Model portfolios

JACK JANASIEWICZ: I'm Jack Janasiewicz.

BRIAN HESS: I'm Brian Hess.

JACK JANASIEWICZ: And this is Tactical Take.

BRIAN HESS: Hey, Jack. It's good to be sitting down for another podcast. There's been quite the market melt up since the last time we spoke on Tactical Take. So the S&P 500, since March 30, up 16% through Friday. NASDAQ 100 up 26%. So it's been some pretty big moves in a short period of time. And Q1 earnings seems to have been the major catalyst for the market's strength. So I thought maybe we could start by talking about what was it about tech earnings in the first quarter that propelled stocks to such a degree off those March lows?

JACK JANASIEWICZ: Yeah, it all comes down to the earnings backdrop. If we look at the summary there, earnings per share growth for the S&P 500, the broad market up 23% on a year-on-year basis. If we take out the Mag Seven, it was still up a hefty 14%. And just to put a comparison in there, Europe was up about 5% on a year-on-year basis.

But I think a big chunk of the earnings are still being driven by the AI-related theme in the marketplace. So to your point, that tech backdrop is still pretty important. But I think even still, when we look at the breadth that we've seen of earnings, there are a few things worth highlighting there.

Seven out of 11 sectors were actually up double digits in terms of earnings per share growth, with only one actually down on a year-on-year basis, being health care. But the other thing that I thought was interesting, when you look at what was going on, earnings are going up and to the right. Estimates continue to grind higher.

Same thing with margins. Estimates for margins for the end of the year continuing to push higher. Yet, we're seeing a derating, or had seen a derating, with multiple contraction across the board. And so we don't really see that very often.

When you get margins expanding, that tends to signify quality. And investors tend to like to pay up for quality, which means they're willing to assign a higher premium. We didn't get that this time around. So I thought that was one other interesting takeaway is what we're seeing with regards to multiples actually coming back down.

BRIAN HESS: So I guess the derating is, in part, a response to concerns about the fallout from Iran.

JACK JANASIEWICZ: 100% percent.

BRIAN HESS: There are two different market drivers, one going well, and that would be the earnings, and the other maybe less clarity, so markets discounting the future.

JACK JANASIEWICZ: And when you're rattling off those return numbers, I wonder how good those would have been had we not had such a strong earnings backdrop because the overriding factor probably would have been the uncertainty around Iran.

BRIAN HESS: Yeah, perhaps it would have been an even stronger, just like persistent trend, forgetting the February, March correction. Before we move on, one quick thing that came to my mind when you're talking about the year-over-year comps and the breadth of them. Was there something about Q1 last year that depressed earnings to allow for so many sectors to have double-digit growth? Or is it just that it's been such a good 12 months that they're—

JACK JANASIEWICZ: Yeah, I think—

BRIAN HESS: --they're all experiencing quite good earnings.

JACK JANASIEWICZ: --when we go back and look at the number of consecutive months of double-digit earnings growth, I think we're pushing seven or eight consecutive quarters. So I'm not sure it really was a base effect, so to speak. I think it was still a pretty healthy backdrop.

And maybe the one caveat worth highlighting, when we look at the earnings for the tech space, you had, I think, Google and Amazon really boosted that because of their mark-to-market of their investments in the AI backdrop. So a lot of those private investments that they've made, they've actually started to mark-to-market those. And they had a pretty significant jump up. So that could be worth seven or eight percentage points of absolute earnings per share growth. Take those out, still a healthy number. But those are one time markups, I think, to keep that in the back of your head.

BRIAN HESS: But the bottom line is that it's pretty healthy backdrop for earnings in the US across the board.

JACK JANASIEWICZ: 100%.

BRIAN HESS: So that speaks to good economic strength, broad-based economic strength, and a couple of tailwinds that we've been talking about on this podcast. OK. Well, I guess it's clear that, as you mentioned, the AI buildout has been a big driver of earnings growth, of economic growth. That's one of the factors I was just referring to.

But I guess the question now is, as we look forward, and we've got this margin expansion, we've got this persistent strong earnings growth, has the big rally in the tech space priced in too much? Or is the multiple contraction that you were talking about-- tell us. There's room to run here.

How are we thinking about that? Because it does seem like some areas of the market are showing what you would think of as classic signs of excess-- semiconductors and thinking about memory. But maybe the Mag Seven itself isn't really too bad from a valuation standpoint.

JACK JANASIEWICZ: And I think that's the question that needs to be answered because that's going to be the overarching theme that we need to figure out going forward here. But I think there's a few things that are worth pointing out here.

There is an actual rotation going on underneath the surface within the semiconductor space. It's no longer about GPUs. I think we're also now starting to see that shift towards inferencing chips, custom silicon, and memory. And I think that is partly why we're seeing such huge runups in names like, let's say, Micron, AMD and Intel.

And when you start to look at some of the revenue projections from, for example, the semiconductor-- yeah, the Semiconductor Industry Association calling for revenues to hit close to $1 trillion by the end of this year. I've seen a few other estimates out there even closer to 1.3 trillion. It seems like they're actually backing up some of these numbers. You look at some of the things, for example, from TSMC, their first quarter revenues, almost $36 billion. It's just first quarter.

BRIAN HESS: Taiwan Semiconductor.

JACK JANASIEWICZ: Yeah. Lattice Semiconductor-- earnings per share growth up 86%. Revenues were up 42%. And then you start to think about the valuations that are being placed on some of these. Micron is trading at 12 times 2027 earnings estimates. So I think there's a lot of good going on here.

But to your point, can this earnings per share growth persist? And we tend to look at what's going on with the hyperscalers. What are they saying? And when you hear from the Amazons, the Googles, the Microsofts, the Metas, especially over the last couple of earnings calls that we've heard from them, they're saying basically compute demand is certainly outstripping chip supply.

And so that, I think, gives the rotation underneath the surface, which is lending credence to a lot of this cycling of moving from GPUs to CPUs sort of thing. And what's interesting is we move from deploying AI into inference or memories. You're looking at the ratio of GPUs to CPUs shifting. For every eight GPUs, you need one CPU. Because that's now starting to shift, I'm seeing estimates where that's now going to be more at parity going forward.

And so, again, it just proves that this rotation underneath the surface is pretty healthy. And to throw a couple of data points out there, when you start thinking about high bandwidth memory, guys like SK Hynix and Samsung overseas are both basically saying they expect to see shortages through 2027. And on top of it, they're raising prices by 20%.

So can it persist? It certainly seems like there's a runway out there, at least for the next year or so, but it remains to be seen. You get a breakthrough on some of these language models that basically require half the compute and half the energy. Maybe that rechanges everything here. So who knows?

BRIAN HESS: So it's really hard to call an end to this, given what we're seeing fundamentally. But we have to, I guess, remain somewhat skeptical that the technologies are constantly innovating. And normally, you don't see these kind of growth rates sustained perpetually.

JACK JANASIEWICZ: 100%.

BRIAN HESS: Nature of capitalism is to come in and arbitrage that away.

JACK JANASIEWICZ: And I think the two things to pay attention to, what are people saying on earnings calls? Are the earnings still backing it up? I guess you could say yes. And then, what are the hyperscalers showing us in terms of CapEx spend, and just continues to go up and up, at least out to '28, '29. So those are the data points we're paying attention to. And they're still telling us things are OK on that front.

BRIAN HESS: One of the challenges for people investing in the stock market, outside of just technology, is that a lot of sectors have stopped participating and begun underperforming. And so the market leadership, particularly on this move from March, has been dominated by tech, with lots of industries, like financials, in particular struggling, and many other sectors just not making new highs. 

So that's kind of a red flag, I think, for the broad market that we have narrowing breadth from an individual name standpoint, but also from a sector standpoint. And then some of the parabolic price action points to the risk of maybe a little bit of an overshoot, at least near term. But I get your point, that the fundamentals are quite robust.

JACK JANASIEWICZ: And I think maybe if you want to make the bull scenario to continue, all of a sudden you're going to start to see the use cases for the AI backdrop starting to manifest, which then I think helps to broaden out the backdrop here. So it's no longer just AI-related tech themes that are driving the market. Then you start to see the users benefiting from that, and you see the broader market starting to catch on.

BRIAN HESS: Other sectors can become AI winners, too, not just technology.

JACK JANASIEWICZ: Exactly. Yep. Remains to be seen on that one.

BRIAN HESS: That's a good point. Before we leave Q1 earnings, any other takeaways outside of technology? Were there any other sectors, like with respect to the US consumer or anything you'd like to highlight?

JACK JANASIEWICZ: Yeah. I mean, I think what we've heard from the banks, for example, and the credit card companies, we're largely what we'd expected. Still bifurcated economy. You still have that k-shaped economy, so to speak, where the lower incomes are getting squeezed, but the upper incomes continue to do well and continue to spend. And again, we've talked about this in prior recordings, but who does the bulk of the spending? It's still the upper income. So that can still be sustainable there.

I thought some other things that have been flashing as concerns running into first quarter earnings season, private credit had always been on the front burner. Again, comments coming out of the banks are basically saying that they're viewing this as an idiosyncratic event. Largely seems to be more retail-focused products, so BDCs. And you're hearing, again, from some of these managers where institutional investors are actually lining up to buy while retail is selling. So it certainly feels and seems like the indications are for that to be somewhat of an idiosyncratic—

BRIAN HESS: That may have moved from the front burner to the back burner.

JACK JANASIEWICZ: Exactly.

BRIAN HESS: It seems like, especially with the Iran war risk.

JACK JANASIEWICZ: Yeah, and that's a good segue to the last thing that's maybe worth highlighting is we did hear some concerns in some of the commentary, but the concerns were more geopolitical related as opposed to demand concerns. And there's a nuanced difference there. But that geopolitical risk uncertainty backdrop is really the one risk most of the highlights that we saw from a concern perspective we're pointing to.

BRIAN HESS: And that's more intangible and more concern about what could happen, as opposed we're concretely seeing this deterioration.

JACK JANASIEWICZ: Yep.

BRIAN HESS: All right. Great. That's a pretty good rundown. It sounds like tech is booming, and the rest of the economy is still doing fairly well also. And that's why we're getting this persistent bull market.

JACK JANASIEWICZ: Sure.

BRIAN HESS: All right. Very good. Now, when we think about-- we were talking about, oh, we have some sectors going parabolic, and we have a lot priced in. When we think about potential risks or the spoiler that could be out there, the one thing that comes to mind, I think the one obvious candidate, is inflation, where we've been getting increasing talk of inflation rising.

And so last week, we got the April CPI and PPI reports, and both were hot. When we look at headline CPI, that's now up to 3.8% year-over-year again. And when we look at even core PPI, there's a couple of different measures. But regardless of which one you're looking at, it's like 4% to 5% year-over-year, and that's stripping out energy prices.

So these are big numbers, and I think they could start rekindling memories of 2022. Because prior to 2022, we did not see 3.8% inflation and 4% to 5% PPI very often. So it looks like based on this, Fed rate cuts are off the table.

And in fact, the market's now pricing a chance of a hike this year, actually. Not a full hike, but there's increasingly risk that it might happen. And at the April Fed meeting, we had an interesting lack of consensus with a variety of dissents. So I'm wondering, what did you make of the large number of dissents at that Fed meeting?

JACK JANASIEWICZ: Yeah. So we had, what, four dissents? Obviously, Myron, a little bit of a unique dissent.

BRIAN HESS: Not all in the same direction. Right, we did have— 

JACK JANASIEWICZ: So we had three members voting to, I guess, remove the easing language that was written into the statement. And I think the market, in our view, at least, I think took that a little bit too hawkishly, only because when we think about where we're at right now, the idea of going from easing to an easing bias, to neutral to a hiking bias, to hiking, so sort of along that continuum, so to speak, that—

BRIAN HESS: Yeah, there's five possible stops.

JACK JANASIEWICZ: Exactly. I think when you move from easing to easing bias to neutral, that's pretty linear. You can move up and down that pretty easily. But when you start to then go to a hawkish bias in an actual hiking, I don't think it's quite linear there. I think then you start to take step-ups, if you will.

So I feel like the market, in looking at those three dissents, assume this linear continuity pattern going across that continuum, I'm not sure that's really the case. I think there's still a higher bar for them to move to a hawkish tilt, and even more of a higher bar to actually move to hikes. And I think that's going to be a key differentiator.

So the three dissents to me just basically puts the market, or the Fed, back on, listen, we're in neutral. We're in a holding pattern for however long it takes to see what happens with the data. And so that's how I think I would interpret what came out of the FOMC in terms of that last meeting. It's hey, we're going to sit on our hands for a little while and just see what happens.

BRIAN HESS: I mean, given what we just talked about related to earnings and related to the stock market and related to inflation, it kind of makes sense that they should drop the easing bias. Does the economy need additional rate cuts?

JACK JANASIEWICZ: 100%. If there was ever a time to have a cushion built in where you maybe could tilt a little bit more to a hawkish tone, so to speak, this is it. The economy is doing well. Stocks are at all-time highs. Maybe the one risk is, let's see what happens with the bond market here because the bond market can certainly short-circuit what's going on out there. But the backdrop, I think, is still in pretty good shape, where, hey, if you just want to sit back and do nothing, that's probably not a bad—

BRIAN HESS: You have a window of time where you can safely do that.

JACK JANASIEWICZ: 100%. Right.

BRIAN HESS: And so with respect to rate hikes, like taking it even another step, it sounds like you're still of the view that there won't be rate hikes this year. And it's pretty unlikely.

JACK JANASIEWICZ: Yeah. I mean, again, the things could change. But at least from our perch where we sit, we still put a very low probability on a hike, and maybe a little bit of a door opening for potential slowing of the economy in the back half of the year. And maybe that opens up a little bit of room for maybe an even easing. But still, neutral is probably more in line with that.

BRIAN HESS: I guess we'd have to see if we got like three or four more inflation reports like the last one, at that point, maybe a hike would become pretty tangible. Because there's going to be some number of inflation reports where the Fed has to do something because they don't want to risk. I mean, and look at breakevens. The 10-year breakevens are up to 2.5%, which is a pretty lofty level. So I think for the Fed to retain its credibility, at some point, they'll have to act. But one hot report in April, and a medium hot one in March is probably not enough.

JACK JANASIEWICZ: I think the one thing that we keep falling back on, it's the idea that in order to have a sustained inflationary impulse to go forward, it really needs to be coming from the demand side. And so when we look at things like really a no hire, no fire labor market, and then you lump on top of that real wage growth, which is actually declining, we have a hard time seeing that demand impulse pulling through.

So a lot of what we're seeing today is really coming from tariffs and the energy shock. How much of Fed hikes really get to help on that? That's probably going to do more harm than good. But the risk, obviously, is if this stuff starts to bleed into the broader economy, then maybe you'll have to do something about that.

But again, we still hang our hat on the idea that we're not seeing that wage impulse here. That's really, I think, the key driver where we would be concerned about inflation really coming back aggressively. Can we drift higher? Sure. But I think we're more worried about a sustained spike in inflation going forward. And we just don't see the ingredients for that right now.

BRIAN HESS: And that's a big difference between the current environment in 2022. There was an element of a supply shock, a pretty big element, initially in the post-COVID era, where clearly that was the initial driver of inflation. But then you had massive stimulus that was arguably overdone, which put a lot of spending power in the economy. And then you had wages growing at a very high rate relative to history.

We're lacking the stimulus, and we're lacking the rapid wage growth this time around. We mostly have the supply shock. So maybe that will limit the pass-through from headline to core, or the durability of the high inflation.

JACK JANASIEWICZ: And that's why I think you have time to wait this one out from the—

BRIAN HESS: From the Fed standpoint, it's easier for them to look through it.

JACK JANASIEWICZ: Right.

BRIAN HESS: All right. That makes sense. Now, one thing we spent a lot of time talking about the prior two episodes is the situation in Iran. I feel like we should check in, probably briefly, because not much has changed since the last time we talked.

Oil prices are still high. I think WTI is 105 this morning, as we're recording, and refined products are still elevated. And really, there doesn't seem to have been a tremendous amount of progress on the discussions, the negotiations between the US and Iran. So I guess, what are you-- just generally, what are you focused on with respect to that war right now? What are you looking for to tell you one thing or another?

JACK JANASIEWICZ: Yeah, it's really the market's impressions looking out. So the one year, one year forward inflation numbers, they're still remaining decently contained, drifting up a little bit, but not taking off. Looking at those far contracts for delivery on WTI or Brent, those are moving back up to the upper end of the range. So certainly seeing plenty of ideas that yeah, maybe oil prices will end up being higher for longer. Inflation doesn't seem to be really moving quite as much. But that's the things that we're paying attention to in here.

And then the other one too is the distillates market because they're going to be a little bit more twitchy, if you will, in terms of reacting to shortages out there. So things like jet fuel prices, heating oil prices, those sort of things. They're well off the highs, but still elevated. So until those start to come down again, there is still the outside risk that the higher for longer in terms of this uncertainty starts to bleed back through, and things start to drift back up again. So are we out of the woods yet? Not by far, but the market seems to still be looking past this.

BRIAN HESS: So the war still has the potential to be market moving. It seems like it's lost some of that impact recently, but I guess your point is if things just remain status quo for the time being, it's probably not a big market moving event. Things will be more focused on what's going on with memory and the tech investment. But if we get a further rise in oil, further rise in distillates, or if we're talking about three months from now where nothing's changed, and now we've gotten those two more hot CPI reports—

JACK JANASIEWICZ: Yeah, that's a problem.

BRIAN HESS: --at that point, the Iran wars back to the forefront, and we're like less focused on the tech buildup.

JACK JANASIEWICZ: 100% agree with that. 

BRIAN HESS: All right. Well, we'll check in then next time—

JACK JANASIEWICZ: Spot on.

BRIAN HESS: --and see how that goes. All right. Now, we made a model trade since the last time we chatted and added a couple of new positions. So I figured it'd make some sense to talk through the thesis behind these two new ETFs that we purchased.

So the first one, ticker AIRR, that's the First Trust RBA American Industrial Renaissance ETF. And this is built around the idea of reshoring, building out manufacturing, Making America Great Again. But can you get into it a little bit more for the audience. What was the thinking behind AIR?

JACK JANASIEWICZ: Yeah, and we're going to go into both trades here. So I think the thesis really applies to what we're going to talk about for both of these positions, but—

BRIAN HESS: All right. So let me just bring in the other one while we're at it.

JACK JANASIEWICZ: Sure.

BRIAN HESS: The second ETF ticker PICK, P-I-C-K, that's the iShares MSCI Global Select Metals and Mining Producers ETF. So that's more of a global-- not more of-- it is a global ETF. Whereas, AIR is a domestic one. But they are related in a way. Yeah, there you go.

JACK JANASIEWICZ: So I think when you look at what we've gone through, we've seen a bunch of supply shocks hit the economy, going all the way back to COVID, to Ukraine and Russia, to what we're seeing today in Iran. And I think that's put a lot of pressure on the ability to navigate these concerns going forward there.

Layer on top, the idea that we're seeing, I with some of the Trump policies going forward, we've come a little bit more isolationist, if you will, sort of pulling back from the global stage and really focusing more on the United States itself. And I think we've traditionally seen a bipolar world, where it's really been China, US, and everybody else moving more to, I think, a multipolar world. And you can draw those parallels sort of up and down the globe.

So you've got the US, Latin America sphere, maybe the Europe sphere, the Asia sphere, Japan itself, and then China and Russia. But you can all suddenly now say maybe there's five or six different spheres, if you will. But with each one of those, you want to become more and more independent. You don't want to be reliant on others around these spheres to help continue to build you out, so to speak. And so I think that puts a precedent or a greater importance on national security issues. And that again, goes back to what we saw during COVID and the supply chain problems that we ran into.

So when you're starting to talk about potential concerns, national security interests take the forefront. What's the next thing to think about? Well, you've got to go through what's key there. Well, semiconductors. The chips are going to be important, raw materials, critical minerals those sort of things. That's part of the national security story. And that means we need to do a lot of that, at least at home, or maybe within our sphere of influence. And I think both of those tickers that we just talked about play into that theme.

AIRR plays into the global reshoring onshoring, or the US reshoring onshoring theme. Less reliant on our partners overseas. PICK is really a play towards those raw materials, those critical minerals. That's really, I think, the overarching theme that we're trying to get to.

And maybe add one other thing in there. When you start to think about, for those who follow some of our consultants here that use the cyclicality versus inflation theme work, we're trying to move a little bit up and to the left, so to speak, a little bit of cyclicality, as well as a little bit of inflation backdrop.

BRIAN HESS: So more cyclical sensitivity or growth sensitivity and more positive inflation sensitivity.

JACK JANASIEWICZ: Exactly.

BRIAN HESS: You need stocks to do well in a rising or high inflation environment.

JACK JANASIEWICZ: Exactly. So that reflationary environment, and these two basically put us up into that quadrant, so trying to get exposure to those themes as well.

BRIAN HESS: So this is regionalism over globalism. This is about countries building up national champions and securing access to raw materials for those national champions.

JACK JANASIEWICZ: 100%.

BRIAN HESS: And that's our medium-term theme across the board. Now, we did have to cut one position in order to make room-- well, not even to make room for. We had to cut a position for risk management purposes, but we also used it as a funding source for the new ideas. And that's ILF, the iShares Latin America 40 ETF.

We still like Latin America on a secular basis, but it does seem like near-term, some of the inflation concerns we were highlighting earlier may have hit with a bit more impact in Latin America. So we know Brazil is one country where the central bank is now probably going to be hiking rates. Is that the basic reason here for ILF? It got off to a great start for us, one of those trades where you're like, wow, we put this on at the perfect time, but it rolled over hard in relative terms.

JACK JANASIEWICZ: Yeah. I think, the Bovespa does tend to trade very well—

BRIAN HESS: It's the Brazilian equity index.

JACK JANASIEWICZ: Yeah. Trades, very well with the idea that the Koppam central bank there will be cutting rates. There's a high correlation, high beta to that. So when we first put that trade on, the market was still anticipating several more rate cuts coming from Koppam. That has since changed. So I think that's really the overarching theme with regard to the Brazilian equity market. And our view is highly levered to the rate cut backdrop, and those rate cuts have evaporated. So let's take a little bit of that off and go elsewhere.

BRIAN HESS: And even though it's called the Latin America 40 ETF, Brazil, I believe, makes up a majority of the equity ETF. So it's very sensitive to what's going on in Brazil.

JACK JANASIEWICZ: Right.

BRIAN HESS: OK. Thank you. Now, with this trade, we remained 1% overweight stocks, and that does seem to follow logically from everything we've talked about over the course of this episode. But last question. Can you just explain why we're so comfortable being overweight stocks despite the massive rally in the S&P 500 since late March?

JACK JANASIEWICZ: Yeah, listen, are we subject to a potential correction here given the runup that we've seen? I mean, we look at a lot of the position indicators. Certainly, they look a little bit stretched in here. So would it be shocking if we get a 5% or 10% correction? No, but I think-- and, again, those are normal in market cycles. In bull markets, we do get these profit-taking sections.

BRIAN HESS: We're not trying to trade around every zigzag in the market.

JACK JANASIEWICZ: 100%. That's what we're trying to get to here. We're not going to sit there and try to call 5% and 10% corrections. The bigger theme for us is still really what we opened up with here, is that the earnings backdrop.

When you're talking about earnings that are coming in at 15%, 16%, and expected to continue to grow, you're seeing margins continuing to grow, that backdrop is pretty conducive to stock prices continuing to push higher here. And what tends to short-circuit this backdrop? It's usually when the Fed starts to hike.

And as we just talked about, at least between now and the end of the year, we're not seeing a Fed hike potential coming in yet. So I think the backdrop is still supportive. Is it great? I won't say it's great, but it's also not bad. And that's probably the sweet spot for the market. And corporates are going to do what they do, and that's post earnings.

BRIAN HESS: I think what's happened probably is that the rate hike fears have cropped up a little bit. And so certain parts of the market that are more sensitive have begun underperforming, like I mentioned, financials, but also small caps started rolling over in relative terms. So if we're focused on US large caps, which is where our overweight exists, then for now, we should be insulated for the reasons you just highlighted.

JACK JANASIEWICZ: 100%.

BRIAN HESS: But we have to keep an eye on that Fed story.

JACK JANASIEWICZ: Yep.

BRIAN HESS: All right. Well, thank you, Jack. It was a good discussion today. It's been an interesting year, and I think it'll probably continue in that direction. So I look forward to next episode and sitting down again. Thanks a lot.

JACK JANASIEWICZ: Excellent. It was fun.