Vote No on Election Trading Tips

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This is not a rerun. That's the place to start, right? Fresh. If you want to call it an episode, fresh. I mean, unless you are hearing it at some future date where it's rerunning, but I can almost guarantee—

Yeah, I can't imagine someone listening to this and then 6 months later listen back and say, hey, I remember that episode.

All right. What's going to happen here is it's going to be short. I'm going to say a few things about a few things, uh, just, you know, to catch up on some stuff that has happened while I've been away. And then we'll be back with a regular episode next week, right? We're going to talk about politics. Hold your applause. And Small caps and Apple. Have I got that right?

Ding, ding, ding.

Our audio producer is Jackson Cantrell. He's wearing an In-N-Out Burger t-shirt. Thanks for dressing up.

Double double animal style cut in half.

This is your In-N-Out order, right?

Which is what exactly? It's double cheeseburger with grilled onions, fry sauce, and I like to get it cut in half so it's not as messy.

And animal style means they put it in a tin dish and slide it across the floor, or, or is that just the sauce part?

That's, that's just the sauce.

I gotcha. Okay. Some things have happened since I've been away. There was a fairly benign reading on inflation. There was an assassination attempt on former President Trump, and there was a massive 5-day rally for small-cap stocks. Some of those things might be related. It's always tough to tell. We do this thing every election cycle where we say, if this candidate wins and if this is the makeup of Congress, which stocks will outperform? It's fun to do it. I don't put a lot of faith in it. Whenever you try to talk about the relationship between who's in the White House and how stocks are doing, there's always a big, big problem, and that is sample size. There have been to date just 46 presidents. And in statistics, there's something called the law of large numbers. Sometimes you hear people talk about like a company, a big company that's struggling to grow, and they say, well, it's the law of large numbers. No, it's not. You're just saying that there's an actual thing called the law of large numbers, and it's not that. What it refers to is in probability math, if you have some kind of randomized event and you only perform it a few times, who knows what the results will be. But if you perform it a lot of times, then those actual results will draw closer and closer to the predicted theoretical results. As an illustration of this, I went to the U.S. Mint's website just before I left for vacation.

I'm on the website now.

Right. There's a virtual penny flipping game for kids or for audio producers. There's a button you can hit and it flips the penny. Go ahead, hit it 10 times, Jackson. Let's count the heads.

I've done 6 flips. You're not going to believe this. I'm at 6 tails.

You got 6 tails. 6 tails in a row.

Oh, now I got heads.

Well, see, there you go. Should we have bet on another 6 tails? Of course not. When I was there, I hit the button 46 times for the 46 presidents, and I got 17 heads and 29 tails, which is a ridiculous outcome. But that's what can happen when you have a small sample size. Anything doesn't have to make sense. Also, if we're talking about presidential terms and stock market returns, there's the problem of arbitrary start dates. Presidential terms are out of sync with business cycles, and there are hidden variables. Those are things that you don't see or think about that could explain the results you're seeing— things like wars and new technologies. There can also be shifts in the makeup of the political parties and so on. I would say that the starting point for valuations matters a lot more for long-term returns than who's taking over. But anyhow, Schwab did some math on this. We heard from Kathy Jones, their bond strategist, on this podcast a little while ago, and she was talking about this result. They simulated an investor putting $10,000 in the S&P 500 in 1961. If they held only when Republicans were president, they would've made $102,000 and change by the end of last year. Only Democrats, they would've made a little over $500,000. I hear those cheers/boos out there. Forget it. Hidden variables, small sample size. Do not try to weaponize this information on Facebook with your, uh, uncle that you argue politics with. But the key finding here is that if someone has stayed in the stock market, no matter which party held the White House, they would've made over $5 million. It's just much more important to stay invested than to try to time things for politics. But it's fun to speculate, right?

Oh yeah.

It's even more fun when JP Morgan does the hard thinking for us. So they came out earlier this year with this kind of predictor of what will do well depending on who wins. With a Democrat in the White House and a Republican or split Congress like now, they say that would favor companies exposed to the CHIPS Act and reshoring. So names like Intel and Thermo Fisher Scientific. They also say It would be good for child tax credit beneficiaries. Among the names they list are— this is hilariously stereotypical— Hasbro and Mattel, the toy makers, and Kellogg, the company that makes Froot Loops. Okay, now if Donald Trump wins the White House and you have a Democratic or a mixed Congress, JPMorgan says stick with things that a president would be able to do quickly, like raising tariffs and cutting climate regulation and issuing energy permits. They say that could be trouble for companies with high exposure to China like Apple and Tesla, but on the other hand, it would be good for ExxonMobil. If there's a Republican sweep, JPMorgan says you should add some extra caution for companies that benefit from the green provisions of the Inflation Reduction Act, but it could be good for defense players that are sensitive to the federal budget. Think GE Aerospace and Northrop Grumman. And finally, a blue sweep. JP Morgan calls that a tail scenario, which means unlikely given recent polling. They say it might be bad for companies that are sensitive to healthcare and drug pricing reform. Now that was JP Morgan's view before the first presidential debate. The debate was viewed as pretty darn bad for President Biden's chances in the upcoming election. Have I mentioned yet during this episode, by the way, that I hate talking about politics? I hate talking about politics, but there was also, while I was away, this assassination attempt on former President Trump. And I would hate to engage in the dreadful business of trying to figure out what a thing like that means for someone's chances in an election. But the people who do engage in that dreadful business, they seem to say that it's neutral to positive for Trump. So if you're trying to figure out in a short-term, gambly kind of way what that would mean for the stock market, you might say, It should be good for small caps. Why? Because small caps were among the chief beneficiaries early on during Trump's 2016 win. I think the thought process goes that these are largely domestic companies, and if you're out there talking about tariffs, that might be bad for some of the multinationals, but it should favor companies that operate closer to home. It's not quite that clear-cut because we also had, as I said, that favorable inflation reading. So that might lead you to believe that interest rates are going to be on their way down soon. And that would be good for small-cap companies too. They don't find it as easy as large-cap companies to secure financing. So they depend on those lower rates. Whatever the case, small caps had a heck of a short run with the Russell 2000 index. That's mostly small companies up 12% over 5 days. It hadn't done that well since April 2020. That was much better than large-cap stocks did. And so that begs the question, is this going to continue? Is this the long-awaited resurgence of small-cap stocks? I saw one recent note from Truist Advisory Services. It says, even with the sharp gains of the past week, aided by the increased probability of the Fed lowering interest rates, relative performance still appears to have upside. Small caps remain below the 2021 peak and are coming off one of the most extreme underperformance periods in history. Earnings, which continue to lag, remain a key for a sustainable long-term shift. Hold that thought about earnings. It is certainly true that small caps have had a rotten run. If you invested 10 years ago in the Russell 2000 small cap index, you've made 118%. If you invested in the Russell 1000 large-cap index, you've made 228%. So more than 100 percentage points better off in large caps over the past decade. And even this year so far, despite that recent jump for small caps, large caps have done much better. Not everyone thinks this is the beginning of a big run for small caps. The US Equity Derivative Strategy team at UBS, in other words, the folks that think about stock options, They write that it's the same old story. There's room to run, but the fundamental backdrop remains concerning. Over one-third of that Russell Small Cap Index, they point out, remains unprofitable. Earnings momentum for small caps has slowed recently relative to large caps. The small caps have more leverage than large caps. Their ability to service their debt has fallen, and over 45% of the collective debt of those small caps consists of floating rate paper. In other words, debt with variable interest rates. For large caps, it's only about 10%. Now that can cut both ways. If interest rates fall, it's good for small caps. Let me just make a point about the earnings portion of that small cap discussion. We have touched on this before, but maybe it bears repeating. If I look at a typical exchange traded fund that an investor might buy, iShares Russell 2000 ETF. And I wanna figure out how expensive it is. So I look at the portfolio characteristics and the P/E ratio. It shows a P/E of 15.8. And I say, hey, that's pretty darn good. Isn't the S&P 500's P/E over 20? So maybe small caps are trading at a big discount, but there's a footnote. And if I click on the footnote, it says negative P/E ratios are excluded from this calculation. But we just heard that more than a third of the constituents of the index aren't profitable. So that's leaving kind of a lot of companies out. That's making the earnings sound a lot better than they are. If you include the negative earners, that P/E ratio is well over 20. There's also something that sticks in my mind from early last year from Torsten Sloke. He's the chief economist over at Apollo, and he put out a chart of the percentage of companies in in the Russell 2000 that have had negative earnings over time. And what the chart shows is that in the 1990s, the percentage was around 15%. It was well less than half what it is now. So the percentage of unprofitable companies has been rising over time. You would expect a high percentage if we were in the depths of a recession right now, but we're not. So when we talk about the long-term underperformance of small caps, I sometimes wonder if we're also talking about long-term earnings deterioration. Now, I don't know who's right and who's wrong about whether the small-cap rally will continue. It seems to have fizzled a little bit in the past couple of days. We'll see. I do think it's a good idea to diversify. So, if you have an S&P 500 fund, you can have a smidgen in an S&P 600 small-cap fund. By the way, that S&P small-cap index, unlike the Russell one, has a screen for profitability. So, the earnings quality there will be higher. If you look at the valuation on that index recently, about 16.5 times this year's earnings. So that one is trading at a discount to large caps. I don't know who's gonna win the upcoming election. I'm not even 100% sure who's gonna run in the upcoming election. There's a lot of time left, and I don't think you should change your investment allocation or approach based on what you think politics will mean for the stock market. I do think it's fun to speculate about these things, so have at it in your mind. Just take it easy in your account. And if you don't have any small cap exposure, maybe get a little, not because I'm totally confident that small caps will keep shining from here, but just because I think diversification is good for you in an eat your vegetables kind of way. Speaking of vegetables, Apple, close enough, once again reasserting itself as the largest US company. It has outdone other big tech of late, We'll talk about why and whether it can continue and whether we're going to get an iPhone supercycle. Is that a long enough dramatic pause? I went too long on the pause. It got too dramatic. That's my bad. Coming up right after the break.

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. What's driving the markets this week? What's on investors' minds as they look ahead? Find out on The Markets Podcast from Goldman Sachs.

A breakdown of market moves and macro signals in 10 minutes or less. The Markets Podcast from Goldman Sachs. Listen now. Welcome back to the non-episode. Still a non-episode, by the way. Vacation week. I tried to set your expectations low earlier. Let's keep them manageable. We're going to say a few words about Apple. Here's why. I'm looking at recent stock performance for some of the mega-cap companies, recent meaning since the end of June, and I'm seeing some negative signs. Meta down 5.6%, Amazon down 4.9%, Alphabet down 2.4%, even Nvidia down 2%, and Microsoft down 1.5%. But Apple Bucking the trend is up 6.4%. So what's causing the sell-off in big tech? Now, not everything needs a reason. I probably shouldn't say this too loudly because it's a big part of the financial news business, but one of the things we do is we come up with a clear explanation for every little percentage point move that's going on in the world. And you know, sometimes it's just like big tech has gotten expensive. It's been on a wild run. Investors are doing a little profit taking. Now let's keep that between us and get back to the narrative here. It's a Trump 2.0 trade, of course. More politics. So I'm looking at a note from our friend Dan Ives over at Wedbush, and it says, we have seen a brutal tech sell-off post-Trump comments to the media at the RNC National Convention about stepping up China tariffs and protecting Taiwan from China, which catalyzed 'a street panic for semis, AI revolution names, and big tech.' Now, Dan goes on to say, 'Don't sweat it too much, it might be a buying opportunity.' He writes, 'Just like our view since 2016, the bark will be way worse than the bite on the US-China cold tech war fears.' He also writes, 'We believe the Trump trade does not ruin the AI revolution thesis and tech bull market.' You can agree or disagree on whether there's more upside from here for big tech, Dan is particularly bullish on Apple. He sees the possibility of an iPhone supercycle coming this fall, and Morgan Stanley agrees. The Apple analyst there recently elevated Apple to his top pick with a big price target increase. He expects Apple Intelligence— that's the new AI functionality— to benefit more than just iPhone shipments, given users will need to buy an iPhone 15 Pro/Pro Max newer models to use Apple Intelligence, which will result in positive mix shift and iPhone average selling price growth. And just 24% of iPads today can run Apple Intelligence, implying the iPad could see its own mini upgrade cycle. So that's Morgan Stanley and Wedbush. Is there anyone out there who wants to poo-poo this Apple supercycle thesis?

I will.

Go ahead, Jackson.

Yeah, I have an iPhone 12 mini. Still works fine.

Still ticking.

No need. Still ticking. That's my analysis.

Jackson with the Timex theory. If it's still ticking, why replace it? Well, you're not alone. The analyst at UBS wrote recently that fiscal 2025 optimism is misplaced. He has a neutral rating on the stock, although his price target is now well below where the stock traded recently. The analyst writes, following WWDC— that's Apple's big developer conference where it talked about its AI plans— he writes, confidence in an iPhone AI supercycle in fiscal '25 has reached a fever pitch as the most optimistic scenarios underwrite over 250 million iPhones in Apple's fiscal 2025, with some estimates over 260 million. However, Our analysis of smartphone demand by region and prior cycles, income demographic data, and carrier subsidies argues for a more modest cycle next year. Therefore, we forecast iPhone revenue growth of 2.4%. That's roughly 400 basis points or 4 percentage points below consensus and almost 10 percentage points below the rosiest forecasts. The analyst writes that Apple had a big surge in iPhone demand a couple of years ago, but that was following two soft years for sales, and around that time Huawei was effectively shut out of the high-end smartphone market. We don't have conditions like that now. He writes that Apple Intelligence and ChatGPT are not currently approved for use in China. Therefore, mid-teens iPhone unit growth in China would not be driven by AI functionality. He writes that income demographics might limit the replacement cycle, basically If you look at all the iPhones out there, the installed base, 1.3 billion units, and you ignore refurbished phones or hand-me-down phones, they figure that 63% of the base owns either a version 13, 14, or 15 series, including the minis. Jackson, what'd you say you're working with over there, a 12?

A 12 mini, yeah.

So nearly two-thirds of people have phones that are newer than yours. You say you're happy enough.

Dingo.

Yeah, I think that's their point. The analyst also writes that prices are likely going to have to rise on these new iPhones and that demand for iPhones with regard to price is not inelastic. In other words, customers might balk at paying higher prices, especially because, he writes, over 40% of iPhone owners have an annual income equivalent of $50,000 or less. Another 44% are in the $50,000 to $100,000 range. Only 14% make over $100,000. Two more potential headwinds. First, to have an iPhone supercycle, you might need generous subsidies from the phone companies. UBS's analyst calls that, quote, a low probability assumption in our view, given the relative stability of the postpaid market. Postpaid market meaning most of the people who have a regular monthly phone bill. Not those who were prepaying for minutes. The last headwind is what the analyst calls net interest. Basically, they survey a bunch of users before the release of a new feature, and they say, how interested are you in buying a phone based on this feature? And they subtract the people who are not interested from the people who are interested. Now, when they did that before 5G phones came out years ago, they had 58% net interest., but now prior to the AI phones, it's only 18% net interest, 40 percentage points lower. It seems to be a lot of people saying in surveys at least that they're not willing to buy a new phone just based on the new AI features. Now maybe that'll change over time. Maybe people will start to see the usefulness of the new features, but that's one of the things UBS points out. They write, the lack of applications is likely to be a demand headwind as well, similar to 5G iPhones and even the recently launched Vision Pro. Dedicated applications designed to take advantage of a new technology/platform has been somewhat lacking. Now we're going to get quarterly results from Apple on August 1st, and I would expect to get guidance around then from the quarters ahead. But who really knows until the devices go on sale what those orders are going to look like. It'll be interesting to see. I think, Jackson, that I have a 15. I can't quite remember. Where do you tell?

Hold on. Go into settings. General about—

I found it. iPhone 15 Pro Max. I think that— I think the fella said that I'm going to be good for the new features. Isn't that what they were saying?

Morgan Stanley said that you can test the AI.

I'm gonna be— I tell you what, I'm gonna AI this thing when the AI stuff comes out. I'm going to be AIing for all I'm worth, and I'll let you know whether it's worth it. I should point out that I'm not a tech reviewer, and if I'm being honest, my relationship with Siri has been Just a little bit tense lately.

Too much politics talk.

We're working through— we're working through some things. Thank you all for listening. Jackson Cantrell is our producer. It's been a couple episodes in a while where I've remarked about your shirt. Is that going to be a new regular thing? And you want to say anything about next week's shirt? We're talking Hardee's, Bob's Big Boy. What are you going for?

Think auto repair.

That'll be fun. You can subscribe to the podcast, Apple, Spotify, wherever you listen. If you have a question you want answered on the podcast, tape it on your phone, use the voice memo app, and you can email it to me, jack.hough, that's H-O-U-G-H, @barons.com. If you're offended about something I said about politics, you can email me on that too. It's jack.hough@hotmail. See you next week.

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.