“Given the popularity of our weekly Market in Pictures, we started the habit of picking out a few and going into more detail with our PMs. In this edition, John Luke and Dave spend a few minutes on each of the following:
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- Follow Through from April Lows
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- Earnings Strong to Quite Strong
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- Grow the Economy Faster Than the Debt
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- Tariff Rollercoaster
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- “Time of the Tails”
Hope you enjoy, and please send a note to [email protected] if there’s a particular chart/topic you’d like to see covered next month. Time to swing it around!
3 Minute Read: Executive Summary
Full Transcript
Derek
Good afternoon. May 29th, it is Thursday. There’s still another business day in the month, but our guys like to help advisors get ahead of the curve and think about how they want to prepare for June. And it’s been a pretty eventful month, certainly, an eventful couple of months. So here we are. We’re going to talk through some of the stuff that’s been going on. We’ve got Dave Wagner, head of equities, John Luke Heiner, head of fixed income. We’ll cover all the stuff that’s been going on. Some of the main things, earnings, tariffs, debt, deficit, everything that’s going on. And we’ll try to be concise about it. And we appreciate you tuning in. Dave, JL, thanks for joining.
John Luke
Thanks a lot.
David
There’s a lot going on right now, D. Hern.
Derek
There is a lot. Oh, I’ve got to do my disclaimer too. The opinions expressed during this call are those of the Aptus Capital Advisors Investment Committee and are subject to change without notice. This material is not financial advice or an offer to sell any product. Forward-looking statements are not guaranteed. Aptus reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. More information about Aptus’s investment advisory services can be found in its form ADV Part 2, which is available upon request.
So we’re starting with earnings. I remember when we were on either last month or the month before, just talking about how it would be nice to get away from politicians and towards CEOs. Market tends to like that better sometimes. That seemed to be the case. And here’s where we ended up for this past month. Obviously, April ended up I guess flattish after being way down, but May was pretty clearly to the upside. So I’ll let you run through some of that.
David
Yeah. I think a lot of people could be surprised by the performance or at least the magnitude of performance that we’ve seen since the April 8th bottom. But the question I’m probably getting the most right now is like, “Dave, how can we get these types of equity returns given the backdrop, not just of politics …” Actually, not politics at all right now, it’s more focused on interest rates. And I think John Luke has done an absolute great job really covering and foreshadowing the bond market, specifically on the long end of things. And given the recent fee bias of 2022 when rates went higher, valuations came down, it’s not the story right now. So that’s the question I’m getting the most. How can performance be so good given the volatility on the long end of the curve?
Well, my response is that the market’s been focusing on something else right now, and it’s earnings. And it’s obviously some of the jargon on the pullback of the tariffs out of Washington DC that’s really been driving this market. I think the thing I’m focusing more on when looking at this table, because I just ran it a few minutes ago, and you’re getting my raw knee-jerk thoughts on some of these returns, it’s going to be a few things. It’s the continued performance of the MSCI EAFE and even on the EM side. And I’ve been a big believer that the market is the best arbiter out there. And what we’ve seen from the international markets is that it outperformed on the way down from February 19th to April 8th, but it’s actually even outperforming the S&P 500 on the way up.
I don’t think it really changes our thesis on the international side of things, and I put a musing out there not so long ago talking about the concentration in the countries alongside their heightened valuations with low margins and low growth means that, I’m not a big believer in the rally of international, but I think if you want to play devil’s advocate with yourself, right now the market’s telling you something different. Albeit a lot of the rhetoric about performance on the international side versus the US, which is about like 13% or so, is coming from the dollar weakening and valuation expansion on the international side of things. But I think that’s what I’m focusing the most on, is just the give and take on the international side versus domestic.
Also looking at small caps performance. Small caps just really continuing not to be invited to the party. And that’s after, in my opinion, a pretty good earning season by small. Obviously we’re going to talk earning season here momentarily. And large did an unbelievable job, but small still did really well. And as the market’s focusing, trying to figure out if the soft data is going to turn into hard data, if the weak soft data is going to turn into weak hard data, we’re just not seeing that right now. And it seems like a lot of the jargon around the R word, which is recession, has somewhat abated, which should help small caps, but just hasn’t really happened yet.
I think the last thing I’ll look at here too is more on John Luke’s side of things. It’s on the high yield bonds. Really doing well year to date, up 2.8%, outperforming the Bloomberg Agg, which probably would surprise a lot of people. And John Luke, tell me if I have this statistic wrong, but I think it’s a great point of why high yield has been working. It’s probably due to the spreads, compression of spreads. I think it’s like 50% of the high yield index as an option adjusted spread of like 200 basis points, an unbelievably low level.
And if you want to put that in context or relativity, the market tends to see high yield spreads get close to about 700 during recessionary periods at the peak and about 1,000 during the depths of a recession. And so far this year we saw spreads go to maybe 500 base points in the high yield space, but yet somehow only 50% only have an OAS of 200 basis points. It’s kind of unbelievable, but I think any sense you’re really looking towards right now is that a soft landing is still very much plausible in the face of all of the volatility coming out of DC.
John Luke
Yeah, the high yield piece is certainly interesting. The high yield as you think of it today is quite different than maybe how it was thought about 10 or 15 years ago from a quality and construction perspective. A lot of the really crappy stuff went under. And so it’s no longer represented in the index, or at least much less. And many of the names that have either split ratings or the highest rating of non-investment grade are still really high quality companies, or relatively high quality companies, but many of them were fortuitous during 2020 and 2021 to lock in a lot of low-cost debt that was longer dated, which has been kind of a joke within our company, is like, what the heck was the federal government and the treasury thinking not doing the same thing back when rates were much, much lower? It would have alleviated a lot of the pressures that are creeping into markets and becoming much more mainstream the last couple months.
Derek
The numbers are, they are pretty wild when you look over pretty much every time period comparing investment grade to high yield. And it’s probably a whole separate discussion on the construction index. That’s probably a topic for another day, and maybe you can write something up on that, but I do think that that definitely stands out. So cool. Well, we did just come through earnings season. Dave, I know you spent a lot of time with earnings and company calls and all the rest of it just to get a sense of what the outlooks were. I think a lot of people were expecting outlooks to be completely withdrawn. What was your take through the earnings season?
David
Party on, Wayne. It was great. The commentary is much better than anticipated also. I’m writing a musing right now on my overall thoughts. I’m still gathering them myself, especially with NVIDA out this week, being the summation of all the S&P 500 earnings. But go back a month ago with all the uncertainty and the depths of the April 8th bottom, earnings per share was expected to only only to grow 8% on a year over year basis during this quarter. Well, results came in and earnings grew by 14% this quarter. So that means in the last two quarters, earnings per share on a year of year basis grew by 16% in Q4 and 14% here in Q1. That’s substantially above the Mendoza historical average line of 8% to 8.5% earnings per share growth for the S&P 500.
And I’m not too surprised by it. I think a lot of people didn’t believe me on my original commentary when we came up and said like, “Hey, earnings this quarter is going to be good.” And I actually think the commentary moving forward is also going to be better than anticipated. And it was very simple, our logic that really played out. We all know that the S&P 500 as a pretty substantial concentration issue, or at least people say it’s an issue for the S&P 500, with the mag seven equating to like 30% of the index itself. But as the mag seven earnings goes, so does the market, but vice versa also. And the capex spend that we saw come out of Microsoft, Google, Amazon, it just continues to be, Meta, continues to be unbelievably good. And Google said it best a few quarters ago, the risk is underinvestment, not overinvestment. And that thematic just continued to move on here.
And when those mag seven that equate over 30% of the index live and die right now, at least, by this capex number that’s not slowing down, it’s really hard for earnings to get in trouble. And so the mag seven commentary was unbelievably awesome. Six of the seven mag seven companies beat on the top line and beat on the bottom line, the outlier being Tesla. And I think if you delve into the commentary from not just the companies of the mag seven, but some of the cyclicals out there, some of the other bellwethers, commentary is really, really good. I think one of the lines that stood out the most to me was from the CEO of Visa when I was reading through the call, saying like, “Hey, Q1 consumer spending, great.” But the inevitable question always pops up like, “Hey, what are you seeing so far this quarter now that we’re three weeks in?”
And they came back and said, “You know what, actually it’s even better than what we saw during the first quarter from a spending perspective.” So you’re really just not seeing that translation of the weak soft data turn into the strong hard data just yet, not just last quarter, but this quarter date so far. So all in all, it’s really good. And I think people have got to recognize the different levers that corporations and equities as a whole can pull to get some type of earnings growth. Obviously, to John Luke’s point that he always makes, bonds don’t have levers to pull for growth, only equities do. And even though there’s some uncertainty and some decision-making abilities, capex slowed a little bit on the S&P 493, but that just gave them the ability to go out there and repurchase stock to an extent where margins started to expand, and the market liked that because that drove a lot of earnings per share growth.
A lot of people throw shade probably at that, that it was engineered growth. But all in all, it’s still growth. It’s still tangible growth for these companies investing in themselves, which is something that you absolutely love to see. So it was a great earning season. Obviously people are going to say that, “Well, the focus needs to be on Q2 season. No one cares about Q1.” But the commentary is really strong. And I think that’s why we’ve seen pretty tremendous stock market returns over the last, call it six weeks.
Derek
Right. So corporate America’s doing all right. How’s the government doing?
John Luke
Private sector can figure out problems. Public sector, eh.
Derek
How are we doing there?
John Luke
Yeah, so we’ve gotten a bunch of news, and Scott Bessent is probably one of the more respected treasury secretaries that we’ve had in a while, where he actually came from true money management side where he’s had a real job and not gotten a paycheck from either academia or the government for his entire career. So a lot of folks, including myself and the team, have really paid attention to what he said. And he came out last week with some sour-ish thoughts about the fiscal backdrop that the administration has inherited from the Biden administration and the fiscal spending obviously being substantial, probably overly substantial, part of GDP growth the last several years. And the thesis of what he was saying that has to be done is, you have to continue to grow the economy at a faster level than the debt grows. And so going back to our three ways of getting out of a debt problem that we’ve talked about for a long time, you deflate out, you grow out, or you inflate out.
Sorry, you grow out, you inflate out, or you burn it down. Austerity. We know austerity isn’t an option. The thing that we thought the way out is that inflation lever, and hopefully you get some part of gross. And what this chart is really just showing is, with public debt to GDP near 100%, obviously the government debt’s a hefty chunk of GDP from a total, there’s a ton of treasuries in existence, $38 trillion of treasuries. So you look at the deficits that we’re running, you look at the effective interest rate, and what essentially Scott Bessent is telling us, and I think this applies to our asset allocations and how we’ve constructed portfolios, is, you have to run nominal GDP at about 6.5% to slightly higher in order to just keep the debt to GDP metric stable. And so going back to those three points, nominal growth has an inflation component embedded in it.
And so we think that there’s going to continue to be the emphasis to grow our way out of this problem, which is just really bad for long-term bondholders, full stop. And so if you look at periods where GDP has run above that 6.5% nominal level, it’s really only been a handful of times. The secular inflation that we saw from the mid-’60s to the mid-’80s, and then bubbles, so the dot-com bubble, the housing bubble, and then post-COVID where we really ran hot during that period. And so the backdrop in our opinion is like, just listen to what the government officials are telling us. And I take a little bit more credence to someone that’s actually navigated difficult markets and environments for the bulk of their career. And he’s really just telling investors, don’t own long-term bonds, which is kind of interesting, because he’s basically the US salesperson for all treasury bonds and has to get someone to buy them. So our thought is, we’re not going to be that guy.
Derek
John, you said it great the other day on a call, Scott Bessent has given investors the playbook, and yet people are still shying away from that playbook, and it’s right in front of them. And it’s the exact point that you just said. Hey, fiscal spending is going to be higher because we need to get some type of growth. We’ve got to go faster than the debt to GDP ratio, and we’re going to do it. And it just shows you the debasement case that we continued to make, the case not to own long-term bonds and the need to own risk assets, which is stocks. And that was the exact playbook Bessent came out and said. You need to be doing this.
John Luke
Yep. And if you take it to another chart we’ve showed, which, it shows real returns of bonds looking back to 1900. And I don’t have that one in the presentation, but essentially from 1900 to 1981, bonds lost money on a real basis for 81 straight years. Then rates got jacked up with Walker, and we saw a steady decline of disinflation and weakening growth. And so bond yields rallied drastically from the mid-’80s until COVID, effectively. But you had 81 years where bonds were a legitimate certificate of confiscation. And it just seems like that’s probably the playbook from here. We’ve seen high debt levels in the past after wars and other events, and back after World War II they implemented yield curve control for a number of years to really cap the yield on treasuries. And effectively that’s just the government debasing you.
And another chart we’ve shown drastically is just purchasing power over the last 50-odd years, and your $1 million 50 years ago, in terms of purchasing power today, it’s worth about $130,000 in terms of what you could actually buy with it today. And said another way, in order to have the same dollar today as $1 million was 50 years ago, you’d need over $7.5 million to have the same purchasing power. And it’s just debasement. That’s how governments work long-term, is they have to, we live in a debt-driven world, and you have to debase the value of that dollar to service the debt.
Derek
Yeah, obviously there’s a lot going on. As far as that, debates with the Fed, and I know the Fed minutes came out this week and there was something about Trump and Powell actually spoke today. I’m curious your opinion there on the Fed. Are they even in a position to do anything either way?
John Luke
Well, in the graphic we have coming up on tariffs, I had some thoughts on potentially how the Fed could spin that, but it’s a difficult backdrop, because Chairman Powell also has a pretty distinguished career in the private sector. I don’t think he likes being bulldog-ed around. We know Trump likes to be the bully, and it’s going to be hard for him to bend the knee to just do what Trump says. I think that Trump’s probably made it even more difficult for himself by pushing that button with him. I do think that if you do have, like we saw last night with the tariff policy being upheld in court as unconstitutional and not an option, since the Fed has really leaned on the fact of tariffs creating this inflation uncertainty and hence unwillingness to cut rates, that, well, if tariffs get back down, could that put the Fed in a spot where they could cut rates quicker?
But I think ultimately what the Fed has been doing is, by keeping tight, they’ve tried to protect the long end of the curve ultimately by not letting it get too overheated. And it hasn’t worked super well now with 30-year rates over 5%.
David
And that’s globally, the long-term rates are just getting obliterated, whether it’s Japan, the bonds, all of them.
John Luke
UK, yep, all of them.
David
This chart here is obviously talking about the wildness that we’ve seen with tariffs. And to John Luke’s point, last night, we’re recording this on May 29th, there’s some news that federal court was coming after Trump’s IEEPA utilization to impose these tariffs. And I think my knee-jerk, because I don’t want to get in the minutia of policy and the 19, was it 30s, tariffs act. You get into all these details and go into weeds, but the Trump team is going to try to find a way to bring tariffs back to the table. I would say the big news that comes out of this data for me, out of this information for me, is that trade negotiations are likely to become more difficult right now, at least in the short term, given the trade partners. There’s no need to cut a deal right now. I wouldn’t say that the July 9th deadline from the 90-day pushout, it doesn’t mean anything any more, but it definitely means less.
But I think the big questions we’ve got to be asking ourselves in regard to that news is, what happens next? And also, what do we need to be focusing on? And on the former, what happens for here, I’d say that there’s just a slew of methods that Trump can reimpose tariffs. I think those could be really two things, at least from what I’ve read, and I’m not a pro here, I’m very much a novice. But there’s some lines in the section 338 of the 1930s tariffs act that would allow up to like a 50% tariff rate. And I think that’s why Trump came in with the 10% across the board rate, knowing that this was not a loophole, but a secondary ramification that he’d go if he was challenged here in court. And then there’s also the balance of payments authority that allows for Trump to impose tariffs on countries with large trade deficits, but limits that rate to 15%.
I would say that that authority is temporary, as it gives Congress 150 days to vote on this measure itself, obviously which they would not pass, but it definitely buys Trump and his team to find another type of workaround with those 150 days. So I think today’s reaction with the market that was up maybe 40 basis points a day or the day after this announcement, where majority of today’s performance was contributed from the NVIDIA earnings last night, that the market doesn’t really have to think too much about this because they know tariffs are going to continue to stick around and Trump’s team is going to find some type of way to instill them in place.
John, the last thing I would say before I turn it over to you is the latter point that I made. What am I focusing on here with this news of the federal court blocking the tariffs? It’s probably the tax bill. What is it called? The one big beautiful tax bill here that made it through the House and is on its way to the Senate right now. Because tariff revenue, it’s growing at a pace right now, it’s so far year to date like maybe $190 billion year to date right now from these new tariffs. But if you include all these tariffs over the next 10-year window, it’s roughly equal to the 10-year cost of the tax bill. If these tariffs are removed and not replaced through other means, the US deficit is just going to be larger than otherwise would have been the case.
And so I believe that these tariffs will get reimposed through other methods that I just explained, but the bias is another headwind for long-term bond yields just in the short run, because there has to be some type of pay-forwards, which are supposed to come from tariffs, to not allow these individual tax tax things that are supposed to sunset at the end of this year to move forward. There’s a necessity for that to happen. So all in all, I think this just creates more volatility, while the knee-jerk reaction is probably positive because it takes the tariffs kind of out of the question. But there are going to be other workarounds here, and I think the focus should be on the ramifications on the pay-forward and what we can get from the tax side.
John Luke
Yeah. Well, we know Trump probably knows the courtroom better than a lot of lawyers do, just given his background. So I would expect him to aggressively look for the different varieties of loopholes or other legal ways that he can get around some of the court rulings to keep imposing tariffs to some degree. As much as he’s run his whole campaign and the start of his administration on increasing tariff revenue, it is very hard to see him, like the Muhammad Ali quote about getting punched in the face, I think he gets back up and punches right back. And the two big pieces are, number one, that tax deal of, how do you replace the fiscal measures in terms of the tax revenue that was expected to come from tariffs and was key to passing the bill?
But the second piece goes back to the Fed, and does it change the rate or the speed to which that they’re going to cut rates? And they’ve argued that inflation from tariffs is really what’s kept them on the fence from cutting policy further, even though some of the data I think would say that their policy is restrictive and there’s some room to cut. So whether that plays out or not, I guess time will tell. But if there is an abrupt halt to tariffs, I think that that could push the Fed to cut rates faster than maybe what the market’s expecting.
Derek
All right. So we’ve talked about a lot of the stuff that’s really in our face right now, April, May, June, stuff that’s going on. This is always a fun one to come back to, because it does stretch things out and put things in a little bit of perspective. Dave, you always reference, when you’re doing presentations, everybody says, “What’s the average return for stocks?” That’s like 8%, 9%, 10%, somewhere in there. Well, it never does that in a given year, right? I mean, never. So we’re probably, you can quote the stats, but chances are we’re not going to end up at an 8% to 10% gain, even though that’s where all the strategies start every year. So talk through this one a little bit.
David
Yeah, this is something that we just always, you have to harp on and come back to the asset allocation, that tails are just going to occur more often than not, or at least what we’ve been accustomed to. And the stat you’re referring to, Derek, is that if you go back to 1950, there’s only four years where the S&P 500 had a return between 7% and 9%. That’s what, 5.6% of the time? The average doesn’t happen. The tails occur more often, and they actually occurred a lot back in the day. If you go back to 1924, if the S&P 500 was up in a calendar year, it was up on average by 21%. If the mark was down during the calendar year, it was on average down 13%. Over the last 100 years, tails have occurred in the market more often than not. And I think given the composition of the benchmark, I’ve written a lot about this, exactly what our outlook was heading into this year, that tails will just continue to happen more often and probably at more of a grandiose scale than what’s been occurring over the last 100 years.
I would say that I had another point in my head that I wanted to bring up, but … Oh, it’s this one. In this decade, the 1920s, it’s only been five years, four, whatever, it’s, we’ve seen three 20% pullbacks this decade. 2020, 2022, and then March and April of this year. And if you go back over longer period of time, as far back as I had to go, you’ve never seen two 20% market pullbacks so close in a timeframe, ever. And yet now we had another one just three years later from 2022, so we’ve seen three 20% pullbacks. That just doesn’t happen. We’ve seen the market pull back fast and then rebound fast. I’m a big believer that the faster the market pulls back, the faster it gets back to break even or all-time high. Then the slower there’s a pullback, the longer it takes to get back to where it was previously.
But given the introduction of Fed policy and fiscal policy, we’re probably just going to continue to see more sharp declines and sharp, not pullbacks to the opposite points, but rebounds. And I think that’s why it’s so important that one needs to do better in the tails, the left tail when the market pulls back fast, but also in the right tails when the market rebounds fast, and the need to be active when the space and not be calendar constrained, because volatility happens interquarter. There’s not just peak volatility to at the end of the month or at the end of the quarters where a lot of these calendar constrained products can benefit from. You have to be very advantageous and active, because volatility con strike at any time and not just at the end of a month or at the end of a quarter. And that’s what we exactly saw in the first quarter of this year and part of the second quarter so far. So just be prepared for more tails moving forward. Good tails and bad tails.
John Luke
Yeah, the DC volatility has certainly increased, and arguably that was the left tail that we saw in March and April. And then like you said, quick fall and quick rebound. So arguably two tails within the last two, three months, with March and April being down and the past six weeks or so being hard up. And so I think that it’s just likely that those are here to stay. But going back to the first or second chart that we showed about growing our way out of this debt problem, you don’t grow your way out of the debt problem if there’s a recession, because think about tax receipts or highly correlated stock returns. This year we had records tax receipt collection with a really strong market in 2024. So I think running it hot also benefits the government from a tax perspective, of people realizing gains and selling stocks and having to pay taxes on it.
So just going back to what that means for markets and what that means for the economy, we have to run our way out of this and grow our way out of this. And if you look at the left tail types of environments, and as a backdrop, well, the Fed’s got a lot of ammo that they can cut rates into, they can turn back on QE, which probably happens even without a recession, where the Fed balance sheet continues to grow. There’s just a number of tools that I think are there to insulate the left tail. So you really need to be advantageous and take advantage of them, but still keep that at that allocation geared towards owning stuff that can grow.
Derek
Well, I think for better or worse, we’re getting into June. The earnings boost and support and distraction that came is pretty much over, right? You’ve got NVIDIA, NVIDIA just came out, now you’ve got maybe some of the retailers.
David
Broadcom next week are coming through.
Derek
Okay, so Broadcom. But in general it could be back to tariff talk and the rest of the macro type stuff that swings markets around. So I don’t know if there’s anything else on your radar.
David
A weak period too, from, what is it, April until September. All the PMs, except Aptus, of course, they all go on vacation and summer vacation and don’t do a whole lot. But it tends to be a pretty quiet period. But historically speaking, we’ll see if that reigns true given all the talk out of DC.
Derek
Awesome. Well, thanks for making the time, guys. Always appreciate it.
John Luke
Thanks, fellas.
David
God bless America.
Derek
All right, see you.
Disclosures
Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The information contained herein should not be considered a recommendation to purchase or sell any particular security.
The opinions expressed are those of the Aptus Capital Advisors Investment Team. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Forward-looking statements cannot be guaranteed.
Aptus Capital Advisors, LLC is a Registered Investment Advisor (RIA) registered with the Securities and Exchange Commission and is headquartered in Fairhope, Alabama. Registration does not imply a certain level of skill or training. For more information about our firm, or to receive a copy of our disclosure Form ADV and Privacy Policy call (251) 517-7198. ACA-2505-26.
