Transcript
Jeff Schulze: I’m privileged to welcome back to the booth my colleague and co-author of ClearBridge’s AOR program, Josh Jamner. Josh is an investment strategy analyst and my regular collaborator in what will be our eighth annual outlook podcast. This is our one chance every year to throw some pop culture angles into the discussion. But beyond our attempt at entertainment, Josh and I will walk you through our base case for the economy and equity markets in today’s podcast “ClearBridge Outlook 2025: Will US exceptionalism continue?” Josh, it’s hard to believe that it’s been eight years in the podcast booth with you, but here we are yet again. So welcome back.
Josh Jamner: Thanks for having me. And it does not seem like it’s been 12 months since the last time I was here doing this with you. The last year has flown by.
Jeff Schulze: Time flies when the market’s up over 20% in a given year.
Josh Jamner: Absolutely.
Jeff Schulze: But we find ourselves here yet again prognosticating on what’s going to occur in 2025. In our annual tradition, let’s talk about a song that maybe the title encapsulates what you’re anticipating over the next 12 months. I know that you’ve had a lot of time to think of this.
Josh Jamner: I’m glad that you said the title encapsulates, because nobody wants to hear my singing voice, which I think everyone remembers with those who have listened in years past. I’m going to go with eighties Rock Classic from Whitesnake, “Here I Go Again.” Just seems very fitting given what’s gone on in the election, which was two weeks ago as we record this. Two weeks ago tomorrow.
Jeff Schulze: Alright, Whitesnake, I was not anticipating that turn, but I like it. It does fit. It actually kind of fits in line with what I was thinking. “One More Time” by Britney Spears, maybe? We’re going to get another Trump administration and a lot of the pluses and minuses that we saw from that administration over the next four years. I was thinking about “Don’t Stop till You Get Enough” by Michael Jackson talking about the tariffs, but I felt like “One More Time” is a little bit better fitting of the situation.
Josh Jamner: We were on the same page. Here I go again. I mean we’re really two sides of the coin here.
Jeff Schulze: The lyrics of the song, not so much. But again, I think the title really gets to where we’re going. But obviously that brings us to what everybody’s talking about right now, which is the US elections. You had a Republican sweep and when (generally speaking) you have a sweep scenario, you have a lot more on the table from a legislative perspective. But there are pluses and minuses, which we clearly saw in Trump’s first term. So maybe we can go down the positives first and foremost, and Josh, I’m going to kind of kick it over to you. The sweep puts some tax cuts and some fiscal policy in motion.
Josh Jamner: Yeah, absolutely. So the GOP sweep enables the utilization of the reconciliation process or the budget reconciliation process I should say. And that is really expected to ease the extension of a number of provisions that were passed back in the 2017 Tax Cuts and Jobs Act or TCJA, which was the big tax cut that the first Trump administration passed at the end of 2017. And a number of those provisions are slated to expire at the end of next year, at the end of 2025.
Jeff Schulze: Okay.
Josh Jamner: And the ability to use the budget reconciliation process means that they only need a majority vote in both houses of Congress.
Jeff Schulze: Okay.
John Jamner: So you only need 50 votes (or 50 plus one a tiebreaker) in the Senate. You need, I forget the margin off the of my head in the house, but you need 218, I guess it is. And ultimately this lowers the threshold for the second Trump administration to cut taxes. But ultimately it should be pretty individual tax heavy when it comes to extending these provisions. And that’s not to say there won’t be anything that should benefit corporations. I think that a couple of provisions like the accelerated depreciation, the treatment of how research and development is expensed, both are likely to be extended as well or seen as likely to be extended.
Jeff Schulze: And that’s going to help Capex- [capital equipment) heavy companies?
Josh Jamner: Absolutely. And there’s also discussion of trying to maybe lower the corporate rate. That was something that happened in 2017. It was not set to sunset, but there is the opportunity should there be the votes for the corporate rate to come down. Maybe not all the way to 15% like was discussed on the campaign trail, but ultimately it could step down from 21 seems to be within the realm of possibility right now. So taking a step back, some individual tax cuts coming or extensions of tax cuts, the potential for some additional tax cuts. No tax on tips was widely discussed. Early reports as the transition team is being assembled and the future cabinet appointees are being assembled is that the tax on tips (no tax on tips I should say), is a priority that would like to be kept and some corporate tax cuts as well. And so ultimately I think we’re looking at a pretty favorable environment. And one of the big takeaways from the election is that the tax environment should be pretty favorable for equity markets.
Jeff Schulze: And maybe a marginally lower corporate tax rate can take off some of the sting that you may see from higher tariffs that are obviously something we’re going to talk about in just a second. But I think you bring up a really important point. The margin in the House is razor thin, right? And just because you have a sweep scenario doesn’t mean you get a blank check. If you look back to build back better in 2021, Democrats had a sweep, right? But it was blocked by members of their own party, in particular Senators Manchin and Sinema from West Virginia and Arizona. So we’ve got to tame expectations on ultimately what’s going to be able to pass because you need almost literally everybody’s vote to have this move forward. But nonetheless, positive fiscal impulse, which is why the market’s cheered this outcome in the days following the election. But obviously there’s another positive aspect of it, which is regulation, right? Regulation is going to be a positive tailwind. You certainly saw it with financials, you saw it with energy in the days following the election.
And obviously these could be a tailwind for a little bit longer. But I think we need to temper expectations, because just because you have a regulatory tailwind (or deregulation) doesn’t mean that you actually outperform, right? If you go back to the Obama administration, expected to be pretty big headwind to health care. And health care outperformed on a relative basis during those eight years. Trump, a pretty heavily pro-energy president and energy, believe it or not, even before COVID happened and well went to negative energy was the worst performing sector both pre- and post-COVID, right? So it’s good to have that tailwind, but more importantly, the direction of the economy is ultimately going to dictate the fates of these individual sectors. But at the margin, deregulation is going to help these areas and you could provide at least a near-term tailwind to relative performance over the next three to six months as things tend to develop.
Josh Jamner: And you mentioned it a second ago in terms of increased animal spirits, right? An appetite on the part of corporations for a little bit more M&A [merger & acquisition], a little bit more Capex. Lower taxes aren’t going to hurt that. less regulation isn’t going to hurt the willingness of a corporate manager to say, you know what, let’s go ahead and move forward with building this factory or hiring these extra workers or taking over this other company and expanding into something new. If you look back to 2016, after Trump was elected, the NFIB Small Business Optimism Survey jumped by almost 12 points, which was its largest three-month bounce.
Jeff Schulze: Which is massive.
Josh Jamner: Which is massive. Yeah. Largest three month bounce back to I believe 1980 it was. So you had a real improvement in small business optimism. You saw it in a number of other sentiment surveys in that time period. And ultimately, I think a reasonable expectation would be that you should see improved sentiment on the part of corporate managers given what we were just talking about: lower taxes and less of a regulatory headwind.
Jeff Schulze: Yeah, improved sentiment means more business investment. It means potentially more hiring, right? If there’s been this election uncertainty overhanging people’s actions, I mean that could unlock some economic momentum as we move through the next couple of quarters, right?
Josh Jamner: Yeah. And you’ve been hearing that. I’ll talk more about earnings probably later in the podcast, but in third quarter earnings season, it’s been a pretty consistent theme that decisions have been on hold leading up to the election. We want to wait and see how things are going to play out, whether it’s around hiring or other business decisions.
Jeff Schulze: And we haven’t gotten any business sentiment releases. The NFIB did release, but the collection period was pre-election, but I’m anticipating maybe not a 12-point bump, but maybe something relatively close.
Josh Jamner: Yeah. And it took a couple months. It wasn’t just the first month after the election back in 2016. It was the next two prints that really saw that step higher.
Jeff Schulze: Okay, so we’ve talked about the positives, right? We’ve got a stronger fiscal impulse, maybe a lower corporate tax rate, but individuals aren’t going to see their taxes go up in the next couple of years. You have deregulation and release of animal spirits. Obviously the market liked it in the aftermath of the election. But there are negatives, right? There’s going to be some headwinds. And the two that come up the most is lower immigration, maybe mass deportations, but also tariffs. So I want to talk about immigration first. Josh, what are your thoughts there?
Josh Jamner: Look, reduced immigration would be a headwind to the economy. It’s a matter of how much, and that’s going to ultimately come down into how much does immigration change?
Jeff Schulze: Well, it’s a headwind to the economy because nominal GDP growth is …
Josh Jamner: … closely tied to consumption, right? And so there’s a couple ways that this can manifest. One is through fewer people in the country spending money is going to translate into less consumption. Immigrants spend money and contribute to the economy in terms of their spending. They also contribute to the economy in terms of what they produce, right? Most labor force participation rates for foreign born workers tend to be higher than domestic born workers. Most immigrants tend to be what are called prime work, prime age individuals. But immigrants tend to be people who are kind of in their prime working years, coming usually looking for a better life and in search of work. If ultimately you’re going to have less of a labor, it’s going to be a reduction in labor supply that’s going to tighten up the market, that’s going to put a little bit of upward pressure on wages, which should be a modest drag on corporate margins.
At the aggregate level, you’ll see more or less impact across specific industries that use greater or lesser degrees of immigrants and in their labor force. But ultimately it would be a negative to the economy. And we’ve actually already seen the pace of immigration slow. Back in June, President Biden signed an executive action that showed up as soon as July. July was the lowest level of immigration into the country since early 2021. So we’ve already kind of seen a step back. If you, you know, if we were doing this podcast six or so months ago, the Congressional Budget Office at the time was estimating about 3.3 million workers, immigrants coming into the country. And the latest data looks like we’re running more like 2.5 million for this year, could even be down to two million. The data comes out with a little bit of a lag. Obviously it’s harder to measure illegal immigration than legal immigration. And I think the expectation is as we look to 2025, 2026 and beyond that the pace of immigration will drop even further. So I think that will manifest in a couple of ways. One thing that you and I have discussed a fair bit is “What is the concept of a break-even pace for job creation?” If you have more immigrants coming into the country every month, you’re going to need to create more jobs to absorb those workers. We’ve already seen the break-even pace of immigration step down. And as we move forward into next year and beyond, I think that break-even pace will continue to step down. And also as we were talking about at the beginning, the consumption impact is going to be a headwind.
Jeff Schulze: Yeah. And nominal GDP, right? Two things. The increase of productivity growth, which is manufacturing more widgets with the same input costs every year or the increase of labor force, right?
So obviously that’s one reason why you’ve seen US exceptionalism, but again, if we do see a big slowdown there, that’s not going to be a next year problem. But it’s really going to start to take into effect in 2026 and 2027.
Josh Jamner: And as you were saying, it’s not just immigration, there’s also a tariff component I think is probably the other potential big headwind out there when we think about what the impacts of the election are for equity investors. You want to talk a little bit more about the tariff side of things?
Jeff Schulze: Yeah, and a lot of airtime on tariffs here recently, and it remains to be seen what exactly is going to transpire. But there’s really been two things that have been floated in on the campaign trail, right? A 60% across-the-board tariff for all Chinese imports, and then a 10% across-the-board tariff for all of our trading partners.
And when it comes to China in particular, I think timing and magnitude are really important considerations that we just don’t have visibility on right now, right? For example, if we have a 60% tariff day one (and it’s going to take a little bit of time, but relatively early when Trump steps into office), that’s going to be really disruptive. Markets are not going to like that and you’re going to see a lot of pain than what’s currently being priced right now. But if you have a 40 or 50 or 60% tariff that’s phased in over a three- or four-year period, right, it’s going to be very different. Now these companies are going to be able to relocate their supply chains into more jurisdiction-friendly areas that are not going to be affected by this potential headwind. So I think that really matters. But I think when it comes to China, there’s going to be a little bit of a punishment because they didn’t fulfill their phase one trade agreement commitments back in 2020 with COVID.
So I think you’re probably going to see a five or 10% tariff increase on China immediately. And then I think that’s going to be stepped up pretty meaningfully over the course of the next couple of years, especially on areas really important for US economic security and national security—areas that China has a pretty critical advantage over the US and has some leverage. So I think tariffs are going to move higher on China, but I think it’s going to be phased in over a longer period of time where it’s really going to minimize that pain.
The 10% across-the-board tariff, that’s really harder to kind of handicap on what’s going to happen. There are some people saying out there that the president can use the International Emergency Economic Powers Act, better known as the IEEPA, to declare a national emergency and put those tariffs on broadly day one, and then you can start discussing some exclusions and some exemptions.
But again, I don’t know if that’s actually going to transpire. So this is a pretty fluid area and we’re going to have to ultimately see what ultimately comes up from the Trump administration. But this obviously could be a headwind to equities that have supply chains in these countries or they have a lot of sales or revenues from these countries where you could see some retaliation. It is going to be a little bit of a back and forth and there is a view that Trump is going to be using this as a negotiation tactic in order to extract better trade terms with our trading partners. So I think it’s going to be a situation that’s going to have a lot of uncertainty over the next couple of years.
But let’s not forget, when you think about these negatives—immigration being lower, higher tariffs—back in 2018 when we had higher tariffs, guess what? The economy continued to move forward. Equity markets did fine in that environment even though it was choppy because it came back to the health of the economy, right? Something that I’ve been stressing on these podcasts and when we’ve talked with our clients is that policy matters in the near and intermediate term, right? It mattered when we had the red sweep in 2016 and we got that legislation. Happened when we had the Democratic sweep in 2020 and we got more friendly fiscal impulse. We’re probably going to see it this time around, but the economy matters most. And if you go back to Richard Nixon, the last 10 presidential administrations, eight out of 10 of those presidents saw an annualized price return of the S&P 500 from 7% to 15%. Actually out of those eight, seven of them had double-digit annualized returns.
Josh Jamner: Pretty good.
Jeff Schulze: Right? Really good. The only two that had negative returns were Richard Nixon and George W. Bush. Negative returns of -4 and -5.6 respectively. Why? Well, they came into office and they were bookended by recessions. So when Nixon took over, you had the 1969-1970 recession and when he exited, you’re going through that 1973 to 1975 recession. Same thing with George W. Bush—came in as the dot.com bubble was bursting and that ’01 recession and he left during the global financial crisis. So again, these are things that we need to understand and figure out, but ultimately the economy matters more. And me and you have talked about this pretty much every day since I can remember. We’re pretty optimistic right now. We’ve increased the odds of a soft landing to 85%. It was at 75% in July. But 85% is as good as it gets, right? So what are you seeing in the dashboard that we have, Josh? Are you obviously getting more optimistic as we go forward? Is there any concerns on the dashboard?
Josh Jamner: No, there really aren’t. Though, as you said, 85% is about as good as things get. I think from a base rate perspective or historically we’ve had a recession every seven, eight years. It’s hard to have odds of a recession below 15% or so. The dashboard has an overall green positive or expansionary signal. We haven’t seen any indicator changes over the last two months. I was looking at it, we’re recording, today’s the 18th, so we’re recording right around mid-month. I was just quickly marking to market the dashboard this morning and things continue to improve beneath the surface even though we haven’t had a positive indicator change over the last two months. We have seen incremental progress in a couple of individual indicators. And as we’re looking ahead, things like housing permits, truck shipments, money supply and retail sales (probably in that order) are getting closer to seeing a little bit of a positive shift. Even the yield curve has been re-steepening a fair bit lately. It wouldn’t surprise me if that’s probably a 2025 signal change, but you never know.
On the other side, always keeping an eye on what could be getting worse. The ISM [Institute of Supply Management survey] had been looking better, it slipped back and obviously, hopefully there’ll be a bounce but not holding my breath there. And I think the thing to watch is jobless claims. That has been the economic canary in the coal mine. I think we’ve probably talked about it on last year’s outlook podcast, two years ago outlook podcast. Jobless claims are holding up very well. They ticked down to the lowest level since May last week, the report that released last Thursday. And they continue to be the one indicator to watch. If you said “Josh, you have to go to a desert island and you get one indicator and that’s the only thing you get,” I would still pick jobless claims.
Jeff Schulze: And it’s a high frequency data point and it’s not subject to huge revisions, which is why it’s such a valuable indicator.
Josh Jamner: And the one last one I think to watch for would also be job sentiment. That signal’s been red. It was getting better. It got pretty close to yellow back kind of over the summer and then it turned around. It’s been getting worse as of late. It did tick better last month. But that’s one to watch for as well as another thing that, see how that goes.
Jeff Schulze: Well, something has me optimistic and pretty fired up and I think it has created this US exceptionalism, one of the pillars, has been the US consumer.
Josh Jamner: Absolutely.
Jeff Schulze: Right? There’s some concern about the labor market over the summer, that’s why we saw that selloff. You had a pretty bad jobs report in October—12,000 [nonfarm payrolls]. Well below consensus expectations of 100,000. So there’s still a little bit of concern out there. But you know, again, as you mentioned, you had the two hurricanes, you had some strikes at Boeing and other areas that really weighed on that number that we’re probably going to get a bounce back looking forward for the last two releases of this year.
But when you think about the consumer, one of the reasons why economic growth was so slow in the last decade following the global financial crisis is you had a balance sheet recession, you could cut rates to zero, you can do QE [quantitative easing], but if people think they have too much debt and they need to pay that down, there’s nothing you’re going to do other than give them money to get them out of debt to change that trajectory. But after paying down debt for a decade, household debt to disposable income has dropped over 40 points. People feel better about spending in a more durable manner today. And you would think, with interest rates rising as aggressively as they have, debt servicing costs would be high. But they’re, you know, as low as we’ve seen in the last 30, 40 years, right? So the consumer has been a workhorse of this expansion. They continue to be a workhorse. And barring layoffs, I just see a hard time seeing consumption stepping down in a manner that’s actually recessionary. I think the consumer has been underrated this entire cycle. They continue to be underrated. One of the things that the bears were pointing to was that savings rate being artificially low, that the consumer was strapped. And then we got some revisions to the annual data that showed that guess what, the savings rate’s back up to 4.6%, which is in line with what you saw prior to COVID. So one of the things that I’ve been optimistic about has really just been the consumer and the resilience that we’ve seen there. And with household net worth up $47 trillion since before COVID happened, I think there’s more room to run on that front.
But one thing that obviously could hurt the consumer in my opinion is if inflation starts to pick up, right? You’ve seen inflation move down a lot. Wages have moved down. But again, people are getting more real income and it gives them more purchasing power at the end of the day. So Josh, what are your thoughts there as far as, is inflation going to move lower from here? Are we going to see a resurgence of inflation? And then what are the implications for Fed policy given what we talked about with the elections and the resilience of the economy?
Josh Jamner: Yeah, the underlying trend in inflation, I think the best I can tell, it looks to be that inflation’s going to continue to rise in roughly the high 2% range. If we were talking a couple months ago, I might’ve said mid 2%, but I think we’ve kind of probably shifted back up into the high 2% range. And so, look, there are consumers out there and individuals out there that still would like prices to go back to where they were in 2019. I’m sure we’re all one of them, but that doesn’t seem likely to happen. But ultimately we’re not seeing seven, eight, 9% high single digit aggregate basket of prices of consumer prices increasing year over year like we were two or three years ago. There has been a lot of noise in the inflation data. I’ve mentioned the seasonal adjustment problem. That is certainly true in inflation, but we try to filter through as many things as we can. It really does seem like core PCE [personal consumption expenditures} is probably running somewhere in the kind of high 2% range. I think as we look as to why that is, we’ve seen broad-based improvement on the goods side over the last couple years as supply chains have healed.
Jeff Schulze: And China’s exporting deflation, which certainly helps.
Josh Jamner: Absolutely. And on the services side, we’ve seen some disinflation, but it’s been slower progress there. A big part of that is due to shelter inflation that really impacts measures like CPI more than the Fed’s preferred measure like core PCE, which has a smaller weight to housing. But ultimately as we kind of think about it, high twos is not consistent with the Fed’s goal of 2%. But ultimately, look, we had a hot first quarter to inflation and it’s kind of cooled off in the second quarter over the summer and as we’ve moved into the fall, we’re seeing a resurgence in inflation. It is not taking us back to 7% or anything. It’s just, as I was saying before, if we were talking late summer, early fall, we would’ve been saying, oh, trend inflation’s looking kind of mid twos. Now we’re saying high twos. And so that’s where that resurge is. There’s not one single thing. It’s not used cars like it was two or three years ago. It’s not this specific category, this specific outlier.
Jeff Schulze: No.
Josh Jamner: I think it’s a broad base. You’re seeing less or more of an inflationary impulse from the kind of core services ex housing portion of the economy in terms of what that means for the Fed. Ultimately, I think that you and I have been skeptical of market pricing for Fed rate cuts for some time.
Jeff Schulze: Very skeptical.
Josh Jamner: The market is coming around towards that view. There’s about two and a quarter additional cuts priced into the market. If we look at mid-year of 2025 as just sort of a period of time that’s somewhere in the future that doesn’t seem too far off.
Jeff Schulze: I’ve always had five in my mind.
Josh Jamner: Yeah, exactly. So right around five total cuts. Could you get to six, could you get to four? It’s going to kind of, the Fed has continued to be data-dependent and I think that they’ll get there, but ultimately the Fed has won most of the battle against inflation. I think they’re very cautious about—I’m a New York Jets fan, we literally had a player spike the football before he reached the end zone a couple of weeks ago. The Fed is very wary of that. And as a fan that was very frustrating a few weeks ago. It’s been frustrating to be a Jets fan for much longer than that one game obviously.
Jeff Schulze: Builds character. Builds character.
Josh Jamner: But ultimately, I think the Fed has done a pretty good job. They’ve had an assist from things like the supply chain easing and ultimately they have a little bit more to go. And I think that is why we’re talking about could the Fed ultimately cut less and go on pause whether it’s in probably the first quarter of 2025 or maybe the second quarter of 2025 and say, “Well there’s a little bit more to go on inflation. We want to keep rates just a little bit higher than we might’ve previously thought to make sure that we get the last piece. We’ll get there over the next few years.”
Jeff Schulze: A lot of people point to tariffs and tariffs are inflationary. There’s two ways the Fed could look at that. They can look at, hey, we were behind the curve and underestimated how transitory inflation was in 2021 and 2022, and we don’t want to repeat those mistakes. Or they can look at it as a one-time increase of prices, which will ultimately slow economic growth because it’s a tax on the consumer. So if you’re paying more for all of these goods, you have less to spend on these other goods, right? History has shown that tariffs are actually deflationary. I personally think that the Fed will think of it in those terms rather than it’s going to be inflationary, because, to have inflation, you need price increases year after year. And that means aggregate demand is too hot, you don’t have enough supply, which tariffs do the opposite of that. But again, it’ll be interesting to see. I’m in your camp, I think we get one, two, I think three may be aggressive, but I think we probably get to four or five cuts.
Josh Jamner: You mean four or five total?
Jeff Schulze: Four or five total cuts, yes, we already have three. But if you look at history, when you’ve had 75 basis points worth of rate cuts or more going back to the 1960s, usually the economy troughs about six months after that first cut, reaccelerate 12 and 18 months later, Fed’s already done three cuts. We could get four or five, which I think is a pretty strong likelihood and we only have three cuts in ‘95 and ‘98, which actually propelled the economy in those two instances as well.
So again, I think the Fed’s already done enough to keep the economy in this environment and usually when those cuts happen, the economy’s decelerating. You’ve had 2.8% GDP growth last quarter, 3% in the second quarter. So the economy is actually doing quite fine. So it kind of plays into this US exceptionalism theme and I know a lot of people think that this trend is over. I think the US is going to continue to outperform from an economic perspective, right? You still have a strong fiscal impulse. Productivity is better than a lot of areas of the world and this increase of productivity really comes back to better job matching. During the pandemic, people exited their jobs, they moved geographically, they went into new industries and because of that, yes the churn rate’s moving down, the quits rate are moving down and that’s usually a bad omen. But I think it’s just because people are happier in their jobs and they’re becoming more productive.
And that’s again, a nice tailwind to economic growth and profitability. Immigration could be a bit of a headwind, right? Because labor supply is the other part of the question when it comes to nominal GDP growth. But a lot of those pillars, the consumer as well, are still there, which I think the US is going to continue to be the best house on a bad block or whatever analogy you want to use there. I mean, would you agree?
Josh Jamner: As you said, we’ve got 2.8% GP growth last quarter. We’ve been running kind of right in that ballpark over the last two or three years now. And I think it’s fair to say like is it actually that bad of a block? You know, almost 3% GDP. It’s not gangbusters, it’s not five, but it’s certainly better. In the decade between the global financial crisis and the COVID pandemic, we averaged, I think right around 1.6% GDP growth. So we’ve taken a step higher and I think a big part of it is exactly what you were talking about a second ago. We’ve seen improved productivity environment is maybe one of the bigger drivers. And it’s a fair question to be asking, going back to what I was talking about a second ago, is interest rates are high, the economy’s doing really well. Do we need to lower interest rates as much as we think? Is the neutral rate of interest higher? That’s a very academic question. It can’t really be observed, measured, or frankly, truly answered. It’s kind of an opinion, not a fact one way or the other. But I think it’s a fair question and the Fed is starting to discuss this. Chair Powell was talking about it last week, Lori Logan of the Dallas Fed was talking about it recently.
And I think it’s a pretty good question to be asking, do we need as low interest rates as we thought? Are we in a little bit of a different environment relative to the kind of pre-pandemic experience that I think most investors are accustomed to at this point?
Jeff Schulze: Alright, let’s move on to equities. We’ve had US exceptionalism with equity returns really since the onset of the global financial crisis and the troughing there. And so the US has been leading for, you know, I’ll call it 15 years a little bit longer, but there’s a pretty optimistic scenario priced into the markets right now. Earnings for the S&P 500 are close to 15% for 2025. Forward P/E of the market is 21.5, give or take. So that’s pretty high. Josh, on the earnings perspective, is that attainable and could we even beat it potentially?
Josh Jamner: Yeah, I think we could. 15% is a big number, but it’s also: part of this is there’s been a bifurcation in the market. So if we just look at the third quarter, we’re not quite done. We’re somewhere between 85% and 90% of the S&P 500 has reported their third quarter results as, and I think we’re going to get to like 95% to 97% by the end of this week. So far we’re seeing 8.4% growth. That’s a very healthy number. But there’s a couple things that stand out. One is there is a huge gap between cyclical and non-cyclical earnings when you look at the sectors. Energy has put up a negative 25% year over year earnings number for this third quarter. So it’s not like that; 8.4 is every company’s growing 8.4. You’ve got a couple of companies that are down 25% from an earnings growth perspective. Even ex. energy industrials are negative three, right?
When you look at some of the defensive companies like staples, in the staples sector, plus four is what the group is going to be as a whole. So it’s not uniform. You’ve seen a great reporting season for financials tech, including the Magnificent Seven1 stocks have done quite well, but this 8.4 is somewhat narrow. And as we look ahead to ‘25, I think the encouraging thing and how could we get to that 15% or potentially even better or something in that ballpark number is we need to see a broadening, right? So hoping and expectations are that some of these cyclical sectors are going to do much better (generally somewhere in the mid to upper teens) and the defensives that have been kind of mid-single digits in a lot of cases are expected to step up to the high single digits. So if we’re able to get this sort of broadening of earnings growth and expectations, which admittedly are lofty, come through, then I think that there’s a possibility. When you look at what’s driving the expectations, revenue growth expectations are 5, 6% generally for the market as a whole. So, there’s a fair amount coming from the margin line. Now that has been a source of skepticism in the investment community for …
Jeff Schulze: 20 years?
Josh Jamner: I was going to say my entire career. I remember people questioning margins when I first started my career. Like can they go any higher, are they? And look, I think you can look at it from a number of ways. There’s certainly the potential for some headwind to margins from the wage side of the equation or from the input cost side of the equation, from some of the policy choices we were talking about earlier. But at the end of the day, I think one of the biggest sources of upside to margins over the last couple years has been what you were talking about a minute ago, Jeff, was that productivity, you have workers being in their jobs for longer. As most people, I think, understand the longer you’re in your job you pick up know-how, you kind of understand how to do the job better and you’re able to produce more. And that’s kind of a real hack, if you will, from a corporate perspective, is that you can give a worker a 5% raise, but if they’re giving you 7% more stuff, you’re coming out ahead.
Jeff Schulze: Right.
Josh Jamner: Right? And so that’s going to be the biggest thing I think for that margin story is, is can productivity continue to hold up? But to answer the question, talk about this in a number of ways, 15% expectations are lofty. I think that the market has a fighting chance to kind of deliver on something in that ballpark. And if they do, that will set us up for an interesting year, because it’s only half the equation, the other half of that is going to be, what are valuations doing. Now you’ve been thinking about that quite a lot lately.
Jeff Schulze: Well, just to stick on earnings really quickly—in 2025, expectations are basically where they were when they first came out. Usually at this point expectations are down pretty massively as those kind of lofty expectations meet a harsher reality. And the fact that they’re actually staying pretty still is actually a really good dynamic in my opinion. So I actually do think it’s achievable. From a valuations perspective, yes, the S&P 500 [Index] is rich versus history, but it’s really a top heavy issue. So the top 10 names, largest weights in the index trade at a forward P/E of close to 30. Bottom 490 trade at a much more reasonable call it, 18.5, 19, right? So that’s a little bit expensive versus history, but not really as expensive as you think. Furthermore, if you look at the equally weighted index, so everybody’s P/E is the same, NVIDIA is the same as Starbucks, what have you, trading about one and a half, two turns more than its long-term average.
So there’s a lot of opportunity in the market and what we’ve seen really since July 11th, when you got that soft June CPI [Consumer Price Index] print became very clear that the Fed would be able to embark on that cutting cycle. You’re going to likely have a softer note landing, you’re going to have broader earnings delivery like you’re mentioning. When that became apparent, you started to see a rotation out of the Mag Seven out of large caps out of growth and into the areas that have lagged. Put some numbers around it. Since that release, the Russell 1000 Value [Index] has outperformed the Russell 1000 Growth [Index] by over 8%. Russell 2000 Small Caps have outperformed the Russell 1000 Large Caps by 6%. The Mag Seven has underperformed the S&P 493, so the rest of the index by six, 7%, right? So you’ve seen this rotation happen, I think there’s a lot more opportunity for that rotation which can drive the market higher.
And even with the Magnificent Seven lagging, the S&P 500 is up over 4% as of yesterday’s close with that happening. So you don’t need those biggest companies participating to have a positive market action. And I think that this rotation continues. So small caps, value, active managers that can sidestep some of the concentration risks, I think really have a really good opportunity as we look forward.
But I want to go to my second favorite part of this podcast when we close here, when we prognosticate and we make our predictions, we look into the crystal ball and we make some predictions here. And I have three lightning round questions for you, Josh. So first one, we talked about earnings being high. We talked about valuations being high, the S&P 500 over the next 12 months from a price return perspective: over or under 8%? And that would mean the S&P 500’s at around 6,350.
Josh Jamner: I’ll take the over.
Jeff Schulze: I’m going to take the under by a smidge. If we’re talking with a dividend, you might be able to tell me that we take the over, but I think we’re going to have a digestion period and some choppiness. Ultimately it’s going to sow the seeds for further upside. If we’re talking cap-weighted index, I take the over, but I think just by smidge a little bit lower. Okay? So we’re different there. 10-year Treasury, I didn’t look today, but it was at about 4.4%.
Josh Jamner: 4.4%, 4.5%. Right in there.
Jeff Schulze: Okay, so let’s just say 4.45%, cut right down the middle. Higher or lower in 12 months. I’ll take lower.
Jeff Schulze: Okay, something we agree on, I think lower is, well last one. Style box, Morningstar style box, large, small growth value core. What’s the best part of that style box from a return perspective over the next 12 months?
Josh Jamner: I’m going to go with small cap value.
Jeff Schulze: Wow, we’re agreeing again. Usually when we agree, good things actually do happen, believe it or not. So I’m actually not looking at this as a negative omen. I think there’s not a lot of expectations embedded in there. Higher nominal GDP growth should supercharge their earnings delivery and ultimately create a period of outperformance.
Josh Jamner: And I think a lot of those companies are particularly levered to some of the policy changes that we’ve talked about earlier and can really see an outsize benefit from those at the margin.
Jeff Schulze: I agree. So with that, I want to thank everybody for joining us here today for the 2025 update. We hope that you’ll join us, here our podcast next year.
Host: Jeff and Josh, thank you for your perspective this year. We look forward to 2025 and hearing more from you. To all of our listeners, Happy Holidays and thank you for spending your valuable time with us. 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 at any other major podcast provider.
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1. The “Magnificent Seven” are Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla.
