Beyond the Magnificent Seven: Liz Ann Sonders on Markets, Cycles & Investing

[00:00:00] I think one of the most important shifts that is underway that is, I think, of the secular variety, not just pandemic-related, not just short-term, is I think we have exited the so-called Great Moderation Era.

[00:00:14] Many investors have, maybe artificially or for whatever reason, have the S&P as their benchmark on the upside.

[00:00:21] But how quickly does a positive return become the benchmark on the downside?

[00:00:25] But we get in the throes of, I need to know what the future holds and then I can make great investment decisions.

[00:00:31] Well, it's the unknowable, so don't invest based on it.

[00:00:33] Welcome to Excess Returns, where we focus on what works over the long term in the markets.

[00:00:37] Join us as we talk about the strategies and tactics that can help you become a better long-term investor.

[00:00:42] Matt Ziegler is a Managing Director at SunPoint Investments.

[00:00:45] Justin Carbonneau is a Managing Director at Life & Liberty Indexes.

[00:00:48] No information on this podcast should be construed as investment advice.

[00:00:52] Securities discussed in the podcast may be holdings of clients of SunPoint Investments.

[00:00:56] Hey guys, this is Justin.

[00:00:57] In this episode of Excess Returns, Matt and I sit down with Lizanne Saunders, Chief Investment Strategist at Charles Schwab.

[00:01:02] We discuss our 2025 market outlook and some of the big questions facing investors today.

[00:01:07] From inflation to the Fed to the types of investment and company factors investors may want to pay attention to,

[00:01:12] and the rise and impact of ETFs and passive investing and much more.

[00:01:16] Lizanne has a way of bringing what can be complex topics on the economy, markets, and investing

[00:01:20] and making them understandable for all investors.

[00:01:22] As always, thank you for listening.

[00:01:24] Please enjoy this discussion with Schwab's Lizanne Saunders.

[00:01:27] Hi, Lizanne. Thank you very much for joining us today.

[00:01:29] Hi, Justin. Thanks for having me.

[00:01:31] We wanted to have you on to talk about a lot of different things, but the one thing I think where

[00:01:37] I want to start is just, and I think on behalf of Matt and I, we feel this way that,

[00:01:41] you know, we value sort of your perspective on the market, your data-driven, sort of explainable

[00:01:49] approach that you've been bringing to investors for all these years. Matt and I have followed

[00:01:54] you for a long time, so I think, you know, we feel very privileged to have this opportunity to talk

[00:02:00] to you. So, really appreciate it. Oh, thank you very much. That's very kind.

[00:02:05] Um, it's the start of the year. I think investors are thinking about a lot of different things.

[00:02:10] There's a lot of pluses. There's a lot of minuses that I think we'll, we'll talk about. Um, and we'll

[00:02:15] use a lot of your recent research to try to get at the heart of some of these things that I think are

[00:02:21] in a lot of investors' minds. And what I would say out of the gate is, um, Lizanne's pretty active on X.

[00:02:27] So I encourage our listeners to go and follow her there. Um, obviously with Schwab, they're putting out

[00:02:33] lots of great content and she has her own podcast. So, you know, always want to make sure that our

[00:02:38] guests that are giving us their time, we're supporting our audiences is supporting them.

[00:02:42] Hey Justin, can I, can I throw a little PSA in with regard to my social media?

[00:02:47] Sure.

[00:02:48] I'm, I'm only on X and LinkedIn. Anything you see thinking it's me on Instagram or Facebook or WhatsApp

[00:02:57] or threads or blue sky is not me. It's an imposter. And I've hundreds and hundreds and hundreds

[00:03:02] of them. And increasingly they're using AI generated videos. That's actually me and it's my voice,

[00:03:09] but saying stuff that I would never say claiming I have a stock picking private stock picking club and

[00:03:15] it takes people into the money grab through WhatsApp. None of those people are me. So that's my PSA.

[00:03:21] Thank you.

[00:03:22] Yeah, no, for sure. That's yeah. It's crazy that people are spending time doing this,

[00:03:26] whether it's the coordinator or whatever. So yeah, stick to stick to X and stick to LinkedIn.

[00:03:30] And the real me on those, cause I've had impossible on X as well. So yeah.

[00:03:36] Okay. So before we get into the markets, I want to ask you two things about sort of your career and

[00:03:41] experience. And the first is you had the opportunity to work with the famous growth investor, author,

[00:03:50] Marty Zwaag, a regular on Louis Rukeyser's Wall Street Week. I wanted to ask you,

[00:03:58] you could kind of capture the biggest lessons that you learned from Marty. What would you say?

[00:04:05] Well, he would, he was, I don't know that he would generally call himself a market timer. He

[00:04:10] he called himself in, in more lingo terms, sort of a tactical asset allocator, but

[00:04:16] generically he was thought of as a market timer, but he would be the first to admit

[00:04:21] just how difficult an exercise that is, but really based his work on when to have more or less exposure

[00:04:29] to different asset classes based on an extraordinary amount of data. It wasn't, you know, just finger in

[00:04:38] the sky, gut instinct, wanting to be bombastic and make market calls. It was really based in

[00:04:46] economic liquidity and investor liquidity and breadth trends. And he was a big believer in the power of

[00:04:55] sentiment analysis. He was very much in keeping with that old Sir John Templeton line of, you know,

[00:05:00] bull markets are born on pessimism, they grow on skepticism, they mature on optimism, and they die

[00:05:05] on euphoria. And I've always loved that expression because it really does highlight the characteristics

[00:05:11] of a full market cycle with words that have nothing to do with fundamentals and earnings and valuation.

[00:05:17] It's just pure emotion. So we understood the power of that and really just invented and created a lot of

[00:05:23] the investor sentiment indicators that many of us use today. He also understood the power of monetary

[00:05:30] policy. He coined the phrase, don't fight the Fed, but he also understood the power of staying with

[00:05:36] the trend. The trend is your friend was a phrase that he coined. So I really learned from one of the

[00:05:41] best, but ironically also learned that market timing is so, so difficult to do that. I took the lessons I

[00:05:49] learned in 13 years working for him, but didn't apply it in an attempt to try to short-term market

[00:05:56] time. He did that particularly well, but again was the first to admit that it's a really hard thing to do.

[00:06:03] Do you think the way that maybe you viewed the markets when you first started out your career

[00:06:10] has sort of changed and evolved over time? Well, you know, institutional investors were much more

[00:06:17] dominant in the market. You know, the moves of retail investors were not irrelevant, but it just didn't

[00:06:26] have the ability to move the market as much as it did back in the mid-1980s when I started. There was

[00:06:33] also a bit less sophistication around asset classes, certainly for individual investors and how to get

[00:06:40] exposure to different markets. It was a little more simplistically a stocks, bonds, cash world in terms of

[00:06:46] individual investors. The ability to go into non-correlated asset classes, into the world of hedge funds or

[00:06:54] private equity, was really just the domain of the ultra-ultra wealthy. So I think there's been

[00:06:59] a leveling of the playing field and further democratization in that near 40 years that I

[00:07:05] have been in the business. And frankly, I would give a lot of credit to our founder and chairman,

[00:07:12] Chuck Schwab, for a lot of that democratization and really bringing individual investors onto the

[00:07:19] playing field with institutional investors and making the market more accessible, certainly

[00:07:25] cheaper to invest in fees or down commissions to zero. And more recently, just further democratization

[00:07:32] and opening up the market into other asset classes that, again, historically was just the domain of the

[00:07:40] ultra-wealthy. So I've certainly seen a heck of a lot of change in this industry in the past near 40 years.

[00:07:48] Speaking of don't fight the Fed, going back to that swag quote, you know, inflation for almost 20 years was,

[00:07:58] well, since the financial crisis was, you know, below historical average. And then, you know, COVID hit.

[00:08:04] And then for a whole host of reasons, which maybe we can talk about, you know, inflation, people know about,

[00:08:08] you know, inflation sort of picked up. But what do you think the biggest lessons

[00:08:12] that recent bout of inflation should teach investors?

[00:08:17] Well, I think there were unique drivers to that bout of inflation. And that's why we often

[00:08:21] talk about maybe more importantly, the differences between this era of inflation and say the 1970s

[00:08:30] era of inflation, very different drivers. And in this case, although there's some longevity,

[00:08:36] obviously, to the inflation problem at the outset, it was driven by the pandemic and severe supply

[00:08:45] disruptions. It's very different than the backdrop that existed in the 1970s.

[00:08:49] That said, I think one of the most important shifts that is underway, that is, I think, of the

[00:08:56] secular variety, not just pandemic-related, not just short-term, is I think we have exited the

[00:09:03] so-called Great Moderation era. So the Great Moderation period, and I'm not sure who initially

[00:09:09] coined that term. I've heard people credit Ben Bernanke. I've heard people credit Larry Summers.

[00:09:14] Maybe it doesn't matter who came up with it, but it's now the label that is regularly applied to the

[00:09:20] period from, you know, people will start it at different points, but let's call it mid to late 1990s

[00:09:26] through to the beginning of the pandemic. And it was an era, to your point, of basically disinflation

[00:09:33] most of the time, save for a bit of a spike in some measures of inflation in 2008. But essentially,

[00:09:40] disinflation and or low inflation, generally benign interest rate backdrop as a result of that,

[00:09:46] and maybe most important for investors, it was an era where nearly the entire time

[00:09:53] bond yields and stock prices moved in the same direction. Because in that low inflation era,

[00:09:59] when bond yields, as an example, were going up, it was typically because growth was improving

[00:10:03] without the attendant inflation problem. That's great for the equity market. Vice versa, when yields

[00:10:09] were going down, it was often because growth was weakening, moving into a recession, not because

[00:10:14] inflation was coming down, negative for the equity market. I think we're now have already transitioned

[00:10:20] into an environment that looks a bit more like the 30 years that preceded the Great Moderation. So

[00:10:26] the period from the mid to late 60s to the mid to late 90s, which I've been calling the temperamental

[00:10:32] era. I'm neither Ben Bernanke nor Larry Summers, so I don't know whether it's going to take off as a

[00:10:38] label, but I'm going to keep using it for whatever it's worth. And that was a period of greater inflation

[00:10:45] volatility. That's not the same thing as saying inflation was high and it stayed high for 30 years.

[00:10:49] But bigger swings in inflation up and down. There was also more economic volatility.

[00:10:55] Bigger swings both on the upside and the downside, shorter cycles, more frequent recessions. You had

[00:11:01] more geopolitical instability and more volatility in commodity markets. I think that is more akin to

[00:11:07] the backdrop we're in right now. Importantly for investors too, is the bond yield stock price

[00:11:13] relationship was the opposite of what was the case during most of the Great Moderation.

[00:11:17] During almost that entire 30 year period, stock prices and bond yields moved opposite one another.

[00:11:28] When yields were moving up in that era, it was often because inflation was reigniting,

[00:11:33] negative for the equity market, and vice versa. So we're back in that negative correlation mode right

[00:11:39] now. And I think if that persists, that would be sort of the more definitive sign that yes, we're out of the

[00:11:47] Great Moderation era and we're in a different era, maybe one that looks a little bit more like that 30

[00:11:52] year period.

[00:11:52] So if we play that out a little bit, like in the 20 years leading up to COVID, like this 60-40 stock

[00:11:59] bond portfolio, super simple, super cheap, did phenomenally well. Do you think that maybe paying

[00:12:11] a little bit more attention to multi-asset diversification in that type of environment that

[00:12:16] you're thinking about would make sense for a lot of investors?

[00:12:20] Absolutely. And it's why the further democratization of investing, which we already talked about,

[00:12:25] and the branching out of access by individual investors to other asset classes aside from just

[00:12:32] stocks and bonds, alternatives, hedge funds, private equity, private real estate,

[00:12:37] is the timing is great because I think there might be more limited diversification opportunities

[00:12:44] if you're just limiting allocation decisions to just that stocks bonds relationship. So

[00:12:50] I think that the timing is serving investors well.

[00:12:55] It's funny when we think about just how unique this has been, this cycle. And I love that you draw

[00:13:01] the line on kind of the beginning of the pandemic as this shift. So back to Templeton.

[00:13:11] It dies on euphoria. I mean, we even had a television show called Euphoria and this market

[00:13:16] hasn't seemed to want to die. Do we ever have recessions again? Are recessions over? What's happening?

[00:13:21] I don't think recessions are over. Although, you know, maybe we have to think a little bit more

[00:13:28] broadly about recession. So we obviously have avoided a formally declared NBER dated recession

[00:13:37] since the very, very brief COVID-related recession in 2020. However, we have had recessionary pockets.

[00:13:45] So if you think about how this cycle from the start of the pandemic to now has unfolded

[00:13:52] in so many unique ways relative to your typical cycle. Not that we want to rehash the last four

[00:13:57] and a half years, but bear with me for a minute. If you go back to the early part of the pandemic,

[00:14:03] when essentially everything was locked down, then we got the stimulus. That caused a huge surge

[00:14:10] in the economy, but solely concentrated in the good side of the economy. And that was initially fueled by

[00:14:16] the stimulus dollars too, because services were shut down. That also became the breeding ground

[00:14:21] of the inflation problem with which we're still dealing. So you just had sort of this surge in

[00:14:25] growth on the good side, a surge in inflation on the goods, within the goods categories of inflation.

[00:14:30] Then ultimately when we had the reopening, we had the pent down demand on the good side,

[00:14:37] pent up demand on the services side. That resulted in actual recessions in manufacturing,

[00:14:43] in housing, some of those areas that were early beneficiaries during the lockdown phase.

[00:14:47] We went from hyperinflation to disinflation to deflation in those goods categories. We just had

[00:14:54] the later offsetting strength on the services side of the economy. It's a larger employer,

[00:14:59] kept the labor market afloat, and its inflation components have been stickier on the high side. So

[00:15:05] I still don't think we've outlawed traditional NBER-declared recessions,

[00:15:10] but it's also not quite accurate to say there's been nothing to see here. We've had nothing resembling

[00:15:17] a recession. We've just had it in pockets. We've just had the offsets. And I think that could

[00:15:22] continue. I think there is a scenario whereby if and when services maybe has its day in the clouds and

[00:15:29] falters, and you see it on the employment side too, it might be the case, particularly if that means the

[00:15:35] Fed goes back into easing mode, that we actually start to see recovery and growth in those areas

[00:15:41] that have already had their individual recessions. Therefore, the roll through continues. So that we

[00:15:46] may continue in that component of this unique cycle.

[00:15:50] It's really, that's fascinating to me because you're basically saying there's diversification.

[00:15:55] Think of diversification in the economy.

[00:15:56] A hundred percent. And that in turn helps to explain some of the funky action by the stock

[00:16:02] market. We've had this resilience at the index level, which some people find odd given all these

[00:16:08] uncertainties that we have. Yet under the surface of what the indexes have been doing, there's been a

[00:16:14] lot more subsector volatility and factor volatility and churn and weakness and member maximum drawdowns

[00:16:24] that maybe does tell a fuller story of what is going on in the economy and that connectivity to

[00:16:31] what goes on in the stock market.

[00:16:33] It reminds me, I think your metaphor was like a bull bear and a duck, right? You're the person who coined

[00:16:39] the duck phrase.

[00:16:40] Well, it comes from, I think Michael Caine is the one that coined, you know, a duck is sort of

[00:16:44] just smooth and calm on the surface, but paddling like the Dickens underneath. I mean, just last year,

[00:16:51] of 2024, S&P was up 23%. If you stop the analysis there, you'd think fabulous year. The average

[00:16:59] member within the S&P had a maximum drawdown of 21% last year. The NASDAQ's even more extreme. NASDAQ

[00:17:06] was up, I think, 25% or so last year, but the average member within the NASDAQ had a maximum drawdown

[00:17:12] of 49%. It just happened under the surface. So much like the real story of the economy needs to go below

[00:17:21] the surface of recession versus no recession. The fuller story of the stock market needs to go below

[00:17:27] the cap-weighted index level analysis.

[00:17:30] David Sherman

[00:17:31] Surely you're not suggesting we've lost nuance in our modern society in any way.

[00:17:35] No, no, no. Everybody's got a very, very long attention span and we really dive into this stuff

[00:17:41] and we're not at the mercy of soundbites and social media.

[00:17:47] That's why I always get my advice from the real Lizanne Saunders.

[00:17:51] Thank you.

[00:17:52] Bring that PSA back.

[00:17:53] Thank you.

[00:17:53] Thank you.

[00:17:54] And talk to me about the, and I hate this expression, but I don't know how else to put it.

[00:17:59] The above average level of uncertainty. We all feel about everything right now.

[00:18:04] You know, the different versions of phrases about the market and uncertainty often make

[00:18:10] me chuckle. The most common is the market hates uncertainty. And I always think,

[00:18:13] is there ever a certain period of time?

[00:18:16] Dr. David Sherman

[00:18:16] And also, you know, the most dangerous words are it's different this time. Really?

[00:18:20] It's always different this time. There are always different drivers of the economy and the market.

[00:18:25] There is always uncertainty. I don't know that there's ever one era that has it in spades more

[00:18:30] than others. There's just different kinds of uncertainty. So I don't generally balk at that notion.

[00:18:38] Dr. David Sherman

[00:18:39] I will say when you have sort of extreme eras of worry, I think that there is, even though I don't

[00:18:46] like market hates uncertainty line, I already said why I didn't like that. I don't like the,

[00:18:50] it's different this time or why people criticize that. But, you know, the market likes to climb

[00:18:55] a wall of worry. I think that there is credibility to that statement. I think that that background,

[00:19:02] that backdrop of sentiment, I think is important. It's not a market timing tool by any means, but

[00:19:09] it can serve as a catalyst in both directions.

[00:19:13] Dr. David Sherman

[00:19:14] How do you play that out with where we see investor positioning coming in with the new

[00:19:17] administration? Because it seems like there's a change in the flavor of uncertainty, at least,

[00:19:22] as we do this handoff. How do you see that?

[00:19:24] You know, sentiment's interesting right now. And maybe it's because of policy-related uncertainty,

[00:19:29] which none of us yet can really put our fingers on. If we use the 2018 playbook as an example from,

[00:19:37] you know, Trump administration 1.0, we know that the policies around tariffs, and maybe

[00:19:44] by extension this time on immigration as well, it's the method of those announcements, you know,

[00:19:52] coming via social media. I don't know about you guys, but back in 2018, it was probably every

[00:19:58] investor's exercise to get up in the morning, go on what was then Twitter, say, okay, what are we

[00:20:03] going to read now? You know, what was tweeted out at 1 a.m. about trade or tariffs? And we know that

[00:20:09] those became really significant market-moving events, sometimes in the short term. So I think that that

[00:20:16] playbook is important. But in terms of sentiment, one of the ways it may be manifesting itself is

[00:20:21] the differential between behavioral measures of sentiment and attitudinal measures of sentiment.

[00:20:28] The behavioral measures do still show a pretty decent amount of froth in the market. The last two

[00:20:35] months flows into equity exchange-traded funds, particularly of the large cap variety, are close

[00:20:41] to a record and akin to very frothy periods that we have seen in the past. You've got an extremely low

[00:20:49] equity put-call ratio. That's a behavioral measure. You certainly have pockets of froth in

[00:20:56] maybe less traditional asset classes, you know, bananas and duct tape and, you know, crypto to some

[00:21:03] degree and maybe a slightly different version of meme stocks relative to the ones back in 2021. But

[00:21:09] certainly some pockets of froth. However, what may be interesting and may be testament to the concerns

[00:21:15] that investors have about coming policy is attitudinal measures of sentiment are much more subdued

[00:21:22] and much more quickly move to sort of pessimistic territory. So probably the most common popular

[00:21:30] attitudinal measure of sentiment is AAII, American Association of Individual Investors. It's just asking

[00:21:36] their members, are you bullish or you bearish or you're neutral? And right now as we're recording this,

[00:21:42] there's a almost exactly an even percent somewhere in the mid-30s of percentage of bulls or percentage

[00:21:48] of bears. That's very different relative to what we're seeing in things like fund flows. So it's this

[00:21:53] backdrop of, you know, I'm chasing momentum. I'm really enthusiastic. I'm going to keep buying. But you get me on the

[00:21:59] phone and ask me what I think about the market. I'm going to be like, I'm a little worried. You know, sentiment as a

[00:22:06] contrarian indicator. It's not a great market timing tool, but when you really want to put it in the

[00:22:12] risk column is when you have extremes both on the attitudinal side and the behavioral side. And I'd say we

[00:22:20] have more of a mixed picture right now. I love that framing of the behavioral versus the attitudinal. That's

[00:22:25] actually really, I think, useful. Did you see, this is out of nowhere, did you see Kyla Scanlon's piece

[00:22:31] on memes as policy proposals? No, I will have to look for that. Look it up. She's great. She's

[00:22:37] phenomenal. And this, I think you just helped explain that piece even more to me in the attitudinal

[00:22:43] sense, because what she's talking about, and we're going to turn this into a Fed question in a second,

[00:22:47] is like the, we saw, you know, incoming President Trump or President Trump saying that the Fed should,

[00:22:54] you know, cut rates or hold rates or whatever the announcement was. And that's very much like an

[00:22:59] online survey. That's literally putting it out there and seeing how everybody reacts to it and

[00:23:02] almost being like, hey, here's a policy, a proposal. How do people do on this? Just like when you get the

[00:23:07] phone call from the place. So we're coming into an administration that's really probably going to lean

[00:23:12] on that stuff again. How do we think about that? And let's talk specifically about the Fed. Where's the

[00:23:16] Fed going and does the president matter to this? So right now, I think the Fed's bias is to be in pause

[00:23:22] mode. That's certainly what they telegraphed at the December FOMC meeting, even though they cut at that

[00:23:29] was expected. And that may be the reason why they did. I think you could argue that maybe it wasn't

[00:23:34] justified, but that's what they did. It was interesting that there was a dissent and it was

[00:23:38] the newest member. That was pretty bold on her part to dissent. But let's now assume that we're in

[00:23:46] pause mode for some period of time. And I think the bias by the Fed is still to want to cut and the market

[00:23:53] has priced in about one and a half cuts in 2025. But boy, that could change. And in part because

[00:23:59] some of the policy proposals that are more likely to be front loaded in 2025 on tariffs, on immigration,

[00:24:06] particularly combined impact, it is really, really, really difficult to argue against the notion that

[00:24:13] they put upward pressure on inflation and downward pressure on growth. So concurrent with that to be

[00:24:18] saying that the Fed should be all out in easing mode, that's a cross current. And I think the market may

[00:24:25] have to test the administration if there are those sort of competing messages out there of here's what

[00:24:32] we're doing on tariffs, here's what we're doing on immigration, particularly if we actually see

[00:24:36] a deleterious impact on inflation, to then side by side be pressuring the Fed to cut interest rates,

[00:24:43] you could get some market behavior, both on the equity side of things and the fixed income side

[00:24:49] of things that may send a message. And what we also know from administration 1.0 version is that

[00:24:55] there is sensitivity to market moves. And you throw Scott Besson into the mix and Howard Lutnick into

[00:25:01] the mix. One would assume that there's not just sensitivity to the equity market side of things,

[00:25:08] but the fixed income market side of things. How much sensitivity, what that means in terms of

[00:25:12] plowing ahead or backing away? I have no idea. My crystal ball is no clearer than anybody else's on

[00:25:18] that front because just the communication methodologies is so unique with Trump himself

[00:25:25] and the administration. But it's a clear uncertainty and there are many, many cross currents. There's the

[00:25:32] pro-growth aspect to extending tax cuts and deregulation, but there's ostensibly the anti-growth,

[00:25:38] higher inflation side of tariffs and trade, or trade and immigration.

[00:25:44] You officially passed the fake Lizanne Saunders test by not trying to sell us a crystal ball.

[00:25:48] We want to thank you for that.

[00:25:50] My pleasure.

[00:25:51] It's interesting too, when I think about it and you explain it that way, I wrote down,

[00:25:54] it's recessions are kind of economic correlations all going to one. And there's this weird thing if

[00:26:01] they're all focused on the same market feedback loops where that's almost a new danger we have to look

[00:26:05] for on the economic side. Yeah, but that's why I think you have to think

[00:26:11] more broadly about recessions and what is a recession. It'll still be the case that we've

[00:26:17] got these traditional recessions that are called and dated by the NBER. I don't think we've outlawed

[00:26:25] that. I think there is still validity in metrics like the inverted yield curve and the index of leading

[00:26:32] economic indicators. But this unique cycle has made us rethink some of what those messages are.

[00:26:40] And in addition, maybe the time gap between triggers, for lack of a better word, on some of those metrics

[00:26:48] and the long and variable lags between that and impact on the economy. So I think we know this cycle

[00:26:56] is quite unique. And I think we'll go back to cycles that maybe are a little less unique and a little

[00:27:00] more normal. But I think the mindset that this unique cycle brought in is that there are differences

[00:27:06] in every cycle. And I also think this cycle unleashed a different thinking in terms of

[00:27:14] inventories and just in time to just in case. So I think there are structural changes to the economy

[00:27:20] and how businesses go about running their day-to-day lives that have changed probably forever by

[00:27:28] virtue of the pandemic.

[00:27:29] A fascinating place. I feel like this shows up. So perfect segue. This is part of your 2025 outlook.

[00:27:36] You were talking about the issue of confidence and how confidence always seems to be lagging on both

[00:27:41] the consumer and the business side. But Jim Paulson, who we recently had on the show here, he was talking

[00:27:46] about how confidence is finally picking up again. You know, thinking in those smaller businesses and kind

[00:27:52] of the, if we survive the pandemic, if we right-size some of these problems, do they actually

[00:27:58] start to feel a little bit better right now than we've seen them feel in a good while?

[00:28:01] Yeah, I will say when people ask me, what do you see as sort of bright spots on the horizon?

[00:28:07] I think we are shifting into what may be more of an investment-driven economy than a consumer

[00:28:14] spending-driven economy. Not in a really smooth way. It's not some massive launch. And I think the

[00:28:21] uncertainty near term with regard to trade policy and immigration policy probably puts a constraint

[00:28:27] on unleashing some of those animal spirits and kicking the CapEx cycle back in. But I do think we

[00:28:33] may be entering a secular era where a number of things unfold. I already talked about the great

[00:28:41] moderation versus temperamental era, maybe a little bit more volatility in the economy and inflation,

[00:28:46] but also a shift to more of an investment-driven economy at the expense of what has been sort of

[00:28:51] a consumption-driven economy. Now, consumer spending is right now 69% of GDP. That's not crashing by any

[00:28:59] means, but I think there'll be a relative shift down a little bit in consumption and fixed investment,

[00:29:05] which is the category as defined in GDP lingo, is likely to pick up. And I think that that's a better

[00:29:14] footing for the economy than one that is just highly driven by consumer spending. So I see that as a

[00:29:22] longer-term positive, notwithstanding some of the short-term constraints on unleashing that

[00:29:28] by virtual policy uncertainty.

[00:29:31] How do you think that translates through to the rest of the markets? Like what's the U.S. equity

[00:29:35] market outlook relative to that idea of this stronger foothold?

[00:29:40] So I think 2025 might have some similarities to 2024 in that you've got to, to get a clearer picture of

[00:29:51] what's going on, you need to look at both index-level changes and under the surface. I also think it's

[00:29:57] important to remind investors, particularly those with maybe short memories, is that as recently as

[00:30:04] 2022, which may seem like a lifetime ago, but it was really only two years ago, given we're at the

[00:30:09] beginning of 2025, that was a bear market year. And that's not me saying we're going to have another

[00:30:15] bear market soon, but I bring it up because that was a year when the mega caps were a detriment to

[00:30:21] performance. The Magnificent Seven or the Mega Cap Eight or the Top Ten, it was different, you know,

[00:30:28] the FANG Plus stocks. You had different monikers and acronyms being used at the time, but they were

[00:30:33] the drags on performance. But memories are short. So I think for the most part, people think that what

[00:30:39] happened in 23 and 24 with that concentration, with that bias up the cap spectrum, that's sort of the

[00:30:46] lay of the land going forward. And I think that there is a possibility that we have more fits and

[00:30:52] starts, like we did for several months this year, where you get a lift in equal weight relative to cap

[00:30:58] weight. You get a little bit of a pullback phase or a corrective phase in some of those high flyers in

[00:31:04] favor of perhaps down the cap spectrum, especially if the Fed can move back into easing mode for whatever

[00:31:12] reason. You know, you don't have the impact on inflation from tariffs or they back down from

[00:31:19] tariffs or economic growth slows enough that, you know, if economic growth slows enough and we

[00:31:26] actually go into a traditional recession, as a reminder, that's a pretty consistent cure for an

[00:31:32] inflation problem. It's not the way you would want to see inflation come down, but that could bring,

[00:31:37] you know, easing policy back into the mix. And given that smaller companies have more variable rate

[00:31:42] debt, they're more at the mercy of moves in bond yields, that could provide maybe a longer term

[00:31:48] support for small caps. In the meantime, though, I think this churn and rotations under the surface

[00:31:56] and at the sector level, I think is likely to continue to be part of the 2025 story. The one shift we have

[00:32:02] made in what we're suggesting to investors about how to navigate this is a change from thinking in

[00:32:09] level terms to rate of change terms. And what I mean by that is we've been very factor focused,

[00:32:14] a little bit more so than sector focused, meaning telling investors invest based on characteristics,

[00:32:20] look for companies upon metrics like or factors like free cash flow, strength of balance sheet,

[00:32:25] interest coverage, forward earnings estimates, as opposed to picking a sector or two to underweight

[00:32:33] which is a little bit more of a monolithic approach. And performance has been more consistent

[00:32:38] at the factor level than it has at the sector level. Even the best two performing sectors last year,

[00:32:44] vacation services and technology, if you were to look at their rankings of the 11 sectors on a month

[00:32:49] to month basis, both of them were all over the map. Top of the leaderboard, the bottom of the

[00:32:53] leaderboard, back to the top of the leaderboard. They ultimately ended in the top two spots, but man,

[00:32:58] the path along the way was incredibly wild. I think that could persist, but more consistency

[00:33:04] at the factor level. If you were to look at stocks that had high free cash flow, that had high interest

[00:33:09] coverage versus the opposite, that's where you saw more consistency. The one shift, as I mentioned,

[00:33:15] from level the rate of change is last year was a little bit more about strong versus weak in measures

[00:33:20] like cash flow or balance sheet, high versus low in measures like interest coverage. Now I think maybe

[00:33:27] it's more rate of change, whereas there's improvement in free cash flow, where there's improvement,

[00:33:33] where your interest costs go from being very high to starting to move down. So it's subtle,

[00:33:39] but it's often the case that better or worse matters more than good or bad. I think last year was a

[00:33:44] little more of a good versus bad. This year might be a little more of a better versus worse.

[00:33:49] That's really interesting. I'm curious how you think this shows up. You had a couple of different

[00:33:53] charts on the stocks who are hitting their record 52-week highs and just how much that gap in

[00:34:00] performance has been in the last couple of years.

[00:34:02] Yeah. Breath has been also all over the map. We've had periods, particularly when equal weight was doing

[00:34:08] well and small caps were performing better. The breath statistics started to look really good.

[00:34:13] New highs versus new lows, percentage of stocks trading above 50-day moving averages or 200-day

[00:34:19] moving averages. But maybe a little bit more unique way of looking at market breadth is one. It's a table

[00:34:25] that shows up on my X and LinkedIn feeds almost on a daily basis, which is what percentage of the index,

[00:34:34] in this case the S&P 500, has outperformed the index itself. So what percentage of constituents have

[00:34:40] outperformed the index itself over trailing periods, over the trailing one-year period, over the trailing

[00:34:45] six-month period, five months, and down to shorter-term periods. And for calendar year 2024,

[00:34:51] only 19% of the stocks within the S&P outperformed the index itself. The highest reading on a trailing

[00:35:00] basis was the final four months of 2024, where 40% of S&P stocks outperformed the index. But that's still

[00:35:09] obviously sub-50%. And by the way, we're only a week and a half or so into the start of the year.

[00:35:17] But that 19% for the calendar year 2024, if you do trailing one year, that's down to 17%. So

[00:35:25] on that metric, unfortunately, at least at the early start of this year, we're not moving

[00:35:29] in the right direction.

[00:35:30] And how rare is that for it to get that way?

[00:35:34] Well, last year, I don't remember exactly when. I believe, don't quote me on this,

[00:35:39] although this is airing out there, so anybody can quote me on this.

[00:35:43] But I'm telling you-

[00:35:44] Snip this part right here.

[00:35:46] I'm purely guessing based on faint memory, sometime mid-ish year, might've been in May,

[00:35:53] might've been in June, because we track it on a day-to-day basis. That trailing one-year

[00:35:58] percentage dropped down to, it was either 10 or 11%. I think that was the low. And I'm pretty

[00:36:05] sure it was an all-time low based on how far back we can gather that type of data. I can't say for

[00:36:11] sure that it's an all-time low in the history of, you know, back to 1928 and the S&P 500, but

[00:36:17] certainly an historic low. And from there, it has, you know, started to improve, but not to the degree

[00:36:23] that you would say would suggest that, you know, the soldiers have come to the front lines along

[00:36:29] with the generals.

[00:36:31] I just want to go back to just the confidence thing for one second before we get too far. So

[00:36:37] I'm just curious, do you sense that there's pent-up demand for M&A? I'm thinking like capital

[00:36:46] allocation and like, I mean, we've been in like this drought of, it seems like M&A and IPOs. And so

[00:36:53] I'm wondering, you know, from your vantage point, do you, no one knows for sure, but is that like on

[00:36:59] the horizon for us of, you know, possibly seeing this stuff come back?

[00:37:03] I think there's more pent-up demand for M&A than there is for IPO-ing. I think a lot of companies

[00:37:09] have plenty of access to liquidity and capital outside of coming public. And that's been a force

[00:37:17] behind why IPO flows have been weaker. But then there may be a more real world simplistic explanation

[00:37:24] for it, which is a lot of companies say, I don't want the hassles of being a public interest

[00:37:30] companies. You know, even Chuck Schwab himself at times has joked about at times being a little

[00:37:37] envious of Fidelity because they're not a publicly traded stock. So I think those two maybe work

[00:37:44] against some huge surge in IPOs. You know, you had the SPAC boom a few years ago. I think that was

[00:37:51] in conjunction with some of the froth that also found its way into, you know, the meme world.

[00:37:56] I don't expect a big boom in SPACs either. But I think that, I think where there is pent-up demand

[00:38:03] is not just M&A, but just really big, you know, CapEx expenditures. Maybe still on hold because of

[00:38:13] policy uncertainty. But I think that there is, there is brewing animal spirits on that side of

[00:38:19] things. I also think, and it's somewhat related, but it ties into some of these secular changes.

[00:38:25] You know, you go in these long cycles where capital is more powerful than labor. I think we are

[00:38:35] transitioning into a cycle where labor is sort of increasing in terms of power and as a share.

[00:38:45] And this is more of a global comment than it is just a U.S. specific comment. It has a lot to do with

[00:38:51] demographics. Some people, when I say that, they'll say, oh, so you're a big believer in unions and

[00:38:56] everybody's going to unionize and that's going to give more power to labor. That's not what I'm

[00:38:59] talking about. I'm talking about these big secular cycles that have most to do with demographics and

[00:39:05] labor shortages and working age population versus, you know, retired age population.

[00:39:10] Those are forces in play globally that I think is starting to shift to a little bit of a degree,

[00:39:17] that balance between capital slash profits and labor as drivers of the economy.

[00:39:22] And that trickles through the entire economy, back to your point before, of looking at all the

[00:39:26] different subcomponents because there's a demographic subcomponent in story at almost

[00:39:30] each one of these levels.

[00:39:32] Absolutely. And there's a demographic component in labor market statistics, in inflation data,

[00:39:38] in trade-related data. It's very pervasive.

[00:39:44] The details and the nuance of looking inside of the pie. So this one too, market multiples. And I'm

[00:39:50] thinking of market multiples really as a sentiment indicator. We're starting to see the charts blow

[00:39:54] around. You had some specific comments on this. What are market multiples telling us about sentiment

[00:40:00] today at these?

[00:40:02] Well, I've always said, you know, I already made the comment earlier in our conversation about

[00:40:06] sentiment, even though it can be a pretty valuable contrarian indicator at extremes.

[00:40:13] Particularly in optimistic extremes, it can stay there for quite a while. So therefore,

[00:40:20] it's not a great market timing tool by any means, even if as a backdrop at extremes, it might reference

[00:40:26] as a contrarian indicator. Valuation is similar in the sense that it's a terrible short-term market

[00:40:31] timing tool. One of the charts that I had in our 2025 outlook was your classic scattergram. And on

[00:40:39] the horizontal axis, I believe it was the horizontal axis that showed starting point PE ratios, just

[00:40:44] forward PE over time. And then on the vertical axis, it was S&P returns in the subsequent one year.

[00:40:52] And there was no correlation. I mean, the trend line was almost flat. The dots were all over the page,

[00:40:58] which suggests that valuation is almost like a sentiment indicator, or maybe reverse the wording,

[00:41:04] an indicator of sentiment. As we know, we lived it in the late 1990s, valuations can get rich,

[00:41:11] and then ridiculous, and then absurd. But that can last for an extended period of time, and you never

[00:41:16] know what the trigger or the catalyst is going to be. For what we know is the inevitable bear market

[00:41:22] that unfolds when you have a combination of really frothy sentiment and rich multiples. But trying

[00:41:28] to pinpoint the timing associated with that, I think, is a fool's errand and a very difficult task. And it

[00:41:34] works in the same direction, maybe to a slightly narrower timeframe degree, when you get extremes of

[00:41:40] pessimism and you get to extreme lows in valuation. That can also persist, but the persistence tends to be

[00:41:47] a bit more short-lived than what you see at the opposite end when you have frothy sentiment

[00:41:52] sentiment and rich multiples. You also have to go below the surface of, say, just looking at the

[00:41:57] forward PE of the S&P 500, which right now is around 22. And you have to look at equal weight

[00:42:03] versus cap weight, or even cap weighted S&P, but X the top 10, or X the magnificent 7, look at various

[00:42:13] indexes of mid-caps and small-caps and see that there's also a very wide range right now in terms of

[00:42:19] multiples and where there's greater richness and maybe more opportunity.

[00:42:25] Yeah, I love that valuation is an indicator of sentiment flip. And it makes me think about going back to the

[00:42:32] level terms versus rate of change terms. Is this one of the things we're starting to see show up in small-caps

[00:42:37] where you had a great chart, profits have been favoring large-caps, but is this small-cap

[00:42:43] underperformance? Is there actually some value there that might prove out? Maybe not next year, but as we go forward?

[00:42:48] Well, you've got a consensus expectation. I believe it's north of 30% for earnings growth for the Russell

[00:42:56] 2000 in 2025. That compares to 14% right now for consensus for the S&P 500. The near-term rub is that

[00:43:06] there's been more of a descent in the change in consensus for small-cap. So I think that's what

[00:43:14] probably needs to be arrested is stopping that deterioration in estimates, even though in

[00:43:20] snapshot terms and in level terms, you've got higher growth rate for small-caps versus large-caps.

[00:43:26] It's the rate of change. It's the better or worse matters more than good or bad phenomenon. Same thing

[00:43:32] applies even if you're looking within, say, an index like the S&P 500 and that cap weight versus equal

[00:43:38] weight or the earnings growth associated with the mega caps or with the Magnificent 7. Given its

[00:43:45] popularity, I'll use that as a proxy. Also important in looking ahead is that we've got some convergence

[00:43:52] happening where you're seeing declining expectations in the Magnificent 7 in terms of 2025 estimates,

[00:44:00] still north, comfortably north of where the rest of the S&P is, but directionally something worth

[00:44:07] watching because the expectation bar is set so high that there is that opportunity that comes where

[00:44:14] if there's a miss relative to that high bar, even if in level terms, you know, you hear it all the

[00:44:21] time. If a popular company, a tech stock or something, you know, misses, you'll hear people say,

[00:44:27] but what's the big deal? They missed, but they still have, you know, 28% earnings growth.

[00:44:31] But it goes back to that mantra. I've always passed on to people, which is better or worse often

[00:44:39] matters more than good or bad, especially as it relates to things like earnings and what market

[00:44:45] reaction is or economic data and its relationship to market behavior.

[00:44:50] So you had this quote in one of your articles, an old adage on Wall Street about market breast

[00:44:55] is that the market is strongest when the soldiers and not just the generals are at the front lines.

[00:45:00] And then you had a chart in there that showed over one, two, three, four, five, six months in one year,

[00:45:05] the percentage of stocks that were outperforming the S&P.

[00:45:10] So do you just want to talk to that for a second?

[00:45:12] Yeah. So that's what I mentioned that they sub 20% before that has actually gotten worse,

[00:45:18] which is just what percentage of the S&P has outperformed the index.

[00:45:22] It's maybe a less traditional way to look at breadth versus things like percentage of stocks

[00:45:28] trading above 50-day moving averages or 200-day moving averages.

[00:45:31] But it does highlight what is the concentration problem in the market.

[00:45:36] And what I think is maybe most important for individual investors as it relates to this concentration

[00:45:42] is when you have a small subset of stocks outperforming the index and a larger,

[00:45:50] a very small percent that are outperforming the index over, say, a trailing one year period of time,

[00:45:57] when it's just the generals on the front line,

[00:46:01] especially when you've got hype associated with a grouping like the Magnificent Seven,

[00:46:06] it generates some misperception, I think, on the part of individual investors

[00:46:12] that the only way I can do well is to be in those generals.

[00:46:17] And I think that that gets misconstrued.

[00:46:21] I think not having the same weight in an Apple or an NVIDIA or a Tesla as exists in the S&P 500

[00:46:30] is a problem for professional active managers that are tracked against the S&P 500 on a quarterly basis.

[00:46:38] And it's almost like they have no hope unless they absolutely nail the best performing stocks

[00:46:47] and own them in significant size that it offsets the contribution associated with the largest names.

[00:46:54] And I verbally emphasize the word contribution because people, when they hear,

[00:46:59] these are the biggest contributors to S&P returns, a lot of investors think,

[00:47:04] oh, they're the best performers.

[00:47:05] So I just want to be in those stocks because they're the best performers.

[00:47:08] They're not the best performers.

[00:47:10] Their contribution to cap-weighted gains, whether it's the S&P 500 or the NASDAQ,

[00:47:16] doesn't specifically come from their price performance.

[00:47:19] It comes from what you multiply that price performance by, which is their size.

[00:47:24] And I use as an example of this and the message to individual investors just to look at the top 10 best performing stocks in the S&P over the past year.

[00:47:33] Only one of them is in the Magnificent Seven.

[00:47:36] Maybe no surprise it's NVIDIA.

[00:47:38] It's not number one.

[00:47:40] Vistra Energy is number one, which is a utility.

[00:47:43] There's another utility in the top 10.

[00:47:45] There's four industrials in the top 10.

[00:47:47] United Airlines is in the top 10.

[00:47:49] GE Verona is in the top 10.

[00:47:52] Only one of them is in the Magnificent Seven.

[00:47:54] If you go to the NASDAQ and look at the top 10 best performers over the past year, none of them are in the Magnificent Seven.

[00:48:00] None of them are mega cap names.

[00:48:02] None of them are even large cap names.

[00:48:04] None of them are household names.

[00:48:07] I barely heard of any of them.

[00:48:10] So the point is there's other places you can get performance.

[00:48:14] It's trickier in a concentration when you have a concentration problem.

[00:48:19] But the idea that the only way to do well is to take on that same concentration risk, that's conflating the institutional problem with a problem for individual investors that maybe doesn't not exist, but is very different than the perspective of a professional active manager that's trying to beat that cap-weighted benchmark on a quarterly basis.

[00:48:43] That is probably the most Jesse Livermore level unpacking.

[00:48:49] The Reminisces of a Stock Operator, best book on the market ever.

[00:48:54] Hands down.

[00:48:55] Because you just unpacked.

[00:48:56] That's probably the best thing I learned from Marty Zweig.

[00:48:58] He gave me that book the first week I joined the firm in 1986.

[00:49:03] And I have so many copies.

[00:49:05] They're dog-eared.

[00:49:06] And it is the answer to the question I give 100% of the time when people say, what's the best market-related book you've ever read?

[00:49:12] That is it.

[00:49:14] You just explained the institutional attribution problem with talking about performance contribution.

[00:49:22] Yeah.

[00:49:23] Absolutely.

[00:49:23] Perfect.

[00:49:24] Well, I love that because, I mean, for retail investors, it's about are you on track to meet your goals?

[00:49:29] I mean, you don't have to beat the S&P every year or even come close to it.

[00:49:32] It's just like, are you on track?

[00:49:33] Some investors love to do that.

[00:49:35] But what I find is many investors have, maybe artificially or for whatever reason, have the S&P as their benchmark on the upside.

[00:49:43] But how quickly does a positive return become the benchmark on the downside?

[00:49:47] You don't tend to hear a lot of people saying, woo-hoo, I was only down 15% when the S&P was down 22%.

[00:49:53] I nailed it.

[00:49:54] Right.

[00:49:55] You know, I lost 15%.

[00:49:58] The other thing that comes into play, I had such a fascinating conversation.

[00:50:01] It was actually specific to NVIDIA.

[00:50:03] With a client a number of months ago, I was out in the Bay Area, obviously a lot of interest in and ownership of tech and tech-related stocks in that area.

[00:50:12] And I had a gentleman come up to me after Advent, at which I spoke.

[00:50:15] And it was an informal conversation.

[00:50:17] He was very nice, very lovely.

[00:50:19] He wasn't critical.

[00:50:20] But he said, I had a little trouble.

[00:50:22] My financial consultant at Schwab suggested that I trim 10% of my NVIDIA.

[00:50:26] I didn't want to do it.

[00:50:27] I kind of fought him.

[00:50:28] And he just talked about the merits of diversification, taking some profits.

[00:50:32] So I trimmed 5% instead of 10%.

[00:50:34] And then the stock kept going up.

[00:50:36] And I'm really annoyed.

[00:50:37] I said, well, you still own 95% of your position.

[00:50:40] Would you really be happier if the stock cratered because you would have the bragging rights of having trimmed it?

[00:50:50] Like, you should still be happy that the stock is going up, even if you have 5% less.

[00:50:56] Trying to time these things with precision, both on the buying end and the selling end, is just an impossible exercise.

[00:51:02] We shouldn't do it, and we shouldn't let it infect our mindset and our emotions.

[00:51:08] And to his credit, he said, you know what?

[00:51:11] I never really thought of it that way.

[00:51:12] You're absolutely right.

[00:51:14] The experience of it going up sometimes, that's one of the hardest things.

[00:51:18] Because it's not like you're trading the experience of it going up, but the experience of, like, it's great when somebody sells something like that and then goes and buys the second home or, like, pays for the kid to finish school or whatever else.

[00:51:30] That always feels okay.

[00:51:31] Right.

[00:51:31] But when you don't trade a commensurate experience, it feels like hell.

[00:51:35] Very good point.

[00:51:36] Very good point.

[00:51:37] But it shouldn't because the 95% you still own is still doing well.

[00:51:41] Yes.

[00:51:41] Let's circle back to factors just for a second.

[00:51:43] And so the traditional value factor has been a relative underperformer for maybe the last 15 years.

[00:51:51] It had some bouts in there where it's, you know, done great.

[00:51:54] But generally, it's, you know, underperformed many of the other factors.

[00:51:58] Do you have any thoughts or takes on the value factor?

[00:52:02] Well, so you can look at, say, a value factor in a really, really, really broad sense.

[00:52:07] But we look at factors a little bit more granular than that.

[00:52:10] So you can look at a number of factors that might be categorized within that value moniker.

[00:52:17] You know, how stocks are trading on, you know, relative to book or sales, you know, dividend yield, valuation metrics.

[00:52:27] So there's lots of ways or lots of factors that would fall under that umbrella, just like there's lots of individual factors that would fall under a growth umbrella.

[00:52:37] What we've been emphasizing, as opposed to labeling them growth or value, is quality.

[00:52:43] So a quality, a higher quality orientation in terms of factors.

[00:52:48] Now, that sometimes elicits, well, Dullesan, wouldn't you always want to invest in companies that screen well from a quality perspective?

[00:52:57] Well, yes, I get that.

[00:52:58] And more often than not, higher quality companies will do better than lower quality companies.

[00:53:02] But as you know, there are times in the cycle where going down the quality spectrum, you can do really, really well, where there's leverage to that, you know, better or worse, the inflection point.

[00:53:14] And that especially happens when you're coming out of an economic downturn, recession or otherwise.

[00:53:20] Or you go from a severe tightening cycle to an easing cycle and you get that sort of turn and that inflection and leverage to higher interest rate environment to a lower interest rate environment.

[00:53:33] So there are times where you, it is beneficial to sacrifice a little quality to get that, pick up that turn on the upside.

[00:53:44] I don't think that's the scenario we're in right now where we're in anticipation of some big pickup in the economy.

[00:53:52] So I think we want to still stay up in quality.

[00:53:55] But the subtle shift, and I can't remember, this is my fourth kind of time doing this today, both on the host end of the spectrum and the guest end.

[00:54:06] And I did a client event.

[00:54:07] So I'm in that time of day where I think, did I say that to these guys or did I say that two hours ago?

[00:54:15] But one maybe subtle shift, and stop me if I already said it, is, and I touched on it in other ways, I know, in this conversation of the idea of level versus rate of change or good versus bad versus better versus worse.

[00:54:28] I think from a factor perspective, I think what will matter a little bit more this year is that improvement as opposed to just good versus bad.

[00:54:37] But those quality-oriented factors would be things like strength of balance sheet, whether you've got strong free cash flow, high interest coverage.

[00:54:48] You're not at the mercy of changes in interest rates.

[00:54:51] And then you can kind of almost blend some of the growth and value characteristics in looking for reasonable valuation, but stocks that have that ability to grow earnings, that have positive earnings revisions trends.

[00:55:07] It's almost like what we used to call GARP, growth at a reasonable price.

[00:55:12] Call it CORP.

[00:55:13] You can do quality at a reasonable price.

[00:55:15] You can term it.

[00:55:16] CORP.

[00:55:16] I don't know what the U stands for, but we'll eliminate that out of the mix this time.

[00:55:22] But yeah, I think that that is maybe an old-school way of thinking about blending those growth and value factors in addition to those quality-oriented factors.

[00:55:33] We know this is like hour five in podcasting for you, so we'll let you go just in a second.

[00:55:38] But definitely.

[00:55:39] Last of the day.

[00:55:40] I'm in no room.

[00:55:41] Nice.

[00:55:41] So I'm yours until you're tired of me.

[00:55:44] Thank you.

[00:55:46] We've had a lot of guests on the podcast that have talked about this idea that passive investing kind of sort of originates out of some academic work.

[00:55:53] But then Mike Green from Simplify has talked a lot about this, like the role of passive flows and the influence some believe they have on the largest stocks in some of these passive indices.

[00:56:06] So, yeah, what's your opinion on this?

[00:56:08] No.

[00:56:09] It's really hard to argue against that view.

[00:56:13] When you've got the 10 largest stocks in the S&P 500 accounting for 39% of the index, that's by far a record high, well above what we saw even in 1999-2000 period of time.

[00:56:26] And the more flows that come into passive ETFs, whether it's new money coming in from other asset classes or what has been this ongoing shift from traditional mutual funds into the ETF space.

[00:56:39] There's no doubt, of course, that it feeds on itself and that these funds then have to buy more of the structure of the index, which means more money going into those larger names.

[00:56:50] The interesting thing, though, is that the strongest growth within the ETF space in the last couple of years, and I think one that will continue, is actually in active ETFs, not passive ETFs.

[00:57:04] There's still growth in both, but the growth rate in active ETFs.

[00:57:09] So I think we're in the process of seeing a bit more of a level playing field, active versus passive.

[00:57:16] We've got the return of the risk-free rate.

[00:57:18] There is sporadically maybe a bit more connection between prices and fundamentals.

[00:57:27] And we are seeing a slightly rising trend in a percentage of active managers outperforming their benchmarks.

[00:57:33] It's still, the scales are tipped still toward passive over active, but there are some interesting trends that bear watching over the next couple of years as it relates to that active versus passive conversation.

[00:57:46] What do you think Marty would say about that?

[00:57:49] Like, what do you think his read on this would be?

[00:57:51] Yeah, I mean, you know, ETFs existed, but Marty passed away, I think it's been 11 years now.

[00:57:57] So they were nothing back then relative to what they are right now.

[00:58:01] That's a really good question that no one has posed to me.

[00:58:06] So I think he would be fascinated by the sentiment environment and how quickly attitudinal measures of sentiment can shift.

[00:58:16] You know, you see much more big swings in those attitudinal measures like AII or investors' intelligence.

[00:58:22] So I think he would have to maybe lessen their weight in some of his sentiment models in favor of a little more weight given to those behavioral measures, fund flows, the put-call ratio.

[00:58:36] I'd also be really curious whether he would have had any shift in thinking around the notion of don't fight the Fed, because frankly, the market has fought the Fed to some degree and has done so successfully.

[00:58:52] Maybe not specifically in 2022 when we're dealing with the inflation problem, but you certainly had part of the tightening cycle that was met with pretty decent equity returns.

[00:59:02] So I think he, I don't want to go as far as saying he's, you know, rolling around in his grave looking at market structure, but I would be fascinating to see how he would have adjusted his thinking about the market and his models, which he used to keep on that, you know, green, you know, graphing kind of paper for the modern era.

[00:59:25] You know, an interesting tidbit about Marty.

[00:59:28] He was asked once by a reporter, and then because it became a headline, he was asked about it a lot, if he had to throw all of his sentiment indicators in the garbage and only keep one, in terms of if you had to make your market calls based on one sentiment indicator, what would it be?

[00:59:44] And his answer was dueling bull or bear covers of Newsweek and Time.

[00:59:51] Now, that was in an era of Newsweek and Time being paper publications, and there was no such thing as social media.

[00:59:58] So if both of those publications had bulls on their cover in the same week, it was sort of a lookout below and vice versa when there were bears on the cover.

[01:00:07] But clearly, there needs to be more sophisticated thinking around sentiment conditions and indicators in this environment versus, say, the 1970s when he started developing his work.

[01:00:19] So we like to ask all of our guests sort of a standard closing question, and that is, based on your experience in the markets, if you could teach one lesson to your average investor, what would that be?

[01:00:30] Oh, I love that question.

[01:00:32] Can I – well, it's related, but can I answer it kind of with two different answers?

[01:00:37] What kind of things I say all the time?

[01:00:40] I'm often asked, as many strategists are, particularly when there's more weakness in the market or it's a volatile week,

[01:00:47] okay, Lizanne, what are you telling your Schwab investors?

[01:00:50] Are you telling them to get in or get out?

[01:00:52] And I have a love-hate relationship with that question.

[01:00:54] I hate it because I think it's a stupid question, but I love it because I get to explain why I think it's a stupid question.

[01:00:59] And the real gist of it is neither get in nor get out is an investing strategy.

[01:01:02] Not even close.

[01:01:03] It's just gambling on two moments in time.

[01:01:05] And there's no one that has ever been successful doing that over and over again.

[01:01:09] And that ties into the second part of this, which is we think it's what we know that matters, meaning what's going to happen, what's going to happen in the future, what's the market going to do.

[01:01:19] Whether we're trying to do that on our own or trying to figure out which Yahoo on TV or which strategist is going to have the best market call,

[01:01:27] it's not what we know that matters, meaning about the future.

[01:01:30] It's what we do along the way that matters.

[01:01:31] So those are my on the soapbox views that I think should matter to investors.

[01:01:38] But we get in the throes of, I need to know what the future holds and then I can make great investment decisions.

[01:01:44] Well, it's the unknowable.

[01:01:45] So don't invest based on it.

[01:01:47] We're good.

[01:01:48] Thank you so much, Lizanne.

[01:01:49] We really appreciate your time.

[01:01:50] Happy to be here.

[01:01:51] Thank you.

[01:01:51] This is Justin again.

[01:01:52] Thanks so much for tuning into this episode of Excess Returns.

[01:01:55] You can follow Jack on Twitter at Practical Quant and follow me on Twitter at JJ Carboneau.

[01:02:02] If you found this discussion interesting and valuable, please subscribe in either iTunes or on YouTube or leave a review or a comment.

[01:02:10] We appreciate it.