The Compound and Friends - A Very Tom Lee Christmas | What Are Your Thoughts?

Episode Date: December 22, 2022

Join Downtown Josh Brown, Michael Batnick, and special guest Tom Lee for another round of What Are Your Thoughts and see what they have to say about the biggest topics in investing and finance! Get the latest in financial blogger fashion: https://idontshop.com/ Investing involves the risk of loss. This podcast is for informational purposes only and should not be or regarded as personalized investment advice or relied upon for investment decisions. Michael Batnick and Josh Brown are employees of Ritholtz Wealth Management and may maintain positions in the securities discussed in this video. All opinions expressed by them are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. Wealthcast Media, an affiliate of Ritholtz Wealth Management, receives payment from various entities for advertisements in affiliated podcasts, blogs and emails. Inclusion of such advertisements does not constitute or imply endorsement, sponsorship or recommendation thereof, or any affiliation therewith, by the Content Creator or by Ritholtz Wealth Management or any of its employees.Investments in securities involve the risk of loss. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. The information provided on this website (including any information that may be accessed through this website) is not directed at any investor or category of investors and is provided solely as general information. For additional advertisement disclaimers see here https://ritholtzwealth.com/advertising-disclaimers. Obviously nothing on this channel should be considered as personalized financial advice or a solicitation to buy or sell any securities. See our disclosures here:  https://ritholtzwealth.com/podcast-youtube-disclosures/ Hosted on Acast. See acast.com/privacy for more information. Learn more about your ad choices. Visit megaphone.fm/adchoices

All right, all right. The chat is packed tonight. Do you see this, Mike? I don't. You don't see the comments live? You've got my full attention. All right, I like that. Dave Arias see the comments live? You've got my full attention. All right. I like that. Dave Arias here. Roger Weatherford. Kelly SF. Nicole is in the chat. Sean's here. Missy is

here. Chris Hayes. Jack Rosenfield. All the regulars. Cliff, we see you. Thank you for coming. John Carlo is here. Looks like he skipped dinner to be with us tonight live, which is very cool. Hey, guys. Thanks so much for being with us all year. Tonight we have a very special treat. Before we can bring that treat to you, we're going to do a quick sponsor thing. Michael, who is sponsoring the show this evening? Well, thank you, Santa. The sponsor for tonight's show is a company called Craneshares.

You know who they are. We've spoken about them a bunch. If you want to learn more about their products and the risks of investing in those products, of course, go to craneshareswithak.com. But I also want to point out, they do this thing, our friend Brendan Ahern does this thing called China Last Night. If you want to read about China, what happened overnight, it's chinalastnight.com. And I got to be honest, I read it every morning. Super informative. Okay. That was a lie. That was a lie. I don't read it every morning. However, anytime that there is news and I'm like, what happened? Then I do read it. So China Last...

Did you read about what Japan did overnight at China Last Night? That would be a violation of my rules. Well, I did see that they wrote about Japan, but I didn't. I stick to China. It's ChinaLastNight.com for Brendan Ahern's stuff. Let's bring him in. Let's bring him say that they wrote about Japan, but I didn't. I stick to China. ChinaLastNight.com for Brendan Ahern's stuff. Let's bring him in. Let's bring him in. Let's do it, Josh. Hey, Tom,

come on on the show. Duncan's going to send you in. Look who's here, everybody. Fan favorite, Tom Lee. Round of applause. Yeah, yeah. Tom, we're so excited to have you.

We went through your whole presentation for 2023 yesterday, and we pulled out what we thought were the most provocative or interesting charts. And you have a really interesting outlook for this coming year. And we, we have huge fans of yours on the compound. Every time you come on, they there's huge feedback.

So we really appreciate you doing this. Thank you so much for spending some time with us tonight. Yeah. Glad to be here. Thanks. Awesome. Enjoy the shows format. And so glad to do it. Awesome. Thank you. Thank you very much. Where should we begin? Well, this, this, the whole presentation was a banger as the kids say, Josh, where do we want to start? Well, I guess let's start with consensus because in your presentation to clients, Tom, one of the things you said really resonated with me. You said what you have to keep in mind as an equity investor, consensus thinking isn't necessarily wrong. Consensus thinking is just

what's already priced into the markets. And you try to think, what you're saying is that thinking more about what might change is more important than thinking about today's headlines, which everyone is very aware of. And let's throw this up. We have the – let's see. Now, yeah. Yeah. This is the consensus now. You have short SPX as one of the most popular trades according to Goldman Sachs.

That's got to be pretty rare. But wait, Josh, they asked, which US trade do you think offers the best risk reward for the first half of the year? And it's 19% of respondents that short the S&P 500. Tom, what does that mean? I mean, it means a couple of things. I mean, one is obviously, I think there is some recency bias because, you know, this year has been incredibly painful and challenging and tough. So I think that there is a lot of emboldened investors thinking that we get more of the same next year. But at the same time, as you know, when something is so popular and really a popular consensus like short the S&P, I do think that we have to think, and Josh, you said it, about what could surprise consensus. And I just think that that's what's going to determine next year is if you put a checklist together of what's not in the central case for markets, where do you come out? I can probably list 10 things that would argue that we'd be up

10, maybe more than 20% next year. So I want to get to those, but if we were to rewind a year, the consensus for this year, I think had the S&P north of 4,800 by year end. So that's like the same as this situation, but in the opposite way. We were coming into this year with stocks up big and stimulus worked and the reopening and the vaccines worked. And this is pre-Russia, pre-oil price spike. There is some inflation, but there's not yet a full-fledged panic over inflation. And the consensus was very bullish and wrong.

So this looks like now the entirety of the consensus has shifted, which I know you want to talk about. But they're all the way on the other side now. That's right. And not only has the buy side moved off the boat, because that's what that survey is, is Goldman's institutional clients. But if you look at the sell side, Wall Street, which is pretty good at capturing sort of the mood of the world, I think of like the almost 15 or 16 strategists that have published targets for next year, only three of them think the equity market can earn more than money market funds.

So the sell side is also coming into this year really bearish. Tom, I want to make the point that we had an event on Friday where we had 100 plus viewers come out and thank you to everybody that showed up. That was great. And I asked the question, how many of you think that we take out the October lows? 95% of the hands went up. How many of you think we're going into a recession? 95% of the hands went up. How many of you think we're going into a recession? 95% of the hands went up, myself included. I was in that part of it. But

then when all the hands went up, I said, hey, wait a minute. Wait a minute. That's a lot of hands. But I want to throw this to you because you say that consensus is baked into the cake, and it's usually true. But if we do go into an earnings recession and an actual economic recession, is the damage, so the asset prices have front run a lot of the damage, right? But has it been enough? So the S&P is down 19% or so on the year. Is that enough to absorb what bad news might be coming? Yeah, it's a good question. I mean, if there's a recession, one of the challenges, we never know how severe a recession could be, so then it's hard to know if enough price didn't peak to drop. The S&P fell 28%, so I would say it's discounted a pretty severe contraction.

I think the pathway to saying we don't go down in the first half is really we either don't have a recession or the macro changes in a way that the recession is actually secondary to what markets focus on. I want to get into this overarching concept that you have for this year, which is less crisis, more opportunity for 2023. crisis more opportunity for 2023. And you've got six reasons why next year has the highest probability of a double digit stock market gain since 2020. And we have this slide up on the screen, Tom, but everyone can hear you. Do you want to kind of walk us through these six big reasons? Sure. And I got these up on myself. Chart off. Okay. Oh, sorry. No, just talk over it.

Got it. Yes. First and foremost, I think inflation, this is, I think, the biggest shock. I think inflation is fixed. I think we're going to be printing through March or April roughly less than 0.2% CPI for the next six months. And so I think it's going to be definitively seen as inflation is now back to 2%, but then people will look at the second half and realize that shelter is going to start falling sharply. And that's going to take out another point for, I mean, inflation might just be sub two most of next year.

And I know that might surprise people. That is very outside of consensus, I would say. Yeah. And I think the December CPI might be the turning point there. So I think we don't have to wait all year. I think we can see it in January. But Tom, you're talking about annualized on a go forward basis. Mike, we're going to get to those charts

in a minute. Let's get through the rest of these. Yeah. The second is, and I think that is going to really cause an abrupt shift in the Fed's framework, because unless they move the goalpost and say they worry about global inflation, they don't need to raise more than maybe even after December. December could be the last. We might have just seen the last hike, possibly. Maybe one, maybe one, maybe one in February. They have all of January to digest data without a meeting, which is an interesting setup. Yeah. And I know we'll get into it, but I just think there's actually potentially a technical factor that's caused the Fed and a lot of investors to make a mistake, too, on inflation's trajectory.

And then the third is that this essentially means we avoid a recession because now inflation is not quite transitory, but it's not really a problem into 2023. And so we don't have to break something to kind of get wages down because we might be in a scenario where wages are still 4%. But if inflation is 2%, that's actually good social policy. Now, outside of that macro, one of the key things here, keep in mind, is it's rare for stocks to post back-to-back negative return years. I mean, it's kind of, you'd have to have a calamity, like a balance sheet deleveraging event. And if you don't, we're going to have a double-digit year. And on top of that, I would just point out volatility rarely posts two years of gains. So next year, volatility probably drops 20%. Guess what?

The average stock gain in a year when delivered vol or the VIX drops around 20% is more than 20%. So the last time I could remember back-to-back down years had to do with like 9-11 coming after the dot-com blowout. 2000, 2001. Do I have that right? That's right. Yeah, that's right, Josh. And that was what I'd call a serial crisis because we had a dot-com bubble burst

and that did cause like a shock, but that itself was not even triggering necessarily recession, but then in 9-11 happened and then that was a huge shock because that was both a delever leveraging shock and a consumption shock. And so we had a recession. If that 9-11 event didn't happen, I'm not sure we would have had double back-to-back years of declines. Okay. So we have a chart of that that's going to come up later.

Let's see. And then I can rush the rest of it. The other stuff is high yield yields going to do well. High yield, whenever high yield does well, stocks always an average post 22 percent gains. And then, you know, we think earnings have a lot of tailwinds, including dollar falling. So the earnings might surprise next year instead of declining. It might hold up really well. And then PEs typically expand pretty sharply if we're at the end of a crisis. I mean –

This might be the most – I want you to spend a second on this because this might be the most controversial statement that you're making here. PE expansion is very hard for people to picture going into next year because of how difficult that PE contraction has been. And we all have a little bit of a recency bias. With the one year, close to 5% or wherever it is, it's hard to envision unless you think that that's going to come down. Yeah. Well, there's a couple of vectors to think about. One is that I think we're talking about equilibrium. So let's say crisis mode passes people's minds. When the tenure's been between 3.5% and 4.5%, the tenure yield, and this is for 90 years, the median PE is between 18.5% to almost 20 times, depending on if you're doing tightening or non-tightening cycles. So the midpoint is basically the PE should stabilize at around 19 times next year.

Okay. And then you like technology, energy, and industrials to lead. Yes. I guess technology is still in the doghouse for most strategists just because it's crashing now. And I think a lot of it relies on enterprise spend that probably doesn't show up if margins decrease. Why do you like tech? probably doesn't show up if margins decrease. Why do you like tech? Well, I think tech is really a demand solution. One of the things that is intractable is global labor shortage. Since 2018, the world has been experiencing a shortage of prime workforce growth.

The only way to solve that while population growth is still strong is to find non-human labor, digital or capital-based labor. The biggest supplier of that is tech companies. So I think tech is really the way out of companies experiencing future inflation. And I know that that's not what companies thought this year, because companies this year have just been dealing with paying huge wages. But now the use case for automation is tremendous. That's what makes technology work next year. This is a rabbit hole we don't need to go down. But there's a lot of chatter that tech CEOs are going to take Elon's lead on.

The Twitter plane is still flying, although it might be crashing. But the actual platform is still working with substantially fewer workers. Yes. It's a great point. I will share that there is a financial company that I know quite well that had noted because of their surveillance capabilities during COVID, they realized that 80% of their workers did nothing. And this is a company with more than 100,000 employees. So in a world where we don't have to worry about social stigma of layoffs, this company could cut 80% of its staff and actually have the same revenue. You just said that this particular company found that 80% of their workers do the words that you used were nothing.

And I didn't, well, next to nothing. They have quite a lot of surveillance about mouse movement and computer clicks and, and what they were actually engaged in. It reminds me of the tech talk that the young lady who worked at meta posted. And then I think regretted where she's like a day in the life of whatever she does there, an account manager or something.

And it's like snacks and coffees and sitting on the roof. So I think there's probably more of that in Silicon Valley than there is nationwide. Or maybe I'm wrong. So let's move on to inflation. Tom, we spoke about this on the show in recent weeks. I can't remember which one, but one of the things that had a lot more predictive power than I would have suspected was just simply, is inflation higher or lower than it was a year ago? And the spread between the S&P 500 12-month return when inflation was lower than it was, was I think 12% a year versus 6% when inflation was rising. So that is a primary factor to

consider going into next year. And where do you think we're going to see inflation shake out? Chart on please, by the way, for time. Yes. So that chart's a good jumping point. And I think that there isn't a lot of agreement what inflation is because people look at year over year on trailing. And so they're saying, hey, you know, the Fed's still got a problem because inflation is still running at seven. But that's not really what monetary policy is trying to target. It's targeting what future inflation will be.

So I think three-month annualized is a decent proxy for the trend in inflation. As you can see here, inflation is falling like a rock. Tom, can you explain to the audience, you're taking a three-month rather than a 12-month. So the headlines, like people on TV say inflation was up 8.5 percent year over year. You're saying use the last three months because it's more recent and we should be waiting the current reality. And when you do that, inflation has been cut in half from eight to four percent since June. Do I have that right? Yeah, that's correct. And I give you an example. So inflation is a price level. And so gasoline is a good example. You know, gasoline hit like almost six dollars and now, as you know, has fallen almost by 50 percent.

And that's just in the last four or five months. Right. Yeah. But we showed to our clients that if you look at year over year, gasoline isn't going to be negative until February. So the question you have to ask yourselves is if gasoline has dropped by 50% in the last five months, is gasoline deflating? Like you and I would say 100% yes because it's dropped by half. But actually, if you did year over year, it's still inflating. because it's dropped by half. But actually, if you did year over year, it's still inflating. Why do you think that the headline isn't core CPI cut in half since June? Why isn't that getting more attention? Because not enough people are looking at the data that way? Or is there just a general misunderstanding of how to track inflation? Well, I spoke to Tom Block, who's our policy

strategist, and he was J.B. Morgan's lobbyist for almost 30 years. And he says that in Washington, CPI catches the attention of politicians because they know voters care about it. And CPI is a year-over-year calculation. So it's easy for them to go to voters and say, it's 7% inflation. Let's vote these people out of office. Surely the FOMC should know better. That's not politicians. You're right. And yet when I see a lot of people on TV talking about inflation, they're still talking about the year-over-year number.

And I think they should look at the last three months and then annualize that. That's how we look at company earnings generally. Tech is what they call sequential earnings. That's what we drive. And they always say long-term is a series of short-term. So people string the last four quarters to make the year-over-year. So the people that are making policy surely must know what you're talking about. Do you think that there's any risk of them either pushing us too far or causing a policy error to make all of our hopes for next year go down the toilet?

I think it's urgent that the Fed and central banks really start to examine what could be where the puck is going, realized inflation in the future, because December's CPI, which is coming on January, I think it's going to be another 0.2. So now we're going to have strung together three months in a row of 0.2% or less core inflation. And that's 2.5%. That's still, while shelter housing is still posting something closer to 8% inflation, which we know housing is not running at 8% right now. And in fact, if you took out housing from the last two CPI, core CPI prints, core CPI was negative in each of the last two months. We're actually experiencing core deflation without

housing. Right. So you would not be taking overnight rates north of 5%, which historically over the last two decades is pretty much the high end. If you really understood that that's what current inflation is doing. So maybe there is that disconnect and they don't see it. That's right, Josh. And if you add in QT, which, you know, San Francisco Fed publishes a number that also includes QT, we're at six and a half percent Fed funds rate right now. Wow.

I want to go. Oh, please finish that thought. Oh, and well, I was just saying that you guys used the word mistake. I do think there's a data error that's actually affected the summary economic projections of the Fed as well. But we can talk about that later. The current consensus is bearish. We talked about how rare that is. What else do we want? What else do we want to say about that setup going into a year? Well, Josh, you've made the point before, which is true, is that a lot of

the technical guys are going to be super bearish at the bottom, which by definition they should be. Things are going to look so black. So for example, I thought this chart of Amazon, please, John, So for example, I thought this chart of Amazon, please, John, we've got Amazon going, going back to its March, 2020 lows. The stock is in its deepest drawdown in the last decade by a mile. It's down 54%. You've got Tesla, not, not even close actually to its March lows, but you've got Disney at the Marshalls. You've got things just, just looking at the charts without any sort of opinions.

Things don't look very great technically. So here's the question. We asked the question, has enough work to the downside been done to account for what's going on in the economy? So this is the situation. Put Amazon chart back up. This is the situation. The stock is now lower than the March 2020 low. chart back up. This is the situation. The stock is now lower than the March 2020 low. So we're saying the prospects for Amazon right now are being judged by buyers and sellers to be more

bleak than they were at the onset of the pandemic, which is pretty interesting to me. For the first quarter of 2020, Amazon had about $296 billion in revenue, $10 billion in net income, 12.5% EBITDA margin, and about $1 in earnings. Fast forward to the last quarter they reported, Q3 22. Amazon had $502 billion in revenue, $11 billion in net income, 10% EBITDA margins, and about $1 in earnings. income, 10% EBITDA margins, and about a dollar in earnings. So if you just looked at the earnings per share number, watching the stock round trip, I suppose makes sense. But how do you account for all of that revenue growth that in theory should be a source of future earnings if they can keep it up? We're treating the company like none of that matters. I have three answers. One is anticipating the slowdown in consumer spending that the stimulus is going to wear off.

Number two is the recession that is undoubtedly here with us in technology, hurting AWS. The advertising probably to a lesser extent. And then obviously, it's interest rates, right? Like it's just not trading at the multiple that it was previously. Tom, what are your thoughts? Yeah, Tom, I'd love to hear because this is like emblematic of probably 100 stocks that we could all think of that are large index weights and have arguably priced in a lot of negative news. Yeah. Well, I think a great question that I've heard a lot, and I think it answers the question is, what will get people to buy a stock again?

I had some clients over in the past couple of weeks. couple of weeks, you know, we've, you know, we've been doing a lot of different sort of year end things with clients. And one of them said exactly that, you know, they, they, they don't know if anyone really wants to buy stocks next year. And if they're not going to buy stocks, you know, why are they going to buy an Amazon? What I would say is Amazon is a central household word. It is not going to be disrupted by something. So if someone says, well, they think interest rates are suppressing the valuation, I mean, they're making an interest rate bet on Amazon. One, I personally think the 10-year may be flat or lower next year, but Amazon can do a lot to improve its value if that's the case because they're in a dominant position. They're becoming more important to customers.

They can do a lot with their streaming and with AWS. And, you know, believe it or not, they benefit from inflation to the extent that they're a balance sheet story. So I think Amazon, if you don't think it's going to be disrupted, this is sort of like buying Amazon when it was stuck at 25 for many years, you know? So you're saying like the argument of a 3.5% 10-year treasury versus Amazon. But it's not competing with the 10 years. It's competing with cash, I think. Okay, fine.

So can Amazon earn a higher return on capital than 4% a year for the next two or three years? Yeah, no doubt. Is like the argument. Yeah, Amazon can definitely compound its capital faster than that. Of course it can, but that doesn't mean the stock will. It very well might, but I'm just saying, like, people aren't thinking about two years. To your point, Tom, they're thinking about what's in front of them today and not what can change. Let's go into this energy market cap share.

That's a good one. I thought this was a great chart because it very clearly illustrates the fact that, because a lot of people are saying, did I miss the rally? Is it too late to buy energy stocks? They were, I think the only sector that went up this year. But what you're showing here is that actually the fundamentals are running ahead of the size of the energy market cap share of the S&P, right? Yes, that's right. I think it's a good jumping point because we'd say, okay, well, hey, is energy discounting all the great news that we seem to think because they've had great earnings and they're benefiting

from the higher strip and oil prices. And the market cap share is only 5%, but their net income share of the S&P is more than double that. And in fact, so it means energy stocks could actually double just to catch up with their market share of net income. And to me, energy has proven to be vastly more important than people realize. Because I think, you know, two years ago, it was very easy for people to say, well, you know, no, we're not going to be using fossil fuels, we're really talking about renewables and ESG. So energy stocks are not even touchable. And that's clearly not the case today. I think the war has really highlighted how important central energy security is.

So I think that they should at least catch up in their multiples. And in the 80s, when we did have supply risk, they did trade at the same multiple as the market. So I think that's why energy stocks could do really well next year. On top of the fact that maybe oil prices could go up too. If they were to catch up, you're showing the dotted line net income share of the S&P 500.

If they were to match that, which nobody's saying they have to, that just an eyeball test looks like it's more than a double for the sector's stock prices. test looks like it's more than a double for the sector's stock prices. Correct, Josh. That's right. And if you're to annualize energy earnings now, they're going to have 20% earnings growth next year. And if people think S&P earnings are flat, then their net income share is going to go up another 20%. What's interesting about this setup is that they're still under-owned. I don't think retail really understands the sectors, the drivers of the sectors. I don't think there's an affinity for, we don't have like a cult following for any of these stocks. Like they kind of remind me of where tech was in 15, 16, when people were first starting to take an interest in technology stocks again

after 15 years of no new highs. These stocks seem to be in that position. But what I like about it is it's not a multiple expansion story. They're producing tons of cash flow. The publicly traded companies in this space. That's right. They've actually kind of learned their lesson, right? That they decide to not rein actually learned their lesson that they decide

to not reinvest all their capital into CapEx. They're returning money to shareholders. That's very different. You're right. That's what made tech a little different too. Instead of just eyeballs, tech companies did start to actually produce real return for shareholders. Let's move on to the next topic. I love this chart. It's making the case not to wait for the coast to be clear. Tom's showing don't wait for the Fed because the market bottomed before Volcker shifted tactics, and it's likely to do the same. So when this thing turns, it's going to turn real quick. Tom, can we just- Yeah, well, let's just set this up first because we have a lot of young viewers. It's YouTube.

And I don't know how the familiarity level with with Paul Volcker. But for those who aren't sure what we're talking about, Volcker was the Fed chair in the early late 70s, early 1980s. And he came in with a mandate to really whip inflation. Inflation had been hurting the economy and the stock market for pretty much all of the 70s. So he came in and he immediately started to rapidly increase interest rates. People would say punishing interest rate levels. And ultimately, I think the overnight rate got to 16 or 18%. Tom can correct me. But I think the message here is really fascinating, which is that even if you know that history of Volcker fighting inflation as the Fed chair, you might not understand what the ramifications were for the stock market. You might have that

part of it wrong. So can you walk us through what you're showing us here? Yeah, glad to. We marked a couple of points on this chart. The first line, which is at the top of the S&P peak there, that's around the time Volcker tried. Volcker, who was Fed chair beginning in 79, was inheriting a big inflation problem that had already been running close to a decade. And by 1980, he launched his most aggressive tactics. So this was his latest wave of war on inflation. And that created almost overnight a recession. And that's why that S&P then fell 27% over 27 months. So it was a painful two and a half year bear market that's highlighted there. But what's interesting is that the stock market

bottomed in August 82. And that bottom in August 82 then turned into a vertical rise in the stock market. Here's what's interesting. Paul Volcker, who did use communication policy very carefully in speeches, carefully planned speeches, didn't even address the idea of ending the inflation war, even thinking about it until October, which is the blue line. By then, the stock market had already been rallying for two months. And from the time the stock market bottomed to the time the Volcker made the statement, almost all of that bear market was erased. And in fact, within four months,

the stock market rose 40% and made all-time highs. So if you wait for Volcker, sorry, today, not Volcker, if you wait for Powell to say inflation war is ending, I think there's a good chance we're at all-time highs on the S&P. Can I throw two caveats at you and see what you say? The first is I think the S&P 500's trailing 12-month multiple finished under 10 times earnings, which is significantly cheaper stock market than what we have now. The second is it's tough to compare Volcker's war on inflation with the current one just in terms of how long it's been going on, one. And two, the severity. I mean, 4% interest rates are high only versus the last two years when they were zero or

negative. They're not high historically and definitely not versus the early 80s. What would you say to those two caveats? Sure, Josh. I have some slides I can send you guys later, but people have a misconception of what earnings were doing in the 80s. Earnings were indeed growing because when you have 15% inflation, you're going to produce 15% earnings growth. But more importantly, 80% of the profits generated was inventory holding gains. That is a company buying paper towels, selling it six months later,

but because paper towels went up 20%, they just booked actually close to 20% profit growth because of the way marginal cost was. Just for keeping it as inventory, right. Yeah. So actually free cash flow is a better metric, and the market in the bottom of 82 was trading at 20 times free cash flow. It was a 5% free cash flow. Where are we now?

We're actually closer to 6 or 7 now. We're actually cheaper on a free cash yield basis than 82. One of our research scientists, Matt Cermonero, just did an analysis. He looked at the change in earnings yield. So kind of another way to look at how cheap market was. By August 82, you had a 250 basis point rise in earnings yield. We just experienced a 200, close to 250 basis point rise in earnings yield over the past 4038 days. So we're generating the same type of valuation signal you would have seen at the bottom of August 82.

The thing that I think is most important here is that the market front runs. And so this idea that investors might wait for the dust to settle, by the time the dust settles, the market's going to be screaming higher. And another chart that we have from you, Tom, shows that the S&P 500 does bottom before earnings. And this is so instructive. If you look back to 2009, where you see the first dotted line on the left, you see where the S&P 500 bottomed and the EPS didn't bottom for another, I don't know, is that a year later?

And we saw the same thing in 2020. And so the news will continue to get worse, but the market will stop reacting to the downside. Can you talk about how that works? Yeah. It's important to keep in mind because we tend to think, oh, well, earnings bottom, and that's when the market can bottom. But history shows that investors begin to anticipate that bottom in earnings beforehand, and that's why stocks can bottom. It's almost like if we all know there's this big valley coming in two quarters because of X, by the time we get to that valley, you actually need to buy that good news because

the bad news was already priced in. I mean, 82 is an extreme example that people had already two months ahead of the Fed anticipated the end of the inflation war. What's that lag typically from where stocks bottom to when finally the earnings stop going down. Is that one quarter? Since 1930, Tireless Ken, our data scientist, has calculated out of the 16 lows, the median lead time is 11 months. Wow. So the stock market bottom is well ahead of earnings. That requires a lot of faith though,, during that 11-month period. Because everyone's shouting at you, the earnings are still going down. That requires a lot of fortitude to withstand.

Correct. And so if October of this year was an important low, and that's a possibility, that means earnings could bottom anywhere between now and October 2023 and we would have discounted that decline in earnings. And I'm okay, Cam. Okay, let's keep moving. Let's move to the fair value stuff. Well, wait, we have one more from Volker. I love this chart.

I want to do it. So this is the thing that's a really big misunderstanding. When people think about that era and none of them were alive, I was like three trading my face off. But people – I don't think people understand the history that despite the war on inflation of the early 80s or late 70s, early 80s, there wasn't a lot of down stock market uh during that period of time you had one pretty bad year can can you walk us through this really quickly yes i think that's a really important uh like alignment people have to make because they you know when they look back and they hear people talk about stagflation and the Volcker era and Volcker markets were terrified of him. And he was spent here since 79. As this chart highlights, stocks averaged a 13% gain

and only had one negative year, which was 82. And that's at a time when inflation during those three worst years averaged close to 10%. when inflation during those three worst years averaged close to 10%. That's incredible. So you had inflation averaging 10% and you only had one down calendar year. But wait, the real returns were not good at all. They were in fact terrible. And you had a lot of volatility and a lot of drawdowns. So you're right.

The calendar returns were okay, but it was pretty bad. Where were the drawdowns? The drawdowns. So you're right. The calendar returns were okay, but it was pretty bad. Where were the drawdowns? The drawdowns were 73, 74. Yeah, I don't think they were huge. By this point in time, though, the American public is finished with stocks. There's not even anyone left to sell anything because people aren't even paying attention. So I don't think they had the crashes that you would normally associate with 10% CPI ratings. Yes, exactly. And I think the difference today is, like Josh, you guys have pointed out,

the level of inflation is far lower and companies have done a great job of navigating through this. I think if someone said inflation was going to hit 8% this year, what would S&P earnings do? I think a lot of people would be getting crushed by that mismatch. But companies actually managed to produce earnings growth this year. If the dollar wasn't up 20%, remember the 20% rise in the dollar probably took out 8% out of S&P profit growth this year. How much? It's somewhere between 5% to 8% is the effect of strong dollar. I think the contribution from energy sector earnings,

which might be unique to this year. We don't necessarily know for sure, of course, but that also played a big factor in making it look more resilient than maybe it really was. Yes. Yes. Okay. S&P was a good hedge overall. Let's do your S&P fair value calculation.

So basically, this is how you're thinking about 2023. What do you mean when you say fair value by the midpoint year end 2023, 4750 Can you can you walk us through how, how you arrive at these estimates? Yeah, I think one thing to just point out is, when we get to the end of next year, we're not going to be talking about 2023 earnings, in terms of how we value the stock market. That's right. We're going to talk about 2024. Just like when people talk about where the S&P should be worth today, no one's saying 2022's value of the S&P is based on 2022 earnings. It's on what they think next year is going to do. Right.

So our team, you know, we talked to both Adam Gold and Brian Rauscher. And then, of course, Tyrus Kent did his own calculations about what earnings could do in 2023 and 2024. And our guys expect that, especially because of the dollar, that S&P earnings could actually be somewhat better than expected in 2023. And that's why you're getting that sort of 200, 220 kind of level. getting that sort of 200, 220 kind of level. But then in 2024, you start to put that crisis and the dollar swings and a lot of those pressures behind and you get to 250, which, by the way, if you did a linear trend since the 80s, that would just say we're getting back to trend earning.

So 250 in 2024 is not an extraordinary economic expansion. It's just resuming out of a crisis period. So by the end of next year, that's the number that we're going to be focused on. And then we're going to be applying some PE ratio on that. And you're arriving at 18 and a to 19.75? Correct. Okay. And that's kind of a function of the VIX coming down, inflation falling rapidly, and that's why you would get an 18 PE on 2024 numbers.

And there's a scatter in that presentation that shows the X x-axis is uh the level of interest level of tenure yield and the y-axis is where pe uh settles and we have two kinds of plots one showing you the regression using years when the fed's tightening and then just all years and between three and a half and four and a percent you end up close to a 19 PE. That's where we should settle. And so that is the opposite because I hear people say, oh, well, if inflation, if the 10 years settles at four and inflation's at three, whatever it is, they think the PE should be 13. That's not supported by history. A lot of this is predicated on margins. And one of the interesting things over the last decade has been the persistence of high margins, which had thought to be a very mean reverting series.

They've not been reverted at all. They've stayed historically high. And we have another chart showing that margins actually are higher in 2022 than they were for 2021. This is showing the annual change. Yes. If margins come down, earnings will come down. And what does that do to potential future scenarios? Well, it becomes a headwind, certainly. The reason we don't think margins actually come down is the supply chain and the associated bullwhip effect that it creates has actually been a headwind for margins.

And so a lot of how people think about what margins should do next year, if they're doing it based solely on ISM surveys or manufacturing or some change in interest rates, it's really not accounting for the fact that there was a sort of very big disruption of how companies conducted business this year. And next year, as we all kind of realize, if the pandemic eases too, there's going to be less excess staffage. Companies have been holding on to people and even overstaffing because of planned outages associated with health. And so I think you actually have, I'd argue, more room for margins to expand. I think I have this hunch that in January, you're going to see a wave of layoffs. And I'm not rooting for this. I want to be very clear.

I think there's some hesitancy to let people go ahead of the holidays if you haven't done it already. Like firms like Goldman don't care because it's like tradition. But just generally in the real economy, small businesses, I wouldn't be surprised to see in January a whole bunch of people in a whole bunch of segments of the economy be laid off because of exactly what you're talking about. I think there's going to be less fear of finding people to work than there was a year ago. Yeah, I mean, and Josh, if that happens, that changes the narrative because, as you know, people are worried about the services inflation, which is really wage-driven, and the labor market would really loosen up.

I mean, you already see it in LinkUp and these other things that scrape online listings, the number of new postings has collapsed. Yeah, shelter is in services, which not a lot of people know or understand that don't pay attention to this. And travel is not a big part of services, but it's a big swing factor.

It's very volatile. And I think those two things are probably in the seventh or eighth inning of, of being exacerbating the inflation issue and are now about to swing the other way. Just my, like just my guess and looking at probably the same data everyone else's. I want to, I want to move ahead. We're rounding the turn here after a decline. So we mentioned this early tonight. Let's just drill into slide 35, John. There've been 21 down years for stocks in 18 of them. The following year for stocks was positive. Can you talk a little bit about this? Yeah, I'm glad to. I think this is something that's important to keep in mind because it's sort of counter to how our instinct is.

And that is that stocks, when they have a bad year and this year is terrible. I mean, it's awful. You know, we've really been the doghouse because of that. Investors naturally think, well, if stocks did bad this year, there's nothing that can make them go up next year. Well, if stocks did bad this year, there's nothing that can make them go up next year. But as this chart shows, historically, you price by the end, by the time we get to this year, we've priced in a lot of bad news. And so unless there's another wave of something to shock us, markets tend to do very well the following year. And as these are the little blue lines highlighted, as you can see, they rank among the most the

most extraordinary years for the stock market. So the best years for single year returns for the stock market have tended to occur after a bad year, not after a string of good years. Are these, Tom, are the red bars full year, like calendar year final return, or are they max drawdown during the course of the year? No, that's the annual price change, just January 1 to December 31. So it's not even max drawdown. It's just the decline for the year. Tom, that's such a good point. There's a really good book called It Was a Very Good Year. And it talks about the 10 best years in the history of the stock market. And almost all of them come after a very bad year. Yes. And it's kind of this thing what they they call like stacked numbers to your stack. That means when you string together a bad year and a good year,

maybe two years you came out, it turned out to be average two year period. They average out. Right. Absolutely. All right. I think that's important because I think there is a lot of negativity and given what went on this year, it makes sense for there to be a lot of negativity just on the surface. People have lost a lot of money. Every asset class was net negative with a very small handful of exceptions, but people should remember that history that it's rare for it to reoccur. And when it does, there's usually something extraordinary going on. So we've, Josh, the other charts that we've got are just rehashes of what we've already spoken about. Are we cool to move on to four themes for the next year? Yeah, let's do it. Let's go to slide 44, John. This is four themes from Tom

for 2023. Why don't you walk us through these, Tom? Yeah. You know, if I say, hey, what are reasons investors are going to buy stocks? I think it's going to fall into one of these four categories. A company that helps protect businesses or households from future inflation, we know that that's going to resonate as we exit this year. That's a strong pitch. That's a strong sales pitch for a company if they can do that for you. Yeah. I mean, imagine if someone offered you gasoline as a subscription. It'd be like a $1 trillion company, right? They'd be like, hey, you pay this price for the rest of the year, everybody would sign up. And the second on there is energy security, which just ties into energy. The third is we know there's a structural shortage of labor. The Fed and central banks can't fix it by trying to slow down the economy. In order to really fix the labor shortage and then grow the economy, you have to replace

human labor. And I think the easiest way is actually technology spend. And by the way, we have in the report showing that every time there's been labor shortage, tech stocks have historically gone parabolic as well as tech spend as a percentage. A lot of the automation names tend to actually be categorized in the industrial sector of the S&P 500.

I'm thinking of names like Rockwell, companies making robots. I mean, we've got that next chart. This is a wild one. I'd love to hear your thoughts on this, Tom. Well, the last one is millennials are the largest generation, set to inherit $76 trillion over the next 20 years. They care about specific things.

What do millennials care about? Well, it's kind of interesting. Millennials, they actually do care about ESG. So I think that there is this sort of ESG 2.0. They do care about DeFi or what I'd call decentralized finance. And that's why names like SoFi and PayPal, like sort of these next generation financial companies. But interestingly, I think millennials are actually quite similar to their grandparents. You know, you've seen it in their habits, like whether it's purchases of RVs or motorcycles. And, you know, an interesting aspect of that, too, is actually demand for credit cards, because, you know because credit cards are essentially invented by the boomers in the 70s, things like American Express, et cetera. going to be a lot more long equities than bonds because you know gen x uh you know the prior generation really got dinged by the gfc and by the dot com so so there was a very low allocation for almost the last 20 years and i think that's going to change drastically especially as they

inherit you know 76 trillion is a big number that's more wealth than the entire nation of china so a 20-year sliver of the u.s of u.s households are going to's more wealth than the entire nation of China. So a 20-year sliver of US households are going to own more wealth than the entire nation of China. Let's go to this last chart, automation. This is technology becoming 50% of S&P 500 weight. How long do you think it takes for that to happen? We think it's going to, I actually think it's going to happen within a decade. We think it's going to, you know, I actually think it's going to happen within a decade. So one of the things that people can't write off is that in order to fix, to really, for the world to come out of this labor shortage, tech spend has to go up.

You know, it's really the rise of the robots and automation and productivity. And here we're highlighting since 1910, there have been two prior cycles of structural labor shortage where the world had less prime worker growth than total population, 1948 to 67, 1991 to 99. And the bottom half of that chart shows that technology stocks versus the broader market went parabolic every time. I think we're in the third parabola, or as some people call it, the age of exponential growth for tech. Where do you get 2047 from as the ending point of this period? Is that demography? Yeah, it's demography. So anyone could pull it up using UNDESA or the U.S. Census has projections.

UN DISA or the US census has projections. What you do is you do single year forecasting by age, by birth year. And so it's simple demographics and it shows that we won't exit labor shortage for almost 20 years. So Tom, you are telling us not to give up on technology, even despite what's gone on in the last year or two. That's right. I mean, the chart you had on Amazon says, hey, you get to buy Amazon back at the pandemic low, yet you know Amazon has become a better company today and it's done better with Prime.

It's stronger in AWS and they have so many other initiatives underway. So to me, it's almost a gift. So I just want to say thank you so much for joining us tonight. I could tell from the live chat, the crowd really appreciated your optimism tonight and some things to think about that they're not hearing elsewhere. Hey, Tom, how do people find your work? Yeah, I was going to say, tell us where we can send people if they want to learn more about Funstrat. Well, they can find us at www.fsinsight.com. It's the back of my monitor. So fs, like Frank Sam, insight.com.

And there, there's an easy ramp page. And it'd be easy for them to sign up for a free trial if they're interested in getting some of our work. And, you know, we have a lot of team members here. You know, we have five different team senior members writing on markets and strategy. Well, you guys do a great job. So thank you so much. Thanks for being with us tonight. And happy holidays, my friend.

Yep. Happy holidays. See you guys soon. All right. And to all the pounders who joined us this evening, thank you so much for everything this year. Thanks for spending time with us. We really appreciate it.

And we will be back the Tuesday after New Year's Eve. Count for spending time with us. We really appreciate it. And we will be back the Tuesday after New Year's Eve. Count on it. Thank you. Good night, everybody. Bye.