00:00We begin this hour with stocks holding at record highs as the AI trade gains momentum.
00:04Binky Chata of Deutsche Bank writing,
00:06It is hardly a surprise that growth for a variety of industries is being boosted by AI,
00:10but management comments make it clear that demand strength is much broader.
00:15Binky joins us now for more. Binky, great to see you.
00:17Good morning.
00:17Happy almost summer. It feels like we're almost getting to vacations.
00:21I am curious how much you see the recent rally as confirmation of the bull case
00:26or potentially creating more fragility heading into a more volatile period.
00:30So what I would say is, you know, definitely confirmation of the bull case.
00:35So this is the second quarter in a row where in the run up,
00:38the market was basically in a relatively tight range,
00:42perhaps more pronounced in the previous quarter where the range went on for six months.
00:47And then, you know, as earnings are growing, equities are getting cheaper, essentially.
00:53And so when you do get earnings and you do get big positive surprises,
00:57as we did in both of the quarters, you've seen the market basically ratchet up.
01:02So that's number one.
01:03Number two, what I would say is plenty of gloom,
01:07plenty of reasons to think about why we're going to get a pullback.
01:12And typically before the midterm elections, the market does tend to flatten out
01:15as people buy protection for, you know, potential volatility.
01:18But, you know, that's the negative side.
01:21The positive side is you typically get a very strong rally afterwards.
01:24Midterm election years, 21 out of 23 are positive.
01:28So risk reward is positive.
01:31And the average returns 7% in the fourth quarter in midterm election years.
01:36So, you know, the risk premium gets put on.
01:39It gets taken off.
01:40But I would say the S&P 500 is, and I, you know, think that sometimes it's not really well
01:47appreciated.
01:47If you look at the S&P 500 the last four years, so four years from the bottom in 2022,
01:54this is very, very clear, very, very steep, 23% price appreciation at an annual rate in place for four
02:02years.
02:02And what has the recent rally done?
02:04It has taken us back to the bottom of that channel.
02:07We have not really been inside the channel since Liberation Day.
02:13So the market is still relatively cautious.
02:18And, you know, what this chart suggests is that the risks are, you know, pretty strongly to the upside.
02:24The bottom of that channel on December 31st is 8,500 on the S&P.
02:31And it's been in place for four years.
02:34You have to have a very good reason for why that's not going to happen.
02:37You talk about how this has been broad-based growth.
02:40And that's one of the reasons why you've seen the Equal Way outperform so significantly over the past couple of
02:44weeks.
02:45How much is coming just by efficiencies, whether it's AI or whether it's post-pandemic lessons of how to create
02:52more efficiencies,
02:53rather than true consumer strength driving growth?
02:56Yeah, so I wouldn't say it's necessarily consumer strength.
03:00It's more about industrial and company strength, I would say.
03:05And I would emphasize as, you know, that it's not just really about AI.
03:10You can take the S&P 500, divide it up into AI and its beneficiaries and everybody else.
03:16That would be 30% and 70% of the S&P 500.
03:19And if you look at the contributions to, you know, what is absolutely unimaginably off-the-charts growth that we're
03:28getting in the second quarter of 34% a year,
03:31we're not talking about a tech company, we're talking about the whole S&P 500, you know, we have basically
03:39equal, almost equal contributions from AI and the rest.
03:45Where is that coming from, which was about your question?
03:49You know, I think you have to keep in mind that it's partly circumstantial.
03:53We had the ISM manufacturing, which is historically the best cyclical indicator for S&P 500 earnings and the market,
04:00actually.
04:01It was in a funk for three and a half years.
04:03It was below 50.
04:05That happened to, you know, go vertically up in February.
04:10And so the first quarter, because it's February, you know, most of the effects don't come through.
04:16But if you look at the second quarter, ISM manufacturing has continued to not only sustain, but move even higher.
04:22And if you look at it, it's not that high.
04:24So it can definitely go higher.
04:27So this is AI accelerating, cyclical growth kicking in, and the war in Iran helping oil and commodity prices.
04:34So you have three things happening together.
04:36In terms of the equal weight, in terms of ISM manufacturing, I would say that's, you know, the most unappreciated
04:42part, perhaps.
04:43And that's, you know, a big kicker.
04:46Because typical economic recovery is just about ISM manufacturing, if you boil it down to what's driving the earnings.
04:53And in your note, you put together a lot of memorable quotes from corporates this quarter and how everyone keeps
04:59using the idea that this is broad-based.
05:01Yeah.
05:01Do you have confidence that it truly is broad-based?
05:03Yeah, it's really the ISM manufacturing that, to which the earnings growth is actually very well tied.
05:10And you think it continues?
05:13Absolutely.
05:13So if you look at the bottom-up consensus, which typically I would remind gets beat by about 5%, it
05:25just got beat by 7% to 8%.
05:28It's looking for growth both in Q3 and in Q4 currently, and both estimates continue to rise.
05:36It's at about 25% for each of the quarters, which is 24% and 26%.
05:41And so the bottom-up analyst consensus, which I would, without being personal to anyone, it tends to be pretty
05:50risk-averse.
05:51It doesn't get in front of things.
05:52And like I just said, it tends to get beat, is in a bit 20.
05:55So I think, you know, the boom is here.
05:59The boom is likely to sustain.
06:02But so is all the gloom.
06:04Which is partly a good thing, right?
06:06Because then you can climb the wall for it.
06:07So if you are an analyst that's doing ground-up work, he just said that you'd sandbag every single time
06:11and that essentially it's always better.
06:13We're getting 34% earnings.
06:14And what everybody wants to talk about is this peak earnings.
06:18And if you think about whether, you know, the market's positioned for that or whether this is priced in.
06:23I won't go into the multiples.
06:24What I would say is equity positioning is aligned with 14%, 15% growth right now, which is not bad
06:31growth.
06:32But we are getting 35% and likely to get 25%.
06:36So positioning, you know, there's still upside for the market.
06:39If you were just looking at this kind of market and you said the benchmark rates were at some of
06:44the highest levels that they have been going back a couple decades,
06:47you probably would be surprised.
06:49In the past, that would be a limiting, constraining factor.
06:51This time around, it hasn't been or has it?
06:54I mean, would the S&P be at a much higher level, at a much higher multiple if we did
06:59have lower rates?
07:00Or are we looking at a rate-insensitive equity market unless they remain on hold or unless they potentially hike
07:06rates really considerably?
07:07Yeah, so I would think it's no more or less impactful rates on equities.
07:16If you look at the one period where – and I would argue it's essentially one period where, you know,
07:24increases in real rates, it really caused the equity market to go down.
07:29And so if you look at the historical sample and why most people conclude that higher rates are negative for
07:34equities comes from the Volcker, a very, very severe hike.
07:39And if you look at the equity market during that period, you'll see that through most of the rate hikes,
07:44the equity market was going up.
07:46It's only when Mr. Volcker convinced the equity market that he was going to cause a recession that was worse
07:52than anything that they had ever seen,
07:54that because of the expectations for what would happen to growth, that we went down.
07:58So I think rates by themselves, I think the lesson of the last few years is that it's not about
08:04the level of rates, which is what most of the discussion is about.
08:08It's really been about rates volatility.
08:10So we hike by 50, so we cut by 25, maybe we go 75, maybe we hike on a Sunday
08:15afternoon through the Wall Street Journal.
08:18I think those days are over.
08:19There's a lot of volatility and it's that volatility which temporarily impacted equity markets.
08:28And as soon as that volatility was over because the Fed was either done hiking or close to getting done
08:32hiking or just simply moved to 25 basis point hikes,
08:35which is what happened in 2022, volatility collapsed and equities rose.
08:42And that's the channel we've been in for four years.
08:45So
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