You Don’t Want a 50 Basis Point Rate Cut – They Always Mean Recession
Summary
Interest Rate Cuts: The Federal Reserve is expected to cut interest rates by 25 basis points, with a 94% probability, while a 50 basis point cut is unlikely as it typically signals a recession.
Market Reactions: A 50 basis point rate cut would be a significant shock to the market, suggesting recession fears, whereas the market is currently pricing in a 25 basis point cut.
Earnings and Valuations: Despite high valuations, companies like Nvidia and Meta are demonstrating superior profitability and efficiency compared to their 1990s counterparts, justifying higher multiples.
Sector Performance: Financials show potential for growth with improved earnings expectations but limited PE multiple expansion, indicating an opportunity for investors.
Technology Sector: Big tech companies have evolved with better business models, margins, and growth prospects, supporting higher valuations compared to the 1990s.
Investment Strategy: Emphasis on earnings over economic data has proven beneficial over the past 15 years, with tech companies leading the charge in market performance.
Utilities and Rates: Utilities have benefited from both secular growth stories and rate changes, making them attractive in a low-rate environment.
Financial Sector Outlook: The financial sector, with improved earnings but stagnant multiples, presents a potential investment opportunity as it proves its growth and balance sheet strength.
Transcript
Ladies and gentlemen, today's show is brought to you by Vanguard. To all the financial adviserss listening, let's talk bonds for a minute. Capturing value in fixed income is not easy. Bond markets are massive, murky, and let's be real. Lots of firms throw a couple flashy funds your way and call it a day. But not Vanguard. At Vanguard, institutional quality isn't the tagline. It's a commitment to your clients. We're talking top grade products across the board of over 80 bond funds actively managed by a 200 person global squad of sector specialists, analysts, and traders. These folks live and breathe fixed income. So, if you're looking to give your clients consistent results year in and year out, go see the record for yourself at vanguard.com/audio. [Music] That's vanguard.com/audio. All investing is subject to risk. Vanguard Marketing Corporation distributor. Ladies and gentlemen, welcome back to What Did We Learn? My name is Downtown Josh Brown. I am your host and with me today is my friend Nick Kolus, co-founder of Datrek research and the author of Datarat's morning briefing newsletter which goes out daily to 1,500 plus institutional and retail clients. Nick's research partner and co-founder Jessica Rae, who's usually here, will not be joining us today, but she's here in spirit. Um Nick and Jessica also have their own YouTube channel which you can find a link to in the description below. This week the Federal Open Reserve Committee has an interest rate decision to make and it looks like for the first time in 9 months we will have an interest rate cut. The consensus is currently for a 25 basis point cut. Although there is some chatter about a 50 basis point cut. The current odds as of this morning, 94% chance of a quarter of a point cut, only a 6% chance for a 50 basis point cut. Nick, what are your thoughts as we head into that uh late Wednesday afternoon announcement? >> Well, I brought a little show and tell for this topic. So, let's pop it up on the screen. It is all the Fed rate cuts since 1990 sized by 25, 50, and then 75 or 100. And the table here just shows how many cuts of those sizes have occurred in every year with a rate cut back to 1990. There's been 55 cuts of various sizes since 1990 when the Fed first started to really be transparent about what rate policy was. And um 33 of those or 60% were 25s. Uh 33% or 18 were 50s and then four or 7% were 75s or 100s. So the odds are usually for a 25 basis point cut. That's usually what the Fed does. >> It's like two to one. >> Yeah, it's it's much more prevalent. Now, the thing to take away from this table is the Fed only cuts by 50 or 75 or 100, but mostly 50 when there's a recession or when we're just going have been through a recession. So, the 50s happened in 1991, 1992, 2001, 2002, 2007, 2008, and in 2020. So those are all recession or immediately postrecession years. The only exception to this rule is last year when the Fed cut by 50 to start the current rate cycle that wasn't in a recession. Obviously it was more to normalize rates. And so the takeaway from this is you don't want 50 basis point cuts. 50 basis points cuts say the economy is in recession and you don't want that kind of signaling which I think the Fed knows, traders know. So as much as there was some chatter about 50 earlier in the month, I don't see it. It's going to be 25. >> Okay. So let's let's talk about the exception. So last year you could not have done a 50 you did one 50 basis point cut. But like the thing that people should understand about that is that is coming off of one of the most extreme hiking cycles ever. So, it's it's like the context of how fast rates went up and by how much is really important to normalizing last year's 50 basis point cut. In that context, it was almost more like a 25 basis point cut just because of like how much rates had risen. Am I like trying to rationalize something that's not really there or do you think that's a good interpretation of the need for that 50 last year? >> It's a very good interpretation. However, let's let's think about what the bond market did after that 50 basis point cut. You know, 10 years rallied by almost 100 basis points of yield from September through the early part of this year. So, even then the bond market took that cut as a uh that's that was a lot. That was very stimulative. So, the 50, you know, it it came and went and we had two more 25s, but you're right, the 50 was very exceptional and as the historical data that I popped up shows, very very unusual. We shouldn't expect to see that again. We had a massive Dow Jones rally last week and a big move up in small caps and a lot of cyclical stocks, homebuilders, and I was on TV Thursday. Um, and and I think Friday was an even bigger rally than Thursday. Um, but I think it was a gap higher for the Dow every day last week or something like that. And I was asked on TV, is this the market starting to potentially price in 50 basis points? And I sort of felt like, yeah, that that actually could explain why this sudden burst of excitement for home building stocks because that's the only thing that really moves those stocks. So, do you think that that at the do you think that's not really the case? What was happening last week? Um, it was like the door opening to wait a minute, maybe they'll do 50. No, because 50 is the short end of the curve and things like homebuilders work off of mortgages were really the long end of the curve and twos and twos and tens didn't move all that much last week, which is interesting. But tens have come down a lot and so I think the market was saying was the Fed's going to be locked in on 25 every meeting for the rest of the year. That's going to pull the short end of the curve down. And the economy is slowing enough, particularly labor market slowing enough that you're not going to have a lot of incremental inflationary pressures and so the long end of the curve comes down as well. And it was the market kind of the equity market signing off on what the bond market was already saying. >> Do you think the 25 basis point rate cut is already mostly priced in? No one's going to be surprised by it at this point. It's been telegraphed. It's where the betting market has already been. So, it's like, >> all right, how would the market hypothetically react to the Fed doing 50 even if they did it in a hawkish way where they said, "Okay, we're adjusting rates based on, you know, our data dependence, but we don't see the need to do much more than this." Like, if they kind of said it not exactly those words, >> it would be such a departure from the way the PAL Fed has operated, which has been much more slow and methodical to their, you know, to many people's criticism of the POW Fed. That's the way they've done done it. So if they went at 50 out of the blue with no pre-warning, no Nick timmerous leak, no no conditioning of the market, tremendous shock and I think we'd revert back to that table that we started with, which is 50s happening recession. And the market would say crap, the Fed sees something we don't see. We're going into a recession. >> I want to put that table back up and ask you another question. Um, in 2001, there were eight 50 basis point cuts. Was that every Fed meeting that year was a 50 basis point cut? Am I reading that right? >> Uh 1991 was 25s. There were eight 25s. And then in 2001, yes. >> And if you add the two together, you'll see that there were 11 cuts. >> There were 11 cuts. There's only eight Fed meetings in the year. 2001, Jan 3, was an emergency rate cut of 50 basis points. And that's when the market said, "Oh my goodness, we are really in some trouble." because the Fed met an emergency meeting on the first full business day of the year and cut rates and then cut them again in their normally scheduled January meeting. So that was a that was a very tumultuous year for those of us who remember living through it. That was a tough year. It was one I think that was uh chart off. I think that was the hardest year of my career and I I barely had a career but I just remember every stock going down every day of every week of every month and with almost no exception. Every month was lower than the prior month and then sort of like as a capper after 9 months of um stock selling off we had 911. >> Yeah. and I lived in New York. I can't actually remember a worse period of time for me personally. Um I I can't believe that there were 11 separate rate cuts that year and eight of them were 50 basis points. I really I didn't remember that detail until I saw it on your your table. Um we are we are in the opposite of that situation right now. >> We've got stock prices that go up every day. >> We've got earnings growth every quarter. It surprises to the upside. And uh I get that there's like a little bit of squishiness in in some of the labor metrics, but like by and large it's a pretty damn good environment for most people. Um so this looks nothing like that. So I guess I would agree with you a 50 basis point rate cut would throw the market for a loop like that. Like in terms of sentiment, you might get a lot of people say, "Wait, wait, wait. What did they do? Why did they do that?" >> Yeah. So, it's okay. All right. So, so you're you're on board with the 25 basis points. You also believe the market pretty much knows that's what's going to happen. If that's the case, how important is the commentary accompanying the uh the rate cut, the statement itself, the the press conference? What what do you think? You know, the the the common wisdom and what I hear from clients is we're going to get a POW that is less dovish than the Fed funds futures market says because Fed funds futures say you're 60 70% chance of cuts at every meeting through the rest of the year. And Pal's not going to want to sign off on that entirely. So, it's logical to think he's going to be a little more hawkish and be a little more narrative around data dependent, but the market knows which way the wind is blowing, so I'm not sure it really matters all that much. And against that backdrop, we have an amazing amount of positive earnings revisions for the S&P happening right now. You know, you we've talked about this in prior prior videos, but typically speaking, numbers come down all through the course of a year. That's the way they do it. Analysts start at 100 in January for the year and they end up at 87. This since the beginning of the third second quarter earning season, numbers have just gone up every single week pretty much. And so, we've got a tremendous earnings momentum right now, which no one's really talking about. So all this worry about the Fed, I'm not too worried about it. The numbers keep rising, estimates keep going up, which is super unusual in a midcycle market. And so I'm very heartened to see those numbers go up and I think that'll more than offset anything from the Fed. >> That's a great segue. So, let's talk about earnings estimates because one of the observations that um I've made and I've heard you make and a lot of other people make if you if you have a choice and there's a scale and you slide the scale on on one end is pay attention to the economy and the on the other end is pay attention to earnings. If you had slid uh the marker all the way toward earnings and away from the economy, you probably outperformed over the last 15 years. >> Yes. And if your right and if your marker is all the way on the other end where you're just constantly talking about economic data and macroeconomics, you have probably underperformed to a substantial degree. At some point, maybe that will change, but probably not tomorrow. So, let's let's dive into the earnings expectations and and that uh the fact that they've risen um since uh I don't know when when we last talked, June. Yeah. >> Or or July. Okay. June. July. They're up every week. So, you have an update to that. Let's put that uh table up, John, and Nick will walk us through what we're looking at. >> Okay. So, this is a grid that we've shown, I think, the last two videos, which our clients really love. Um, they don't necessarily love the message, but they love the analysis. What this shows is S&P 500 fair values based on a range of PE multiples from 14 to 26 times earnings. And then assuming we get the current estimate, actually comes true for 2025 and 2026. and then a range of different earnings outcomes. So maybe earnings are lower by 10 or 20% for this year. Maybe they're lower by 10 or 20 or 10% higher for next year. But it gives you a nice sensitivity analysis based on investor confidence as expressed by PE ratios and actual earnings as expressed by this range. And for those of you >> I'm sorry uh Nick Nick before we go forward. So just um to keep the chart up for for clarity just so I make sure I understand this. There are only seven scenarios in which stocks should go higher and then all of and those are in green and then all of these blue or red scenarios represent the market effectively staying flat or declining. >> Yes, that is correct. There are there are 49 potential scenarios on this table >> cuz it's seven by seven. Okay. >> Yes. And only seven deliver upside. A bunch 1 2 3 4 5 six seven are fair value or a kind of fair value and the rest show declines. And all the analysis is meant to show is that we need to we're trading at very high multiples which we all know but we also need to believe in higher multiples or earnings upside in order to be long here because it's not just enough to say hey we're at 22 23 times earnings okay fine we need to say okay I want to make money here so how do we make money we make money when PE multiples go higher or when earnings beat. So, for example, simplest scenario, >> the simplest scenario for 10% upside, 11% upside to the S&P from right here is if we earn $35 a share next year. Now, that's two bucks higher than it was the last time we spoke. So, numbers have gone up a little bit and we do a 24 multiple on those numbers. So, kind of peak.comish kind of valuations. That is the cleanest upside story. >> If you have trouble with that story, you got to think about your stock exposure. I don't and we'll talk about why not. But that is the central takeaway from that grid is that you've got to believe not just that we hold 22 23 that we can get to 24 otherwise it's super hard to justify being along US large caps. >> So how do we um how do we convince ourselves that either earnings estimates will go higher and they've been going higher but continue and or multiples will go higher. What's the story that we need to tell ourselves in order to justify, okay, that's where the upside's going to come from for large cap US stocks? >> Yeah, it's obviously the right question to ask and really dig into and and we've got some fundamental stuff we can talk about in a minute, but let me just give my high order explanation or high order answer to that question. PE multiples, valuations, they're a function of investor confidence in the future. That's what they measure. When pees are 14, no one has any confidence. Like in 2018 or 2020, pe got to 14 in a heartbeat because you had the Fed raising rates or you had a pandemic. Confidence went out the window. Conversely, when you're 22 24 times, like you were 22 times through most of 2020 21, that means investors have a huge amount of confidence. And in that case, it was because we had a lot of fiscal and monetary stimulus that was shoving money into the economy and we weren't going to get a recession. Fine. >> Okay. Now you got to believe in 24 times and 24 times is a little bit higher than dot com. And so the question becomes are you as confident in two things. The first is the US economy and the second is the fundamentals of the companies leading the stock market higher. On the first point I think you can have a high degree of confidence in the US economy because the Fed's cutting rates. The long end of the curve is finally coming down and so the backdrop is pretty healthy and the labor market's squishy but not rolling over. So that's the fundamental answer. I also think you've got a demographic tailwind and you've got less immigrants competing for jobs. Um, and they might not be the same jobs as the jobs that kids coming out of college would get, but just generally speaking, you do have a tighter labor force almost for political reasons. And um, you have a lot of 30-year-olds in this country and they're going to work. They're not It's not the same as when the labor force was so dominated by boomers and a lot of them were just opting out or, you know, via labor force nonparticipation. >> Mhm. >> With a with a population that's heavily concentrated amongst people in their late 20s, early 30s, they're going to work. So, I like I feel like that demographic/immigration story is how you can get past mentally the squishiness in the labor uh market data. Yeah, that absolutely feels right. Um, you know, and we'll see in the next couple of weeks. I that initial claims number last week was a little bit worrisome and there's some commentary that maybe it was due to some fraud in Texas. So, we'll see what this week's data looks like, but it was a three standard deviation above the mean reading, which is by definition hyper unusual. So, I'm I'm willing to be convinced the labor market is still solid. I I do believe it, but I'm also cognizant that the data is not 100% compelling. >> Yeah. Um, now that now that we've got John Voit as the head of the BLS, um, it it should be a little bit more convincing that the data is good. Um, I think that's like a part of the sideshow that's happening here politically is just the upheaval at the the bureau itself >> and um, a lot of like questions now being asked that haven't been asked in a while and maybe should have been like, can we even trust the veracity of this data or how it's collected or what it means? Um, but that being said, if you believe in the data, it's not as strong of a labor picture as it was a year ago, two years ago. >> Absolutely. And look, I mean, as a sidebar, it is strange that we measure unemployment the same way as we did in 1948 with a survey uh of households and businesses. And I understand why that's the case from an economic analysis standpoint. You want continuity of the data series. But it is pretty astounding that we measure and manage a huge economy with the same basic math as after World War II. >> Okay. All right. So if if we're at the current valuations and the plan is to remain long and uh you know hope for one of those blue or green outcomes either fair value or the market has room to trade higher in the near term then we have to get comfortable with the individual components of of the indices themselves. So, let's start with uh let's start with Nvidia. It's the biggest most important stock in the world. It's where a lot of the uh growth is coming from for the S&P 500 this year and next year. Uh and I know you've got uh an interesting way of thinking about um the fundamentals of the Nvidia of today versus their counterparts from 30 years ago, 25 years ago. >> So, we did this a couple weeks ago for clients and let's pop up the Nvidia Intel comp and I'll talk walk you through it. So this is Intel's second quarter financial results some basic measures and um sorry Nvidia's and then this is Intel's financial results in 1999. So literally apples to apples what they have in revenues margins and so forth. And the upshot of this data is I'll just run through these numbers. Nvidia's operating margins are 1.8 times as high as Intel's in 1999. Intel powered obviously the PC boom in the late 90s. Nvidia is powering um AI. So kind of equivalent in terms of their position in the market. Net margins, Nvidia's net margins, dollars of income for every dollar revenue, 2.3 times what Intel's was, 57% versus 25%. Nvidia's asset intensity is eight times less, eight times better than Intel. Intel ran its own fabs in the '90s. Nvidia doesn't. So Intel has 20 times revenues to PPE turns. return on equity. Nvidia's is 106% ROE annualized based on Q2. Intel 99 was 23%. So Nvidia is 4.7 times better on ROE than Intel was. And Intel was no slouch. It was a great company. And then if you compare the size, if you inflation adjust Intel's revenues in 1999 to now, it's like 57 billion. Nvidia's annualized revenues just based on Q2, $187 billion. Nvidia now is three times the size of Intel on an inflationadjusted basis and it's 7.5 times more profitable. It's making annualized $106 billion. Intel would have made $14 billion inflation adjusted. So the upshot here is Intel is just a hugely better business than Intel was in the 90s. Nvidia is >> Nvidia is a better business. Yeah, >> Nvidia is much better. Intel looks downright industrial compared to the Nvidia numbers of today. It's like, and this is apples to apples because Intel was probably the most important stock of that time. Some would say CIS. Some would say Cisco, but like it's a semi. So, it's a better comp to Nvidia. Number one, and number two, it was every bit as elemental to that bull market. That bull market was about the PC revolution combined with the internet combined with server uh demand and and uh laptops and even phones eventually. So Nvidia is I think uh I Intel I I think is the right comp to Nvidia of today >> and you illustrating that Nvidia is seven and a half times more profitable than Intel. All right. So maybe we don't deserve a multiple that's seven and a half times higher. But >> 2x, why not? >> It should be higher, right? Is that like a very obvious? >> Yeah, absolutely. And this so two points. First is I also ran the Cisco numbers. Intels were better, which is why I popped those up, but we also have the Cisco numbers in our report. The second is that this is the crux of the problem with valuations today. And we have other examples, but let's just sort of hit this now. I don't know how you value these companies versus the 1990s. I just know that you have to value them more highly because the returns are better, the margins are better, the asset intensity is lower, the competitive advantage is better, and we'll touch on that in a second. And the upshot is, is it worth 2x a multiple of 1999? I don't know. 50%, I don't know. It's definitely more. And that's what the market struggles with. That's why we're at 22 times earnings because the market knows we're better than we were in the '90s. We absolutely are. What was what was Intel's peak multiple back then? >> Yeah. 24 and change. 25. >> Okay. So, it's absurd to say that Nvidia should be worth seven and a half times that. Um, you know, like obviously because a uh it's unlikely that they will preserve their their operating margin. >> Yes. >> Um, it's even more unlikely that they'll keep the revenue growth rate. Mhm. >> They're not telling people they can. Nobody honestly should expect that. So, okay. So, but is it like outrageous for Nvidia to be valued at twice as much as Intel was? Not really. >> Not really. No. And not with those returns on capital. I mean, this is kind of a grimy financial analysis topic, but 100% ROE is insane. >> 100%. You're taking your equity and you're earning all that money for your shareholders every year. Two companies do that. Nvidia is one, Apple's the other. >> Yeah. It's right. It's It's not something that you would expect to be repeated across 20 different companies. >> No. >> So, it's extraordinarily unique. >> Yeah. >> Okay. You have another comparison. You have Meta versus IBM. >> Yeah. Meta Meta of today IBM in 1999. This one was just sort of a sentimental choice for me because I remember Lou Gersonner and IBM in the 90s and it was one of the bestrun most highly regarded companies on the planet. And so this lines up Meta's Q2 and IBM's 1999 and they're kind of remarkably similar in some ways. The ROEs are actually exactly the same at 37.6%. >> And interestingly, IBM was a more capital efficient company at a PP&E level than Meta is today. But where the difference comes in is in margins. IBM was a 9% margin business in 1999. Meta is a 39% net margin business today. 4.4 times higher. So Meta is expressing a much stronger level of competitive advantage, meaning it has a stronger moat by virtue of showing those margins than IBM did in the '90s. And IBM in the90s was a fantastic company. Meta is just way more fantastic. And interestingly, when you inflation adjust the revenues, Meta of today is almost exactly the same size as IBM in 1999, like 190 billion versus 170 billion in inflation adjusted revenues. But Meta makes five times more money on an inflation adjusted basis. It's making annualized $73 billion. IBM inflation adjusted would made $15 billion. So Meta by virtue of margins, by virtue of size, is wildly more profitable than IBM in 1999. And and for those of you who remember IBM in the '90s, this was a well-run company. This was a well- reggarded company. >> Can I uh also point out, and I don't think it shows up in any of these particular items, Meta is way more aggressive about investing for future growth. And probably that was the problem that IBM has was that it was way too focused on returning capital to shareholders and not thinking big enough about technology in the as decade and the 201s decade which is why effectively the stock price did nothing for I don't know 16 17 years until re you know recently um whereas Meta is full throttle we don't know whether or not all of that investing is going to pay off. But what we do know is that they are not managing um future growth the way that IBM was. >> Yes, that's an excellent excellent point. Totally agree. >> Okay. Um do we think given this do we think that Meta is appropriately valued relative to the way IBM was being valued at the top of the dot bubble in 99? So for for for a higher valuation or is it pretty much already getting it? >> I think you touched on exactly the right point which is what's the investment profile of Meta versus IBM back then and Meta is doing you can argue about how much they spend but they are putting money to work in anything that they think will grow. So they you know tried the metaverse they renamed the company for the metaverse that didn't exactly work out but they didn't deter them from taking another swing when it came to LLMs and Genai. So they're still trying and I think your point is so well taken that IBM in the 90s was writing the PC boom but then they kind of gave up and because they didn't make their own chips very much they didn't leverage Moore's law and then they missed cell phones they missed a ton of things and they were dead where Meta is still in the game still trying and I think you have to attribute that a lot to Zuckerberg being the founder who still runs the company and whose wealth is tied up in the value of that company and he's not going to let it die that way >> right Gersonner was a boardappointed CEO not a founder. Um, this is Zuckerberg's baby. I also think Zuckerberg does not like giving Apple a third of of uh the profits from from Meta's apps and they seem to be hellbent on creating their own device platform uh starting with the Rayban uh glasses. Yeah. because whatever the next form factor is for the AI age internet, I don't think that they want to be um taking a backseat to Apple in terms of where do the profits get diverted from all of this activity. I think they'd like a primary relationship with their users um and and putting that equipment in people's hands. >> IBM gave away its computer business to Asia. >> Yes. >> They they they went the other they went the other way is is my point. >> Yeah. >> Um All right. And you've got one more and this is a fun one. Microsoft in 1999 versus Microsoft today. >> Yes, this was another another like you said another fun one because it's nominally the same company, same symbol, same you know everything but the companies are very different. Um the margins are relatively similar 39% then 36% now net margins but Microsoft interestingly is a much more PP&E intensive company now than it was in the '90s. It was very lean back then. Um, so it spends a lot has a lot more money invested in equipment in in hardware. Um, it still doesn't matter because their roe are higher now than they were in the 1990s. ROE's now is 32% back then 27%. So Microsoft's a slightly better business. But the magic of this analysis is back on this bottom two lines. If Microsoft had grown by inflation since 1999, it would be about a $ 38 billion revenue business, about a $15 billion net income business, just if it grew by by inflation, CPI. In reality, it is a $300 billion business. So basically 10 times what inflation adjusted should have been. And it's making $ 109 billion in net income versus 15 inflation adjusted. So call that eight times more. And this to me is explains the power of technology generally because here's a company that has held margins the better part of 30 years and grown 10x where it should have been just given inflation growth. That's the power of technology. Moore's law, the permanence of technology as a driver of revenue growth, of net income growth. And so you end up with a company that is orders of magnitude bigger than you would have thought possible 25 years ago. What's so interesting is right just after this 1999 periods worth of numbers is when Bill Gates steps down, hands the reigns to Steve Balmer. Bomber then presides over 16 years of modest earnings growth but a flat to down stock price and ultimately the company makes this fullbore pivot into cloud computing builds the second largest cloud computing platform in the world and that's how you get a company that if they were just muddling along selling office uh uh software and operating systems it's you know and maybe a little bit of revenue from Bing and Xbox. It's a $ 38 billion business, but they didn't do that. They reinvented themselves for the cloud era, and that's how it gets to 300 billion in revenue. And they take the cloud guy and they make him the CEO. And uh Bomber goes off to the NBA. So, it's a it's a I agree it's a really fascinating what if like what if they had not built Azure and had not gotten into the cloud to the degree that they did be a very different story here. >> Totally. it it would be the CPI numbers, not the numbers that are today. >> Okay. So, your upshot here is that big tech business models have gotten a lot better over the last 30 years. Better margins, more efficient companies, faster growth, more defensible modes. And to look at today's valuations versus 1999's doesn't quite tell the right story or doesn't give investors enough credit for being smart enough to know that things have changed. >> Yeah, that's exactly right. And I'll sum it up is, you know, I worked for Steve Cohen for a couple of years and one of his favorite sayings was math is not an edge. If you can do it on a calculator, it is not an investment edge. So, as much as I respect the PE multiple analysis that we started with, and obviously I dedicate some time to doing it for our clients, it's the reasons why those numbers are the way they are that actually make the investable edge. And I've staked my, you know, my thesis on the idea that these companies are substantially better than the ones that were met that we're benchmarking against in the 1990s and deserve a higher multiple. So, I'm totally comfortable with a 22 multiple on the S&P because we're looking at companies that are orders of magnitude better at the top of the stack than they were in the late 1990s. Not just in terms of size, but cash flow and ree everything. >> To your credit, this is something that you've been saying for 10 years. And I know because I've been reading you and this was it's easier to say today because we've all kind of accepted it. This was not popular to have said five and ten years ago when people were still carrying on about cape ratios and everything was a comparison to 1999. It was not a popular thing to say yes multiples are high and here's why that's a good thing because the market is recognizing that business has changed and some businesses are extremely unique. Now, I feel like most people have gotten over that and they get it. But back then, it just looked like, "Oh, Nick's being complacent again about elevated multiples." Like, like, "Here we go again. This time it's different." Blah, blah, blah. It turns out this time it was very different. And I want to give you credit as somebody who recognized that a long time ago. >> Thank you. Yeah. And I'll tell you I'll tell you where it comes from. I covered the crappiest sector on the planet for a decade. >> I covered the domestic auto industry >> in the 1990s. And I did it for Steve as well. And that taught me to respect these valuation measures and these return on capital measures because the auto companies are horrible at it. And so when I look at these tech companies, I can see them with fresh eyes and say, "No, this is materially better than anything else I've ever seen. >> This ain't Ford and GM. This is an amazing thing. >> This is not even IBM 999." >> Okay. Speaking of sectors, let's finish with uh this this recent thought that you had. Um it's kind of fascinating to me and I I'd love to have you walk us through um PE multiple expansion and changes in earnings growth expectations. >> Yes. So let's pop the the the visual up. This is something I did for clients last night and I I I'm a little embarrassed that it took me this long to figure out this paradigm, but let's walk through it. The table here shows how every sector of the S&P has performed year-to- date. And we have outperforming sectors on top and underperforming sectors on the bottom. And then we decompose that price return into two things. The first is the percent change in the forward P multiple. How much did P multiples change this year up or down? And then by extraction we know how much earnings expectations changed because the price return is just a function of change in PE and change in earnings expectations. And the takeaway from this is the winning sectors communications, tech, industrials, and utilities average 7% better PE multiples and 9.4% and 4% better earnings expectations. And both of those numbers are better than the S&P as a whole, which was 12% up on the year driven by 4.7% P multiple expansion and 7.3% net change in forward expectations. So the recipe for a winning sector has been on average both a better forward multiple because investors have more confidence in earnings and enough of an earnings momentum story so that the street says, okay, these guys can continue to show better earnings growth than expected. That's the case with in some form almost every outperforming sector. It is not the case with underperforming sectors. So you end up with much less PE multiple expansion and almost no change in forward earnings expectations for losing sectors. And my investment takeaway from this and we can talk about the numbers individually, but the one sector that stands out is financials. They've had some very good changes in Ford earnings expectations, 10%. They've only had 1% improvement in P multiples. That's an opportunity. I think I think financials can work between now and year end and end up outperforming. >> So all right that's the thing that jumps out to me. So in other words the forward PE for the financial sector in January to start the year was 16 a.5 and 16.5 and right now it's 16.7 so unchanged but forward earnings estimates are up 10%. So, the financial sector has gotten no credit in the form of like an upward rerating um for the fact that they're growing earnings this year by 10%. I wonder if you have an explanation for why. Is it just we're trapped in this thing where people think a bank should be 1.5 times book value and that's just what it's going to be? Or do you think there's another reason why financials haven't had the benefit of that rising um multiple? I think it's you touched on a really important one. Banks, bank balance sheets, bank risk profiles, lending standards, credit quality. I think that's probably 80% of it um of it. And so yes, I mean that's that's a group that has persistently had a very low multiple because the bank component of financials which is now call it 40% of the index 50% of the index has this cap in terms of perceived peak ROE but with some deregulation perhaps more deals like we saw last week you get more fintech you get a little better multiple and you let's not forget like Visa and Mastercard and financials now they didn't used to be so we have some potential for you know rerating on some of the growth side as well. So financials to me is like the easiest trade into year end I think. >> Yeah. I think there was a period of time where Mastercard was in consumer discretionary and Visa was in tech. >> Yes. >> Is that true? >> It is true. >> Okay. One of the more interesting stories this year marketwide is in the financials where Robin Hood got added to the S&P 500. Um Coinbase became a a huge market cap company. a firm has done really well. You've got like all of these new fintechy kind of financials that now have a meaningful enough market cap where you know compared to the JP Morgans and the Bank of Americas which are enormous they actually show up. You've also had big turnarounds in Wells Fargo and City >> which are are years in the making. like there I feel like the financials are more interesting this year than they've been really going back to the financial crisis. Um there's a lot of dispersion within the financials. I know there's more dispersion in areas like industrials, but like within the financials you got this big rally, but then you have some stocks that have done incredibly well in there. And uh it's just it feels like it's been a while since people were excited about these stocks. >> It is. Listen, I think you touch on a really important kind of macro point for the market is reratings, better multiples, they will like not happen for years and then they'll happen all at once. And it happens when the group proves itself. And I think this group is really finally starting to prove itself both in terms of growth and in terms of balance sheets. >> Two other things that jumped out at me, just a quick comment from you. utilities um did have the jump in uh forward PE multiple probably because increased demand as a result of the AI capex build out and a lot of these names even the regulated ones are getting rerated because of this new layer of demand. Does that seem justified to you? >> It does. I mean I always struggle with utilities like how much of it's a rate story, how much of it's a secular story. It feels okay. And I think the rate story is probably just as important as the as the secular growth story. >> So rates come down and people are looking for things that still have a high yield. Exactly. Utilities become more competitive with bonds. >> Yeah. Yeah. But you know like staples haven't had the same benefit and staples have pretty good yields too. So you can point to the secular story in utilities to say that's why utilities are working and staples are not. >> Okay. Last one. Um consumer discretionary. I'm surprised by this and I know it's a weird sector because Amazon and Tesla make up such an outsized portion of this, but um consumer discretionary is now selling at the same multiple that it was in January despite the fact um that you did have oh I guess I guess it's only 4% earnings growth for the group. So it's kind of underwhelming >> earnings growth. All right. So that makes sense to you too then you would say. Yes, it does. Okay. For sure. >> Okay. None of these sectors have really fallen off much other than energy in terms of forward PE multiples. Um Oh, excuse me. Have any >> energy is higher? >> Healthare. >> Healthcare. Okay. All right. And that and that's easily explained by just how difficult it is to navigate being a healthcare company in 2025. >> Yeah. Yeah. It's funny if you look at the top 10 names in XLV, the large cap healthcare ETF, like 40% of them are up decently on the year. It's just the rest are just disastrous. >> Yeah. Okay. All right. Uh Nick, this has been incredible. I want to remind people that um if they appreciate your insights, and I know they do, there's a lot more where this came from. And I want to send you guys two places. Number one, you can check out Nick and Jessica on their very own YouTube channel. It's youtube.com/nickcolas and Jessica Rae uh where they are published on a regular basis. And you could subscribe to Nick and Jessica's research at datreach.com just as 1,500 other institutional investors and uh individual investors do and you guys are publishing 5 days a week which I still find extraordinary and uh awesome. So thank you so much for your insights. We appreciate having you. Please say hello to Jessica for us and uh hope to see you again soon. >> Great. Thanks so much.
You Don’t Want a 50 Basis Point Rate Cut – They Always Mean Recession
Summary
Transcript
Ladies and gentlemen, today's show is brought to you by Vanguard. To all the financial adviserss listening, let's talk bonds for a minute. Capturing value in fixed income is not easy. Bond markets are massive, murky, and let's be real. Lots of firms throw a couple flashy funds your way and call it a day. But not Vanguard. At Vanguard, institutional quality isn't the tagline. It's a commitment to your clients. We're talking top grade products across the board of over 80 bond funds actively managed by a 200 person global squad of sector specialists, analysts, and traders. These folks live and breathe fixed income. So, if you're looking to give your clients consistent results year in and year out, go see the record for yourself at vanguard.com/audio. [Music] That's vanguard.com/audio. All investing is subject to risk. Vanguard Marketing Corporation distributor. Ladies and gentlemen, welcome back to What Did We Learn? My name is Downtown Josh Brown. I am your host and with me today is my friend Nick Kolus, co-founder of Datrek research and the author of Datarat's morning briefing newsletter which goes out daily to 1,500 plus institutional and retail clients. Nick's research partner and co-founder Jessica Rae, who's usually here, will not be joining us today, but she's here in spirit. Um Nick and Jessica also have their own YouTube channel which you can find a link to in the description below. This week the Federal Open Reserve Committee has an interest rate decision to make and it looks like for the first time in 9 months we will have an interest rate cut. The consensus is currently for a 25 basis point cut. Although there is some chatter about a 50 basis point cut. The current odds as of this morning, 94% chance of a quarter of a point cut, only a 6% chance for a 50 basis point cut. Nick, what are your thoughts as we head into that uh late Wednesday afternoon announcement? >> Well, I brought a little show and tell for this topic. So, let's pop it up on the screen. It is all the Fed rate cuts since 1990 sized by 25, 50, and then 75 or 100. And the table here just shows how many cuts of those sizes have occurred in every year with a rate cut back to 1990. There's been 55 cuts of various sizes since 1990 when the Fed first started to really be transparent about what rate policy was. And um 33 of those or 60% were 25s. Uh 33% or 18 were 50s and then four or 7% were 75s or 100s. So the odds are usually for a 25 basis point cut. That's usually what the Fed does. >> It's like two to one. >> Yeah, it's it's much more prevalent. Now, the thing to take away from this table is the Fed only cuts by 50 or 75 or 100, but mostly 50 when there's a recession or when we're just going have been through a recession. So, the 50s happened in 1991, 1992, 2001, 2002, 2007, 2008, and in 2020. So those are all recession or immediately postrecession years. The only exception to this rule is last year when the Fed cut by 50 to start the current rate cycle that wasn't in a recession. Obviously it was more to normalize rates. And so the takeaway from this is you don't want 50 basis point cuts. 50 basis points cuts say the economy is in recession and you don't want that kind of signaling which I think the Fed knows, traders know. So as much as there was some chatter about 50 earlier in the month, I don't see it. It's going to be 25. >> Okay. So let's let's talk about the exception. So last year you could not have done a 50 you did one 50 basis point cut. But like the thing that people should understand about that is that is coming off of one of the most extreme hiking cycles ever. So, it's it's like the context of how fast rates went up and by how much is really important to normalizing last year's 50 basis point cut. In that context, it was almost more like a 25 basis point cut just because of like how much rates had risen. Am I like trying to rationalize something that's not really there or do you think that's a good interpretation of the need for that 50 last year? >> It's a very good interpretation. However, let's let's think about what the bond market did after that 50 basis point cut. You know, 10 years rallied by almost 100 basis points of yield from September through the early part of this year. So, even then the bond market took that cut as a uh that's that was a lot. That was very stimulative. So, the 50, you know, it it came and went and we had two more 25s, but you're right, the 50 was very exceptional and as the historical data that I popped up shows, very very unusual. We shouldn't expect to see that again. We had a massive Dow Jones rally last week and a big move up in small caps and a lot of cyclical stocks, homebuilders, and I was on TV Thursday. Um, and and I think Friday was an even bigger rally than Thursday. Um, but I think it was a gap higher for the Dow every day last week or something like that. And I was asked on TV, is this the market starting to potentially price in 50 basis points? And I sort of felt like, yeah, that that actually could explain why this sudden burst of excitement for home building stocks because that's the only thing that really moves those stocks. So, do you think that that at the do you think that's not really the case? What was happening last week? Um, it was like the door opening to wait a minute, maybe they'll do 50. No, because 50 is the short end of the curve and things like homebuilders work off of mortgages were really the long end of the curve and twos and twos and tens didn't move all that much last week, which is interesting. But tens have come down a lot and so I think the market was saying was the Fed's going to be locked in on 25 every meeting for the rest of the year. That's going to pull the short end of the curve down. And the economy is slowing enough, particularly labor market slowing enough that you're not going to have a lot of incremental inflationary pressures and so the long end of the curve comes down as well. And it was the market kind of the equity market signing off on what the bond market was already saying. >> Do you think the 25 basis point rate cut is already mostly priced in? No one's going to be surprised by it at this point. It's been telegraphed. It's where the betting market has already been. So, it's like, >> all right, how would the market hypothetically react to the Fed doing 50 even if they did it in a hawkish way where they said, "Okay, we're adjusting rates based on, you know, our data dependence, but we don't see the need to do much more than this." Like, if they kind of said it not exactly those words, >> it would be such a departure from the way the PAL Fed has operated, which has been much more slow and methodical to their, you know, to many people's criticism of the POW Fed. That's the way they've done done it. So if they went at 50 out of the blue with no pre-warning, no Nick timmerous leak, no no conditioning of the market, tremendous shock and I think we'd revert back to that table that we started with, which is 50s happening recession. And the market would say crap, the Fed sees something we don't see. We're going into a recession. >> I want to put that table back up and ask you another question. Um, in 2001, there were eight 50 basis point cuts. Was that every Fed meeting that year was a 50 basis point cut? Am I reading that right? >> Uh 1991 was 25s. There were eight 25s. And then in 2001, yes. >> And if you add the two together, you'll see that there were 11 cuts. >> There were 11 cuts. There's only eight Fed meetings in the year. 2001, Jan 3, was an emergency rate cut of 50 basis points. And that's when the market said, "Oh my goodness, we are really in some trouble." because the Fed met an emergency meeting on the first full business day of the year and cut rates and then cut them again in their normally scheduled January meeting. So that was a that was a very tumultuous year for those of us who remember living through it. That was a tough year. It was one I think that was uh chart off. I think that was the hardest year of my career and I I barely had a career but I just remember every stock going down every day of every week of every month and with almost no exception. Every month was lower than the prior month and then sort of like as a capper after 9 months of um stock selling off we had 911. >> Yeah. and I lived in New York. I can't actually remember a worse period of time for me personally. Um I I can't believe that there were 11 separate rate cuts that year and eight of them were 50 basis points. I really I didn't remember that detail until I saw it on your your table. Um we are we are in the opposite of that situation right now. >> We've got stock prices that go up every day. >> We've got earnings growth every quarter. It surprises to the upside. And uh I get that there's like a little bit of squishiness in in some of the labor metrics, but like by and large it's a pretty damn good environment for most people. Um so this looks nothing like that. So I guess I would agree with you a 50 basis point rate cut would throw the market for a loop like that. Like in terms of sentiment, you might get a lot of people say, "Wait, wait, wait. What did they do? Why did they do that?" >> Yeah. So, it's okay. All right. So, so you're you're on board with the 25 basis points. You also believe the market pretty much knows that's what's going to happen. If that's the case, how important is the commentary accompanying the uh the rate cut, the statement itself, the the press conference? What what do you think? You know, the the the common wisdom and what I hear from clients is we're going to get a POW that is less dovish than the Fed funds futures market says because Fed funds futures say you're 60 70% chance of cuts at every meeting through the rest of the year. And Pal's not going to want to sign off on that entirely. So, it's logical to think he's going to be a little more hawkish and be a little more narrative around data dependent, but the market knows which way the wind is blowing, so I'm not sure it really matters all that much. And against that backdrop, we have an amazing amount of positive earnings revisions for the S&P happening right now. You know, you we've talked about this in prior prior videos, but typically speaking, numbers come down all through the course of a year. That's the way they do it. Analysts start at 100 in January for the year and they end up at 87. This since the beginning of the third second quarter earning season, numbers have just gone up every single week pretty much. And so, we've got a tremendous earnings momentum right now, which no one's really talking about. So all this worry about the Fed, I'm not too worried about it. The numbers keep rising, estimates keep going up, which is super unusual in a midcycle market. And so I'm very heartened to see those numbers go up and I think that'll more than offset anything from the Fed. >> That's a great segue. So, let's talk about earnings estimates because one of the observations that um I've made and I've heard you make and a lot of other people make if you if you have a choice and there's a scale and you slide the scale on on one end is pay attention to the economy and the on the other end is pay attention to earnings. If you had slid uh the marker all the way toward earnings and away from the economy, you probably outperformed over the last 15 years. >> Yes. And if your right and if your marker is all the way on the other end where you're just constantly talking about economic data and macroeconomics, you have probably underperformed to a substantial degree. At some point, maybe that will change, but probably not tomorrow. So, let's let's dive into the earnings expectations and and that uh the fact that they've risen um since uh I don't know when when we last talked, June. Yeah. >> Or or July. Okay. June. July. They're up every week. So, you have an update to that. Let's put that uh table up, John, and Nick will walk us through what we're looking at. >> Okay. So, this is a grid that we've shown, I think, the last two videos, which our clients really love. Um, they don't necessarily love the message, but they love the analysis. What this shows is S&P 500 fair values based on a range of PE multiples from 14 to 26 times earnings. And then assuming we get the current estimate, actually comes true for 2025 and 2026. and then a range of different earnings outcomes. So maybe earnings are lower by 10 or 20% for this year. Maybe they're lower by 10 or 20 or 10% higher for next year. But it gives you a nice sensitivity analysis based on investor confidence as expressed by PE ratios and actual earnings as expressed by this range. And for those of you >> I'm sorry uh Nick Nick before we go forward. So just um to keep the chart up for for clarity just so I make sure I understand this. There are only seven scenarios in which stocks should go higher and then all of and those are in green and then all of these blue or red scenarios represent the market effectively staying flat or declining. >> Yes, that is correct. There are there are 49 potential scenarios on this table >> cuz it's seven by seven. Okay. >> Yes. And only seven deliver upside. A bunch 1 2 3 4 5 six seven are fair value or a kind of fair value and the rest show declines. And all the analysis is meant to show is that we need to we're trading at very high multiples which we all know but we also need to believe in higher multiples or earnings upside in order to be long here because it's not just enough to say hey we're at 22 23 times earnings okay fine we need to say okay I want to make money here so how do we make money we make money when PE multiples go higher or when earnings beat. So, for example, simplest scenario, >> the simplest scenario for 10% upside, 11% upside to the S&P from right here is if we earn $35 a share next year. Now, that's two bucks higher than it was the last time we spoke. So, numbers have gone up a little bit and we do a 24 multiple on those numbers. So, kind of peak.comish kind of valuations. That is the cleanest upside story. >> If you have trouble with that story, you got to think about your stock exposure. I don't and we'll talk about why not. But that is the central takeaway from that grid is that you've got to believe not just that we hold 22 23 that we can get to 24 otherwise it's super hard to justify being along US large caps. >> So how do we um how do we convince ourselves that either earnings estimates will go higher and they've been going higher but continue and or multiples will go higher. What's the story that we need to tell ourselves in order to justify, okay, that's where the upside's going to come from for large cap US stocks? >> Yeah, it's obviously the right question to ask and really dig into and and we've got some fundamental stuff we can talk about in a minute, but let me just give my high order explanation or high order answer to that question. PE multiples, valuations, they're a function of investor confidence in the future. That's what they measure. When pees are 14, no one has any confidence. Like in 2018 or 2020, pe got to 14 in a heartbeat because you had the Fed raising rates or you had a pandemic. Confidence went out the window. Conversely, when you're 22 24 times, like you were 22 times through most of 2020 21, that means investors have a huge amount of confidence. And in that case, it was because we had a lot of fiscal and monetary stimulus that was shoving money into the economy and we weren't going to get a recession. Fine. >> Okay. Now you got to believe in 24 times and 24 times is a little bit higher than dot com. And so the question becomes are you as confident in two things. The first is the US economy and the second is the fundamentals of the companies leading the stock market higher. On the first point I think you can have a high degree of confidence in the US economy because the Fed's cutting rates. The long end of the curve is finally coming down and so the backdrop is pretty healthy and the labor market's squishy but not rolling over. So that's the fundamental answer. I also think you've got a demographic tailwind and you've got less immigrants competing for jobs. Um, and they might not be the same jobs as the jobs that kids coming out of college would get, but just generally speaking, you do have a tighter labor force almost for political reasons. And um, you have a lot of 30-year-olds in this country and they're going to work. They're not It's not the same as when the labor force was so dominated by boomers and a lot of them were just opting out or, you know, via labor force nonparticipation. >> Mhm. >> With a with a population that's heavily concentrated amongst people in their late 20s, early 30s, they're going to work. So, I like I feel like that demographic/immigration story is how you can get past mentally the squishiness in the labor uh market data. Yeah, that absolutely feels right. Um, you know, and we'll see in the next couple of weeks. I that initial claims number last week was a little bit worrisome and there's some commentary that maybe it was due to some fraud in Texas. So, we'll see what this week's data looks like, but it was a three standard deviation above the mean reading, which is by definition hyper unusual. So, I'm I'm willing to be convinced the labor market is still solid. I I do believe it, but I'm also cognizant that the data is not 100% compelling. >> Yeah. Um, now that now that we've got John Voit as the head of the BLS, um, it it should be a little bit more convincing that the data is good. Um, I think that's like a part of the sideshow that's happening here politically is just the upheaval at the the bureau itself >> and um, a lot of like questions now being asked that haven't been asked in a while and maybe should have been like, can we even trust the veracity of this data or how it's collected or what it means? Um, but that being said, if you believe in the data, it's not as strong of a labor picture as it was a year ago, two years ago. >> Absolutely. And look, I mean, as a sidebar, it is strange that we measure unemployment the same way as we did in 1948 with a survey uh of households and businesses. And I understand why that's the case from an economic analysis standpoint. You want continuity of the data series. But it is pretty astounding that we measure and manage a huge economy with the same basic math as after World War II. >> Okay. All right. So if if we're at the current valuations and the plan is to remain long and uh you know hope for one of those blue or green outcomes either fair value or the market has room to trade higher in the near term then we have to get comfortable with the individual components of of the indices themselves. So, let's start with uh let's start with Nvidia. It's the biggest most important stock in the world. It's where a lot of the uh growth is coming from for the S&P 500 this year and next year. Uh and I know you've got uh an interesting way of thinking about um the fundamentals of the Nvidia of today versus their counterparts from 30 years ago, 25 years ago. >> So, we did this a couple weeks ago for clients and let's pop up the Nvidia Intel comp and I'll talk walk you through it. So this is Intel's second quarter financial results some basic measures and um sorry Nvidia's and then this is Intel's financial results in 1999. So literally apples to apples what they have in revenues margins and so forth. And the upshot of this data is I'll just run through these numbers. Nvidia's operating margins are 1.8 times as high as Intel's in 1999. Intel powered obviously the PC boom in the late 90s. Nvidia is powering um AI. So kind of equivalent in terms of their position in the market. Net margins, Nvidia's net margins, dollars of income for every dollar revenue, 2.3 times what Intel's was, 57% versus 25%. Nvidia's asset intensity is eight times less, eight times better than Intel. Intel ran its own fabs in the '90s. Nvidia doesn't. So Intel has 20 times revenues to PPE turns. return on equity. Nvidia's is 106% ROE annualized based on Q2. Intel 99 was 23%. So Nvidia is 4.7 times better on ROE than Intel was. And Intel was no slouch. It was a great company. And then if you compare the size, if you inflation adjust Intel's revenues in 1999 to now, it's like 57 billion. Nvidia's annualized revenues just based on Q2, $187 billion. Nvidia now is three times the size of Intel on an inflationadjusted basis and it's 7.5 times more profitable. It's making annualized $106 billion. Intel would have made $14 billion inflation adjusted. So the upshot here is Intel is just a hugely better business than Intel was in the 90s. Nvidia is >> Nvidia is a better business. Yeah, >> Nvidia is much better. Intel looks downright industrial compared to the Nvidia numbers of today. It's like, and this is apples to apples because Intel was probably the most important stock of that time. Some would say CIS. Some would say Cisco, but like it's a semi. So, it's a better comp to Nvidia. Number one, and number two, it was every bit as elemental to that bull market. That bull market was about the PC revolution combined with the internet combined with server uh demand and and uh laptops and even phones eventually. So Nvidia is I think uh I Intel I I think is the right comp to Nvidia of today >> and you illustrating that Nvidia is seven and a half times more profitable than Intel. All right. So maybe we don't deserve a multiple that's seven and a half times higher. But >> 2x, why not? >> It should be higher, right? Is that like a very obvious? >> Yeah, absolutely. And this so two points. First is I also ran the Cisco numbers. Intels were better, which is why I popped those up, but we also have the Cisco numbers in our report. The second is that this is the crux of the problem with valuations today. And we have other examples, but let's just sort of hit this now. I don't know how you value these companies versus the 1990s. I just know that you have to value them more highly because the returns are better, the margins are better, the asset intensity is lower, the competitive advantage is better, and we'll touch on that in a second. And the upshot is, is it worth 2x a multiple of 1999? I don't know. 50%, I don't know. It's definitely more. And that's what the market struggles with. That's why we're at 22 times earnings because the market knows we're better than we were in the '90s. We absolutely are. What was what was Intel's peak multiple back then? >> Yeah. 24 and change. 25. >> Okay. So, it's absurd to say that Nvidia should be worth seven and a half times that. Um, you know, like obviously because a uh it's unlikely that they will preserve their their operating margin. >> Yes. >> Um, it's even more unlikely that they'll keep the revenue growth rate. Mhm. >> They're not telling people they can. Nobody honestly should expect that. So, okay. So, but is it like outrageous for Nvidia to be valued at twice as much as Intel was? Not really. >> Not really. No. And not with those returns on capital. I mean, this is kind of a grimy financial analysis topic, but 100% ROE is insane. >> 100%. You're taking your equity and you're earning all that money for your shareholders every year. Two companies do that. Nvidia is one, Apple's the other. >> Yeah. It's right. It's It's not something that you would expect to be repeated across 20 different companies. >> No. >> So, it's extraordinarily unique. >> Yeah. >> Okay. You have another comparison. You have Meta versus IBM. >> Yeah. Meta Meta of today IBM in 1999. This one was just sort of a sentimental choice for me because I remember Lou Gersonner and IBM in the 90s and it was one of the bestrun most highly regarded companies on the planet. And so this lines up Meta's Q2 and IBM's 1999 and they're kind of remarkably similar in some ways. The ROEs are actually exactly the same at 37.6%. >> And interestingly, IBM was a more capital efficient company at a PP&E level than Meta is today. But where the difference comes in is in margins. IBM was a 9% margin business in 1999. Meta is a 39% net margin business today. 4.4 times higher. So Meta is expressing a much stronger level of competitive advantage, meaning it has a stronger moat by virtue of showing those margins than IBM did in the '90s. And IBM in the90s was a fantastic company. Meta is just way more fantastic. And interestingly, when you inflation adjust the revenues, Meta of today is almost exactly the same size as IBM in 1999, like 190 billion versus 170 billion in inflation adjusted revenues. But Meta makes five times more money on an inflation adjusted basis. It's making annualized $73 billion. IBM inflation adjusted would made $15 billion. So Meta by virtue of margins, by virtue of size, is wildly more profitable than IBM in 1999. And and for those of you who remember IBM in the '90s, this was a well-run company. This was a well- reggarded company. >> Can I uh also point out, and I don't think it shows up in any of these particular items, Meta is way more aggressive about investing for future growth. And probably that was the problem that IBM has was that it was way too focused on returning capital to shareholders and not thinking big enough about technology in the as decade and the 201s decade which is why effectively the stock price did nothing for I don't know 16 17 years until re you know recently um whereas Meta is full throttle we don't know whether or not all of that investing is going to pay off. But what we do know is that they are not managing um future growth the way that IBM was. >> Yes, that's an excellent excellent point. Totally agree. >> Okay. Um do we think given this do we think that Meta is appropriately valued relative to the way IBM was being valued at the top of the dot bubble in 99? So for for for a higher valuation or is it pretty much already getting it? >> I think you touched on exactly the right point which is what's the investment profile of Meta versus IBM back then and Meta is doing you can argue about how much they spend but they are putting money to work in anything that they think will grow. So they you know tried the metaverse they renamed the company for the metaverse that didn't exactly work out but they didn't deter them from taking another swing when it came to LLMs and Genai. So they're still trying and I think your point is so well taken that IBM in the 90s was writing the PC boom but then they kind of gave up and because they didn't make their own chips very much they didn't leverage Moore's law and then they missed cell phones they missed a ton of things and they were dead where Meta is still in the game still trying and I think you have to attribute that a lot to Zuckerberg being the founder who still runs the company and whose wealth is tied up in the value of that company and he's not going to let it die that way >> right Gersonner was a boardappointed CEO not a founder. Um, this is Zuckerberg's baby. I also think Zuckerberg does not like giving Apple a third of of uh the profits from from Meta's apps and they seem to be hellbent on creating their own device platform uh starting with the Rayban uh glasses. Yeah. because whatever the next form factor is for the AI age internet, I don't think that they want to be um taking a backseat to Apple in terms of where do the profits get diverted from all of this activity. I think they'd like a primary relationship with their users um and and putting that equipment in people's hands. >> IBM gave away its computer business to Asia. >> Yes. >> They they they went the other they went the other way is is my point. >> Yeah. >> Um All right. And you've got one more and this is a fun one. Microsoft in 1999 versus Microsoft today. >> Yes, this was another another like you said another fun one because it's nominally the same company, same symbol, same you know everything but the companies are very different. Um the margins are relatively similar 39% then 36% now net margins but Microsoft interestingly is a much more PP&E intensive company now than it was in the '90s. It was very lean back then. Um, so it spends a lot has a lot more money invested in equipment in in hardware. Um, it still doesn't matter because their roe are higher now than they were in the 1990s. ROE's now is 32% back then 27%. So Microsoft's a slightly better business. But the magic of this analysis is back on this bottom two lines. If Microsoft had grown by inflation since 1999, it would be about a $ 38 billion revenue business, about a $15 billion net income business, just if it grew by by inflation, CPI. In reality, it is a $300 billion business. So basically 10 times what inflation adjusted should have been. And it's making $ 109 billion in net income versus 15 inflation adjusted. So call that eight times more. And this to me is explains the power of technology generally because here's a company that has held margins the better part of 30 years and grown 10x where it should have been just given inflation growth. That's the power of technology. Moore's law, the permanence of technology as a driver of revenue growth, of net income growth. And so you end up with a company that is orders of magnitude bigger than you would have thought possible 25 years ago. What's so interesting is right just after this 1999 periods worth of numbers is when Bill Gates steps down, hands the reigns to Steve Balmer. Bomber then presides over 16 years of modest earnings growth but a flat to down stock price and ultimately the company makes this fullbore pivot into cloud computing builds the second largest cloud computing platform in the world and that's how you get a company that if they were just muddling along selling office uh uh software and operating systems it's you know and maybe a little bit of revenue from Bing and Xbox. It's a $ 38 billion business, but they didn't do that. They reinvented themselves for the cloud era, and that's how it gets to 300 billion in revenue. And they take the cloud guy and they make him the CEO. And uh Bomber goes off to the NBA. So, it's a it's a I agree it's a really fascinating what if like what if they had not built Azure and had not gotten into the cloud to the degree that they did be a very different story here. >> Totally. it it would be the CPI numbers, not the numbers that are today. >> Okay. So, your upshot here is that big tech business models have gotten a lot better over the last 30 years. Better margins, more efficient companies, faster growth, more defensible modes. And to look at today's valuations versus 1999's doesn't quite tell the right story or doesn't give investors enough credit for being smart enough to know that things have changed. >> Yeah, that's exactly right. And I'll sum it up is, you know, I worked for Steve Cohen for a couple of years and one of his favorite sayings was math is not an edge. If you can do it on a calculator, it is not an investment edge. So, as much as I respect the PE multiple analysis that we started with, and obviously I dedicate some time to doing it for our clients, it's the reasons why those numbers are the way they are that actually make the investable edge. And I've staked my, you know, my thesis on the idea that these companies are substantially better than the ones that were met that we're benchmarking against in the 1990s and deserve a higher multiple. So, I'm totally comfortable with a 22 multiple on the S&P because we're looking at companies that are orders of magnitude better at the top of the stack than they were in the late 1990s. Not just in terms of size, but cash flow and ree everything. >> To your credit, this is something that you've been saying for 10 years. And I know because I've been reading you and this was it's easier to say today because we've all kind of accepted it. This was not popular to have said five and ten years ago when people were still carrying on about cape ratios and everything was a comparison to 1999. It was not a popular thing to say yes multiples are high and here's why that's a good thing because the market is recognizing that business has changed and some businesses are extremely unique. Now, I feel like most people have gotten over that and they get it. But back then, it just looked like, "Oh, Nick's being complacent again about elevated multiples." Like, like, "Here we go again. This time it's different." Blah, blah, blah. It turns out this time it was very different. And I want to give you credit as somebody who recognized that a long time ago. >> Thank you. Yeah. And I'll tell you I'll tell you where it comes from. I covered the crappiest sector on the planet for a decade. >> I covered the domestic auto industry >> in the 1990s. And I did it for Steve as well. And that taught me to respect these valuation measures and these return on capital measures because the auto companies are horrible at it. And so when I look at these tech companies, I can see them with fresh eyes and say, "No, this is materially better than anything else I've ever seen. >> This ain't Ford and GM. This is an amazing thing. >> This is not even IBM 999." >> Okay. Speaking of sectors, let's finish with uh this this recent thought that you had. Um it's kind of fascinating to me and I I'd love to have you walk us through um PE multiple expansion and changes in earnings growth expectations. >> Yes. So let's pop the the the visual up. This is something I did for clients last night and I I I'm a little embarrassed that it took me this long to figure out this paradigm, but let's walk through it. The table here shows how every sector of the S&P has performed year-to- date. And we have outperforming sectors on top and underperforming sectors on the bottom. And then we decompose that price return into two things. The first is the percent change in the forward P multiple. How much did P multiples change this year up or down? And then by extraction we know how much earnings expectations changed because the price return is just a function of change in PE and change in earnings expectations. And the takeaway from this is the winning sectors communications, tech, industrials, and utilities average 7% better PE multiples and 9.4% and 4% better earnings expectations. And both of those numbers are better than the S&P as a whole, which was 12% up on the year driven by 4.7% P multiple expansion and 7.3% net change in forward expectations. So the recipe for a winning sector has been on average both a better forward multiple because investors have more confidence in earnings and enough of an earnings momentum story so that the street says, okay, these guys can continue to show better earnings growth than expected. That's the case with in some form almost every outperforming sector. It is not the case with underperforming sectors. So you end up with much less PE multiple expansion and almost no change in forward earnings expectations for losing sectors. And my investment takeaway from this and we can talk about the numbers individually, but the one sector that stands out is financials. They've had some very good changes in Ford earnings expectations, 10%. They've only had 1% improvement in P multiples. That's an opportunity. I think I think financials can work between now and year end and end up outperforming. >> So all right that's the thing that jumps out to me. So in other words the forward PE for the financial sector in January to start the year was 16 a.5 and 16.5 and right now it's 16.7 so unchanged but forward earnings estimates are up 10%. So, the financial sector has gotten no credit in the form of like an upward rerating um for the fact that they're growing earnings this year by 10%. I wonder if you have an explanation for why. Is it just we're trapped in this thing where people think a bank should be 1.5 times book value and that's just what it's going to be? Or do you think there's another reason why financials haven't had the benefit of that rising um multiple? I think it's you touched on a really important one. Banks, bank balance sheets, bank risk profiles, lending standards, credit quality. I think that's probably 80% of it um of it. And so yes, I mean that's that's a group that has persistently had a very low multiple because the bank component of financials which is now call it 40% of the index 50% of the index has this cap in terms of perceived peak ROE but with some deregulation perhaps more deals like we saw last week you get more fintech you get a little better multiple and you let's not forget like Visa and Mastercard and financials now they didn't used to be so we have some potential for you know rerating on some of the growth side as well. So financials to me is like the easiest trade into year end I think. >> Yeah. I think there was a period of time where Mastercard was in consumer discretionary and Visa was in tech. >> Yes. >> Is that true? >> It is true. >> Okay. One of the more interesting stories this year marketwide is in the financials where Robin Hood got added to the S&P 500. Um Coinbase became a a huge market cap company. a firm has done really well. You've got like all of these new fintechy kind of financials that now have a meaningful enough market cap where you know compared to the JP Morgans and the Bank of Americas which are enormous they actually show up. You've also had big turnarounds in Wells Fargo and City >> which are are years in the making. like there I feel like the financials are more interesting this year than they've been really going back to the financial crisis. Um there's a lot of dispersion within the financials. I know there's more dispersion in areas like industrials, but like within the financials you got this big rally, but then you have some stocks that have done incredibly well in there. And uh it's just it feels like it's been a while since people were excited about these stocks. >> It is. Listen, I think you touch on a really important kind of macro point for the market is reratings, better multiples, they will like not happen for years and then they'll happen all at once. And it happens when the group proves itself. And I think this group is really finally starting to prove itself both in terms of growth and in terms of balance sheets. >> Two other things that jumped out at me, just a quick comment from you. utilities um did have the jump in uh forward PE multiple probably because increased demand as a result of the AI capex build out and a lot of these names even the regulated ones are getting rerated because of this new layer of demand. Does that seem justified to you? >> It does. I mean I always struggle with utilities like how much of it's a rate story, how much of it's a secular story. It feels okay. And I think the rate story is probably just as important as the as the secular growth story. >> So rates come down and people are looking for things that still have a high yield. Exactly. Utilities become more competitive with bonds. >> Yeah. Yeah. But you know like staples haven't had the same benefit and staples have pretty good yields too. So you can point to the secular story in utilities to say that's why utilities are working and staples are not. >> Okay. Last one. Um consumer discretionary. I'm surprised by this and I know it's a weird sector because Amazon and Tesla make up such an outsized portion of this, but um consumer discretionary is now selling at the same multiple that it was in January despite the fact um that you did have oh I guess I guess it's only 4% earnings growth for the group. So it's kind of underwhelming >> earnings growth. All right. So that makes sense to you too then you would say. Yes, it does. Okay. For sure. >> Okay. None of these sectors have really fallen off much other than energy in terms of forward PE multiples. Um Oh, excuse me. Have any >> energy is higher? >> Healthare. >> Healthcare. Okay. All right. And that and that's easily explained by just how difficult it is to navigate being a healthcare company in 2025. >> Yeah. Yeah. It's funny if you look at the top 10 names in XLV, the large cap healthcare ETF, like 40% of them are up decently on the year. It's just the rest are just disastrous. >> Yeah. Okay. All right. Uh Nick, this has been incredible. I want to remind people that um if they appreciate your insights, and I know they do, there's a lot more where this came from. And I want to send you guys two places. Number one, you can check out Nick and Jessica on their very own YouTube channel. It's youtube.com/nickcolas and Jessica Rae uh where they are published on a regular basis. And you could subscribe to Nick and Jessica's research at datreach.com just as 1,500 other institutional investors and uh individual investors do and you guys are publishing 5 days a week which I still find extraordinary and uh awesome. So thank you so much for your insights. We appreciate having you. Please say hello to Jessica for us and uh hope to see you again soon. >> Great. Thanks so much.