First Trust ROI Podcast
On the ROI podcast, we discuss some of the most important questions facing investment professionals today, ranging from macroeconomic views, to perspectives on the equity and fixed income markets, to insights on practice management. We aim to cut through the noise, examine the data, and provide fresh insights to investment professionals as they help their clients find better ways to invest…seeking to generate attractive returns on their investments.
First Trust ROI Podcast
Ep 29 | Bob Carey | Risks and Opportunities for Stocks When Interest Rates Decline | ROI Podcast
Ryan talks with Bob Carey about the implications of a falling interest rate environment for equity markets.
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Hi, welcome to the First Trust ROI podcast. I'm Ryan Isakainen, ets strategist at First Trust. For today's episode, I'm joined by Bob Carey, chief Market Strategist at First Trust. Bob and I are going to discuss what's likely to happen down the road as the Fed begins cutting rates, which sectors may benefit and what sorts of investments financial professionals should consider. Thank you for joining us on this episode of the First Trust ROI Podcast. So, bob, this is your third appearance on the podcast. You were my first podcast guest, so I'm glad you're willing and able to come back for a third time.
Bob:Absolutely. It was fun, let's do it again.
Ryan:We'll definitely do it again. So since you were on the first time, believe it or not, there have been people that have watched this podcast in 73 different countries. Really, isn't that crazy? That is Like the reach of podcasts is like. I'm shocked when I look at some of the underlying stats.
Bob:That's really cool, that's 73 countries 73 countries. Is there a country that we have not reached that you would like you have as a goal?
Ryan:I haven't really looked at where we have and haven't been. Some of them are just one or two views, so I guess okay, we don't have a big following.
Bob:Your ancestors are from finland. It'd be fun to see if somebody in finland actually watched.
Ryan:They saw your last name and they're all probably related to me that have watched from Finland, but that's okay.
Bob:Exactly.
Ryan:So you and I spent some time together driving cars recently, and one thing I didn't realize about you after having worked with you for 20-some years is that you are kind of a maniac behind the wheel of a race car.
Bob:Where did that come?
Ryan:from. Do I have to answer this? Yes?
Bob:you're on camera. I don't know what it is, but I've always enjoyed being around fast cars and I've always been around cars. My dad was in the car business and after school when I was a kid, I used to walk to the dealership where my dad worked. My dad worked there, my grandfather worked there, my dad's cousin worked there, and then we had two dirt tracks reasonably close to the town that I lived in when I was really young, so I was always around race cars and cars and we'd go to car shows and went to tracks all the time, so I grew up with it. I don't know what I'd do if I couldn't do that.
Ryan:You know I was going to ask you, and maybe this helps answer it If you weren't chief market strategist at First Trust, if you didn't go into the financial industry, what would you have ended up doing, you think?
Bob:That's a good question. My degree is in physics and I've always had an interest in audio and music and I probably would have done something in that field or I would have gone into some sort of automotive engineering type of discipline. Yeah, you're very much a sort of analytical engineer kind of guy, it seems, and then I get behind the wheel.
Ryan:You get behind the wheel. No, no, but there's a lot of there's a lot of thinking, though.
Bob:You know. It's true, there's a lot of adrenaline, but there's a lot of thinking about how am I going to make it through that turn without crashing.
Ryan:Yeah, you know there's a lot of calculations going on yeah, well, it was, uh, it was great fun hanging out with you, uh, in some fast cars. So, uh, we'll have to do that again sometime, absolutely Okay. So, speaking of fast cars, I want to get this clear, because you asked me before we were recording. Last time we were on the podcast together, I told you I was planning on getting a Cybertruck, the Tesla Cybertruck. It didn't actually happen, and it's not that I dislike the Cybertruck or the amazing technology behind it, but I found the Ram Charger, which hasn't yet debuted. I reached my spot on the Cybertruck list and I decided to go with the extended 650-mile range Ram Charger, which is supposed to make its debut early next year. Is that a good or a bad decision?
Bob:Oh, I love Ram pickup trucks. They're amazing.
Ryan:They are.
Bob:They're absolutely fantastic. I think they're the best pickup truck in the market from everything that I've seen and just driven myself.
Ryan:Yeah, very comfortable. Probably not quite as fast as the Cybertruck, which is probably not a terrible thing for me.
Bob:Especially living in New York, speed limits are not very high. No, in fact. Sammy Hagar wrote I can't drive 55 after getting a speeding ticket in New York State. You know.
Ryan:Is that right?
Bob:Yeah, true story, true story.
Ryan:I did not realize that. Absolutely so, bob, there's been a lot that's happened in markets and the economy since the last time you joined me. We're recording this on September 12th 2024. We're basically around a week before the Fed is going to meet again and the market is expecting them to start cutting rates. Do you expect that to happen?
Bob:Oh yeah, I think it's pretty much a foregone thing that they'll cut rates. Really, the big question is is this the first of many rate cuts or are they going to cut rates once or twice maybe, and just see whether or not inflation continues to come down? We printed a 2.5% inflation rate last month, which is closer to 2% than it's been in a very, very long time. So the trend is good. The Fed definitely is looking at that trend and I'm sure they're expecting it to persist. But at the same time we still have core inflation above 3%. So I think the Fed felt pressure to cut rates. They felt like they could cut rates given the trend in inflation. But it's going to be interesting to see how far they go. The bond market clearly has many rate cuts already priced in. I mean the 10-year Treasury at 3.6%, I think this morning 3.7%. That implies going forward, that we're going to get a lot of rate cuts.
Ryan:Yeah. So do you think that the market is too aggressive in its expectations or do you err on the other side?
Bob:It's interesting. The Fed's 2% inflation target has not been met very often historically. It has, more often than not the last 15 years or so, with the exception of what we saw during the pandemic. But the reality is that inflation has averaged closer to 3% 3.5%, depending on how far back you go. So I think the Fed you know they do have a dual mandate and I think the reality is that they typically keep the Fed funds rate about 1% above the inflation rate. That's been the average over decades.
Bob:Now they got away from that in the years coming out of the financial crisis With rates at zero. We did have low inflation. But there was a long period of time where if you had money sitting in money market funds and anything short-term in nature T-bills and whatnot you weren't earning the inflation rate. Inflation wasn't all that high. So we've been above that inflation rate recently for a while, but the amount of time that we were below the inflation rate is many, many years longer than what we've seen on the other side with rates above the inflation rate. So I think Powell is probably more in the camp that he would like to keep rates above the inflation rate and if inflation does go down to 2%. That tells me that they'll cut it to about 3% and declare victory and then see how the economic data comes out.
Ryan:So the yield curve has been inverted for quite some time the 2s and the 10s, as well as shorter term in the 10s, and it recently normalized, or disinverted I'm not sure what the right word is for that.
Ryan:So when the Fed does start cutting rates, it's likely to be even more normalized and that has historically often been a precursor to a recession. Do you think that that is like a cause and effect sort of relationship, or is it just a coincidence? I mean, there's really not that many instances we look back. It's happened quite a bit, but it doesn't always follow that it will continue to. But do you have an opinion on that?
Bob:Yeah, I think a lot depends on why the Fed's cutting rates. I mean, when that happens, that means the market is anticipating the Fed cutting rates, and so the question is, why is the Fed cutting rates? We've had two cycles in the last 20, 25 years where they cut rates and it was because we were in a bad situation. All of a sudden, we've got 9-11, we've got the pandemic, or we've got the financial crisis, got the pandemic or we've got the financial crisis. That's been typically the reason the Fed has cut rates in recent times is something bad happens and they're reacting to it by cutting interest rates.
Bob:In a more normal economic cycle, we've been in a recession for a while and the Fed is holding rates, holding rates high until they see that the recession has in fact given us lower inflation and then they begin to cut interest rates and we haven't had a recession. There's certainly been a lot of expectations that we would have a recession the last couple of years, but you know, whether or not we've had a recession or there's been a recession, this cycle seems more like what we would have seen prior, to say 9-11, you know, many years ago, where we'd have an economy that was overheated, the Fed would raise rates, we'd have a recession, and the Fed would hold rates, and hold rates, and hold rates until they saw that the economy was finally giving the inflation numbers that they wanted to see, sometimes even having disinflation, and then they would start to cut interest rates.
Ryan:And I think that Do you think that the Fed should wait to cut rates until we? I mean, does the Fed really want there to be? I know they want inflation to come down, but do they need to wait until there is actually a recession that emerges before they cut rates in order to actually get rid of the inflation that they're trying to get rid of? In other words, you know, in the 1970s we all remember looking at the charts that have that double spike of inflation, right, right. So is that a risk? What do you think that they should do?
Bob:I think we have a lot more productivity today in the economy globally than we had back in the 70s. I grew up in the 70s and I just see how the world operates today and how businesses are able to be so much more productive. You know, goods and services are done on a much larger scale with higher levels of productivity, which in theory, should keep inflation down. So I think, if I'm the Fed, I'm a little bit more confident that cutting interest rates is not going to reignite inflation than I would have years ago. We've seen massive changes in the way the economy functions. However, if we have policies going forward from a regulatory perspective, from a fiscal perspective, that are not good for inflation coming down and they're anti-productivity basically, then it's a different discussion, but we're not there yet.
Ryan:So do you think the Fed believes that they're out of the woods when it comes to inflation?
Bob:I don't know if they actually will ever admit it. Powell, even if he cuts rates all the way to say 3%, I think he's going to be pretty cautious about suggesting, hey, we've succeeded.
Ryan:Mission accomplished, yeah, mission accomplished.
Bob:I don't see him spiking the football sort of analogy. That just doesn't seem like his personality.
Ryan:I think the conventional wisdom is once they start cutting rates, they can't reverse course and raise rates in response to emerging data. Once you go down that path, you have to continue down that path. Do you think that's true?
Bob:That's very true. That's been true historically too. I think the Fed, I think they'll cut rates 25 basis points and I think Bob Stein has been, I think, on the money with his idea that they just cut rates 25 basis points on a regular basis here until they settle, I mean. And where the plane lands really is the question when do they, you know, do they cut it down to three and stop and then see what happens? Or I think so much of it's going to depend on the economy and the data they get that they have to look at.
Ryan:One of the things I was wondering about the other day is, I think, so much of it's going to depend on the economy and the data they get that they have to look at. One of the things I was wondering about the other day is, I think, about the Fed systematically cutting rates over a long period of time. Is that if I'm looking to finance some sort of debt, I might want to put that off until the end of next year? If I'm confident they're going to continue to lower rates, why not put off my economic activity until then, which could then slow the economy, not put off my economic activity until then, which could then slow the economy, which maybe that would argue for cutting rates faster, just so there doesn't have to be that lag.
Bob:They tend to cut rates or they tend to raise rates more slowly and, historically, if the economy really does start to go into a bad place, then they usually cut rates rather rapidly, and that's what we've seen more often than not. I think. So much of this is we just we haven't seen this sort of typical economic cycle in a long time where we have inflation, the Fed raises rates. Brian's talked about this extensively Brian Westbury, the Fed the way they conduct policy is different today than they did prior to the financial crisis. So we don't we really don't know whether or not even these rate increases actually did reduce inflation. Probably, but you know, there's some arguments to be made that it was just. You know, we went through a pandemic and productivity collapsed because of that, and productivity has just come back. And you know, you just, all you have to do is go to a store and you just, you just see a lot more inventory these days and where things were we were clearly in a scarcity situation here three years ago.
Ryan:Let's assume for a second that rates do continue to come down, as our expectations suggest, and the Fed continues to cut rates. Do you think that at the longer end of the yield curve we see a similar pattern, that the 10-year kind of moves along with the federal funds rate, or do you think it's going to move somewhat independently of short-term rates?
Bob:I think it will move, it'll correlate, but I think most of the change in interest rates is going to be more on the very short end of the curve. Clearly, I think that you know we've got inflation at 2.5, a little over 3 on the core. A 3.7 percent inflation or 3.7 percent rate on the 10-year is anchored right about where it should be given, where inflation is at, I think. So I think most of the change in rates is going to be on the short end of the curve. I'm not expecting the yield on the 10-year to go back down to 3%. Maybe it does, but I think we'd have to see 2% inflation, I think for an extended period of time for that to happen.
Ryan:Now, does that have an effect or an impact on the way that you view opportunities in various sectors, on the way that you view opportunities in various sectors? Are there certain sectors that you think do better or will do better if we've got a certain rate-cutting environment?
Bob:or rates moving lower. Yeah, I think there's one really obvious sector that would benefit from the yield curve getting back to normal, where we've got the twos and tens doing what they do where they should be and where they've been historically, but the short end of the curve below the two, just a classic, you know shape yield curve, and I think it's the financial services sector. Not necessarily every bank or necessarily every stock in the financial services sector, but you think about the nature of lending and banking. Most funding is done at the short end of the curve with deposits, you know savings accounts, checking accounts, short-term CDs. That's the funding engine for bank loans and most loans have a longer duration, if you want to think of it that way. And so getting that yield curve back to normal, I think is going to benefit the financial services sector more than any of the sector.
Ryan:Yeah, that margin between the very short end and the higher yielding longer end is important.
Bob:Now there are a lot of banks that are, I would argue, overcapitalized, that when you look at their deposits and you look at their assets, they have massive assets compared to their deposits and so they have excess reserves, if you will, and they have parked those reserves at the Fed in huge numbers and they have made very, very good interest on that and funding costs for a lot of that still very, very low. So there are some financial institutions that are probably not real happy with the Fed cutting interest rates. They would probably like to keep this ability to earn without taking any risk at all, just parking money at the Fed, but I think the vast majority of banks are not in that position. There are very few of those and they typically are the very largest financial institutions. You start getting into the regional banks and the community banks, they tend to lend out pretty much all that they can lend out, so they are truly banking institutions that don't have a lot of wealth management, capital markets activity, things like that. They're usually traditional lenders.
Ryan:Turning to other sectors of the economy, you know the technology sector has really dominated recently. When we look at fund flows into ETFs, the technology sector is at the top of the list. When we look at where the innovation is happening and the enthusiasm is happening, it's the technology sector Right. And even you know, when rates were before the Fed pivoted or, you know, started talking that way, the technology sector was doing pretty well. Yep, do you think that, as the Fed does pivot, or maybe even setting aside the Fed, because we're always talking about the Fed what's the opportunity in the technology sector?
Bob:Yeah, I think that the tech sector there are trends in tech that really have nothing to do necessarily with economic cycles and the reality is the companies in the tech sector, from a stock market perspective, are companies that generate just such high returns on their business. I mean just very, very high ROIs ROEs, however you want to calculate returns. These are businesses that don't really need a lot of external capital, so they, for the most part, generate capital themselves. They're self-funding, and I think that's one reason why the sector has done so well the last couple of years because they really don't care what the Federal Reserve is doing. They don't care whether rates are 0% or 5%. When you're generating 25%, 30%, 40, even 50% returns on capital, do you care whether rates are 5%? On the short end of the curve, 5.5%? If you're looking at the Fed funds rate, they're not going to slow down, they're going to keep on going. The biggest impact from the Fed cutting rates from, say, 5% down to closer to three, it's going to be companies that have lower returns on their business that need external capital. And since Chairman Powell's speech on July 9th, where he finally came out and said, without saying it directly, that the Fed was about to embark on rate cuts.
Bob:We've seen a pretty significant shift in leadership in the markets. So you know small caps initially had a big surge. You know, when you look at the small cap space, mid caps, a lot of companies that might be in the S&P 500, but they're not necessarily huge. You know weightings in the index or high return businesses. You know that shift in policy benefited those stocks significantly and the market, to me, is sending out a very clear message that their cost of capital is about to come down, and not only that, which is good for valuations, but it's also good for them to expand and grow their balance sheets, going forward and making investments in their businesses. Ultimately and that's kind of a classic thing we tend to see as we come out of a recession, we typically see small caps, mid-caps, do pretty well in the early stages of an economic cycle when this change in policy happens.
Ryan:So it makes a lot of sense that capital-intensive businesses would be impacted with lower costs of capital.
Bob:Absolutely, absolutely Assuming these are businesses that don't have high return businesses. You know, you think about companies that are more classically cyclical businesses. You know manufacturing, you know industries like that construction, home building, automotive, the automotive sector, things like that. These companies, they need a lot of external capital from time to time and especially when the economy's been slow, they tend not to have a lot of capital sitting on their balance sheet looking for a place. They usually need that external capital.
Bob:And then you have a lot of smaller companies. They're small and they want to get bigger one day, and so the only way that happens is you've got to make investments in your business. So it's kind of a life cycle thing. Big companies tend to get big until they hit a wall and they just can't grow anymore and eventually some of them fall into decline. And then you have all these other companies that are earlier in their life cycle that need capital. Some of these companies are burning capital. You think about the biotech sector and whatnot. They don't have a business yet, but they need capital and investors, I would argue, are probably going to be a little bit more inclined to look at some of those companies that are in need of capital with the cost of capital coming down.
Ryan:Yeah, I was thinking about the biotech industry in particular the other day, about the relationship between interest rates and the returns of that industry in particular, and it seems like they're pretty. I mean there's a pretty strong relationship recently, but even longer term.
Bob:No question about it. You know you've got all these companies that you know they've got clinical trials going on. They've got. You know they're making investments. They don't have anything to show for it yet there's no business there. There's no there there yet, and yet there's. You know the market capitalization reflects the anticipation that at some point those investments they've made will generate cash flow down the road.
Ryan:Yeah, the duration of those cash flows is very long, oh big time.
Bob:You think about how long it takes to bring a product to market and the clinical trials and all those sorts of things that need to happen, and we've been in an environment where mergers have been discouraged, I think from a regulatory perspective as well. So that's another sector that I think will benefit a little bit from shifting policies.
Ryan:To your point with M&A, I would think that lower rates would also maybe be at least one input to potentially spurring on some more M&A. If you're going to finance an acquisition, having lower rates could actually be important for that as well.
Bob:Yeah, especially when you're buying a business that has high future returns potentially, but low returns right now. That could be all the difference between a company having enough capital to make it to the finish line and actually having these investments pay off. And that's always the question these investments pay off? And that's always the question Do these companies have enough capital to stay in the game until they actually have a product in the marketplace? And that's a balancing act for a lot of these companies.
Ryan:What are your thoughts about artificial intelligence? This is an area, especially in technology, where there's just been so much enthusiasm. There's been incredible amounts of revenue that have been generated by some of the chip companies, NVIDIA in particular, but others, and the forecasts are pretty impressive as well. Is this something that is? I mean, where are we in the cycle? I guess? Is this something that you're expecting to continue along the same pace, or are we nearing the peak of the enthusiasm or the hype cycle?
Bob:I do think that there has been a lot of. There have been some factors that have driven valuations higher for these stocks, and I think the so-called carry trade, for example, is that the Bob carry trade. It's C-A-R-R-Y not C-A-R-E-Y Exactly.
Bob:I've had to mention that to a few people, especially when the market was getting volatile and these stocks were blaming the carry trade Folks. It wasn't me, I had nothing to do with it, but a lot of hedge funds, primarily, have borrowed money in yen and they've turned around and they've bought other assets. Now they can buy anything they want. They could buy treasuries, they could buy real estate, whatever the case may be. But it's pretty clear, based upon the recent surge in the yen against the dollar, as the market began to price in the Fed cutting interest rates that was seen initially in the currency markets the dollar did weaken against the yen. The yen surged a little bit and boy, all of a sudden, we had a lot of pain in those AI-related stocks. And so that tells me that a lot of the advance that we've seen, especially this year, probably last year as well, was fueled by investors who were essentially buying these things on margin, if you want to think of it that way. And so anything that would cause that margin trade to unwind is going to have an effect on the shares of those companies, and clearly the valuations are very, very high for a lot of those companies. But when you take a look at the earnings and the forecast for earnings for the rest of the year and for next year, it's like you kind of understand, in fact you do understand why these stocks are doing so well. These companies are growing like crazy, and so it gets down to one thing Are these investments in AI ultimately going to pay off? The people who are benefiting from all that spending right now the chip companies and whatnot. They are clearly making a lot of money because a lot of companies are spending a lot of money as they migrate into this space, and so the question is are there going to be new businesses that come out of this? Are there going to be new sources of revenue for some of these companies? And so far, I would argue that we haven't really seen a lot of that yet. It's really, I think, probably way too early to know whether or not these are going to pay off, so we'll see how this plays out.
Bob:This reminds me this whole cycle reminds me of the late 90s. We were seeing a lot of enthusiasm about the Internet and e-commerce and all these different things back in the day, and then we hit like an air pocket. We were expecting that broadband Internet services were going to be rolled out much faster than they ended up getting rolled out. I remember back in 98, 99, a lot of people were in many places. They were seeing their streets torn up because they were laying fiber optic cable and there was a lot of enthusiasm about getting rid of these dial-up modems, which were really slow, and that process took five or six years instead of taking one to two years. And that's when we got this massive correction in these dot-com stocks and a lot of that air pocket was the result of policy changes.
Bob:There was a lot of concerns about, well, who's going to own these Internet service providers, and there were a lot of things that were going on in Washington that caused that process to slow down. And so you know, unless we have some sort of crazy thing that we're not expecting from a policy standpoint, regulations and whatnot If this is truly an organic change and doesn't have, we don't throw a wrench into this from a policy standpoint. I do think that we are going to see a lot of things come about as a result of this. I think a lot of businesses will emerge. I think clearly it'll help productivity in the economy longer term, as well, yeah, that's what's important for these sorts of investments.
Bob:Yeah, and at the same time, the technology based upon the stuff that I've messed with. In some ways, it's very good. In other ways, you can tell we have a long way to go before this is truly a revolution in the way we do things.
Ryan:Yeah, the Internet, I think, is a great analogy because it's with the benefit of hindsight. Looking back, a lot of it was kind of a second order effect after you had the build out. Right Apple and its iPhone wouldn't exist without the internet, but that didn't happen for five, six, seven years. Right Right Amazon. It's a huge company. It's got a lot of different types of ways to earn money, but initially it was a bookseller online and that wouldn't have existed Losing money like crazy.
Ryan:Google or Alphabet, they wouldn't be able to advertise Meta, they wouldn't have social media. All of that kind of came down the road from the internet. So I wonder the same thing what are the companies in these amazing revenue-generating machines and efficiency and productivity that comes out of AI?
Bob:I think the market's initial assessment is that it's going to be companies involved in building data centers. It's going to be the chip companies. That's where probably the most secure bets that you can make are going to be in that sort of thing. To me, it's the next generation of products and services we haven't seen yet. I think it's going to be five to ten years down the road when, all of a sudden, there are going to be things that we take for granted in our daily lives that we can't even see right now. And that's the way technology has always been.
Ryan:It's interesting Data centers, the amount of electricity that they are actually going to consume because of artificial intelligence and cloud computing and all these high-demand sources that didn't exist just a few years ago and electric vehicles and the electrification of appliances, and all these things happening at once Ram superchargers or ram chargers.
Ryan:There's exactly there's an estimate that I saw I think it's from the IEA that by 2026, that's two years away data centers are going to consume a thousand terawatt hours of electricity per year, which is about the same as the nation of Japan, right? Which is incredible, yep. And at the same time, there's, you know, bitcoin mining, which is consuming a tremendous amount of electricity, and all those other things, right? It just seems like we're going to have to build out that infrastructure pretty quickly.
Bob:What is well. At least this was true as of a of a couple days ago. What was the best performing sector in the stock market year to date? It was the utility sector. Yeah, that's which we haven't seen that sector perform all that well, that's so recently.
Bob:I do think interest rates are part of that and there's no question these stocks are. From a valuation perspective, they are sensitive to interest rates. They're very bond like in terms of their businesses. You know, low returns, steady returns, and so they're. You know these are kind of long duration plays. So that's that's certainly helped, I would argue. But when I look at the, the earnings estimates for this year compared to last year, I believe earnings this year will be up 10% for the utility sector in 2024. If the estimates for Q3 and Q4 are correct, we haven't seen that sector grow 10% in a year in a long time. I don't remember ever seeing that sector actually have that kind of an increase in earnings. So I think a lot of it is what you just mentioned.
Ryan:Yeah, and as they build out their infrastructure they actually get to pass all that cost along to you and I and all the consumers.
Bob:So it really is an interesting time to be a utility company, in comparison to maybe the last several decades stories about some of the utilities or some of these, you know, nuclear power plants that have been offline for many, many years, bringing those back and so forth. So it's an interesting time watching this. This is a sector that has been hasn't really interested me in a long time. I've had a lot of concerns about different things. Part of it is just you can't I can't get excited about the growth rates when other sectors are growing much faster. Historically, that's been a sector that you like.
Bob:When we are actually in a recession or about to head into recession, the stocks are defensive in nature, and that's still going to be true going forward, I'm sure of it. But now you've got the possibility, these companies will actually start to increase their businesses. They'll actually see more projects and more ways to make money, and so I would expect that we'll see some merger activity and things like that as well. These are huge capital investments when you have to supply more power to these data centers, and a lot of these companies are actually building their own. A lot of these data center companies are actually building their own power plants too. They're actually, you know. So companies that make the equipment that go into that are also, as you say kind of a second order. That's another area of the market that I think is interesting yeah, absolutely.
Ryan:Market, that I think is interesting yeah, absolutely. And that is another interesting trend, as we're seeing, you know, the reshoring of manufacturing and some of the building of factories and things in the US, and part of that makes me think about what's going on in other parts of the world, because this is a question that I've asked you several times in the past. Obviously, we've had a great performing equity market in the US this year surprisingly so but sometimes our focus is pretty myopic and narrow. What's going on overseas? Do you think there's any opportunity yet in?
Bob:some of those markets. Yeah, I don't think things have changed all that much. I'm a numbers guy and when I look at the stock markets of the world and I look at the United States and I look at, say, for example, the S&P 500, and I see what these companies have done, looking at earnings estimates, what they might do over the next year or so, a couple of years, I don't see any other region of the world or any other country in the world that has anything like what we have here in the US. Now, the reality is those big companies in the S&P are global in nature they do business all over the world.
Bob:So I have been in the camp that you're better off letting those companies navigate the global economy. The US companies are better at creating shareholder value than companies in Europe, companies in Japan. Not that you should completely avoid markets overseas, but I think it's I would argue it's more important to be selective when having those allocations overseas. You know we are a lot of people argue well, hey, we're only 25% of the world's GDP Only. The reality is we're 4% of the world's population but we're 25% of the world's GDP. When that's when you have those kind of metrics, that means you've got a lot of wealth being created, a lot of economic activity being created, and I think our companies are just simply better than companies overseas. I know valuations are better when you look at Europe. I mean, pes are quite a bit lower, but I would argue that difference can be completely explained by the differences in returns on capital.
Ryan:Obviously, one of the things happening here between now and November is the political season. We've got election day coming up. I think if you were to ask most of the pundits they'd say it's kind of a coin flip. At this point we don't really know who the eventual winner will be for the presidency and you know the houses of both houses of Congress are up for grabs to some extent. Maybe Bob Stein would tell us that the Senate favors the Republicans. How important do you think that is for investors to pay attention to? Should they tailor their investment decisions based on who the eventual winners will be?
Bob:History says you shouldn't. That doesn't really matter all that much. I think that the biggest factors impacting the stock market and what investors really should care about are proposals on the tax side, and if we raise taxes on dividends and capital gains and whatnot even estate taxes going up, that is going to have an impact on valuations. It won't be the only factor impacting the market, but clearly those are factors that we plug into our models. You know what is in, and when we start hearing talk about taxing unrealized capital gains and things like that, then you know my antenna goes up.
Bob:I'm like, ooh, how's that going to work? If you have success in the market and you've made some money, now you may be in a situation where you have to sell some of your shares in order to pay taxes. So you're effectively forcing a liquidation, potentially if you've got some gains. But then the market you would think would adjust for that If it knows that a founder of a company that's been successful that has to pay taxes more on an ongoing basis. That could affect the value of the stock because the market knows that somebody's going to be in the market selling to pay taxes. So it's kind of a you know that would be on. We've never seen that before.
Bob:So those kind of proposals, you know I doubt that they actually would become law. I think that would be very difficult to pass into law, but all of a sudden you start to wonder whether or not that would be the case. So I think in the end, I think ultimately, the stock market likes when there's a sharing of power, because nothing crazy happens at that point. In other words, we don't have massive shifts of policy as a result of that, and when we've had one party control everything, it's usually very, very short term. We've only had a couple of years here and there in my lifetime where the Democrats have run everything or the Republicans run everything. For the most part it's, you know, both parties sharing power.
Ryan:Yeah, it's interesting because we're coming up to I believe next year is when the individual tax rates that were part of the original tax package that was passed by the Republicans when Trump was in office. That's when those individual tax rates expire. The corporate tax rates were more permanent.
Bob:Yeah, the only thing about taxes going up. If that happens next year, what do we have the year after that? We have another election.
Ryan:We've got midterms. That's when midterms come.
Bob:And so that's the one kind of. The beauty of our system is that, even if they don't vote for tax increases and we see taxes going up, you know you just don't want to be the party in power and you just raise taxes potentially, so you don't care. If you're in the White House, probably you wouldn't care, but if you're in Congress you're probably I don't know if I want to vote for these taxes going up when. I have to face the electorate next year.
Ryan:So that's an incentive to actually get something done to extend some sort of maybe make it so it's not as bad as it would be.
Bob:Right exactly Whether you keep it at this level and selling it as such. Yeah, it's an increase, but it's not all that bad. This is your medicine. It tastes good, doesn't it?
Ryan:Great question for Bob Stein, and Bob was on just a couple episodes ago.
Bob:I've got.
Ryan:Bob coming on once more before the election to give his perspectives.
Bob:I thoroughly enjoyed your conversation with him.
Ryan:Yeah, it's always great to talk with Bob Stein.
Bob:Whenever a Georgetown alum gets to visit with a Syracuse fan, you never know what might come of that. That's true. But that was good.
Ryan:We brawled off camera. You never know what might come of that, that's true, but that was good, we brawled off camera, okay. So my final question for you, bob, is and I've asked this, I think I've asked you this before, but I'm going to ask you for another recommendation what's on the Bob Carey book list? Is there anything that you've read recently that you're considering reading, or that maybe even a classic that you would recommend? I know you're into music.
Bob:I have a book about the Beatles lyrics and Paul McCartney did a book a couple years ago and it's thick and there's a lot of information. But a Princeton professor collaborated on this and it just has all the Beatles lyrics in the book and there's a whole discussion about what the lyrics mean and what they were thinking at the time. That's just the whole creative process. It's just amazing to me. It is, as you know, I play the guitar and I've never written a lyric in my life, I've never written a song in my life, and I'm just trying to figure out the music of what these people wrote over the years. And why does that sound so good? And then you throw the whole storytelling and the lyrics and all that into it. It's like that's a great topic for sure to dive into.
Ryan:It's also interesting because everyone has their own story of how they got to be successful. You know what they went through to get to where they ended up. It's really fascinating because I think it's applicable to any industry. Any sort of success story has a similar kind of trajectory. It's very interesting.
Bob:Yeah, it's interesting seeing bands. I don't know if this so much happens anymore, but you think about bands coming along. They have ideas. Bands I don't know if this so much happens anymore, but you think about bands coming along. They have ideas. A lot of bands start off covering other band songs and that's kind of how they make their mark, or at least they try to.
Bob:That's what maybe pays the bills. And then that process of going okay, I want to create my own thing, or we want to create our own thing. A lot of bands, they hit that wall and they don't succeed, and for every band that's made it, there's thousands of bands that just hit that wall and they never make it. Yeah, maybe they release one album or two albums if they're fortunate. Yeah, and then they're gone.
Ryan:Well, thank you once again for coming on the podcast, bob. It's always interesting. We'll have to get together and drive some race cars again sometime soon.
Bob:Bob, it's always interesting, we'll have to get together and drive some race cars again sometime soon.
Ryan:I love that, but always great speaking with you. Thanks to all of you as well for joining us on this episode of the First Trust ROI Podcast. We'll see you next time.
