Given the popularity of our weekly Market in Pictures, we started the habit of picking out a few and going into more detail with our PMs. In this edition, John Luke and Dave spend a few minutes on each of the following:
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- August Rally
- Steepening Yield Curve
- Learnings from Earnings
- When Does the Capex Cycle End?
- Does the Government Have Intel Investors Don’t?
- Interest Incoming
- The Pause That Refreshes?
Hope you enjoy, and please send a note to info@apt.us if there’s a particular chart/topic you’d like to see covered next month. Time to swing it around!
3 Minute Read: Executive Summary
Full Transcript
Derek
Welcome. Last day of August, kind of last day of summer I guess. Got John Luke Tyner, head of fixed income, Dave Wagner, head of equities. We’re going to do our usual monthly wrap and it’s been a pretty wild month for the market. Not a ton of movement up and down, but pretty steady up. So, thanks for coming on guys.
John Luke
Thanks, D Hern.
Derek
I’ll do my compliance little disclosure-
David
You did get our titles right there though, DH. Back to back month you’re getting our titles correct.
Derek
Yeah, sometimes I slip. All right. The opinions expressed during this call are those of the Aptus Capital Advisors investment committee and are subject to change without notice. This material is not financial advice or an offer to sell any product. Forward-looking statements are not guaranteed. Aptus reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. More information about Aptus’s investment advisory services can be found in its form ADV part two, which is available upon request. You don’t have green and red on here, but I think this is a lot of green. So, Dave, I know this is your work.
David
That’s actually a great point, D Hern, like if you look at this table, are there any negative numbers? I see two and I bet we could each guess which asset class those negative numbers are and it’s the five-year annualized returns for the Bloomberg Agg and investment grade bonds. It just shows you quite the remarkable run that we’ve not just seen since the recent market bottom of April 8th, not since the COVID bottom, but going back even further. And that should just show more conviction in the story that we have here at Aptus. How this market has changed and evolved with the new-found mechanisms of monetary and fiscal policy, helping continue to drive this markets to returns greater than what we’ve been accustomed to for a very long period of time. And not only that, if you go to short-term performance of just August, I think we’ve been positive.
John Luke, tell me if I’m wrong here. I think we’ve been positive on the S&P 500 four weeks in a row. We’re positive every single week in the month of August and the S&P 500 returned down those 3%. But the S&P 500, it was not the story during the month in my opinion. The story of the month in my opinion was the third number from the bottom. The Small was the greatest. Small Caps were up almost 7.67%. And John Luke, I’m going to ask you a question. Since the April 8th bottom, what’s outperforming, Small Caps or Large Caps?
John Luke
I’m going to go with Large Caps.
David
Most would say Large Caps, but this month it’s switched. You actually have since the April 8th bottom, Small Caps up 35 and a half percent with the S&P 500 up 30 and half percent. So, Small Caps are outperforming Large Caps by 5% into the market bottom, which is something you and all investors would expect specifically when there’s a heavy risk on “also lower quality rally”. You would expect Small Caps probably to outperform by more. I mean really since this April 8th bottom, I’m going to contradict myself here for a second, but I’m going to bring it full circle really since April 8th, it’s just been a very historically narrow market on the equity side of things. I mean almost nearly every way imaginable, even through whether it’s earnings or not. All of that was broad. Earnings has been very, very broad over the past three or four quarters.
Yet market performance has been very, very narrow. And I think if you look at it, it’s almost like rates are ruling every scene around this equity market right now. When rates are going higher or stay stubbornly high, it feels like there’s a lot of narrowness in this market. But when rates have come down, there’s been more broadening out of this market. And really ever since the non-farm payrolls data of July when the market started to price in maybe more rate cuts and more certainty of a rate cut in September, you had that Small Cap. The Small Cap asset class party really start to outperform. And that’s what we were just talking about.
I, for a long time during this when the market was narrow, I had a pretty big thought like are the winners going to catch down or are the losers or are they going to catch up? And luckily we’ve kind of got a lot more out of the losers catching up over the past month than the narrowness of winners catching down. So, I’ve actually started getting more questions like how far can this broadening go right here? Or how much pain could there be for the dominant tech gross AI trade? Could there be left now that we’ve seen this broadening out? And I think it all comes down to earnings and we probably won’t get that message for quite some time because we just had an amazing earning season with great profitability. So, really shouldn’t be that much of a surprise that this market went four for four on a weekly basis in returns for the month of August.
The last thing I would probably say here is that since this recent market bottom on April 8th, you are still getting some outperformance on the EM side of things and I think you actually had some pretty good quarter date performance on EM themselves, not to the tune of what we’ve seen in the S&P 500, but it’s still keeping pace with the domestic markets here, even when the dollar started to chop around of some appreciation and some depreciation over the past month. So, it’s just something that we’re continuing to keep an eye on just given year to date, you have the MSCI defrauds, the proxy for developed market stock performance is up about 12 or 13% versus the S&P 500. This is just a story that we’re going to keep our ear to the ground and keep watching to really see if there’s a change in a guard or if we really want to continue to fade this pair trade right now and still promote Small Caps and promote specifically Large Cap beta over international.
John Luke
Yeah, I think you laid that out well. And this chart really illustrates why we’re seeing some of that outperformance from lower in the cap spectrum, whether it’s equal weight S&P or Small Caps. So, really what this is showing is the spread between the two-year treasury and the 10-year treasury. And really the trend has been up, we’ve seen some normal slope to the yield curve where it’s positively sloping, it’s upward sloping, which is what you want to see into the backdrop of recovering economy. And so really what we would call this is a bull steepener. And so in childish terms that just means the two-year yield is coming down faster than what the long-term bond is doing.
And so basically all of the steepening has occurred because as the market continues to forward look these rate cuts that are coming, the two-year treasury has moved down to price that in. And what we’ve seen is the longer term bond has basically been in this range between call it four and four and a half percent, the 10-year bond for the better half of the last 18 months. And so I think what markets were expecting here, or at least really looking at was how does the 10-year treasury bond and the yield react to a little bit of a pivot, maybe 3.0 from Powell at the last Jackson Hole where he committed to, I’ll say committed loosely, committed to continuing the rate cutting cycle because of some of the slowing down in the labor markets.
And the benefit or the good thing that I see is many were worried about the long end really ripping higher. You’ve got the fiscal backdrop like Dave mentioned, you’ve got some maneuvering that the Trump administration is doing regarding different FOMC governors and how that’s going to impact things long term with Fed independence. But really when you see the long end of the curve stay neutral or even fall a bit in the face of rate cuts, I think that’s the market essentially telling the Fed that rate cuts are the play from here, at least starting back the rate cutting cycle.
David
I think there’s a great chart too, John, if you go back to last year the curve was flat, the two-tenth spread was zero and now they’re starting to increase obviously back to the performance conversation that should … The asset classes should benefit the most of is probably banks. And we know that banks have such an overweight Small Caps too. So, that’s just another great [inaudible 00:09:21] to understand why Small Caps are outperforming Large Caps and doing really well because they can get money on the lower end of the curve and then give out loans longer out in duration. And that’s what they create their spread, it’s called a net interest margin spread. They’re NIMS. So, shouldn’t be surprised that Small Caps did pretty well this month.
John Luke
And their debt loads are typically shorter. And so as rates move lower, hopefully it gives them a little bit of a release now from financing pressures and we’ll hit a little bit more on that towards the end.
David
Talking about banks and loans and financing pressures. John Luke, I actually thought that it would take longer in this call to bring up Cooke, but I think we got there in the first five minutes.
John Luke
Yeah, kind of the du jour of the month,
David
Not my du jour.
Derek
You’re done with earnings season pretty much.
David
We’re done.
Derek
NVIDIA … That was it.
David
The cement has been set. We are done. You’re right, NVIDIA. NVIDIA is now accounted for during this last week of August and their earnings came in right in line and the stock was basically flat on the day. I wasn’t too worried heading into that earnings report to be quite frank because you get almost all of their guidance and their revenue earlier on in earnings season when you get Microsoft reporting, Google, Meta, Oracle, Amazon, you kind of know what their revenue and their guidance is going to be given the CapEx conversation. But I think one of the things that I want to take away from earnings season outside the fact that it was unbelievably strong, one of the best in four quarters, I think we have like two or three quarters in a row, double-digit earnings per share growth for the S&P 500 a year-over-year basis, a sales growth number of 6%.
We continue talking about operating leverage and operating leverage works for you when you had increasing in sales and sales came in over 6%. Holy moly, that was great. But the point that I want to talk about with earnings season is profitability of the S&P 500 because many people don’t know, or maybe they’ve heard me say that the two largest contributing factors that [inaudible 00:11:42] future returns of the S&P 500 is 30 day change in EPS expectations and also the profitability from an operating margin perspective of the S&P 500. Those are the two things that drive this market higher or lower. When margins are stable or growing, it’s tough for the market to get into trouble, but when margins pull back, that’s where the market sees some type of shakiness and given the fodder and jargon all around tariffs, obviously this is the first quarter where we got full market commentary from management teams of tangible earnings results, but also the guidance as we’ve seen the cadence of tariffs transform really since April 2nd Liberation day.
Everyone was expecting from margins to get obliterated but they weren’t. And that’s even in the face where taking a step back, if you talk to any economist out there and everyone knows my thoughts on economists, they’re just, they’re God’s gift to the investment world. Just kidding. But they prognosticate that 70% of the tariffs will be borne by consumers and about 23% will be borne by US corporations with foreign export orders being the residual. Well, so far US corporations have taken the largest chunk, the biggest bite out of the tariff costs here in the United States.
So, one would think that that would pressure margins, but what we’ve seen on the chart on the left-hand side from Strategas talks about the estimated next twelve-month operating margin for the S&P 500, operating margin didn’t flinch. And so what’s probably going on here is that those affected, those corporations affected with tariffs, they’re still working through some inventory that they rolled forward before the tariffs. But I think more importantly, I think the Magnificent Seven and their newfound characteristic of operating leverage has expanded margins at the index level so much where it insulated the degradation from margin hurt from tariffs. So, it’s kind of a really nice yin and yang here.
And last point I’d make here is myself, John Luke, and the rest of the IC team, when tariffs were announced, we talked about how right now may be the best time to implement tariffs or try this new tariff exploration out because of the consumer strong. We’re getting growth from AI right now. Corporations are strong, margins are [inaudible 00:14:09], it might be the best time to try this experiment. And so what we’ve found out so far with higher than expected tariff revenue coming in, it’s not hurting margins, it’s helping out the deficit rate now and profitability pretty good. So, that was a fun earnings season. A lot of dispersion underneath the hood. Please reach out if you have any questions on individual stocks in there, their respective earnings results, but a lot of dispersion, but it’s a lot of fun.
John Luke
You got a twofer here, Dave.
David
You want to start here, John Luke, so I don’t keep going or would you like me to go?
John Luke
Yeah, I mean I’ll tee you up, but what we’ve seen is the AI CapEx war has been really the theme over the last three to four quarters where the amount of spend when it comes to basically NVIDIA or Broadcom related chip production has dominated the data center build out where these companies are making huge investments for the future and for AI, which I think is great things long-term, but really what you’ve seen is the huge beneficiary has been NVIDIA. But I think when you look down the cap spectrum at some other stocks, the old saying that we go with this one man’s CapEx is another man’s revenue. And you’re seeing that spread out across a number of companies, not just NVIDIA.
David
Yeah, there’s been obviously from a performance perspective up until this last month, performance has been very narrow amongst the Magnificent Seven driving this market. Like NVIDIA is 4% of the S&P 500s debt income. But one of the best factors one can look at when looking at a stock or the market is going to be free cash flow. And the question that this market’s trying to debate time and time again outside of the health of the consumer, everyone said that the health of the consumer’s been terrible since 2022. Wrong, but the new-found trying mechanism that everyone wants to become a bear on is like they’re spending too much CapEx. There was $364 billion in CapEx spend from the Magnificent Five, so, the four hyperscalers plus Oracle. That’s a package larger than the most fiscal policy packages that we saw pre-COVID. That’s just not sustainable because we need to see the optimization turn from CapEx into profitability.
And that’s a lot of the bears. If you’re bear in this market, you blame valuation or you blame too much, this CapEx cycle cannot continue. And I think that this chart does start to show because we’re doing it X NVIDIA for reasons. I want to show that there’s a lot of CapEx being pushed out there into this market right now. How long can this CapEx cycle continue into where the market’s going to start to punish these companies because they haven’t seen that return on invested capital yet, that profitability. And I think that you could probably lean more bearish I think with this chart, but I don’t. I think it’s a lot of numbers especially to come across our sixth quarter of free cash flow growth coming down.
So, you do look at this on a year-over-year basis. So, there’s some [inaudible 00:17:20] timing effects here where you’re starting to see it go negative, but I just think that this might just show you that the CapEx cycle could continue, but the level of CapEx growth that we’ve seen amongst these hyperscalers is probably going to start to slow down a little bit. That’s not a reason to be bears, not a reason to be optimistic. It’s just probably mathematically going to start to slow down due to the law of large numbers. And hopefully we see the breadth of earnings continue into the S&P 493 or Small Cap or maybe you can help insulate some of this slowing growth from the CapEx spend amongst those five hyperscalers, Meta, Amazon, Google, Microsoft’s and Oracle. I think it’s something we need to be cognizant about, not worried about.
John Luke
Yeah, I think there’s a right hand and left hand to everything and basically what you’ve seen here is with fiscal spend-
David
You just made yourself an economist, John Luke.
John Luke
I know. With the fiscal spend from the government decreasing that basically this has helped fill some of that void and as things shift back and maybe companies don’t spend quite as much, you get the other impact from the consumer filling the void.
Derek
Yeah. So, obviously a lot of the market has been talking about the Mag Seven and some of these and the hyperscalers and the dominance there. Kind of at the other end of the tech spectrum from a technology standpoint and from a growth standpoint for sure, it has not exactly been a juggernaut the past couple of decades. So, I know you put this in there for a reason and probably have some discussion on it, but I’m curious your thoughts there because I know everybody is [inaudible 00:19:12]-
David
I think John Luke and I can probably take it from two different sides. John Luke, you start talk about it from the government side and I’ll talk about it from the fundamental side.
John Luke
So, this is the new stance where the US government is taking a financial interest in a company that’s not the cause of some financial catastrophe event like a Fanny and Freddy where basically they had to be recapitalized or they were going to be another layman brothers. And so the stance here is a bit different, but I think that there’s some warranted sides to the equation. The government’s giving hella subsidies to many companies with the CHIPS Act and on the conductor side and with that subsidy they want a return or a reward and obviously there’s the component of jobs created and buying things from America and the CapEx to build the factories and the facilities and the fabs. But this is a new position that we’re taking from here and I really don’t know how it plays out. I can get kind of both sides of it, but the government taking a stance in a publicly traded company is a bit different. So, I’ll tee it up there for you Dave, because I don’t have any answers.
David
All right, let me ask you a question, and I know it’s not always black and white. Do you agree with this or disagree with this move? Yes or no or C, don’t want to respond?
John Luke
Yeah, I mean it’s kind of like C because I want to see how it plays out. I get both sides of it. As a capitalist, you don’t want the government involved in things, but also the government is involved in everything in a sense. And with all the subsidies and the taxpayer dollars that are being thrown towards this sector, I get the rationale for wanting a return on that.
David
Do we want a sovereign fund?
Derek
You labeled him-
David
It’s a hard seat.
Derek
… as an economist with a left hand and a right hand and he delivered.
David
Twice. I don’t know my thoughts if we need a sovereign wealth fund or not here in this country. Luckily, I guess this is kind of the scapegoat answer to it, luckily it’s not becoming a fully state-owned entity. Maybe it’s funny-
John Luke
That’s the big question is does it work? If it works, then it probably makes this move look brilliant. If Intel continues to be what they’ve been the last decade plus, like Derek said, then I think this is a flop.
David
I don’t see us ever owning Intel. I would say that I want to start with this point, but Intel’s just a terrible company. It’s horrible. The CEO obviously came over from, what was it the company called Cadence, I think. He’s come out with this new plan to try to reinvigorate this company. But even back in 2021 on CNBC, I go, I love the paratrade of long AMD and short Intel. AMD’s keeping up with innovation not as much as Intel or not as much as NVIDIA, but Intel hasn’t come out with a new chip in 10 plus years that can even come close to competing with AMD let alone competing with NVIDIA.
And in technology there’s so much economy to scale. Once you fall behind, it’s pretty tough to get back into parity. So, I think this is a sign saying that Intel and the government recognizing this, that Intel is in a worse position than what any investor could have imagined previously, because they’ve fallen so far behind on the innovation side of things. And I think that this 10, what was it John Luke? The 10%, I forget how much money here, whatever it is, $10 billion or $11 billion. Is that what it came out to be, John Luke?
John Luke
Yeah.
David
I think you’re kind of just lighting that money on fire if you’re the government. To your point, John Luke, we will see how this works out, but a lot of it has to do with the success of Intel as a company. And it doesn’t seem like they’re going to mandate certain people utilizing their chips because to protect Intel, because those companies using those, probably they’re going to be simply AL superior. I would end here, John Luke, I thought the funny part was me and you spoke about this briefly, I think it was on Tuesday or Wednesday. There’s a guy by the name of David Zervos, he’s been with Jefferies, an economist for quite some time. He looks like Wall Street Jesus, if your Google works and you type his name into it. But he’s in the running for Fed share right now. The big market guy. I’m not sure if that’s because his girlfriend, her name’s slipping me, John Luke-
John Luke
Kellyanne Conway.
David
Is very tight with Trump. Kellyanne Conway is very close with President Donald Trump. But he was on TV the other day with CNBC kind of talking about this and saying, “Hey, I disagree with this, but I don’t want it known that I disagree with it because I don’t want a job done with President Trump because I would love to be Fed share.” It’s like a lot of people don’t agree with the government doing this, but those close to Trump know that they probably shouldn’t go against the grain of something that is publicly done. And I think it’s so funny, John Luke, it’s like anytime something goes wrong with tariffs or a decision like this is made, Scott Bessent is out of the office. So, I think it’s better to invest with Scott Bessent is in DC than when he is outside of DC.
John Luke
Yeah, that’s a good point. Yeah, we’ll see. I mean it’s a new world.
Derek
Well, speaking of the Fed and the Treasury and everything about interest rates, I know we were going to talk a little bit about where rates are and what that implies for a lot of different things, but I know you put this chart in there for a reason.
John Luke
Yeah, so really what this is looking at is your inflation adjusted monthly income that’s coming from money market funds. So, I think there’s somewhere around $7 trillion in money market funds with rates. We’re at 5%, now they’re about 4% in terms of money market yields. That’s a lot of income that investors have been receiving to spend into the economy. And so the bullish side of that was the consumer was even more flushed with cash. And the higher end consumer, which is probably the bulk of who holds a lot of cash in money markets, was getting a huge payment every month from their risk-free treasury holdings in these money market funds. And so what we’ve seen from here is as rates have come down, of course the number has moved lower.
So, you can kind of put it on a scale like yes, some consumers are going to see less monthly income as rates move lower from their money market positions. Of course they could move it into something else. But the other side of the equation is do we see a backdrop where these lower rates help the other side of the coin where consumers can get better access to financing terms, lower mortgage rates, lower consumer loans, lower car loans. And so I think that you can see some balancing from maybe the bottom half that sees positive impacts from lower rates as the Fed continues cutting to offset some of the spend, the dampening spend from risk-free returns on the money market side.
Derek
I guess it all depends whether you’re looking to lend or whether you’re looking to borrow right now, which obviously we’ve got a pretty split economy when it comes to that. That’s why housing is-
John Luke
I think housing’s obviously locked up in a sense. And if you see rates get back down to 5% on thirty-year mortgages, I imagine that that will re-spur a lot of activity. But what you’re also seeing, and going back to the chart showing the yield curve slope is banks are getting more and more interested in lending. They can make better spreads. And so the backdrop for the consumer’s access to credit and access to capital I think is improving with some renormalization of the yield curve. So, I think ultimately it’s a positive thing.
We know that the top-end consumer drives a huge chunk of the economy, but it’s not like they’re relying on these money market funds to live off of in most cases. And so really it was probably just gravy on top. And I would even say that the bulk of the money from these money market funds was probably just reinvested back in. I don’t know what the numbers are in terms of what got spent, but if someone’s worth $20 million and has a huge slug in money market funds, do they need the extra 50 grand a month to spend into the economy or do they already have it?
David
Great point.
Derek
Well, before we meet again and have our quarterly wrap, we will have a Fed meeting that everyone’s anxiously waiting for. I guess most people think the pause is ending, so you got to put this one in there just kind of showing the cases where we’ve had this cut, cut and then stop and then cut again.
John Luke
Yeah, the two questions here, and I’ll let Dave finish her off, but you’ve got the big question of what happens when the Fed cuts rates or do they ever cut rates at all-time highs in markets? And we’ve seen that that happens fairly regularly. And the outlook, the forward outlook from there is typically bullish for markets. And then the backdrop of being this spacing between rate cuts and what this graphic shows from the Carson group who tends to put out some very bullish numbers and graphics, and I think a lot of times they can help ease some of the backdrop where people are fearful about the uncertainty of the future and looking back in history to see maybe it’ll rhyme a little bit.
And what you see is whenever that there’s space between months between cuts, which is shown on the left-hand side, and then of course the timing of when it happened. What is the market return the next month, three months, six months, and over the next 12 months? And what you see largely, especially the further out that you look is it’s typically very bullish for markets. The average returns almost 13% in the median return, 14 and a half, and it’s been higher almost 91% of the time. So, while short-term noise might be a little bit as this plays out and then the market wonders, when’s the next cut? Longer term, I think it’s a very positive thing looking forward for returns.
David
There’s always ways to data mine to bring weird data to light, but honestly, I think it’s just a great reminder that bulls make money, even if bears sound smart. And I think everyone needs to continue to be a rational optimist. I don’t think anyone could assume that returns are going to be at this high-velocity level that we’ve been, or at least seen since the April 8th bottom. Obviously that has to slow, most likely will slow, but it all is dependent on why the Fed cuts rates and the rationale behind why they’re probably cutting rates right now tends to be more of a bullish signal than a bearish signal. And so remain a rational optimist. Let’s continue to recognize the huge importance of having the right structure of an allocation in place in case we are wrong.
And I think that’s the rationality side of being an optimist, like let’s be overweight stocks, underweight fixed income, but with guardrails. And Derek started this entire call-off perfectly saying, when we looked at the performance table, is there any negative numbers in there? Yeah, there’s two over the last five years and it’s the Bloomberg Agg and investment-grade bonds. So, you know what? Let’s be optimistic, this market could pull back. Let’s just still keep things to the basic level of let’s unhitch our wagon to fixed income as a safe asset class because we know it’s just a way to lose your money slowly and we’re never going to be able to time the market.
So, just focus and rely on the structure of an allocation of work for you because if anyone reaches out to myself, John Luke, Beckham, Brad, Sephora, Brett, Arch, JD, anyone on the IC team, they’re just going to say, it’s so hard to time the market and just unhitch. I forget what I was going to say there. To be fully honest, I thought I had something very, very awesome to say, which I never do. But just reach out to us if you have any question, want to talk through the structure on how we’re positioned moving forward for really whatever the market has to throw at us, not just over the next few months tend to be seasonally, but over longer periods of time.
John Luke
Awesome. 100% agree.
Derek
On to September. Thanks for recapping August for us.
John Luke
Yeah, thanks Derek. Everyone have a good Labor Day weekend.
David
God bless America.
Derek
Yep, you as well.
John Luke
All right.
Derek
Talk to y’all soon.
Disclosures
Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The information contained herein should not be considered a recommendation to purchase or sell any particular security.
The opinions expressed are those of the Aptus Capital Advisors Investment Team. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Forward-looking statements cannot be guaranteed.
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