Our guest this week is Michael Santoli, who is senior markets commentator at CNBC, which he joined in 2015. Prior to that, he was a senior columnist at Yahoo Finance, where he wrote analysis and commentary on the market and economy. That followed a long stint at Barron's magazine, where Santoli was a columnist and feature writer for 15 years. Santoli began his career in the early 1990s as a reporter covering the securities industry for Dow Jones Newswires. He earned his bachelor's degree from Wesleyan University.
"Santoli: The S&P 500, Lifted by Earnings, Makes a Run at a Key Threshold and Tests Its Downtrend," by Michael Santoli, cnbc.com, July 19, 2022.
"Santoli: Earnings Beats Propel Some Major Bank Stocks, but They Still Have a lot to Prove," by Michael Santoli, cnbc.com, July 18, 2022.
"Santoli: The S&P 500 Nears a Level That Could Indicate Whether the Recent Rebound Is Sustainable," by Michael Santoli, cnbc.com, June 27, 2022.
"Santoli: Agreeable Economic Data and Earnings Releases Lift Stocks Into a Relief Rally," by Michael Santoli, cnbc.com, July 15, 2022.
Inflation and Recession
"Santoli: There's Little for the Market to Like in June's Hot Inflation Report," by Michael Santoli, cnbc.com, July 13, 2022.
"Santoli: Investors' Worries Migrate From Inflation Panic to Fears Over U.S. Growth Risk," by Michael Santoli, cnbc.com, June 22, 2022.
"Santoli: June's Jobs Reports Is Too Strong to Feed Recession Fears, but Key Inflation Data Looms," by Michael Santoli, cnbc.com, July 8, 2022.
"Santoli: Strengthening Case Against a Recession Pushing S&P 500 to Highest Levels Since Early June," by Michael Santoli, cnbc.com, Aug. 3, 2022.
Risk and Rising Rates
"Santoli: Investors Grapple With a Sense of Surrender After the Fed Raises Interest Rates," by Michael Santoli, cnbc.com, June 16, 2022.
"Santoli: Investors' Worries Around the Fed's Rate Hikes Have Found a New Focal Point—Risks to Growth," by Michael Santoli, cnbc.com, May 25, 2022.
Housing, Stocks, and Tech
"The Spring Setup for a Resilient Market That Got Past a Tough First Quarter Without Much Damage," by Michael Santoli, cnbc.com, April 2, 2022.
"The 2022 Stock Market Doesn't Have to Repeat—It Only Has to Rhyme," by Michael Santoli, cnbc.com, Aug. 6, 2022.
"Santoli: Low Expectations Lift Netflix Shares, but the Stock Remains in Growth Purgatory," by Michael Santoli, cnbc.com, July 20, 2022.
"After Another Big Weekly Loss, Assessing Whether Weekly Stocks Are Cheap and a Buying Opportunity Is Near," by Michael Santoli, cnbc.com, June 18, 2022.
"Santoli: As a Reckoning Unfolds in Tech, Could Megacap Growth Names Be Poised for a Bounce?" cnbc.com, May 11, 2022.
Jeff Ptak: Hi, and welcome to The Long View. I'm Jeff Ptak, chief ratings officer for Morningstar Research Services.
Christine Benz: And I'm Christine Benz, director of personal finance and retirement planning for Morningstar.
Ptak: Our guest this week is Michael Santoli. Michael is senior markets commentator at CNBC, which he joined in 2015. Prior to that, Michael was a senior columnist at Yahoo Finance, where he wrote analysis and commentary on the market and economy. That followed a long stint at Barron's magazine, where Michael was a columnist and feature writer for 15 years. Michael began his career in the early 1990s as a reporter covering the securities industry for Dow Jones Newswires. He earned his bachelor's degree from Wesleyan University.
Michael, welcome to The Long View.
Michael Santoli: Great to be with you. Thank you.
Ptak: Well, thanks so much for joining us. We're really pleased to have you. We're going to dive in and talk about things like corporate earnings, the market, the macro picture, tapping into your expertise and perspective. But before we did that, we wanted to take a little bit of time and ask you to reflect on your career. You've had a long and accomplished career in financial journalism. As you reflect on your long tenure covering and analyzing the markets, what are some of the key changes you've witnessed in market and investor behavior?
Santoli: I think the main change has been the speed of the markets, the speed at which the market attempts to grasp for the latest turn in the prevailing storyline, but also, I think just how much better in most respects the investing proposition in a practical way has become for individual investors. I always like to tell the story: My first job out of college was at a Wall Street trade publisher. I had a colleague who liked to trade stocks on the side, and he had, I believe, it was a Charles Schwab account. And at the time, he was allotted, I believe, it was 10 free telephone stock quotes per month after what you'd have to pay to call and get a stock quote. So, that's just one example of just crazy. The frictional costs that used to exist in this world and now for better and somewhat maybe, in some respects, for worse, it's that much easier. You guys know so well how much we used to talk about putative fees and loads on mutual funds and all of that. So, I think that's one of the bigger differences.
And then, a related point is the level of sophistication in some of the concepts that are now pretty mainstream and my time at Barron's, like a lot of these seasonal and technical market indicators and these old Wall Street adages that I felt used to be just restricted to the archivists and the real obsessives of investing, are now very commonplace. The average person on the Street didn't used to know there was a thing called sell in May and go away. And arguably, as soon as everyone knew that it became kind of obsolete. But I think all those things have made it a challenge to try and stay interesting and relevant in communicating about markets and communicating about investing.
In terms of investor behavior, I think human nature is pretty hard to change, and I do think the crowding and herding and overextrapolation of trends, that's going to be with us forever. So, in a sense, people just have more ease in implementing things and whether that means making the same mistakes or learning from them, depends on the situation.
Benz: You hinted at the fact that costs have come way, way down for individual investors and also transparency and accessibility of information has gotten a lot better. But when you think about the most beneficial specific developments for investors, perhaps products or services, especially for individual investors, what are the ones that stand out to you that you think have really taken individual investors forward during your career?
Santoli: I would say some of the low-cost automated asset-allocation services that are out there. I was pretty early in trying to get to know the idea behind robo advisory services and just something that makes it very simple to pursue a disciplined approach. And I think those things have been a genuine advance. And what's really interesting about it is, I remember some of the entrepreneurs, let's say, 10 years ago, talking about the early days of those types of products. And they would talk about how well the millennial generation, they let the software do the work for them. They're very digital native. They get it. They don't really intend to beat the market. They know the historical math on how difficult that is. And so, they're willing to just allow the software to do the work for them and to rebalance and all those things you're supposed to do. And it made tremendous amount of sense. And then, we saw 2020, when all of a sudden, it was Reddit and meme stocks and people deciding that we're going to have fun with this and we're going to say, it's really all just a story and a pose, and we're going to have a herding behavior that's going to be self-fulfilling, and everything is an abstraction and forget about not beating the market. We actually want to force the issue and send things to the moon.
So, my point only about that is the tools are there and beneficial and still exist. I think many people are making great use of them. It doesn't mean that the overall market buys into what's enabled by these advances. So, those would be the main ones that jump out at me. We've obviously seen that zero-cost stock trading is obviously good for people's ability to implement strategies in the market but also can be something that enables reckless behavior or at least less-disciplined behavior.
Ptak: What about the flip side: unwelcome innovations that maybe have worked to individual investors' detriment? I know that probably when we look at it and weigh it on the scales, we would find that there has been more good than bad. But there's probably been some things that have been not so healthy. What's your take on that?
Santoli: I think that there is a class of fairly gimmicky exchange-traded funds that are just trying to capitalize on some recent fad or trend that seem like they're pretty cynically constructed. Those would be some. I would go back to things like the user interfaces on some discount brokerage platforms, which quickly, first of all, encourage, greatly incentivize things like options trading and they make the interface, the options array, essentially mimicking sports-betting apps. So, it just seems as if just because you can doesn't mean you should in some respects. So, those would be a few of them.
I stopped a while back, getting hung up on, well, this is something that doesn't really need to exist. It doesn't really enable corporate America to raise capital, enable investors to capture the returns of the private sector the way the Jack Bogles of the world would say this is what the market is for. VIX futures; do we need VIX futures? Do we need exchange-traded funds that trade and capture the role in the Volatility Index futures, which is like a derivative of a derivative of a statistical outgrowth of an index option? I doubt it. But it doesn't mean it's harmful. It means that there is some kind of risk exchange that occurs on that. So, your mileage may vary as to whether these are good developments or not. But knowing what you own, knowing why you might own it, and what role it should probably play, if at all, in a general portfolio approach is still, I think, the standard for whether something is worth using or not.
Benz: You're a keen observer of the market. We wanted to switch over to discuss corporate earnings. We're about two thirds of the way through earnings season. Corporate profits have deteriorated, but they don't seem to have been as bad as some had feared. What's your take as someone who is in the thick of things?
Santoli: That perfectly captures, I think, what has gone thus far. The market really did get itself pretty clenched up in advance of earning season, trying to read through things like Treasury yield curve and these somewhat leading indicators of recession to say that somehow it was going to come to a head in this latest earnings season. I think one of the things that perhaps was missed in that is, even if in fact we may get a statistical recession, we may be in one, the inflation means that there is high nominal growth in this economy, relatively speaking, certainly relative to what we've gotten used to over the prior decade. That's the pie from which corporate revenues feed and that has been a little bit of a cushion.
I do think there is also, to some degree, a fair amount of noise in the general cyclical indicators right now, and it's still because of the whipsaw effect of the pandemic. So, we mistook this huge front-loading of goods demand that really did fatten up a lot of corporate bottom lines last year and now we're having the recoil from that. I think maybe that was mistaken for an across-the-board weakening of consumer and business activity. So far, I think we've pulled through it OK. I'm a little bit generally skeptical of trying to characterize an earning season in any neat and tidy way because I feel like it's always essentially going in multiple directions at once. There are conflicting messages from different companies. There are those that navigate better and worse and all the rest. But so far, I do think the beat rate in terms of relative to forecast earnings coming in are pretty consistent with what the economy has tended to do, or what corporate America has tended to be able to do for some time. It's reassuring.
I think it became a very, very comfortable consensus out there in the recent months that earnings estimates are simply too high and must come down, to which I'd say, yeah, that's logical, but that's also the normal course of things. In any given year, typically, estimates start too high and then get trimmed back. So far, it's at a manageable level. I think the key factor is absolute dollar level of profits. Are they higher this year than last year? They are. Will they likely be next quarter? Probably. And that is a little more of a key signal of whether the market has more reckoning to do on the downside than whether the estimates are coming down or not. And in my view, the S&P 500 went from roughly 22 times forward earnings down to a low, below 16. That's a lot of work that was done. And I think everyone said, well, now the earnings have to go down, the denominator has to go down to really flush things out. Maybe that's going to happen. But in my view, valuations being compressed are the markets way of expressing doubt about the reliability of earnings. It's not just kind of the algebra of what bond yields have done filtering into to equity valuations.
Ptak: As you've listened to earnings calls, what's the tone you've heard from management teams in the consumer-related sectors, both discretionary and staples? Have they sounded alarms about demand destruction due to inflation really biting and consumers cutting back or substituting?
Santoli: I would say mild alarms or not very loud ones so far. There's absolutely an acknowledgement out there, especially I would say, in the second half--well, starting in around April--that there was a sharp deceleration, especially in goods-based purchasing. Clearly, retailers were caught flat-footed and were too busy worrying about getting inventory and ended up with too much of it. We know that story is well-played-out. But in general, I think more CEOs and CFOs are pushing back against the idea that the consumer has just quit, or is fatigued, or is unduly stressed than those who have said, we're very concerned about.
There is another theme, which I think is maybe having some people concerned about how this plays out in subsequent quarters, which is, there is a lot of acknowledgement out there that CEOs feel as if they have productivity issues within their workforces, that there was a mindset of labor scarcity that got them to just hire in a relatively aggressive and indiscriminate way over the course of the prior year or two, and today, there is almost an opportunity or a need for that to be rationalized. You're seeing it obviously in technology. There is some reaction to digital advertising volumes there, but I also think it's more of a general mutual disarmament among these companies. So, if Facebook says, we're doing a hiring freeze and we feel as if we've hired too much; if Amazon says we invested too much, we probably added too many people in a short period of time, that gives permission for Alphabet to say, OK, I guess they are not going to steal every one of our candidates in the hiring pool, let's try to also figure out how we're going to rightsize.
So, I'm on alert for that snowball a little bit to see if that's in fact what happens or if in fact it's just moderation around the edges. And everyone is focused on job openings as opposed to whether that level is going to come down. We saw that actually in the latest data, that in fact, the number of job openings did retreat. The Fed is looking for that as a way to cool off the labor market without necessarily causing a huge spike in unemployment. I think that's semantics. It's what the Fed has to say. But it's definitely going on and you hear some resonance of that in the corporate conference calls this quarter.
Benz: There has been a long-running debate about the sustainability of high corporate profit margins. Some argue that it's just a matter of time before they come down. Others believe they will remain at this higher plateau. What do you think about that?
Santoli: I think it's a nuanced issue. For one thing, the observation I'd make is, part of this long-term increase in corporate profit margins that many people cite, if you do the aggregate S&P 500 levels, is a bit of a mix issue. So, when you have these companies with somewhat structurally higher profitability, like the big growth tech companies that are now such a huge part of the index, I think just mathematically it makes the index look like it's more profitable and it's over-earning to a great degree. So, maybe there is a little more resilience in earnings in part for that reason. I don't think that in general across the board the typical company is going to be able to perfectly protect margins. The good news is, you're already seeing that to some degree. You're seeing some margin erosion. And at the same time, as I mentioned before, with nominal growth being high enough, revenue is growing enough that there's a bit of a cushion. And so, that aggregate profit of net income if you want to say, can still be OK, even if margins do come down. So, there is no escape from the sort of commodity cost pressures, wage costs going up, and things like that. We may get a corporate tax-rate bump, as we know, through this newly passed package. But I don't think there is really a waterloo on the way for corporate profitability.
I'm not going to say that somehow businesses are much better across the board than they used to be, but there has been some ability to defend margin in the last couple of cycles that, I think, has confounded the historical mean-reversion camp. I do remember, I think it was a very large buy-side well-known investor, who I think it was in the early 2010s, was saying profit margins are the most mean-reverting series in economics or something like that. And it didn't happen, even though that was the case in prior years. Is that going to change? Are we in more of a short-cycle boom/bust scenario, the way maybe we were prior to 1990? That remains to be seen. I think there's some plausible cases to be made for that. But right now, I think what's interesting is that the market has rushed to seize upon the decline in commodity prices and this idea that inflation has peaked to start worrying about is aggregated growth going to be OK, not so much can companies protect their margins because of costs going up.
Ptak: We've been talking quite a bit about the corporate earnings picture outlook, some of the components thereof like margins. I think for some of our listeners, the question they will have is how much attention should I pay to things like these? If someone who pays very, very close attention, is really, really astute on this topic, how would you advise them? Do you think it's better for them to just tune it out? Or do you think it's helpful for them to pay attention to it in an appropriate context?
Santoli: I think it is helpful to pay attention to it as a periodic check-in on whatever thesis they may have had for owning a particular company for whatever glimpses it might offer at the macro environment. What I think would be a mistake is to try and tactically trade off of it in any determined way. I sit here when it's 4:02 p.m. on a given day in earnings season. We'll see the stocks react in an automated way before the headlines are out from the earnings press release. Because there is literally an algorithmic news product that gets fed out into some of the higher-frequency trading players, and they will have it pre-coded to react in a certain way based on keywords and metrics.
So, I did time—I worked for 3.5 years early in my career at Dow Jones Newswires, and this is just a quick anecdote, which I actually quite enjoy. I covered the Wall Street, meaning like the securities industry and markets, and there was an editor there who used to like to, I would say, motivate and also somewhat intimidate new reporters by saying—and this is in the early 90s—"We've determined that a Dow Jones Newswires customer, if they get a market moving headline from us as little as 20 seconds in advance of a competing news service client, they might be able to execute a trade based on that information." So, they were basically saying as little as 20 seconds is the window of advantage here, where they might be able to get a trade-off. And that same editor eventually developed the algorithmic news product, which was operating in the tens of milliseconds in terms of trying to beat the competition by precoding that bit of information out into their clients. My point being you can't really beat those systems if you're an individual trying to react to it.
It is somewhat jarring, I think, this past earnings season, especially, or maybe these past couple of earnings seasons when you see a stock as large as a Netflix or a Meta, have these absolutely massive moves on their results because it was a complete narrative break from the preconceived idea of what was driving their businesses and whether their growth path was going to be. But it's really tough to try and get ahead of that. It almost just happens as a step-function move. And to me, the advantage the individual has always had is time horizon arbitrage. Take advantage of the fact that you don't actually get marked to market every day in some relevant way, and use the market moves more as an opportunity to counterpunch than to try and get there first or participate in that initial reactive move.
Benz: Wanted to switch over to discuss the broader economy, which you've already alluded to in your previous responses. But the market is at a hinge point, where inflation fears seem to be giving way to concerns about a recession. So, a two-part question: Has inflation peaked and where do you think it will settle? And also, with respect to the economy, will we have a recession, and if so, how deep do you think it will be?
Santoli: I wouldn't argue with the way the markets are pricing the inflation path at this point, which is to say that, yes, year-over-year inflation levels have almost certainly peaked. We can just see that in gasoline prices. That's really the main input in terms of headline inflation in terms of the way you would run the models. I think the big question for me and for everybody is where is it heading to and how quickly and where will this settle out?
I've seen some relatively persuasive work that says that in the next few months core inflation maybe gets down to the 3s, 3% year-over-year-type levels. That would be a tremendous win. I also like to remind folks that right before we got into this inflationary upward spiral, the Fed was busy revamping its entire methodology with regard to inflation to allow it to remain higher than previously targeted for longer because they were too worried about their inability to accommodate enough inflation. So, clearly, that was the absolute extent of the pendulum swinging toward disinflation. But that being said that framework remains in place. So, I'm not of the opinion that the Fed says it's 2% or bust. It's like if we're getting close enough there, if the economic risks are higher, if we're at neutral with our rates, we're probably OK. So, I think the next few months will see a sharp deceleration in inflation. I do not know if it gets down to a comfortable level or not on time.
In terms of the recession question, I think almost like what's the difference if we're technically in a recession or not. What I mean by that is, the bond market is acting as if it's a high likelihood with the way the yield curve is set up. Consumer sentiment survey work is there just about. ISM manufacturing-type survey, those types of diffusion index indicators are pointing in that direction. So, to me, it could be a distinction without a difference as to whether in real terms we are in a bit of a recessionary phase or if we are about to go into one. Again, I go back to the nominal growth story. The difference between 2011 and now is that back then, when the real economy was at stall speed, in nominal terms, you were also at zero. And now, I think that there is a little more of a nuance about nominal growth being a little bit better, and theoretically, that could make it feel different.
I also don't have a prediction on this. I certainly don't have my own economic models. I don't pretend to have that kind of strategy framework. But I do like to track the big overarching preoccupations or narrative tendencies in the market. And I got into this thing in the early ‘90s when the term “jobless recovery” was coined. And why did it get coined? Because economists who were trained on this kind of relatively short cycle boom/bust were confused that the economy was growing in every observable way, and yet employment was not responding in a way that they were used to in terms of adding net jobs. It was a different type of recovery. And obviously, there were productivity initiatives going on, it was demographic, and all the rest. But I wonder right now if we could have something of the obverse of that, which might be, yes, the economy has to reset lower because we did come out of the pandemic in this aggressive way. We are dealing with a big fiscal drag this year. Let's remember the Fed is being very aggressive. Financial condition is tightening a lot. The economy is going to respond to all those things and very well in real terms might decline. But because of demographics, because of the fact that we're coming out of labor scarcity, it would seem to me that you could have a softer landing for employment than we have become used to in prior recessions over the last 20, 30 years, just because that's not really where the excesses were built up in a systemic way.
I look at things like consumer balance sheets, the household debt/service ratio. That's very, very low and manageable. It would seem like there's been a little bit of padding that's been put in place right there. I have a feeling that when we do a lot of the retrospective research work on the impact of the pandemic-related fiscal measures, and I've seen some of this already done. But for the average person getting the checks in the mail was an opportunity to essentially do revolving debt paydown and to build themselves a little bit of breathing room on that. You've seen what happened in consumer credit, really just crashed during the pandemic. It's being rebuilt now, but not even back up to trend. So, to me, all those things mean you have to have these asterisks in place that say, yes, recession, but it might really not follow along. And I don't know if we're going to get another shoe-dropping. I don't know if it could be like the early 2000s, where it was economically speaking, a relatively mild recession in terms of employment and whatnot, but on the corporate level and on the market level, it was devastating because you actually had had overvaluation and a lot of things going on in corporate overinvestment that just had to have some payback along with it.
Ptak: Wanted to go back to inflation and something that we've observed at Morningstar, people tending to fight the last war, which means they're scrambling for inflation hedges. Do you think they're better off just spreading out, diversifying in stocks, which over the long haul have tended to do a good job of combating inflation? Or do you think perhaps this time is different and maybe some additional steps are needed where they actually go and allocate a little bit more to something that's a supposed inflation hedge?
Santoli: I tend to think that simply taking advantage of the fact that equities have tended to reap some benefits from inflationary periods that they obviously are nominal assets and things like dividend growth can help you out if inflation is going to be with us for a while. I'm much more in that camp than I am to say, we have to tear up the textbook and find these new targeted vehicles to specifically capture inflation. I don't know what those would really look like. Obviously, we have inflation-protected securities. Obviously, the world chased the series I savings bond to the extent possible. But, to me, it's much more about like just let the asset classes do what they're supposed to do in this environment.
What I find interesting is, if I look at things as far as we can tell in terms of retail investor or private client-type asset allocations, equity allocations still remain relatively elevated by historical standards, but fixed income is way below average. I look at things like Bank of America's private client survey on this, the American Association of Individual Investors, and my observation is that, for the typical investor, they hate bonds more than they fear stocks at these levels. I don't know what the sentiment takeaway from that is, if therefore people have to maybe reduce equities more before there's some kind of enduring bottom, or if that just tells you that a lot of the repositioning has been done that basically for so long people expected yields to go higher, that we've kind of already gotten to that place. And maybe it means cash is now giving you something in nominal terms and maybe that's enough to have people say, why do I want to bother with longer-term fixed income at this point. Meanwhile, of course it's been rallying for a few weeks right now in the face of what most people expected.
Benz: Speaking of inflation, what inning are we in, would you say, with respect to these supply chain disruptions? It seems like the automotive industry is still being impacted. But are there other industries where you've noted big improvements?
Santoli: Well, it would seem that smaller-ticket goods have definitely flushed, meaning you've had the inventory. I've heard there's warehouses full of bicycles now; we couldn't get bicycles in 2020. So, I do think that in general we're on the path of improvement. I know that the semiconductor issue is very tricky, because now, all of a sudden, it's involving not just genuine, supply chain or shipping glitches; there's a geopolitical element and there's the China lockdown element to it. So, that to me is mostly about automotive. But the handset side, all that stuff seems like they've managed through it at this point. So, is it still a source of sticky inflation? Perhaps, but I really think that at this point, it's mostly yesterday's issue, at least in terms of the way I view things typically, which is, its capacity to destabilize the markets, or to confound current expectations. I really do agree with what you guys said earlier, which is, we've fully shifted over to being concerned about growth in aggregate demand rather than the ability to produce enough and deliver enough product out there.
Ptak: Wanted to shift and talk about risk and rising rates and the interrelationship between the two. One thing that clearly appears to have changed the market's tolerance for red ink. For a while, investors were willing to look the other way toward some of these very speculative types of enterprises, but not anymore, judging from the way some of the least-profitable, most speculative stocks fared last year and earlier this year. What changed in your opinion? Was it as simple as real yields pushing off the lows and investors having to recalibrate? Or was there more going on?
Santoli: I think that was certainly an issue that was an element of it. I've generally been a skeptic of the idea that the market in its aggregate infinite wisdom was doing a real-time discounted cash flow analysis at every moment, and that's why they bought GameStop and that's why they paid up for every hot new software IPO that was coming out. Obviously, there is a crowd psychology element of it. There was without a doubt an exacerbating factor was the real economy was on its back and impaired by what was happening in 2020. And so, you had a lot of capital chasing the scarcity of growth and that fed on itself and snowballed. And then, once we got to a point of, I would say, series of reopenings really, because if you go back, the market had a bunch of these impulses to price in an aggressive reopening beginning actually in June of 2020, there probably were four or five of them. Over that period of time, what we saw is, well, we're going to have massive fiscal response. The Fed is still all out trying to accommodate, and the real economy was responding, and therefore, growth wasn't scarce. You wanted to capture the cycle. And that's why old economy and a lot of the real economy plays started to work. And I think that's a typical dynamic when it comes to growth versus value. This is just almost an extreme case of that where you had the very, very with end of unprofitable growth that just became completely overdone. At the same time, nobody wanted real value stocks that were playing auto parts companies or something like that.
And so, I think you've recoiled back from that. I think, in general, just that creates a risk-appetite reset. That means we're not just going to say assume that liquidity is going to take all of our concept stocks up. I do like this one analyst Jeff deGraaf at Renaissance Macro, who coined the term “concept finance,” which can include everything from SPACs to some IPOs. And one of my favorite things to do during that 2020 period was to look at the brokerage analysts who are covering the new companies that were coming out and look at what the peer groups that they assumed they should be in. And so, you'd see a thing like the Robinhood IPO or the Coinbase IPO, and they were using comparable companies that would be like PayPal and Shopify. In other words, the best of the new class of growth stocks, whatever their valuations were, we were going to retrofit them onto a financial-services company that was mostly about the capital markets’ ebb and flow.
So, I think, that whole psychological dynamic got unwound. And when times are tough and you have to go back to free cash flow, the ability to service debt, the ability to pay dividends, to me, it is almost just the way that the cosmic pendulum swings. And then, this week, we have Uber touting its free cash flow generation. Even if on an accounting basis, it's questionable, it's clear that they believe that investors want to hear about that as opposed to want to hear about the total addressable market and the open-ended growth that they're pursuing.
Benz: It's been a while since investors have had to grapple with the reality of rising interest rates. How much of the market's rise do you attribute to the fact that rates have recently fallen? And to what extent is the market vulnerable to further losses if rates resume their rise?
Santoli: It's interesting. I do think that right now rates in the sense of market yields, to the extent that they're a proxy for how aggressive the Fed will continue to have to be, yields coming down are supportive of equity valuations, and that's been a whole part of the last several weeks--you've had this loosening of financial conditions. It only works if credit spreads remain tame, and they have. They've improved from their worst levels recently. Otherwise, if you're having yields come down in government bonds and, of course, credit spreads blowing out, that has the opposite effect on equity valuations. So, I think it's somewhat encouraging that you've had this return to bonds providing some diversification value at the same time that stocks are saying, OK, the cost of capital, no matter how you look at it, or the cost of financing what the economy needs has been reduced. If you see how mortgage rates have come off the boil and obviously, corporate rates, it's been modestly beneficial. I think, really, because the yield curve itself is a source of pressure, or at least a source of worry for a lot of investors, that can go only so far. So, if the 10-year Treasury yield goes down at 2%, it's because people are becoming more confident that it's a recession and the Fed is going to have to start cutting aggressively--it's not clear to me that that's going to help out on the equity side of things.
I do think there's a pretty good debate to be had right now as to whether things like corporate credit have built in enough of a margin of safety and they start to look OK again. Once again, I go back to the decent nominal growth and the ability to service debt and keep default rates in check--that could be a decent bullish case for some segments of corporate credit that have definitely been cheapened a bit.
Ptak: A lot has been written about the greater interconnections between private equity and public equity. Some had made the argument that heady private market valuations were a justification for lofty public market multiples, and there's a little bit of back and forth with that. But my question is, with tougher borrowing and lending conditions, albeit a little bit easier in recent weeks, do you see signs of slippage in private markets that could be a worrisome portent for public equities or at least certain segments of the public stock market?
Santoli: I was actually just looking at some of the publicly traded business development companies, the midmarket lenders, things like that, and you've started to see signs of some stress there. What's interesting is that on the venture side of things, it seems like some of that medicine has been taken, but not quite all of it. So, I don't know about the private equity buyout business right now. Clearly, there's going to be casualties, but it wasn't as if that was really a high momentum part of the market that you had a lot of deals done at the very top and that were very aggressively financed. So, I think, obviously, it's definitely a little bit of a hangover that's going to be there. SPACs, to me, almost took the place of LBOs as the locus of the crazy. And those things are just languishing out there. There's a few hundred of them that still need to make a deal. They're probably just going to hand their money back. I don't know if that gets us to anything systemic.
One part of it that I've been trying to figure out is, on the private market venture capital side, if we are seeing a rerun of some of the things that did happen after the 2000 tech bust, which was, you had a lot of companies that were just using venture money to buy digital ads or to buy networking equipment or to buy servers and such and today, it would be cloud subscriptions. And once the VCs say the party's over, it's time to take our money back or we're not going to fund you in the next round, then it really does sap demand from the bigger established players. And you've probably seen some of that, but that could be a shoe to drop, I suppose. I don't know how to quantify that myself, but that's something I do think has been weighing on the big established cloud software companies, big digital advertising platforms. That could be one aspect of it.
Another part that's pretty opaque is private credit, which I can't count the number of people, chief investment officer types, who in recent years have said that for their high-net-worth investors they really love private credit, as if it was this free lunch to play that role of lender there who's got better yields. And I don't know what the whiplash is in that area, but I suppose that's another one that I would monitor. I just prefer to watch the public indicators of credit stress to see if I should be worried about those things. When it comes to equity market valuations, I think private equity will continue to mark things where they prefer to mark them to the extent possible, but the public market has already taken the medicine, I think.
Benz: Wanted to ask you about housing. Rising interest rates and supply chain issues have thrown the brakes on the housing market. So, how concerning is this to you and do you see any parallels to the global financial crisis where housing really led everything down?
Santoli: I'm in the camp that doesn't really see the direct parallels, mostly because of the banking system was not permitted to have as much fun with housing finance on the way up this time, and housing scarcity was a little more of a factor this time than aggressive spec-building and flipping and things like that. So, I think that's a consensus idea to be frank. I don't think that I have an edge in all that. But in terms of the housing cycle being in some respects the economic cycle just because of its contribution to marginal GDP, I do think there's definitely reason for concern. Builders not able to complete homes or being very slow to and giving buyers a chance to moderate things. I think that's still something we have to work our way through. It's something where the homebuilder stocks have had, what, 30% gut check, as a group, maybe a little bit less than that from peak to trough. That's not bad. What's interesting is they all statistically start to look cheap, and that's when you have to start to worry when the real cyclical stuff looks like it's got very low P/Es because there are peak earnings. And I don't know if I'm willing to say, well, but it's different now, because the millennial generation, demographically speaking, is going to have more enduring demand and we have to build so many more houses. So, I'm concerned, but I'm not concerned so much that it's going to be the kind of systemic trigger point that it was the last time. To me, it's much more about what does it mean for the pace of GDP than it is an existential issue for the capital markets.
Ptak: We've gotten this far in the conversation, and somehow I've managed not to ask you what you think of the U.S. stock market, whether it looks undervalued or not. So, there we go. Do you think the U.S. stock market looks undervalued at this point? I think you had alluded to multiples, and I suppose one could make of that what they may. But looking through your lens, do you think that there's attractive value in U.S. stocks at the moment?
Santoli: I would say, broadly speaking, it looks more fair than undervalued. There's some subtlety, I guess, to how you might want to analyze that. Again, the outsize effect of those big expensive, big Nasdaq names, the trillion-dollar club and all that, does also skew the aggregate valuation of the market. So, you have a 17.5 times forward multiple on the S&P. The equal-weighted S&P is more like 14 times. So, I do think that you are in one of these phases where there's more opportunity below the index surface most likely than there is elsewhere. So, median valuation looks like it's built in a little more margin of safety. It doesn't seem as if you can make that case by many other metrics, let's say, dividend yield and all the rest of it. So, I think it's priced for reasonable returns longer term right now, but not some kind of a fat pitch that suggests that we're going high.
What I do find interesting is, if I'm looking at the last few serious market corrections, borderline bear markets, whatever you want to call it, let's say, in late 2018, early 2016, you did get the S&P to go to below historical valuations based on then-prevailing consensus estimates of, let's say, 13, 14 times earnings, but it's stayed at those levels for like five minutes each time. It's just dipped down there and then it quickly sprang higher. I don't know that's going to happen again or it has to be in that sequence. To me, everything that you look at in terms of how much valuations have come down, which is basically by a magnitude that typically has happened in a cyclical bear market already. So, in other words, you didn't necessarily have to come down further off the highs. Or you look at just the performance itself, the first half of this year being the worst since 1970, just exactly how oversold things appeared at the mid-June lows. All those things, if you do the historical pattern work, tell you that forward returns have a high probability of being pretty good over the next 12 months-plus unless we're playing by the rules of the 2000 to 2002 and 2007 to 2009 bear markets, which did see these successive waves of de-risking and macro stress. I know that doesn't really help to say you're in good shape unless it's one of the bad bear markets, but that's what most of the work, including the valuation work, suggests.
Benz: Wanted to ask about an individual stock, if I might, to the extent that you feel comfortable weighing in. I wanted to ask about Meta, which remains in a funk. The stock has fallen more than 30% since Feb. 3, and that was the day the stock dropped more than 26%. So, what has the market so bearish? And do you think those concerns are well founded?
Santoli: Clearly, the main thing that has the market as bearish as it is, is simply the stalling out of user growth and the idea that in aggregate the platform has probably seen it's best growth days. TikTok is without a doubt the thing that is sapping a lot of the energy out of all social media. And Facebook has gone from being the upstart, to the predictable grower, and now is the incumbent that has more to lose than to gain. All that being said, it's happening at the same time. I think the market would really respond well if it got clear signals that the company was not in an urgent, desperate way, throwing billions of dollars on a speculative next act of whatever the Metaverse initiatives are going to be.
So, the stock has started to look quite inexpensive relative to current profitability. They clearly are getting a little bit of cost discipline when it comes to things like head count and all the rest, but there's not necessarily a lot of reassurance that they themselves are confident of how their business is going to evolve, and they seem to be closed out of making transformative acquisitions or even helpful ones that could enhance the profitability of the platform right now. So, it's a really interesting debate for a post-growth company with an amazing balance sheet and ability to buy back a ton of stock. That's the other thing. Wonder if they need to do a Microsoft in the early 2000s type of thing and effectively concede that they are now going to be more about capital return and steady growth as opposed to aggressive growth. So, all those things mixed together I think place it where it is right now.
It's definitely more in the hands of value investors than it ever was before. It doesn't mean that that's going to be well timed, but it is interesting that the life cycle of Meta seems to now be taking it to that place where they have to convince the Street that they have a clearer view of what the future is as opposed to just being a general “me too” participant in what's going on with TikTok and other more exciting platforms at this point.
Ptak: For our last question, I wanted to widen out a bit and ask you about the U.S. 60% stock/40% bond allocation, which I believe has had its worst seven months start to a calendar year ever. If not that, it's pretty close to it. It's been a bad seven months for the U.S. 60/40. In view of that, do you think that allocation needs to be reconsidered, and if so, how would you alter it?
Santoli: I am, by general orientation, skeptical of saying, we really need to change some time-tested thing. I'm also very aware that the purported death of the 60/40 framework has been heralded for many years, and it hasn't necessarily happened. I did recently look at the previous worst-ever periods of performance for the 60/40 portfolio. And once you had the terrible stretch, it was not really advantageous to give up on it. So, all that being said, just as a more general matter of let's not be too hasty in ditching something that seems to have some merit, I'm open to the idea of having the 40% be a little more in the mode of cash. I'm very ambivalent about commodities as an asset class. As a return generator, there's this case to be made that as a counterbalancing element, diversifier in certain times of stress in other public markets, maybe there's some help there. But I generally feel as if it's the setup that might get an investor into the least trouble.
My whole thing is just, if I had an investing philosophy, it's stay involved but keep expectations low, or stay involved and keep expectations rational. And by that, it usually means, maybe you have to actually be smarter or more disciplined about rebalancing, or you have to maybe make higher contributions than you thought you were going to have to because return expectations aren't great. I'm not really in the weeds enough or haven't run a lot of the scenario analysis enough to say with a high confidence that I have a better idea than 60/40 right now.
Ptak: Well, Michael, this has been a really enlightening discussion. Thanks so much for sharing your time and insights with us. We appreciate it.
Santoli: My pleasure. Thanks for having me.
Benz: Thanks so much, Michael.
Ptak: Thanks for joining us on The Long View. If you could, please take a minute to subscribe to and rate the podcast on Apple, Spotify, or wherever you get your podcasts.
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Benz: And @Christine_Benz.
Ptak: George Castady is our engineer for the podcast and Kari Greczek produces the show notes each week.
Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email us at TheLongView@Morningstar.com. Until next time, thanks for joining us.
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