Markets rebound after Iran ceasefire, but risks remain

JACK JANASIEWICZ: But, again, persistently higher energy prices will eventually work its way into the prices that we pay for, let's say, goods. And that's the risk

BRIAN HESS: And so our portfolios are still set up in a way that, I think, allows us to participate, will allow us to participate in strength, but yet, give us dry powder if we see some downside for whatever reason.

JACK JANASIEWICZ: as we talked about in some of our meetings, it's like, what's the incentive for some of these management companies to stick their neck out and actually make a bold call in here? 

BRIAN HESS: Exactly.

JACK JANASIEWICZ: If anything, hide from that. 

BRIAN HESS: They could use it as an excuse not to commit-- 

JACK JANASIEWICZ: Don't give much of any sort of inklings in terms of the forward guidance.

BRIAN HESS: this war in Iran, if anything, probably serves to accelerate and reinforce those trends.

JACK JANASIEWICZ: --the reaction to the news is more important than the news itself.

JACK JANASIEWICZ: I'm Jack. 

BRIAN HESS: I'm Brian. 

JACK JANASIEWICZ: This is Tactical Take. 

BRIAN HESS: Hey, Jack. How you doing? 

JACK JANASIEWICZ: Back at it. 

BRIAN HESS: Back at it. Another month. Last month, we started the podcast with the war in Iran. And I think this month, we're going to have to do the same thing. It's top of mind for everyone. It's still the dominant market driver. That said, this time we have a ceasefire in place, and markets have started to rebound. So I thought, let's start with the ceasefire and get a sense for how much of a game changer you think this is. Is it changing your outlook on things? 

JACK JANASIEWICZ: Yeah, I think the big takeaway from our perspective is-- and we've talked about this in the past where we discuss the risks in terms of tails, right? The upside, right tail and the downside risks for the left tail. I think the ceasefire is at least chopped off some of that downside left tail, so to speak. 

So again, just reframing the potential worst-case scenario-- that's probably been short circuited to an extent. Is it completely gone? No, but you can certainly see how the markets reacted accordingly. So the market has been pretty quick to price out that left tail risk pretty aggressively in here. So I think that's probably the right way to think about it. 

BRIAN HESS: OK. So basically, cutting the risk to the downside. But we're definitely not all getting an all clear signal here. How about on oil prices? They're back above $100 as we're recording this morning. How far do you think they need to fall before oil prices stop being a threat to growth? 

JACK JANASIEWICZ: Yeah, that's a good question. I think that maybe it's more so the trajectory that the back end of the curve, so to speak, is pricing in. So think about maybe just the December contract for the rest of this year. Is it down significantly? And, yeah, I guess we could say it's trading below $80 a barrel, looking at Brent. 

And so, based on where we are with spot, relative to where that is towards the end of the year, it's a market decline. I think that's what the market is really hopeful for. And that's the bigger issue right now. It's always been duration and how high. And this is giving us more and more indication that the market still sees this as a short-term disruption. 

And we'll get through this in oil prices, probably end up a little bit higher. There is still probably going to be some geopolitical risk premium baked in. But is it enough to really cause a recession, so to speak? At the margin, maybe we get a little bit of slower growth. But I don't think it's detrimental to the overall global economy. 

BRIAN HESS: So as long as the deferred-- like December, the contracts for early next year stay well below $100 a barrel, you're generally comfortable that we're not going to have some kind of oil spike-induced, growth scare? 

JACK JANASIEWICZ: Exactly. 

BRIAN HESS: How about our inflation, though? So we've been pretty comfortable with the inflation outlook this year, despite the levels being above target. And we were hanging a lot of that on housing or shelter-related inflation. I'm wondering if your thinking has changed at all with respect to the inflation risk, given that, now, we have a new source and a fairly potent one coming from the commodity price channel. 

JACK JANASIEWICZ: Yeah. And I think the risk here is that higher commodity prices ultimately start to bleed into the real economy, right? Because we know the Fed pays attention to core inflation. And core inflation strips out food and energy prices. But, again, persistently higher energy prices will eventually work its way into the prices that we pay for, let's say, goods. And that's the risk. Right now, we're not seeing that, but early in the game here. And again, this is all a function of how high and how long these oil prices remain elevated. 

I thought another interesting piece, though. One of the regional Fed banks-- I think it may have been the San Francisco Fed put out a report where they were looking at the impact from tariffs. And we haven't talked about tariffs in a little while. But they were basically saying two things that I thought were interesting. One, that basically all of the excess inflation coming out of Core PCE. So basically, above that 2% target right now has all been predominantly from tariffs. 

BRIAN HESS: Yeah, I saw that report. OK. 

JACK JANASIEWICZ: And then, I think, the second one there, which I also thought was interesting, is they are also arguing that peak, tariff, inflation-related issues are now behind us. And so we start to see that rolling over. And what's interesting-- you need to keep in mind that inflation is a rate of change. And so if you think about when those tariffs are put in place-- April of last year-- that's the base effect for which we're measuring that change in inflation. 

BRIAN HESS: We're lapping it, essentially. 

JACK JANASIEWICZ: Yeah. Now, all of a sudden, that base effect starts to move higher. And now, it makes it look less, I guess, impressive from a growth perspective. 

BRIAN HESS: So while we have a new risk of inflation from energy prices, goods prices in general, like by extension, maybe the tariff component of inflation will start to lessen. And we're still comfortable with the shelter component of inflation being a disinflationary force? 

JACK JANASIEWICZ: Right. And, if again, we pay attention to a lot of those market metrics where you look at one-year inflation and then one-year inflation, again, the one-year inflation numbers have elevated, but they're starting to come back down again. That one-year inflation, one year from today, that one-year forward rate, really hasn't moved much. So again, the market is telling us this is a short-term impact. Look through this. Because this will all fade away, eventually. 

BRIAN HESS: Yeah, the market is still flexible—

JACK JANASIEWICZ: So far so good. 

BRIAN HESS: --with the medium-term inflation outlook. 

JACK JANASIEWICZ: Yep, exactly. 

BRIAN HESS: Was there anything in Friday's CPI report that caught your eye. We got the March CPI on Friday. 

JACK JANASIEWICZ: Yeah, there's a couple of one-offs in that, were kind of quirky, if you will. But again, the stuff that we have been seeing pressures from, so things like airfares which, not surprisingly, if oil prices are going up, jet fuel prices going up. Airlines have to pass that on. And that's where you're seeing some of the increases being picked up. 

So the idea of it bleeding through to the real economy-- that's one of the areas we're certainly seeing it right now. That had jumped up. Again, some issues on the cars, autos insurance prices there. Those are all ticking higher. But it's just these weird one-offs that we're seeing. And so, I think from a broader base perspective, things are still, I think, comfortably in a range where we're still good with it, I guess. 

BRIAN HESS: OK, so still fairly comfortable with the inflation outlook. Not a reason for us to hit the panic button on the bond market or anything like that. OK. And then, I guess, finally, on this topic, how about central bankers? Do you think their impression about inflation is changing? That matters even more than ours, probably. That could be anyone. It could be, obviously, the Fed. But it could be the ECB or the Bank of England. 

JACK JANASIEWICZ: And it gets tricky. Because, again, the Fed is one of the only institutions that has that dual mandate, right? It's going to have full employment and price stability, whereas if you look at the BOJ or the ECB, they're really only targeting the price stability side of the equation. 

So if you look at what the market has been pricing in the US, futures had moved to actually looking at potentially small hikes between now and the end of the year. That's now been priced out. So the market is now saying, by the end of this year, the Fed stays on hold, which is probably the right thing. I think the Fed should be sitting on their hands, waiting for this to play itself out. 

But if you look at somewhere like the ECB, the ECB is actually-- or the market is telling us that the ECB might potentially hike by two times by the end of the year. So again, they don't have the price to-- or they have the price stability mandate, but not the full employment mandate. So you can see how maybe some of those other banks might lean a little bit more hawkish, if you will, than what we're seeing from the Fed. 

BRIAN HESS: For them to be doing their job, it might just mean hiking rates. Because they can say, look, we hiked rates to try to control this inflation that's rising. And they don't have to worry about collateral damage in the economy. 

JACK JANASIEWICZ: Exactly. And maybe the last one to point to on the BOJ-- the market has already been expecting them to hike rates. And basically, those expectations really haven't changed, so at the margin, really. No new information for the market to absorb there, so no real change in expectations, still expected to hike. 

BRIAN HESS: And that's been the case. 

JACK JANASIEWICZ: Exactly. 

BRIAN HESS: The BOJ has been in a hiking regime for quite a while now. OK, let's switch gears to the investing from here and talk about our models where we made a recent trade at the beginning of April. So we made a small de-risking trade, sold out of our position in S&P 500 equal weight technology, put the proceeds into the US ag. 

That was essentially a reflection of what you talked about, I think, at the outset, how the balance of risk is maybe not as bad as it was before this ceasefire. But it's still two way, where we can see downside scenario unfolding, particularly if oil prices remain elevated. But we could also see an environment where things continue to do well. The economy ignores this. And oil eventually comes down, earnings arrive as scheduled, and we get a nice continuation of the rally. 

And so our portfolios are still set up in a way that, I think, allows us to participate, will allow us to participate in strength, but yet, give us dry powder if we see some downside for whatever reason. So I guess, just to put it to you, with the S&P 500 having rallied sharply off its recent lows, it's back in the ballpark of that 6,900 to 7,000 area it had been struggling with earlier this year. How are you thinking about the balance of risk and upside versus downside? Do you find the market attractive here or more of a neutral-type setup? 

JACK JANASIEWICZ: If I had told you that we're sitting-- I don't know-- 2%, 3% below all-time highs, we have military activities going on in the Middle East where we're threatening to shut down the Strait of Hormuz. 

BRIAN HESS: Yeah, a blockade. Right. 

JACK JANASIEWICZ: Yeah, the list goes on and on here. What would you think about the market there? You'd probably say, well, I should be primed for a correction. So, again, just what we talked about. The skews of risks, I think, probably a little bit more in favor of maybe not breaking through to make new, all-time highs, so from that perspective. And that sort of feeds into what we were just talking about with regard to the potential upside, downside risks here. Lightening up a little bit is certainly one of the things that we were just thinking about with that perspective. 

But I think maybe what could change-- we're going into earnings season now. And earnings are really the driver in here. And they've been holding up fairly well. The question is, are we going to hear from management something that might actually get a different conclusion to come from that? And we're going to find out over the next couple of weeks. 

BRIAN HESS: And do you think enough time has passed yet? 

JACK JANASIEWICZ: Well, that's the other-- that's the issue, right? Because again, as we talked about in some of our meetings, it's like, what's the incentive for some of these management companies to stick their neck out and actually make a bold call in here? 

BRIAN HESS: Exactly. 

JACK JANASIEWICZ: If anything, hide from that. 

BRIAN HESS: They could use it as an excuse not to commit—

JACK JANASIEWICZ: Don't give much of any sort of inklings in terms of the forward guidance. Say, they don't have any clarity. They don't have any better crystal ball than we do. And you don't really get much out of that. And so I think that could be the potential risk going forward. 

And personally, I think the market would probably spend more time focusing on guidance as opposed to the actual beats and hashing through the numbers there because it's already happened. And so maybe we don't get the clarity and the guidance the market is hopeful for, just because the CEOs, managers don't have it. 

BRIAN HESS: And that could be another overhang that prevents us from breaking through that $7,000 level if we just don't have any kind of guidance we can rely on. And the historical-looking data is not as valuable, given the things have changed. Are there any areas of the market that held up very well through the correction that may have signaled some underlying strength that have caught your eye? 

JACK JANASIEWICZ: Yeah. And it's the things that we had expected, right? It's the tech trade. We're seeing quite a bifurcated market within tech. But the semiconductors continue to still hold up quite well. And we keep hearing more and more about the shortage of compute power. So the processors and the chips there continue to actually have a pretty good supporting backdrop. And if anything, you can argue there's maybe some backlash from what's going on with the Middle East. 

You keep hearing about helium and how they're used to cool the wafers. Well, there's a helium shortage now. So is this going to slow down the chip production. So now, we're getting a chip shortage again. So you can see how the pricing there is probably still going to be supportive going forward. But from a broader perspective, we did see tech do OK. And is that a question of the tech having significantly derated? We've seen P/Es--

BRIAN HESS: Large cap, anyway. 

JACK JANASIEWICZ: Yeah, 20% to 30%. So you've got a better cushion from a valuation perspective. And these guys still have decent growth numbers, pretty good margins. If you think about it from those defensive characteristics, maybe not surprising that they've held up pretty well in here. 

BRIAN HESS: All right. So tech is one area that is maybe—

JACK JANASIEWICZ: It's held up pretty well. 

BRIAN HESS: --resilient, if anything else. 

JACK JANASIEWICZ: And I think it's basically go back to those same trends that were in place. And I would say maybe those ideas that we were thinking about, even before we started to have hostilities with Iran. Those maybe are just becoming amplified now, and things like defense spending, and not just here in the United States, but globally, things like trying to onshore, reshore supply chain, trying to shore up supply chain. So that means bringing some of the industrialization back to the US. 

These themes, I think, are still in play. And I guess you can go back to it. Instead of being maybe a bipolar world, it's now a multipolar world. And that just means you're really taking care of your own self, national interests. And those are being drawn along regional lines. And so that, I think, is one of the things we talked about in the past. That probably still persists. 

BRIAN HESS: Yeah, those are secular trends we've been following for several quarters now. And our colleague, Luke, the other day made an interesting point, I think, in one of our meetings, saying, this war in Iran, if anything, probably serves to accelerate and reinforce those trends. It sounds like you'd be in agreement with that. 

JACK JANASIEWICZ: 100%. Yeah. 

BRIAN HESS: So, if that's the case, I mean, we talked about, obviously, defense spending. That's a clear one, but also, resource nationalization and nearshoring. I think those were the three big ones we've been tracking. Can you name any industries that might stand to benefit or countries in which investors could look to play this or look for opportunities with the more longer term horizon? Obviously, this wouldn't be a call over the next month or two. 

JACK JANASIEWICZ: I think the one we've been showing in our portfolios has been Latin America. 

BRIAN HESS: ILF. 

JACK JANASIEWICZ: Yeah. And that's the play on both Brazil and Mexico. Mexico, obviously, for the relative relationship in the US from a geopolitical and backyard proximity, so to speak. Again, a net exporter of oil, but still a net importer of petroleum products. So a little bit of a wash on the energy front. 

But again, a close neighbor, close ally, so to speak, for the US. So that'll certainly have a benefit and then Brazil being a net exporter of energy. So they're going to be a beneficiary of higher oil prices. But not only just oil prices, but commodity prices in general. 

So you can see, if we start talking about that multipolarity, so to speak, you've got basically the Western Hemisphere that we're talking about. And Latin America falls within that. So that Latin America theme, I think, really underscores what we've been talking about here with regard to those ideas and themes playing out in terms of portfolios. And Latin America probably continues to benefit. 

BRIAN HESS: ILF is one where-- and the models-- I think we have a view, that we want that to be a structural holding that we then trade around. So we held it earlier in the year. We took profits. And now, we're back in it as of a couple weeks ago. So I think that is a good place for investors to look for opportunity.

Now, one place where maybe there's opportunity, but there's also been a lot of risk lately is software stocks. And I've noticed that there's not been much of a bounce at all in them, since the recovery elsewhere in markets. So what do you make of that? Is it a new overhang? Or is it just the same old fears around AI? 

JACK JANASIEWICZ: Yeah. And we've talked about this, I think, in a couple episodes previous to this. But we said, I think you need to have evidence that AI is not completely destroying the software universe. And more importantly, what are they doing to the revenue streams and the profitability? And I think that's going to basically take a couple of quarters of actual earnings announcements, earnings seasons, so to speak, for that to be proven out. 

And so you're really getting into the first quarter, I think, where you have a potential overhang from AI, those concerns. And what are we going to finally hear from these software companies? And we'll get a little bit of an idea of how big of an impact this could be. 

And I think you're probably going to need a couple of other quarters, I think, before investors get really comfortable with whatever that trajectory that they assume to be going forward. Is it being supported by what these companies are saying? So proof is in the pudding. We don't have the pudding yet, so to speak. 

BRIAN HESS: But that's one area of the markets where the CEOs are incentivize to say something during the earnings. So I think, there, we do really want to pay attention and hear what they have to say. I think there'll be an effort to defend the business models, as opposed to maybe some of the other industries, like we were saying earlier-- let's use this war in Iran as a chance to not commit to anything.

JACK JANASIEWICZ: And I think the risk, too, in here is that we've certainly seen earnings upgrades stalling out for software. The question, though, is, do we have to see them, maybe, start to be downgraded? We haven't seen that yet. So if you think about it in stages, maybe halfway through, potentially. And so if it does get worse, we could still see downgrades in terms of those earnings estimates going forward. And that would be the bigger tale, I think. 

BRIAN HESS: So, are you are saying, by and large, up to this point, the earnings have remained intact for software companies? 

JACK JANASIEWICZ: Yeah. 

BRIAN HESS: The market has just violently derated them, based on fears about future earnings. 

JACK JANASIEWICZ: Exactly. 

BRIAN HESS: And so the next leg down might have to be catalyzed by actual deterioration.

JACK JANASIEWICZ: Yeah. And again, does that just mean the E grows into the P/E? And maybe you don't have to continue to see it going down. But the flip side is if you want to see a catalyst going up, I think you need to see that E starting to manifest into something a little better than maybe what the market is perceiving it to be. 

BRIAN HESS: All right. Well, we'll pay attention to software earnings, for sure. Anything else as we look ahead to the first quarter earnings season? We've talked about it a fair bit already. But I guess, in closing, anything else you're looking for? 

JACK JANASIEWICZ: Yeah. I would say the last one is-- historically speaking, you've always seen estimates ratchet down as we run up into the start of the reporting season. And in some cases, you're looking back, over the previous six months, if you will, in the run-up to earnings season.

You get somewhere between, let's call it, an 8% to 10% drawdown in those expectations, right? So think about it as the bars being lowered. And then when actual earnings come out, you tend to do better than that revised, lower estimate. And so then, all of a sudden, you get this big gap higher in terms of that. 

And we call that the fishhook effect, right? It takes the shape of the letter J. This time around, we didn't see that sort of revision lower in the estimates. And so, is the bar a little bit higher coming into this earnings season? So the typical revision, lower of about 10%, we get in the run-up to actual earnings season. We didn't get that. 

BRIAN HESS: So you're saying earnings estimates just continue to move higher through the quarter. 

JACK JANASIEWICZ: Instead of being revised lower, they've actually held steady. 

BRIAN HESS: OK.

JACK JANASIEWICZ: Traditionally, they get revised lower. 

BRIAN HESS: Higher, but they've just held steady, OK. 

JACK JANASIEWICZ: Exactly. Yeah. And so the argument there is, have the analysts finally caught on to this? It's been going on for years and years and years. But the issue here is, simply, is the bar higher? And that just means, would a traditional beat no longer really be a beat? Because the expectations are much higher than where they have been historically.8 

BRIAN HESS: OK. On the other hand, I guess, the impression would be, well, their estimates weren't revised lower. So if you beat them, that's even better, right? 

JACK JANASIEWICZ: Exactly. 

BRIAN HESS: Well, regardless, remains to be seen how that plays out. And it'll be interesting to assess the market's reaction, relative to the evolution of those—

JACK JANASIEWICZ: They always say that—

BRIAN HESS: estimates.

JACK JANASIEWICZ: --the reaction to the news is more important than the news itself. That's where we're be paying attention. 

BRIAN HESS: For sure. All right. I think that's a good place to end it, as we anticipate this upcoming earnings season. We'll check back in next month and see how the early reports have fared, relative to those estimates.

JACK JANASIEWICZ: Yeah, exactly. 

BRIAN HESS: Thanks a lot, Jack. See you then. 

JACK JANASIEWICZ: All right. Same, Brian. Take care.