Lori Calvasina, Head of US Equity Strategy, RBC Capital Markets

[00:00:00] Hello, this is Dean Curnutt and welcome to the Alpha Exchange where we explore topics

[00:00:07] in financial markets associated with managing risk, generating return, and the deployment

[00:00:12] of capital and the alternative investment industry.

[00:00:17] In Lori Calvacina's role as head of US equity strategy at RBC Capital Markets, assessing

[00:00:25] the interaction between macro variables like rates with top-down factors like the equity

[00:00:30] market multiple is critical, but important as well is an evaluation of markets from

[00:00:34] the bottoms up.

[00:00:35] And here she not only seeks to pull together the views of colleagues doing strategy work

[00:00:40] in sector verticals, but also to actually read earnings transcripts during reporting

[00:00:45] season to get a sense of what companies are saying.

[00:00:48] Her broad assessment of the outlook for corporate America is generally optimistic as she sees

[00:00:52] companies having come out of multiple stress exercises, trade wars, the COVID shock and

[00:00:58] the inflation and monetary policy response in the pandemics aftermath among them with a

[00:01:03] stronger defensive plan.

[00:01:05] Companies are harnessing technology and managing costs more effectively leaving them less

[00:01:09] likely to be forced to reduce head count.

[00:01:12] The result is a consumer holding up quite well.

[00:01:15] Our discussion touches on the Mag 7 and how today's top heavy portion of the market is similar

[00:01:20] and different to the high flyers of the tech bubble.

[00:01:22] For Lori, the valuation premium for names like Nvidia and other mega cap tech stocks

[00:01:27] is justified by the premium of earnings growth they've been able to consistently deliver.

[00:01:32] We explore the impact of higher rates on the markets multiple and the relative performance

[00:01:36] of sectors as rates rise or fall.

[00:01:39] She likes energy both for its high dividend yield, its strong relative performance as

[00:01:43] rates rise and the potential for a geopolitical tailwind.

[00:01:47] On this last front, asked about the market risks that she worries about most is uncertainty

[00:01:52] on the global political front along with the US election.

[00:01:56] She cites as well sentiment that may be too bullish and positioning that appears stretched.

[00:02:01] Lastly, we touch on Lori's recent recognition as one of Baron's top 100 most influential

[00:02:06] women in US finance.

[00:02:08] Asked about the industry efforts to empower female careers in markets, she's optimistic,

[00:02:13] arguing that it's critical to have not just a mentor, but a sponsor as well to push you

[00:02:17] to the next level.

[00:02:18] I hope you enjoy this episode of The Alpha Exchange, my conversation with Lori Calvacina.

[00:02:26] My guest today on The Alpha Exchange is Lori Calvacina.

[00:02:29] She is the head of US equity strategy at RBC capital markets.

[00:02:34] Lori, it's great to have you on the podcast today.

[00:02:36] Thanks for having me.

[00:02:37] It's great to be here.

[00:02:39] I am looking forward to the conversation and an exploration of your process and what

[00:02:45] you observe in this wonderful world of asset prices and what the implications are for investors.

[00:02:52] Let's get our conversation underway and learn a little bit more about you and your career

[00:02:56] history.

[00:02:57] Tell us about how you got started in finance and take us through how you got to become

[00:03:03] the head of US equity strategy at RBC.

[00:03:06] It's hopefully what I think is an interesting story.

[00:03:08] I would describe myself as an accidental strategist.

[00:03:12] I grew up down in Alabama.

[00:03:13] My dad was a business professor, had nothing to do with finance.

[00:03:16] It was more managerial and I was always dead set on not going into the business world.

[00:03:22] Made my way up to the University of Virginia, studied political science, was in what the

[00:03:26] time called the government and foreign affairs honors program.

[00:03:30] I really wanted to do a PhD in political theory that was where I thought I was headed.

[00:03:37] My major program we were allowed to audit classes and they tended to be graduate classes.

[00:03:41] We wouldn't get grades but they really tried to encourage us to go out and explore different

[00:03:45] things.

[00:03:46] I ended up in a class with a professor named Ed Burton, I think it was called Theories

[00:03:50] of the Financial Markets or something along those lines.

[00:03:53] He talked me into taking a look at Wall Street.

[00:03:56] My senior year, we called it fourth year there, set me up with some interviews.

[00:04:00] I remember talking to one hedge fund, talking to someone in fixed income at Lehman and

[00:04:06] then eventually talked to the strategist over at what was then Smith Barney.

[00:04:09] I think City had just bought them.

[00:04:11] He ended up offering me a job and so after college made my way that summer to New York City

[00:04:17] dropped my car off at a relative, moved in with some other relatives for a few months

[00:04:21] and I've been doing equity strategy ever since.

[00:04:23] I did it at City for a number of years, ended up working for Tobias Lev-Kovic, who had

[00:04:27] been the long time strategist there, worked for him for about seven years and then one

[00:04:32] day he looked at me and he said, the person who was the small cap strategist at the time

[00:04:36] was retiring and he said, Bert's retiring.

[00:04:38] Do you want to be the small cap strategist?

[00:04:40] I said, I guess, I didn't know that much about small cap at the time and ended up taking

[00:04:45] a look and I got married and I said can we wait till after I'm married and he said sure.

[00:04:50] So we waited till after the wedding and I launched on small cap in 07, hung out at City for

[00:04:54] a few more years, made my way over to Credit Swiss as a small cap strategist and then made

[00:04:58] my way over to RBC in 2017.

[00:05:01] My time at Credit Swiss I started working from being a small cap strategist to covering

[00:05:05] the broader equity market again and over at RBC I'm the only equity strategist so we cover

[00:05:10] the S&P 500, Russell 2000, I do a lot of work on sectors and work really closely with other

[00:05:17] strategists and derivatives, fixed income, effects and that's probably one of the things

[00:05:21] I pride myself on.

[00:05:22] I've done this a long time, I know a lot of analysts around the street, a lot of macro

[00:05:26] people and I really do view my job one to make calls but also to be a little bit of a

[00:05:31] diplomat and to try to pull the views of the group I'm working with together into one cohesive

[00:05:36] view.

[00:05:37] Well you mentioned 2007 and then 2017 so I live and breathe the VIX as part of my process

[00:05:45] and at least at the very early part of 2007 you had a VIX dip below 10 and then in 2017

[00:05:52] it spent a lot of time below 10 and both those periods for the next year market blew up

[00:05:58] in some ways.

[00:05:59] One of the things that I think is consistent among us all in markets is that we're some

[00:06:04] byproduct of our experiences and so I was just hoping to have you reflect back a little

[00:06:09] bit that you've been doing this for quite a while and we see these market cycles, these

[00:06:15] financial cycles, cycles of monetary policy.

[00:06:18] If you're to think back on the types of experiences or the interaction with folks like Tobias

[00:06:24] who I had the pleasure of meeting and sadly we lost him what are the people or the experiences

[00:06:31] that have been influential in helping you develop your framework, your mosaic for thinking

[00:06:36] about markets?

[00:06:38] I think Tobias obviously had an enormous influence on me.

[00:06:41] At the time I started at City he was not the strategist but he took over about a year or

[00:06:46] so after I was there and I hung around and continued to work for him as well as the outgoing

[00:06:51] strategist at one point of time I was working for both of them which was interesting.

[00:06:55] But at any rate he had been an industrial analyst and so I think that's one of the reasons

[00:06:59] why I tend to stay so close and listen so much to the analysts I work with because he always

[00:07:04] had his ear to the ground with the analyst community and brought his industrial experience

[00:07:08] into the role.

[00:07:09] One thing people will say about me is I'm a bottom up top down person but I think I definitely

[00:07:14] got my inspiration for doing that from him and really not running the higher level macro

[00:07:19] models but when things we do on my team I have a couple of associates and we divide up

[00:07:24] the S&P 500 in earning season and we read transcripts because I want to see what the

[00:07:28] companies are talking about and I want to see what the companies are saying.

[00:07:31] I think that bottom up approach very much got from him.

[00:07:34] I think the other thing I got from him was probably he had no filter sometimes and he

[00:07:39] would just go out and tell people what he thought they needed to hear not what they wanted

[00:07:43] to hear and sometimes that made him popular and sometimes it didn't but that is really

[00:07:47] the only way I know how to do the job is to really just try to help people and even if

[00:07:52] that means delivering unpopular opinions or taking a new look at things like valuation

[00:07:58] and really try to do the job from that perspective.

[00:08:02] I would say in terms of events one thing I've been talking about a lot lately is how

[00:08:07] I started in the business right as the tech bubble was imploding shortly after the peak.

[00:08:12] I think I got my job offer and maybe March 2000 and started that summer and then moved

[00:08:17] over to credits with shortly after the crisis in 2010 but I viewed those as big mile markers

[00:08:24] for the stock market and what I remember is that each of those errors was different from

[00:08:29] the previous one and there were different rules of thumb you needed to follow sectors acted

[00:08:33] differently.

[00:08:34] I've been talking about that a lot since COVID and really comparing the period where it

[00:08:40] now is the early post-COVID era of investing.

[00:08:44] That's going to be very different from the post GFC era of investing and very different

[00:08:47] from the post tech bubble era of investing.

[00:08:50] I think just understanding that things change when you have these big enormous breaks in

[00:08:57] the market.

[00:08:58] Not everything is the same as it was in the prior cycle and I think that's really as I

[00:09:02] talked to clients these last few months, that's where I feel like my thinking is very

[00:09:06] differentiated versus some of my peers right now is I really am looking for what are

[00:09:10] the new rules of the road, how are things different?

[00:09:13] Does your post 2010 playbook still work?

[00:09:16] Maybe it doesn't.

[00:09:17] Maybe you need to think about things in a new way.

[00:09:19] Well, it's really interesting you bring up your start in the industry during the tech bubble

[00:09:24] and there's certainly some comparison in terms of the common narrative around valuations

[00:09:30] being stretched especially at the very top of the S&P with the Mag 7 and that being compared

[00:09:37] to the tech bubble but surely there are significant differences.

[00:09:40] I would love for you to frame out what you see as similar to that period and then what

[00:09:46] is different from what makes the comparisons of 2024 to let's say 99 and 2000 different.

[00:09:54] So if you think about some of the similarities and I would say well maybe let's tackle

[00:09:59] the differences first so if you think about 1999, 2000 versus today I would say one

[00:10:04] thing that's just very different is I think the over valuation when the Mag 7 or the top

[00:10:09] names whatever cohort you want to pick I do think it's been justified.

[00:10:14] If you look at differences in earnings growth expectations, look at the actual earnings

[00:10:19] growth for 2023 and it was just an enormous advantage in the Mag 7 versus the rest of

[00:10:24] the market that merited a premium valuation.

[00:10:26] So the top 10 names slightly more expansive bucket has been trading around 27 times.

[00:10:31] The rest of the market's been trading around 16 times but when you look at the differences

[00:10:36] in long term earnings growth expectations or recent earnings growth actuals it certainly

[00:10:41] seems merited and so the silliness that we saw back in the late 99 period just isn't there.

[00:10:46] There's a rationality and when I think about the Mag 7 bucket what I've seen in sort of

[00:10:51] late 2023, early 2024 there's a Darwinistic attack on that bucket and if your long term growth

[00:10:58] profile is holding up or there's something to miss in your earnings expectations or otherwise

[00:11:04] in your fundamental story you're getting kicked out of the bucket.

[00:11:06] So I see a very very rational shrewd investor base and yes we have resulted in some excessive

[00:11:12] valuations but perhaps they're just much more deserved than they were in the past.

[00:11:16] In terms of similarities and I think this is the post crisis period but what I remember

[00:11:21] about 0203 and I've been in the business a few years at that point was there was just

[00:11:27] we had that initial drop the market rebounded and then we entered into this just two year

[00:11:32] period of funk or malaise there was just a complete loss of competence it was like the

[00:11:37] investment community had gotten knocked down and just couldn't get back up.

[00:11:40] And there was obviously mid term election politics had just become contentious remember

[00:11:45] we had the lack of sort of resolution to the 2000 election that sort of rocked people in

[00:11:49] late 2000 so device of politics were out there there was geopolitical angst from the Iraq

[00:11:55] war that was a big big event for people caused a lot of nervousness post 9-11 for obvious

[00:12:01] reasons.

[00:12:02] I just remember people were constantly afraid of tipping into a recession that never occurred.

[00:12:07] I started thinking about that probably at some point in 2022 present day era and we actually

[00:12:13] put together a chart that showed and I think through late last year there was some 80

[00:12:17] ish percent correlation between how the stock market traded from 2022 to 2023 and 0203

[00:12:23] if you picked sort of the early year highs and looked at the daily trading and that just

[00:12:27] got me thinking about it more and more.

[00:12:29] I thought about this a bit at the other last year as well when people were putting out their

[00:12:33] year ahead outlooks said one client who said to me the bears are recycling the same old arguments.

[00:12:37] So this is what happens after these crises people just consistently underestimate the economy

[00:12:43] they're constantly afraid of tipping into the abyss and they're constantly worried about

[00:12:47] the recession that never comes and I just started talking about that more with people

[00:12:51] late last year and I find a number of investors I'm speaking with at least are coming to

[00:12:55] the same conclusion that after these big crises confidence just gets shaken there's some collective

[00:13:01] PTSD in the investment community and the forecasting community and it takes a while for people to understand

[00:13:07] that things really will be okay and are not on the precipice of blowing up again.

[00:13:11] So that's to me is sort of one similarity and I think have a that understanding

[00:13:16] and that view of where we are I would say has definitely evolved in the last year and a half

[00:13:21] but it is something I've been thinking about for quite a bit. Last year I was not constructive

[00:13:25] enough on the market but I was more constructive than many of my peers and I think having that

[00:13:30] understanding of the psychology was something that really helped me creep a clear head as we navigated

[00:13:35] markets. You mentioned the top down versus bottom up in this effort to listen to let's say folks

[00:13:43] who have expertise in the verticals and playing a role in aggregating what you're seeing there

[00:13:49] from the bottom up and then combining that with maybe an assessment of the impact of inflation or

[00:13:55] the trajectory of monetary policy. You also mentioned having your team read transcripts I'd love

[00:14:02] for you to just talk about what that recent exercise is yield in terms of insights on the health

[00:14:07] of corporations and specifically let's say along the sector lines. In terms of reading through

[00:14:14] the transcripts it's interesting I felt like there was a period last year may have been the three

[00:14:18] key reporting season where we just weren't learning all that much and I was pretty frustrated

[00:14:22] pretty annoyed frankly that me and my team had been reading so much and just didn't feel like we

[00:14:26] were learning anything but I do think it got better since then and this last reporting season

[00:14:31] it was interesting I felt like companies were making a concerted effort to talk down expectations

[00:14:37] and of course there's going to be an exception for a company here and there but there was no

[00:14:40] smoking gun in terms of the demand environment is really falling off. I wasn't really seeing

[00:14:47] evidence that a recession is at hand or really that we were anywhere near one and I think that's

[00:14:52] been the case for quite some time. I was however those seen and intense focus on costs and we only

[00:14:59] read S&P companies 500 companies I don't have time to read the Russell 2000 ones as much as I would

[00:15:04] love to. I just think that awareness of the cost pressures that companies were still complaining about

[00:15:09] didn't really rattle me too much when we got a couple of hot inflation reports recently because I

[00:15:14] felt like we'd been prepared for that. I think the other thing I've noticed if you look at the

[00:15:19] consumer conversation and this has really been consistent for the last year or so but the high end

[00:15:24] does seem to be holding up very well the cracks are seen more on the lower end. I'm not trying

[00:15:29] to dismiss those as not being serious but the engine of the economy, the upper income earners,

[00:15:34] the middle class earners do continue they seem to be continuing to spend on the things they want

[00:15:39] to spend. They are being pickier, they are being chooseier, they are being selective but they're

[00:15:44] being rational not panicky. I feel like that is a consistent theme that I've seen really over

[00:15:49] the last year and maybe it's intensified a little bit in terms of the pickingness and the choosingness.

[00:15:54] I felt like that was very very stable in terms of recent months based on what I was seeing

[00:15:59] in the company commentary. The other thing I've noticed companies really have developed a confidence

[00:16:06] or an ego. I don't mean ego in a bad way but I just think there's this understanding that they

[00:16:11] have managed through so many different crises since 2018 whenever these new issues come up in

[00:16:18] the market or in the economy they take it and stride and I think that confidence very much comes

[00:16:22] through when the earnings calls. So you can go back say to 2018 right when you had the trade war

[00:16:28] and that did seem to rattle companies at the time but we've thrown a lot at corporate America since

[00:16:33] then from COVID to the supply chain crisis to the inflation shock and I remember reading after SVB

[00:16:39] we went back and my bank's team was really taking the lead in terms of managing the conversation

[00:16:44] about that around here I was more in listening mode but really I read through a lot of the 8Ks

[00:16:48] and press releases that companies put out and that confidence was just really apparent. I saw so

[00:16:54] many companies alluding to their experience during the financial crisis or some other crisis

[00:16:59] and how they just swung into action and took care of things and I feel like I see that come through

[00:17:04] time and time again in terms of these earnings calls and how does that feed into market outlooks

[00:17:09] well it's one of the reasons why we're not having a recession is that companies have more levers to

[00:17:14] pull and they have a confidence that they can go in and preserve margins and cut costs or work

[00:17:20] around whatever issue is out there without having to cut bodies that's one of the later levers

[00:17:24] that they pull now and I think that was probably less true in past cycles. So to me that work is

[00:17:29] very very helpful in terms of challenging some of the group thing that's out there about how

[00:17:35] necessary recession has to be. It's really interesting the way you frame it you go back five years

[00:17:40] as you said it companies have been through a bootcamp around responding to and managing through

[00:17:46] crisis you said trade war supply chain the SVB shock Russia Ukraine and the shock to

[00:17:53] crude at least for a period of time rates and of course the lockdown itself in 2020 it's such

[00:17:59] tremendous exercise in having to have a plan and a backup plan to get through these periods

[00:18:05] that's a really interesting way of framing it. I want to talk a little bit about the

[00:18:10] relationship between the earnings yield and the S&P which is part of your chart deck

[00:18:16] and the level of rates you've outlined that rolling differential between S&P earnings yield

[00:18:23] and the level of rates which of course is around zero right now it's certainly been higher before

[00:18:30] one of the things I think in 2022 that a lot of folks were asking themselves was what's the right

[00:18:37] PE ratio for the S&P in a 5% rate world having come through a 0 to 1% rate world for so long

[00:18:45] in that post GFC period a lot of folks said well the multiple should be higher because rates are so

[00:18:51] low and inflation is so low how should we think about that the comparison of the earnings yield

[00:18:56] of the S&P to the level of rates now. I think there's a lot we can unpack there so if I think about

[00:19:03] the basic earnings yield gap analysis this was something that came up a lot last year

[00:19:09] I didn't feel particularly bullish but people kept telling me I was bullish because I wasn't bearish

[00:19:13] but I think one of the things that sort of the more bearish part of the investment community was

[00:19:18] focused on was that collapse of the earnings yield gap between the Ford the earnings yield based

[00:19:23] on the Ford PE and the 10 year treasury yield. I'm not a cross asset strategist I think back to those

[00:19:27] days when I interviewed with the bond people at Lehman and said the bond market is just not where I belong

[00:19:32] I'm an equity person through and through but I got pulled into this discussion enough that we

[00:19:37] just ran some numbers and I should say I'm very quantitative I didn't go to business school I didn't

[00:19:41] take the CFA I'm good at learning new things but I don't have the traditional training and so when

[00:19:46] a topic like this comes up what do I do I go and I run the numbers I don't take what people are

[00:19:51] saying as conventional wisdom and assume that it's true I go out and find what the data is telling me

[00:19:56] and so that's what we did with this earnings yield gap analysis and when I looked at it and I'm

[00:20:01] like oh okay it is collapsing that's a very different environment that we've been in since the post GFC

[00:20:07] world okay I get it this is very very different but let's just do a back test what does this

[00:20:11] actually mean for stock market performance going forward and it turns out and you know I do things on

[00:20:15] ranges and when you're sort of arranged that we've been in recently stock markets up about 12.8

[00:20:20] percent on average over the next 12 months that is literally what the data says and we don't have

[00:20:25] fantastic historical data on this it really goes back to the late 80s so really what we have to look

[00:20:31] at at the 90s and I wasn't around in the 90s I was in high school in college but what I see on the

[00:20:35] data is that the stock market did just fine we had the mid cycle slowdown we had a recession the

[00:20:41] garden variety recession everyone talks about it at the beginning I looked at that as things are

[00:20:45] over done in terms of the bearishness just based on that one indicator if I think about the PE I

[00:20:51] would say I tackle that from a slightly different way and this goes back to my just sort of willing

[00:20:56] us to look at the world a little bit differently not the way everyone always looks at it I started

[00:21:00] getting questions in the summer of 2022 from investors well if the PE is at X and if inflation is at

[00:21:08] X and the Fed is at Y what should the PE be and I said wait I'm actually working on a little model

[00:21:13] I was testing out PE's against different macro variables at the time trying to come up with a model

[00:21:18] that would forecast I said I can run stress tests for you let me go look at that and I had that

[00:21:23] conversation enough with people and did enough you know sort of requests for people that we ended

[00:21:27] up putting a formal model together publishing it and really found that it resonated with people

[00:21:33] now tell you some people hate this model a lot of people think it's interesting this model did

[00:21:37] stirris in a good direction last year so what did we do we have an average S&PPE time series

[00:21:43] that goes back to the 50s we just built a very simple four variable regression with PCE as an input

[00:21:49] we have Fed funds the effective rate then the target rate once it was available we have 10-year

[00:21:55] treasury yields so the model starts in 1962 because that's how far back I can get that data

[00:21:59] and then eventually we put GDP in the model GDP is not my favorite input in that model but we started

[00:22:05] to get questions last summer can you flex this economic assumption and so we added it in what I love

[00:22:10] about the model is that it's not just post GFC I feel like a lot of strategists are looking at

[00:22:16] averages back to 2010 or 2014 and this is the average and this is the high and low end and so

[00:22:21] this is what our target PEE should be or maybe they're doing a regression on a forward PEE with

[00:22:25] a 10-year treasury yield since 2010 and goes back to my idea of we are in a new era we are at the

[00:22:31] beginning of a new era we don't know if the 10 year is the dominant variable anymore maybe it's

[00:22:36] something else let's go back and look at history I think my poly side background my history

[00:22:41] background probably plays into this a bit but let's go back and look at other cycles and see what we

[00:22:45] can learn from history that might inform what this new era is going to look like and so we

[00:22:51] built this model and it's been telling us to look for trailing PEEs in the low 20s based on where

[00:22:56] the street not Lori but based on where the street consensus thinks things like PCE and interest

[00:23:02] rates and the Fed are going to end up and so we've just been plugging in consensus assumptions

[00:23:06] to this model using the formula having it spit out what the target PEE is and last year it was

[00:23:11] telling us to look for 21 to 22 times which on my earnings number which was pretty close to the

[00:23:16] street at the time was looking for 47 to 4800 on the S&P what the model is telling you now if

[00:23:22] you use consensus assumptions just to look for about PEE of a little over 23 times and on my

[00:23:27] earnings number that would take you to around 5400 on the S&P now I do think consensus numbers are

[00:23:33] probably a little bit stale right now and need to be adjusted a little bit when you're thinking

[00:23:38] about things like rates and inflation so I ran a stress test over the weekend and just said what

[00:23:44] if we keep interest rates flat the Fed doesn't cut 10 years stays where it is which at the time we

[00:23:49] did this was about 4.3% and we took inflation we took PCE to the 4Q run rate of about 2.8% that on my

[00:23:57] earnings number point you to about 5,000 on the S&P on consensus earnings I'm a little bit below

[00:24:03] consensus on earnings takes you to about 5,200 on the S&P and that's a range mid-march we've been

[00:24:09] hovering around in we've broken out a little bit recently but I love the model because whenever

[00:24:14] there are just sets of assumptions that people get fixated on like this stress test I just ran

[00:24:19] been hearing the last month or so my godly economy is so hot that Fed's never going to cut I can

[00:24:24] run a model and it often will tell me why the market's getting stuck at a certain level if you buy

[00:24:30] under those assumptions or where high should be where low should be if you want to put in different

[00:24:35] views of where the macro is headed but I will tell you Dean the biggest difference I have with some

[00:24:42] of the other strategies around the street is fair number of people who are looking for mid-teens PEs

[00:24:46] and admittedly they're probably doing their work on forward PEs not trailing I really do think

[00:24:51] they're taking too narrow of a view of history and I think it's a little bit of a leaf for some

[00:24:56] people to look at trailing PEs as opposed to forward PEs but I do think switching the focus has

[00:25:02] served me well in the last year it's always uncertain as to what the beta let's say of one variable

[00:25:09] is going to be to another variable that we think logically or from an economic framework is going

[00:25:15] to drive the dependent variable so something like rates and inflation or rates and economic growth rates

[00:25:23] and the PE profile of the S&P and so that's certainly been a head scratcher for folks

[00:25:30] and so I love first for you to just talk about how you think about how interest rates impact

[00:25:37] the S&P at large maybe on a sector basis as well you've done a lot of work on energy that's

[00:25:44] an attractive sector from your perspective for a number of reasons so maybe we can talk about that

[00:25:50] and then I would also love to talk about your work on balance sheets and the maturity profile of debt

[00:25:56] and so the opener is just walk us through your framework for thinking about the interaction between

[00:26:01] the level of rates, the trajectory of rates in the S&P or just the sectors within it.

[00:26:07] It's a complicated question and I would say I do think in general companies are just less sensitive

[00:26:14] to short term rates than they've been in the past we see this with all these balance sheet charts

[00:26:18] that we put together companies have shifted more to long term debt, really reduce their short

[00:26:23] term debt for the typical S&P 500 company or weighted average maturity is eight and a half years

[00:26:29] and the effective interest rate that they're paying on the debt they currently have is creeping up

[00:26:33] a little bit but it's still near historical lows and by the way everything I just told you

[00:26:38] almost all of it's true for Russell 2000 companies small cap companies only major difference

[00:26:42] obviously the levels are a bit worse than what you have in large this cleaning up of the balance

[00:26:47] sheets and the recalibration is very similar and the weighted average maturity there is about 4.3

[00:26:51] years right now when I tell people that stat it blows their minds people have this vision of small

[00:26:56] caps headed off a maturity cliff it's just not true so I think in general corporate America really

[00:27:02] did put in some important buffers that allowed them to weather this interest rate increase very

[00:27:08] very quickly are very very well I do think putting the valuation issue aside I think that interest rates

[00:27:15] falling I think it just gets very very complicated when we think about sectors so you mentioned

[00:27:20] energy I think that is one sector that looks very different than it did say 10 years ago

[00:27:26] it has one of the best dividend yields in the S&P 500 relative to other sectors it also has a

[00:27:32] much higher dividend yield than what it's had in the past if you talked to our analysts they'll

[00:27:36] tell you they've really cleaned up their balance sheets and look much better from that perspective

[00:27:41] so I think that this is a sector when we're looking at the S&P that has a very low level generally

[00:27:47] of companies with dividend yields and excess of the 10-year treasury yields it's a little bit harder

[00:27:51] for the income seeking investor to find things to buy I think the energy sector stands out in a

[00:27:56] very good way and in a very different way than it might have in past cycles so I don't know that you

[00:28:00] can just go back and look at all the history and make a conclusion I think there's some very unique

[00:28:05] things about that sector now that do make it very appealing given where rates are I think the other

[00:28:10] thing that I noticed on energy recently we haven't overweight on it we were debating whether

[00:28:15] not to keep that overweight on to start the year because generally our worldview was interest rates

[00:28:19] are going to fall the economy is going to continue to do well we'll probably see some rotation in

[00:28:24] the market but energy's not always a sector that do well when interest rates are falling if you

[00:28:30] look at the data since 2010 you basically see energy as one of the sectors that tends to outperform

[00:28:35] a bit when interest rates are rising rather than falling we had enough things that we liked about

[00:28:40] the sector it's cheap you have that dividend yield appeal my analysts are very constructive on

[00:28:45] the sector relative to analysts and other sectors at RBC that's based on a quarterly survey I do

[00:28:50] of the of the analysts and we looked at it we said okay we're going to overlook that interest rate

[00:28:55] sensitivity and then we thought about it a little bit more and we said you know what the way

[00:28:59] the fed conversation is just swinging and the way the inflation conversation is swinging I'd like

[00:29:04] the idea is having a little bit of an inflation hedge sitting in my portfolio and we felt like if

[00:29:09] the inflation fears came back you'd see some rate fears come back to the market and energy would be

[00:29:15] one of those places you want to be in and we'll see how that works going forward but I will say it

[00:29:19] feels like it served us pretty well throughout March because energy has been on the better sectors

[00:29:25] and if you look since the end of January there's also obviously some geopolitical tailwinds or

[00:29:29] issues that are pushing that sector up a bit right now but that really is a good example I would

[00:29:34] say of all the different things we think about when we make our sector overweight and I do think

[00:29:38] that dividend yield appeal just really speaks to the competition of stocks versus funds but you can

[00:29:45] find some pockets of equities that will give you that yield well you've got one chart in your deck I

[00:29:50] think that you're alluding to which I've used some version of myself you're pointing to the

[00:29:56] relative performance of each sector to the S&P and it's that the correlation of that relative

[00:30:02] performance to the tenure and I think what's so interesting is you've got the positive correlations

[00:30:08] i.e. higher rates outperformance for sectors like energy materials financials and then you've got

[00:30:14] the other side which maybe it's consumer discretionary at the obvious ones like utilities in real

[00:30:19] estate and so there's sort of some implicit almost self hedging component of the S&P where you get

[00:30:26] this diversification to this macro factor of interest rates. It's a great point we actually upgraded

[00:30:33] consumer discretionary we had been underweight before that underway didn't work out so well

[00:30:37] but we pulled it up at the end of last year and I remember talking to someone who was

[00:30:42] bearish on the consumer fundamentals and I just said look if the Fed really is going to cut next

[00:30:49] year we get any kind of improvement in rates I said you don't want to be underweight the sector

[00:30:53] that's dangerous and maybe there is a little bit of a inherent conflict right between being

[00:30:58] overweight energy and pulling that one out when they're on opposite sides of the same chart

[00:31:03] but I think what I've learned over the years and I do lots of studies like this consumer sentiment

[00:31:08] versus sector performance inflation expectations i.s.m we do these for a lot of different economic

[00:31:13] variables what I've learned is that you can't just sort of make your whole portfolio on one side of

[00:31:20] the chart or the other because strategists as much as anybody else can get sucked into the vortex

[00:31:25] and consensus thinking and if something like say i.s.m is falling and it's falling and you haven't

[00:31:30] seen the turnaround yet you could sit there and you can say okay I'm just going to put on all these

[00:31:34] trades while it's falling when it inflicts you're not going to be able to turn fast enough

[00:31:39] or if you sit here and you're watching it looks like it's in the depths of despair and you want to

[00:31:44] be a contrarian and try to pick the trade that inflection may take longer than you anticipate to play out

[00:31:50] so i think you have to be aware of these issues but we've just never been the strategist that said

[00:31:55] well i think interest rates are falling therefore i'm only going to buy the stuff on the right hand

[00:31:58] or the left hand side of the chart you've pointed to this observation that

[00:32:03] post the SVB debacle march of 2023 the leadership of the s&p has been aligned with movements in

[00:32:11] the 10-year yield and of course that leadership has become more and more concentrated over the last

[00:32:18] let's say a year certainly led by Nvidia and led by an explosiveness in earnings as well

[00:32:25] just give us the big picture of how you think about this very top heavy s&p what observations do

[00:32:31] you have or they're a particular set of concerns or opportunities that emerge from something

[00:32:36] that's so top heavy i don't think there's anything inherently that should worry us about having

[00:32:43] a top heavy market i understand if something goes wrong i understand the math but we have actually

[00:32:48] gone back and looked at spikes and concentration from market cap perspective and what you tend to see

[00:32:53] is that they're associated with periods of nervousness in the market and stress

[00:32:56] but sometimes those spikes occur in the middle of the stress sometimes they occur before the stress

[00:33:01] and sometimes they occur after the stress and i still view us as an after the stress period so

[00:33:07] i'm not sure i've seen enough times when it's continued and times when it's reversed i just don't

[00:33:11] think there's any clear signal there i will say if you look at the top 10 names in the s&p 500

[00:33:18] from evaluation perspective and you look at the p e and that p e is bumping up against levels

[00:33:24] that have marked the high in the recent past so i do think we're at sort of a natural pressure

[00:33:29] re-evaluation point if you look at p e the rest of the market it's got room to run to pass

[00:33:35] high so i'd see the data it looks to me like there's a catch-up trade in the rest of the market

[00:33:40] that could potentially happen i think we talked about the earnings growth advantage of mega caps

[00:33:45] before if you look at the mag 7 and their 2023 earnings growth it was just by far dominant relative

[00:33:54] to the rest of the market but if you look at bloomberg's got some great data on this

[00:33:58] if you look at 2024 the s&p the rest of the market x the mag 7 is expected to flip from negative

[00:34:04] to positive earnings growth the mag 7 is expected to decelerate and then if you look in 2025 mag 7

[00:34:10] further decelerates and rest of s&p further improves and so the gap between those two buckets is

[00:34:15] only about 3% it was close to 40% in 2023 so i see a shrinking earnings growth premium between

[00:34:23] the mag 7 and the rest of the market and i think that earnings growth premium in the past

[00:34:28] merited the premium valuations but that rationale is fading and i think as economic growth

[00:34:34] expectations continue to pick up i mean we've already seen gdp forecast for 2024 move up from

[00:34:40] think around 1% to start the year 1.6% mid-february and they're 2.1% now we're starting to see those

[00:34:46] move up very very quickly and i think as economic growth expectations continue to improve it's

[00:34:51] going to help the denominator in that equation it's going to help the earnings growth

[00:34:55] for the rest of the market which is a little bit more cyclically exposed so i think that we're going

[00:35:00] to get some rotation in the market as the rest of the market makes more of an earnings growth case

[00:35:05] for itself which i think is a byproduct of the improving economic backdrop and i do think you've got

[00:35:10] expensive valuations you've got some crowding in the space if you look at cftc data and the nasdaq

[00:35:16] 100 futures positioning on the buy side you hit new highs that's starting at the time we're recording

[00:35:21] this at least that's starting to fall off pretty sharply so i think that we're very much

[00:35:26] seeing the seeds of rotation but i think it may take a little bit more time to play out i think

[00:35:31] that earnings growth advantage disappearing may have to become a little bit more apparent to people

[00:35:36] before we can really see it shift i do think last year the better balance sheets at the mag 7

[00:35:41] help them out i think that fueled a lot of the trade in the fall one of the things you point out

[00:35:45] to is this pattern with respect to how the market prices earnings expectations that we start the

[00:35:52] year with a lofty view of earnings we spend the first two quarters of the year marking those down

[00:35:58] a little bit and then we stabilize i just was hoping you could talk a little bit more about that

[00:36:03] and frame out what you think the implications are as we get closer to the middle point of the year

[00:36:08] it's great you bring that up it's one of my favorite charts in the deck right now and we put

[00:36:12] that together last year there was this view on the market out there that earnings growth expectations

[00:36:17] were too high they were going to have to come down that was going to cause a big pullback in the

[00:36:20] market and i'll tell you in late 20 22 i originally subscribed to that theory as well but then i

[00:36:26] started digging into it a little bit more and we realized we had a different chart that basically

[00:36:31] showed us that earnings revisions bottomed a couple of quarters there was a big difference between

[00:36:37] that and the stock prices so we see the stock prices bottom first and then two quarters that

[00:36:41] earnings revisions would bottom later and so we looked at that and we're like okay there's something

[00:36:45] to this let's dig into it a little bit more and so we put together those charts that basically show

[00:36:50] you that if you look at the summer of the prior year you see down grades in the second half of

[00:36:55] the prior year to the forecast and then you get those down grades again in one q and two q

[00:37:00] and they basically stabilize starting in June if you look at the s and p 600 for the small caps

[00:37:05] it stabilizes a little later but it's more like July or August so that was a lesson to us last year

[00:37:11] we actually reversed our view a little bit just gotten to the more constructive camp because we

[00:37:16] said you know what we think the stock market has probably already put in its low and the earnings

[00:37:21] down grades are going to continue for a little bit longer but that's normal and we think they'll

[00:37:25] be washed out by mid-year so i think that helped us get on the right track with our market call last

[00:37:31] year as we think about it today again go back to this 4q reporting season we just went through

[00:37:36] i really do think companies were trying to talk expectations down a bit or at least keep them in

[00:37:42] check we didn't see big downward revisions to the numbers but i do think companies are very

[00:37:46] carefully managing the outlooks now and by the time you get to the middle of the year

[00:37:51] you've only got two quarters i think most companies can make it through two quarters and if you can't

[00:37:56] then you've got bigger problems than the quarter and so i think that as a strategist i don't

[00:38:01] necessarily want to fight what the bottom up stock pickers are telling me about the earnings outlook

[00:38:06] for 3q and 4q because they're much closer to the companies they really understand how to read those

[00:38:11] t-leaves from the companies and i think you just get a bit more certainty when you get to the back

[00:38:16] half of the year about what your earnings outlook is i would say on balance as i listen to your

[00:38:21] outlook it's reasonably constructive you've got end user demand holding up pretty well valuations

[00:38:29] can be stretched in certain pockets but in a lot of ways justified by just sizzling earnings growth

[00:38:35] you've talked about the debt maturity profile and the companies taking the opportunity as did

[00:38:41] the us homeowner to restructure their debt at very very low rates and buying themselves plenty of

[00:38:47] time if you were to put on your nervous hat and talk about the things that you're less sanguine

[00:38:54] about the things that you think could go wrong what does that look like the one that probably keeps

[00:38:59] me up at night the most is just the geopolitical backdrop fortunate that i worked with haleem

[00:39:04] acroft who's really the expert on those issues but i think back very much to 2022 and really

[00:39:10] the fall that proceeded she was very early on sort of calling the conflict in russian

[00:39:15] Ukraine and really trying to tell people like russia is going to invade when nobody believed her

[00:39:19] we saw markets really get hit and really had a bit of a scramble i think that markets do not

[00:39:25] price geopolitical risk in advance we have one chart that looks back at world war two even after

[00:39:30] you had the official declaration of war the market went down a little bit it didn't go down a lot

[00:39:34] it wasn't really till Hitler invaded France that you saw a parable whatever the reverse of

[00:39:39] parabolic is you just saw sharp media downward drop in the market in a massive way and those two

[00:39:45] events looking at that history of world war two watching what haleem went through in 2022 i do think

[00:39:52] we're just not prepared if things deteriorate too much on a geopolitical front i think it's

[00:39:57] just not possible for markets to really deal with that ahead of time so i worry about that a lot

[00:40:02] i do worry about the fact that our sentiment models right now are sending one sending

[00:40:07] a yellowish signal the other's flashing red so looking at the cftc data you're basically on

[00:40:13] byside positioning on us equity futures you're basically back to the highs that we saw in early 2018

[00:40:19] early 2020 pre-COVID you're above the highs we saw in 2021 and 2022 if i look at a a a i i it's not

[00:40:26] as bad we're one standard deviation above the long term average not two but we are at levels that

[00:40:31] are consistent with a short term pullback in the market and less than trend gains over the next 12

[00:40:37] months so i feel like i'm both those sentiment gauges i'm seeing that the market is vulnerable to

[00:40:42] bad news if we get it i have a more difficult time outside of the geopolitics telling you what

[00:40:47] that bad news could be i do worry a little bit at the end of the year about the us election

[00:40:53] we saw back in 2000 that the market did not get its usual post-election pop because we really

[00:40:59] didn't have resolution on the outcome it had to get kicked after the supreme court so i do worry

[00:41:05] this is more of a tale event but i do worry if there's not a clear resolution on the us election

[00:41:09] that's something it could be difficult for markets to deal with so that's admittedly pretty far off

[00:41:14] the list of geopolitical uncertainties is a long one and think as you're implying they generally

[00:41:20] don't materialize and it really takes the materialization of them for the market to react so just

[00:41:27] give you quick summary of what we see in the options market you look at global equity indices

[00:41:34] crude gold effects implied volatility rates fall has come down a lot these are all in extremely

[00:41:42] extremely low percentiles and they should be because the markets really are pretty well behaved

[00:41:47] the event has to happen i think for the market to ultimately react they don't tend to be

[00:41:53] all that forward looking in a lot of ways a lot of what you and your team are doing is responding to

[00:42:00] requests from the clients of rbc and the interaction with you and the clients i think inspires a lot

[00:42:07] of the work some theme that we touched on is just the difference in markets today versus let's say

[00:42:14] the post-GFC period where rates got really low and it was just a very different way of thinking about

[00:42:20] markets i was just hoping you could talk to us a little bit about how the client demand for your time

[00:42:27] and research is different now or has changed over the past couple of years in this higher rate environment

[00:42:34] there's always been an aspect of being a strategist and i think this is true of people on the cell

[00:42:38] side generally they want to know what other people are thinking they want to know what the zeitgeist

[00:42:43] is they want to know what the questions are asking and i think in a cell side role you have to be very

[00:42:46] careful to respect your client's privacy while at the same time sort of providing that service of

[00:42:52] what the zeitgeist is out there so i feel like that's much more important than it's necessarily been

[00:42:58] in the past just that how are people feeling what are people thinking about as opposed to doing

[00:43:03] projects for people i think the by side rather has started to do a lot of their own in-house

[00:43:09] quantitative analysis so i think there's a bit less of that than what we've seen in the past and

[00:43:13] there's a little bit more of just getting the color and things that you can't get out of the bloomberg

[00:43:18] or the facts that are the client tool i want to finish our conversation which i thoroughly enjoyed

[00:43:24] Laurie by noting that you and your colleague elima have been named two of barren's 100 most

[00:43:32] influential women in u.s finance so that's not a small bit of recognition so congratulations

[00:43:39] that's fantastic and well done tell us about the state of the state with respect to efforts to

[00:43:47] further and empower the career development of females in this industry of finance

[00:43:54] a very male dominated industry that's been that way for a long time but certainly there's been

[00:44:00] initiatives at firms like rbc and just in the broader financial community to try to

[00:44:05] empower the growth of female careers i'd love just to get your perspective on that as a woman

[00:44:10] of prominence in the industry i will say i feel like i've been very lucky throughout my career that

[00:44:17] i've worked for people for the most part who have been very supportive of my career i think back to

[00:44:22] tebias i was 27 years old or something when he told me i was going to be i think he basically just

[00:44:27] told me i was going to be the small cap strategist i don't think it was really a question but i think

[00:44:33] back to how young i was then would end up he's no one or with us but i remember talking to jack

[00:44:38] report who was one of the great small cap investors at all time and the fact that he even took the time

[00:44:42] to talk to me but i think having those kinds of sponsors not just a mentor but a sponsor who's

[00:44:48] going to say push you a little and say like you need to be in this role in pushing an institution

[00:44:53] to put you in a role i think that personally has probably been the most impactful thing to me

[00:44:59] i think also the last few years it's been a tough few years in society definitely getting better

[00:45:06] on the upswing and the mom of two small kids a three-year-old and a eight-year-old i had a COVID baby

[00:45:12] and just having people i know she's been on your podcast before Amy Woo Silverman

[00:45:17] our derivative strategist Halima Elcellino who's our affect strategist having other

[00:45:23] senior women who have been going through the same sorts of things and are doing the same

[00:45:27] source of jobs having people like that to talk to for advice and just a set an example for you

[00:45:33] for me i think is extremely important all the mentoring programs that are out there the senior

[00:45:38] women need support as well so i think having sponsors i think having those mentorship programs

[00:45:45] is extremely helpful i think sometimes it can be peer-to-peer i don't think it always has to be

[00:45:49] senior to junior i've also gotten very inspired by some of the younger women that i've worked with

[00:45:53] over the years and we don't have them for support so i think doing things where you can really just

[00:45:58] push women into new roles so they can be there to be trailblazers and to set examples and to be

[00:46:04] those peer mentors i think those things are extremely important and i think things like this list

[00:46:10] giving people concrete examples of someone who may look a little bit different or think a little

[00:46:16] bit differently or be different than the person who is traditionally in a role i think it's

[00:46:20] important to have those visuals for managers for executives and for people who might be thinking about

[00:46:25] doing those jobs i think just having those examples that are tangible that they can see i think

[00:46:30] are very important that's great to hear so plenty of progress behind us but plenty of progress

[00:46:36] in front of us as well and i think the message is keep at it a lot of this stuff is working but it's

[00:46:40] certainly going to take some time but it's great to hear folks like you so engaged in the process

[00:46:45] and congrats again on the barren's recognition lori thanks so much for your time it's been great to

[00:46:51] have you on the podcast i've enjoyed learning more about your framework and your process and hearing

[00:46:56] what you think about markets in the here and now so thanks again thanks for having me i really enjoyed it

[00:47:03] you've been listening to the alpha exchange if you've enjoyed the show please do tell a friend

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