The S&P 500 is up over 9% so far this year, the Federal Reserve continues to try to reign in inflation, and the Ukranian-Russian war roars on. Patrick Ryan examines the environment that markets are presenting and where he is finding opportunities from his position as Madison's Head of Multi-Asset Solutions.
Transcript:
Tim Van Pelt
Hello everyone, this is Tim Van Pelt head of the Private Client Group here at Madison investments. Happy to have a continuation of our conversations with the pm here in our monthly series. And today I have joining with me, Patrick Ryan, who's head of multi asset Solutions Group. Welcome, Patrick.
Patrick Ryan
Thank you glad to be here.
Tim Van Pelt
So while we certainly don't have a lack of things to talk about today, the debt ceiling legislation is going on as we speak. But let's jump right into it. You know, one thing that's curious to me is we've had two quarters now of domestic earnings declines, yet this market continues to raise higher, can you help explain what's going on for us?
Patrick Ryan
Yeah, it's a very unique situation, when you look at the s&p 500, it's been a really positive number a lot better than anyone would have expected this year, we're up over nine and a half percent through the end of May. And like you said, that earnings growth hasn't really been there for the last couple of quarters, has actually declined. But yet, you've seen at least the market level advance, but when you pull it apart, kind of look at what really what's going on. Under the scenes, you do see some signs of stress. So for the first five months of this year, only three sectors are positive, so the big growth sectors, so it's really just a handful of stocks that are driving the market higher and higher. Everyone's hearing about the AI craze, things like Nvidia, adding almost 200 billion in market cap in a single day. So certainly there are some very unique things going on. But again, we look under the hood, three sectors have been positive for the last six months, the last year to date period. And then also looking at some of the sectors that are doing poorly there are the more cyclical areas, things like small caps are underperforming, you have energy underperforming, a lot of things that are a little bit more economically sensitive. And small caps have been a little bit tied into the banking crisis that we saw and saw go on throughout the first quarter of this year. But certainly, their size and things are not altogether healthy and do reflect that kind of decline in earnings, you're seeing more on the broad base. So just a handful of stocks supporting the market, a lot of other stocks are down, I believe over half of the s&p 500 through the end of May, is actually down. So again, pulling it apart, it's been a year that's been driven by a very small set of stocks to the point of thinking recently, we looked at, I think an equal weight position of those seven largest real stocks was actually up 70% year to date, while the rest of the index was about 0.1%. And kind of even further looking at that when you look at the equal weight s&p 500. So the unweighting of those, take those large cap stocks and kind of neutralize them, that index is actually negative for the year. So about a 10% gap between the market cap weighted s&p 500 and equal weighted which brings in a lot more of those small cap companies.
Tim Van Pelt
Yeah, thanks for that, under the hood explanation. Looking outside the US the other curious phenomenon that we're seeing is significant earnings increases in Europe and other foreign countries, which for some of us is counterintuitive given the Russia-Ukraine war, and arguably bigger inflation problems over there than here. So what's what's driving earnings increases outside of the US?
Patrick Ryan
Yeah, I mean, you're exactly right. If you looked at Europe, you know, eight months ago, it looked like it was going to be a disaster from an energy crisis, the war on Ukraine, all of those things were kind of coming to a head. But a lot of those alleviated Europe had a very warm winter. So they didn't need as much energy as they thought they were going to need. Energy prices actually declined on that level. So some of that was cost, you know, health savings on the cost side, and Europe is a much more industrialized economy than the US. So they do have a little bit of benefit of some of those commodity prices declining. And then you also had China reopening. And Europe is also much more tied into Germany into China, in terms of manufacturing, that reopening helps stimulate a lot of the economies in Europe on the hopes that China would reopen which would go well, some indications now that that's not going quite as well as what it maybe was led to believe at the turn of the year. And then you also have to remember earnings are nominal number two, so the fact that Europe's inflation was so high, actually was also propelling those nominal numbers up quite high.
Tim Van Pelt
One of the unique things about your team within Madison Investments is every single day and week your team is looking across all asset classes, whereas other portfolio managers are more focused on singular asset classes. So sitting from your perch today, What risks do you think are underappreciated across the markets right now?
Patrick Ryan
Yeah, I mean, I would actually stick with one of them is just sticking to Europe, I think the whole Ukrainian situation is not getting any better. And more recently, it seems like that's actually accelerating a little bit with North skirmishes on the Russian border and a couple of different situations that things happening in Russia, approval of the F16. So certainly, everyone's anticipation over the last six, or eight months has been that this Ukrainian war is going to settle down, eventually, there'll be some type of peace agreement, and we're still not even talking about peace. And there are actually some fairly significant events that look like you could actually see the war actually accelerate or jump into a broader conflict. So I think that got lost in the last six months from page one to page 10 on the paper. But the bigger aspect that we continue to look at is what's going on between, I guess, maybe the market's belief of what the Federal Reserve is going to do and what the Federal Reserve probably feels they need to do. I think that's still though it's front page news almost constantly in terms of what the Feds going to be doing. Now, we're looking at over to probably about a two-thirds percent chance that they raise interest rates here again, in a couple of weeks. Along with that same banking crisis going on, it seems the banking crisis also seems to get lost in this, but the Fed continues to remain fairly strong, believing they need to raise interest rates because inflation has come down, but it's sticky. So there's a belief that the Fed is going to be very quick to pull back on the measures that they've been putting in place in terms of quantitative tightening and raising interest rates. And that, you know, when push comes to shove, they'll step aside and start cutting rates rather rapidly, you know, the pricing on that in the markets fluctuating. But given how bad they let inflation get out of control, you know, they're kind of whipping things back the other way more forcefully, because they still have a little bit of egg on their face from the whole situation. So, you know, with the market continuing to march up, 10%, we've talked about, you know, that that's not the case underneath the hood. But you know, by and large, they're looking at things, nothing's necessarily breaking yet. So our fear, I guess, is that they will not actually react until they strongly break something. And things are actually tumbling into a more severe recession than maybe, you know, anyone is really expecting out there in the marketplace.
Tim Van Pelt
Yeah, thanks for that insight. Last question for today, you know, flipping the coin, on the positive side, when you're looking across all asset classes today, where's your team seeing the most opportunity or value today?
Patrick Ryan
Yeah, where we've seen the most value is really in the safest area. So I mean, we've been looking at high quality bonds, first. When you think about the environment that we just went through, where you get paid nothing for over 10 plus years, and fixed income markets, you know, and high quality corporate bonds, you can still get, you know, an intermediate term anywhere from five to five and a half percent and higher grade investment grade type products. And to us, that's quite attractive when you're looking at an S&p 500, that's trading at 18 plus times forward earnings with a very questionable or very questionable, I should say, economic environment and what's going to happen with earnings. Even on the front end, you're getting paid very well in safe Treasury investments up over 5% for a year, we kind of look at balancing that out between you know how long those rates are going to be around when you can lock in something like five to five and a quarter with a more benign interest rate environment on those higher grade corporates. You know, that's something that you definitely want to be looking at. So to us right now. There's a lot of fear of recession, there's a lot of fear of what could go on. There are a lot of questions on you know, what lies ahead for the equity market, all the while, you don't have to take that much risk anymore because they're safe instruments out there that you can grab and get a pretty good return for a kind of a set period. So to us bonds are still the most attractive first and, then within the equity markets, we kind of still look at some more beaten down areas with emerging markets and still some things that are tied into, you know, kind of the resources and commodity shortages that we think are probably down the road.
Tim Van Pelt
Thanks, Patrick. Well, that concludes our today's program for the monthly conversations with the PM. Really appreciate your time, Patrick, and we'll talk to you again soon.