It does take us to our talk of the tape, the full run, which marks its two-year anniversary tomorrow. Let's welcome in Tom Lee, Fundstrat's managing partner, head of research, also a CNBC contributor. It's good to see you on this Friday. Welcome back, Tom. Thank you, Scott.
Great to see you. I let in here with the fact that, you know, we have this streak going for stocks. We're above 5,800 for the S&P for the first time ever, though it seems to me from your notes that you're a little bit cautious as this month progresses.
Why? Well, Scott, we're cautious, but we advised our clients to be buying the dips. And the reason we're cautious is that, and I'm probably saying something very obvious, but I think investors want to see who ends up becoming president after Election Day. So I think we are in a period where markets are just sitting on the sidelines.
But at the same time... 2024 has been such a strong year, Scott, that I think the last two weeks have proven that maybe macro is taking a little bit of a step back now, and liquidity and all this cash on the sidelines is really the dominant factor. You think we just have to get the election out of the way, and then it sort of clears the way for what you still think can be a pretty decent rally? I think your target's 6,000 or around that? Yeah, Scott, there's a lot of firepower supporting stocks.
post-election, because we've got a Fed that's dovish and the economy looks healthy. I don't think we're in a recession. And so the three-month and six-month outlooks are very strong for stocks.
And I think China, while there's maybe some hesitation, but China's government is really starting to unleash some measures. And that's supportive of that region finally turning. And of course, the third factor is I think after two years, investors who've been very cautious are starting to realize that, you know, the six trillion of cash on the sidelines and the low levels of margin debt need to be put to work at a time when the Fed is supporting the economy. The other possible headwinds, I think, are ones that are maybe outside of the political cycle, at least as people, you know, refer to them.
Valuations, they say, are too rich or stretched, right? The S&P is about 21.5. That's above, obviously, its historical average. Yields are up. Now, you could make the argument that they're up for the right reason, but I think they're still up a little bit more than people thought they might be after the Fed did its 50. And then if the Fed's going to be a little bit slower and smaller in the way they progress with rate cuts, is that an issue?
Of course, the flip side of that is, well, why would they need to do anything anymore anyway? Because the economy is as resilient as you just suggested it is. Yeah.
Well, on all those points, Scott, on valuation, I know people use the aggregate number for the S&P, but it is misleading because as we know, the top seven stocks do have a higher deserved multiple. And the median PE, it's not that much cheaper, but it's around 18 times. But that's not a bad deal considering the 10-year yield is actually a 25 PE. And with regard to the Fed cuts possibly slowing, I think the What really matters now is the Fed is on a path to essentially normalize interest rates back towards neutral because the inflation pressures are ebbing. I mean, I think even CPI this week, even though it was a little hotter than expected, really didn't send a signal that inflation is reaccelerating.
And so the Fed is on a path towards 3%. And I think that's really constructive for stocks. Let's say we can all kind of come to agreement because I think.
We could say that the consensus is bullish at this point. People think stocks are going to go higher from here because of the economy and rate cuts. The principal disagreement among the crowd at this point appears to be where.
Where do you need to be positioned to take advantage of a market that looks like it really wants to go higher? You obviously have suggested that small caps could have the opportunity to have the biggest jump between now and the end of the year. That's a controversial view because. You know, if yields are elevated, if the economy is slowing at least a bit, or there are questions around it, maybe those stocks don't do as well. I thought it was interesting, the thoughtful commentary that Ricky Sandler put forth of eminence yesterday on social media, to where he says the best place to play offense, and he thinks you should play offense, are in below mega cap companies that have interesting earnings equity stories at mid to large cap, not mega.
but mid to large, and he doesn't say small. So how would you argue your points against those? I mean, I'd say that we're on the same side of that line, which is market breadth is expanding, and he sees a better risk-reward. in mid to large just because he, I think there are some reasons, you know, there's argument that maybe you can find higher quality and longer histories. But I think that small caps really do perform when the market is believing we're having a soft landing.
I don't think that they can make that case in their mind yet until after election day, whether or not Harris or Trump is president. But I think once we're through that period. I think small caps not only have underperformance as a tailwind, but it's really, and I know I'm repeating myself, but median PE of a small cap stock is 10.7 times.
It's like seven turns cheaper. We're already looking at third quarter earnings growth of 43% versus around under double digits for S&P. So you're getting better growth.
But I think small caps probably do better if Trump wins just because of- potential deregulation in M&A. So I think that's why Election Day probably is a pivot point for small caps. Would you agree with Mr. Sandler that, you know, the market at the index level is both expensive and consensus? And that's why, you know, he has the urge to look elsewhere.
You know, mega caps are underperforming, or at least the Nasdaq is today. And maybe that's how the story is going to end up playing out for at least two of those reasons that he mentions. Well, I think if someone thinks PEs mark the top of stocks, then people are cautious.
But to me, the PE is rising because the U.S. economy and companies survived a stress test, Scott. We had a pandemic. We had global trade stop. We have a huge inflation cycle. The Fed, the fastest rate hikes in history.
Let's say four things that just bombarded corporate earnings and companies are producing record profits. So to me. They survived a stress test that warrants higher multiples.
I just don't personally think 20 times for a category-leading company is expensive, even 25 times. And if we're talking about NVIDIA, I'm not sure the cap should be 30. So I think that we have this uncomfortableness because PEs are rising, but I think companies have really survived four cataclysmic stress tests too. Tom, let's broaden the conversation.
Let's welcome in some guests. Shannon Sikosha of NB Private Wealth, RBC's Lori Calvacina are with us today. Shannon's a CNBC contributor. It's great to have you both with us. Lori, you're reasonably cautious on this market.
Your year-end target is below where we are today. Why? So look, we do five different models to come up with our target, and a couple of those actually did go up to 5,800. The 5,700 is the median, essentially. And, you know, we do feel neutral in the short term.
I think a lot of the stuff, you know, that Tom talked about, you know, kind of getting through this election, we do normally see a bit of a pullback prior to the election. We haven't gotten that yet for October. But I do think valuations feel a little bit full for the here and now. When I fast forward, though, into 2025 and I run my valuation numbers and we take inflation down a bit more, we bake in some more Fed cuts, we get 10-year yields down a little bit more.
Our modeling suggests you can get to a 23 times trailing PE and if you use my earnings around 268 that gets you to 6200 on the S&P. 6500 if you bake in consensus earnings. So I still feel reasonably constructive over a longer period of time but right now the valuations kind of we feel like we're where we deserve to be and sentiment is a little bit stretched.
You think that It could be a little tactically messy between now and the end of the year as the election takes center stage? I think that's a perfect way to put it. And, you know, I tell people we can't live in the tails, right? And maybe I'm a little bit too guilty of doing that right now. But we do think that, you know, there's just a lot of uncertainty related to this election.
And one thing I hear from investors is what if we don't have a resolution, you know, sooner rather than later? I'm not saying it has to be decided the next morning. But there are some concerns about kind of what awaits us on the other side.
And if you even look back to 2000, when the case got kicked up to the Supreme Court, that's one time in recent history where we didn't get our typical post-election pop. Yeah, Shan, what about that? You know, the market has this incredible tunnel vision, it seems. It doesn't seem to be too worried about what might happen with the election today. But obviously, as we get closer.
It's going to focus more heavily on what it believes the outcome might be and thus what sectors and stocks are going to possibly perform better in the months ahead. How are you thinking about those issues that Laurie so well articulated? I don't disagree.
I mean, we do have that one particular example of uncertainty leading to, you know, significant weakness in terms of the market trading in 2000. I think the most important thing that we're looking at, though, Scott, is that. You know, there is, I think we talk a lot about the difference between between the two candidates. I think it's important to focus on the similarities.
If you think about things like deglobalization, if you think about the protection of certain important industries, the CHIPS Act, infrastructure, Inflation Reduction Act, there are parts of those spending bills that will continue for many years to be stimulative to the economy. And so I think in this shorter term positioning, of course you're going to be looking at what does it mean for healthcare companies. What does it mean for energy?
What does it mean for defense? But I think more importantly is looking to some of those similarities and understanding that you can capture opportunity going into 2025 on those areas of similarity that, frankly, are unlikely to be upset by either candidate. I do agree that we'll see some uncertainty if we don't get that answer fairly quickly in the days following the election. But I think in terms of seasonality.
Boy, we've kind of blown those comparisons out of the water with September already. So I think we should be geared up for something perhaps a little bit different than what we've seen historically. Lori, what about rate cuts? You know, there's a—I feel like the market has like one and a half feet on the idea of resetting expectations thoroughly now as we move forward.
I don't know that we're all the way there, but Ed Yardeni sat in his chair yesterday and said— One and done. He doesn't think they're going to go anymore this year. Bostick yesterday was on the tapes. Yeah, I mean, if the data suggests it, I could be totally comfortable with not going again right now. I'll go back to my valuation model.
I can only really make the math work to get us higher if I get in a decent number of cuts next year. And, you know, I will say that as a house, RBC has not been looking for a series of 50. We were back in the 25 camp. Our rate strategists were on that last meeting.
Which was obviously a very divisive meeting, but I do think in general, you know, whether I'm talking to hedge funds, whether I'm talking to long-onlys, they've been anticipating some significant interest rate relief. And if you even go back and just listen to companies and what they've been talking about the last few quarters, how many times have we been hearing about the cumulative impact of inflation and uncertainty over interest rate policy as something that is restraining not only consumers but corporations in their business activity decisions? And so I really think if we don't... You know, we just can't sit here and keep debating.
We need to know the outcome of this election. We need to know what the Fed is going to do, that they're on a particular path, or actually you're going to see this paralysis in corporate America, frankly, I think, get worse. Okay, so Tom, rate cuts justifying the multiple of the market.
Laurie makes a good point. It's like if you were justifying the valuation before based on the number of cuts you thought we were going to have and the size of them, And then those don't live up to that expectation. Then how can you justify the multiple being where it is? Well, I think maybe, you know, if we step back, we never know what's priced into stocks.
So I think it's hard to say how many cuts were priced into the equity market multiple. I think stocks are being supported because there is a lot of cash on the sidelines, Scott. You know, I mean. I just think a simple thing to point out is margin debt is like $730 billion or something right now.
It was $936 billion in October 2021. So in the last four months, margin debt has actually been flat, actually declined. So there's less money buying stocks, but they're being supported. I think it's because they're being bid. I don't really know how many cuts were priced into the PE.
I mean, none of us really do because there's so much that gets priced into Y. Stocks are where they are. I mean, there's never really equilibrium in a stock price.
No, but something's got to give, though. I mean, at some point, I mean, earnings have to live up to a higher expectation, potentially, if you're not going to get the cuts that you might have thought you were going to get in order to justify the multiple that stocks are trading at. Tom, don't you think? True.
I think one thing we have to keep in mind is that there is excess interest rate cost in the economy right now because the. The mortgage, the 30-year mortgage should only be 1.7 percentage points higher than the 10-year yield. So in a normal environment, the 30-year mortgage should be at 5.7. I think it hit 6.7 this week. And we know credit card debt is going to get cheaper and auto loans and small business borrowing costs and home equity lines of credit as the Fed cuts.
This is going to unleash not only East's financial burdens, but unleash pent-up demand because we know I mean, just look at the ISM. Companies have been cautious for two years now. I mean, if companies are cautious for two years, it's not as if the economy grinds to a halt. It's now two years of pent-up demand that has to be normalized, and that's why earnings could really do well next year.
Shan, you agree with Tom, and I think Lori agrees with both, that it's these other non-MAG-7 areas of the market. And if you want to go all the way down to small caps, you can put those into the groups you think are going to be the outperformers moving forward. Yeah. I mean, higher credit growth, Scott. I mean, we're talking about lower interest rates.
We're talking about stabilizing inflation. Clearly, Tom made an excellent point earlier on the relative valuation. But can I just go back and talk a little bit about positioning? Because you just asked about the multiple of the market and thinking about valuation.
And Lori talked about what's happening in terms of the path of interest rate cuts. There is a lot of volatility in the bond market. There's a lot of volatility in the yield curve. But what's not as volatile and what is pretty certain is that rates in the short end of the curve are coming down. So, Scott, I would I would say that.
One of the areas, as long as we continue to have this data dependency, this whipsawing from meeting to meeting in terms of expectations for the Fed, how many rates will they, how many rate cuts will we have? What does that look like for 2025? That actually supports positioning and flows into the equity market despite the valuations because there are these other factors in terms of the boost to underlying earnings from a resilient economy, better credit growth, lower costs, lower rates.
All of that sort of supports this outsized multiple, at least right now, as cash is coming out of the short end of the curve. I mean, Laurie, that kind of Rick Reader's point when he was sitting with me recently was like, look, the market is stretched. But and I'm uncomfortable to be bullish here, but there's so much money around that it's really hard not to be.
I totally sympathize with that. And again, I don't feel bearish longer term. I would say, though, tactically, you know, when I hear the word positioning, you know, the hairs on the back of my neck go up a little bit, because if you look at AAII net bulls, we've been hovering around the one standard deviation mark in recent weeks.
And that's tactically where in recent years we keep having these five to 10 percent drawdowns. If you look at the CFTC data that comes out every Friday, and I haven't seen today's, I don't know if it's out yet. But it's been just climbing higher and higher and higher for S&P contracts, for Nasdaq contracts, it's been bumping up against historical highs and those are charts that when I talk to my clients in meetings we all sort of agree they keep you up at night. So the positioning does feel a bit stretched and even if you want to look at Federal Reserve flow of funds data, equity holdings as a percentage of the financial assets are sitting up around peak. So I absolutely understand and sympathize with the idea of where else are you going to go and things still look okay.
But we are at the same time hitting some tactically concerning pressure points. Yeah, yeah. Tony Pasquarello, I've cited him often too.
He's a Friday note drop guy. And he talks about the flow of capital, tips the scales in favor of the bulls, like many are talking about. I really appreciate the conversation, everybody.
Lori, thanks for being here. Shan, thanks. Tom Lee, be good.
We'll see you soon.