Podcast Summary: The Compound and Friends - "Why Defensive Stocks Have Disappeared"

Episode Information:

• Title: Why Defensive Stocks Have Disappeared
• Host: Downtown Josh Brown
• Guests: Todd Sohn (Strategus Securities), Matt Serminaro (Exhibit A)
• Release Date: June 20, 2025
• Description: Downtown Josh Brown, Michael Batnick, and their guests delve into expert insights and hot takes on the latest in business and investing. This episode explores the diminishing role of defensive stocks in today's market dynamics.

1. Introduction and Guest Presentations

The episode kicks off with Josh Brown introducing the show’s new format featuring two special guests: Todd Sohn, an ETF and technical strategist at Strategus Securities, and Matt Serminaro, co-founder and Chief Product Officer of Exhibit A.

Notable Quotes:

• Josh Brown [01:24]: "We're remote. I would like to just say this is going to be a new format of the show, not permanent. Just because we felt like having some fun..."
• Matt Serminaro [03:10]: "I'll let the charts talk. That's it."

2. Federal Reserve’s Current Stance and Economic Projections

Josh Brown initiates the discussion by analyzing the Federal Reserve's recent statements. He highlights that the Fed maintains its stance on solid economic activity, low unemployment, and somewhat elevated inflation, citing Peter Boockvar’s critique that the Fed appears complacent ("lying on a chaise lounge").

Key Points:

• Economic Projections:
  • GDP Growth: Forecast decreased to 1.4% from 1.7%.
  • Unemployment Rate: Expected to rise to 4.5% from 4.2%.
  • Inflation (PCE): Headline PCE increased to 3% from 2.7%, and core PCE to 3.1% from 2.8%.

Matt Serminaro comments on the Fed’s hesitancy to make definitive moves due to insufficient deterioration in economic data.

Notable Quotes:

• Matt Serminaro [05:29]: "It's hard for them to cut or make a move or telegraph that to the market right now."
• Josh Brown [08:12]: "I think you need to cut the rates. The housing market is literally a disaster."

3. Disappearance of Defensive Stocks

The core of the episode revolves around the decline of defensive stocks' prominence in the market. The hosts explore reasons behind this trend, questioning the traditional categorization and effectiveness of defensive sectors like utilities, healthcare, and consumer staples.

Key Points:

• Market Concentration:

  • The S&P 500’s composition has shifted, with defensive sectors now comprising less than 21% of the index—the lowest in 35 years.
  • Michael Batnick [26:34]: "Know what you own when you're buying an S&P 500... understand that the traditional defensives do not work anymore."

• Sector Performance:

  • Industrials, driven by AI and defense technology, are outperforming traditional defensive sectors.
  • Josh Brown [30:26]: "The whole concept of breaking the market into two pieces... defensive versus cyclical."

• Redefining Defensive Stocks:

  • Modern companies traditionally seen as defensive (e.g., Visa, MasterCard) are now intertwined with growth themes, blurring the lines.
  • Matt Serminaro [32:00]: "Is Netflix a defensive stock? To somebody who says, look, no one's going to cut their Netflix subscriptions..."

Notable Quotes:

• Michael Batnick [27:06]: "Traditional defensives do not work anymore. You have to think differently about playing defense."
• Josh Brown [32:59]: "We don’t really know what's a defensive stock anymore..."

4. Market Cap Concentration and Sector Shifts

The discussion shifts to the concentration of market capitalization within the S&P 500, particularly the diminishing dominance of the "Mag 7" (the top seven large-cap stocks).

Key Points:

• Chart Analysis:

  • Matt Serminaro presents a chart showing that while the S&P 500 is near all-time highs, the Mag 7 have only recovered about 60% of their previous declines.
  • Todd Sohn [33:35]: "Is it bearish or bullish or neither that Apple is relatively weak?"

• Expansion of Market Influence:

  • There's a growing influence from stocks just below the Mag 7, indicating a broadening market.
  • Matt Serminaro [38:05]: "The companies that you're talking about, they're in like that eighth, ninth decile. They've been the sweet spot."

• Implications:

  • The redistribution of market cap suggests diversification and reduced risk from over-reliance on mega-cap stocks.
  • Michael Batnick [41:19]: "The influence is declining, which is not a bad thing."

Notable Quotes:

• Matt Serminaro [33:35]: "This is kind of like a broadening story and also highlights that the Mag 7 has been a drag this year."
• Josh Brown [41:36]: "The market cap is being redistributed. It’s going elsewhere."

5. Proliferation of Leveraged Single Stock ETFs

Michael Batnick introduces the topic of leveraged single stock ETFs, highlighting their rapid growth and the potential risks associated with their existence.

Key Points:

• Growth of Leveraged ETFs:

  • A scatter plot reveals numerous leveraged ETFs tied to volatile, often small-cap stocks.
  • Michael Batnick [43:21]: "Leveraged single stock ETFs are a three-year-old category that’s gone crazy recently."

• Potential Risks:

  • These ETFs can escalate beyond the underlying stock's market cap, posing significant operational risks.
  • Josh Brown [44:16]: "If you read the headline, IonQ's 2x ETF now has more money in it than the company's market cap. You just buy it, ask questions later."

Notable Quotes:

• Matt Serminaro [47:15]: "And there’s no reason to be a publicly traded small cap. Many can raise money in the private market."
• Michael Batnick [46:58]: "The ETF industry has always been a spaghetti cannon. And I'm old enough to remember..."

6. Breadth Signals and Historical Performance

Matt Serminaro presents a chart analyzing the S&P 500's performance one year after 58% of its stocks hit a four-week high. The data indicates a strong historical trend where such breadth signals correlate with positive returns.

Key Points:

• Historical Analysis:

  • Instances where 58% of S&P 500 stocks reached a four-week high typically result in an average 19% return after one year, with no cases of negative returns.
  • Josh Brown [48:09]: "If you genuinely see 58% of stocks making a four-week high, historically, it has never been negative."

• Current Market Situation:

  • As of mid-May, 58% of S&P 500 companies were achieving four-week highs, akin to historical bullish signals.
  • Matt Serminaro [55:25]: "The market is making its recovery from the March low... every stock is up."

Notable Quotes:

• Michael Batnick [51:44]: "If I had to pick one measurement to use all the time... it would be that data."
• Todd Sohn [51:40]: "These are the type of dates that most investors, especially those who went to cash, would never buy."

7. Valuations and Forward PE Ratios

Matt Serminaro discusses the current valuations of S&P 500 stocks compared to their 2021 peaks, demonstrating that even the most expensive stocks are trading at lower forward P/E ratios today.

Key Points:

• Valuation Breakdown:

  • Average forward P/E ratios across all deciles of the S&P 500 are lower today compared to the 2021 peak.
  • Matt Serminaro [20:35]: "Across the board, regardless of forward P/E decile, we are cheaper across the board right now."

• Implications:

  • Relative valuations suggest that stocks may still hold growth potential despite appearing expensive.
  • Josh Brown [21:19]: "I think we're not that overvalued."

Notable Quotes:

• Josh Brown [21:04]: "But that's gotta play a role in why we were paying up for stocks."
• Todd Sohn [21:19]: "We really had it all, didn't we?"

8. Final Thoughts and Market Outlook

In concluding the episode, the hosts share their perspectives on the market's health and future directions.

Key Points:

• Healthier Markets:

  • Despite rotations and sector shifts, the overall market remains healthier than at previous highs.
  • Matt Serminaro [57:54]: "Markets are healthier than they were at the February high."

• Investment Strategies:

  • Emphasis on diversification and exploring beyond mega-cap stocks to capture broader market gains.
  • Josh Brown [42:09]: "There's a lot of money being made elsewhere, not just in the top decile."

Notable Quotes:

• Matt Serminaro [57:54]: "I just wouldn't be bearish. Personally."
• Josh Brown [58:27]: "Thank you so much to Todd Sohn of Strategus and to chart kid Matt Serminaro of Ritholtz wealth slash exhibit A."

9. Conclusion

The episode sheds light on the evolving landscape of the stock market, particularly the reduced significance of traditional defensive stocks amid increasing market concentration and the rise of diversified large-cap influencers. The discussions underscore the importance of adapting investment strategies to align with current market dynamics, emphasizing diversification and caution against over-reliance on mega-cap stocks.

Overall Takeaways:

• Defensive Stocks: Their traditional roles are diminishing, necessitating a reevaluation of what constitutes a defensive investment.
• Market Concentration: A shift away from the Mag 7 suggests opportunities in mid-tier and diversified market segments.
• Valuations: Current P/E ratios indicate potential for growth despite high valuations compared to historical peaks.
• Investment Signals: Breadth indicators remain a reliable signal for future market performance.

This summary encapsulates the key discussions and insights from "The Compound and Friends" episode on the disappearance of defensive stocks, providing a comprehensive overview for those who haven't listened to the episode.