← The Master Investor Podcast with Wilfred Frost
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- [00:00]
A
What was the peak to trough drop recently with the Iran war?
- [00:03]
B
9.1%.
- [00:04]
A
So quite small.
- [00:06]
B
But look, it was rational and so, you know, we sort of look at that 9.1% and that's about what the market should do if you are not putting recession on the table. And as concerned as the geopolitical community has been about this, I do think the market did what it was supposed to do if we're not having a recession or seriously concerned about one. I would say as we have read through company transcripts, we are really hearing a lot about buffers in terms of inventories hedges that are in place. And we're also really hearing a lot from companies about their ability to manage through tough times. And I can't tell you in this last reporting season how many companies I saw referring back to Covid, referring back to tariffs, patting their supply chain teams on the back and saying what a great job they're doing and really projecting a lot of confidence about their ability to manage through. If I just sort of think about a very basic kind of next 12 months S&P 500 pe, that one is sitting on our last update. I think around 23.6 times what we saw back in the fall was it was around 28 times. We are not cheap and we never got cheap. You know, with this 9.1% drawdown we saw around the war, I think the lowest number we recorded was maybe around 22, but it's certainly not back to where it was. So we think there's still a little bit of room to run on that basis.
- [01:27]
A
Welcome to the Master Investor Podcast with me, Wilfred Frost, where we celebrate and learn from the success of the greatest investors, business leaders and politicians in the world, giving you, our listeners, the edge. The Master Investor Podcast is sponsored by Elseg Interactive Brokers, the World Gold Council and BNY Investments. Please do remember the views expressed in this podcast are for general information purposes only. Nothing in the podcast constitutes a financial promotion, investment advice or a personal recommendation. More on that in the show notes. My guest today is Lori Calvacino, one of the most respected and closely followed US Equity strategists, making her name initially in small caps at companies like Credit Suisse and Citi, before broadening her expertise to become head of all US Equity Strategy at RBC Capital Markets, where she has been since 20 2017. Laurie, it is a delight to see you. Welcome to the Master Investor Podcast.
- [02:29]
B
Thanks for having me. It's great to see you again.
- [02:31]
A
Really good to see you again and lots to get to. Been a Fascinating couple of weeks of bits of data to come out to react to. But my first sort of big picture question to you. As an equity strategist, I know RBC and you personally, with your small cap background, you love to pour over every little bit of data that comes out. The earnings, the numbers, but also the call transcripts. When you come up with, we think The S&P 500 is a buy or a sell. Is it just the data, the hard data? Do you have to. How do you gauge as well the kind of less tangible factors like sentiment and just what you're feeling in your gut?
- [03:11]
B
It's a great question and I'll say I've been doing equity strategy for I think like 25, 26 years. I've been doing this since 2000. Not always head of the team, a peon for many of those years, but I've thought a lot about it because I think AN S&P 500 price target, it gets a lot of attention. It's a very tricky exercise. The answer is all of the above. But I would say where I feel like I'm a little bit different is I do try to lead with the data and rely on the data much more than say, some of my other competitors. I think the reason for that is that strategists, like anybody else, can get sucked into the emotions of the moment. Whether you're at the top looking at euphoria, whether you're at the bottom looking at pessimism. I think those numbers, even if you do have to some adjustments, and I'm making one adjustment right now, which we can talk about, but I think the numbers really force you to think through the math. I think that process of taking a minute to stop and think through the math and saying, even if it is different this time, how is it? I think that really grounds you in terms of thinking about forecasts and keeps you from getting too swept up in the emotions.
- [04:15]
A
Just to be clear, when you're talking about the numbers and the math in this regard, it's company earnings first and foremost rather than headline macro data.
- [04:24]
B
I would say if I'm thinking specifically about the price target, I'm always tweaking it. It's always evolving, it's always updating. I've settled on a five pronged approach. We have five different models. One of those is looking at investor sentiment. One of those is a pretty simple cross asset test looking at stocks relative to bonds, just a simple earnings yield gap analysis. We also do a valuation and earnings test where we come up with a projected PE and we put that against a company level earnings outlook. We have a GDP test and we have a Fed test. The Fed test is actually the new one that we added this year. But we're trying really with the different models to think about the potential path of the market from a number of different angles, a number of different perspectives that we think are all relevant.
- [05:10]
A
Well, I want to get into all of that. And the Fed test being new and with a new Fed chair is definitely something to come to. First though, you just recently lifted the S&P 500 target. You have 7900. It's one of the most bullish on the street.
- [05:26]
B
Now, I think there have been some new forecasts that have come up and there was one that just came out that's a bit higher than mine. But I will say we have generally been more on the constructive end of things. Now we also do a 12 month forward price target that's rolling. We update it once a month. Most strategists, I think, are still doing December 31st type numbers. We made a change to move to that new methodology this year and we can get into the reasons for that more. But I do think generally the tone we've had has been a bit more constructive. I've joked recently that I felt a little bit like a lonely bull, also a math nerd, but I have interestingly felt a little bit more pushback than I would have expected. Even before we raised the target. We were at 77.50 before and that was one of the more constructive numbers. Even back in January when it was a December kind of 31st type number. Again, we kind of go back to the math, but we can see it from a GDP perspective. We can see it from a valuation earnings perspective. We can also see it from a sentiment perspective. It has been interesting to me that we've been getting a little bit of that pushback with what we think has been a more constructive tone.
- [06:34]
A
That is very interesting. I guess the other point in my prep for this that kind of struck me knowing that you're one of the most bullish is there's not much upside. Yeah, we're talking what, 10%?
- [06:46]
B
Well, at the time we changed it to 7900, it was like a 7.7% gain from, I think the May 7 close, which is when we priced all the models. And so I was saying in meetings this week this is not a terribly heroic forecast. We've had further appreciation since then and I want to say now it's like a little bit less than 6% appreciation. We have said there's some upside risk to our numbers because we're not taking the exact median. We're taking sort of the second lowest of the models. And again, we can sort of talk about that in more detail but it's interesting. Again, kind of getting the pushback for perhaps people think we're being a little too optimistic when it doesn't feel like a highly optimistic forecast.
- [07:26]
A
So that's interesting. Of those five factors you've outlined five models which gives you the most bullish outcome and which is the most cautious?
- [07:34]
B
Basically our Fed model and our cross asset model are giving us the two most optimistic numbers right now and they're kind of at the time we priced it sort of in the 8300, 8400 range, looking for about 13 to 14% type returns. I'll tell you that cross asset model has actually been the most accurate the last couple of years. The one in the middle is the sentiment model looking at AAII net bulls, that's looking for about a 10.8% gain on a 12 month forward. Bas then our valuation and earnings test, which is what we're syncing up to right now, I think that one came out to 79.29, which we rounded to 7900. And then our GDP test, which is looking at how much stocks tend to gain in basically a 1.1% to 2% GDP range year over year. It's about a 5.7% return, which actually is in line with our old target of 77.50.
- [08:24]
A
I'm really interested is where exactly now? Because since March 30th or March 31st we've ripped higher.
- [08:33]
B
Yeah. So basically what we're seeing on the model, and honestly partially why I didn't go with the median and average this time around, is I do feel like this model might be about to shift into a new zone. But where it is right now, it's basically between average and one standard deviation below the average. If you look at AAII netbulls and we look at the entire history of that data series to sort of gauge the average and the standard deviation levels, but we're basically kind of sitting at neutral type sentiment. We've seen a big rebound from deep bearishness, but not really into euphoric territory. Now we are really, really close to that average. So I have a feeling fairly soon it's going to kind of bump up into another return range. Right now where it's sitting, it's sort of still bearish enough to be signaling a 10.8% return over the next 12 months. It's a contrarian model. You see worse returns when everybody's feeling euphoric and better returns when people are feeling pretty pessimistic. It's kind of made this round trip. It had gotten down between minus 1 and minus 2 standard deviations below the average. The worst week in March, I think it was around -21.9% in favor of the Bears. Now that's not in line with what we saw with tariffs. That's not in line with what we saw in the great financial crisis. I think Even back in 2022 we were getting down to like minus 40% or worse. Right. So this wasn't everybody's just running for the hills putting their money under the mattress. But it was a deeply kind of bearish number.
- [10:04]
A
Is a similar kind of percentage score to the upside when you'd start to then get much more cautious.
- [10:11]
B
When we went back in terms of those lows, it was actually sending a 15% a positive signal going forward. It never actually turns negative when you're on the upside, when everybody's kind of euphoric on the other side. But you do tend to see flattish returns, more depressed returns. When you get up to that 2 standard deviation above the long term average type number, you know you're in store for some shorter term, pretty severe type pullback. We haven't had a lot of those. But it does tell you to gear up and look for flattish returns over
- [10:43]
A
the next 12 months when we dive in more specifically to the company's numbers. Obviously had quite a lot of the earnings for Q1, including most recently the big tech names, some still to come. What's your assessment there of how much earnings are rising?
- [11:00]
B
It's really interesting. We talk about earnings, the fast lane and the slow lane. The fast lane is AI related and the slow lane we think is going to be everything else. And that's something we tried to sort of put in this latest forecast when we were thinking about the earnings outlook. I have one chart in my marketing deck and I've been seeing clients this week and this is one of the go tos we have. But we basically look at the 2026 consensus numbers and there's a little grid and we basically show which sectors have above S and P level growth rates expected for the full year. And also where have they been rising since the beginning of reporting season? It's energy, materials and tech. So it's your inflation sensitive commodity sectors and then the tech sector which is really a function of the AI trade. Everything else you're seeing below kind of S and P type levels of growth rates. Most things have been flat. You haven't seen too much movement on the 2026 numbers. Comm services is one exception to that. It's still a little bit below the S and P, but has moved up a little bit. But generally it's sort of these AI inflation stories versus everything else. And you're just seeing tremendous excitement on quadrant of this grid and everything else just looks really sleepy.
- [12:14]
A
So do you think people are missing the scale for the AI fast lane companies? At least people are missing the scale of those upgrades.
- [12:22]
B
I think that what's happening is, and I spend a lot of my time talking to investors, especially on the long only side stock pickers. I think the stock picking community is pretty aware of what's happening. They may not have the exact right contours. These charts that we're showing people are pretty revealing but it kind of fits with what they're hearing when they're reading through earnings calls, looking through the companies they own. I'm finding when I'm talking to more kind of top down macro folks, what I think they're doing is listening to, you know, sort of the geopolitical community and all the concerns that are coming out of the Middle east and even frankly, you know, just the idea that things have been broken are going to take a while to be fixed. Right. That we're going to be dealing with some longer term ramifications in energy and commodity markets. I think what's happening is that people who don't understand the bottom up composition of S and P earnings that well are looking at all that commentary about the Middle east and saying, well, this has got to take the earnings numbers in the US and it's not that they're wrong, it's just that for this AI part of the market, it doesn't really impact it all that much, if at all. And the other part of the market we are baking in some downward revisions to consensus numbers there. But I would say as we have read through company transcripts, we are really hearing a lot about buffers in terms of inventories, hedges that are in place. And we're also really hearing a lot from companies about their ability to manage through tough times. I can't tell you in this last reporting season how many companies I saw referring to, referring back to Covid, referring back to tariffs, patting their supply chain teams on the back and saying what a great job they're doing and really projecting a lot of confidence about their ability to manage through that does not mean those buffers are going to last forever. It does not mean that damage in terms of things like higher freight costs or difficulty finding certain commodities doesn't mean it's not going to pinch at some point. But I do think generally we've got some insulation on 2026 earnings even in that impacted cohort where the risks are probably lying are more in 2027 when some of those buffers run out.
- [14:19]
A
It's really interesting. I think big corporate America has learned some of the supply chain lessons from COVID and Russia, Ukraine. I'm not sure actually that's the case for a lot of Europe, which is going to be interesting how things play out in the next few months as these straight up hormuz pressures hits or not. This episode is sponsored by Interactive Brokers. Building wealth starts with the right broker and Interactive Brokers helps you reach your goals with powerful tools, global market access, low costs and unmatched financial strength. That's why the best informed investors choose IBKR. Learn more@ibkr.com MasterInvestor. This episode is brought to you by Elseg, the leading global financial markets infrastructure data and analytics provider. To learn more about how ELSEG connects businesses, investors and markets worldwide, visit lseg.com. I want to come back to the 2027 pressures in a second. Just first though, those sectors that you like that are part of the AI fast lane, tech, energy, materials, what are we looking at at the headline valuation multiples?
- [15:41]
B
When we go through and we look at the different multiples on the sectors, we tend to do equal weighted analysis when we're looking at those, as opposed to market cap weighted analysis because yes, things are market cap weighted in terms of performance, but if you try to run valuation multiples, every sector's got some big chunky company that's going to throw off all your data. What we're seeing, if we look at technology and we are actually neutral on that, we tend to think about these things from an equal weighted perspective. The semis look very expensive. They have fantastic earnings revision trends that are sitting up around past peaks. If I look at software, we've all obviously got very cheap valuations. The earnings revisions are actually hanging in. Overall with tech, I'm seeing a very, very strong earnings revision profile, but I'm seeing slightly expensive valuations because of semis just really pushing all of that up. I would say as I look to something like materials, which were actually overweight, we see more valuation appeal in that sector, we see less valuation pressure. Earnings Revisions have been challenged in certain areas like chemicals, but we are seeing a lot of strength in things like metals and mining. Energy is one, I'll tell you. We've talked about this one a lot this week, which is surprising in Europe, but energy is a sector that we're neutral. We tend to not like to chase geopolitical headlines with that sector, which does feel like it drives a lot of the price action. What I've been highlighting to people is that it is a very reasonably valued sector, even though it has been a very strong outperformer throughout this first part of the year. I know it's post ceasefire, it hasn't done as well, but the valuations never got expensive. It's still a slightly attractive sector on a valuation basis. You've got really nice earnings revision trends. You've got very reasonable valuations throughout the two major groups within it. We like to see that breadth when we look at a group. This is one that we feel like investors have ignored for a very long time and they're actually interested in talking about it again.
- [17:43]
A
Obviously those are the attractive sectors. What about the S&P 500 overall on your numbers? What multiple are we talking about and where does that sit in the historic range?
- [17:51]
B
It's going to depend on which model we're looking at. I always describe myself as a math nerd, so we have a few different versions. If I'm just.
- [17:59]
A
Nerds are very welcome on this podcast. Celebrate Good.
- [18:03]
B
I mean this is definitely one business where the nerds are celebrated a little bit more than we were in say high school or elementary school. But no, I think if I just sort of think about a very basic kind of next 12 months s and P500PE. This is one of the charts we have in our deck and I think it's been a useful one for navigating the last, I would say six to nine months. That one is sitting on our last update, I think around 23.6 times now. It's a bottom up calculation. It's market cap weighted. We write some rules to kick out crazy nonsensical multiples, loss makers, that kind of thing. I'm an old small cap strategist so we really do clean up the data a bit. What we saw back in the fall was it was around 28 times. 28 times was in line with the highs around Covid. That was really when all the angst around. I called it the AI jitters that morphed into AI fears. We saw private credit really emerge as something investors were quite worried about. But we were basically sitting at peak value valuations last August. We are not cheap and we never got cheap. With this 9.1% drawdown we saw around the war, I think the lowest number we recorded was maybe around 22. Maybe it got a little bit lower, actually, I think around 21. So it did come back down a bit, but it's rebounded. It's not cheap, it's not as reasonable as it was, but it's certainly not back to where it was. So we think there's still a little bit of room to run on that basis.
- [19:26]
A
But it's so interesting that, because for someone that has one of the most bullish numbers on the street, to come back to that, if we're at 23ish times and the really strict October high was 27, 28 times, it's showing why your price target's only upside of 5, 6%. You're playing quite a lot of risk against the reward proposition at the moment.
- [19:49]
B
You're threading a needle a little bit. We have a different model that we use in our price target calculation. Unfortunately for your listeners. Going to have to nerd out a little bit more.
- [19:58]
A
No, no, no. They'll welcome.
- [20:00]
B
And I'll tell you, I built this model in the summer of 2022 when I was still working from home. And I think I spent that summer sort of researching macro variables that drive PE multiples. If you can imagine Lori sitting down in her basement away from the children and all that kind of thing, just literally falling down a rabbit hole trying to solve the PE puzzle, that was me. But basically we came up with this model and we use an average trailing S&P 500 time series that we have that goes all the way back to the this particular model we started in the 60s because that's when our 10 year treasury yield data started. But I basically did all this back testing and figured out that if you look at 10 year yields, Fed funds effective rate up until when they announced things and then announced data point thereafter and then inflation. And you could pick PCE or cpi. We're using CPI right now. Basically take inflation, take the Fed, take interest rates. We built a little regression model that does a very good job of predicting where the PE should be based on whatever inputs you put in for those different variables. So we've looked ahead to 1Q27 and said, okay, let's put in 3.3% CPI. That's in line with the stress test my economist did around oil that stays above $100 for an extended period of time we kept the Fed flat, so we're not going to get any cuts in our assumptions. And we took 10 year treasury yields up to 4.5% which we didn't expect to already be close to that right now. We might need to stress that a little more in the future, but this was basically sort of our stress test for higher inflation because of the situation in Iran. And so that produced a trailing pe of about 24.11 and that is actually so projected for 1Q27 and that is actually down a bit from the highs that we've been seeing on that particular time series, which has been consistently up around 2728. So that's giving us maybe a little bit of a higher PE than most people would assume. It's trailing, it's not forward, it's based on all this data going back to the 60s. So remember, we're baking in less from an extremely higher inflation environment, an extremely higher interest rate environment, but it's giving us this PE that's getting knocked down a couple pegs and then we're marrying that up with some earnings assumptions and that's how we get our 7900.
- [22:18]
A
I know you don't have the model open in front of you, but if we did have a 10 year that was not going to go to 5% probably, but was more like 4.7, not the 4 0.4.45 we're at now and or a 25 basis point rate hike, would that collapse the PE multiple you'd expect? And I ask in light of because the PPI data that we've just had obviously coming in quite hot on the inflation front and we're all waiting to see the extent to which the war does push up these things.
- [22:49]
B
So I've got my deck with me. I don't usually use props, but I'm getting a little too old to remember quite all these numbers, but we did actually we call it higher oil scenario number three. Everything I just gave you was higher oil scenario number one. I'm not very creative with my titles but in the scenario number three I took inflation from 3.3 to 3.8, I added in two hikes and then I took 10 year yields from 4.5% up to 5% and that took my multiple down from 2411 down to 2271 on the same earnings number which is 329. We can talk more about how we get to that 329, but it took the fair value estimate for the S and P from 7,929 down to 7,468.
- [23:32]
A
It's not much of an adjustment.
- [23:33]
B
It's not huge. Now if I also worsen earnings. And so the 329 I just gave you was a 5% haircut to earnings. So just take the consensus. So just taking the consensus down by 5%, let's say I just cut earnings by 5%. Right? Just take them actually down on a year over year basis by 5%.63.26 on that higher oil scenario number three. So you know we can work through these numbers. And I know 6300 doesn't sound so good but I do think there is comfort in working through the numbers and understanding if things really do get bad, where could we go? I like having that information ahead of time for sure.
- [24:16]
A
And I guess that brings on to another topic which is the extent to which, you know, you might have the AI fast lane chain companies but we might see a significant fall off in demand if the economy really weakens. And I guess your base case and RBC's base case is that that doesn't happen enough to lower those earnings forecasts.
- [24:36]
B
Right. And I would say I leave all the economic forecasting to Francis Donald, Mike Reed and kind of our U.S. and Canadian economics team. But they said something, I think it was on the CPI report, not the PPI report, but they said something in their recap that basically as long as consumers have jobs, they will continue to spend. Right? The composition of the spend, we will change. We have gotten an earful from consumer companies, right, about value consciousness. Fewer items in the basket, less snacking. That's always one of my favorites. We know consumers respond. But I will say as I go through the company transcript, I really try to focus more on the earnings data as opposed to the economic data. But what I'm seeing from companies, again going back to this, we can manage through for a bit longer. That confident tone coming from companies tells me my economists are probably right on the labor market backdrop because they're not anticipating big job losses. And in fact we just had a pretty good April NFP report that followed a good one in March. So you know, we are keeping a close eye on that. We've said we're going to keep a close eye on C suite surveys. I always like the Duke CFO survey which comes out right before reporting season to see, you know, if we do have that drop off in corporate tone. But I will tell you we ran some charts on this last reporting season through the end of April where We looked at at mentions of different keywords and sort of smart matches and geopolitics is obviously climbing. It's just permanently elevated. Post Covid layoff references are very, very low. There's no discernible uptick in the chart. We know that in the challenger data you're seeing more tech layoffs. We're not really seeing that translate into that broader challenger set into anything we're really worried about in terms of broader layoff. We know the tech layoffs are getting a lot of headlines, but they do seem to be limited there for now.
- [26:24]
A
Hi guys, it's Wilf. I hope you're enjoying this episode. Just a quick reminder to please hit follow or subscribe on your podcast or video app so that you never miss an episode. And if you've got time, please do give us a five star rating and leave us a comment. It really helps other people find the podcast too. Now back to the episode. So with all of that kind of fairly constructive sort of commentary, or at least not too worried about some of the challenges, bring me back to why you said earlier that the earnings looks good for this calendar year, but you might start to worry about it for 2027.
- [27:00]
B
So it's interesting. I went back and again it kind of goes back to some of these comments in the transcripts of I'm reading and companies are not all being super transparent. We read through a lot of stuff. I'm an old small cap strategist. I read through a bunch of off cycle smid companies in, you know, just you're trying to pick up these breadcrumbs and we were seeing some of this, you know, from the S and P companies as well in this last reporting season. But again, references to we've got a quarter or two of whatever, you know, commodity we need. Saw one healthcare company say we have a year's worth of poly. You know, there was one company that has, you know, a year's worth of helium in a cavern down south. So and we saw one of the big consumer goods companies. They didn't really tell people what hedges they had in place right now, but they said that gives us some visibility and generally we hedge for six to 12 months. We have an idea that these buffers are in place for a couple of quarters maybe to some extent through the end of the year. I went back and I looked at 2022, 2023, around the Russia, Ukraine war. And then I also looked back at 2018, 2019, which was the first tariff issue. I remembered this probably more just in my gut from 2018 because I remembered that 2019 was sort of the problem on earnings, not 2018. So I went back and looked at the data and if you look at consensus forecast just on a bottom up basis for The S&P 500, 2018 was basically fine. And there was never really a blip on the numbers. But if you looked at 2019 numbers, they were sort of steadily coming down. And we saw something similar in 2022. If you looked at the full year 2022 numbers in the back half of that year, you saw them step down just a little bit, like knock off a percentage point or two. But 2023, we saw more steady declines. Neither one of those is a perfect analogy, but synced up for me with the idea that companies have protections in place. We've always known that companies are pretty good by the time you get to June of managing to the end of the year, we feel like companies are pretty good at managing through in the short term. If those buffers start to run out next year, some of these pressures from the Middle east are still in place. And you just go back and look at the history. New hedges have to be put on, but you're in a higher oil price environment, you're not going to be able to get the same level of hedging that you got before. If you're replenishing your inventories, you're going to have to do it at a higher level, so your costs are all going to go up. It's not that we think 2027 necessarily has to be a disaster, but we think that's probably where the pressures are more likely to, to come.
- [29:36]
A
And so just obviously a lot of that relates on the Iran war issue. With Trump and Xi meeting in Beijing, I wonder the extent to which that is still a swing factor or whether that was a swing factor a year ago, but the tariffs haven't ended up being as kind of punishing as they might have been. And thus, if there's a bit of good news there, it's less incremental than otherwise. What's your snapshot there?
- [30:03]
B
Well, we were trying in this last reporting season to kind of keep an eye out for any other sort of hidden buffers. I don't want to say, you know, companies were hiding things, but this is why you do read a lot, right, and try to see what a few people are saying, not just what everybody's saying. And, you know, we saw one company got asked a question about the IEEPA tariffs being struck down and they were like, well, yeah, this is going to be a benefit to us, but we're not baking that into anything because it's going to get eaten up by higher gas prices. So, you know, we've, I'll put the refund discussion aside because I think that one's more complicated. But, but we do get a sense that maybe there's a little bit of benefit from just the IPA tariffs coming off. We already knew from companies and my economists had made this argument as well that you were gonna see peak tariff impact in the first half of this year. So some of the pressures felt like they were coming off in the back half anyway. The other thing we noticed, and this isn't directly related to tariffs, but we saw a bunch of companies talking about FX tailwinds. And so, you know, these little things in the background, you know, we think have the potential to also give you a little bit of buffer in the next few quarter. And I think it's possible tariffs could show up in that. It's not going to be true for every company. Some companies in industry still have to deal with the sectoral tariffs. Didn't really see as much relief, but that's something we're watching for. I would say we found a few hints of it. I wouldn't say overwhelming evidence.
- [31:30]
A
This episode of the Master Investor Podcast with Wilfred Frost is sponsored by BNY Investments, a trusted partner for many delivering financial solutions to investors and institutions worldwide. This sponsorship does not constitute financial advice. This episode is sponsored by the World Gold Council, the global experts on gold. They champion gold as a trusted strategic asset provided market leading research to help investors understand gold's role and modernize how gold is owned, traded and used. Developing industry status standards and market infrastructure. Learn more@goldhub.com. I want to talk about the midterms and the politics. I mean, we're seeing in this last week here in the UK how politics can negatively impact markets with the midterms. I'd say that the kind of gist of the consensus that I hear is it should be good as we approach the midterms, just purely from, from the simple kind of belief that President Trump will wanna make sure there's a positive wind going into the vote. Is that your kind of take on it or what does the history tell when you analyze what midterms actually mean?
- [32:44]
B
So it's interesting, midterms came up a lot in the year ahead outlook discussions well before Greenland or Iran or anything like that was on the scene and it was sort of seen. If I think back to kind of my December meetings, I was over in Europe back then as well. I was also up in Canada in early January. But midterms were cited as a risk factor. And so we had a reasonably constructive view on the year. We found most even European and UK based investors had a constructive view on the year. But when we would sort of kick the tires on what could go wrong, the midterms always came up in discussion. And the history is not on the side of the market. You even saw in 2018, 2022, those were Trump and Biden's midterm years. We had pretty tough years in equities. And if you go back over stretches of time, that is the worst average return you're going to see in the presidential cycle. If you think about this time around, what we saw back in December is that a lot of the hedge funds in the US had looked at the off cycle November elections where the Republicans hadn't done so well. The Democrats had some surprise successes. And I actually found that the hedge fund community was looking at that and saying, well, this is just going to make the case for incremental stimulus next year ahead of the midterm. So that's good for the economy, that's good for the stock market. We think that's really died down now. Not really hearing indications that we should be counting on something coming out of Washington. What I do think is more interesting is if you look at that 9% drop we had in March and I'm not totally sure how much this had to do with the 9% drop, but we had seen, if you look at betting markets, we're baking on a Democratic sweep. What we've seen as we've kind of de escalated the war, we've gotten the ceasefire, you've seen betting markets reverse course a bit. So the Democratic sweep scenario is coming down and the Republican sweep scenario is moving up. And this has just happened over like the last two weeks. And I bring this up because I mentioned this to my rate strategist before I left on this trip and he wasn't aware of it. I've talked to a few different clients who hadn't noticed that this was starting the shift in the data. It was before even these redistricting battles started to shift back in Republicans favor. So I have one standard, this recovery in the market and everybody's scratching their head trying to figure out how is it still going. Is renewed optimism about the Republican sweep, which investors tend to view as more business friendly. Is that fueling some of this recent momentum? I think it might be.
- [35:08]
A
People expect them now to hold Both
- [35:11]
B
houses, if you look at the betting markets, and I believe this is polymarket specifically, but Republican sweep is not the dominant outcome. It's still the Democratic sweep, but you're seeing the Democratic sweep come down and the Republican sweep move up. And we all know that markets often react to subtle changes and pivots and inflections and when things are starting to shift in a different direction.
- [35:33]
A
Really interesting. I need to check exactly what those latest numbers are. Let's talk then a little bit about the Fed. Just quickly, you mentioned your base case now is not for a rate cut. New Fed chair brings a lot of other questions with it. Do you think that the next year will be looser policy than otherwise? Is it going to support the market? Does it risk the market if it's too loose?
- [36:02]
B
The view of our rates team, they've not been looking for either cuts or hikes in the next year. My rate strategist and I, Blake Gwynn, we actually did our own podcast last week and we were talking about this issue a little bit. I would say cuts matter to me. It helps boost your equity multiple. But again, I'm an old small cap strategist and we've really seen since 20, if broader financial community is baking in cuts, it tends to goose the small cap trade. In the short term, perhaps I like small caps right now, but the Fed is definitely an argument against my constructive view. If we're taking out that potential tailwind, that little bit of foot on the accelerator that gets the trade going, that's a challenge for that space, I think. Generally, though, what was probably the most interesting part of my conversation with Blake was that that if we sort of change the communication around what the Fed ends up doing, if there's less forward guidance, if investors feel like they might have a little bit less of a handle on what's going to happen going into any given meeting. If you do get something happening, does that just create more short term reactions in the market? Does the market have less of an ability to price things ahead of time? That just feels like it could add to volatility in my world. I don't think that's necessarily good or bad, but just different. Something we might need to get ready for.
- [37:19]
A
So let's talk a little bit about your positioning calls. Why don't we start with one you just alluded to, but you like small caps, but you prefer still the really big caps.
- [37:31]
B
Yeah, I think in strategists we're always supposed to say I like this over this, I like that over that. I think this is just the year of Lori doing things a little bit differently. The reality is, I think if you look at the earnings growth dynamics and we look through this with the lens of net income growth forecasts, but if you look at a broader basket of AI stocks to show superior growth to the S and p, to the Mag 7 and to small caps in 2026 and you're actually expected to see kind of that earnings dominance accelerate in 26 versus 25. Right. And I think you have this broadening out of the AI trade from an earnings perspective that's fueling a broadening out of the AI trade from a performance perspective and keeping people excited on large cap growth. AI maybe different names than before, but kind of keeping the focus there. Now if I look at that same data set on the Russell 2000, small cap essentially has been in an earnings recession and it's coming out. When you come out of a negative period of earnings growth, you have a faster ramp, you have generally pretty good numbers. Small caps are seeing that, but they're not really expected to overtake that AI basket until 2027. Depending on your time horizon. If you're reacting to the here and now, and we all know things feel a little uncertain, so maybe, maybe when time horizons compress a bit, that AI trade, that big cap growth trade feels better from an earnings perspective. If you're willing to take on a little more risk and look farther out, small caps look like the tastier part of the earnings growth story. Now I have done small cap a long time and I will tell you, multi asset investors, private banks, they tend to not think that there's a whole lot of worth to small cap earnings forecasts, that they're kind of lower quality in nature. It's a little bit more of a show me story. We may have to get closer to that time period for smaller small caps to prove themselves. But in the meantime, I would say valuations are tricky in small cap. They're moving up, you're around 17 times. The most recent peak was 18. So maybe not a ton of room to move from a valuation perspective. But ISM manufacturing is an expansionary territory. That's typically a good signal for small. We've had a couple good NFP reports. Accelerating jobs growth is usually good for small and positioning. If you look at the CFTC data, data is showing you pretty sizable net short still in small cap. It's not a perfect story by any stretch, but there's some good stuff coming on the earnings front and there are a few other tailwinds it's got at the moment.
- [39:52]
A
It's interesting that when you dwell on 1718 times for the cheaper small caps versus the 23 times for S&P 500 overall, yet you continue to think that there's not enough of a valuation gap to international to recommend international and the US is where it.
- [40:10]
B
Well, if you think about us, non us. So we've started doing some work this year on the MSCI world indexes. That's kind of the cohort that we're living in. It's interesting if you look at US non US or US Europe over the past 20 years, it generally syncs up with growth versus value in the US as I think back to all the times I've come to London, Paris, Milan and talked to international investors, they usually want to about talk about tech stocks and they usually want to talk about the growth trade and health care and consumers and those sorts of things. Very rarely do they want to talk about financials and I would say energy. This trip may be an exception, but I think generally we see international investors wanting to go to the US for growth opportunities. So it makes sense that those two things sync up. If I look at the relative valuations, I think what was really, really interesting was that coming in in to the Iran war, If you use February 27th as your starting point, what we were seeing was PE multiples coming down in the US whether I'm looking at S&P, MSCI US and they were kind of rerating higher in Canada, in Europe, Australia, we were seeing those PE multiples move up so completely different directions. And by the time we got to the Iran war, we have this one chart looking at US versus non US on just a forward PE data point and it had basically come back down to the 20 year average. And if you looked at the five year average, we had come in well below it to kind of the post Covid lows. So we thought a valuation door had actually opened for the US at a time when the fundamental narrative favored the US because basically of insulation from these pressures coming out of the Middle East. And we're watching that and on the five year chart, which I think is probably the best one to watch right now, now we've moved back to average. We don't look expensive yet. We are above average on that 20 year chart, but we're not back to the past peak. So again this is something we're watching closely but we still see some room for the US to run right now.
- [42:11]
A
And you mentioned growth and value there. What's your kind of favorite There
- [42:17]
B
we would be selective within value. So we do like things like financials. We talked earlier about how energy tactically looks interesting on the PE basis. If I think about top down growth value from more of a market cap weighted perspective, growth is where the earnings growth is. The cohort of growth that has the superior earnings growth story has evolved a bit, has broadened out a little bit. I think that when you have one part of the market that's likely to be challenged from an earnings growth perspective or maybe has to cool off its expectations a little bit, at a minimum come under pressure on the worst, I think the market is going to chase the thing with the safer superior earnings growth growth story. Our view on growth value has been a little more tactical, I would say than most of my competitors. The last two years all the strategists came in and said buy value. This is the year of broadening. We came into this year saying we're leaning into value, we're leaning into broadening for now. But unless the value x big cap tech part of the market really can display earnings growth leadership in a sustainable way, growth is going to fight back. And that's exactly what happened. Same thing that happened last year after the tariffs. You had sort of a summer of big cap growth outperforming.
- [43:31]
A
As we start to wrap up, I want to get your long term advice in a second. But the kind of final market space question I had, which is not really data driven, so you'll forgive me for it, but is with these big tech IPOs that are going to come, whether it's the SpaceXs of this world or some AI or quantum name, obviously that will attract some capital, which is one factor. Do you worry that it's also a sort of step back and mark the top type moment to come? I mean, particularly when you start to hear the factors that they're going to get into the S&P 500 much quicker potentially than has been the case in the past, there's just a couple of at least amber flags waving, even if it's not red flags.
- [44:16]
B
I think that generally what we're going to have to do is just take it one day at a time time and we're going to have to see what valuation levels look like. We do know on, you know, sort of, you know, some of these topics that people are thinking about them. But I would say, you know, cohesive thoughts haven't really emerged in my conversations. But I think, honestly I think you just keep an eye on the things you always look at. Are you seeing Froth on valuations, are you seeing, you know, sort of froth on things like earnings revision trends? Where's sentiment? I think you just, I think you just stick with your playbook, to be honest. Honest.
- [44:46]
A
As we wrap up Laurie, we ask everyone that comes on for their overriding investment advice for our listeners. What is yours?
- [44:55]
B
I would say for me, and maybe my mom inspires this a little bit, but I find myself saying this to investors as well. But I do think you really want to stay focused on the long term. That's part of why we changed our target methodology from a year end bogey to a 12 month view. I think, I think we know what recession pricing in the S&P 500 looks like. We know what recession near misses look like. We know that markets do see a lot of 5 to 10% drawdowns and those are normal and they don't feel fun while they're happening. But we do know these things usually end up being buying opportunities. You know, I'll give you one stat around Covid because we have had Covid creep back into the conversation recently. And if you look at that, you know, kind of peak to traffic trough decline in early 2020, it was obviously an unbelievably scary time. We were confronted with this issue for civilization, this massive health crisis, something we hadn't seen before. It was a classic recession drop in the market. We were down about 34% peak to trough. That is right in line with the average since the 1940s. And I think the other thing, the piece of advice I would give people right now, just the environment we're in, is take a deeper, take a deep breath, take it one day at a time. Sometimes we do have to see how things unfold as opposed to just assuming the worst case scenario is going to come to fruition.
- [46:17]
A
It's great advice. I absolutely love it. It prompts one more question in my mind. What was the peak to trough drop recently with the Iran war?
- [46:24]
B
9.1%.
- [46:25]
A
So quite small.
- [46:27]
B
But look, it was rational. And again, I'm going to take you down one more rabbit hole before we sign off. But we have this tears of fear framework that we put together last year during tariffs. I had a hedge fund and a financial advisor ask me the same question within the course of a week before, most people had gotten worried, frankly and you know, was just sort of how should we think about drawdowns? And these were, you know, two sets of people who were starting to get worried. And we said, well, tier one, garden variety pull back 5 to 10% we have plenty of those. If you look post GFC, we have what we call tier two drawdowns, which are 14 to 20% and that is when the market fears a recession that doesn't happen happen. So those were 2010, 2011, 2015, 16, 2018, and then 2025. 18.9% for 2025. And recessions, your median and average drawdown is, you know, I think it's like 27 and 33%. If you go back to the 40s, we don't talk about Tier 4. Tier 4, great financial crisis, tech bubble, you basically lose half your market value. And so we sort of look at that 9.1% and that's about what the market should do if you are not putting recession on the table. And as concerned as the geopolitical community has been about this, I will tell you that in the U.S. as I think back of my marketing, my client meeting since the beginning of March, I can count on one hand the number of clients who were seriously concerned about recession. Now, I've talked to plenty of people who are wary that we're not baking in enough damage. I've talked to plenty of people who are confused about the objectives of the war and how we're going to get out of it and what things look like going forward. But even, you know, and I've talked to plenty of people when the market was starting to make new all time highs that were like, I don't understand this. I walked them through all the US versus non US type analysis. And so I think there's been plenty of confusion, wariness. I don't think there's been complacency, but I do think the market did what it was supposed to do. If we're not having a recession or seriously concerned concerned about one, well, let's
- [48:31]
A
hope the market is right on that regard and that one doesn't materialize. And certainly the US is better positioned for that than much of Europe. Laurie, it has been an absolute pleasure to catch up. Thank you so much for stopping by on the Master Investor Podcast.
- [48:43]
B
Thanks for having me. This was a lot of fun.
- [48:45]
A
It certainly was. That was Laurie Calvacena of RBC Capital Markets. Coming up next time on the Master Investor Podcast, we'll be speaking to Jan Van Eck, of course, the E. ETF King. So make sure to hit, follow or subscribe to get that episode if you haven't done so already. And for now, our thanks again to Laurie.
- [49:04]
B
All right, see you soon.
- [49:06]
A
The Master Investor Podcast is sponsored by Elseg Interactive Brokers. The World Gold Council and BNY Investments. Please do remember the views expressed in this podcast are for general information purposes of only. Nothing in the podcast constitutes a financial promotion, investment advice, or a personal recommendation. More on that in the show. Notes this podcast is produced by Paradine Productions and Master Investor, Ltd. In association with Birdline Media. If you've enjoyed the show, please do subscribe on YouTube or click follow on your podcast platform and you'll be automatically notified each time a new episode drops.