Why The S&P Just Hit A Record High — Despite Soaring Yields

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We talk about his critically claimed run in death of a salesman, taking his dog to therapy and winning an Emmy for all the murders in the building. New episodes of Happy Hour are available every Wednesday. You can watch on YouTube or listen wherever you get your podcasts. Cheers. So, for the show comes from First Citizens Innovation Banking, formerly Silicon Valley Bank. First Citizens is the bank of the innovation economy. The name may have changed before it 40 years of commitment to bold ideas, relentless ambition and delivering what's next as strong as ever. So, if you're wondering where the road innovation starts, it's here. First Citizens Innovation Banking had the firstcitizens.com/innovation to learn more. Welcome to Profty Markets, I'm Ed Elson, it is October 7th. Let's check in on yesterday's market vitals. The major indices climbed as stock investors grew bullish ahead of the earnings season. The yield on tenure treasuries declined slightly but remained near multi-decade highs. Brent Crude climbed back about $100 per barrel as industry executives warned that global stockpiles are running low. Meanwhile, Constellation Energy popped more than 12% after Google agreed to a 20-year nuclear power purchasing deal. OK, what else is happening? Big tech just pushed the S&P 500 to its first record close since August. The S&P rose nearly 1% yesterday and it's now up more than 14% so far this year. While the stock market is ripping though, bond yields are still near record highs. On Monday, the 10-year treasury yields closed above 5.3%, it's highest level since 2002. According to Cal State traders are now betting that the chances of a rate hike before the end of the year are above 70%. In other words, the bond market and the stock market are now telling somewhat opposite stories which leaves us all wondering who is right. Here to discuss the markets, we are speaking with John Murray, Chief Investment Officer at NFJ Investment Group. John, good to see you. The S&P hit a record high which I think was surprising to some considering the fact that we saw yields rising as much as they did and usually when yields rise, that means stocks come down. That's not what happened though. Stocks kept rising. We're now at 14% here today. What do you make of what's happening here? It really is remarkable if you had told me at the start of the year that the 10-year bond yield was going to go to 5.25 or 3%, oil would be at 100 or higher for multiple consecutive days. I think that's kind of textbook units have expected the market to be lower. I think the reason that we've seen such resiliency is that we've got four earnings at nearly 38% for the S&P and it contextualized that. The only time you've seen earnings growth at 30% or higher is coming out of recession. Coming out of COVID, coming out of 2009, the GFC in 2008, that was the only other times you saw that. The earnings have been incredibly resilient and what's fascinating at is actually the market has gotten cheaper even though it's hitting all-time highs as we sit here today. That's the part. It is hot in a lot of ways to call the market overvalued right now when you've got the S&P trading at about 19 times forward earnings below its five-year average. I guess the question, we should try to understand what the risks actually are here. Some are questioning the earnings themselves. The earnings are exploding and that's why you've got, based on those forward earnings, a cheaper market. Some people are wondering, to what extent can we trust these earnings? Do we think that these earnings are sustainable, durable? What do you make of that? Because you're right, the earnings growth is tremendous and it seems to be the thing that's powering this market. Yeah, I'd say a couple of things. You're getting a lower multiple. That's textbook for when you have higher interest rates. The market is responding appropriately, interest rates are up and so that's pushing the multiple down. But you have substantial earnings growth and that's why the market is at all-time highs. If we think about are those earnings durable, there's a lot of people that look at the AI trade and they think, "Hey, is this a bubble?" I might take the other side of the equation. I might take the side that maybe we're mistaking a bubble for a boom because when I look at the durability of earnings, it's a cross-sector. This is not one group. I think there's a misconception in the market that this is a narrow trade and I keep hearing people say that only a handful of stocks are holding the market up. I would take the opposite side of that. Small caps are doing well this year. There are double digits, mid caps are up double digits and you've seen tremendous performance out of refiners, industrial machinery, material stocks. There's a whole cohort, I think that the counter to that is well, is that being driven by kind of the capex cycle, which is roughly 900 billion coming from the hyper-scalers. My answer is larger, yes, you're seeing a lot of that come from that, but the counter is, would you rather there not be strong earnings coming out of an investment capital cycle? I would rather have the setup we're in, which is where we have low valuations, strong earnings growth and actually a backdrop that might get a lot more favorable. Should we see some alleviation in oil prices or bond yields as we look into the next six, 12 months? The reason that this breadth question is coming up, this idea that the market is so narrow or that it's so concentrated right now, you're right when we look at the full year that generally speaking, it's been pretty good. But over the past couple of months, just looking at individual stocks in the S&P, the equal weight is down since August, more than half of S&P companies right now are in a bare market. I mean, at least over the past few months, basically since the end of the summer, it has been all tech driving the gains. I guess what would you say to that pushback? It's a great point. I mean, small caps are pulled back. There's no question. So why is that? I would always use directly tied to what's going on with bond yields and with oil prices. Because if you think about oil prices, that's a progressive tax. That's going to impact the smaller, medium-sized companies more. And then the smaller, medium-sized companies have less leverage to pull when interest rates go up. So Apple, Nvidia, Microsoft, interest rates going up doesn't impact them as much as the smaller companies for two key reasons. The first is that the cost of capital directly impacts their ability to go to the capital markets. And secondly, the smaller companies typically have more debt on their balance sheets. So you're more concerned about what it's going to be to roll that debt, get those interest expenses stay up. So that's the reason you've seen that. I think the small caps are kind of spring loaded here, though, because you are still seeing earnings growth there at 27%. So really strong earnings growth after years of kind of flat to no earnings growth in the smaller companies over the last few years. Are you concerned at all about the fact that we, just to at least over the past couple months, it has been a story of tech. Do you worry that it seemed as though we had kind of a broad market that was pretty diversified. You know, the equal weight was really strong. A lot of these small cap companies were doing really well. But now it seems like maybe we're reverting back to this sort of top-heavy dynamic where you have a handful of companies. Is that a concern for you or do you think that it's not a real issue right now? You know, we kind of had a little bit of a pretty harsh sell-off after June in a lot of the semiconductor and AI names. It wasn't just technology. It was also kind of industrial machinery that was tied to data center build-out or connectivity stocks as part of that kind of data center wiring that's needed for the capital cycle. So it's been a group, I think, that ironically, we kind of had an alleviation in that semiconductor trade. We've got some of the lowest multiples we've seen. If you look at the multiple you're paying for Nvidia. I think it's very reasonable. the market obviously. It is doubting the earnings, but I think that the re-rating and some of the tech stocks are warranted, given that you had a lot of compression kind of coming out of the end of a lot of the reconstitution actually that happened at the end of June and some of the Russell indexes. You had a lot of kind of pressure as those were reconstituting with some of the semi-names coming down. For example, a lot of the memory stocks were very large weights and some of the large indexes like the 1000 value and those completely got moved out. So I think you had some just kind of, I would say, technical selling pressure and so now you're kind of seeing some of those re-rate and I mean, micron just supported stellar earnings. So again, the results keep coming through and there's a lot of doubters out there. And again, I kind of go back to the case that maybe as opposed to doubting the build, it would be a little bit wiser to kind of look at how it's impacting kind of a broad swath of companies and participate because it's really good for the country if we're kind of at the lead and the forefront on the AI buildout, not just for national security but for productivity gains. The concern that I think is valid at least in my view is this circular financing concern that we have these earnings that are moving in a circle. That's largely why the earnings have been so dramatically large is because we have all of these big tech companies, these hyperscalers kind of trading revenues and recycling the revenues through the system. That at least is my concern. One, are you also concerned about that? But two, the follow-up is, is that priced in and I wonder if maybe at these multiples, when you look at the multiples on forward earnings, especially that maybe that is priced in and maybe this is a healthy market that is, you know, acknowledging the risks. Well, and I couldn't agree more. The circular financing is something we've got to pay very close attention to and I'd actually extend that further to. We really need to see how much of this is going to be financed with debt versus cash from operation. So I kind of put both of those as kind of the worry poles on the first one on the circular financing. I mean, let's take Amazon, for example. They had a great previous quarter, but it was criticized because of the gains they had with Anthropic, which is a large investment they have, which also buys their chips. So that's kind of a circular argument. So I think that, you know, we need to see validation from third party independent sources. But I think that the circular financing, to some degree, is part of the ecosystem. When the largest companies in the world are driving the capex cycle, it's inevitable that you're going to have some of those customers buying products from these companies. And we have to remember, these companies are like their own countries. So I mean, these are massive enterprises. So I think that the circular financing is, to some degree, expected, but it is a concern. We do need to see independent demand and so I completely agree something to watch closely. Something that I am watching closely is how some of these operations, particularly with these investments are being financed to the extent that they're being financed from debt and not from cash flow from operations that is a concern. And we need to see demand materialized to justify the amount of spend that's coming. I think the return on, the return on the AI trade, that's the real question. You know, everyone's spending what's the return going to be? The flip side is you have to invest to state competitive. So it's why markets do create bubbles because it's not that people are stupid. It's not that people don't understand that you can spend too much and over build data centers. You get that, but the risk of not doing it is that you fall behind in a very competitive space that is moving at the speed of light across the globe. The return on the AI is so essential because as you say, the system is dependent on that capex right now. That is what is driving the earnings growth and the only reason they're willing to do that is because they think that they're going to get the return. We haven't seen it yet, at least among those those those extremely large spenders within their own businesses. So I guess if that doesn't show up or if it underwhelms in any way, you might see a massive reduction in that spending and therefore you'd see a reduction in the earnings growth, which I think goes to the sustainability question. I guess just sort of as we wrap here, do you believe that that is sort of reflected in these prices? Do you think that that concern is properly priced and therefore this is something to be not so worried about? You know, as my kids would say that it's mid priced, it's mid priced. I don't think it's fully priced. The market tries to discount, but it doesn't fully know what that return is going to be still. So I don't think we know on that one. I think that if you look at kind of the price and the demand for compute, everything they're points to that it's going higher and that actually contracts may reprice higher for compute ads. So we actually are still in a pretty you know, you know, you know, constrained market. To me, I think the real interesting dynamic, if I look at the S&P 500, just as kind of the broad market, it's trading at 19 times, it's growing at 38%. We've got bond yields over 5, 5.25 today, oil and a hundred. If you see oil prices move lower, interest rates should come off quickly and the market should rip. So I think that it's actually to the upside, risk to the upside that the markets move substantially higher and that people are off sides because they're trying to kind of deconstruct and decompose is the AI trade real and maybe missed the upside move. I mean, markets would be substantially higher if the conflict in Iran had been resolved. And that's dragged on longer than, you know, folks in Washington would have liked and that's really keeping kind of a coil spring underwater for the market. Is it your expectation that yields will come back down soon? Let's break this down. The CPI, you know, you know, to your bond yield forced the Fed's hand. The CPI should roll over over the next 12 months if nothing else because of the calculation. So even if oil prices stay elevated at, the way that calculation works when this is kind of the cruel economics of how inflation worked, it's not the things necessarily need to get cheaper. It's that the rate of change needs to slow. And that's unfortunately the way this is done. And so that right there, if I look a year out, I would expect the CPI to be lower. And so the Fed should have a easier time with interest rates potentially out of year. So my expectation is yes, oil prices come down, CPI, you know, gets a little bit weaker. And if earnings growth stays, we'll see what the next couple quarters produce, that's going to be real bullish on markets. John Murray is Chief Investment Officer at NFJ Investment Group. John, we appreciate your time. Thank you. Thanks, Ed. After the break, a check-in on the housing market. And by the way, my newsletter simply put was just nominated for a signal award. So please go vote for it at vote.signalaword.com, it would really mean a lot to me. Just type in simply put in the search bar, you'll find it, we'll also leave a link in the description to make it easier. The report for the show comes from NetSuite, successful business owners know how crucial it is to keep up with changing technology, so when it comes to adapting AI for your business, it couldn't be easier with NetSuite next. 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Joining us to discuss the housing market was speaking with Robert Armstrong, US financial commentator for the Financial Times, and author of the Unheged Newsletter. Rob, thank you for joining us. You just wrote about housing recently in the Financial Times. You wrote about the mortgage on your house. Tell us about that situation and what it tells us about the larger housing market in America. - The entire motto of my life, Ed, is that it's better to be lucky than good. And I was lucky in that I was at the stage of life where I needed to buy a new bigger house in 2020 when mortgages were like two, three percent. If you played your cards right, and I ended up with a good size two and three-quarters mortgage on this house. And now that looks brilliant. Now that we're at seven and a half percent, I have all this cheap financing, way below market financing. So I'm in this slightly weird position that one of or perhaps the biggest asset I have that I have is a liability, meaning some really cheap debt. And that actually has implications for the larger economy because there are millions and millions of Americans like me who got mortgages in the zero rates era, the kind of 2010s through 2020, and who now essentially boring something really great or really awful happening to them are never going to leave their home, right? Because if I get a great job offer in Cincinnati or London or Tokyo, I've got to give up this mortgage. And if I decide to downsize when my kids leave for college next year, same thing. I'm not gonna, right? So I'm going to stay in the house no matter what. And the effect of these, and it is, by the way, a somewhat uniquely American phenomenon. These very long-term 30-year fixed rate mortgages, subsidized basically by the government, which we can discuss in a second, very American phenomenon. The impact of this is that the market freezes when rates rise. So people like me, mortgage rates go up, people like me to stay put, and essentially the supply of homes or in any case the liquidity of available homes goes down, right? That's one phenomenon, the second phenomenon is nobody wants to sell their house for a loss, right? So people will always wait a million years rather than sell at a loss in a normal market, Ed. The price of financing this asset would have gone up and the price of the asset would have gone down. But because people have trouble accepting the fact that they're selling their house at a loss, again, the market freezes. And so that's fine for me. I'm in this great house in Brooklyn, everyone's happy. For you, age 27, Ed, maybe you live in a fabulous home that you own, but if you should be a renter-- - Yeah. - Nah, if you should be a renter, you're on the outside looking in, right? - Yeah. - And there's less houses for you to buy, and the price of those houses hasn't fallen, even as the price of financing them has risen, which is kind of crazy. So what happens as a result of that? Prices don't fall, transactions do, right? So we're running along at about four million home sales a year now, which is the same level as right after the housing bubble burst 15 or 20 years ago. So it's not a market crash, it's a market deep freeze, and that's extremely bad for young people, even as it takes care of old people like me. - You wrote that the, quote, the prevalence of the 30-year fixed rate mortgage is a policy choice. In other words, we have decided to set this system up this way, where you have rising rates that don't even affect the price of the house. - Yes. - You would think that as you say, if the rates go up, the prices go down, we have a situation where rates go up, prices either continue to rise or remain extremely high, no one sells, and therefore no one, no one new buys a house. - There's no law that says thou shalt have 30-year mortgages forever and ever. But we do have this unique home finance system where mortgages like mine can be bundled into bonds, and those bonds have a semi-explicit guarantee from the US government in the form of their approval by Fannie and Freddie, who buy the bonds, bundle them up, and sell the bonds. So there's a kind of semi-explicit subsidy and guarantee that makes this product, the 30-year fixed mortgage, possible in America, where it's a lot harder and a lot of other markets. Now, you might say, this is great. This protects a lot of people like Old Armstrong, right? But it's pretty tough on the people, as I said, who are on the outside looking in. But this is the policy that we've chosen. This is the housing market we've chosen. - You also quoted the economist, Edward Lima, who said that quote, "Housing is the business cycle," but you said that is no longer true. What is the relevance of housing either being the business cycle or not being the business cycle? - So it used to be, we had kind of normal business cycles in the economy where sometimes you were in an expansion and sometimes in a contraction and these things went in slow waves of six or seven years or whatever it was. And Lima's point is that if you look down in the data, one of the biggest swing factors is the housing sector. The housing sector is not that huge a chunk of the economy, but it moves around a lot. So it's the thing that trinks the most and goes up the most because people buy homes when they're feeling rich and financing gets cheaper and then there's a lot of buying and then the cycle naturally turns as houses gets more expensive and nobody's buying. So it's this massive swing cycle. And remember, it's not just the housing transactions themselves. It's the paint you buy, it's the renovation, it's the money you spend moving, it's all of that related stuff. Now, housing has been because the market has been frozen since rates first really started to go up a couple of years ago. This part of the economy has not been contributing to GDP. And normally that would mean we were in the lower part of the economic cycle, right? Because housing is either detracting from or not contributing much to GDP. But we have something else said. So we don't need housing anymore. We have AI which has sort of taken the place of housing in this cycle, in that it is giving that important incremental swing to keep the economy growing. Or it's not the only thing, but it's a big reason. If we didn't have the AI boom going on, we would notice the absence of the housing sector as a contributor to the economy. Let me put it that way. And in a way, unless you're shopping for a house now, you wouldn't have noticed it. How does this all play out? Because I mean, I've looked at it. But housing prices for a while, they continue to go up, or at least they stay high. I keep thinking at some point, something has to change, and you point out that we are looking at price levels here that looks very similar to basically the top of the housing bubble in 2006-2007. But it almost feels like we've been stuck in this moment for years now, and it never seems to arrive at that turning point. So I guess my question is, what would it take for things to change, and do you think things will change at any point in the near future? Part of the puzzle here that we haven't talked about is housing supply. And part of the reason the issues I've just discussed are so severe in this country is that it's not particularly easy to build housing here for reasons that involve zoning regulation, the price of land, all kinds of stuff. And it feels like we're at a moment where some of the ice is thawing in that area. This law was passed this summer with bipartisan support that is without the president's signature, of course. I forget what he was mad about, that he didn't sign it, but he was mad about something else I wouldn't sign it, that makes it possible. I mean, the key things it did were basically, localities have an incentive to roll back zoning regulations. The problem with changing our zoning problem in this country is that it's all at the local level. So the nimby's are solidly in charge of local zoning. And this law did something to change that. And you hear, I think people are becoming more aware of how big a problem this is. So slowly, slowly, we have to get better at being a society that builds housing and builds the right kind of housing that young families need, basically. In the, you know, as that's happening, it's very, very hard to get home prices to go down. And they can be kind of stable and inflation can bring them down in real terms, but it's hard to see anything more than that happen in aggregate, even in the housing bust, housing prices didn't fall that much. They just stole, you know, they went down, you know, whatever, 15% nationally or maybe 10% and then just stalled for a while, right? And became cheaper in real terms as there was a little bit of inflation. So it's hard to see any quick fixes here, but we hope the country gets religion on zoning and building. Is now not the right time to buy a house, do you think? Of course, it's always situational, it's always based on locality, but if we were to, if someone were thinking about buying within the next, I don't know, one, two, three years, wait. I mean, there's a difference to, you know, is it time to buy as an investment as a time to buy a place to live? And the advice I've, I've followed in my life, which I got from other people was that, you know, you should buy a house if it's a reasonable price for buying the service you're getting. Which is a place to live. What I don't think you should count on, which my, you know, and parts of my life, it has worked. It definitely worked for my parents is betting it's also going to be a savings and investment vehicle. Yes. I think you have to buy the house because it's a house. And, you know, and then it's just a matter of, you know, what do you got in your pocket and what are you getting for the money, you know, depending on where you live? You should honestly, is a decent argument for renting because that's what renting is. It can be. And so I think renting, and there's a lot of countries, right? Where renting is just the norm. Again, it's a uniquely American thing that we necessarily think of our homes as the thing with which we save for retirement. This is probably not a very good idea. 100% but it's how we do it. I could go on for hours with you about this, but we have to wrap it up. Robert Armstrong is US financial commentator for the Financial Times, author of the Un-Hedged Newsletter. Rob, really appreciate it. Thank you. Always fun to be on the show. Paramount has officially closed its 111 billion dollar takeover of Warner Brothers Discovery. The merger will hand over some of the world's largest media assets to one of the wealthiest people in the world, or more specifically the sun, of one of the wealthiest people in the world. David Ellison will run the company. David's father is of course Larry Ellison, the founder of Oracle, and also the eighth richest man on the planet worth an estimated $193 billion. So Larry provided the lion's share of the financing, roughly $47 billion. The Gulf states provided another $24 billion, that includes the sovereign wealth funds of Saudi Arabia and Qatar and the United Arab Emirates, and the remaining $50 billion was financed with debt, and as a result the combined company now faces a junk credit rating, as its leverage ratio approaches nearly eight times earnings for context, that is roughly 300% higher than most investment-grade corporations. So what is in it for David Ellison? Everything. The air to the Oracle fortune now controls practically all of American legacy media. He owns the Paramount production studio, the Warner Brothers production studio, CBS News, CNN, HBO, HBO Max, TNT, TVS, MTV, Comedy Central Nickelodeon, the Food Network, Paramount Plus Pluto TV, the Star Trek franchise, the Mission Impossible franchise, the entire DC Comics universe, and also the entire Wizarding universe of Harry Potter. Put it this way. Any storied media entity that you grew up with and that still exists, he probably owns now. The ultimate question is, why does he want all of this? And why would he risk so much of other people's money to get it? There are a lot of theories that are floating around. Some believe he has a political agenda, others believe he has a geopolitical agenda, and some think that this is just a case of billionaire mind control, that this is his attempt to brainwash the American public into believing whatever it is that he believes. And I get it, it's not out of the realm of possibility that those things might be true, but my take is a lot more simple than that. My take is that this is a rich kid who is bored, whose dad is a sion, and who wants to make a name for himself. And so this is how he's decided he is going to do it. And by the way, it wasn't that hard. Now I also want to be clear, I don't think that that is a good thing. I don't think it's good that the children of billionaires have gone from buying boats or houses as their pastime to now buying the entirety of American media. To me, that is a signal that wealth inequality has gone at least a step too far. But indeed that is where we are today. David Ellison controls the media because his dad is Larry Ellison. And by the way, this is a story we are seeing more and more of. The next largest media company in the world is Comcast, which is run by the sun of the founder Ralph Roberts. After that you have Fox Corporation, which is run by the sun of Rupert Murdoch and the New York Times, run by the sun of Salzburg, Jr. And don't forget who David Ellison bought Paramount from. He bought it from the daughter of the billionaire, some note Redstone. So the reality is that the world is increasingly being run not by billionaires per se, but by the children of billionaires. And that's not to say that they're bad people, I'm sure many of them are great. It's simply to acknowledge that the reason they are in these positions of power is because of who their parents are. In fact, more than a third of billionaires today become billionaires not because they started companies, but because of their inheritance, because essentially their parents died. So we're starting to see the crystallization of what we call the inheritocracy. We see it in this 111 billion dollar transaction. We see it in the rest of media. We see it in government. We see it in business. Power in America is increasingly being inherited, not earned. And the question for us is whether we are okay with that. Okay, that's it for today. This episode was produced by Claire Miller and Alison Weiss and engineered by Benjamin Spencer. Our video editor is Brad Williams, our research team is Dan Chalon, Cristina Donahue and Mia Silverio. And our social producer is Jake McPherson. Thank you for listening to Profty Markets from Profty Media. If you liked what you heard, give us a follow. I'm Ed Elson. I will see you tomorrow.