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00:00We begin this hour with stocks adding to gains to kick off the first full week of the first quarter,
00:04the third quarter.
00:05Mike Wilson and Morgan Stanley writing,
00:07Falling energy prices, peaking tariff inflation, and contained services keep the Fed on hold rather than hiking this year.
00:14Lower real rates should support equities and further fuel the broadening trade.
00:17I'm pleased to say that Mike joins us around the table for the next hour.
00:20He joins us for more. Mike, good morning. Good to see you.
00:22Good morning.
00:23Let's just start with the stability we're seeing in the rates market
00:25and how important that is to set the stage for what you're anticipating in the next few months.
00:29Yeah, I mean, I think you were saying it earlier. I was listening to the show.
00:32I mean, there's somebody expecting a hike. There's someone expecting a cut, and we're on hold.
00:35And this is, I think, what we've got to get used to is that with the new chair probably not
00:39giving as much guidance,
00:40he's going to allow the market to kind of figure it out on its own and have these differing views.
00:46We're in that adjustment period now.
00:47And I think that's one of the reasons why the market's been a little choppy or even correcting in the
00:51last month or so
00:52is we're getting used to this new regime, which is going to be higher volatility and potentially the bond market.
00:58But over time, I think what's going to end up happening is the market's going to settle down.
01:02It's actually more estimates or wider dispersion of estimates actually leads to lower volatility in the pricing over time.
01:08But we're in that adjustment period.
01:10So we think rates are lower ultimately, particularly at the back end.
01:13And, oh, by the way, we've talked about this on the show many times, new Treasury secretary, new Fed chair,
01:19this kind of new Fed Treasury accord to really anchor the back end.
01:25That's what they're focused on. You've got to get the back end down or at least anchored
01:28because you have so much debt that you have to basically finance.
01:31Do you think in the meantime we're confusing a reduction in guidance with an increase in hawkishness?
01:35Just in the meantime?
01:36Yeah, I think that's right. And the market's pricing that now.
01:39So that's the good news is that we've already had that adjustment.
01:42And that adjustment started four months ago, right?
01:45This is why precious metals have traded really poorly.
01:48You know, the day that Worsh was announced as a nominee, the gold market peaked.
01:52And that was a sign the dollar has been stronger.
01:55So once again, the market has really gotten ahead of this.
01:57So rates have reset. We've come down from around 4.2% to 4.1%.
02:01There's a belief this morning, at least, we've removed the urgency to hike as soon as July.
02:05So we can put that story to bed.
02:07Crude's declined. Massive reset in crude from triple digits down to the 60s on WTIs.
02:11Does that open the door within the equity market?
02:13And let's talk about the stock market exclusively.
02:15Does that open the door to the broadening trade again?
02:17Yeah, that's our call, basically, is that that was happening at the beginning of the year.
02:22Then we had Venezuela and then Iran.
02:24By the way, the market priced Iran before the invasion even happened or the attacks happened
02:29because, once again, it was pretty well signaled.
02:32And so that's when the broadening trade stopped.
02:35The broadening trade literally stopped the day that the attacks happened.
02:38And we had the big spike in oil and then the pricing of the Fed to hike rates.
02:43Since, I say, mid-May, which is when we reiterated the broadening call, we had a different view than most.
02:48We thought oil prices would come down.
02:49And that has allowed now Fed pricing to sort of stabilize.
02:52And that has allowed the broadening trade to reignite.
02:55Small caps have performed nicely.
02:57Just had a massive quarter, up by more than 20% on the Russell.
03:00We've seen the broadening trade speak to the performance we've seen in the equal weight on the S&P 500
03:04as well.
03:05Let's talk about the MAG-7, which increasingly was called the LAG-7.
03:08You've got a note out this morning talking about maybe the money going back into the hyperscalers.
03:13Just walk us through how you're thinking about what's happened in tech and that divergence between the big spending companies
03:18and the beneficiaries of all that spending and the divergence that's really widened in the last few months.
03:23Yeah, I mean, there's a symbiotic relationship between the spenders and the beneficiaries.
03:27And typically, they trade sort of in lockstep.
03:30And a couple of things we've been writing about for the last several months.
03:33Number one, capex to sales, that particular factor has been straight up since the big, beautiful bill was passed, right?
03:40That basically, the government's incenting businesses to spend money today rather than later.
03:45And so that capex to sales factor has been driving a lot of stocks higher.
03:49That looks like it's peaking now.
03:51And by the way, the hyperscaler stocks started to trade poorly about a month and a half ago into this
03:57idea.
03:58But that's not sustainable.
03:59You can't have the spender stocks trading poorly and the beneficiary stocks continuing to go straight up.
04:05And now what we saw last week, you know, Meta announced that perhaps they're going to sell some excess capacity,
04:10maybe turn into a provider of capacity.
04:13That is just a reason for these things to take a break.
04:16Also, peak rate of change on revision breadth, right?
04:18The memory stocks, revisions have been spectacular, but they can only go so high.
04:23So all of that's kind of happening at the same time.
04:25And I expect the hyperscalers now to stabilize.
04:27That's what's going on the last couple of weeks.
04:29And the semiconductor stocks are going to correct.
04:32That's a good development.
04:33That doesn't mean the capex cycle is over.
04:36But that ebbing and flowing between the two is a natural kind of governing factor because you can't have this
04:42divergence continue.
04:43It's unstable.
04:44Your words take a break.
04:45That's interesting.
04:46Some people have called it a narrative shift for the overall trade and maybe a shift in spending too.
04:50Why is it one and not the other?
04:51Well, we don't know for sure.
04:53But we've had three of these already, John.
04:54So since ChatGPT was announced in November of 22, we've had three of these sort of mini cycles within the
05:00broader structural capex cycle,
05:02which is that the market starts to question, oh, the return on capital isn't good enough to support this kind
05:07of capex.
05:08What happens then?
05:09The stocks trade poorly.
05:10And then the CEOs of those companies come out and say, well, you know, maybe we won't spend as aggressively.
05:15And then it ebbs the other way.
05:16And so that's the story.
05:18That's the dance back and forth.
05:19Now, there is going to be a period, there is going to be a time, we don't know when it's
05:23going to happen yet, where the capex cycle will exhaust itself.
05:27And we will have, you know, we've talked about this, there is going to be malinvestment here.
05:31We don't think that that spending cycle is over because they just started raising the capital in the credit market.
05:36So they're going to spend the capital.
05:38OK, so but we can have these mini cycles within the structural bull market of capex.
05:43I think, as you know, though, forget the spending that's not yet happened.
05:46It's the intentions that matter and a deceleration in capex intentions from here.
05:51How do you think this market is going to internalize the prospect of that in the coming months?
05:55Well, it's doing it right now.
05:56So we talk about it as a peak rate of change or, you know, trough rate of change, second derivative
06:01growth.
06:02And that's exactly what's going on.
06:03There's two things we're focused on.
06:05Earnings revision breadth for the semi-country stocks themselves are like 75 percent.
06:10That's about as high as it goes.
06:11We've documented that.
06:12So that's going to roll over.
06:13That doesn't mean it goes negative, but the deceleration on that can cause those stocks to correct.
06:18And then, of course, the hyperscalers will benefit if the market perceives these companies as being somewhat capex disciplined,
06:23that they're not going to do willy-nilly spending in a way where free cash flow goes to zero or
06:28negative.
06:29And by the way, free cash flow expectations for some of those companies are going towards zero.
06:33That's why they've underperformed.
06:34So it's this dance, like I said, back and forth.
06:37And now in the last week and a half, the hyperscalers, some of the hyperscaler stocks have started to trade
06:41better.
06:41That's a good sign that we're going to have this little correction.
06:44This could last, you know, four, six, eight weeks, something like that.
06:47And then we'll probably have the next up cycle for the semi-country stocks.
06:49These newer names that were in bear markets.
06:51I'm talking about Meta and Microsoft.
06:52Meta had a better week last week.
06:54Chips.
06:54You keep using this word correct.
06:56When I hear that, I'm just thinking, what do you mean by that?
06:58How much is the downside?
06:59How big is the downside for some of these chip names?
07:01Well, these are high beta stocks.
07:03I mean, they can correct 30%, 40% in a bull market.
07:05By the way, just look at the 200-day moving average.
07:07That's probably a really good gauge.
07:09These stocks are so extended relative to those moving averages.
07:13That's how you've got to think about it.
07:15Those moving averages exist for a reason, right?
07:17They always return to the moving averages.
07:19Does it happen in a violent way or does it happen kind of gradually over time?
07:23We'll have to wait and see.
07:24But yeah, 30% correction in these stocks is, I mean, well within possibility.
07:28In fact, some of them already have corrected 30%.
07:30You can have a 30% correction in chips.
07:32Just bear with me here.
07:34And you can still see the index move up and to the right on the S&P 500,
07:38even with the massive weighting they have on the S&P.
07:40Well, we didn't say that.
07:41That's what I'm asking.
07:42But I mean, that's part of our call too,
07:44is that we think this rotation is happening in a down tape.
07:48Okay.
07:49Unlike the correction we saw in the precious metal stocks in January,
07:53because they're such a small part of the index.
07:55Energy stocks had a big correction after having a great run in January and February.
08:00Now the market traded off a little bit because of the war itself.
08:03But so I agree with what you're saying or your premise or your question,
08:06which is since these stocks are such a big part of the index,
08:10it's going to be really hard for the index to make any upward progress
08:13until this rotation has sort of happened.
08:15This is a summer story for you?
08:17Oh, yeah.
08:17I mean, we're not bearish on the year end.
08:20We're still 8,000 plus for year end.
08:22And we've had that call for quite a while based on the earnings story.
08:26So that earnings story is very much intact.
08:27In fact, the fact that we're rotating now to some of these other areas
08:31almost confirms the thesis we've had all year,
08:34which is this is not just a tech story.
08:36That's a great story.
08:37But the broadening story is the story that I think people have really underestimated
08:41the rolling recession from a year ago,
08:44this operating leverage story, which I think is still very underappreciated.
08:47Do you think the banks can start working now too?
08:49Well, they have been.
08:50I mean, the money center banks and the capital markets banks really have been phenomenal.
08:56Your stock, absolutely.
08:56Goldman stocks, fantastic.
08:58I'm talking about the others.
08:59The regionals.
08:59And so they've started to perform.
09:01And that's been an area we've been highlighting.
09:03Now, the yield curve is flattening still or is having trouble kind of re-steepening.
09:07So I think that group could pause a bit.
09:09We took that off of our list of favorites for the broadening trade this week.
09:13But ultimately, between now and year end, we do think the banks are going to do quite well
09:17because this is the strategy of the Treasury and the Fed is they want more lending going
09:22through the traditional lending sector.
09:25So while the yield curve is flattening, loan growth is accelerating.
09:27And that's feeding this whole broadening out story of the economy.
09:32This is the strategy of the administration.
09:33They want a privately driven organic economic expansion.
09:38And that's what we're getting, notwithstanding that maybe the labor market isn't as robust
09:42as some people were hoping.
09:43But that's also then feeding the earnings story, right?
09:46Because you're seeing revenue growth without a crazy need to hire a bunch of people.
09:50And that's the operating leverage story 101.
09:52We'll talk about that cost discipline through the hour.
09:54Mike Wilson and Morgan Stanley is going to be sticking with us.
09:56Equity futures in this session highs up by about 0.4% this morning on the S&P
10:00with an update on stories worldwide.