Transcript:
CAROLINE WOODS:
Joining us now is Thomas Carroll, Vice President, Portfolio Strategy at Stifel Thomas. Great to have you at the desk.
THOMAS CAROLL:
Thank you for having me on.
CAROLINE WOODS:
Thanks so much for being here. All right. You’ve been making the case that mega cap concentration is extreme. That rotation out of eye winners is likely. We are seeing that play out today. Is this the start of it or is this just the pause and a still powerful trend?
THOMAS CAROLL:
Yeah, I think, you know, we had noticed that markets were at 40 year highs of concentration, where ten stocks made up nearly 50% of the S&P 500market cap. And so we thought this overall rally, which had been very strong was very narrow. And so we were expecting a broadening trade. However broadening sounds good. But we looked at the for the past five years, broadening actually led to index consolidation.
THOMAS CAROLL:
And so it can lead to some weakness which we’re seeing today. Exactly.
CAROLINE WOODS:
Okay. So what should we expect from here though is the bigger question. Is this something that we should be concerned about or is it healthy?
THOMAS CAROLL:
I think it’s a volatility spike. We’ve seen a very large schism in the market. I don’t think necessarily this is a sign that the eye trade is over, but I do think it is a sign that the market had gotten very narrow. And so we thought that you’re going to see this rotation, which was going to kick up volatility, and it was going to lead to massive dispersion in the market and a lot of volatility driven headlines.
CAROLINE WOODS:
So we’ll talk about where that money is rotating. But first for the long term investor is this actually a buying opportunity. Or should we just start to expect lower returns from some of the biggest winners specifically in technology?
THOMAS CAROLL:
Yeah, I don’t think I’ve seen enough of a selloff yet in the mega caps to come out here and say we should go rotate into them. I do think we still are have a very running hot business investment sector. So there’s still tons of capital flowing into the AI scarcity space. But I do think a correction is healthy for the market here.
THOMAS CAROLL:
And we would expect it to continue over the next quarter.
CAROLINE WOODS:
So no fresh capital in tech right now. But if you’re already in it, stay in it.
THOMAS CAROLL:
Yes I would say yeah. Well we’re expecting we’ve been saying is a rotation from Mega taps into your equal way counterpart. So more of your value will catch a bid after some of the mega top mega cap tech growth has done exceptionally well off of the Hormuz conflict resolving.
CAROLINE WOODS:
Okay, so let’s dig into this rotation that you’ve been seeing. You mentioned mid caps, but talk to us more about where the money’s actually going and where retail investors should be putting theirs.
THOMAS CAROLL:
Yeah. So if you look at the overall U.S. economy, we’ve been talking about this idea that GDP growth is really bifurcating. And so we’re seeing a very hot business investment sector but an inflation squeeze consumer. And so we want to be cognizant of where the economy’s headed from where we’re telling investors to be pivoted to. And so yes we’ve seen consumer stock lag.
THOMAS CAROLL:
But I think that makes sense given where the economy is. Whereas for me on a pullback I would want to allocate more towards the areas that are really benefiting from the I build out. So we’re looking at industrials materials, energy. If we see a resolution here a pullback, we could potentially see a flare up later in the year.
THOMAS CAROLL:
A possible way to get back in there. And I think a healthy pullback in the tech trade with the potential opportunity to get back into it.
CAROLINE WOODS:
We’ve been hearing more about this broadening though into specifically you mentioned mid caps but also small caps. So is that where investors should be focused as well. Because if how the economy is doing matters, if the economy isn’t doing well, one would assume that small caps might not either. So is that the wrong place to be putting money, or is that where investors should be focused on?
THOMAS CAROLL:
Well, I think the thing that’s helping small caps for the first time in really 4 or 5 years is we’re actually getting durable earnings growth and earnings momentum. And so we wrote a report today and we said this is a earnings led market. That is an environment that small caps can actually do well in. Even if there is some overall index volatility around just the momentum trade of the eye wear hit out a bit.
THOMAS CAROLL:
So we do think small caps could do well in this environment.
CAROLINE WOODS:
Okay. So you mentioned industrial. Any beneficiaries of the trade. So break that down just for us once more or kind of recap it for us. Yes industrials energy.
THOMAS CAROLL:
So I like to think of it as the the hard the hard hat parts of the economy, the things that are really about building, you know, the, the, the industrial build out of the I anything in that space is really what’s interesting to us. And so that would encompass is that industrials energy materials I think could do very well.
THOMAS CAROLL:
They, they were a actually loser of the Hormuz conflict. Energy as well. If we get a pullback there.
CAROLINE WOODS:
Pullback I mean.
THOMAS CAROLL:
We’ve had.
CAROLINE WOODS:
Below $8. So what what sort of a pullback would it make it look more attractive.
THOMAS CAROLL:
So I actually think that’s an interesting point is that if you look at the energy market specifically the oil market, what’s been interesting to us has been everyone’s focus is on the the front dated contract of the crude. But if you look at the longer term contracts of the December price for where oil is going to be, it hasn’t really fallen that much, which is an indication that maybe some of that demand the inventory we need to rebuild.
THOMAS CAROLL:
There is still more demand for oil, which could actually be bullish for energy as well. If the demand if we get a little bit of resolution of a geopolitical conflict, we’ll come back to more of the actual durable energy, because that’s an important part of the I build out.
CAROLINE WOODS:
What areas of the market would you avoid right now?
THOMAS CAROLL:
Yeah. We think anything really that’s been squeezed by inflation. I do think once we get past some of the volatility of the Nasdaq, we might see this splintering show back up. And yeah I trade but anything consumer oriented, we think that there is a real consumption squeeze specifically on incomes in the US that overall shape methodology.
THOMAS CAROLL:
And it makes it very difficult for consumer led companies to pass on price when they’re also getting margin compression. So we’re seeing earnings weakness there. And so anything related there we would be cautious.
CAROLINE WOODS:
So no staples no consumer discretionary. Yes. You mentioned the splintering coming back. What what does that mean.
THOMAS CAROLL:
Yeah. So we had noticed this earlier this year. It’s actually a pattern that was reminiscent to the last, tech bubble that we had in 99 was the final stages of the tech driven scarcity bull markets, as we see the quote unquote, services side of the eye services companies. So think, like your hyperscalers, the people who are doing the spending, the software, they begin to underperform as the spending requirements go up for these companies.
THOMAS CAROLL:
But the people that are receiving the CapEx, the beneficiaries, the semiconductors, the tech hardware companies, the ones that we see in the news all the time, they do very, very well. And that’s been a trade that’s started to occur last year and has really accelerated this year. And so we’re seeing a pullback today a bit in that trade.
THOMAS CAROLL:
But the demand is still there. The numbers that these companies are talking about spending is only getting larger.
CAROLINE WOODS:
Interestingly enough though, some of those beaten down software names are actually higher today. So would you bet on software at this point to play catch up, especially if you’re looking for value?
THOMAS CAROLL:
Yeah. So if software multiples right there back to like 2008 levels. Right. The sector has had very, very strong underperformance. But I do think it’s somewhat justified. If you look at the overall credit risk premiums in the bond market for these companies, there is a real risk being priced in these companies that these business models are basically under siege from.
THOMAS CAROLL:
I. And so yes, I think we can tactically play maybe a balance here there. But ultimately, I think having a better feel for the overall business model risk for this sector, I don’t think we really know how that’s going to play out.
CAROLINE WOODS:
Okay. So that’s not the part of the splinter that you would be putting your money.
THOMAS CAROLL:
Yeah, I would still be, you know like the hard hat part of the economy. Right.
CAROLINE WOODS:
The build out, you described bull markets in your notes as having explosive starts, unexciting middles and FOMO driven finales. Where are we right now?
THOMAS CAROLL:
Yeah, well, I think it’s pretty clear to us we’re in that final stage. We said bull markets do not go quiet into the night. There’s this grand finale, like at the fireworks show where all of a sudden things start. Just volatility spikes, price goes up. And so you see these momentum driven rallies. And it was interesting to us that the best part of the bull market is the beginning and the end.
THOMAS CAROLL:
So it becomes difficult to time things because right when you think, oh, we’re at a top, that’s actually the second highest returning period for markets. And so it’s very much so a tactical trading market.
CAROLINE WOODS:
So are you saying this is the end of the bull market then.
THOMAS CAROLL:
I don’t think we’re there yet. I do think we’re in the final stages. I think we’ll get a resolution at some point, probably in the back half of this year. On the scale of the span, are we getting the return on invested capital from the spend that we’re doing? But I think until we really get a sign from the hyperscalers that, hey, maybe there’s not the returns on investment that we thought here, I think that will likely continue.
CAROLINE WOODS:
So the final stages could be years.
THOMAS CAROLL:
Well, I would say no. I think the final stage is probably over the next 12 months. I think we’ll have a we will have a more durable answer. On just given the sheer size of the spending, if they can sustain it, because now they’ve burned through their cash flow, they have to go to equity markets and bond markets, to capital raise to be able to sustain the the spending, which is really where things get more treacherous.
CAROLINE WOODS:
So it’s not time for investors to turn cautious yet. Or what should they be doing to potentially prepare themselves for the final stage of the bull market, if this is it?
THOMAS CAROLL:
Well, I think we all want we need to be aware with eyes wide open of the risks. As I said earlier, we were expecting this volatility driven rotation, right. What we are seeing today is very much what we were expecting from markets. The question becomes is is this the end of the bubble right. Everybody wants to time it.
THOMAS CAROLL:
We think the things to look for are really the hyperscalers spending the guidance. Is there signs of that momentum speaking out yet. We don’t think that’s happened yet. And so that would be really the sign where all of a sudden I would be thinking, oh my gosh, the market could really fall. We think it will just be a period of chop.
THOMAS CAROLL:
And so if you would like to hedge, we call it defensive value. There are some sectors there that that do well when the market goes under these periods of volatility. But we still like the cyclical value space.
CAROLINE WOODS:
And I should note that your S&P 500 price target was just raised to 7800. So this is a market that you think is ultimately heading higher and just might not be a straight line.
THOMAS CAROLL:
Exactly. So we were expecting some near-term weakness in the third quarter. We had become we had become very one sided on this trade. And so at times, you know, when we see these dispersion widening, these corrections happen. And so they prevent present buying opportunities. What’s really driving this market now is it’s an earnings driven rally. And the earnings still look good to us.
THOMAS CAROLL:
And so that’s really what we’re focused on. It’s not we’ve been saying we thought multiples were going to come down for some time which they have. But the earnings have been so strong.
CAROLINE WOODS:
What’s the bigger mistake here chasing the winners or sitting in cash waiting for an even bigger pullback?
THOMAS CAROLL:
Yeah. Well, as I said, the final stage of the bull market is the second best returning period, right. So if you are sitting there waiting for a top, you might actually miss out on one of the most lucrative times for these bull markets. So especially at the same time where inflation is actually very high, especially relative to money market rates.
THOMAS CAROLL:
So if you sit in cash you might actually underperform this inflation. So it’s not really an answer. So we prefer rotating within the market. And so for us the best way to play this in the shorter term is to look at more of your equal weight indices and then look for a better opportunity to get back into the mega caps, because we do think we are just seeing the start of a pullback.
CAROLINE WOODS:
Okay. And I guess maybe reset your expectations in terms of what sort of returns you could see. Yeah, leadership is coming from areas other than the most powerful areas of the market right now.
THOMAS CAROLL:
It’s I think been three years. You’ve had almost 20% gains year over year over year. It seems very easy. But as my boss would always say, or my former boss would always say Barry Bannister is very famous. It’s like, this game is not easy. Markets are made. It’s made, you know, as soon as you get confident, they come in and hammer you right there.
THOMAS CAROLL:
So we have our eyes wide open on these trades.
CAROLINE WOODS:
Okay. I think this is a great time to pivot to our rapid fire game. Let’s do that. Quick questions quick answers. Are you ready. Yes. All right here we go. Markets right now. Resilient or fragile? Fragile economy running hot or cooling off.
THOMAS CAROLL:
Running hot.
CAROLINE WOODS:
Valuations today. Stretched or justified.
THOMAS CAROLL:
Both I would say that’s a cop out.
CAROLINE WOODS:
But where are they stretched? Where are they justified?
THOMAS CAROLL:
Well, the overall multiple is very elevated, but it is somewhat understandable given where interest rates I guess, have been. Credit markets are still very tight in terms of risks are low and also margins are very high. So they’re expensive. But I don’t think that’s necessarily a recipe to see. All of a sudden stocks come down because of it okay.
CAROLINE WOODS:
Important context there. Eye healthy leadership or excessive concentration.
THOMAS CAROLL:
Excessive concentration.
CAROLINE WOODS:
Next leg of the bull market I winners are everything else.
THOMAS CAROLL:
Everything else.
CAROLINE WOODS:
Value or growth from here.
THOMAS CAROLL:
Value.
CAROLINE WOODS:
One sector you’d bet on for the rest of the year.
THOMAS CAROLL:
Good question. I think industrials and materials I know it’s two one.
CAROLINE WOODS:
You’d avoid.
THOMAS CAROLL:
Consumer discretionary.
CAROLINE WOODS:
More upside. Small caps or large caps.
THOMAS CAROLL:
Small caps in the near term.
CAROLINE WOODS:
Small caps or mid caps.
THOMAS CAROLL:
And small caps.
CAROLINE WOODS:
More likely by year end new highs or a 10% correction.
THOMAS CAROLL:
I think a 10% correction could occur quickly.
CAROLINE WOODS:
Markets by year end higher or lower from here higher.
THOMAS CAROLL:
I think we I think we get a V.
CAROLINE WOODS:
What’s your price target.
THOMAS CAROLL:
We are at seven 800.
CAROLINE WOODS:
One word to describe how your feeling about the market for the rest of the year.
THOMAS CAROLL:
Nervous.
CAROLINE WOODS:
We’ll leave it there. Thank you so much. That’s Thomas Carroll, Vice President, Portfolio Strategy at Stifel. If you enjoyed this Street Talk, check out our full interview with Keith Lerner. He shares why tech is actually due for a rest and where leadership goes next.