The Anything-But-A.I. Rally. Plus, Social Security’s Countdown

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Lamb Weston Jackson. Lamb Weston, that's a company. All right, I want to know what do they do, and I want to know how much they're up. Actually, I'll tell you, you tell me what they do. I'll tell you how much they're up.

Wool conveyor belts.

I don't know what you mean by that. I don't know if the conveyor belt's carrying the wool. Are they made of wool? Just quickly elaborate. Just give me another 5 words on what we're talking about there. I just want to be sure.

I don't mean they're made of wool. It's conveyor belts for the wool industry.

It's actually French fries. It's frozen French fries. It's very close. That stock has returned 13%, more than 13% year to date.

I'm gonna— you know, In-N-Out doesn't freeze their french fries, and that's why I think they're like not very good.

Whoa.

It's like all the, you know, McDonald's and stuff.

Out of nowhere, In-N-Out, it's just getting slammed out of nowhere.

They have great burgers.

It's the fries are trash because they're not— because they're fresh.

I think it's because they're fresh. I think they want to hold on to the fact that they're using fresh potatoes, but, but something about the maybe cold to hot and the The hot oil makes the fries crispier and better at McDonald's.

Hey, they're not called fresh fries, people. They're called French fries. All right, who knew? I want to give you a bunch more of these stocks. Church Dwight, what do they do?

That is an office spinoff entertainment conglomerate.

That's Arm Hammer. Yes, it's Arm Hammer baking soda and a bunch of other consumer staples products. Some of which may be used in offices. I don't really know. Most of which are used at home.

They have toothpaste. I know they have toothpaste and underarm deodorant.

Yeah.

You're saying Arm Hammer does? Arm Hammer.

Yes. Okay. Not, not In-N-Out. All right. Um, next up, Smurf It Westrock. Smurf it if you got it, Westrock. That's gotta be fake. That's a real, it's a real company. And I think it's the second time I've mentioned them over, I'm going to say the the past year.

And it's not a competitor to Mattel and Pet Rocks.

They make what a Philistine would call a cardboard box. They make cardboard boxes is what ordinary, the people who don't know any better would say that.

But a paper— I remember corrugated containers. That's what they—

Yeah, we did the international paper episode. I'm so proud of you. And then the whole paper industry is proud of you for saying that. Smurfit WestRock, that one has returned 20% year to date. Dow, I don't have to tell you about their hits. Polyethylene, need I say more? Dow, the chemical company. Chemicals, right? Yeah, that one has returned 28%. And the last one, Bunge Global. That don't—

it's got nothing to do with cords.

What about springs? I can't guarantee that I'm pronouncing it right. Elastic bands? No, they are— I call them a soybean squeezer. That's probably— I don't know, I don't know if they would like that characterization. They are a processor of agricultural product, a crop processor. They turn soybeans and other crops into usable products. And that stock has returned 37% year to date. So what's going on? What, what kind of market move is this where it's pulling boxes and polyethylene and soybean squeezers higher? What's going on? This is part of what I'll call the great rotation, which seems to have started.

Maybe it's already ended. I don't know. And this is the Barron Streetwise Podcast.

I don't know if you said that for folks who just have been listening to this for the last couple of hours. I was going to wait to see if it's any good. We might not want to, let's not, for now, let's not say what podcast it is. Let's see how it goes. Give me another 10 minutes. I may or may not be Jack Howe. This may or may not be our audio producer Jackson Cantrell with me. For more than a year, we've been talking about, wow, these Mag Seven, these Magnificent Seven tech stocks, they're leading the S&P 500 higher and they've gotten expensive. The index has gotten expensive. The index has gotten concentrated with these companies. And what should you do as an investor if you're worried about that?

You should look outside the US. You should look at small caps. You should look, look at big companies that make widgets.

We, well, we've told people 2 out of the 3 things that you, that you just mentioned. We've told them you can look overseas, right? Markets are cheaper there. We've told them you can look at value stocks, look at small caps. And I've said dividends. I'm not, that's not something you want to really say out loud. Polite financial society. I'm a dividend fetishist. And, um, you know, but I don't think you're allowed to say that on a— that's an overshare. Okay. But I do, I like, they're out of fashion, but I like dividends.

And so I've recommended those too. And so, you know, we've been saying this for so long, but it seems like it just happened all at once.

We've, we've said it. And for a long time people have said, yeah, that sounds great. I'm going to go buy some more Nvidia., but now the AI stocks, uh, have stopped working as well. They've, they've fallen off. There's actually, there's a weird thing going on in AI where it was either last week or the week before where we talked about the SaaS-icure, and I realized afterwards we never told people who, who don't know what SaaS stands for. So they're probably thinking, what are these guys talking about? SaaS-icure? We're, it's software, software as a service. That's an acronym, SaaS. And so what's happening is The AI infrastructure companies, the hyperscale companies that are the providers of AI, those have sold off, some of them, but also the companies that are the perceived AI victims, the, the, the ones where investors are saying, hey, AI might replace some of the things these companies do, or it might cut into these companies' margins down the road. Those are also selling off. That's been going on. And then investors have, I call it the Everything Everywhere All at Once trade to borrow a name from a not especially recent movie that I did not see.

What year was that movie, Jackson? The 2022 film by directors Daniel Scheinert and Daniel Kwan.

It won the Academy Award for Best Picture. It won a lot. I remember it won a lot. I should see it. That's not that long ago, actually. Every— all right, so the everything everywhere, it's like I described it in Barron's as a violent act of prudence. Investors are suddenly saying all that stuff that everyone's been talking about for so long, we suddenly think that all of that is a good idea. And I do mean all of it. And we want to do it right now, simultaneously, everywhere. So like, look at some of these index funds, these ETFs, if you will. Let's take Vanguard Value as an example of value stocks. That one has returned 8% year to date. And if you compare that with Vanguard Growth, Value has outperformed Growth by 12 percentage points just so far this year. The S&P 500, by the way, is— it's not doing terrible. It's, uh, you've made 1% and change there. Small caps, iShares Core S&P Small Cap ETF, that one has returned 9%. Overseas stocks, Vanguard Total International Stock ETF, 12% return. And dividends, the Schwab U.S. Dividend Equity ETF, the old SCHD, that one has made 15% year to date. So what do we call this thing? I mean, we can't— we got to come up with something better than the Everything Everywhere All at Once. The stock market skulls, the ones who've said get out of that crypto and get out of those pricey AI stocks and get yourself into some soybean squeezing.

Suddenly they're exactly right.

It's the stock market's gold comeuppance. I'm not sure that's going to catch on, but let's give it, let's give it a week and let's see. Sometimes I'm wrong about these things. I could tell you that JP Morgan, the technical strategist there, they call this a pro-cyclical rotation. What do we mean by that? It's got nothing to do with bike shorts. Holding for laughter for that joke. Nothing. All right, that chafes. I gotta be honest. The pro-cyclical rotation means it's being driven by economically sensitive stocks. Let me give you some examples there. Deere, that's made 34% year to date. Caterpillar, also 34%. Okay, so procyclical rotation. You know, there are decent signs for the economy. There's something called the Purchasing Managers Index, and it's been slumping for more than a year. But for the first time in a year, it reached a level that indicates expanding manufacturing. We'll kind of have to wait and see. It's based on a survey, so you never quite know. Some people say it might just be post-holiday reordering. And also last year, U.S. manufacturing shed 68,000 jobs. But let's see, we'll wait for a few more PMI readings and see where they come in. The problem is that the JPMorgan looked at economically sensitive stocks and they said they've already risen to levels that anticipate much higher global PMI readings. So if this is a pro-cyclical rotation, we might have already missed it. Barclays says this is a kind of a temporary change in both sector and factor leadership. For sectors, they point out that tech and financials have fallen off. The ones that have done well are staples, energy, and materials. We talked about staples. Exxon and Newmont Mining are both up. Exxon has made 25% year-to-date. That one's been coming around just recently. Newmont has also made 25% year-to-date, but that one's been on a tear for a long time. It's tripled over the past 2 years.. It's been riding the price of gold higher. So the question is, what do you do from here? What you don't want to do is get Coorsed, as I put it recently. I'm talking about Molson Coors, the brewer. That stock, the ticker is TAP. That one has lost investors' money for a decade. It hasn't been a great time for beer in general. Jackson, are you a Coors guy? Will you drink a Coors?

Somebody offers you a Coors, you're all right with that? Oh, man, I don't want to disparage Coors in this podcast, so I'll plead the Fifth.

I'm a beer snob, Jack. All right. I know, you know, the one that they got, one called Coors Banquet Beer. It ain't fancy, but I'm just, you know, it's fine. It's a totally serviceable beer. Nothing wrong. Nothing wrong with a Coors. You'll look down on that, right?

As a beer snob? I don't know. I don't like to look down at anyone or anything, but I, you know, if I'm thirsty, I'll drink a Coors.

What if the can of it is twice the size of a normal can? What if it's a 24-ounce can?

Do you feel better or worse?

That's better. Definitely better. Okay. Well, that stock at one point this year was up 16% and change for the year. The problem is the company soon after that came out with bad guidance on earnings and investors took the stock right back down. So if you bought it when it was up 16%, you said, hey, it's a staples mega rally. I get it. Get in while the getting's good. Well, the getting wasn't good. Then for that one. So you gotta be careful about whatever kind of great rotation this is. You have to be careful about chasing it. So what should investors do now? What if you're looking to put some money to work? What if you're looking to change some of your percentages? I don't know what's gonna happen next with this rotation. Also, the, the person who is telling you what's gonna happen next, they don't know either, but we can make some observations about what maybe still looks reasonably attractive and what kind of doesn't. The first observation to make is if this was a stress test for your S&P 500 fund, you gotta say it's holding up pretty well. I mean, we, we were so worried that that thing had gotten very expensive and that it was dominated by this handful of companies that all did the same thing. And what if they all of a sudden sell off? Well, we've seen a sell-off in those companies and you're still modestly positive for the year on that S&P 500 fund. I don't know, if it's going to stay that way. But so far, there's been this upheaval under the hood on the S&P 500, but the, the overall numbers, your return for the year, not so bad. Number 2, Ed Yardeni, the economist, we've had him on the podcast. He points out— this is about a week ago— he pointed out that the Mag 7 tech stocks, they were down to just under 26 times earnings for the group. And at one point, at their high in 2020, they were 38 times earnings. So they're not as expensive as they used to be. And that compares with 22 times earnings for the S&P 500. So you're only paying this, this kind of modest premium. What you're getting for that is a decent amount of growth. Or as Ed writes, the premium is, quote, arguably justified. He says that the Mag Seven, they're projected to grow earnings over the next year by almost 23%, and that compares with just under 13% for the rest of the S&P 500. So you're paying more, but you're getting a lot of growth. I'll tell you the one of these that I don't love that's been working well is I'm not sure about value stocks. In principle, it sounds like a great idea. Let's forget about the glamour stocks, the darlings that everyone's paying attention to that have run up in price. Let's instead focus on these neglected stocks over here. Yes, they have a few flaws and they might be challenged on their growth, but they're cheap. Look how cheap they are. Well, let's look. Vanguard Value, that ETF that goes for over 17 times this year's projected earnings. Projected earnings. I grant you that that is cheaper than the S&P 500, but it's nowhere near as cheap as value stocks have traditionally traded on their own., and it's not even as cheap as the, where the S&P 500 has traditionally traded. So I don't know. I, I just don't love the idea of, if you're worried about how expensive the stock market is, uh, I'm not sure that that's the way to go to, to just buy cheap, flawed companies right now that are, that have had a big run-up in price. I also don't know how I feel about small caps. That ETF trading about 16 times earnings, not terrible. Barclays doesn't like either one of these from here. They write that the value rally has been driven by expanding valuations and not better earnings growth. And for small caps, they say that the trend in earnings revisions has weakened. Okay, I'll tell you about two of them that I do still like. If you don't have enough overseas exposure, if you're a US investor and you're loaded up on the S&P 500 or something like that, I don't think it's too late to put money in overseas stocks. And this is certainly not a sell— what they call a sell America trade or anything like that. It's just, there's two things that you get in addition to your overseas exposure. I'll take the example of that ETF I mentioned earlier. The ticker is VXUS. That's trading at just under 15 times this year's projected earnings. So it kind of doubles as a value fund and it triples as a dollar hedge. The dollar has lost ground over the past year versus peer currencies. If that keeps happening, you'll want to have some exposure to overseas stocks. So I like that idea. You know, it still seems reasonably priced to me. And again, it worked last year and it's still working this year. We'll, we'll see what the rest of the year brings. The other one, and, uh, I don't, I don't know if I should, uh, should I whisper this one or should I, you know what, I'm going to let the whole world know. I don't care anymore. Dividends, dividends still look attractive to me. That Schwab US Dividend Equity ETF, SCHD, that goes for 16 times earnings. So it's, it's kind of a value investment, but you get a 3.4% dividend yield. That's roughly triple the yield of the S&P 500. There are not a lot of— there's not a lot of companies out there, period, with big dividend yields. Companies, in my opinion, are kind of underpaying as a percentage of earnings right now. Dividends are out of favor, so companies haven't increased their payments like at the same clip that their earnings have grown. I think that that will change if we ever go through a prolonged downturn or stall in the stock market. Investors will get antsy. They'll want to see some money coming their way. They'll start clamoring for dividends and companies will cough them up. That's my guess. But for right now, you're going to see in this fund's top holdings, you're going to see some pretty familiar ground. You're going to see crude oil and soda and fighter jets and pills and cigarettes. This is sounding, Jackson, like it's got potential for a Taylor Sheridan show. Except for the soda. Without the soda, right? Yeah. Unless it's soda, unless that's the whole thing, right? Soda Man, right? So Soda Man's got his territory and he don't look, he doesn't care. He's got a cigarette and he doesn't care what you think of him.

He's got soda to sell. There's Succession. The kids want to start a kombucha factory.

I think you got something here. And I forgot to mention phone service as one of the areas with the big dividend payments. So, you know, Soda Man's only got 3 bars and there's a jet fighter going overhead, so we can't hear too well right now. Taylor, if you're listening, I got more ideas on the subject. Go ahead and reach out. That is all I have to say for now about the Great Rotation or whatever it is, the County Fair Tilt-A-Whirl, whatever we're calling this thing. Let's take a quick break, and when we come back, we're going to have Brett Ryan. He's an economist from Deutsche Bank. He's going to talk with us about tariffs and the national debt and the deficit and Social Security and the outlook for the US economy in the year ahead.

That's next. Data is everywhere, but is it ready for consumption? Morningstar developed the language of global investment data so you have the right ingredients to help you shine.

Morningstar, where data speaks. There's a new CBO report out about the debt. I hear there's a lot of it, the debt. I hear it's a problem, but I've been hearing that for 30 years. So I should— and I could have safely ignored it during those 30 years instead of sweating about it. So why should I be worried now? What's different or what's happening now that I should be concerned?

Sure. So what's happening now, and let's start with the near-term outlook for the debt and deficits. And relative to the last CBO 10-year outlook, which was what was used to benchmark the reconciliation bill last year, you're looking at deficits as a share of GDP only increasing about 30 to 50 basis points, which is surprising because the tax bill had some significant tax cuts built into it. And so you're wondering sort of what's going to make up for the revenue loss. And it turns out, as the CBO noted, that 70% of the revenue that was being lost because of the reconciliation bill was slated to be covered by tariffs. And as the Supreme Court decision on Friday threw a wrench into that plan. And so the question is, where is this revenue going to be made up? And if not, then we're going to see an acceleration in deficits as a share of GDP and debt piling up even quicker. And then lastly, the reason why that's a problem is that interest expense as a share of GDP is set to continue to rise. So the higher the debt pile, the larger the interest payments are, and interest payments have now surpassed defense spending.

Let me run through that and you tell me if I've got this right for the benefit of folks who might not look often at the national debt. When we're talking about deficit, the debt and deficit are two different things. The deficit is the amount by which we're going further into the hole each year. And you're saying that was slated to increase and that gets applied here as revenue to the federal government. But now those have been— those are being overturned, some of them. And we're missing a lot of money. Couple of— what is it, a couple of trillion dollars?

How much are we talking about? Yeah, we're talking about $3.5 trillion over the course of the next 10 years. So it's not an—

it's, it's not a small amount of money.

It's more than I've ever lost.

Pretty soon it adds up, as the old saying goes. You know, I'm always looking for a tipping point, and I think that a lot of people are. When does— like, when the debt gets really bad, right? When we've reached the point of no return and when everybody feels sure that it's spiraling out of control, what would we expect to see? We would expect to see the bond market panicking and Treasury yields jumping and, you know, all sorts of bad fallout.

How do we know where that tipping point is, and are we getting close to that tipping point? So I think the conversation tends to focus sometimes too much on this idea of a tipping point where the bond vigilantes come out and we see Treasury yields flying higher and spiraling out of control. And I think that is less of the immediate concern. And the immediate concern is actually the Social Security trust fund. Which in 2032 will go to zero. And absent some sort of reforms, either raising taxes or lowering the growth rate of benefits or benefits payments, what happens is an automatic 20% adjustment to everyone's Social Security checks. It's a 20% cut if you have to pay out of current receipts. So it's more about identifying where are the points, and it's very clear where that point is, 2032. When you run into problems with paying your obligations. In terms of how high can debt-to-GDP go, that's a very open question, and that depends on the rest of the world's demand for dollars. You can look at countries such as Japan that have 200% debt-to-GDP and say, well, where's the problem there? I think it's more about do we have the fiscal capacity to handle what's coming in the near term?

And to do so without causing large societal frictions. When you look at the CBO projections, any opinions on how good of a job they're doing or how complete or how reasonable those projections are? I mean, when you look at them, do you feel like that's what you anticipate or do they need to imagine something better or something worse?

So the CBO has a set of rules that they have to abide by, and one of the key rules being that all of the laws and all of the executive orders that are statutorily on the books right now, they have to incorporate into their forecast. And so they have to incorporate, you know, the trillion of Medicaid spending being cut. They have to incorporate— they can't make a political judgment about whether that's going to happen. They have to incorporate all of the tariff executive orders that are currently on the books. Doing so, they come up with a 15% effective tariff rate. But as we've seen, that is very much in question post the Supreme Court decision. And who's to say that the next administration lifts tariffs on some of our allies? And obviously the legal question around that throws that into some doubt.

If you want to fix the deficit, right, you have to collect more money from the citizenry or you have to cut spending. Increasingly, the options there are like a lot of that spending is is kind of tough to cut. You run the risk that when you do this, that you hurt economic growth. Do you ever think about what policymakers could do in a way to reduce this problem without really damaging the economy too much?

What are, what are the sort of paths that are the most benign out there? Well, one of the best CBO reports that they put out every year is a menu of options to address these issues, both from the revenue side and from the spending side. There are literally hundreds of these options. Politicians never seem to read this report, unfortunately, for whatever reason. And, you know, the reality is it's not necessarily the spending that Congress controls that's, quote unquote, out of control. Discretionary spending as a share of GDP is projected to continue to decline. Right now, it's around 6% of GDP. That's going to, you know, below 5% by 2035 under the current law. It's mandatory spending and net interest that are really driving deficits higher. And that's simply the result that you're going to have an aging population. You have increasing numbers of retirees relative to the number of workers. So to give you an example, in 2006, you had about 4.4 workers for every retiree. By 2036, you'll have roughly 2.6 workers for every retiree. And so with your dependency ratios deteriorating, and by definition, those that are working, those that are working will be supporting a larger group of people that are not working. And so if they don't have the requisite savings, then that burden's going to grow. One of the things you need to do is have some sort of mechanism that either brings up the payroll tax a bit and/or slows the growth rate of benefits because those benefits are adjusted every year by inflation. And that's partly why the Fed is so important and why a 2% inflation target is so important because that 2% inflation target Also means that these government programs that are adjusted every year for a cost of living, the COLA adjustment, if inflation's higher, that's a problem.

Economists, feel free to push back on this if you think I'm wrong, economists sometimes get a reputation for being gloomy, right? Don't they? What's that phrase that they use for, they call it the dismal science. Is that what they say about economics, right? Of course. You don't seem to me to be a particularly gloomy person. Personally, I bet you're fun to hang out with, but you're talking about things here that just feel so crippling in their scope, like these massive problems that we're going to have to deal with down the road. Yet when I look at, I don't know, house prices, they're riding high. The stock market, okay, it's wobbling a little bit lately, but it's been on this ferocious tear for years. Company earnings are good. Unemployment is low. Like things are okay. Why aren't things worse right now? Why aren't financial markets reflecting these concerns you have? Or are we just, are we delusional? Are we, you know, is this a, you know, is this musical chairs and the music is about to stop soon?

What do you think is happening? Well, I think ultimately what you have to remember historically, especially as an economist, we have to look back over history and we've dealt with bigger problems in the past, world wars, for example, and somehow, you know, we found a way around these things. The last Social Security trust fund crisis was in 1983. We solved that problem eventually. You know, while you would like to see policymakers address these situations earlier so that it minimizes the impact, you know, the reality is that they tend to, they tend not to do so until it's right in their face. And that's probably what's going to happen again this time. But again, you will deal with it because you have to, and sometimes you get lucky. So productivity growth, for example, and the AI boom, the promise of the AI boom would be a big help in that respect. It's not going to solve all the problems, but to give you an idea, if let's call productivity growth is a half a percentage point greater than what the CBO has in its forecast. Well, the trajectory of debt to GDP is about 10 percentage points lower over the 10-year period. The thing that matters massively for the debt is central bank independence, because what happens is when you look at treasury yields, you decompose them into inflation expectations, forward rate expectations. So what do people expect for the Fed to do over the next 10 years per se? What do they expect inflation to be at over the next 10 years, per se? Then there's a component that can't be explained by those, those two variables. And that's called term premia, the risk of owning treasuries, things I can't account for. And we're seeing term premia rise, starting to rise globally. That term premium rise makes it harder and harder to stabilize debt to GDP. As long as your economy is growing faster than say the 10-year interest rate, that's a pretty good situation. And so if term premiums are rising globally, that's telling you that the risk of owning treasuries, investors, the large asset managers are seeing a higher risk of owning treasuries going forward and in general government debt going forward. So it's not just the US. But China has a similar problem. Japan is well beyond at 200% of GDP. There isn't a magic number. What matters though is that your economy's growing faster than your, let's call it, 10-year interest rate.

So keep an eye on that 10-year treasury rate. And you just mentioned central bank independence. If I read between the lines, if I understand you correctly, you mean Probably we should. I don't want to dip too far into politics here, but we have an administration that's kind of like made its preferences well known to the Fed. The president has called for lower rates. The president has badgered the Fed chair and this sort of thing. And if you were perceived as having bullied your way into rate cuts somehow, then you might not end up with lower rates at all because the bond market might not like it and yields might go up.

Have I got that wrong or right? That's exactly right. And that's the point I was getting to, is that if the market sensed that the Federal Reserve was not independent and inflation expectations became unanchored from the 2% target, that, that term premium would rise dramatically. And that's where you start to have significant problems because your net interest expense is going to start way outpacing the growth of the economy. At the end of the day, all bond markets are, are trust. I trust that these institutions are going to hold. I trust that the Fed's going to attempt to achieve a 2% inflation target and not let it get out of control.

And it, it doesn't take all that much for that trust to be lost. Thank you, Brett. And thank all of you for listening. If you have a question you'd like played and answered on the podcast, you can send it in. It could be in a future episode. Just use the voice memo app and send it to jack.hough@barons.com. Jackson Cantrell produced this episode. You can subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen. If you listen on Apple, write us a review.

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