Transcript
Jeff Schulze: Really glad to be here.
Host: All right, Jeff, let’s get started. First question today is—the elections are now complete and the results are being finalized. It certainly looks like a Republican sweep at the national level with the presidency, Senate and the House of Representatives all going red. What are your expectations regarding legislation that could be passed given this new political landscape?
Jeff Schulze: Well, certainly it’s a positive dynamic when you have a sweep scenario from a legislative perspective. A lot more generally gets passed with this composition. The one thing I’ll mention though is that you’re still trying to see how much of a majority you’re going to have in the House of Representatives. And if it’s a very thin majority, that’s going to limit how much is going to pass versus a majority that’s a little bit more robust. And the reason why I say that is if you go back to 2021, when the Democrats had a sweep scenario, they were actually blocked from passing “Build Back Better” by members of their own party, specifically Senators Manchin and Sinema from West Virginia and Arizona. So just because you have a sweep scenario doesn’t necessarily assure you a blank check when it comes to your priorities. But I’m expecting a majority that could pass legislation that’s going to extend the entirety of the Tax Cuts and Jobs Act.
That was the Trump tax cuts from 2018. They could potentially pursue some further individual rate cuts, but I think that’s going to be more selective in nature. There’s been some talk about reducing the corporate tax rate from 21% to 15 for US companies that are producing things domestically. I’m not sure if there’s a lot of appetite there, but you could see a reduction in the corporate tax rate to take off some of the sting of potential tariffs as we look forward in 2025. And then you’re likely going to see an extension of full expensing and bonus depreciation. And this is really going to benefit high-capital-expenditure industries. That’s going to be technology, it’s going to be health care, industrials, and telecommunication. So, you know, I’m expecting a pretty decent package, but ultimately this should create a much stronger fiscal impulse than what we would’ve seen in a divided government. And I think it’s one of the reasons, obviously, why you’re seeing a strong market rally.
Host: So Jeff, US equity markets certainly reacted positively to the election results. I guess my question here is, can US equities continue to move higher from this point? And do you see some opportunities?
Jeff Schulze: They can. With the red sweep scenario, you’re seeing the 2016 playbook play out, but to a lesser degree, in my opinion, just because we have a more mature economic backdrop, so there’s less slack in the economy. I mean, you have higher equity valuations. So I do think that you’re going to see a rotation into the more cyclical areas of the market. You started to see this when the red sweep scenario became a higher probability in the beginning of October. And I think that this continues because the market’s going to anticipate stronger economic growth, which will come with better earnings delivery from this cohort compared to what’s being priced. Financials and energy—we saw it in trading the day after the election—they’re big beneficiaries from a deregulation standpoint.
So again, these are areas that we’re expecting to outperform. Importantly, though, you did see a pretty big move in value in small caps and the equally weighted S&P 500. These are areas that have been outperforming on a relative basis versus their counterparts: growth, large caps and the cap-weighted S&P 500. And believe it or not, it’s been our call since July that value, small caps and the equally weighted S&P 500 would outperform. But this just accelerates that trend, because you’re going to have this stronger fiscal impulse, which is going to create more solid economic data and better earnings delivery. So to put some numbers around this, when this rotation first started on July 11th with that soft CPI [Consumer Price Index] release and it became clear that the Fed was going to cut, increased the odds of a soft landing, growth has underperformed value by 8% through yesterday’s close, which is the day after the election.
Large [cap] has underperformed small by 9%. The cap-weighted index has underperformed the equal weight index by 5% is well. And I think that these are relatively young trades and there’s probably more tread on the tire for this rotation to continue. And then another thing that I think is really important is that the “Magnificent Seven[1],” which had been the leader for a couple of years up until July—that’s no longer the case. They’ve actually underperformed the S&P 493, so the rest of the index, by 9% over the same timeframe. And there was a lot of people that felt you had to have Mag Seven leadership for the S&P 500 to continue to rise. Well, again, since that timeframe, the S&P 500 is up over 5%. So this is a great dynamic. This is what you want to see. A broadening of participation is usually indicative of a healthy bull market and continued upside. And we think that that’s likely going to be the case. And even if the overall index doesn’t move a lot higher from here, those rotations underneath the surface are going to be helpful for those that have a diversified portfolio and have exposure to these areas of the equity complex that have been lagging over the last couple of years. But ultimately really good for active managers that can sidestep some of that concentration risk embedded into some of the larger indices.
Host: In the lead up to this election, there was quite a bit of discussion on the topic of tariffs. How concerned are you about the potential for higher tariffs on imports?
Jeff Schulze: I think we are going to get higher tariffs. So, there certainly is a concern there. Now there’s been two tariffs that have been floated on the campaign trail. A 60% tariff on all Chinese imports, and then a 10% across the board tariff with all our trading partners. Now, one of the tariffs that I think will likely go in is that Chinese tariff. Now it may not be 60%. You know, 60% may be the starting point for negotiation, but I do think it’s going to move up pretty meaningfully because when you think about Trump’s first term, China had a failure and they didn’t fulfill their phase one trade agreements because of COVID. So Trump may look at that as a situation where negotiations are really not worth the effort. So, you know, I think that you’re going to see pretty substantial increases on Chinese goods and the tariffs that are coming into the country.
Now, the key question for me is when does that go into effect? Does it go into effect immediately or is it phased in over a number of years? And ultimately, what are those numbers? For example, if you have an immediate tariff of 10%, for example, that goes into effect over a six-month period, it’s not going to be that disruptive. If you have a 60% tariff that goes into effect but it takes years to phase that in, companies are going to have the ability to shift their supply chains to more friendlier jurisdictions from a tariff perspective. So there’s a lot to be understood on this front. We’re not sure how aggressive tariffs are going to be, but it’s likely going to be a headwind to US multinational companies. It’s likely going to be a headwind to the consumer, because a tariff is essentially a tax. And it could hurt GDP growth and maybe boost inflation. But ultimately, there’s a lot more on this front that we’re going to have to see. But I am expecting some tariffs and that’s going to be potentially a headwind to companies that have these supply chains that run through either China or countries that have a pretty big trade surplus with the US. But again, I don’t think it’s going to be enough to really derail the markets or the economy, but it certainly could be a headwind.
Host: Immigration has been another hot topic for President Trump on the campaign trail. Any views on what might take place here?
Jeff Schulze: Well, I’m a little bit more optimistic on this front. There’s been some talks about mass deportations on the campaign trail. But if you think about that, that’s going to be extremely difficult to implement. Not only logistically because, you know, these undocumented immigrants are inside the US borders, but also legally as well. I think that Trump will likely prioritize sealing the border and deporting undocumented immigrants who have committed crimes in the US. And by targeting the deportation of immigrants who have committed crimes that could allow him to fulfill at least partially his campaign promise. So I think that immigration will be reduced—maybe to 500,000 per year, maybe 750,000 per year—much more legal immigration kind of making up those numbers, which is a pretty big change from what we’ve seen. And it’s below the one million per year pre-pandemic trend that we saw.
But ultimately this is going to slow down labor supply, slow down economic activity. But that’s going to have a lagged that’s really going to take place in 2026 and 2027. But ultimately, you know, if you do have one of the more severe scenarios where there’s mass deportation, you’re going to have a lot of dislocations. It’s going to have lower GDP growth, it’s going to hurt labor-intensive industries like agriculture, like construction, like restaurants, hospitality and leisure as well. The other thing on the immigration front that could come up is you could see the potential expiration of the temporary protected status. This is a temporary status that gives immigrants work permits. If that does expire, it could lead to millions, two to three million immigrants leaving the US workforce. But I want to just suggest here that, again, this is a very fluid conversation. Not everything that gets mentioned on the campaign trail comes to reality, but this is something that we’re watching really closely.
Host: Jeff, President Trump has talked about wanting a weaker US dollar in the past. Do you think we’ll see that happen?
Jeff Schulze: Although he wants a weaker dollar, it’s going to be an environment where the dollar is either stable or potentially even stronger from here. When you look back to Trump’s first term, you saw an appreciation of the dollar, and he wanted a weak dollar back then. And it actually appreciated a lot when you saw tariffs that were imposed. And with more extensive tariffs this time around, you have a pretty big strong fiscal impulse, which is going to create US exceptionalism from an economic perspective. It’s likely going to take some rate cuts out of the Fed’s cutting cycle. All of these things are things that generally are positive for the dollar. So, you know, I think that the dollar either stays at these levels or potentially moves higher as we look through the next four years.
Host: The 10-year Treasury rates have moved aggressively higher since the middle of September. How much more upside do you see there?
Jeff Schulze: Well, the day after election day, the 10-year Treasury jumped 16 basis points off the highs. But you know, again, that’s a pretty big move in one day. As you mentioned, up at around 70 basis points as of right now since mid-September. So some of this was actually because of the Trump trade, better growth and inflation, that you’ve seen from a Republican sweep. Some of it is because of just better economic data. It’s important to remember over the summer there was some recession fears out there with the weaker labor market and the 10-year Treasury was dropping pretty dramatically to reflect those recession fears. And with stronger economic surprises, you’ve seen the 10-year Treasury move higher. So part of that’s the reason. And then also when you go back to the ‘95 soft landing rate cutting cycle, the 10-year Treasury moved up and retraced some of the drop following that first rate cut.
So today you have the 10-year Treasury at around 4.35%. I could see it getting back up to 4.5%, which I don’t think is problematic for US equities. But if we get above 4.6%, I think that’s when you start to see some pressure on the valuations that are currently embedded into US equities. And one positive dynamic that I didn’t mention earlier is that the day after the election, when the 10-year Treasury jumped 16 basis points, small caps did fantastic. Small caps are very interest rate sensitive. And over the last couple of years, when you’ve seen the 10-year Treasury move higher, it’s been a headwind. But participants are viewing the economic environment as conducive to small cap outperformance and stronger earnings delivery, better pricing powers. But I do think if we get back up to about 4.5%, 4.6%, you’re going to start to see that affect the markets in a negative way. But that’s not my base case. I actually think that we won’t go above 4.5% on a durable basis.
Host: So Jeff, the market is expecting the US Federal Reserve to continue its Fed funds rate-cutting cycle into 2025. Has your view changed regarding how aggressive the Fed will be?
Jeff Schulze: Well, we’ve always thought that the Fed would be less aggressive than what the market’s been pricing. And that’s been a camp we’ve been in for all of 2024. You know, if you think about this entire cycle, the markets have been overpricing how many cuts were coming. And I think, you know, again, that’s a similar dynamic to what we’ve seen now. But with the Fed cutting rates by 25 basis points today, you have another two and a half rate cuts that are priced into the middle part of next year. That feels about right. Maybe we only get one or two more cuts, but ultimately, I think that the Fed is going to be able to cut enough to create a stable economic backdrop and potentially a reacceleration of economic momentum as this moves through the bloodstream of the US economy in the back half of next year.
But one thing that people are concerned about is tariffs. There’s an argument that the Fed will look through the inflationary impact of tariffs, because it’s a one-off price adjustment and it’s going to have negative consequences for economic growth. It’s a headwind, again, to the consumer. And there’s another view that because the Fed erred in 2021 by assuming that inflation was transitory, that they’re going to err on the side of caution and potentially pause the cutting cycle if large tariffs are announced. Now, I think that the Fed will probably look through tariffs as a one-off price adjustment and they’ll focus on the negative growth consequences. But we’re going to have to see how things develop. But ultimately, even though the Fed only does four total rate cuts (so that’d be one more rate cut than what we have today for a total of 1%) that’s still more than what was needed for the 1995 soft landing cutting cycle of 75 basis points and the cutting cycle of 1998 of 75 basis points as well. So again, I think the markets are coming more in line with our view, but ultimately I think the Fed has probably done enough to keep this expansion moving forward.
Host: The ClearBridge Investments Recession Risk Dashboard hasn’t come up in our conversation yet. So let me ask you now, what does the dashboard look like as we have moved into the month of November? Any changes in the past month?
Jeff Schulze: No changes. We had no changes in September. We had no changes in October. To all the listeners, that’s actually not a bad thing. Even though there were no changes, we continue to get more green underneath the surface. We’re just not getting to a point where we’re making an individual indicator change. But last time we did this update, we told probability of a soft landing or no landing is 85%. It’s still 85% today. It’s never going to be more than 85%. That’s probably as about as good as it’s going to get. But I think given the progress that we’ve seen underneath the surface, I’d be very surprised if we don’t have a couple indicator changes as we make our way through the rest of the fourth quarter and into the first quarter of next year.
Host: Alright, Jeff, let me follow up on that. I think we saw a fairly weak jobs report in October with the economy only creating about 12,000 jobs. Is that a cause for concern?
Jeff Schulze: It’s not. It was a weak jobs report. Again, 12,000 jobs is well below consensus expectations of 100,000. You had downward revisions to the prior two monthly releases of 112,000. But it’s important to remember that this jobs report was heavily impacted by strikes. You had 33,000 people that were doing strikes at Boeing. You had some other strikes at Textron Aviation, hotel workers, and also there’s a huge impact from the hurricanes that you saw in the southeast part of the US. My expectation is you’re going to see a bounce back in job creation over the next two job releases. And ultimately, although job creation has slowed, it’s really not going to be enough to be concerned about an actual recession. But in kind of thinking about the economy, the consumer is in fantastic shape right now. They’ve deleveraged after the global financial crisis. Household net worth is up $47 trillion since the beginning of 2020, which is before COVID even happened.
Most consumers are locked into low fixed rate mortgages and that’s important because mortgage debt is 70% of overall consumer debt. The savings rate was revised higher to 4.6%, which is a pretty healthy measure in line with the average that you really saw prior to the pandemic. So the consumer’s still a workhorse in our opinion. If you look at the latest GDP release, consumption was 3.7%. So the consumer continues to do their job and I don’t really see a change there as well. Furthermore, if you look at profits, profits were revised higher here recently with the annual GDP revisions. Profits are about a hundred basis points higher than what they were trending in 2023. That shows not only that corporations still have some pricing power, but they’re not struggling to cut costs. And if profits are moving higher, that means that you’re likely not going to see a layoff cycle come into play.
And then lastly, I think I mentioned this a little bit earlier, the economy’s on a pretty good foundation right now. Last quarter, GDP was 2.8%. The quarter before was 3%. Usually when the Fed’s cutting rates, the economy is decelerating. But you have some pretty resilient economic activity, which should create at least a stable economic backdrop next year, if not a re-acceleration, which is what you usually see with a lag of around six months. So the economy, as far as we are concerned, is on good foundation, even though you did see a labor market print that was a disappointment compared to consensus expectations.
Host: Okay. Jeff, as we look to move to the close of today’s conversation, let me bring it back to where we started. How important have US national elections been for equity market returns historically?
Jeff Schulze: Look, policy is important, right? We’re obviously seeing the effects of that today in the aftermath of the red sweep. We saw a pretty big market response with the Tax Cuts and Jobs Act back in 2016 into 2018. So policy is certainly important, but what’s more important is the economy, because there’s a strong link between economic growth and corporate profits and whether or not you go into a recession, quite frankly. And if you look historically, equities have delivered pretty solid returns under leadership from both parties. So going back to the last 10 administrations (this is back to Richard Nixon in the 1970s) eight out of 10 of those administrations had positive equity performance ranging from anywhere from 7% to 15% annualized. The other two presidents that had negative returns of around 4% to 5.5% during their time in office, they actually had the misfortune of recessions occurring both early and late in their terms.
So Richard Nixon, -4% annualized return during his tenure. He came in at the recession from 1969 to 1970, and he exited during the 1973 to 1975 recession. George W. Bush was the other one, -5.6% annualized return—came in as the dot-com bubble was bursting right before that 2001 recession, and he exited during the Global Financial Crisis. So with a recession unlikely in the near term, history really suggests that you’re going to continue to see some positive equity performance as we move through the second Trump administration. And then, you know, maybe looking at this from a different vantage point, going back to 1984, the last 10 presidential elections, if you look six months out or three months out, the only two times where the S&P 500 was down after election day was after 2000’s election and ‘08’s election, again going into those two recessions. So, with the economy being what it is with the Fed cutting, with some fiscal stimulus coming out from a red sweep scenario, we think the prospects are pretty good for further gains looking out on a multi-year time horizon.
Host: Jeff, as we look to close today’s conversation, any final thoughts for our listeners?
Jeff Schulze: Yeah, I think I mentioned something close to this when we did our very deep September election podcast, but it’s an important reminder. Markets go up under Republican presidents, they go up under Democratic presidents. Just because you have somebody new who’s in the presidential position doesn’t change companies from trying to maximize profits. And I know there’s probably a lot of people who are disappointed in the election result, but when it comes to politics, you don’t really want to mix politics and investing. And when you look at it on a longer-term time horizon, it really actually doesn’t matter. For example, going back to 1932, if you invested the day after each Democratic president was elected, on a 10-year forward looking basis (so that’s a longer-term perspective, which most investors are long term) your annualized 10-year return was 6.4%.
Going back to 1932, if you had invested the day after a Republican president was elected, your 10-year forward looking return was 6.1%. So it’s virtually identical. So again, we have an economy that’s solid. We think that, you know, given that momentum that you’re probably going to see some more gains in US equities, but that rotation into smaller caps, into value, into the equally-weighted S&P 500, which is traditionally good for active managers, we think that it all continues and having a diversified portfolio is really going to start to pay off as we look forward over the next couple of years.
Host: Jeff, thank you for your time and your terrific insight as we continue to navigate the landscape here in the final couple months of 2024 and drive into the next calendar year. To our listeners, thank you for spending your valuable time with us for today’s update. If you’d like to hear more Talking Markets with Franklin Templeton, please visit our archive of previous episodes and subscribe on Apple Podcasts, Google Podcasts, Spotify, or any other major podcast provider.
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1. The “Magnificent Seven” are Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla.
