October 2, 2024 – Listen to the full episode: Click Here
Excerpt: “We believe the move started later due to the stall on inflation in the first and second quarter. But as that stall ran its course and we got lower inflation numbers, it set the Fed up with the labor market slowing down. That set up a perfect rate cut cycle.
That’s where we are now. We like the real estate market, the bond market, and small and mid-cap stocks. That’s where we’re really positioning over the next year.”
— Brett Ewing, Chief Market Strategist at First Franklin Financial
Full Transcript – This transcript is automatically generated from conversation and may contain errors. We appreciate your understanding and encourage you to verify details.
Chuck Welcome to The Big Interview on the October 2nd edition of Money Life. Joining me now, Brett Ewing, Chief Market Strategist at First Franklin Financial. If you wanna learn more about First Franklin Financial Services, go to firstfranklinfs.com. Brett Ewing, it’s great to have you back on Money Life.
Brett Thanks for having me, Chuck.
Chuck Let’s start with basically where we are as we enter homestretch for the election, and we’re now into the fourth quarter, which is this market has been better than pretty much everyone expected, when we were doing year ahead forecasts. It’s now finally gotten the rate cuts, which should potentially fuel some more growth, but there are a lot of things happening that are overhangs. So are we pretty benign to the election because that’s what we’re supposed to be, and that’s when things will get interesting, crazy, whatever adjective you wanna pick for it, or we’re set up to keep this run going for a lot longer?
Brett Well, Chuck, like you said, it’s been an incredible year with markets so far. In fact, we just had our best nine months ever to start an election year. You know, I was looking back, going back to like 1950. There’s only been nine other times the market’s been up this much going into the fourth quarter. And going into October, seven of those out of the nine, we saw a decent correction. So, you know, looking at going into this election, my expectations are I think we could easily see a 5% to 10% correction.
I would like to note, though, there is a lot of cash out there in money markets on the sideline that probably would jump in and support any bigger correction.
Chuck In other words, we can only see so much downturn before that money comes off the sidelines and gets involved. But the question that I would have about that as well is with rate cuts, and there was an interesting piece that was talking about how much money is in CDs because people were going in that direction. That’s now those CDs are coming due. Do we wind up having a situation where the rate cut regime really makes it that a lot of money, whatever the market has, gets repositioned, like there’s a lot of impetus, at least enough to make sure that we’re not going to see anything worse than a soft landing?
Brett Yeah, absolutely. What you’re saying is true. There is a record amount in probably the last 20 years in CDs right now and also two-year treasuries with retail investors. So I just did a presentation back in August, and we called this the cash problem, right? So everyone’s piled into these instruments, and now we’re going into a rate cycle. And if you look at the futures markets regarding the Fed rate cycle, a year from now, we’re looking at probably another one and a quarter cut. That means that these CDs are maturing into threes, low threes, if not high twos And where does that money go? Because likely they’re not going to renew there. We believe that the money will chase yield and probably slowly go into fixed income. And we think that’s actually one of the best asset classes you could have over the next 12 months. Historically, when the Fed has started their cut cycle, bonds have actually outperformed equities for that first 12 months. And we think that’s kind of where we are with the cash problem.
Chuck Interesting, because you’ve got a market that, as you said, is poised for at least a mild correction on the short order. But again, having bonds outperform stocks in the first year after a rate cut means that if we get through a stock correction, we would see things muddling along, not necessarily bad, but just not great. Is that what you’re sort of postulating now is your outlook for 2025?
Brett Yeah, I just think, yeah, I think, well, I think bonds are, you know, a great, the risk reward right now, starting the rate cut cycle with fixed income is on the investor’s side, right? So we’re looking at very low downside risk with fixed income. with excess potential upside risk over the next 12 months, with equity like returns, including the yield. So, you know, even though I said here in October going into the election, I expect volatility to the downside mainly.
I do believe that we in the fourth quarter higher for the year. And I think there’s an opportunity the S&P could get close to 6,000 by January.
Chuck That would be a nice run. Is there, are there areas of the market that you think are gonna be giving us leadership? And, you know, as you talk about a market that has a little bit to go through, et cetera, are we rotating away from the magnificent seven or are we still riding at least a few of the seven here?
Brett Well, Chuck, you know, I was back on your show in January and we had a big discussion about what I thought would be the leadership this year.
Chuck Yes, we did.
Brett I think I’m gonna end up, I’m gonna end up being right, okay? But, you know, it was, nothing works on our timeframe, right? That’s just not how it works.
Chuck We better tell people what you’re gonna be right about.
Brett There’s been a massive move and underweight investment going on in small caps. They’ve been in a two-year box that they’ve been trapped into. Well, something interesting happened in early July when finally we got the inflation numbers and the job numbers that were needed to align the Fed with rate cuts. And if you recall, in probably around July 10th or 11th, it was one of the largest upside moves in small cap stocks that we’ve seen in many years. Over a 10% rally with just a few days.
Now that’s only happened 18 times since the inception of the index, Chuck. And every single time, the average return, looking back at those instances, was the average return over 12 months was 35% upside from that moment. Now if you take a look at July 1st, the entire third quarter, guess what ended up outperforming? It was the Russell 2000. It outperformed the large cap growth and it outperformed the S&P 500 almost by a third. 75% and so I do feel that rotation is real and it’s actually happening you know we’re seeing that rotation out of the large cap into other areas of the market like industrials REIT by the way were a great performer in the third quarter and again you know one of our calls is the bonds as well so and again.
Chuck this is a change that will carry into next year it’ll push through a coming correction etc but this is how you’re looking at having assets deployed into.
Brett 2025 absolutely and I we believe that yeah the move started a lot later because of the stall on inflation in the first and second quarter but as that stall ran its course and we got lower inflation numbers set the fed up with the labor market slowing down that set it up for a perfect rate cut cycle that’s where we are we like the real estate market the bond market we like small and mid-cap stocks and that that’s where we are, we’re really positioning over the next year. We think relative performance will those areas.
Chuck will outperform versus large cap growth. Now, you’ve already talked about what you think is going to happen with the market basically post-election as we because of where the market’s been and what typically happens. But longer term, do you look at this election and think there’s much market impact regardless of who wins? You know, I was talking about I was.
Brett doing a presentation back in August. And one of the topics, of course, we want to tackle election, right? Because everyone’s asking me questions. I have a lot of retail clients throughout the United States. And they’re like, well, what do you think about the election? Who’s going to be president? All this stuff. And you know what I say to them, Chuck? I say what the probably I like to pay attention to more is the makeup of Congress. All right. Because that really does matter. And we have a major tax bill that’s set to expire. It’s not being the can’s being kicked down the road. That’s going to be more impactful, in my opinion. if that just frankly expires, without some work being done on it, that’s gonna affect the economy much more. It will affect earnings and the economy much more than who’s sitting in the White House right now.
Chuck Yeah, I tend to agree as well, but I always wanna just double check and make sure everybody else is reading that the same way. Now, for you, given everything that we’ve got going on here, what’s your take on domestic versus international? Because the Fed was kind of playing catch up on the rate cut front. Now other foreign central bankers are responding. Are you at a spot as you talk about the rotation, where some of your rotation is finding places internationally that you wanna head to?
Brett Well, it’s only international front. We really like, we’ve been diving into emerging markets and for the past year actually, buying in there when it looked really rough, right? But it’s paying off. And if you look at, especially on the emerging market debt front, we really- like that space as well. We feel like there’s a low-risk reward. We think the dollar will slowly trend down over the next year. It’s had a nice run, but we feel the trend is down. We feel like the rate cut cycle is intact over the next year. And we think that’s a really good tailwind for the emerging markets arena.
Chuck If you are making a call for emerging markets, there is an obvious follow-up question that needs to be asked during these times, which is, are you including China? Are you doing emerging markets with or without China? And why?
Brett You know, being a market strategist, we would probably, that’s an area in the emerging markets that you want to sub out. I’m not a huge direct China investor. We don’t really put that in our portfolios. But when we lean towards emerging market managers to dive into that space, we kind of leave discretion to them on that. Again, we’re not focused on China per se directly, but it probably is getting there. picked up in some of the emerging markets, especially on the equity side, it’s hard to be like completely out of there.
Chuck Right. But again, for a lot of your emerging markets work, you’re using funds. So you’re basically presumably you’re having a discussion with your clients about do you want or to include or exclude China and then let’s go buy a fund that is either X China because it says it is or it includes China.
Brett Yeah. We try to focus on the quality of the managers, not just pick just directly X China. But I do focus on what exposure they do have in there. And we we lean towards lower exposure to that arena.
Chuck Because you are an advisor and you see clients, you know, there’s been this huge disconnect that has been talked about in this country between what the economic numbers are seeing and then how people feel about it, that the market’s at record highs. Presumably your 401k balances are pretty close to record highs. But you don’t like what you’re paying for bread at the grocery store. You don’t like what you’re paying at the gas pump, so you feel miserable. When you are dealing with clients and they are very nervous about current times, how much of their nerves are just emotions getting in the way?
Chuck How much of their nerves are, no, you should be nervous. You don’t have enough saved. You do have tough sledding. What percentage of people are worrying themselves more than they are performing themselves into some trouble?
Brett Yeah. So when we talk to investors around the country, I think one of the things, you know, they, everyone is talking about inflation and that’s fine. It is coming down. We’re talking about just, you know, the economy is in pretty decent shape here. The Fed is starting their rate cut cycle. I think one of the things that a lot of my clients feedback I’ve been getting is really, you know, the geopolitical situation. It’s just when you look around the globe at all the things going on, I mean, it’s pretty chaotic right here, to say the least. That makes people really nervous when it comes to markets, and we always have geopolitical issues. They’re always there. Every single year, I’ve been doing this for 26 years, there’s always geopolitics. But today, it is elevated more than normal. I mean, we just had the State Department come out and say Iran’s looking to shoot off ballistic missiles into Israel right now. I mean, so these are just extraordinary times, and that’s a lot of the feedback I’m getting. But with regard to this disconnect that you’re talking about, Chuck, I think the story there is you got three groups of people, right? You have the have-nots, the have-sums, and the have-a-lots.
So when we’re in this high inflationary period, the have-a-lots, they look around, their asset prices are all up, whether it’s art, stocks, real estate, what have you, it’s doing well, right? The inflation thing’s not really a bothersome. The have-sums, they feel a little bit, right? They go to the grocery store, they’re not happy anymore. about it. They have a 401k, though, and they also own real estate. Typically, those people are feeling they’re not happy about paying more, but they get along. They’re still have discretionary income in their spending, but they have not. These are the people that are out there, which is the majority of Americans. They live paycheck to paycheck. Very little money in a 401k. They don’t typically own real estate. They rent. Rents have skyrocketed. Groceries have skyrocketed. Utilities, everything that they must spend to survive on in this country is absolutely crushing them. And that’s where a lot of the disconnect comes from. So the have-sums and the have-a-lots are enjoying a pretty decent economy out there, but the have-nots are getting absolutely demolished. And that’s where it’s all coming from.
Chuck Brett, really appreciate the perspective. Thanks so much for joining me on the show to talk about it. Absolutely, Chuck. My pleasure. That’s Brett, you! Doing his chief market strategist at First Franklin Financial Services, which is online at firstfranklinfs.com and on Twitter at firstfranklin. We’ve got more to say.