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Derek

Hello, hello. It couldn’t be any closer to the end of the quarter. This is pretty nice work by all, getting us ready at March 31st, 10 minutes after the market closes. We’ll give people a minute to make their way in.

All right, looks like we have a good crew. Let’s get to it in case we get wordy and the questions pile up. Kind of feel like the old Lenin quote about, what is it, about “Some decades go without anything happening, and then you get a week that feels like a decade.” It seems like that’s been the case of late, a lot of activity. And even just today was kind of a microcosm of that, big down morning and big up afternoon. So we appreciate you coming on. We’ve been making a habit of this. We do our abbreviated version every month, but then every quarter, the guys really just hammer out this quarterly market update within a few minutes of the close, and it’s great, pages and pages of charts and commentary. So we’ll go through it live, and just kind of discuss some of the topics. There’s obviously been a lot going on this quarter.

Just for introductions, we’ve got John Luke, head of equities, John Luke Tyner, and David Wagner, head of equities. We’ll cover, I’m sure, a lot of each of those areas. I’ll read a quick disclaimer and let the smart guys run with it. The opinions expressed during this call are those are 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’ investment advisory services can be found in its form ADV Part 2, which is available upon request. And I will encourage questions along the way, just type them in, and when we get to them, we get to them. But fire away if there’s anything on your mind. But Dave, JL, thanks for coming on.

David

Thanks for everyone hopping on today. As you all know, Aptus wouldn’t be who we are today without many listeners on this call, so we appreciate everyone’s support. And please know that we’re always around if you have any questions, just an email away. But if you’ve been on one of these quarterly calls before, John Luke or myself, we always like to start off with some type of monologue. It’s a little bit something extra, but I would say that we hope that it always tends to be a little bit more uplifting than anything, and I don’t think that there’s a better time to do something that’s uplifting than what we could right now, especially in today’s market environment. I mean, given where the pessimistic sentiment is, I mean the volatility in headlines, volatility in emotions, I truly believe that as investors, we just need to take a step back.

We need to see the forest through the trees, and right now, my word for the quarter, and it probably could obviously bleed into Q2 of this year, but it’s “Perspective.” That’s my word of the quarter, is “Perspective.” Because as investors, we need to keep everything in perspective, and I think I have a few cool little talking points that I can walk through right now, that puts perspective on the current market. But we all know that pullbacks, they’re normal and healthy. Markets that just go straight up without really any volatility, much like what we saw in 2023 and 2024, that’s the outlier. Those are the market conditions that are abnormal, because markets don’t move in a straight line. Again, pullbacks, they’re healthy and they’re normal. The second point of perspective is that all bear markets start with a correction, but not all corrections turn into bear markets.

If you go back to, I think it’s like 1945. So for most people at home, let’s just say since World War II, I think there’s been like 39 instances where the S&P 500 is declined by 10% or more, but only 13 of those 39 instances actually turned into bear markets, where the market pulled back more than 20%. So that’s

only 33% of the time. The third reason to keep the markets in perspective is that the sentiment right now, surrounding this market, is worse than the sentiment during COVID and the sentiment during the financial crisis. Yet if you put things in perspective, the market ended the first quarter of this year at levels not seen since September of 2024, a mere six months ago. The market officially had one 10% pullback year so far in 2025, but if you look at the two aforementioned periods of COVID and the financial crisis, the true peak-to-trough pullback for those time periods with like 33.8% and almost 55%, yet the sentiment right now is worse, just after one 10% pullback. Let’s keep things in perspective.

And the last reason to keep things into perspective is more so along the lines, just don’t bet against the consumer, and don’t bet against the resiliency of corporate America. I know that macro news, what we’re seeing on a daily basis, can seem very overwhelming, but just remember it’s all about stocks, which are all about the underlying businesses. We knew last year, the S&P 500, pardon me, last quarter, the S&P 500 grew earnings by about 16%, and they’re expected to grow earnings per share this quarter by another 11%. So perspective, it’s key, because consumer behavior is very, very simple. Investors hate losses, and they have little patience for Washington DC policies that might not immediately contribute positively to stock market returns, much like we’ve been accustomed to with quantitative easing. But right now, I spent most of the day writing our newsletter for the quarter, and as many of you guys know, it tends to be very thematic. And this quarter’s theme is D.B. Cooper, and for those that don’t know, he pulled off one of the most successful airplane hijacking stories in US history.

Well, potentially, because his whereabouts have really been unknown since that incident in 1971. So it’s FBI, it’s considered their biggest unsolved mystery. But I can tell you right now, that predicting the stock market, that’s forever going to be an unsolved mystery. We don’t know what the future market returns will be, but I’ve learned that… If I had this chart up first, I’m sorry. But I’ve learned that the more certainty that you have in markets tends to lead to worse returns over longer periods of time. That’s why investors, we need to focus on what we can control and prepare for what we can’t. We don’t know where the market’s going to head in the future, so focus on these controllables.

And during periods of time like this, I think it’s just very important to do all the blocking and tackling that you can as advisors. Things like constant communication with these clients, and maybe looking for some tax loss, harvesting opportunities. That’s the blocking and tackling that we need to do right now, because future market performance, it’s an unsolved mystery. We can’t control it. So I would say go out there, chop some wood, and make sure you try to keep everything in perspective right now, during these volatile time periods. Last thing I would say is tomorrow, hopefully by midday, John Luke, myself, and the rest, and JD, and the rest of the IC team, we’re going to try to have our quarterly investment chart book out tomorrow, so you should be on the lookout for that.

Actually, I’m going to do one more. John Luke, I got a question, I think it’s really good to start off with this before we kind of head into your fixed-income market review. Let’s go. I play a game called Wavelength, it’s basically like can I grade something from one to 10? And let’s get your perspective, John Luke, since that’s the key word of the quarter and the month right now. How worried are you on this market right now, from one to 10? But then let’s look at it from a time series analysis, maybe if I asked you that question 12 months ago, how worried are you about this market from one to 10, back in March of 2024?

John Luke

Yeah, I think it’s good to put it in perspective, as you said. I think that if you asked most clients, it would probably be at the top end of that range, seven, eight, nine, based off of what they’re seeing on the headlines. I think when you chop through it, and I’m looking forward to hitting on a big chunk of that list at the end, or towards the end of this, but really, it’s below five, for sure. Maybe it was a three and now it’s a four, something like that.

David

If I were to answer, I’m surprised by your answer, because I would say last year was also a three, it’s probably maybe a four, four and a half now. And so keeping things in perspective, things are still pretty strong if you look at the underlying economy.

John Luke

Yeah. So we’ll charge it off with fixed-income update. I think what we’ve seen this quarter is well received by most fixed-income investors, positive returns generally, across the board. You saw the 10-year treasury rally substantially from the highs, back right before the inauguration, where the 10-year fell from about 4.8% to about 4.2%. The two-year rallied from 4.2 to about 3.9. And so you saw a substantial move in duration, where yields moved lower, longer duration did perform pretty well, which was a bit different from what we’ve seen the last couple of years, where duration has been troublesome. I think the one kind of low light of the quarter would really be some of the more risky parts of the markets, where credit spreads did widen pretty significantly, and it ate away at some of the returns from that aspect. Another positive that you saw was bonds did a pretty decent job of insulating some of the weakness in stocks, where you actually got the negative correlation this quarter, that you haven’t seen for quite a while.

And while I think it’s probably a bit early to throw in the towel, and say that the coast is clear moving forward, it was nice to see bonds re-rate a bit lower. And there’s obviously a number of things that have hit on that, whether it’s the tariff policy and what’s come out of DC, whether it’s some growth scares, specifically in the softer data that markets have gotten tied up to, and just a little bit of a wobbliness in equity markets, have led to decent performance for bonds, from both an income perspective, because again, yields have been higher, so your interest piece of the return profile is more attractive, but also from the rally in rates. I guess the one outlier too, Dave, I think is not only did long-term bonds perform a lot better than they have been, which has been a big talking point of many of our conversations, but TIPS did well, as investors continue to fear short-term impacts on inflation from tariff policy. As you can see at the bottom there, TIPS were up a little over 4%.

Yeah, next one, Dave. So I think that these two charts really caught our attention. I think that it’s really two-sided. The first chart on the left, talks through performance of different treasury durations since the lows in August of 2020, so before the hiking cycle, but pretty much at the low-end rates. And what you see is the short-term rates did better because they were much more insulated to rising rates, and you got income more quickly, to reinvest back in. But the big one on the list is the downturn in treasury bonds and long-term treasury bonds, like TLT, where total returns are down over 40% over that period, which is not something that most investors are typically associated with. Dave was actually talking through a fun fact on… Dave, what was the time it would take for TLT to break back even from an income perspective? Was it like 17 years?

David

Almost 40 years. I thought it was like 40.

John Luke

Yeah, it was a wild stat, in terms of just digging out of that drawdown. And obviously, rates would have to go basically to zero in order to get the price return back up on those. But I think what’s been maybe a bit more puzzling is just the performance of bonds since the first rate cut last fall, where you haven’t seen bonds rally as they have following most rate cutting cycles. And as you can see, the lagger in the performance is still TLT, where even though the FED cut rates 100 bits, TLT is negative. And that’s something that markets aren’t necessarily used to. I think we are getting into maybe a little bit different backdrop of less focus on inflation, more focus on growth, and you’ve heard Scott Bessent talk pretty adamantly about trying to get longer term yields down. But it is notable that since the first rate cut, the shortest duration, bond duration type of investments, continue to perform best.

And then I think the last piece to highlight, is you had seen spreads get to anemic types of levels, extremely tight in terms of the spread, from whether it was investment grades or whether it was high yield bonds, their spread to treasuries were extremely tight. You can see we were well below the five-year average that we show here on this graphic. And really, what you’ve seen is just a bit of a normalization. So as interest rates have fallen, the five-year drop to about 70 basis points from the highs, so you’ve seen spreads just repriced to accommodate the decrease in risk-free yields. So while it’s been a big pop if you look at it on a very microscopic type of lens, when you back out and look at it from a higher perspective, there’s just a move back to the average, and a lot of it’s been accounted for by just the risk-free rate declining a good bit over the quarter.

So I think to sum it up, you’ve got a FED that’s in a little bit of a tough spot, because the inflationary data continues to be a little bit stickier than what they would like to cut rates. You’ve got the employment market, which continues to be relatively strong. You’ve got soft data, which has been a little bit more wobbly, but hard data continues to look pretty solid. You’ve got a backdrop where the FED’s telling you to expect about two rate cuts, in terms of their pricing. The market’s pricing at about three. And I think when you put it all together, if the economy and the labor market and growth continues to be resilient, I think that it’s more bifurcated of less cuts than what the FED’s expecting or more cuts in reaction to something negative happening.

And so while the market has priced in this narrow backdrop of two-ish rate cuts, we would be less surprised if we got less than two, or more, in the face of a weakening labor market. But I think the benefit is that the FED does have room to cut from here and to react to bad news, which should be a positive for other parts of the market, in turn with the rate cuts that have already happened flowing through to the real economy on somewhat of a lag. And we’re still probably just now starting to feel some of the consequences of that.

David

Those are some great points, John Luke. I like how you kept bringing it back to perspective, obviously the word of the quarter here. But we all know fixed-income wasn’t the problem in the first quarter of 2025, it was obviously the equity market that was more the problem child, or the nail that stuck out the furthest, since you finally did see a little bit of an inverse correlation between stocks and bonds. But I would say at the core, the market ended up pulling back on the quarter, and now also year-to-date, by about 4.3%. I think the overall theme of what’s going on here within the equity market, is that basically policy hyperactivity has now been overshadowing the animal spirit that we’ve been accustomed to, whether it’s since the November election or the recent market bottom, going back to whether it’s October 12th, 2022 or October 27th, 2023. But the first quarter basically delivered a classic third-year bull market correction, falling 10% from its highs before rebounding and finishing only down this 4.3% during the quarter.

But the recent sell off has been more centered around, I’d say, probably three prevailing culprits, and that’s going to be a momentum unwind. It’s going to be policy uncertainty, i.e. tariffs, and then a gross slowdown. I would say that one of the biggest highlights, or the key to the quarter for me, was that the market definitely started broadening out to more of the previously unloved areas of the market. Enter stage left, international markets that were up 8.1%, as investors virtually just rotated out of the Magnificent Seven, which became a funding mechanism into the cheaper areas of the market. Well, I’d say except US small-caps, that were down about 9.5% during the quarter. But if we take a step back and go back to perspective, it’s kind of stunning how much is going on right now. And even if implied volatility has started to settle down, the VIX back to 22 right now, the market continues to digest just a huge range of significant variables, and the results of those significant variables will likely be a trading environment that’s profoundly different than what we’ve been accustomed to over the past few years.

Much like I mentioned on the monologue at the beginning, pullbacks are healthy, they’re normal. The markets that have gone straight up with virtually no volatility and no pullbacks, that’s the abnormal side of things right now. But I think the root of all market hesitancy, the biggest single obstacle in the market right now, at least for me, it’s uncertainty. Tariff and trade policy is a total unknown, and headlines are volatile. We’ve had major government institutions that are being gutted or outright closed, and the administration officials are kind of openly acknowledging the possibility of a recession. And that’s basically this cocktail of uncertainty has just hit consumer and business confidence, slowing economic momentum. And you combine that with elevated earnings heading into this year, and a lot of bullish optimism, where everyone was highly levered up on US stocks on the Magnificent Seven, that basically just gives you a recipe for correction, and that’s what we saw during the quarter, but that’s healthy and that’s normal.

And as I continue to rotate my slides, we’ve had a few questions come in already. And as myself, John Luke, and Derek always do, we do these things live, so I’m going to try to answer some of your questions live, as we go through a few of these different slides. But anyone who hops on any of our calls has seen this chart on the left side, ad nauseam. It does talk about pullbacks being healthy, it talks about them being normal, but more importantly, their frequency. On average, during the calendar year, we see three 5% pullbacks, and a 10% pullback every 12 to 16 months. And that’s really what we’re going through, because we haven’t seen a pullback like that, really going back to October of 2022. So remember, pullbacks, they’re healthy, they’re normal, they’re not a cause for concern, and when the markets go straight up to the right, that’s when it’s abnormal.

But the chart on the right, shows you also, the item of perspective I gave you at the beginning, is that all bear markets start with a correction, but not all corrections turn into a bear market. A correction is considered a technical move of the S&P 500 by 10% or greater, and a bear market is to 20% from peak-to-trough is considered a bear market within the S&P 500. And of all these corrections that we’ve had, only about 33% of them have actually turned into bear markets themselves, so keep that into perspective. But if we really go underneath the hood of the market, I truly believe that the three things driving this market down, it’s mostly a momentum unwind. I think in second place would be growth uncertainty, and the third would be more policy in Washington DC. But this chart on the left shows you that if you look back over the last, call it five growth scares that we’ve seen in this market, excluding COVID, 2022 was more of a rates driven market. COVID was very much an extraordinary event.

It tells you that the average pullback when you get some type of growth scare, going back to the financial crisis, is about 16%. We’ve only pulled back about 10% peak-to-trough, so we’re below historical averages. But again, that 16% average is just an average. But if you head into recessions, on average earnings per share, growth at the S&P 500, when you head in towards some type of recession, is about 2%. I mentioned earlier on this call that growth last quarter was 16%, and growth this quarter is expected to be 11%. So the consumer remains very strong, which is not always the case in all these aforementioned five periods where you had another growth pullback. So the consumer remains strong, but also the health of corporations and their balance sheets remains so much better off than what we saw in 2010, ’11, ’15, ’16, and ’18.

So this chart on the right, I think is probably one of the most polarizing charts that we could probably have here, because it’s talking about this momentum unwind. And I said that the pullback would be more growth concerned, DC tariffs, but it’s probably a little bit more of a momentum unwind than anything. And this could probably dovetail into a conversation a little bit later on, when talking about international markets. But it may come to the surprise of many people that capital flows can significantly impact market pricing. And in 2025, we’ve seen meaningful outflows from the US mega caps into international equities. And absence, like some type of fall through on major volatility indicators, like oil interest rates and developed and emerging market currencies, suggests that the key drivers is probably this momentum unwind. Let me explain that.

If tariffs were the primary catalyst of this pullback, I’d expect heightened volatility in the currency markets. If growth concerns were at the core, oil and interest rate volatility would be spiking. Instead, the broad lack of volatility confirms what this chart is signaling, that this is more of a momentum unwind. In my opinion, that’s the dominant force behind these market moves, and it’s really just the mega caps being the funding mechanism to the cheaper parts of the market. The last thing I’ll say before I pass it to John Luke to kind of touch base on a few things, is that there’s so many taglines you could have out there, like “MAG Seven, more like lag seven.” But the really big thing that surprised me in this market, is that when the capital’s flown out of the mega caps into the more unloved and undervalued areas of the market, it’s kind of left small-caps out of the party. Small-caps, as measured by the Russell 2000 core benchmark, was down 9.5%.

And so what’s going on here? I think the R word, which is recession, that’s the worst word for small-caps. Whether it’s regional bank stress, the meme stock volatility, or rising rates, it feels like there’s always been something holding back small-caps recently. So with recession concerns resurfacing, small and mid-cap stocks, they’ve just taken more of a hit than you typically see in the early stages of a slowdown. But fundamentally, it has been a tough stretch for small-cap. As of the first quarter, I think small-cap earnings growth is projected to finally outpace large-caps in the second half of this year. We’ll see if that actually comes to fruition. But unless growth like meaningfully re-accelerates, I think the potential leadership shift may take a little bit longer to materialize. I do think that small-caps still are a great diversifier for an overall allocation, specifically with the concentration in mega caps. But valuation still remains very palatable in the space right now, so let’s just hope for some type of growth pullback.

I’ll stop there, take a breather, and maybe we answer some questions, John Luke, or move on to the macro side of things.

John Luke

Yeah, I’m good on either.

I think some of the macro points will address some of the questions that we’ve gotten, just based on kind of where they’re at.

David

Yeah.

John Luke

So do you want to pull up the good, bad, and ugly, sort of our token slide?

David

Yeah.

John Luke

I think this is one that puts a lot of things in perspective. And how I’d start it off, and hopefully we’ll have a good dialogue back and forth here, Dave, but consumer spending follows jobs, and bad feelings don’t always translate to bad news for the economy. That’s kind of where I’d like to start it off, where the good part is the consumer continues to be resilient. They’ve got a lot of capital that they’ve either earned or given in some capacity, the last couple of years, based on market performance, based on a lot of the fiscal deficit that’s flowed to the private sector, et cetera. And so I think that while the perspective of things might be negative, betting against the consumer has been a bad bet historically.

And so when I put it into perspective, my question is are we going to stop running deficits at the economic level? And last year, for reference, we ran a 6.4% for the fiscal year ’24 deficit to GDP. If you look at Scott Bessent’s Three-Three-Three policy that he’s kind of led with in a lot of his conversations, it’s a 3% deficit, but achieved by 2028, it’s real GDP growth of 3%, and 3 million barrels of oil per day. So many different things to kind of unpack through that, but the goal is to bring down inflation with more oil. The goal is for real GDP growth from the private sector, and then the goal is for the government to be a lesser part of the economy than what they have been. But that’s happening over the scope of three years, it’s not like it’s necessarily going to happen immediately.

And so while I think the DOGE lines have certainly hit the headlines, it’s more of a change up from the 2017 Trump administration than it is to today, where he led with a lot of the, quote-unquote, candy of tax cuts and deregulation, and then came in at the back end, with tariffs. Whereas this time, he’s leading a bit more with the spinach, kind of like mom at the dinner table when you’re a child, and then if you eat it, you get the dessert at the end. And so I think that that’s sort of the backdrop that has scared people, but when you kind of put it into perspective of points like that, it’s a little bit less troublesome.

David

I think we can go to a question real quick too, since we’re talking tariffs. We spoke a lot about tariffs on our mid-quarter markets and turmoil, quote-unquote, making fun of CNBC. We spoke about our thoughts on overall tariffs, we could touch more on that if you’d like. But let me see, I think we had a question about tariffs right now.

Yeah, here’s a question. We’ve read a lot about companies stocking up on inventories right now, whether it’s auto dealers prior to tariffs taking effect. What is your read on economic activity being pulled forward and the future quarters may be poor as a result? Let’s keep things into perspective on this. I read a pretty cool statistic this quarter, it’s actually from John Luke, and if it breaks down GDP, if it bifurcates GDP, those affected by tariffs and those not affected by tariffs, only about 15% of GDP is affected by tariffs. The residual 85% means that it’s going to be more domestic in nature, basically unaffected by tariffs, and 85 is greater than 15. And I think keeping things in perspective of whether we look at it as a percentage of consumer spending, the overall tariffs, a percentage of GDP, or a percentage of earnings per share of the S&P 500, it feels like it’s definitely a lot more of that spinach that John Luke is talking about, rather than candy. Would you add anything to that, John Luke?

John Luke

I think the other thing to put into perspective is remember back in 2022, as the FED was communicating the need to raise interest rates and do it pretty drastically to hone in inflation, and that was a hit to the market in ’22. Things weren’t so friendly. But after the market digested and got used to it, you had great years in ’23 and ’24. So I think my perspective is it’s a little bit of once the market gets some tariff fatigue and companies communicate through their earnings, the impact, and we get a grip of what’s going to happen, and changes are made, then you kind of get a similar type of backdrop, where it’s less of a headline type of shocker and more just a part of the economy that you get used to.

David

Yeah. We’ll probably repeat a little bit on this next question, but it’s also on tariffs, John Luke. I guess we all know the topic du jour of this past month, some Washington DC volatility. But the question is, “In past discussions you’ve mentioned that we’re at year-over-year consumer spending of 6.5%, key positive GDP expected to be around three to 6%. Is that recent six to 5% consumer spending number, is that still correct? Goldman Sachs has stated that tariffs could lead to year-over-year going to 5% for GDP. Do you agree with this still or the case for tariffs moving forward, is it more broad-based than originally thought. Trump himself, over the past weekend, said it’ll be broader than the 10 to 15 countries originally thought.”

Let me start off with making two points. We do know that almost 70% of GDP spending comes from the consumer itself, and then also most GDP readings are put out in real terms, not nominal terms. So this question was put out talking about GDP in that three to 6% level, yada yada, that’s kind of adding back inflation to give you that nominal number. But overall, that 6.5% year-over-year consumer spending, it has pulled back just a little bit to that 5% range. And what we’ve spoken about a few times is that the consumer remains very strong. Historically speaking, the average year-over-year growth for consumer spending is between three and 6%. And one of our partners came out with a statistic, pardon me, saying that if all these tariffs were imposed, and obviously, this is a very fluid number, it’s basically a $300 billion consumption tax on the consumer itself. And relativity, that means that’s a haircut to consumer spending of about 1.5%. So if it was 6.5% last month, it might be 5.7% this month, that consumer spending on a year-over-year basis, that could take consumer spending down to 4.2 to a little bit higher.

But again, that’s still right in that Goldilocks period of the average year-over-year spending for consumer spending is between three and 6%. And in a way, if we get that haircut to consumer spending, that could actually almost negate some of the other clouds out there in the market, such as structurally high inflation. Because a lot of people believe that consumer spending, bidding up prices for these increased inflated prices of goods, it would keep that trend continue to moving. But if you pull back a little bit that on the consumer spending, that could maybe negate some of the headwinds or the worries of this inflation moving forward into the future, which could maybe create a more accommodative FED policy there. So I would say that yes, the consumer remains very strong right now, and I think if there was any time to implement tariffs for the consumer, right now is an okay time.

John Luke

Yeah. And I think, Dave, we hit on a couple of the goods. You talked about the resilient S&P earnings. I think another one of the S&P pieces is just the monetization of all the AI CapEx, where companies, they invest in things to make money off of them. We saw substantial investments in different AI technologies and capabilities the last year specifically, and it’s been going on for longer than that. But I mean at some point, you got to think these companies are going to want to see that turn into real earnings power. And so I think that that could certainly be something that many people are maybe under-looking, or at least not thinking about when looking at earnings expectations for markets and the potential to exceed what’s being priced in.

David

You’re just nailing everything on the head right now, John Luke, with some of these questions. Because we had another question just come in kind of talking about AI in the mega cap parts of the markets. It goes, “We’ve had another sharp sell off of the most expensive high growth part of the market. The last time this was a persistent effect was after the tech wreck of 2000 to 2002. It lasted for a decade, as markets rotated out of growth and into other asset classes. In your opinion, is that where we are now, or just another bump in the long-term growth of the AI narrative?”

I think how our minds work, from a behavioral standpoint, we do believe that history doesn’t repeat itself, but it rhymes. But we always want to relate current period to some period in the past, and it’s kind of difficult to compare the tech bubble and what we see right now. Because you’re correct, those companies, those styles, high value, high growth, they’re basically put into a penalty box for almost 10 years, where from 2000 to 2010, that was the decade of international. From 2010, basically up until now, it’s been the decade-plus of the largest of the large mega-cap tech stocks.

And are we going to see that transition happen again? I think we’ll have a slide here talking about international, what’s kind of been driving international. Maybe we head to that next John Luke, and then kind of bounce back to the macro side. But there’s a lot of differences today with these mega-caps versus back in 2000. Back in 2000, a lot of these dotcom types of stocks, they were funding their growth off of equity issuances and a bunch of debentures, so increasing the debt on their balance sheet. If you fast forward to today, these Mag Seven AI stocks, they’re a funding mechanism for their own growth, where they don’t have to hit the debt markets, they don’t have to hit the equity markets themselves, they can fund everything by free cash flow. So I’m not expecting anything of these types of names being put into the penalty box for a long span, like a long standing period of time. Because one thing that we learned during Q4 earnings season that just occurred all of month ago, is that the spending has not slowed down whatsoever.

If you go back to October of last year, the expected CapEx spend was like $281 billion. Fast forward today, like five, six months later, it’s closer to $313 billion expected spend here in 2025. That’s a 13% increase in CapEx AI type of spending by the Mag Seven, increase just over the last five, six months. So right now, we haven’t seen a full transition of CapEx or spend at any cost, transitioning to growing down on profitability. I think that long runway for CapEx continues to be there. And we all know that one man’s CapEx is another man’s revenue, and that should keep ultimately, the growth in the market to be better than average.

And to whoever asked this question, I think one thing you go back to is our market outlook heading into 2025, it was based off of the 1980 movie Airplane. But it’s showing you that, hey, we may have more tails in the market moving forward, whether it’s right tails, like we witnessed in 2023 and 2024, or almost left tails, I don’t think we’re there yet for what we’ve seen here in 2025. That at the core of the S&P 500, given it’s 36 or 37% concentration at the end of today, is that it has this new found characteristic of operating leverage, that when operating leverage works for you, it’s amazing like the last two years, or maybe you can start cutting against you if actually growth really starts to pull back, we start to see more left tails.

But right now, the spending just continues to be there, so I don’t expect these names to be put in the penalty box for a substantial period of time.

John Luke

And just a peanut gallery comment, with the performance of a lot of those names to start the quarter, you’ve gotten a re-rate in multiple, back down to pretty tolerable levels, some of the more attractive levels we’ve seen in the last couple of years. And if you compare that to anything from the dotcom bubble, which from an earnings perspective was much weaker back then, and from a multiple perspective, was much more expensive, much more hopeful for the growth. That it happened, but it didn’t quite happen like markets had priced.

David

I love that. John Luke, I’m going to audible, because we’re wild cards here, because we keep having some more questions come in. And if people are asking questions, I know if one person’s asking it, probably many people on this phone call are also thinking it and want to ask themselves. And I think this is the great debate right now, and it’s all about international stocks. And so the question is do you see any potential for a rotation or reversal of asset class performance for the remaining part of the year, such that US equities could outperform international or fixed-income for the remaining of the year? What would that scenario look like, tariffs not coming to fruition, this or that?

I’m going to be more holistic here, and it sounds like you want to kind of take the more rightful approach from my shotgun approach on this answer, but international has substantially outperformed domestic stocks year-to-date. In fact, it was the biggest out-performance on a quarterly basis, I think, going back over the last 23 years. Don’t quote me on that, but I think that’s 98% chance that is correct. So the largest quarterly out-performance of the last 23 years probably. Why have equities underperformed international here, at least the domestic stocks? Well, I think that there’s probably five reasons, and that’s Europe, on the first, one is still easy monetary policy, even as inflation remains above 2%, while the US appears to have finished its tightening cycle. The second reason would be that Germany and other European nations are expected to expand fiscal stimulus, increased defense budgets, and reduced reliance on long-standing EU constraints. In contrast, the US is beginning to cut its fiscal deficit, and that may act as a drag on domestic growth while Europe is still in expansion mode.

The third one, and I think that’s probably the most largest reason, is that after years of over-weighting US equities, global investors are beginning to reallocate stock, reallocate capital, pardon me, into international markets seeking broader exposure. The fourth reason would be that earnings has become more evenly distributed across global markets, while the Mag Seven is post-outside the earnings of the last two years. Many international markets saw modest, or even negative growth, and this is really just setting a stage for some type of potential catch-up.

I think the last factor is this, is just more of a valuation catch-up. Historically, international markets have traded at an 8% discount to the S&P 500. They’re trading closer to a 50% discount. And what we know of valuation, it tends to overshoot intrinsic value of where it probably should, when the dust settles, where valuation should be. So maybe the 50% discount somewhat overdid that on the valuation side of things, and this is just a catch-up on valuation off the hopes and dreams that growth is going to pick up. Last thing I would say, John Luke, I want your opinion here, is that do you chase this international rally right now?

I would say I’m not there yet personally. John Luke may have a different opinion. I’m okay missing out on the first and second innings of some type of regime change, to be able to participate maybe innings three through nine. But more importantly, we’ve had so many head fakes in the international space over the past, let’s call it 12 or 13 years. I want to make sure that a lot of these policies, whether Germany’s putting out the stuff that they passed through their government two weeks ago, or the defense spending elsewhere, a lot of that comes to fruition. We’re not sure that it will. Because there’s an ever-changing dynamic on headlines here domestically, that may change some of the opinions on the international side, because they don’t want to spend the capital. We know Germany has a debt to GDP of like 71%, where they can go and spend, but that doesn’t mean that they’re going to, if the US is still going to continue to subsidize a lot of their defense spending, and stuff like.

So let’s wait for a lot of those facts, or those hopes and dreams, to become tangible. And I think that’s when I could get a little bit more ecstatic or interested on the international side right now. But right now, all the return is solely driven by evaluation. So I’m not saying to fade it, let’s just continue to watch this.

John Luke

Yeah. And I think is it really a regime change? And we certainly have seen some insulation from where multiples were relative to start the year. It’s a show-me story to me, from that perspective. And then I think one comment just on the allocation. From an allocation perspective, we’re typically underweight internationals, but we’re overweight equities in general. And when you look at the net difference, we’ve still got enough international exposure in the portfolio to not be an eyesore if they continue to rally, even without doing anything. So I think that’s kind of a safety net that we have. And then the other part of the question was US equities outperforming fixed-income. I think fixed-income had a great quarter, with the backdrop of potential slowing growth, maybe the hope that the FED would get it into gear to continue the rate cutting cycle that we’ve seen.

But I think that if you do get past and digest some of the news, that you can kind of get the best of both worlds, where US equities specifically, are able to get back in the limelight of the news and the backdrop, from a realization that “Hey, earnings are still going to be good, maybe the headlines aren’t going to be as impactful on things as maybe what’s feared.” And then for interest rates, in order to continue to have quarters like what we just saw, you’re going to need to continue to see rates drop pretty drastically. And so I think in order to see rates really drop drastically from here, you’re going to have to have some real degradation in the economy, and that’s not something that I think we’re comfortable calling at this point.

David

That’s such a great point there, John Luke. It’s always a battle like international or domestic, it’s either one or the other. It can be both. You don’t have to pin each other against each other, you can still win at the allocation level by just being overweight stocks and maybe a rising tide that lifts all boats. It’s really just been an argument of US versus international because international has had negative performance. They both could have great positive performance moving forward in the future, where they could still work together. But at the end of the day, I want to own something that actually has sustainable tangible growth, and that’s why I tend to still skew a lot of my opinions on owning US domestic stocks.

John Luke

Yeah. And Dave, I think that one of the next slides that you had was going through… Well, we can start here. But the periods of policy uncertainty, and just how those have typically alluded to decent forward-looking returns. And kind of like you led with here, Dave, I think it’s pretty wild to think that the last month or two, from a sentiment perspective, has gotten more negative than a lot of really bad things that have happened over time. And really, the tariffs are just now going into effect, and we don’t even really know to what extent that they will, or what the actual appetite is for tariffs. If they do create some kind of economic turmoil to have President Trump kind of backtrack a lot. Because at the end of the day, we still think he’s a market-driven guy, and a lot of this could be more talks than reality.

So my comment on this is just from a multiple perspective, you see a lot of things re-rate to more tolerable valuation levels, and then you’ve got a backdrop of a lot of pessimism. So if you just get a little glimpse of something kind of good, I think it could change things and become pretty favorable pretty quickly. And you kind of saw that today with the reversal in markets.

David

Yeah. Yeah, that’s why I love your analogy, John Luke, the candy and the spinach. Previously, we got the candy first then the spinach, now we’re getting the spinach first, then hopefully the candy itself. But I don’t know about you, JL, but I would actually say that the candy that we could have in store could substantially outweigh the negative effects of the spinach. Let me say that in a different way. Obviously, the spinach is tariffs, that cut into maybe two to 3% of earnings per share of the S&P 500, or 1.5% of consumer spending, and maybe 1% of GDP. But the benefits from deregulation, in my opinion, almost prompt, no pun intended, we all know I’m not political, I always vote for Ronald Reagan in elections, but I think the deregulation factor itself could outweigh, on a positive economic balance, the tariffs. Then you throw in maybe some tax policy changes. I’d put more weight on the candy here, moving forward, than the spinach.

So it is pretty crazy to me that there’s a lot of policy uncertainty right now. But if you look at any soft data versus hard data, soft data right now looks absolutely terrible. And I think there’s such a great delineation we need to make between soft data and hard data. I thought I had a chart in here, let me try to find it real quick. What’s the difference between soft data and hard data? Well, soft data is based off of surveys, hard data is based off of tangible data itself. And I think a lot of people are just trying to figure out when does the soft data, the survey data, start to move into the hard data? And I would say maybe it won’t, okay? Because at the end of the day, soft data is just surveys. That sentiment can change, because right now there’s a lot of policy and uncertainty. But we just see nothing flows through the hard data. I would start to get more worried about this market, because me and JL both started off this call ranking.

Our optimism on the market today versus 12 months ago, we both said, “Hey, we were worried about a three out of 10 last year, and we’re worried a four out of 10 right now.” My number, if my number were to increase from that timeframe, to maybe a five or six or seven, it’s when that data goes from the soft data into the hard data. But outside of ISM manufacturing data right now, you’ve seen no flow-through from soft data to hard data.

Derek

One thing I think that’s interesting too, on that topic of hard data, and your opening frame of perspective, I would say in general, that CEOs of companies, publicly-traded companies, are probably a more welcome site for investors than politicians and economists that we’ve been witnessing over the past month. So earnings, I know they’re not this week, but it’s late next week. I’m curious what you think the tone of the calls… We had the question earlier about our tariffs pulling forward some of the demand, or do you think that as we start to get a little less macro, a little more micro, and we hear from some of these innovative companies about what’s going on and how they’re taking advantage of the environment, and all that kind of stuff, do you see opportunities there?

And I didn’t see a chart in here, maybe it’s in here somewhere, but I know you’ve shared it before. The point about no recession has started, and the past whatever, five, six recessions, they’ve all had 2% average earnings growth, and we’re still sitting at double-digit earnings forecast. So I’m curious how you think that the earning season can change, can shift the tone a little bit on things?

David

At the end of the day, that’s why I love this phrase here, Derek, and it’s in our chart book, that macro news can seem overwhelming, but just remember it’s still all about stocks, which are all about underlying businesses. And when I talk tariffs, I always say that there’s this old man saying that… It’s old man yelling at the clouds, it’s like the only thing that matters to the market at the end of the day, is macro economic growth, whether it’s from earnings per share of the S&P 500 or the propensity of the consumer to spend, and both of those are just very strong right now. I think the thing that the market’s trying to digest on the slowing growth, because that’s been one of the narratives for this entire quarter. I think it’s not as structural in general, as many people would assimilate. I think that the first quarter earnings expectations started off the year like being 15% higher year-over-year, and moved down to about 11%.

I think there’s really two reasons, maybe two and a half reasons, on why you’ve seen expectations for this quarter move from 15% to 11%. The first one is going to be that last quarter, in the fourth quarter, the pull forward was just absolutely amazing other than the amount of growth. We grew at 16% in the fourth quarter of 2024, which was only expected to grow at 12%. So the initial knee-jerk reaction, a lot of economists and Wall Street analysts, is that, “Well, hey, that’s just a pull forward in demand. I’m going to take some of the growth out of the first quarter and move that into fourth quarter to try to reconcile my numbers.” So that’s kind of why you’ve seen that number come down from 15 to 11%. But also it was just a really, really cold first quarter. It was one of the coldest environments, as by the weather, in the last 15 years, and it was also one of the worst flu seasons we’ve had over the last 15 years, and I think that’s a slow some spending right now.

I think the half part of my two and a half is that it’s showing the soft data, that people might be a little pessimistic. That if they think some type of recession is coming, they do less spending at the opportunity cost of savings, and they might just be saving a little bit more. So that could obviously propel the economy into a longer bull market than what we’ve always been accustomed to. It’s like what we said from 2011 to 2020, is that was the most hated bull market of all time. Well, maybe we have another one of those. We just entered the third year of a bull market, and that whenever that bull market hits its third birthday, the minimum duration of that bull market’s five years. The average duration is close to eight years. Though the third year does tend to be the most difficult because you have a slowing of market performance because it did so well in the first and second year.

But at the end of the day, you’re right, Derek, we’re going to see what a lot of these companies stay during Q1. It’s probably not going to be much, because a lot of them put their guidance out for 2025, last quarter. And given the ever changing dynamic for headlines, why would you change your annual 2025 guidance just based off of one quarter? So I don’t think there’s going to be a whole lot of tangible changes out there in the market. You might get some different guidance on market commentary of what they’re seeing that can maybe move the market, but I don’t see really anything Earth-shattering at the end of the day. Because like I said, my comments are macro news can seem overwhelming, just remember, it’s still all about stocks. It’s always going to be about stocks, which are about underlying businesses right now. And I wouldn’t bet against the US consumer or US corporations.

Derek

I see we’ve got some more questions coming in, we’ll try try to fire through them with respect to time. But one of the questions that came in makes a ton of sense, and JL, you talked about it with the spinach and the candy. But we could have an environment where in a month, we open our eyes, and all of a sudden, you’ve got a FED cutting and tax cuts and deregulation, and all the other things, and all the tariff stuff is already digested into the markets. We just have this day, this April 2nd, that everybody’s obsessed over. The question that came in that I think makes sense, and kind of ties into that, is “Any comments on the likelihood, or not, of a consolidated FED government budget-slash-tax bill being passed before mid-year? And if not, potential impacts?”

John Luke

I think that there is definitely a high likelihood of substantial legislation passed by the end of the year. There is many moving parts, and obviously, the majority, from a DC perspective, doesn’t favor Republicans drastically. It’s just a small majority, and so I think there’ll be some give and take to get that passed. But I do think that Trump’s got a timeline. He’s got midterms coming up that he’s working against, and if he’s going to try to do, or like Scott Bessent said, with the potential for a detox, it has to happen quick, and then there has to be actionable items behind it, to kind of make up for some of the issues that it solves, or issues that it caused. So I think the short-term answer is that I would not be surprised if we get something passed. And just like your commentary to start that, of think you could have a backdrop of many favorable things hitting, and it alleviates a lot of the consumer sentiment, and maybe it shifts more positive, and that could really be a strong backdrop for really all assets classes.

Derek

So… Go ahead, Dave.

David

Yeah. As we’re cutting up on time right now, we can answer a lot of these questions offline. We still have a ton of questions coming in, so thank you very much for everyone’s participation. But recognizing time, John Luke, why don’t you hit this, and Derek, I would love to hear your answer. I’ll give my answer too. But what’s maybe the biggest thing that the market’s not understanding right now throughout the rest of the year, something that might be overlooked or under-analyzed right now, that may surprise people?

John Luke

Who do you want to go first?

David

You.

John Luke

Yeah. I mean, I think you could just simply sum it up of the fatigue comment on tariffs, where I think that at some point, the market gets more or less over that being as big of an issue as it is, and focus on the kind of candy at the backdrop of it being more favorable for markets and things being digested, and actually ended up being a better, more favorable backdrop for real economic growth than what people are maybe pricing in now. I mean, just think about it, right after the election, what did all markets do? You had a pretty big favorable backdrop for risk assets, a pretty big favorable backdrop on economic growth, and a lot of good things that markets thought would come from another Trump presidency. So I just remember the four years that Trump was in, he focused on markets constantly. I don’t think that that changes, and I think I’d be hard-pressed to say that we have a dissimilar outcome this go-round than we had last.

David

Yeah. I think that Trump put and that FED put really didn’t kick in 2018, until the market was down 20%, which stocks were down like 19.9%, and they bottomed, I think it was on Christmas Eve of 2018. And we really only got halfway there. That’s a great point, John Luke. Derek, you want to go?

Derek

Well, I think I would… To my point earlier, about company results versus government macro policy, one of the comments that came in is as an investor you have to think, not feel. That was a very insightful comment from Mr. Felk. And it’s true, and we’ve been in a feeling market. There’s nothing to think about. We don’t have any idea what the policies are. Nobody has any idea what the policies are going to be. And so I think if you’re going to be optimistic, you pin it a little bit on earnings season, having some clarity to say, “Hey, these sectors, this is how they’re treating it, this is how these companies are treating it.” And you can actually start to think again, and you can do the modeling that you do as an individual stock picker.

And I just think we’ve been in this void, and it happens all the time. It happens a couple times a year, when we get in these gaps between earnings season and the next earnings season. You just go into this blackout period, where the theme of the day just can drive things way up or way down. So I’m hopeful that as we get into earnings season, at least you can start to sort out winners, losers, and have some clarity. So that would be my take.

David

I love that.

I think we all want clarity. The market definitely wants certainty, and I think that will make things much easier, because it definitely feels that there’s just more emotional volatility out there relative to market volatility, even with the market pullback of 10%. But we know with volatility breeds opportunity, and I think that you got to see the forest through the trees, try to get past some of this negative sentiment. But there’s a lot of opportunity out there.

Obviously, international markets have done really, really well. Pardon me, the S&P 500 and the Mag Seven has done pretty good. If you have a 15-stock, highly-concentrated portfolio called the Compounders in a lot of your allocations, that’s even up on the year, outperforming the S&P 500 at quarter end, by over 5%. So there’s a different look to this market than what we’ve been accustomed to over the last two years, and I think that we have to be pragmatic and evolve with this market as it continues to evolve and digest a lot of this data. So remain nimble, remain positive, and definitely keep everything in perspective, because I think that’s going to presage the best potential returns that you can have, not just over the short-term, but over the long-term.

Derek

Thanks for a full hour guys. I know we answered a bunch of the questions, which probably extended us longer than we’d normally be. I actually kind of liked the last question that came in, because it’s a fun theme, given the basketball backgrounds of the Aptus crew, who’s going to win the NCAA tournament. You kind of know where I stood, as much as I don’t love Duke, that was my pick. I’ll kind of stick there. I don’t know, where do you guys sit on this?

John Luke

I answered back Florida. I think that although you could see basically, a final type of game, again with the Florida Auburn matchup.

David

I’m wearing a blue shirt, I’m a blue blood myself, but I will never forget Christian Laettner for what he did to the UK Wildcats. So, I cannot disagree with you more. I can’t trust people that root for Duke. I don’t like people that root for Duke. I’m staying in the SEC, go Florida.

Derek

Awesome.

John Luke

Your question for me is, is does Scotty repeat at Augusta.

Derek

It’s a fun week.

John Luke

And I think he’s going to be hard to beat.

Derek

Yeah. It’s a fun week, and we will… Just, whoever’s on, we’ll have a ton of content out this week. There’s already a bunch in the works, you see what the guys have put together here on March 31st. So be on the lookout, and we appreciate you listening in. And we’re here to help. Our IC meetings, and stuff, will start with different groups this week, so if you have any questions on anything, any client questions that keep coming up, we’re here to help answer them. So appreciate your time.

John Luke

Thanks, everyone.

David

God bless y’all.

Derek

See you guys.

Disclosures

The opinions expressed during this Webinar 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 investment advisory services can be found in its Form ADV Part 2, which is available upon request. ACA-2504-2.

Browse the Outlook’s 3 Minute Executive Summary Here.

Full Transcript

Derek

Good morning. We are December 18th, so a week from today is Christmas, and we’re lucky enough to have a crew ready to talk about what’s happened in 2024 and what to look for in 2025. We’ll certainly let people trickle in over the next minute or so. We appreciate y’all making time to spend with us. I’ve got our experts from both sides. We’ve got Dave Wagner who’s the head of equities, and we’ve got John Luke Tyner, head of fixed income. We’ll certainly cover both of those areas in pretty good depth. We’ll try to keep this to 35 minutes or 30 to 40 minutes and then certainly hit us with questions. We’ll try to get to them depending on time and if we don’t, we’ll certainly hit you afterwards with feedback. If you work with us, you know that our guys are very responsive and always interested in chatting about markets. So yeah, we appreciate any feedback and hit us.

And I’ll read a disclosure here right at the beginning to get us kicked off. 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’ investment advisory services can be found in its Form ADV Part 2, which is available upon request. So welcome guys, Dave, JL, thanks for joining.

John Luke

Yeah, thanks Derek and thanks everyone for popping on and spending some time this morning with us. We always like to start out this end of the year call with just a token of appreciation and gratitude for all of our clients, our shareholders. The trust that you guys have put into us, we definitely don’t take this lightly. The responsibility of helping steward your clients’ assets, their nest eggs, their future, it’s certainly a process that’s very endearing to each of us. It’s been a great year 2024. We have so much to be grateful for. But I think that as we look forward to 2025, we’re going to have a lot of exciting things to post you guys on updates from Aptus, whether it’s the growth of the team, which we’ve had a huge growth for 2024, but we’re expecting much more for ’25.

We appreciate just each of you guys in challenging us daily and weekly and monthly on our process and our philosophy. I think it’s important in how we’re helping approach markets that are very difficult. Things have changed a lot since the pandemic and how portfolios are constructed I think is going to dictate a lot of the success of your clients. And so we feel blessed to be a part of helping navigate those markets and work with you guys on an individual basis. So without you guys, we aren’t here. So we really appreciate everyone’s time and trust.

David

Awesome message there, John Luke. Myself included, all the team, we’re so appreciative for everyone on this call, everyone who’s going to be listening to this call in the future. Aptus is such a cool firm. All of our clients, our partners. Y’all are very cool people. And I think one thing that really embodies everyone here at Aptus from an ethos perspective is that we take our work very seriously, but we may not take ourselves seriously. And I think that’s what separates us and differentiates us from really anyone else. But the challenges that we’ve had in the past that we’re going to have in the future, I know that we have the best team around that I trust to really tackle those obstacles moving forward, so. Speaking about the ethos of that, we take our work seriously, but not ourselves seriously.

We all know our Market Outlook and a lot of the writing that I do, it’s very somatic based. I think that plain reading on most investment jargon is like watching paint dry. So we try to have a little fun here. With our Aptus Market Outlook, I think this is our fifth or sixth year run, and we’ve always had a theme behind it. So the introduction of the 2025 Aptus Market Outlook theme, it’s going to be based off of the 1980s movie Airplane. And I’m always going to get this wrong and Derek can step in here. I always try to say that the main character was Liam Neeson, but that that can be more of a different character than Leslie Nielsen who’s one of the head people here in this movie.

The basis is obviously the market’s now in its third year of a bull market cycle. John Luke will probably talk about how whenever the bull market has hit two years in duration, the minimum duration of the bull market is closer to five years. So we just entered our third year for this bull market cycle, and since 10/13 of 2022 when the bull market cycle started, the S&P 500 is up close to 70.3% as of today, which is December 18th. And so I think a lot of people call us crazy saying, “Hey, you guys are still bullish on equities after that hockey stick up in a performance chart after that remarkable 70% run in the S&P 500? Surely you can’t be serious.” We are serious and don’t call us Shirley.

But that is also coming on the back of a theme that I love back in 2024 based off of Ayn Rand’s 1957 novel Atlas Shrugged that focused on the consumer and the propensity of the consumer to spend. I think the theme from last year actually could continue into this year, which we’ll talk about here on this presentation, is that the direction of the economy, as always, no matter what year it is going to be hinged on the health of the consumer as a whole. In the theme of 2024, we said Atlas is basically like the consumer in the economy holding up the US… Actually not just the US economy, but the world economy as the consumer accounts for 70% of the US GDP. And whenever the consumer may shrug, that’s when the market can see some problems. But right now the market and the consumer looks very, very healthy.

And that’s why we have the conviction of our theme of 2025 of, hey, we want to be bulls for stocks over longer periods of time. That doesn’t mean that we won’t encounter some type of turbulence over the next 12 months. I think that there’s a lot of stuff that’s going on in Washington, DC, whether it’s a debt or corporate or individual taxes that’s going to have to be tackled not just in the next 12 months, but probably in the next 3, 4, 5, 6 months. And some of that political volatility could translate to some turbulence in market volatility. But all in all, a lot of the structural forces that we’ve seen over the last two years from fiscal policy, monetary policy, they still remain structurally ingrained in what’s going on with our market that we’re comfortable to say that, “Hey, we’d like stocks for the long term, there may be some turbulence.”

But I think the biggest risk or one of the biggest risks that investors have right now is finding that wall of worry after the run in the market and becoming too conservative because I’m a firm believer, I know JD is, John Luke and the rest of our team, that the hurdle rate for investors right now is substantially higher than where it was 20, 30 years ago. And if you don’t have the right proper structure allocation in place to own those risk assets, that you could be having more of an awkward conversation with clients than little Joey did with Clarence over in the cockpit within the show, talking about Turkish prisons and other things that I can’t say really here on a recorded webcast.

But one of the things we’ve been talking… Oh, perfect, yes, let’s start off with some polls here.

Derek

We’ll drop a couple polls throughout the thing, so feel free to participate. Nothing mandatory, but it’s always fun to take everyone’s temperature and just see what people think about… I think we’ve got three of them in there if we get to them, one about where’s the market potentially headed, what are the big challenges we see out there, what are your favorite asset classes? I think that’s where we settle on these. These are always fun. Meaningless, but fun.

John Luke

And for the record, we can’t vote on these as a host.

David

Would you be willing to say what your answer is though on this webcast, John Luke?

John Luke

I think it was going to be up 15 or more, just for fun.

David

I’ll play on-

John Luke

All right. So right in the middle there, most people in that 5 to 10% range, which historic average. Doesn’t happen, but-

Derek

The number that never happens but is the historical average

David

Never. It’s funny when you look at a lot of sell-side analysts and their expectations, not just for earnings growth but growth in the price of the S&P 500, they all just take the easy way out and say, “Oh, we’re going to have 8% earnings growth next year. The market’s going to go up 8% because that’s what it’s done historically” because those people want to keep their jobs. So no one really ever steps out of line when they come out with a lot of their outlooks, which I always find comical.

But as we continue here, I think we want to start off with something differentiated. I think that there’s a lot of consensus out there in this market, much like a lot of the sell sides expectations moving into 2025. So we want to start off with where we think we are a little different in our thinking and it really comes through. I think we do a great job here at Aptus of tuning out the short-term noise and focus on what’s going to be driving the market well into the future, not just over the next 12 months because I hate creating outlooks that just embody what’s going to happen in the next three months, the next six months, or the next 12 months.

There’s such a great characteristic for investors to be able to see the forest through the trees on how the market evolves over longer periods of time because if you can do that taking a broader brush at the bigger picture of what’s going on, I think you’re going to be more optimistic about the future and innovation and profitability, which is going to set you up for so much more greater success than those that focus on the short term. Because when you focus on the short term, you try to play with the pie across too much by trading too much or become too pessimistic or too conservative, that can lead to some type of longevity risk in a portfolio.

But the big thing I’m focusing on right now is somewhat twofold. I have a saying is that as the market evolves, you need to evolve with it or you are going to become obsolete. And when I say I want to focus on the forest through the trees, I want to look at the composition of the S&P 500 over last 30 and 40 years. Most people want to look at the composition of the S&P 500 now where the top 10 names account for 39% of the S&P 500, and they take that as a bearish signal. But if I think you step back and look at it from a holistic picture on how the market has evolved from the seventies and eighties and early part of the nineties to today, I think it could paint a very much more optimistic and better picture than just focusing on the negatives having so much market concentration in the S&P 500. Which relative to the rest of the world, the rest of the world tends to have a substantial more concentration within their major indices, which I would say as a disclosure.

But everyone wants to hate on valuation because expensive relative to its past. And there’s a lot of mean reversionist out there that want to say, Hey, you know what? The market’s expensive. It’s in its top 5% relative to longterm. Valuations have to pull back.” But I think those people are nearsighted and illogical in a few different senses. Because what the market was in the eighties, it was a very much more asset-heavy, CapEx-driven market. Fast-forward today, it’s the exact opposite. It’s very asset-light and very innovative industry as a whole. So I hate comparing today’s valuation to the S&P 500 of 22 times on a forward basis to the valuation of the S&P 500 back in 1990.

In 1990, the S&P 500’s forward valuation was 13 times. So right now, the market relative 1990, yeah, it trades at a valuation that’s 69% higher than where it was 34 years ago when the constituents were substantially different, the position was substantially different. And if you look at the chart on the bottom here, yeah, the valuation is 69% higher than where it was in ’90, but its profitability on an operating perspective is now 13.8 expected heading into 2025. And that’s when you compare to a S&P 500 operating EPS margin in 1990 of 5.7%. So you’ve seen operating margin grow over the last 34 years by 140%. The valuation’s actually only increased by 69%. So all in all, what I’m trying to show here is that the market has evolved and the valuation in my mind is not a problem because it has evolved in the right way here in the United States.

But if we take this a step further, I think what are the ramifications of this evolution of the S&P 500 is now that the US markets, as measured by large caps, have this characteristic that no one else has and it’s going to be operating leverage. Basically simplistically said, operating leverage is that for every $1 of revenue input we can have greater than $1 of earnings output. And I think next year is one of the best ways to look at this, is that in 2025, the average analyst expectation for revenue growth is 5%, and that equates to earnings per share growth of about 15%, meaning that we’re basically getting the three to one payoff of earnings growth to revenue growth. That’s operating leverage.

And the reason that the market now has operating leverage is because of those top 10 stocks. There’s mega-cap tech stocks that are very innovative, whether it’s Microsoft, Amazon has a ton of OI and operating leverage in there. NVIDIA, Broadcom. Even Apple to an extent. Meta does. Those are the reasons that the market has this characteristic. And I don’t look at the market concentration as a problem because the reason that there’s market concentration in the S&P 500 allows us to have this operating leverage.

But I would say that the biggest thing you could take away from this [inaudible 00:14:46] invocation of how this market has evolved is that when you have operating leverage now ingrained in system, which again, operating leverage only accounts in US large caps. US small caps doesn’t have it, they don’t have it. International doesn’t have it, those are more service-based economies. And emerging markets don’t have it, they’re going to be more of a commodity-based or metals and miners market. So it’s only US large caps that have this awesome characteristic. But this awesome characteristic of operating leverage can cut both ways. When operating leverage is working for you, it’s your best friend. But when it starts to work against you, it’s going to be your biggest enemy.

Then like next year we have 5% revenue growth, which equates to 15% earnings growth. Let’s flip that up though. What if there’s 5% revenue growth, a detraction of revenue of 5%, maybe that could equate to 15% degradations in earnings per share. And then that would mean slowing growth and lower profitability. Two things that the market hates to see be in negative territory. So I think when you have operating leverage as a characteristic, the ramifications of market performance is that you’re going to get more tails.

And obviously I can talk about more tails in line of the 2025 Market Outlook of airplane because airplanes have tails, but what I think we’re going to start to see and we’ve seen over the past few years is that the better years are going to be better and the worse years they may be a little bit worse. Brian Jacobs, a CFA on our team, great addition over the last year, he showed me a statistic saying that on the average up year since 1926, the average up year is up 21% for the S&P 500. The average down year since 1926 is down 13%. Pretty big tails.

Then John Luke, who’s about to talk here, he showed another amazing statistic that, going back over the last… I think it’s since… Last 90 years or so, I think 27% of the last 90 years have seen a return in the S&P 500 be greater than 25%. That just shows you, those numbers shows you that given the operating leverage in our industry and how it’s evolved from the eighties to today, that we may see more tails moving forward into the future for the overall market. And as we know, and this chart shows it to you, and it’s in our asset allocation chart, but as we know, Aptus’ philosophy is basically two things.

We want to own more stocks, less bonds [inaudible 00:17:05] remaining risk-neutral. That’s one of our first investment philosophy. Our second investment philosophy is that we want to do better in the tails. And what we’ve seen from a data [inaudible 00:17:13] perspective, and what I just mentioned about with operating leverage and how tails happen more often, I couldn’t be more convicted on how we are positioned your clients’ hard-earned money for this characteristic to not only benefit from it, but make sure that we’re prepared for it if operating leverage becomes our biggest enemy. So we’ve had a great year at Aptus, 2024 was amazing, we love our partners, but we continue to have this amazing conviction in what we’re doing not just at our active ETF level, but our overall allocation level into 2025. And I just could not be more excited to be a part of this team and have all of our partners because we’re prepared for whatever the future holds.

Derek

I just dropped-

David

So we’re going to bring up a second poll. [inaudible 00:18:01] a second poll. Let’s look at the challenges that we may see over the next 12 months. Okay. We’re going to have five different options here and please vote for what you think is going to be the greatest challenge that the market or economy has to endure over the next 12 months. It’s going to be jobs growth.

Derek

I think you can pick a couple on here. I think this one we let-

John Luke

Multiple choice.

Derek

Multiple.

David

I loved multiple choice in high school. It could be Fed policy error, government debt, or valuation. I’ll give you a few more minutes and then I’ll let [inaudible 00:18:32] wrap this up. And then we’ll pass it to John Luke to talk about market commentary.

Derek

All right. I’m going to wrap it and we’ll share the results out there. Click your buttons and we’ll run with it. A couple of standouts. And they’re right up your alley there, JL.

John Luke

Yeah. There we go. I can’t actually… I couldn’t see the results there, but I’m guessing debt and inflation were… Yeah, there we go. Yep, that was it.

Derek

He teed you right up. Didn’t know [inaudible 00:19:19], but there you go.

John Luke

Yeah. When you look back over this year and you remember where we started, the market was expecting six, seven, maybe even eight rate cuts at the beginning of the year. It looks like we’re going to get four. Today’s obviously Fed Day where 25 basis point cut is pretty much inevitable. At the start of the year, the 2-Year Treasury was about 4.3%, and right now it’s 4.2. So you had a marginal 10% drop in 2-Year. But where you had seen some maybe differences from what people expected and getting into the next chart too, but the 10-Year Treasury started the year at about 4% and currently it sits at about 4.4%.

And so Derek, pop back to that other one for just a sec, I got a little ahead. But basically what this chart is looking at is the Fed fund futures curve today versus this time last year. And so you can see that there’s been a very, very large change in terms of what the market is expecting, the Fed’s neutral rate or where they’re going to stop cutting interest rates at, now versus a year ago. And that gets back to the initial commentary about markets expected a lot of Fed cuts, we got about half of what was expected in 2024. But the real question is, is what do we get next year?

And I think that the take that we have is the neutral rate or where the Fed leaves their ultimate policy is going to be higher than what most people expected. And it gets down to a lot of the points that Dave hit on about the consumer. It comes to many of the things about how basically everyone extended their debt when rates were really low, but the economy has been much less sensitive to interest rates than what a lot of people have expected. And really what that means is that we’re just probably going to get less rate cuts than what the market had initially hoped for. But the good part is, is as we’ve been in this environment of rates were high for a really long time, couple years, and we just saw the initial rate cut in September. And obviously it’s been pretty quick in terms of the cuts as the Fed has tried to get in front of any inflation woes, but what it has led to has been higher rates. And so next one, Derek, if you can. Or Dave, sorry.

Yeah, so what’s been different with this cycle is rates did what? Where you’ve seen the 10-Year Treasury increase by about 80 bips since that first Fed cut. And that was definitely not something that was on most people’s bingo card. You’ve seen throughout the whole year where interest rates were trying to get ahead of what the Fed was going to do and expectations. But as we were really I think on the forefront of is, just because the Fed was cutting rates didn’t necessarily mean that longterm bonds were going to be the place to be. And I think that this play out has really shown that to be the case.

But I don’t think that higher rates up to a certain level, are going to be a major drag on other asset classes or risk assets. But I think it does make a point for when it comes to portfolio construction that we believe bonds are going to continue to not be friendly to advisors’ portfolios. They’re going to be an anchor where of course they can’t grow, as we’ve talked about. And the big thing I think is… And we’ve heard a lot about this the last couple of months, where the inflation prints that the Fed were really hoping would be moving closer and closer to 2%, while they have improved, they’ve started to become bumpy and the root to 2% is likely to be much longer than what’s expected. Because of that interest rate policy is going to be higher. And I think that it’s going to continue to push yields in an environment where you just can’t bank on those big total returns from rates dropping like folks have in the past. Next one, Dave.

So getting back to the point from last year, when you think about the backdrop of the debt of the country and how liquidity works out, one thing we’ve really harped on the last 12 months is there was a substantial change and the early part of Q4 of 2023 where… That was when interest rates were… You’re getting a 10-Year close to 5%. You were getting some pain in markets. And you saw Janet Yellen really shift policy to issue a ton of the US government debt on the very front end of the curve using bills. That was a big impact to risk assets where, when you issue bills, it just takes much less liquidity out of the market than issuing longer-term duration.

And so one of the things that I think we’re going to be really on the forefront of is we’ve got a whole new political regime that’s stepping into office in January, and you’ve got different beliefs on fiscal policy, you’ve got different beliefs on monetary policy. Obviously, President Trump has pushed in the past for lower rates. You’ve got Scott Bessent who’s very focused on fiscal, and he’s a very hawkish on fiscal policy and big believer that US deficits are too high. And so as we wrap into… And one more slide, Dave, as we walk into 2025, another topic that we’ve talked a ton about is the US Treasury has about 7 trillion treasuries to refinance in 2025.

And the big question is, where on the curve are they going to do it? And so the chart before was really saying, “Hey, we focused on the front end of the curve with issuing a lot of this debt,” which was great for liquidity, but maybe not so great for the short term because that debt rolls over, and if interest rates are going to be higher on the front end of the curve than what people were expecting, they’re rolling them over at higher rates. And I think that Scott Bessent has made some comments that he would like to see some of the issuance be further out, longer duration. And so as the market has to absorb a huge amount of refinancing, a huge stockpile of debt, and if they’re having to finance it at longer durations, that could continue to really pressure the long end of the curve.

So we’ve got this situation room, which the biggest thing that I think is on a lot of people’s minds, which was obviously in that poll, indicated in the poll, and another point that we’ve talked a lot about, but the US debt has obviously risen drastically. It’s knocking on the door of $37 trillion. But you think about the dead and the impact, there’s really a few ways to handle it. Austerity, inflate out of it, or growth. And I think the funny point on austerity is that’s like… I think it was Vivek or maybe Elon talked about using the last digit of people’s social security number that were employees of the government and basically eradicating their position based on those numbers. It’s just funny because that’s not going to happen. So we’re going to focus really on inflate or grow out of within these points because we think that austerity not only is it very uncomfortable on the front end, just ask Argentina right now, but also it’s just politically infeasible. No politicians are voting for any type of austerity types of policies.

David

I think you just wanted to talk about Argentina probably for a little bit there, knowing you, John Luke, but let’s set the stage for this. John Luke, wild-card question. 1 to 10, 1 not worried, 10 worried, what’s your worrisome scale here on the US debt right now? 1 to 10.

John Luke

Probably a 4.

David

Okay. If I had to give my answer, I would be closer to a two. So let’s walk through our thoughts because obviously this is on the forefront of everyone’s mind. I think John Luke doesn’t take enough credit for this, but he’s been so much on the forefront of talking to people about debt in this lens and I think it’s perfect. The only ways out of it is austerity, inflate out of it, or grow out of it. Let’s talk about grow out of it.

I think the best way to set this stage is actually talking slightly quickly about politics. I know, I’m sorry, but we’re going to do it. And I wrote a [inaudible 00:28:27] on this. It’s Trump is the Nominal GDP Growth Candidate? All right. I put the word nominal in there very much purposely because we have to talk about the other aspect here on how to inflate out of it. Trump knows that we’re in a debt problem right now. I think a lot of people wouldn’t know that our deficit has actually come down over the last six, seven months because tax receipts have increased, which we’ll touch base here momentarily. I think John Luke will.

But Trump understands that as long as you can continue to grow faster than the deficit itself, debt’s not going to be a problem. Let’s bifurcate that. All right, what if deficit doesn’t, or if deficit does grow faster than nominal GDP? All right, let’s segment this. So if nominal GDP grows faster than the deficit, that means debt’s not a problem and that means that stocks could probably do really, really, really well. But on the flip side, on the other side of the pillow, if the deficit grows substantially faster than GDP, that’s going to be a problem. But that’s going to mean that rates are most likely going to stay much higher and stocks may have some trouble. Let’s think about that conundrum there. Stocks may go down, but rates may stay higher, that means you can’t rely on fixed income, traditional fixed income as a mechanism to insulate the downside of portfolios moving forward into the future.

But bringing it back to the 10,000-foot level here. Trump knows that he has to grow. Whether Harris was in presidency or in Washington or Trump, we all know that once you turn the water spigot on for fiscal policy, you cannot turn it off. Obviously, Harris’s policies versus Trump policies were completely opposite on where the fiscal spending was going to occur, but it was going to occur no matter what. And Trump knows that he has to have more of a refined rightful approach than a shotgun approach here to utilize fiscal policy to his advantage to create the best IRR of some type of economic growth output because he knows that he has to keep growth above the deficit.

And I would say the biggest misconception in this market is looking at this debt from an absolute standpoint. If you can look at the debt from an absolute standpoint, we’re never going to win this battle. Debt is only going to continue to increase much due to the point that John Luke was just speaking about here, that we’re having to refinance it at higher rates. And right now the interest rate expenditure on the income statement for the US government is basically the second highest behind social security. It’s [inaudible 00:31:04] Trump and greater than the Medicare and the defense budget now. So the absolute debt level is only going to continue to increase.

What we have to think about is from a theory of relativity. All right, what’s our debt relative to GDP or our deficit relative to GDP? And Trump knows that and that’s why he has to make sure that we have the right fiscal policies in place to make sure that it has the best advantage to grow nominal GDP so the debt does not become a problem. But with that brings up the next point that John Luke’s going about. When you have this amount of nominal GDP growth injected by fiscal policy, there’s probably some ramifications that aren’t as great on this side of the ledger and that’s probably going to come through the form of inflation, but maybe inflation isn’t as bad as what you may think in regards to the debt problem.

John Luke

Yeah. And so this is a great chart that looks at basically the two inflation metrics that everyone knows and loves, headline and core. Obviously core inflation, as we saw last week, continues to be above trend. It’s over 3%, which is well over the Fed’s target of two. But when you make some adjustments for the shelter piece, which is very lagging, it’s trivial in how it’s calculated, the inflation rate is much closer to 2%.

And so whenever that Chairman Powell is looking at his job, which is obviously to fund the government in some extent, whether he’ll admit it or not, but he wants to get inflation low, he wants to keep unemployment in check from rising too much out of spades. But really I think what he’s trying to do is effectively not move the inflation target in mandate but move it in terms of the duration to hit it. And so by continuing to bump out the, “Oh, we’re going to hit 2%, but it’s going to come next year. Oh, it’s going to come the next year.” He’s basically just buying time.

Because if you think about from the Fed’s perspective, one of the biggest things that they can do to help offset some of that interest burden is to cut rates. And they can do that and keep nominal growth high. So that piece that Dave just talked about, nominal growth stays above the deficit growth. But when you look at inflation, it’s of course, been… It’s a sore subject and probably a lot of the results of the election were based on the amount of inflation that we have seen the last couple of years.

But when you look at where it’s at, it’s not at a level that is run away. And I think that’s really the important part, is as long as Chairman Powell has inflation in a spot where people aren’t too worried about things getting back to what we saw in 2021 and 2022 where it was absolutely running away. But if he’s got it controlled that it’s continuing to trend, even if it’s long and bumpy, he’s basically setting us up in an environment to continue to slowly inflate our way out of this debt problem while President Trump on some of the other side, the fiscal side, continues to push the accelerator and keep nominal GDP growing at a fast clip.

David

I would add one thing to this, and it’s… Everyone thinks of inflation is terrible. Obviously yes, it degrades your ability of purchasing power into the future, but if you have the ability to have the nominal growth that we [inaudible 00:34:31] in the United States from our policies and whatnot, it probably does mean also due to immigration and wages that inflation is going to be a little bit higher. It’s not an aspect for me to be worried because stocks actually work best within the environment of inflation from 2 to 4%. And if we’re within that range, I would own as much risk assets as possible, as I possibly can. And that’s why I have that conviction that I just spoke about with our asset allocation of owning more stocks, less bond because that’s a terrible environment for fixed income, but it’s an absolutely amazing environment for stocks. And if you can bring that all together while remaining risk-neutral, it’s like you’ve almost found a holy grail of some sorts.

John Luke

Yeah, this chart is nothing to scare investors, it’s just to accept the reality that Chairman Powell is going to accept inflation being above target for much longer than what people originally thought.

David

Because back to as the market evolves, we have to evolve our thinking or maybe our investment philosophy becomes obsolete. This is I think something that JD, John Luke, myself, and the rest of the team, I think we’re very much on the forefront of this conversation relative to others out there in our industry.

John Luke

Yeah. So really getting into this… All right, we’ve got another poll here. Which asset class do you like most in 2025? Large, US small, bonds, international, or Dave’s favorite, gold and Bitcoin?

Derek

We didn’t have a spot for Dave’s favorite that he always does in his presentations, which is guns and ammo. That’s best in an interactive where we can actually see the crowd laugh, people raise their hands and stuff, but that’s always-

David

They’re laughing there.

Derek

That’s always a default option.

John Luke

But regardless of, I assume how this poll is going to end, it really tees up nicely the next slide.

Derek

So we’ll get to some of the key ideas for the year ahead, but his questions too. There should be a chat poll in there and we’ll get to those at the end and we won’t labor on for too much longer than that. But if you do have questions and we don’t get to them, we will hit you afterwards. I’m going to wrap this one and I’ll share the results and we can see… It looks like a little more of the same.

David

This surprised me.

John Luke

I’m a little surprised, yeah.

David

Because I’ve done a lot of presentations around the country the last few weeks and everyone hates US large caps, everyone loves small caps, no one likes international, no one likes bonds. And some people like… I’ve assumed that this 18% that [inaudible 00:37:09] for gold and Bitcoin is probably more on the Bitcoin side than the gold side of the ledger. But this is out of consensus in my mind and I think that’s going to be important. John Luke, let’s bring this back up here in a few slides.

John Luke

Yeah, so one of the main bullets that we think will continue to drive the economy, just like the Atlas Shrugged piece from 2024, is really everything dictates based on the consumer. And when you look at the backdrop of the consumer, you’ve obviously got consumer asset prices which have increased drastically the last two years. You’ve got consumer financial assets that are up about 13% on the year in aggregate. So that’s weighing more than just their stock bond and maybe Bitcoin portfolios. But you’ve got a huge increase from a wealth effect perspective of the average consumer has seen their property values, their 401(k)s, their investment portfolios, their real estate for the most part increase pretty handsomely. And so when the consumer has that money, they feel more inclined or at least more at ease to spend it.

And so when you pair that on top of just a continuation of a pretty strong labor market, you haven’t had a huge uptick in initial jobless claims, which has been something that many of the bears have been really watching for as when do we start to see unemployment tick back up? When do we start to see some pain in the labor markets? But this doesn’t actually hit on the real wages, which have actually grown very significantly the last couple of years. So you’ve got a consumer that’s employed that’s got their net worth increasing and that’s seeing their pay generally rise or really keep up, if not even outpace, the level of inflation that’s measured by the government. And so when you think about how this impacts markets, we think that the consumer has the propensity to spend and if they have the propensity ,they will.

David

I would add, John, the biggest kickback I’ve gotten probably over the last year for the Ayn Rand’s Atlas Shrugged, the consumer theme I’ve had is like, “Dave, the savings rate is substantially low, which is creating the consumer’s income statement to be negative, that their outlays are more than their inflows, and that started to go against their balance sheet or their nest egg because they’re spending more than they’re bringing in because the savings rate is so much lower than what it’s historically been.” The historical rate for the savings rate is between 5 and 7%. We’re getting lots of readings for the last 12, 24 months that is closer to 3%. But the government came back out and revised their savings rate right back into the historical range of 5 to 7%.

But then you couple that in, and John Luke’s always brought up a great point here, is that saves rate doesn’t account for what you’re earning on that savings rate. So I would say the savings rate is right where it’s been historically, that it’s not actually eating into inflation, isn’t eating substantially into the balance sheet of a lot of consumers, but they’re also earning more on it. So I think the consumer just remains absolutely just very strong right now and it’s something to be optimistic for.

John Luke

Yeah. And taking a step further from the government perspective of… Maybe Dave’s answer of two on the debt load and my answer of four. One of the points that I think I saw was just great is the recession isn’t going to cause the market to go down, it’s the market going down that could cause the recession. And I think that goes back to that wealth effect on the consumer. But the other second derivative piece of markets performing the way that they have is Uncle Sam’s taken a nice cut from a tax perspective of all these gains. And so that’s one of those things, like Dave said, where deficits have been actually declining more than what most people want to believe. But when you look at the actual numbers, when you have a market that’s up 30, when you have Bitcoin that’s done what it’s done, et cetera, as people are taking gains on their portfolio, it’s awful helpful from a tax perspective to Uncle Sam.

David

Yeah. Especially he was taking some gains on Broadcom stock, John Luke. It’s just great times.

Let’s go on to the next topic. What could do rail the market? Obviously John Luke and I have been very optimistic here. We are more optimist in genera.l I think that’s… I don’t know if I could say that about you, John Luke, two years ago, but I think that you are more of an optimist now. If we go back to the poll that Derek just put out of what is our favorite asset class moving forward into the future, majority said small caps and large caps. Like I told you before, no one’s really given me the large cap answer in a public form of when I’m presenting conferences for this because there’s a lot of consensus out there. So it feels like the results that we got from a lot of people on this call, the hundreds of people on this call is that… We had an out of consensus view right now and I love that. One, maybe you guys have been listening to us and I don’t know why sometimes.

But I would say that what I’ve learned over the past few months and what I’ve seen anecdotally from the market is that there’s been so much consensus out in this market over the past few years, and consensus has continued to be wrong. Whether it was back in ’21, ’22, ’23. Everyone wanted to hate the small caps in ’22, everyone wanted to hate large caps in ’21, and vice versa, you could say the same thing on the fixed income side. I would say that when there’s a lot of consensus or a step forward when a lot of people are very bullish, it could create air pockets in this market. And to keep with the 2025 theme, there could be some type of turbulence because I would say a lot of the indicators that you’re looking at, whether it’s the AAII bull/bear ratio or through the other studies and soft data points we’re seeing out there, there’s a lot of bullishness.

Obviously that was very different than where we stood two years ago when everyone was bears and that actually became a contra indicator that created a bullish sentiment and the market started to run. So I would say that when everyone has all their marbles or chips on one side of the table hating large caps or just hating the equity markets as a whole, it tends to make me want to take the opposite side of the table because consensus has continued to be wrong. I would say that is obviously the thorn in the side of what John Luke and I are talking about here, but I would say that I’m okay with that because when you get this type of very sentiment results or these air pockets, they’re very short-term in nature.

And I think it’s just a risk that we have to have on the table because there’s a possibility that there’s some type of washout bull system the market could pull back. But again, we have to be longterm mindset there of seeing the forest through the trees and understand that these pullbacks, they happen. We know 3, 5% pullbacks happen on average in a given year, and one 10% pullback happens on average in a given year. And that pullbacks are normal and that they’re healthy and it could be caused that there’s just too much optimism in this market right now.

John Luke

Yeah. And Dave, go back to that for just a sec. I wanted to make two points. So first is a funny point. You just had President Trump go in and ring the bell at the New York Stock Exchange. We saw four years of experience from his last term in office where he grades his performance by what the stock market’s going to do. And I find it hard personally to believe that he’s going to sit back and let things meander. I think he wants another four years of the market booming, and I think that that’s going to work against it. Some of this may be being a negative indicator.

And then the other piece of the pie that I think actually really applies to the portfolios is when everyone is this bullish, what they’re not bullish on is hedges. And when you think about the price of hedges, we’ve got some charts, we’ve shown a lot on this, but it’s very, very cheap to hedge your portfolio. And it’s been very cheap to hedge your portfolio all year. And what you’ve seen whenever we’ve got some bouts, whether it was April, whether it was May, it was July and August, a little bit in September where markets did bobble a little bit. Those hedges really were able to kick in. So not only is the cost to have your hedge very cheap compared to how it has costed historically, but the effectiveness of that hedge can really come into play if we do get some of those mild turbulence to go in line with your flight theme of this. We’re very well positioned I think to combat.

Yeah. I hit on this a little bit in the initial part, usually I do get ahead myself, but the two things that I think on the rate and the inflation side that obviously can cause some additional stumbling to the Fed and maybe even change the outlook for Fed cuts to be even less than the three that’s expected for 2025, which is obviously pretty low, is the 10-Year yield. When we’ve seen the 10-Year yield get above 4.5%, you have started to see some wobbliness in stocks where, from a relative value perspective, there’s been some questions. We’ll see, we’re not quite back to that level. We’re right in between the range listed in this chart, but that’s something to watch for a shorter term, at least noise.

And then the second piece, which is probably the most important is just inflation typically comes in waves. And we’ve obviously seen the wave come and go from the post-COVID, the fiscal craze that we saw. And now the question is, is do we see a return of inflation? And I would say I don’t think that we would see a return of inflation to get back to the levels that we saw before. I think Dave would agree on that. Probably the bigger concern is does inflation bobble more in that 3 to 4% range instead of the 2 to 3% range that the Fed’s hoping for?

David

Last and third, because everything comes in threes. The three things that we said would derail the market is sentiment is very bullish right now. Rates didn’t matter this year, maybe they’re going to matter more this year to equity markets. And third and final, is that… My least favorite of all three, but it’s going to be potential political volatility in Washington, DC. I’m not going to give you my thoughts and opinions on all this such as tariffs or taxes, but there is a lot that needs to happen in Washington, DC over the next few months, whether it’s in the lame-duck session all the way through the first quarter.

But we all know that the 2017 Tax Cuts Jobs Act, acronym TCJA, lot of the individual tax policies are sunsetting at the end of 2025 and they need to be addressed next year. It’s one of President-elect Donald Trump’s one of the biggest things he wants to get done next year because if the tax bill for individuals goes higher, if they don’t get it done, I think that could weigh on the market as a whole. And to John Luke’s great point, Trump is graded in his mind, his report card is the S&P 500’s performance. He doesn’t want that to happen. I like it.

So that’s just one aspect that Trump has to get pushed through next year on the individual side. He’s obviously looking to get stuff done on the corporate tax side of bringing the corporate tax rate from 21% down to 15%. He has a lot of stuff that has to occur on the ACA side for healthcare. And then obviously we’re going to have the reintroduction of the debt ceiling on January 1st of next year. So there’s a lot that has to happen in Washington, DC.

And where the water gets a little bit muddied is that you can’t attack or most likely Trump’s not going to attack each one of those four items. Individual taxes, corporate taxes, ACA, and the debt side of things. He’s not going to attack them in a standalone silo fashion. He is going to try to group a lot of things such as tariffs and immigration into these policies which to kick the can down the road to get a lot of these policies enacted into the market, which could create some market volatility. Obviously he wants to get it done as soon as he possibly can, but sometimes he bites off a little bit more than he can chew. Whether it’s a negotiation tactic or desire, I’m not too sure, but we’ll see how the market digests that moving forward into the future.

Obviously tariffs is at the forefront of everyone’s minds right now too. But all in all, there’s a lot that the market has to endure next year in regards to what happens in Washington, DC. And we know Washington, DC, the politicians in Congress, they were like me in eighth grade. It’s like me writing a book report in eighth grade where I’m going to start writing it at 11:59 the night that it’s due. I’m going to get it done, but it’s going to happen at the last minute. That’s what policymakers do, but the market doesn’t like that because the market likes consistency and it likes knowing its outcome. And when there’s uncertainty, that can create some type of volatility.

So in the next section and final section, our positioning moving forward. I’m going to give you two hot takes and John Luke is going to talk about how we think about it from an allocation standpoint to bifurcate the voices of this conversation. My hot take one is that the path of least resistance is going to continue to be higher. Okay, that’s why we have the theme here. “Oh Dave, you like stocks after the 70% run over the last 25 months?” Surely you can’t be serious. I am serious and don’t call me Shirley. I would say [inaudible 00:50:52] is for the time being, it looks like the prospects of continued monetary accommodation, relatively easy fiscal policy, and regulatory easing should continue to keep the animal spirits alive for both investors and deal-makers.

So that’s why I believe that investors need to own stocks for the long haul right now. And that’s basically my point saying path of least resistance is higher. I love our overweight stocks are underweight to fixed income while remaining risk-neutral, but there’s just too many structural things that are driving this market over the past two years that are still very much present in the market moving forward over the next 12 months. John Luke, any thoughts on how we’re attacking this on the allocation side? Hit it.

John Luke

Yeah. Yeah, you definitely stole a little bit of thunder, but no. When you think at the backdrop of how you address, credit spreads are stupid tight, fiscal policies continues to be accommodative, monetary policy like the next Fed moves are cuts, not hikes. So it’s at least moving in the right direction of being accommodative. You’ve got liquidity that’s very friendly. Just look at Bitcoin. You’ve got the regulatory backdrop, low vol. Typically continues to beget low vol. And then if you think about where the Fed sits with rates, they obviously have the room to cut if things do get weak, which I think continues to be a pseudo put for the market, the Fed put probably in place.

And then one big one that we didn’t touch on, and I haven’t heard a ton about it, but the Fed has been doing QT for a long time. And while a lot of the QT has arguably been offset by some of the bill issuance that I talked about at the beginning, the Fed does have the ability to stop the QT and I think that’s probably coming sooner than most people expect. I would really expect some update on that in Q1 of next year. So that will bring the Fed back in the market to help take down some of the surplus of debt that’s got to be refinanced to at least replace what’s rolling off.

And so when you look at the portfolio from a construction perspective, this year has been as good of a statement of proof for our asset allocations and how they can work. More stocks helps you capture that right tail move when they happen. Less bonds obviously frees up a lot more of the portfolio to own assets that can grow. And the volatility piece continues to be extremely important because not only are hedges cheap, but they can be very effective, and the hedges are in place to really create the differentiator on the downside where we really think that even if you do get a harder landing that it’s not likely that bonds are going to… You’re not going to see interest rates go back to 0%.

Of course now that I say that it’s on record, but I just think it’s very unlikely that you’re going to see interest rates fall meaningfully from here. The economy just continues to rock in a place that I think alludes to rates being higher than what they were in the last cycle. And so it just points to rethinking the asset allocation that we march to the grave on of more stocks, less bonds. And when you think about the government response and you go back to the ways to get out of the problem, some form of inflation, some form of grow your way out of it, the government has basically gone with the de jure policy of continuing to print their way out of the problem. And I think that it’s hard to bet that that’s going to change. And with that you’ve got to be positioned differently.

Dave, the mute button got you.

David

I was definitely not talking there. Since you just used the word de jure there. I don’t know if I’ve ever heard that word or could spell it or use it in a sentence, but we’re going to try. Hopefully I use it right. Everyone knows my de jure are small caps. But what this chart is showing you is that moving forward, given the component of operating leverage that I spoke about at the beginning of this call, it’s hard to bet against large caps right now still because when operating leverage works for you, it is your absolute best friend. But I would say that, I say that we like… Have a saying here now too. We have loved science here at Aptus.

When everyone is looking for alpha, we think beta is underappreciated. And when I say I want large over small isn’t just a call for alpha, it’s a call just like let me own as much beta as I possibly can in my portfolios without more risk because that’s what my clients are grading me on is the S&P 500. So let me own as much as I possibly can within reason of risk. And I think that could be the best thing that could happen to my clients and investors because it detracts their ability to inject and try to time the market or be mad at your performance and try to chase returns.

But when I say I like large over small, it is embodied by the characteristic that large has operating leverage as its main characteristics. As not a knock on small caps because the market could still very much broaden out. It started to broaden out after the election. That’s pulled back here over the last two or three weeks. But I’m comparing large caps to the universe of small caps. Obviously everyone knows my de jure, I love small caps. I know a fund personally with [inaudible 00:56:28] that is really good at small cap investing in my opinion, if I could say the name. But I would say that’s… I’m not comparing large over that, over our active ETF. I’m saying large over the small cap universe. Because what we do in our active ETF versus the small cap universe is very different. Many people don’t know that 40% of the constituents in the Russell 2000 Index, the benchmark for small cap stock, they don’t have positive earnings.

And that’s what I’m saying. I would like to choose quality over low quality. And low quality, if you don’t have the right active manager in place, you’re accidentally injecting a lot of lower quality characteristics into your portfolio. So I’m taking US large caps as measured by the S&P 500 to outperform the Russell 2000 Index as a whole. Okay. So it’s not a hit against all small caps because I… Like Animal Farm, I think all animals are created equal. Some animals that I really like are more equal than the small cap universe that’s littered with low quality, high short-interest, and non-earning companies. So that’s my take here is saying I love large [inaudible 00:57:40] operating leverage characteristic, a characteristic that small caps do not have.

Derek

I think we do. There have been quite a few questions that have come in, I don’t think we’ll get to them all here, but we’ll hit you directly. I think maybe we type back a couple of them, but we’ll also hit you if there’s anything worth, anything more complex.

You guys killed it, covered all the key topics. I think as far as advisors go, it’s hard to know what’s going to happen in the back half of the year or anything. We know that there’s a lot happening in January. Probably people that have had postponed gains, they don’t want to take the tax hit this year. You got some of that. You’ve got possible executive orders. You got two Fed meetings. You got one in January, one in March I think. You got earnings. There’s a lot. Three jobs reports. So there’ll be a lot to happen in the first quarter that is probably going to drive a lot of the action. Obviously, JL, Dave, and the team are always available to answer any of the questions. And we certainly appreciate people taking an hour out of their day right before Christmas kicks in to listen and participate in what the guys have to say.

David

Hey, thanks to all of our partners out there, we love you. We wouldn’t be us without you, so thank you so much.

John Luke

Yep, thank you everyone. Merry Christmas. Hit us up if we can help with anything.

David

God bless, America.

Derek

Thanks, guys.

Disclosures

The opinions expressed during this Webinar 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 investment advisory services can be found in its Form ADV Part 2, which is available upon request. ACA-2410-6.

Browse 3 Minute Executive Summary Here. Full Video Transcript:

Derek

Good morning, 1st of October, early for you on the West coast, but it’s 11:00 for me here in Charlotte and there’s lots going on in the market.

Anyway, I want to thank you for joining us. I’ve got quite the Aptus all-star team today. Founder/chief investment officer, JD Gardner, is here. Dave Wagner, head of equities, is here. John Luke Tyner, head of fixed income, is here.

We’re going to go through a bunch of stuff, what has happened and more importantly, what might happen going forward and how that impacts clients.

We know it’s that time of the year. We try to do this as quickly as possible end of the quarter because a lot of people stack meetings early in the quarter. With the election and everything going on, I’m sure clients have rational and irrational questions to tackle and so we want to be here to at least give you coverage on that and these slides will be available.

Let me do a quick disclosure.

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’ investment advisory services can be found in its Form ADV Part 2, which is available upon request.

It was a good quarter. Another good quarter. It’s been a great year. One of the best in many years. Had a couple of little bouts of volatility early in the months of, I guess, August and September and now, we’re getting another one in October. That seems to be the trend of late but fire away wherever you all want to start.

JD

Perfect. Thanks, D. Hern, and thanks to everybody on this call.

It’s cool to see the growth of these quarterly calls here recently. Probably some good reasons for that. But either way, we appreciate the time.

Our goal today is really going to cover, hey, what happened, what we think about the backdrop of the markets, and how that impacts clients.

I usually don’t get invited to be here. So guys, thanks for letting me crash the party.

To kick things off, I’ll make two points and I think we’re going to talk about the macro. We’re going to talk about earnings and election and everything else, but I think the biggest thing to keep in mind is what matters is higher compounded returns.

That’s what clients want. And everything that we do is focused on allocation. I know you all have heard us say that. How can we create portfolios? Can we create strategies to impact allocation? Because that’s the lion’s share of what matters. And so if we can be good there, we can make mistakes elsewhere.

With that said, the two things I want to touch because I don’t think people touch on this enough. Risk adjusted.

I always give the example. Let’s say Dave generates a 10% compounded return. Let’s say John Luke generates an 8% compounded return, and you give a client, “Hey, do you want Dave’s 10 or JL’s eight?” Most clients are going to say, “I’ll take the 10,” and JL says, “Well, wait a second. Wait a second. My Sharpe ratio is higher. I’m here. This is my opinion. That’s my disclosed statement. It’s my opinion.” No client cares about their Sharpe ratio, they care about their higher compounded return with the reality of, hey, but what is my potential for drawdown, because clients view risk as drawdown. And I can’t stress this enough.

At Aptus, one of our things, the point of emphasis that we make is we think we’re generating higher CAGRs, higher compounded returns, but we’re not doing that to the detriment of drawdowns.

So when a client says, “My million bucks turned into 600,000, I’m concerned about that.” Our whole thing is more stocks, less bonds. We’re going to dig into why that is because I think the backdrop is just further evidenced that we’re not wrong.

But the big thing is like, okay, if it’s more stocks, less bonds, how can I be risk neutral from a drawdown standpoint, and we’ll talk a little bit about hedging and what that means.

That’s the first thing. Risk adjusted. When you adjust returns by risk, I think it needs to be adjusted by the one that matters to clients. And again, I think the allocation impact is critical when it comes to that concept.

Last thing from me to kick us off, and I know if you’ve read anything that we’ve put out here recently, this is a drum we’re beating and we’ll continue to beat. This is the hardest conversation for me personally to have is breaking the chains of, hey, my treasuries are safe, my CDs are safe, my cash is safe.

Obviously, what you’re looking at is by which is a proxy for what we would call risk assets, AG, which is a proxy for conservative or the traditional definition of safe assets.

The CPI running horizontal is the cumulative total of CPI over the last 10 years. What this chart is showing you that there is a significant difference between risk assets and conservative assets, again, traditionally defined and we think the backdrop is one to where this discrepancy is only going to increase.

And so what clients need to hear in my opinion is your risk is not some period of short-term volatility. Your risk is your purchasing power being confiscated from you. I think you solve this problem. You solve longevity issues that are impacted by what I just said at the allocation level. This is like…

Everything we’ll cover today boils back down to this chart again. Again, there is a very, very strong inertia force of, well, my treasuries are safe. I’m sure JL is going to make the point. If you’re getting four and a half, 5% from a treasury bond and our deficit spends 8%, they ain’t safe. I can assure you that.

That’s what I wanted to kick us off with is, hey, we do think higher CAGRs adjusted by drawdown is a metric that makes the most sense to harp on from a risk adjusted standpoint. And then be careful defining safe because I think a lot of people have the wrong anchor when it comes to what is safe.

Dave, I’ll turn it to you.

Dave

Thanks for that introduction there, JD.

I think one of the coolest things about Aptus is if you go out there and listen to really anyone talk, they talk to you about the problems of the world, the wall worry that investors always climb. They tell you what the problem is, they don’t tell you the solution, what we believe is the most efficient way to take a problem of what we recognize and get to the solution where it actually has a tangible effect for you all to make decisions at your allocator level itself.

That’s why everything that JD just talked about right there, myself and John Luke had a fixed income discussion, we’re going to kind of intertwine it with a lot of our macro and fundamental commentary.

Obviously, Dave Wagner here, I do equities here at Aptus.

Equities are hot right now. They’re so strong right now. Risk assets just continued their history during September and obviously, for the quarter as a whole. In fact, they continue their history because the market’s up 22% year to date.

I’m using that word hit streak here very purposefully because I’m a Cincinnati guy. Pete Rose, famous Cincinnati native, who holds the MLB record for most hits in a career. He unfortunately passed away last night. That hits me hard.

But much like Pete Rose, the market is very polarizing to people right now as there’s always this wall of worry for investors to climb, especially as we’re only 36 days away from a presidential election. But like Pete, I’m going to continue to bet on stocks.

Obviously, JD just mentioned our Aptus allocation series, more stocks, less bonds, risk neutral because I always wanted to take the home team because Pete Rose, he always bet on the Reds to win, and I think that betting on stocks, they’re considered to be the home team.

That’s exactly what won this past quarter, specifically the more relatively cheap areas of the market. Think U.S. small cap, think international, those were the winners.

I think that the best way to explain the 43 different all-time highs that the market has witnessed this year is that they’ve all come from now different whys. We’ve had 43 new highs but we’ve started to see from new whys.

That tells me that the character of this market really started to change here in this third quarter, but the direction remained the same because the market finally started to see some breath out there.

Many people have asked us if this is more of a less powerful rally, but I would say the data suggests otherwise. This is still very much a bull market and it’s just a market that has started to broaden.

You had the equal weight S&P 500 up about nine and a half percent on the quarter, which outperformed the S&P 500 by 3.6%.

The broadening rally to me it’s more of an encouraging sign for stocks, especially following the concerns that the market could be vulnerable to some type of reversal and this cluster of text proxy names propping up the market really fell out of favor. This is a very, very healthy development for myself and risk assets.

You saw utilities, staples, real estate really drive this market higher but not only that, you actually had earnings come in much stronger across the board. The market’s pricing in a 10% earnings growth this year and 50% earnings growth next year, and much of next year’s earnings growth, yeah, it’s coming from margin expansion.

But sales growth is still a very strong across the board at 5%. We all know that when margins are expanding at the S&P 500 level, it’s tough to get in trouble with the market.

That’s really one of the reasons why I’m going to continue to be like Pete Rose and bet on risk assets over time. But I always have a saying or a phrase on a quarterly basis. All right?

Last year was it pays more to be patient than clever. But I think the one for this quarter is actually going to be coming from one of our different partners that we work with and he said something along lines, “I’d rather be right until I’m wrong than wrong until I’m right.”

I say that because it feels like there’s just a lot of investors out there that are trying to be more clever than patient, potentially eroding capital from an opportunity standpoint.

That’s really just a blessing to our Aptus structure as a whole because we don’t need to be clever to win. We just want to own as much beta as possible with guardrails because that’s the best way to compound capital over longer periods of time.

But as many of us on this call probably know… I believe Aptus is, obviously I’m biased, we do a lot of things very, very well, whether it’s running active ETFs, our amazing services, our sales team, our ops, our trading but I think one of the most overlooked aspects of Aptus is the material that we put out to clients to give advisors as many arrows in their quiver to make sure that their investors and their clients remain invested, because we all know it’s your time in the market and not time in the market as a whole.

That’s why this chart really sticks out to me here is really walking you through what the S&P 500 returns. We’re looking through the windshield, not the rearview mirror, after the fed cut rates within a 2% all-time highs.

I’m just going to focus quickly on the right side, the farthest right chart, basically saying that stocks are up 100% of the time. It’s a 20 out of 20 hit rates of being positive one forward year in advance when the fed cuts rates within 2% of all-time highs.

Obviously, we all know that the market’s up 43% off the recent market low of October 27th of last year, and a lot of people are trying to be clever and trying to time the market top because that’s fun, but they’re not being patient.

This chart right here helps people, hey, you know what? Let me remain patient. What the data says, this is 100% hit rate, 20 for 20, that the market’s higher when the fed cuts, if the S&P 500 within 2% of all-time highs.

But just because I believe that it’s really hard to be short the market right now, especially headed to election and John Luke will touch base on a lot of the monetary policy and the fiscal policy, really injecting liquidity in the market, doesn’t mean that there’s not going to be pullbacks in the market as a whole.

This chart really shows you that going back to 1928, drawdowns are healthy. They’re necessary. It’s a great reset for the market as a whole. This is something that we all know that in fact the average drawdown in a calendar year going back to 1928 is 16%. We’ve only seen one 8% pullback and that was during the yen carry trade debacle of early August. But we all know that the market on average tends to see one 10% pullback per year and three 5% pullbacks per year.

If we do get some choppiness ahead of this election or into the end of the year, even though I say that it’s hard to be short the market given the liquidity bazookas out there really propping up this marker right now, is that pullbacks are healthy, they’re normal, especially from a seasonality perspective.

The last thing I’ll say in the last 20 seconds or so is leave you with this on the equity front. Be like Pete Rose. Come increase your chances of winning the long-term game because you got to get a lot of hits in this industry.

We work in an industry where you do not get rewarded for home runs, you get rewarded by having more bats at the plate and more opportunities to get hits.

Be like Pete Rose, maximize your hits.

That’s what I believe our allocation does because we trust our defense by owning hedges so we can have more hits than any other player out there. That’s something much like Pete would probably do here. That’s something I would bet on.

JD

JL, not to jump in, but Dave, the two things that you said that I think are worth stressing would be, number one, our emphasis on additional beta. Additional beta versus a benchmark or versus 60/40 turn it into 80/20, that additional 20% we advocate just simply beta. We want to understand the risk that we’re onboarding and that’s critical.

The other thing that you said, you wrapped with it, Dave, but I really liked, “I want to be right until I’m wrong rather than wrong until I’m right,” because that’s what we see the biggest mistake in investing is like, “Well, I’m going to hold this cash in T-bills because the election or because…” You can come up with a million different reasons. But that’s what I think we overlook sometimes is the hedges that we have in place, there’s no correlation that you have to guess about. They have a negative correlation.

Do they cost us to own them? Heck, yeah, they’re going to cost us to own them but that cost allows us to own more of the risk asset. And if equity markets do sell off, if we’re wrong, then we have the brakes in place to prevent that.

I think you’re not going to avoid volatility, nobody’s saying that but I think, again, back to the drawdown measure, I think you’re going to be happy with it.

I just wanted to get that out.

John Luke

And on that note, JD, I think it’s perfect because you look at stocks obviously had a great quarter, it was a little bit of chop to get there but bonds had probably the best quarter that they possibly could have. Only Q4 of last year was better in recent history. Bonds measured by the AG up about 5.3% longer duration bonds like LQD did even better.

With that positive correlation continuing to be in check between stocks and bonds, does that mean that bonds are going to be reliable to be those breaks? I think we would argue that it’s not.

One other shout out for Dave, for someone with such a good saying of patience over being clever, you do have some clever quarterly sayings, so kudos to you on that, Dave.

But what a quarter for bonds. The two-year rallied 111 bips. The 10-year rallied about 68 bips to finish at 3.64 and 3.78 for the 10 year. The yield curve obviously is uninverted, spent a little over two years with a pretty steep inversion that finally came through with the front end of the curve coming down and the long end maintaining.

You also had the 50 basis point fed cut. I know we argued at the end of July or at the end of Q2 in June and early July that we thought that the fed would cut in July and obviously they didn’t. That was followed by some pretty weak labor data, some bad revisions, and data that just was not terrible but not great.

You’ve got this dynamic of the fed coming in, cutting 50 bips, architecting 200 more basis points of cuts, the market’s pricing in about eight cuts by the end of 2025 and about three more cuts for this year. That involves one more 50 basis point cut at some point and I think markets are obviously pretty hopeful that that comes.

What you really have seen is a shift from the focus on inflation to a shift in focus of the labor market. Unemployment has gone from 3.4% at the lows to 4.2. Obviously, that’s a pretty big move in terms of just absolute numbers but when you think about 4% unemployment, historically, that’s been full employment and that’s really nothing to bat an eye at.

Obviously, there’s some caveats with immigration and things like that but the fed has certainly bypassed their focus on inflation. Remember inflation as measured by core is still closer to 3% than it is 2.

One of the key ingredients that we’ve talked about the last 18 months is in order for the fed to get this soft landing, it does look like we’re potentially going to get that inflation is going to have to be tolerated at two point something rather than two on the dot. It does seem like that that’s in play.

Moving forward, I think the couple biggest things to watch is… The fed’s obviously got a lot more ammunition to cut rates if they need to. The fed put is certainly in place if you see the economy deteriorate.

I think the market’s seeing that and it’s probably somewhat reflected in stock prices, but inflation is still not necessarily a problem but it’s still elevated. I think that it could be a problem if the Fed does get too lackadaisical and ease too much into the backdrop that we’re in.

And to start the quarter, I guess, really started last week, you’ve got the Chinese stimulus that’s coming into play. If China is stimulating and growing, that’s going to pressure the global economy in an upward direction.

I think as you put really everything together, it does seem to me like the long end of the curve has probably rallied too much. What you tend to see, especially going into a soft landing, is that the market front runs the bulk of the rate cuts before the rate cut actually happens.

You’ve seen that. The 10-year dropped almost 70 basis points in a quarter. I think what that means is it’s pricing in this pretty aggressive cutting cycle and are you going to get an aggressive cutting cycle if the economy has a soft landing. I think our thoughts would be probably not.

I’ll sum it up to this is when you think about what your return is from a bond, historically, the income level has been a very good indicator of what that return is going to be. Well, you just had a quarter where longer-term bonds returned six or 7%, the 10-year treasury did extremely well.

Well, moving forward, is that going to continue? Are you going to continue to see rate decreases like we saw last quarter? We would argue probably not.

And then when you look at your bond return, you have to, of course, remember that it’s a nominal return that you’re getting after accounting for inflation, after accounting for taxes. Yields have been substantially lower.

In the chart book that we have, we had a great chart talking through after-tax returns of treasury bonds over time and it’s not something that you’re riding home about, loading the boat to buy treasuries on.

Thanks for pulling that up, Dave.

I don’t want to get too much off the fence on the fiscal side because I think we could get going. It’s been a huge driver to the economy to keeping things in place from a debt perspective. From the fed perspective, the huge increase in interest rates obviously substantially increased their interest burden, especially relative to what the securities on their balance sheet were yielding.

As this chart shows below, just the net interest cost of our government debt has surpassed defense spending and it’s been substantial. And if you take it a step further, we’ve been issuing a ton of T-bills at the front end of the curve, which have been the highest yielding part of the yield complex. And so it’s expensive.

As we continue to chop through that, I think you’re going to see more of that continue to pressure the long end or back end of the yield curve a bit, but just there’s no way to deny that when you’re running six or 7% deficits, maybe even higher depending on how you’re accounting for it, it’s just awful hard to get a substantial decline in the economy and we continue to see that play out.

Obviously, it’s an election year, so you maybe get a little bit more of that pulled in but a lot of these fiscal packages that were put in place the last several years, they’re coming through and dripping on this economy for the next several years.

As you continue to factor in, it’s hard to get a recession when you’ve got a strong labor market. We still have a pretty strong labor market. You’ve got net worth at all-time highs.

You’ve got a huge chunk of the economy that’s driven by baby boomers who hold 70% of the net worth of our country. That have changed after COVID. They’ve got more of a propensity to spend, a YOLO type of mentality.

I think that you’ve got so many things that are going to continue to push and elevate the consumer to keep this economy churning.

And then on the backside of that, the fed’s got all the ammunition in the world if we do get any weakness to come in and start punching.

The backdrop, I think, as good of a quarter as it was for bonds, there’s probably not much more in the tank.

I’ll stop there.

Derek

JL, it ties in a little bit to one of the questions that came in about the Fed.

Mortgage rates have come down, but not… They haven’t come down since the fed. We’ve had a couple questions and I’m just going to paraphrase, but can the fed really drive mortgage rates lower and does it matter if mortgage rates don’t go lower? That’s the rate that it seems like most people look at as potentially a tailwind or headwind.

John Luke

Yeah. Look at the 10-year yield when you’re comparing with mortgages. The fed fund rate doesn’t really matter with mortgage rates per se.

But they’re not going to be able to cut it enough to get the people with two or 3% mortgages back in the money. But I do think if they get it, if rates can get somewhere in that low fives, mid five range that maybe you can incentivize folks to move that are golden handcuffed into their mortgage. But I do think it will stimulate for newer home buyers and give them a better opportunity and make housing more affordable.

So if anything, lower rates should continue to keep that fire lit under the economy to balance things out, make things more affordable, etc.

Derek

Awesome.

Good, bad, ugly, but Dave, I know you always put a lot of thought into this with the team, so fire away.

Dave

We actually had a lot of change here too. This quarter tends to be pretty static over longer periods of time, because I love when you try to block out as much noise as possible and actually only focus on what matters. Much like what JD was talking about our asset allocation, focused on max drawdown and your cumulative compounded return over longer periods of time, that’s what you need to be focusing on.

But this is a gauge of what we believe that investors should be focusing on, not just in the near term but over the long term, because we know over longer periods of time, there’s only a few things that’s going to drive the market higher or the market lower, yet there’s so much noise out there in the market. You have CNBC or Fox or whatever it is for people to get afraid of stuff in the market, such as this East Coast port crisis that we’re on the brink of potentially just today. I do believe that’s noise.

These are the six things that we need to be focusing on. And this slide, the good, the bad, the ugly was obviously based off of the Clint Eastwood movie from 1967, and we try to be as balanced as we most possibly can with this because obviously, we want to think holistically from a big picture perspective to make sure that we prepare for what we can prepare for and make sure that we’re also prepare for what we can’t prepare for.

That came out wordy there, apologize.

But I think one of the more recent things that came on this slide here is probably the labor market.

The labor market’s really starting to see some cracks. This is a new addition to the good, the bad, the ugly for the third quarter of 2024. Obviously, this past quarter, we had a few revisions, two very important revisions in my mind from the government data itself.

First came on the labor side of things is basically establishment survey. The non-farm payrolls that comes out on the first Friday of every single month. Those jobs were revised about 818,000 jobs lower than initially expected just over the past 12 months.

That’s pretty substantial. I think that’s just starting to show you some signs that the labor market is starting to see cracks.

That’s important because if you start to see the labor market to see some cracks, you’re going to start to see wage growth come down. That’s going to have a cause and effect that’s showing you that, hey, overall economic growth or GDP growth is also likely to come down on its own.

I think the second government revision that I just mentioned or that I’m about to mention here is going to be in regards to the savings rate. I think everyone knew about that labor number revision, but a lot of people don’t know about the revision to the savings rate number that the government just put out actually just last week. I think it definitely goes on the side that the U.S. consumer continue to be very much more resilient.

The data that we’ve seen from the savings rate over the past year two, three years is that it’s been well below historical normals about a savings rate of 3% is what the market or is what the government is telling us over the past few years when the historical average is closer to five, these revisions came in and actually said you, “Hey, you know what? We actually calculated the savings rate wrong, that the savings rate is actually much higher than that 2.93% that we’ve continued to state over the past few years.”

I think that’s telling you that the consumer actually means very much more resilient than what people have prognosticated over the past two, three years, and that could be the point moving forward in the future that’s going to propel the economy and the market up because if the consumer’s resilient, if the consumer has a lot of healthiness on their balance sheet from a net wealth perspective, they’re going to spend.

I would never bet against the propensity for a U.S. consumer to spend the capital that they have in their checking account because if it’s there, they’re probably going to spend it.

More importantly, momentum is very real that they’ve continued to spend, in financial technical terms, a crap load of money really coming out of COVID since they had so much stimulus out there that they don’t want to slow down the momentum of that spend. So momentum’s a real thing.

I think that could continue to prop up the S&P 500 earnings holistically well into 2025, which we’re already expecting 15% growth.

John Luke

Yep. We’ve had a number of good discussions on the savings rate side where it’s just accounting for the nominal dollar saved. It’s not accounting for the return on those savings. So even if the savings rate was three, if you’re getting 5% on your money market, your savings rate’s much higher than that three level, and it also doesn’t account past return from savings as well when you’ve got networks at all-time highs, equity values, home values, etc.

I think to piggyback on that a bit.

The lags from policy will always be a concern until they’re not. Many have thought that rate hikes were less impactful on the economy this time than they necessarily were guessed that they would be. And so the question there bodes well, were they or is there more of a lag?

I tend to think that they were less impactful due to a lot of the terming out of debt and things on the fiscal side.

But if we did see some type of impact of the lagged policy, the nice part is the Fed has the position here that they can defend against it and so the fed puts alive. It’s like we’re turning one of those bad or uglies into, yeah, it’s not that bad.

Derek

Since we have this up, this is a good time for a question that came in. How do we prepare for your ugly?

JD

Yeah, I’ll take that one.

I think this is really at the heart of what we do.

I think the ugly in most people’s minds is markets are down 20, 30%, whatever it is, and the first thing is how do you protect against that. We build strategies designed to increase the beta exposure of portfolios. So if you give us a portfolio X, we want to turn it into a portfolio Y. What’s the difference between X and Y? It’s going to be more beta exposure.

The question is if we hit this ugly period and equity markets risk assets sell off, how do we protect against that?

We’re huge advocates of owning the thing that carries no correlation risk, meaning they are hedges. They go up when equity markets go down and they do that very convexly, meaning the payoffs are multiples of the risk put on or the cost to own them.

I think the presence of that payoff gives us the confidence to own more risk and that’s how you have your cake and eat it too in that, number one, do you help fight against drawdown when it shows up? Of course.

But more importantly, my definition of ugly is not a two month 20% sell off in the market. My definition of ugly is people being fooled that 4% or 5% on their cash is safe.

I think you prepare… To stress what Dave said earlier, we can paint a backdrop that you’re like, “Well, man, that seems pretty bleak.” It’s the opposite. The backdrop leads to you better own more risk assets, because when your deficit spend is what it is, when the money supply is going to do what it’s going to do, risk assets are most likely going up and we better own them.

Again, I think you overallocate the risk assets, let’s be right until we’re wrong and when we are wrong, we own those things that have convex payoffs.

And again, not saying anything in particular here other than we build strategies that we’ve now been around long enough, the track record of our strategies, the ability to impact allocation, it’s… I think we operate some of the best strategies in the market and the impact has been pretty significant on allocations and we continue to think that that’s going to be the case.

And last thing that I’ll say about that is if we’re completely wrong and what does that mean, it means we’re probably going to be pretty benchmark like. I think that’s one of the things that we have when it comes to strategy, when it comes to portfolios that incorporate some of our strategies.

I always say the difference between a good player and a bad player is your good players’ lows aren’t very low. Your bad players’ lows are extremely low.

We think we’re building strategies and portfolios that when we’re off, we’re going to be roughly in line where there’s no performance discussions because really for everybody on this call, the only thing we want to do is to position you as to be as valuable as possible for your client.

I think a huge part of that is can I produce higher CAGRs? The other part of that is can I produce a very compelling message that my clients can digest? That’s really… If you said, what are the things we spend our time on? It’s number one strategies and number two, messaging around why the use of strategies is there.

That’s maybe longer-winded than you want, D. Hern, but that’s my answer. I’m sticking to it.

Dave

I’ll take it quickly from there too.

You know our investment philosophy. More stocks, less bonds, while remaining risk neutral.

I think anyone can have a great investment philosophy that sounds qualitatively awesome. I think ours does, but there needs to be a proof in the pudding to make sure and show people that we are executing on our investment philosophy.

If you have a great investment philosophy and no follow-through, I could care less about your investment.

Our investment philosophy, what I have pulled up here, we want to have more stocks, remain risk neutral, enhance our income, we can show you that there’s proof in the pudding, that we execute on this structure from a qualitative standpoint and also from a performance standpoint.

There’s no better way to look at it than just our Aptus moderate allocation and we benchmark that against the iShares growth. We’re 75% stocks, 25% fixed income.

Another way, we’re 15% overweight stocks relative to the benchmark at 60/40.

But if you look at our standard deviation, we actually have a standard deviation that’s in line with the benchmark actually slightly lower right there. So we’re able to give you more stocks, less bonds and obviously, have a risk neutral standpoint from a standard deviation perspective, but also a max drawdown perspective.

To go back to exactly what JD was talking about at the forefront, let’s focus on what your clients expect and what they want, tune out the noise, let’s make sure that we have the best max drawdown possible, and also the best compounded cumulative return over longer periods of time.

This chart right here, it just shows you that there is proof in the pudding from an execution standpoint on our investment philosophy.

JD

Derek, I see that the question that just came in, I’d like to touch on that.

The question, do we need to think about using a different term for owning more risk assets based on the last 10 years? It was riskier to own bonds than stocks. So if I wanted to own more risk assets, I would own more bonds.

My answer is exactly, but that’s a hard thing to say to your Mr. or Ms. Jones that just want to save four or 5%. But yes, that is the point.

We think is the greater risk 10 years from now that you own too many stocks or you own too many bonds. I think it’s that you own too many bonds and that’s…

Yes, I won’t call you out, but my answer is yes, that’s the right way of thinking about it, but we have to work within the boundaries that we’re dealing with, which are most people do not see the world that way. They view risk as stocks, they view safe as bonds, and I think that’s backwards.

Derek

And we do-

Dave

Here’s a wild statistic for you actually.

Let me stir this in here, D. Hern. I’ll try to get it right, but it’s like investors should be mindful that long duration exposure in the fixed income space can come with equity like volatility, especially actually the nine of the last 12 years have seen long duration treasuries post a larger intra-year decline than the S&P 500.

Mind-boggling.

But it’s showing that exact point from that question and JD’s point there.

John Luke

And over that 10-year period, risk assets or nine-year period risk assets have compounded at double-digit returns. That’s just a few drawbacks.

Dave

On your slide here.

John Luke

Yeah.

Dave

That’s why your slide here, John Luke, it’s unbelievable.

Look at the Bloomberg U.S. aggregate over the last three years, five years, and 10 years. It’s almost a goose egg on five years. It is less than a goose egg on three years. It just tells you that, “You know what? Let’s make sure we own as many risk assets as possible.”

JD

I think this should go without saying but I think it’s probably timely.

Whatever happens in November doesn’t change our opinion. We’re not going to say, “Well, if this outcome happens, we’re going to have a different story to tell you.” The backdrop for what leads to what we’re saying is it doesn’t matter, right, left, wherever. I still think this is going to be the theme for the next five plus years is, to a lot of JL’s points and a lot of what Dave said, risk assets should be higher.

Derek

On that note, this is where we start our one-hour discussion of the election.

JD, I know you’re going to lead that one.

I’ll say too on the risk thing.

One of the things that I think we’ve always been pretty clear on and we’ve tried to put messaging out there is there are two types of risk. There’s drawdown and longevity.

It’s a constant battle between making sure clients just stick through it and get through the near term drawdowns and obviously, we try to provide strategies for that versus the long-term longevity risk of outliving their money.

Risk is a very arbitrary word and I think that question hit it pretty well.

JD

Yeah. Not to continue to beat the drum, but what we always ask is let’s say, “JL, let’s be conservative and say 7% deficit spend.” We think that that’s a pretty good proxy of what you need to earn on your capital to preserve purchasing power for long periods of time.

So if it’s like, okay, if the hurdle rate is 7%, forget CPI for now. But if the hurdle rate is 7%, what asset class is going to give you that.

Bonds is not in that answer unless you want to hold your nose and buy some high yield bond that you might regret buying.

I think in aggregate, your basic allocation options are bonds, stocks, or cash, which one of those three can give you that hurdle rate? I think we know the answer.

And the other thought like this liquid alt conversation, because we get this a lot and we get grouped into that territory, but anything that is a “alt,” especially a public market vehicle alt, just to stress, I know we touched on this, there is a significant difference between a diversifier and a hedge.

Diversifiers are positive carry and you cross your fingers and hope that they show up when you need them to. Hedges are negative carry and you do not have to guess what they’re going to do.

We are in the camp that if you want to spend time and energy trying to find diversifiers that are going to give you positive carry, that’s actual real return and protect you when you need it, you can go spend your time doing that. We’d just rather own more beta and protect the extra risk that comes with that.

I think that’s an easy, very simplified solution because the obvious thing is hey, if we can produce an additional few hundred bips or whatever additional of CAGR, that’s great for your clients, that’s great for your business and you won’t fire us. We like those three things.

Derek

I’m going to let one more question in.

We’ve had a few questions strategy-wise about the funds and we’re going to avoid tickers here directly because we do want to share this and as compliance causes extra hurdles in doing that. We’ll hit all of them. We see the questions, we’ll definitely hit you, and we think we got some fun stuff to talk about there.

A question that’s coming in a couple different forms and maybe you guys can just do a quick touch on this is questions have come up about international and emerging markets and other asset classes. I guess I’d paraphrase that in saying is there a consideration of adding other exposures like that or changing other exposures and where do we sit on that?

John Luke

I know Dave’s got a great chart on this to start. Dave, leader off and I’ll come behind you.

Dave

Thank you.

I’m trying to find this chart right now if you give me one minute, please.

Well, as I look forward, basically, obviously, international has worked here lately. Obviously, you had the EM up here six, 7% on the month just given all the China stimulus out there.

But I like to rephrase and rethink international a different spectrum. Obviously, the catalyst or the thesis to own international here lately is from a valuation perspective.

We know that over longer periods of time, international has traded an 8% discount to the S&P 500. Yet today, it’s trading closer to a 50% discount as a whole.

I think one reason why you’ve started to see this decrease in evaluation relative to the S&P 500 is simply that there’s been a valuation rerating and no one’s talking about it. They don’t want to say, “Hey, you know what? We want to own international or increase our exposure there because the valuation gap relative to historical norms is going to compress it.”

I just don’t believe that to be fully the case right now. I think you get full rallies much like what you’ve seen out the international market here as of late, but it’s been rerated lower because if you think of the U.S. economy and the constituents within the S&P 500 and then constituencies within like an MSCI EAFE, over there in Europe international, it’s just so service oriented, service focused, lower margin businesses relative to what we have here in the United States.

Obviously, tech proxies like the Magnificent Seven dominate the S&P 500 but they have growth and they have margins and they have increasing margin. They have operating leverage. Something that international does not have.

If you actually rerate the characteristics of the MSCI EAFE into the same sector exposure as the S&P 500, the S&P 500 only trades at about a 12% premium to international markets. But you dovetail that and compare that with what actual growth you’re getting between these two economies and markets, you’re getting three to four times more growth here domestically than you are international.

I think that you can almost own small cap as a better way here domestically to play that valuation mean reverting mechanism, but you’re actually getting U.S. type of growth within the U.S. small caps.

If you wanted to play international, I think the more palatable way to do this is actually owning U.S. small caps.

John Luke

I have two comments.

First on the China part, you look at the long-term returns of China and they’re pretty much zeroed out since the 1990s. It’s been very hard to make money in that, which is a huge slug of the EM space. Hard to chase that piece.

And then you look at the international markets and you had Mario Draghi, however, you say his name, come out last week and talk about the competitiveness of the E.U. and their solution to be more competitive is more regulations. If you look at… They’re overburdened with regulations.

I think many of those things like… You’re just basically relying on the dollar to weaken to get the returns that you want from international and it’s just tough to really bite into that as a long-term game.

I think Dave laid it out beautifully.

Derek

Awesome.

Dave

I would say that our full slide deck is going to be available today too. It’s about 40 pages in this market update.

At Aptus, we’re a bunch of athletes and we just don’t like losing. So we like to have our presentation, our allocation, and market update presentation out there day one and really beat anyone out there. That’s why we’re having this conversation on day one too. So be on the lookout for the overall presentation that you’re seeing today just with a lot more verbiage in it and a lot more depth.

Derek

There’s a lot there.

And I’ll just say, if you’re new to Aptus and are just getting a taste of us, I would just go to apt.us, go to the top, click on the Blog. These guys just crank stuff out. We’ve got probably four to six pieces a week of just different materials, some of it evergreen, some of it very market sensitive about what’s going on with the fed and the election and earnings and everything. But I would definitely hit apt.us, go to the blog, sign up there. We do a weekly summary of it that goes out on Fridays.

And for clients, obviously, you’re already getting that and you’re used to our services but any of these topics, we will spend hours on them if you need it, but we want to be respectful of everyone’s time. We’re at 45 minutes today.

We do appreciate everybody for joining us and we will send a recording of this with all of those slides, because I know there’s a lot in there.

That’s all I got. Thanks, guys, for making the time.

JD

Great job, D. Hern, right there.

John Luke

Thank you, everyone.

JD

Thanks, everybody.

Disclosures

The opinions expressed during this Webinar 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 investment advisory services can be found in its Form ADV Part 2, which is available upon request. ACA-2410-6.

Transcript for Above Market Update Video

Derek

Hello, welcome. Derek here. I’ve got our head of equities, David Wagner, CFA. Our head of fixed income, John Luke Tyner, CFA. We’ve gotten into the habit of doing these before the quarter ends, just especially with 4th of July and everything coming up. We don’t want to try to tie the calendar up during that time, but I’m just going to go through some of the stuff. It’s obviously been a pretty wild quarter and it’s an election year. We’ve got earnings coming up. The Fed is not necessarily the imminent thing, but lots going on out there, so we just figured we’d go through. At the end, we’ll take some questions if you have any.

I’ll read a disclosure at the very beginning here and let the experts run through everything. 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’ investment advisory services can be found in its form ADV part two, which is available upon request. Welcome guys. Thanks for joining.

John Luke

Thanks Derek. Fun to be here every quarter.

Dave

John Luke, can you see my screen in presentation mode?

John Luke

You’re good.

Dave

All right. Name’s Dave Wagner. Most of y’all know me. I head equities here at Aptus. But first and foremost, thank you so much for joining today’s call. I see a lot of familiar names here watching live and actually a few new ones, which is very cool. And so, since there’s a few new names out there, I think it’s always great to start these calls off on a positive note and actually sometimes, even talk about Aptus as a whole. And if you’ve watched some of our quarterly webinars, it’s about once a year, I try to remind a lot of our clients on our individual ethos of the entire company of Aptus because I truly believe that it’s something that we practice as a firm, as a whole, but we never truly say what our ethos is.

And some of these ethos could be that we don’t take any partner for granted. We try to develop every single relationship with our partners on every single day of the week, whether it’s through the different facets of our business, on trading, investments, the relations side of things, like really anything. Secondly, we don’t want to focus on being smarter than everyone else. We want to focus on creating long-lasting relationships and providing the best customer service in the business. And lastly, I think we all take our work very, very seriously here at Aptus, but we never want to take ourselves too serious. And I think that definitely shines through a few of our different personalities here. So hopefully, you all see a lot of these different characteristics that we try to show here at Aptus on a daily basis because I do think it’s something that everyone at Aptus believes in. It separates us from a lot of other people and it’s something that I hope to goodness that we’re just never going to give up, especially as we grow as a company, much like with the acquisition of LibertyFi this year.

So let’s jump right on it here. John Luke and I, we talked to a lot of different advisors and investors across really, the entire country. And we always should gauge where advisor consensus is or where maybe there’s some type of exuberance or even some type of misconception. And one phrase that I’ve really started to use here over the last week, it’s really started to resonate with some of our partners and it pays to be more patient than creative. And being creative in the investment world, it’s fun, it’s sexy, but it’s much harder to be patient. And right now, I think the best characteristic of any investor out there is to remain patient. And most people probably think that when an allocator tells them to be patient, that means that they allocator investor’s probably underperforming. Well, that actually couldn’t be more of the wrong aspect in our case because I think our off the shelf models, they’re outperformed by a few percent year to date. And the majority of our active ETFs are just absolutely kicking butt. And that’s the proper financial technical terms there.

So in this case that I’m talking about, that it pays more to be patient than creative, I’m talking about letting patience by letting the market work for you because when the market is in an uptrend, I think it’s very tempting for investors to try to get creative and really just call it market top, whether it’s the market top on the S&P500 as a whole or Nvidia or probably really, any of the magnificent six companies out there because it’s still been very much a concentrated market. But I just don’t want investors to really lose sight of the bigger picture here. It’s that you need to exercise patience and just let the market work for you because I know that client emotions, especially in an election year and on June 27th when we’re recording this, we have a first presidential election debate tonight, and that really kicks off, I’d at least say, the emotional roller coaster of a lot of our clients throughout the entire election cycle.

But even stepping back, there’s always going to be a wall of worry for investors to climb. So I think it’s always great to go over some of the good, Some of the bullish aspects that we’re currently witnessing in that market. And it all starts with earnings. Actually, earnings have been very strong and it’s a pet peeve of mine when people say that, “Hey, earnings have been resilient.” It simply should say that earnings have been strong because there’s been a lot of tailwinds both on the consumer and on the business spending side. The consumer itself, it’s never been this strong ever, whether you look at it from an absolute standpoint or a relative standpoint.

And then you could look at the amount of CapEx spend by companies, especially over this past quarter on the CapEx revisions. Obviously, this is honed in around on the AI space, but it’s absolutely wild. But investors forget that every single dollar invested in CapEx from a company, it’s going to be a dollar of revenue for another company. I think you look at the market and you have to talk about AI itself as being a bullish reason for the recent market rally of close to like 34% off the October 27th low. But I don’t want to pontificate that AI or this technology is going to be revolutionary or evolutionary. But what I can say is that for the first time in about 20 years, we have a technology that legitimately increases our own domestic economy’s chance of increasing productivity. And that’s just something that I never want to bet against.

AI and the trade, it has an absolute great trend. And our head the equity trader, our head actually, overall trader here, Mark Allen, he has a saying that trend is friend and AI and stocks, it has a trend. So let it be your friend. And by simply owning our structure of our allocation of more stocks, less bonds, or remain risk neutral, you have a very efficient way to actually benefit from this technology without having to risk by picking the correct winners or not owning some of the AI charlatans that are out there. Because I truly believe that there’s going to be a few winners in the space and a lot of losers. So there’s a lot of good out there in the market. If you look at the macroeconomic data, at the end of the day, unless you’re in the depths of some type of recession or at the very start of a new business cycle, there’s always going to be data that conforms to your personal investment thesis.

And it’s our job here at Aptus I think, to really educate clients and investors, what is noise and what is actually material? What is material for the market to continue to drive higher or lower into the future? And that’s why at the end of this webinar, John Luke and I, we’re going to have a section where we hit on three topics that really resonate with our client base that we think needs to be the focal point of our client base. Because at the end of the day, you need to focus on what you can control and prepare or hedge out for what you cannot control. So we’ll start on those facts section. We’re going to talk, I think it’s like the market and elections, it’s going to be talk about, this is the biggest topic I actually think that we’re going to talk about. It’s maybe that the investor hurdle rate is much higher than what most investors think. And then we’re going to talk about just market valuations.

But to end this equity market commentary, I’m going to tell you that the biggest thing I’m focusing on right now, it’s going to be growth. Earnings growth, revenue growth, really any and all type of growth because at the end of the day, if there’s some type of kryptonite for this market rally, it’s going to come in the form of slowing or negative growth. And this is something that I’m highly convicted in because I truly believe that inflation at 3%, it’s not a huge threat to the market or the economy itself, but more so the Fed’s reaction function to how it handles slowing growth. And obviously JL is going to talk more about the Fed and more macro, but I really truly believe that the Fed wants to cut rates right now.

The rest of the world has already started to do that over the past few weeks. And if you look around the globe, I think the rest of the world’s really already seen or is currently in some type of slowdown because at the end of the day, to gauge this perpetual argument that we’re having in the market of hard landing versus a soft landing, the debate’s going to be great and engaged by what the Fed does with rates. If rates are slashed lower, substantially slashed lower, that means that we’ve probably had some type of hard landing and that the market’s in some type of recession.

But the preferred path by the Fed is basically cutting rates very, very slowly to help mitigate the slowing growth there. That’s the soft landing that we’re looking for. It’s really just trying to rejuvenate the market or probably keep that Goldilocks market environment that we’re currently in right now. But as you can see, I’m the equity guy here at Aptus and I’m probably talking more rates and Fed than I normally do, but that’s because that’s what the market’s focusing on right now. And at the end of the day, we all know that the bond guys like John Luke are much smarter than the equity guys like me. So I’ll probably just pass it off to John Luke to talk a little bit more of what we’re seeing from inflation, the Fed and just the bond market as a whole, because I think it’s such a fascinating topic.

John Luke

Yeah, excellent job. Thanks Dave. Yeah. So, we thought that really, this was a nice chart to start with and it just shows that the pain that we’ve seen in the bond market since August of 2020 has been excruciating for most investors that stuck with a 60/40 type of profile and held bonds. And one of the biggest things that I think sticks out is, if you bought bonds in August of 2020, the price return is down roughly just shy of 20%. And so to put that in context, in order to paper over the losses in terms of your price degradation, it’s going to take, if yields stayed exactly where they are right now, there’s no price movement, no rate movements, over four years in order to paper over those losses. And that’s extraordinary. And I think to make it worse, given that we don’t really expect significant decline in interest rates and we expect that even if the Fed does cut rates, that it’s pretty likely longer term rates stay more elevated, that this trend of consecutive months of bonds being in the hole is likely to extend significant into the future.

So borrowing some kind of crazy move and yields lower. This number I think, could maybe even double from where it is now in terms of reality before bonds have dug out of the hole. And to really preface this top left chart, Dave and I go back and forth with some trivia questions. So Dave, as far as stock bond correlation goes, it’s obviously been a huge topic and something we’ve really focused on a huge part of the story at Aptus. If you had to guess for the year, have bonds drawdown been close to as big as the drawdown that we’ve seen in stocks? So for relative stocks, had about a five and a half percent drawdown from peak to trough predominantly in April.

Dave

I would say that I do believe that I know the answer to this question, first. I think it would surprise a lot of people. And actually if you actually just go back to the end of the first quarter of this year, fixed income actually had a greater peak to trough drawdown year to date than stocks itself. And now, you fast-forward three months to today, I think that number between the bonds peak to trough drawdown and the stocks via S&P500 peak to trough drawdown is almost in parity. I think fixed income’s down like 4%, peak to trough stocks are down what you say, 5.5%? The takeaway there is that you can still have a pretty substantial drawdown in fixed income even after you’re like 2022, but more importantly, you’re getting some positive correlation there to the downside.

John Luke

Yeah. And the extra credit answer was on TLT, it’s higher. So longer term bonds have certainly been more volatile, but one of the biggest things we’ve talked about as part of our investment approach and philosophy and building portfolios is you’ve got to have components of the portfolio that can ying and yang together properly. And the correlation of stocks and bonds has increased dramatically in a bad way for asset allocators. And with a positive stock bond correlation, basically, what it does is raises the entire variance or the volatility of your aggregate portfolio. And if you look at how portfolios from a volatility perspective acted from 2000 to say 2020 compared to how they’ve acted since 2020 and really post COVID in August, the chart that we started with, you’ve got a 40 or 50% increase in volatility for a 60/40 portfolio. And it just shows the power of when bond yields aren’t always declining and when you’ve got sticky inflation, it really creates problems for asset allocations.

And as far as how to solve for that, well, we believe you have to have other things in the portfolio like volatility as an asset class. So all in all, to start with that, which I think is going to be one of the biggest drivers of portfolio construction and really bonds in general moving forward, you continue to see that play out. For the quarter, fixed income was relatively flat, had slightly positive, but you can bifurcate the move into two sides. For the first couple weeks of April, you had a continuation of bad inflation data. You had a realization by the market that maybe we weren’t going to get seven rate cuts in 2024 and maybe it was zero, maybe it was one. And you saw bonds sell off drastically and yields rise back up near the highs.

Luckily, some pretty solid data on the inflation front and a little bit of softening on the economic side brought yields back lower. So you look at the beginning and you look at the end of the quarter and it was pretty boring, but not really, the road to get there was quite interesting. On the second chart, which I think also will continue to be a large driver to moving yields is the amount of debt outstanding. We got a nice report last week, well, not really nice, but the CBOE came out with a report talking about the deficit and the move in the deficit was substantially higher than what was estimated at the beginning of the year. And so basically, the chart on the right is just showing effectively, the average yield on outstanding US treasury debt. And as yields have stayed higher for longer, it’s continually risen, it’s sitting at about 3.2%. You’ve obviously heard, if you watch any news, that interest expense is now greater than defense spending.

So I do caution that as we continue the path of this fiscal spending, I’ve called it the drunken sailor spending, approach that we’re taking, I would not be surprised if we continue to see some comeback of the bond vigilante folk in terms of who’s going to buy all of this debt. Coming through to the inflation picture, we continue to see improvements in inflation, the first couple months of the year were a little bit more choppy than I think most hoped, especially if you looked at the service inflation data. The shelter inflation data continues to be pretty robust, but we’re seeing improvements and I think that ultimately, the question that we continue to ask is, is the 2% target by the Fed like the God’s truth or is it two point something and they can live with it?

And I think what they’ve continued to communicate in maybe not a direct way but around the edges is that two point something’s probably acceptable as long as inflation’s not running away in terms of expectations for future inflation. And so essentially, my vision is that the Fed is going to allow inflation to really slowly decline. And you saw that with their estimate for the PCE inflation for the end of the year, no improvements between now and then, but they’re still going to potentially cut rates or at least that’s what they’re penciling in. So you put it all together, the goods inflation piece of the pie has certainly helped. The immaculate disinflation as a lot have called it, has played out. We’ve gone from nine to a little less than three. You’ve got sticky inflation on the services side, you’ve got sticky inflation on the shelter side and those are just going to have to pan out over time.

But I think that, like Dave said, the ultimate reality is the Fed wants to cut rates. If it was up to them, they would’ve probably already cut by now. And I think that’s what the market was really hoping for coming into the year. But you put that aside and you keep in mind that the Fed and the market were illustrating that in 2024, we were going to get a slew of cuts. The market was pricing in up to seven cuts at one point, at the beginning of the year. And to think that how well the markets performed relative to how those cuts have been substantially taken out of the market has just shown the resilience of the consumer. It’s shown the resilience of the economy and it’s shown a lot of things that maybe rates weren’t as high or as restrictive as what we would’ve initially thought.

You fast or you rewind a couple of years ago, and if anyone said that the Fed fund rate was going to be sitting at five and a half, everyone will be pulling their hair out saying that the market could not tolerate that at all. And lo and behold, we’re here. And so, overall, we continue to think that while nominal yields are higher, that cost of living is obviously going up, you see money supply growth, you see deficits into the future that the government’s broadcasting. And I’ve tried to write a lot about that. And it just puts the hurdle rate for fixed income higher than what nominal yields are currently. And when we think about compounding capital, when you think about what matters, you think about longevity, well, real returns matter and you put it to the side and we’ve got a couple other charts. I think that the next one that we’ve got… You want to skip down to 12 there. I’ll hit on this one and then I’ll hush.

But the asset allocation woes, this is a steady Eddie that we always have out showing real growth of the S&P versus cash, and it’s obviously a big decline. But the other important thing I think is, if you look back over the past 20 years and you look at where inflation is, which is the red dotted line, you look at the performance of the Ag and you look at the performance of stocks, and it’s just absolutely bonkers to me that your real return on bonds and people have been okay accepting those returns have been basically in line with inflation. And that’s certificate of confiscation as I like to say. So, hop in, Dave.

Dave

John Luke, this is one of the biggest topics that a whole lot of people are just not mentioning or talking about because for the first time, as you said, John Luke, since 2007, our nominal yields, we haven’t had yields this high since 2007, let’s just call it give or take, 4.5, 5%. And we’ve had to say it here after that people think in terms of nominal, but they eat real returns. So let’s just say nominal returns are at 5%, core PCE or just a CPI inflation is at 3%. So you get a nominal minus your inflation to get your real rate of return from a yield perspective. So it’s five minus three is 2%. So a lot of people have been thinking that their hurdle rate from an investment standpoint versus treasuries or fixed income is 2%, right? And I just think that what you’re talking about right now, John Luke, that just woefully falls short of what the actual hurdle rate is out there in the market.

And JD, our founder CIO, had a great piece from a monthly perspective, I think it was just last month, really walking through in a very palatable way to talk about, hey, that real rate, that real yield of 2%, that is much lower than what your actual hurdle rate should be, and just try to get a few more voices. Actually, I’ll just keep going here, John Luke. If 2% real rate is not the proper hurdle rate, what is that proper hurdle rate that we should be looking at? And it’s probably close to the increase in deficit spend because if you think about the budget, it’s never balanced. There’s always some type of deficit. And over the past year or so, we’ve seen the increase of the budget deficit increased by about 7%. And for the government to balance their budget, they basically have to issue treasuries of about 7% there to increase or to at least negate that deficit windfall itself.

So what happens throughout the schematics of the government issuing treasuries and the Fed is basically the government’s issuing treasuries and there’s basically a buyer of it, and that’s going to be the Fed itself. And through the Fed, you’re getting the increase in the money supply said another way, the M2 itself. So what this chart on the left is showing us here is that basically, through the degradation of your purchasing power by the increase of the money supply, it’s substantially larger than just the real rate of return or the real yield over longer periods of time. So if the government is diluting your money supply by 7% per year, that almost means that your hurdle rate is closer to 7%. It’s not that 2% itself. And at the basis of why everyone invests in T-0, time now, it’s not just to maintain their lifestyle in the future, it’s to make it much better, to have a better lifestyle in the future.

And if you’re just pegging your hurdle rate to be that real rate of yield of 2%, you can be woefully falling short from a purchasing power perspective of your client’s ability to increase their lifestyle into the future. And what we do at our allocation level is very important. Everyone’s heard our saying, it’s more stocks, less bonds, risk neutral. The fact of owning more stocks and on hitching the trailer on hitching the wagon of drag to performance that fixed income provides to you because it’s only giving you that 2% real rate is really one of the best ways to negate this problem, which is called longevity risk and a lot of allocations itself.

John Luke

Yeah. And two big things that I think we shouldn’t brush through is, number one, taxes on bonds are going to make that real return even lower because it’s taxed unfavorably. And then the second piece would be related to that correlation benefit of, if you’re getting good breaks from bonds in an allocation, then maybe you’re willing to have a little bit of a governor on the equity side. But if the correlation is positive, and you saw a prime example in April where the S&P was down five and bonds were down almost two and a half, that combination is painful. And effectively, if you’re going to govern your upside, you’ve got to have good breaks on the downside. And I think that it’s obvious that it’s going to be a struggle for bonds to really give you that.

Derek

I think that’s a key point right there is just the, not that we’re making any prediction on bonds, you’ve talked about some of the challenges that are there, but just that it’s not a reliable. You can’t rely on it to do the job that it did for a period of time because that period of time, that’s not through history that bonds have always served that role. They just happened to do it during the careers of a lot of us and a lot of advisors and a lot of clients, frankly. So everyone benefited, but in general, you can’t look at bonds and say that they are absolutely going to do what you need them to do if stocks take a tailspin. And that’s where I think, the use of hedges and some of the other things we do at an allocation standpoint can be helpful.

Dave

That’s just such important because everyone wants to talk about T-Bill and Chill. They wanted to do it back in August, September and October of last year and see how that worked out for them when the S&P 500’s up 34% since the 1027 bottom. Even right now, we’re seeing that conversation really start to populate again right now just because the market has had such kind of a crazy run. But our thoughts and thesis from a structural standpoint still don’t change even after a market rally here. So let’s move on to the next topic that I’ve had a lot of questions about here, more recently, especially as we head into the second half of this year. We know one of the best things that Aptus does is try to attack the behavioral gap that clients have, more fully to make sure that they remain invested over longer periods of time and just take out the volatility of their emotions in regards to their investments.

And there’s no topic in my opinion that is more volatile from an emotional standpoint than politics. Our country’s split 50/50 between Republicans and Democrats, but no matter whether you’re a Democrat or Republican and your views on the market reviews on fiscal or monetary policy, social policy, the market and election cycles, people believe that there’s a lot more volatility out in the market leading into an election. And while I would say that is correct, you really start to see the VIX, the market’s measure of volatility really start to tick up really after Labor Day. That’s when the market and clients really start to focus on the election itself. But we do have a presidential debate tonight here on June 27th, but I think a misnomer or misconception out there in the market is that during the fourth year of an election cycle, so basically the reelection or open election year, that there’s more volatility and that there’s poor market returns.

Well, that couldn’t be more wrong whatsoever, that here’s a wild side, it’s a chart of the left sided. It goes back to 1944, whenever a president is running for reelection, which we currently have right now with incumbent current president Joe Biden, the S&P 500 has never ended that year in negative territory. So let me say that again. Since 1944 when there’s an incumbent running for reelection, the market has never been negative. Not only that, not only has the market not been negative, it’s had an average annualized return during those years of 16%. That’s 2x greater than the average return of the S&P 500 dating back to 1926 if you include every single year. So in fact, your initial inclination may tell you that, hey, the market’s more volatile this year in a reelection year, the market doesn’t have as great returns in the election year. That’s a myth and it’s so easy to debunk.

But one thing that we’re looking at from a market perspective is that the market does try to figure out what the outcome of election is going to be. And two of the largest things that you can look at to help [inaudible 00:28:43] the outcome of the election is going to be, the first is going to be recession. If there’s ever a recession in the two years preceding an election year, so basing in year three or year four of an election, the incumbent or the incumbent party has not been reelected whatsoever. The second thing to look at when you’re looking at the S&P 500 and the market and its potential [inaudible 00:29:08] the outcome of the election itself is, if you look at the 45 days heading into election, if the market is positive, the incumbent tends to get reelected. If the market is negative, the incumbent or incumbent party tends to not get reelected.

So there is some tidbits that you can look at to the market to figure out what’s going to happen in the election closer to the election date itself. But if you zoom out and try to have a pragmatic view on what’s going on in the market during election years, it just doesn’t matter. In fact, it actually does matter because you get a 2x annualized average return better than the average year, you get an average return to the S&P 500 of 16% when the markets had average annualized returns closer to 8% itself. So John Luke, you asked me a trivia question earlier. I got one for you. I think you know this one. Obviously, I mentioned that the fourth year of an election cycle has an average annualized return of the incumbents running for reelection of 16%. Let’s just gauge the market election cycle. There’s four years in election cycle. What years of that election cycle, John Luke, do you think actually have the best return measured by the S&P 500?

John Luke

Yeah. Well, I think the easy guess would be four, but I’m going to go with three just because they’re priming, getting ready for that year four and the campaigning. And then you look at last year, and that’s basically what you saw too.

Dave

Yeah, you’re exactly correct. It’s like the referendums that an incoming president has. When a president gets elected, the referendums, they really try to put in place in the market, whether it’s from a regulatory aspect, a social aspect, it really inhibits market returns in the first two years in the election cycle. So you’re exactly correct, John. The best year during the market election cycle via measured by the S&P 500, it goes year three of the election cycle is the best year. Year four is the second-best, year two is the third best, and year one is actually the worst year on average during a presidential election cycle via the S&P 500. And it’s pretty obvious, John Luke. You probably have a slew to lift in your mind, John Luke, and I’ll let you talk about that, of the liquidity that’s been injected into the market, not just this year, but last year that’s really started to insulate market returns, whether it’s from an earnings profile standpoint or even from a valuation perspective.

John Luke

Yeah, it’s a laundry list. Fiscal policy has been pretty loose, 7% deficits. The CBOE or CBO Congressional Budget Office, which is supposedly nonpartisan, is basically saying 7% deficits for the next 10 years. But you’ve had student loan relief, you’ve had the SPR drains, you’ve had the infrastructure spending and some of the post COVID stimulus that’s basically a trickle into the economy. You’ve got, which one point that we haven’t touched on, but I think is important is at 5.5% rates, who’s the beneficiary of that income? And it’s the largest companies in the country. Think about the balance sheets of the MAG 6. I like how you did that today, making sure to take Tesla out, but the Mag 6 and the wealthiest Americans are getting a five to 6% clip on their savings. And so there’s so many things that I think just continue to point towards the inflationary backdrop that I don’t even think we can fathom what we could experience the next 10 years.

And it goes back to the points on the asset allocation side of, probably pretty hard to get a drawdown whenever you’ve got the household net worth at all time highs, when you’ve got fiscal deficits at 7%, it’s pointing to a new cycle that we haven’t seen in the last 20 years. And I think that if we have a time machine and we come back and look at the decisions that we’re making today in the portfolios that the impact that we’re going to drive for our clients and for our shareholders is going to make a big difference in their life, and that just goes through some of the conviction of how we’re positioned in the portfolios. Because we talk about it, it’s funny, but at the end of the day, there’s a real debasement going on with your dollar and your client’s dollar and think about the beneficiary of who benefits from inflation?

Well, it’s governments and they’re incentivized to do it long-term because it’s the easy way out. You can’t let stuff burn. We’ve basically shunned having that type of environment and the more debt that they have just means the more things are going to cost, the more that the dollar’s going to be debased over time. And just so important that the asset allocation mix is innovative for these times.

Derek

Typically, when you hear people talk about deficits growing and foot out, a gloom and doom type of scenario is usually accompanying that. And really, what we’ve said is, I think the playbook in the past few years is pretty clear that you can’t just stick your assets in commodities or tips or these other inflation protection type vehicles, companies, US companies in particular still have a lot of pricing power, which this feeds into your world, Dave, but companies that can raise their profits, that’s the protection, that’s the inflation protection which feeds into, does that make stocks more expensive? Well, not if they can grow their earnings at the same rate or more.

John Luke

Yeah. I love being the bond guy that tells you don’t own bonds.

Derek

Yeah.

Dave

I’ve never heard you say that one, John Luke, I love it. But you’re exactly right, Derek, valuations are high right now, but we do have a saying here at Aptus is that price is what you pay and value is what you get. And whether you’re looking our compounder sleeves or a lot of the sleeves that we own, the other SMAs that we run, really embodies that aspect. Companies that have pricing in elasticity, pricing, power, long runways of growth to really combat or utilize inflation to their benefit as a lever to drive not just revenue growth but earnings growth itself. And throughout my career of investing, I feel like 99% of the time, people believe that the market is expensive, which in my mind, in a vacuum, is simply impossible because valuation is mean reverting. It’s either in the top 50% of expensive or below, so it can’t always be expensive.

And so I think it’s so important to try to educate and teach investors on how to look at valuation the proper way because a lot of people would always state that, “Hey, the market’s trading at 22 times 2024 earnings.” Which it is. It’s trading at 22.4 times 2024 earnings. It’s actually closer to 19 times when you actually go out to 2025 earnings. And many people who have listened to me talk for quite some time is that the market finally starts to shift their focus on earnings for current year until the next year, starting in June, July and August of the year, meaning that the market rate now that we’re in the summer, June, July, or August, you’re going to start focusing on earnings in 2025 now. So I actually like to look at the 2025 measure for valuation, putting the S&P at closer to 19 times, but even that 19 times, everyone fully believes that’s very expensive because if you compare it to the valuation back in the ‘1980s, when the mark was trading closer to 12 times or a little lower than that, you’re trading almost at 100% premium.

But it’s just such a wrong way to look at valuation in my mind. And let’s try to break down in the most simplistic form. Let’s say that we have two stocks, stock A and stock B, they do the exact same thing, same business line, same growth trajectory, same everything, but only one thing is different and it’s going to be profit margin. Let’s just say that stock A has a profit margin of about 8%. Stock B has a profit margin closer to 17.5%. If I ask anyone on this call, does stock A or stock B have a higher valuation? And everyone’s going to raise their hand on stock B because they do the exact same thing. Stock B just has a higher profit margin over double the profit margin of stock ed and everyone would be correct. And that’s just such a mainstay answer that everyone is always going to get correct.

But when you transcribe that to the S&P 500 as a whole, they don’t get this correct because currently right now, the next 12 months operating margin for the S&P 500 is 17.5%. Back in 1980, 44 years ago, the operating margin was closer to 8%. So why are we comparing today’s valuation of the market to a market that had a substantially different margin profile and a constituents base 44 years ago? It’s something that we shouldn’t be doing. And what this chart on the top is basically showing us, how our SAP 500 index has evolved over time from a CapEx heavy, a hard asset heavy balance sheet to be more of on the innovative side of tech with asset light balance sheet and higher margins.

A wild statistic that I always talk about is if you look at the aggregate balance sheet of all the companies in the S&P 500 back in 1984, about 90% of the assets on the balance sheets were tangible assets. Fast-forward to today, if you aggregate all the balance sheets of the companies in the S&P 500, 95% of the assets on the balance sheets are intangible assets. That just shows how our economy and our market has evolved over time. So we shouldn’t be comparing today’s valuation to the valuation of yester-years.

Derek

There was also that graphic going around too. Cashflow, same thing. Operating cashflow is like straight up 45 degree angle to the northeast of how markets have changed over the past couple of decades. So the valuation’s important based on that.

Dave

Well, you can almost take that a step further there, Derek, let’s just not look at the domestic market relative to our profile 40, 44 years ago. You could still compare it to international markets as a whole. International markets have historically traded an 8% discount to the S&P 500, and now, you’re actually closer to a 50% discount of international markets relative to domestic US markets. And for about 10 years, investors have always been trying to call the top, “Hey, I want to go overweight international solely because of valuation.” But we know it’s whether a stock investor or invest in allocations itself via asset classing, valuation doesn’t mean anything if there isn’t some type of catalyst to create mean reversion over longer periods of time. And that’s just something that international markets haven’t had because they remain more service oriented on the construction within the constituents of their portfolio or more asset heavy than what the US has itself.

So what the chart actually is showing here on the bottom that I haven’t talked about, it’s basically just taking the sector exposure of the S&P 500 and mirroring the sector exposure and weighting that of the international markets. And that would tell you that the S&P 500 only trades, pardon me, at a 12% premium to international markets. And if you take a step further, the amount of growth that we’ve had here domestically relative to internationals, almost two and a half to three times greater than what you’re seeing international. So if you re-weight the constituents of international and domestic benchmarks that have the same sector exposure, maybe a 12% valuation premium of US markets to international markets is probably merited due to the growth profile, not just over the past five, 10 years of the US but probably looking through the windshield five, 10 years down the road given the construction that we’re more asset light, heavy margin and more technologically innovation driven than other economies in the world.

So let’s wrap this up. And this is something we do on every quarterly webinar. We go on a quick round table from myself to John Luke and to [inaudible 00:41:49], try to figure out what’s something that’s out of focus for a lot of advisors. What’s one thing that they’re not thinking of? What’s a positive and what’s a negative that’s been on our mind lately, maybe where people should start focusing on that? Is it noise that might be material or at least somewhere that we think should get some garner more recognition out there in the market. So John Luke, I’ll let you start. What’s your pro and what’s your con?

John Luke

Yeah. So the definite con is inflation being and continuing to be more sticky. If it’s hanging out in the three point something range, I think the Fed’s going to be uncomfortable with that. And that could create the environment where rates are held higher and there’s just more potential for negative impacts to the economy. That’s got to be the negative. And then I think the positive is you continue to see employment be resilient, you continue to see wage pressures to be strong and all time highs on net worths. And that has so far led to the consumer continuing this resilience and think about what’s the steam engine of the US economy and it’s the consumer. Until you take him out, it’s going to be really difficult to see damage. So I think to sum it up, that’s how I would… Unless you see employment really take a rise or unless you see some lack of further progress on inflation, I think we could continue to be in a good spot for risk assets.

Dave

I totally get that. I’ll go next. I think my positive and negative… My negative is always going to be slowing growth. If growth slows, that’s the kryptonite to a market rally or at least, the expectation that growth is going to slow. And if you look at a lot of the targets for 2025 earnings growth, which is about 10 or 11% right now, a lot of it’s coming off the back of margin, not all AI driven margin, but I really want to make sure that stocks and companies really start to see some type of top line growth that not all the growth and earnings per share is going to come from the margin profile expanding, that to get that really operating leverage on the margin side of things, you’re going to have to get some type of top line revenue growth. And that’s just something that’s been pretty benign here over the past three or four quarters that I think could catch the market off guard if that doesn’t continue. That if margin expansion on the EPS story is necessary from operating leverage from revenue growth, that may not happen.

But again, the rally killer here is going to be growth. I think the positive I have here is something that not many people are focusing on. The beauty of our allocations are that we don’t have to make calls on the market or tilts to be overweight, domestic versus international, this or that. But I think where my view, if I had to make a tilt that’s out of consensus, and this is coming from the small cap guy too, that you could see the MAG 7 continuing to grow earnings much better than anticipated, or pardon me, let me rephrase that. The MAG 6 grow earnings more than what you may expect and it all comes down to CapEx. And obviously, these magnificent seven companies, they got to execute their CapEx and have that turn into some type of profitability or revenue growth. So some type of return on investments.

But if you look at the amount of CapEx spend for this year for the MAG 7 companies, it’s $328 billion, right? A lot of these companies like Google, Apple, Microsoft, they have so much money on their balance sheets that are clipping 5% right now, plus they are a great operating leverage business, has great margin and just operating cashflow itself that they can actually reinvest into themselves and reinvest into the markets where they can invest that $328 billion into CapEx this year. And if you look at that $328 billion of CapEx that aggregates about 60% of the free cash flow by the Mag 7 goes into CapEx. And if you take that in relation to the remaining 493 stocks, that $328 billion is three times greater than the aggregate R&D CapEx spend by the remaining 493.

So I don’t want to call this a winner take all market, but when you can invest that much capital efficiently, because that’s the big difference between the market today and the market back during the.com bubble back in ’99 and ‘2000. A lot of those companies back then were taking on debt and raising equity to finance growth. Nowadays, they’re actually just using cashflow, retained earnings, earnings from income from the cashing on their balance sheets, operating cashflow. That’s the difference between now and then. So I do think that this market could continue to be led by some of the higher concentration or the higher mega cap names than the S&P 500.

John Luke

But to extend the comment that you said earlier, a dollar of their CapEx is a dollar of revenue to someone else. So as long as it’s not directly just paid around to each other, then the rest of the market should see some benefit.

Dave

And you’re seeing that with earnings moving forward with smaller caps, that small caps and large caps have an earnings inflection where they hit equilibrium in the first quarter of next year. I really hope to see that happening. So you get the broadening out of the market because I think that can obviously drive the market even higher than where we are today.

John Luke

Yeah. Agree.

Derek

I do think we did have a question. I do want to open it up in case people do have questions. There’s a question about what’s noise, what’s material? Which to me is really important as advisors are going through, it’s quarter end. This is when a lot of advisors have their meetings in the first part of the quarter and clients always have a long list no matter what the market’s doing, they have a long list of things to be worried about, especially in an election year, especially if they watch the news a lot. So I think the question is, can you put together a slide relating to that? And the answer is yes, I think that’s a great idea, but maybe you guys off the cuff can just think of some of the things that, really what is not material, what seems to be important that really hasn’t been and probably isn’t? I don’t know if you guys have any thoughts on that>

Dave

John Luke, I’ll let you go first, but in our quarterly deck that will be coming out day one. So Monday next week, July 1st, I guess Monday’s the first, we do have this good and the bad ugly that we always put out, and that’s like our rifle approach to what we should be focusing on, what could go really well and what could go poorly with the good, the bad, the ugly. We also have a secondary slide in there that says, “Hey, let’s keep things in perspective,” and it’s going to have a list of really good things that are going on and some really not so good things that are going on. And that can be the north star to showing clients on what they should be focusing on so they can cancel out that noise.

John Luke

Yeah. And I’ll hit on four of really the biggest things that I’m focused on. And then I’ve got to include one Atus wide thought, which happens to be the last slide on our presentation. But at the first level, it’s growth. Just like Dave said, can the companies continue to grow and have the earnings resilience that we’ve seen? And obviously, there’s a bunch of drivers, whether it’s top line, whether it’s margin, whether it’s buybacks, whether it’s acquisitions that can help move the needle there. Core inflation is the second biggest. Maybe the combination core inflation and the employment markets would be the top two or three in terms of impact. If core inflation doesn’t slow down, that creates problems for the Fed. So it’s very important to watch that and even think about the impact of shelter inflation because it is a lagging indicator of at what point does the Fed look past that and look to the future and expect that shelter prices will move lower or at least stop going up.

The employment side is super important because the consumer piece, if we do see marginal increases in unemployment, I think that that would preempt the Fed to act more quickly. And then the other piece is, if we do see degradation in employment, if we do see impacts of slower inflation that the Fed will act. And I think they’ve made that pretty clear. So whether it’s them cutting slowly to essentially not be overly restrictive or they’re cutting more aggressive, the Fed put I think, is actually more alive than we’ve seen the last several years. And then to go to slide 18 there, which just shows the cost of hedging. And I think those other topics are important. They’re the newsworthy pieces, but this vol is cheap piece, I think, is pretty important for their portfolios, especially if they’re invested using some of the Aptus exposures where the cost to protect the portfolio is extremely inexpensive right now.

It continues to make basically the cheapest cost of protection that we’ve seen over and over, month after month. We’re repeating the same line because it gets cheaper. And so to know that we’re buying insurance effectively in their portfolios while the sun’s shining outside and we’re prepared for a crazy election cycle, we’re prepared for geopolitical issues that could pop up. We’re prepared for the unknown, I think just lets us sleep at night to know that we’ve got the protection in the portfolio, that’s a hedge against the market that if things go crazy, not only do we have the protection, but we’ve bought it at really ideal times to be really effective if markets do become wobbly.

Dave

I think this slide is the greatest slide to show right now. The amount of conviction that all of us have here at Aptus in what we’re doing right now, I would say one of our main phrases is, own more stocks, less bonds while remaining risk neutral. Well, the linchpin to all of this is owning vol as an asset class and owning vol as an asset class is like owning insurance. And in a world where insurance inflation is running rampant, whether it’s on cars, homes or whatever, vol insurance on the market itself hasn’t been this cheap basically since 2007.

So I know I’m not allowed to talk about performance, but I love the performance of our allocations off the shelf asset allocations. Every single one of our active ETFs, they’re absolutely doing so great. Now, I’m so excited along with the rest of our team is, but just this slide right here is the epitome of why we have so much conviction moving forward into the future in case something happens that we can be so prepared for. Whatever can be the Black Swan event that we see in the future is that no matter what, we’re going to be prepared for it.

Derek

Awesome. Any other final thoughts? We’re 50 minutes in and probably want to wrap. You guys have done a really good job of really covering all the topics. And I think the question that came in about what matters and what doesn’t is really relevant because it does seem like a lot of clients are just happy to get that CD or that T-Bill something that gives them 5%. And I think everybody knows that number probably goes away. It adds reinvestment risk, it adds longevity risk. There’s a lot of components to that. And I think your job is really to help advisors educate clients on the benefits of owning. We just think of it as equities with guardrails. Having the ability to stay invested in these profitable companies, knowing that you do have protection in place. So I don’t know what you have to add on that, but to me, that’s the focus of the next couple of weeks is to help put more content out that helps advisors in those conversations.

John Luke

Thanks guys for hopping on and appreciate helping organize, Derek. As always, if anyone has any questions, follow-ups, thoughts, recommendations, please share. We’re open ears. I’m sure we’ll talk to a lot of you here in the next couple of weeks as well. And if we don’t talk before, have a great 4th of July.

Derek

Yeah, happy fourth everyone. We’ll send this out. If you’re registered, we’ll make sure that this gets in your hands along with the slides. So appreciate you spending the time with us and talk to you all soon.

Dave

God bless America.

Disclosure

The opinions expressed during this Webinar 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 investment advisory services can be found in its Form ADV Part 2, which is available upon request. ACA-2406-26.