICZ: Sure. And I think the big one, you just hit on it. I mean, financial conditions are what we would consider to be fairly loose as is. And now you've basically got the Fed. And if you listen to what Chair Powell was mentioning the other day in his press conference at one of his speaking engagements, he's basically saying, the market's right to assume probably two more cuts into the end of the year. So he basically blessed the market outlook. So loose financial conditions already on top of the Fed probably going two more times. Again, they're just going to get looser.

BRIAN HESS: Right. Yeah. All right, so that's the great macro story in the backdrop. But what we've also had, which is more micro, has been this AI boom. And it's been definitely lifting assets, driving things. We've seen the relative performance there.

However, at the same time, there's been some increasing talk of circularity within the AI investments, and it seems like every day there's another new announcement of a major investment. And a lot of times, it's the same companies, the same mega-cap growth companies who are involved. So are we worried about the circularity that we're seeing in some of these deals? Many people have seen those charts and with the lines going everywhere from NVIDIA and OpenAI.

JACK JANASIEWICZ: Yeah, and that's probably one of the biggest questions I get when I'm talking with our clients and on the road speaking at events. It's that circular reference, if you will. And a lot of the analogies always tend to go back to what happened during the dotcom era.

And I think maybe the one big difference that I would point to with regard to the circular financing is back in the dotcom days, you had basically non-profitable companies lending to other non-profitable companies. That's not what you're seeing today. You have highly profitable companies lending to other profitable companies. And so I think that's maybe the bigger difference.

And then the second one, again, back to the dotcom references there, you had potentially fiber optic cables being laid that weren't being used. And so the idea was that we're placing that out there for future use. Today you're basically talking about GPUs, and those GPUs are being currently used. So it's not like you have things that are sitting dormant and then they're just going to depreciate and not really add any value, so to speak.

So two very big differences, I think, but it's something to take note of, something we're paying attention to. And maybe the third thing that we-- and we've talked about this in prior podcasts was just on the financing in the past. You've had a lot of those dotcom names basically borrowing to finance this expansion. And what you're seeing today is really a lot of this is coming from free cash flow.

Now, more recently, we've had some issues, like for example, Oracle coming to market and basically financing themselves with borrowing. So that's changing that landscape a little bit. That's something that I think we're getting a little more in tune with, maybe a little bit more kind of poking up and paying attention to that, because it's a little bit different.

If you have free cash flow financing those investments and that goes bad, it's just a bad investment and you lost some of your cash, could have been spent elsewhere. But when you're borrowing, now all of a sudden you have to deal with balance sheet repair and the risks that you end up having to default or declare bankruptcy. That starts to increase. And so that's another subtle difference to keep in mind as we think about this.

BRIAN HESS: Yeah, there have been a lot talks about the analogies where you have this massive build out. We're not quite sure of the use case yet for some of the AI investment. But I guess the fact that these companies are so profitable does make it more sustainable. It doesn't mean that we couldn't have a slowdown in AI investment that would probably have some pretty big ramifications for growth, given that, at least in the second quarter, we saw the AI investment add more to the economy than even consumption. But in terms of systemic risks and the idea that we're going to trigger a massive bear market in stocks, it's going to hurt earnings, still unlikely for now.

JACK JANASIEWICZ: Yeah, and you're hitting on the key point there. You're talking about a slowdown. And sure, maybe we could see that. But actually seeing a systemic crisis emerge from this, that's, I think, a bigger concern, and that's probably not where we are right now.

BRIAN HESS: Yeah, we like to check in on this every few months. So we talked about it a few months ago. We're talking about it today. Maybe three months from now, we'll ask again. Are the analogies to the late '90s stronger now?

JACK JANASIEWICZ: And that's what we're supposed-- we're on risk watch.

BRIAN HESS: That's true.

JACK JANASIEWICZ: We're looking for the next concern, and that's obviously what we should be looking at.

BRIAN HESS: All right, speaking of risk watch, so in the past couple of-- well, past month or so, let's say, we've had some credit stresses turn up. First it was Tricolor. Then it was First Brands. They're concentrated in the auto industry, which is having its own issues. And then there's the immigration situation is putting a crunch on their business models. So that's been a factor.

But the result has been some pretty significant weakness in bank stocks. And so I mentioned we're recording later in October. On a month to day basis, the bank stocks are actually down quite a bit, whereas the broad market is higher. So we're watching that. We're watching regional banks. We're watching the banking system. Business development companies and their stocks have been under pressure. But we're also coming out of a couple of weeks where we got a lot of bank earnings. So what did we hear from management set against this backdrop where there's increasing talk of credit stress?

JACK JANASIEWICZ: Yeah, and I think what's interesting, you hear about these issues. I think we might put some of these into more of idiosyncratic risks. But again, back to that systemic risk that we were just talking about, something everybody's on alert for. And I think when you start to look at the anecdotal evidence outside of just those specific issues, you would probably start to see weakening there.

And when you start to think about the big money centers that reported last week, by and large, they basically are telling us that the consumer is in good shape. Household finances are in good shape. And so you're not seeing that sort of same idiosyncratic risk being echoed by the large money center banks.

And then we also had subsequent announcements coming from some of the regional banks after those sort of headlines hit the tapes, and the regional banks that did report after that basically said something very different than that idiosyncratic risks and that all the stuff they were seeing, still very supportive.

So when you put together the general mosaic here, I think it's still leading us to the idea that this is very idiosyncratic. It's not a systemic risk. You're not seeing it being confirmed by other areas of the market where you probably should be. Maybe the last one worth pointing to, again, credit spreads really didn't do much. We had some widening in high yield. But if you look at what really drove that widening, it really was back to that Friday sell off where the concerns on the tariff front started to hit the market. And that's where you saw the bulk of the spread widening.

BRIAN HESS: Yeah, it's hard to disentangle how much of it was concern over the First Brands and Tricolor versus just a generalized risk off into pretty heavily long positioning. Now, we've also gotten a start on the overall third quarter earnings season. So let's just zoom out from banks and the specific and talk about earnings in general. I think maybe about 20% of S&P 500 companies have reported by now. What are the early takeaways from those 20% of the companies?

JACK JANASIEWICZ: Yeah, it's kind of more of the same. Everybody's basically saying things are still chugging along. I would say maybe modest slowing there. But from an earnings perspective, slow is still a pretty good backdrop for a lot of these corporates when you're looking at record margins. And so the earnings beats are coming in maybe slightly above expectations, especially for the first week of earnings seasons.

But maybe the one takeaway that's worth highlighting is the skew that we're seeing from the performance after earnings, like companies that are coming out and beating, you're seeing decent price performance subsequent. But if you come out and miss, especially on a double miss, you're seeing some outside moves to the downside. And so, sure, I think some of that's a function of just sentiment right now. People are on high alert. It's sort of a sell first, ask questions later.

BRIAN HESS: Also valuations are kind of rich. We're talking about that. But there's a lot priced in. A lot of good news is priced, so the bar's higher.

JACK JANASIEWICZ: Right, and so I think that all feeds into that sell first, ask questions later. So it's not surprising that we're seeing maybe some outsized moves to the downside on misses in here. But again, stepping back to big picture takeaway is things are still, I think, pretty good shape. And that's what at least corporate America is telling us after this first week or so of earnings.

BRIAN HESS: We're in a government shutdown now, so we're not getting our traditional macro data from the government. But it does start to seem like the labor market is the one thing that's out of sync with a lot of the other anecdotes we're getting. Like retail sales have held up really well. Banks are saying the consumer is OK, yet we're seeing very limited job creation. And maybe that is, not to overuse this term, but maybe it's idiosyncratic to the labor market because of what's going on with immigration or something like that.

JACK JANASIEWICZ: Yeah. And I think this is just a function of people are calling it a k-shaped economy, a two speed economy. And again, we've talked about this in past episodes where it's the haves and the have nots. The haves are the ones that basically aren't being impacted by elevated interest rates. So think of it as your home mortgage. You and I have a mortgage. We probably locked those in a long time ago. So we're subject to a much lower mortgage rate, so we're not getting squeezed by higher mortgage costs there.

BRIAN HESS: Or it's like auto loans. I mean, those tend to come due sooner than a mortgage, and it's, like, 8% or something. That's a big difference than what it would have been five years ago. And a lot of people, if you're in a lower income bracket, you still need a car. Might live and die by your car, depending on your job.

JACK JANASIEWICZ: Yeah, and those are the ones that are probably fresh out of college as well. They maybe can't afford to be in a house, so they're paying rent, where rents basically have been skyrocketing post COVID. So you can see how the younger cohorts and the younger or the smaller income cohorts are the ones getting squeezed right now. And that's kind of what you're seeing, especially with what you're getting back to when you started to talk about some of the issues that we've seen in the credit market. But again, push back to what we talk about. It's that upper income cohort that really drives consumption. And they continue to still be in pretty good shape. I mean, they're the ones who are benefiting from a rising stock market.

BRIAN HESS: Yes. The wealth effect.

JACK JANASIEWICZ: And that's the one who continues to drive spending in here. So I think that's the two speed economy. The haves are still continuing to spend, do well, the have nots we're seeing some squeezing going on there, and that's showing up in some smaller places with regard to some of the things that you were talking about with stresses, so to speak.

BRIAN HESS: So as long as the stock market holds up, it does underpin consumption. It's interesting, though, because that injects the possibility of some circularity where you get weakness in stocks and it spills over into weakness in consumption, which then spills over to weakness in the broader economy and back into earnings.

JACK JANASIEWICZ: Exactly.

BRIAN HESS: Putting downward pressure on stocks. So it creates, I think, a bigger risk scenario if you were to get a big sell off in the stock market or it creates a more fragile backdrop. But to the extent that we're still seeing earnings grow and the stocks remain pretty well elevated, and the Fed is supportive with lower rates, it's in a positive phase of circularity for the time being.

JACK JANASIEWICZ: And you might want to argue that the Powell put is now sort of back in vogue, back in play again. And maybe is that the one way we see this doom loop short circuited? And quite possibly. So that's one of the things that we're certainly looking at when we think about our expectations for the market between now and the end of the year.

BRIAN HESS: And then trying not to become too negative.

JACK JANASIEWICZ: Exactly.

BRIAN HESS: One last negative thing before we move on to model positioning is you mentioned the China tariff announcement from a couple of Fridays ago and the big sell off that resulted, at least for one day. So we have the APAC Summit coming up, and President Trump and Xi Jinping are expected to speak at that summit. Any thoughts on the US China relations, the likelihood that these tariffs actually take place or take hold on November 1?

JACK JANASIEWICZ: Yeah, I mean, I guess the blueprint has been escalate to deescalate. And so we've seen plenty of past instances where this has been the case.

BRIAN HESS: Yeah, if we're looking at history, it's to say to discount it.

JACK JANASIEWICZ: So we should probably assume right now, anyway, that escalate to deescalate. Same thing. And you got it from both sides here. So maybe once we get to that, I think it's the, what you were saying, the APAC Summit. Maybe we actually get some deescalation in there, and that provides even another catalyst for maybe another leg higher in here as that tension starts to downshift.

BRIAN HESS: It does seem like there's been some constructive dialogue going on even beforehand and some—

JACK JANASIEWICZ: I mean, you had some comments from Bessent saying he spoke to some lower cabinet members over there, and they were willing to negotiate, that sort of thing.

BRIAN HESS: So maybe that's an upside catalyst for even Chinese equities, which is an area where we're positioned. But it would certainly help risk sentiment globally if we got that issue put to rest where we've dealt with the tariff issues pretty much every other major economy we trade with, but China's been the one where there's still ongoing discussions.

All right. So on to the model. On to the models then, where we do have a position in FXI in China, but we haven't touched that one. But we did just complete a model trade about a week ago. We exited a couple of tactical positions. So we sold out of IDNA, MSCI India and we sold out of US MV, which is a US Minimum Volatility ETF. And we also moved to a neutral weighting on equities overall.

We had been a little bit underweight. We were too defensive. I think we can say, we can admit we were too defensive. And we just wanted to get back to as close to benchmark as we can. Fresh perspective. Wait for the next opportunity. But what happened with India and min vol? Any comments there in terms of those ideas?

JACK JANASIEWICZ: Yeah, and like we had mentioned earlier, when we first started the podcast, we had been expecting a little bit of a pullback in the market, and we were waiting for that sort of by the-- any weakness going forward there, and we're just not getting any of that. And so maybe we did get a little bit lucky on the timing that we actually did start to execute on some of that weakness.

BRIAN HESS: Yeah, we traded on the day of that tariff announcement by luck, which was good.

JACK JANASIEWICZ: But from that perspective, trying to buy the dip certainly seems like a lot of people might be left out here waiting to buy that dip that just never comes. And so that's one of the risks in there. But from our perspective, we were looking at some mean reversion trades. That was part of the India trade. India has really lagged the broader EM markets. And when we look at that relationship over 3 to 6 months, it's at extremes. But obviously, when you get some of these extremes, you can go more extreme. And so from our perspective, we just took that off.

BRIAN HESS: Just from a risk management.

JACK JANASIEWICZ: Exactly. 100%. And the min vol trade is the same thing too. A, it fit in with our idea that we were going to get a little bit of a correction. So taking a little bit of risk off the table. The beta factor relative to the min vol factor had gotten to extremes. So that was somewhat of a mean reversion trade as well. And that sort of hasn't panned out as well either. So back to risk mitigation. Let's look to put some risk back on and close that gap. And that's basically what we ended up doing.

BRIAN HESS: All three of those trades were correlated to an extent, because I think all three would have benefited from a market sell off. India was doing nothing while EM was marching higher. My guess is if EM had pulled back, it would have caught down to India. That would have worked out. US MV has been lagging. Its minimum volatility would have worked in a correction. And of course, we were underweight stocks. So we were early. Maybe we were wrong. We cut it, and we're back to benchmark with plenty of dry powder and plenty of flexibility as we look forward.

JACK JANASIEWICZ: And we're still looking to buy the dip.

BRIAN HESS: Right. And maybe we'll get one, and then we'll still be able to buy the dip. So there's no worries there. All right, so lastly, you and I have both been on the road a little bit over the past month. And as I think about the conversations I've had, one takeaway is that on average, this isn't everybody, but on average, I feel like clients seem to lack conviction.

And I don't blame them. There's a lot of crosscurrents. Things are up a lot, feel rich, valuations are rich. And so I didn't hear a lot of strong arguments one way or the other. I didn't get a lot of pushback in terms of our views as I was relaying them. I'm curious how your meetings went.

JACK JANASIEWICZ: Yeah, I would say, I think we were talking about this the other day, that investors were basically sitting on their hands. And I think I would qualify some of my conversations as still a healthy dose of skepticism out there. That proverbial wall of worry, I think, still exists. And I think we touched on some of the big concerns that we're hearing from clients, whether it be valuations, whether it's the AI trade, whether it's the potential slowing in the labor market, tariff concerns, the list goes on and on.

BRIAN HESS: There's a long list of potential risks. Yeah.

JACK JANASIEWICZ: Here we are still grinding up and poking around all time highs. And so, from that perspective, it gives me a little bit more confidence in thinking about if people are all in and very bullish, then I get a little bit concerned that the marginal dollar is already in the marketplace. And so how are we going to potentially push higher?

I would certainly say that's not the case based on our conversations, and that that healthy dose of skepticism probably still lends people to have to chase the market. And when you think about the seasonal patterns for the last quarter of the year being quite strong, especially when you get into November, does that mean we're going to have a chase into the end of the year? And it's quite possible we might actually get that.

BRIAN HESS: Everybody worries about October, and then you get through that October period and it's like, oh, well, OK, no correction. We're good. We'll see if that plays out again this year.

People do bring up valuations a lot. That comes up. And actually, we had an internal debate about that last week. And I think this is one where you and I have a slight difference of approach. And I even may have catalyzed. You wrote a note last week on valuation that I think I may have been responsible for. I don't know.

JACK JANASIEWICZ: It's also top of mind, so it fits perfect.

BRIAN HESS: Right, right. But would you like to recap the key points?

JACK JANASIEWICZ: Yeah, sure. And here's a plug for my LinkedIn account, because I've put both of those out there for anyone who's interested in just checking out the graphs that we're talking about. But again, I think from a valuation perspective, when you just look at forward PEs and forward multiples and you compare that to the next 12 month returns, it really looks like buckshot, so to speak. It looks like you just threw spaghetti against the wall. There's really no discernible correlation there.

And so the point we're making there is simply from a short-term market timing perspective, valuations are really tough to use. I think you need a catalyst, and that catalyst tends to not be valuations. And so as you move farther out, you start to look out 5 to 10 years, then those multiples start to matter. And that's where you start to see having a little bit more of an impact in terms of determining forward returns.

So again, it's funny, the article or the piece that we had written the other day talked about, well, almost a year ago, that printing of that missive, we had written again about valuations. And yet all those valuations had become even more extended from where we were last year, and yet the market was up another almost 18%. So again, I think what happens with multiples is that it tends to keep you out of the market and maybe missing out on that upside more so than actually calling the top and actually maybe preserving some capital by taking chips off the table.

BRIAN HESS: And I think you made the point that a very rich valuation might impact magnitude.

JACK JANASIEWICZ: Yes.

BRIAN HESS: Maybe you don't rally as much as you otherwise would have if the market were cheaper, but it doesn't necessarily imply direction or it doesn't imply direction based on your work. And for us, it's about the trend in earnings expectations that tends to be the thing that drives stock prices.

JACK JANASIEWICZ: Exactly. Yep.

BRIAN HESS: All right. Thank you, Jack. Well, it's been a great chat as usual. I think we'll leave it for there and see everyone next month.

JACK JANASIEWICZ: Awesome. Thanks, Brian.