Transcript:
Caroline Woods:
We are back in action with Sonali Basak, chief investment strategist at IE capital. Sonali, welcome back to the desk. Good to see you. Thanks for kicking off the week with us. First full week of October, first full week of Q4. And we’re seeing some green arrows on the screen. Underneath the surface though, is this a healthy bull market or the headline numbers hiding anything?
Sonali Basak:
Listen, we have earnings season around the corner. That’s going to be a very telling earnings season. Big tech is still expected to cover a lot of that ground. And so we have to look outside of that and see well where where we see any margin pressure from oil prices staying so high spillover effects into the broader economy. I think that’s why you’re seeing such nervousness still in the consumer in particular.
Sonali Basak:
I will say on the macro front, a lot of people have been talking about that jobs report recently. It did come in as disappointing. But if you look over three months, you still see the economy growing at about trend job growth. So that’s 50 K a month. You did see that employment rate unemployment rate ticked up, but labor force participation also ticked higher.
Sonali Basak:
So there are no really red alarms in the macro right now which can continue to support solid growth which should continue to support earnings. We just think it will be a little choppy through the end of the year.
Caroline Woods:
Okay, so the S&P 500 is already up about 13% up to this point year to date. Do you think we can hold on to those double digit gains. Do you think we can add to them? What does choppy look like?
Sonali Basak:
Sure, I think we can. I think we can not only hold on, I think we can also add to that. I don’t think it’s a straight line. I do think because the path forward is more likely higher than not. Assuming the fed can keep things under control in this hiking cycle. You can see a drift higher, but remember.
Sonali Basak:
What does that mean? It means a pullback that we might see from now to then can start to create some interesting entry points, especially if you’re looking at the sector level where a lot of areas have been left behind in this rally so far this year.
Caroline Woods:
What does an attractive entry point look like? What sort of pullback would you be looking for?
Sonali Basak:
You can start adding at 5% below. I know you’ve been asking that question a lot. I wouldn’t be surprised if you saw as much as 10%. Listen, what we’re seeing in this hiking cycle is even though we have seen of late, those shorter term yields come down because of less of an expectation of hikes this year. You have seen the long end of the yield curve.
Sonali Basak:
The ten year yield remain anchored at closer to 5.3%. There are a few things going on that can start to upset the applecart here. That includes global bond market spillovers. There’s a lot of concern about foreign bond markets that can spill over into U.S. bond markets. And we just don’t know that long and the curve, how far it could fly off and how fast.
Sonali Basak:
If we see ourselves moving very quickly to 5.5% or higher. Then of course, risk appetite would get much more dented. You have seen that that longer end of the yield curve has not come down, even though we have seen those shorter term expectations come down for yield.
Caroline Woods:
So we have the ten year Treasury currently at around 5.3%, and the market is still higher. So is it 5.5% is sort of the the line in the sand for you, where maybe you start to say, oh, maybe we won’t see double digit returns by year end.
Sonali Basak:
Oh, I still think actually, even if you see yields drift higher, you can still see those healthy double digit returns. I don’t think it needs to be terribly damaging, but I do think you need to prepare yourself. And it makes sense to be having some downside protection here. We see our clients do that through structured investment, but you also see other people doing that through reflecting different entry points in the market.
Sonali Basak:
Let me give you an example. Hyperscalers. Some people love hyperscalers. People have been buying single name hyperscalers on our platform do structured investments. However, you also see a lot of people still getting in through fixed income. If a company goes out and raises debt, their debt instruments might still be yielding high single digit percentage points, and people will be okay with that given the uncertainty that you’re seeing in the equity market.
Sonali Basak:
So higher up in the capital structure, people are going because of uncertainty around the future, but it doesn’t mean that there aren’t more gains to be had even in areas in big tech like that.
Caroline Woods:
But here’s the thing. What do we do until we finally see that 5 to 10% pullback? We’ve certainly seen it in individual stocks. You know we’ve seen better entry points. But if people have been sitting in cash waiting for a sizable correction, they’ve been, you know up out of the market for a while. So yeah. So what do you do between now and then.
Caroline Woods:
Do you just dollar cost average and still put money to work despite the fact that we haven’t seen it?
Sonali Basak:
I love a dollar cost average strategy here, but I also think that there have been parts of the market that have been brutally left behind. You think financials and the last week alone, the amount of negativity around financials is a little misplaced. You think about the macro backdrop and we’re still looking at really healthy growth underpinning the economy.
Sonali Basak:
And if that’s the case fine. You’ve had bank executives the last couple of weeks set the bar much lower. You can see how that brought sentiment lower as well. But with that said, the market has still been fairly volatile. There has still been capital markets activity. Some of that has been prolonged. And guess what. We have a steeper yield curve which is also good for the banks.
Sonali Basak:
So when the banks start reporting next week, I think some of that negativity might start to turn around.
Caroline Woods:
So financials still one of your highest conviction areas because I remember last time you really liked it. And then last month it was one of the worst performing sectors. So you don’t look at that as a warning sign. You look at that as an opportunity.
Sonali Basak:
I sure do. And the reason is also because even within financials, let’s take AI. You have moments in the market where people got really concerned about what I mean for financial services. But let’s also look at this realistically. If you are a person, you are not just handing over all your credit cards to artificial intelligence. You’re not having them manage your full picture, financial account.
Sonali Basak:
Right? Because you are still seeing an era where I runs away even from the biggest players, right? You have a lot of concerns about how data security will be managed in the future from a lot of the largest AI models out there, and so we don’t think that that clears up right away. We think that the financials will be big beneficiaries from utilizing artificial intelligence.
Sonali Basak:
And we don’t think that that’s really baked into the market today.
Caroline Woods:
Where else do you want to put money to work?
Sonali Basak:
Right now I still see industrials as an area where there is really meaningful tailwinds. Take manufacturing as it presented itself in the most recent jobs report, tends to be a leading indicator here. And you do see a lot of strength underpinning the market. You see the PMI, you see a lot of economic data pointing to renewed growth in manufacturing in the United States, other areas abroad, to a lot of near shoring.
Sonali Basak:
This is beyond just the AI build out. And, you know, when we talk to clients, we see a lot of renewed interest in areas that are more real economy, storage, for example, building out of critical infrastructure. And so the private markets will tend to be a beneficiary there as well. But we still think that there’s room in public markets to.
Caroline Woods:
Still room to run for tech as well, given the huge run up that we’ve seen. Nasdaq hit an all time high today.
Sonali Basak:
It’s interesting. I just this morning was looking at how semi’s versus software was trading once again. And you can still see the ratio being pretty in favor of the semis. This has been a very crowded trade. That’s not to say there’s not more room especially on the heels of pullbacks. You know and micron people were so excited about micron last week for example Michael had ended the week lower after their initial boost from earnings.
Sonali Basak:
And so there are opportunities. But you would watch valuation at this point. You would watch flows at this point. Because when you watch the crowd enter some of these trades and you kind of have to ask yourself, well, wait a minute, are some of the beneficiaries being left behind? Software has been that for most of this year for us, but most of our clients will look at software now and say, well, maybe we have been reaching a moment where we’re more fairly valued.
Sonali Basak:
It’s an area where select parts of software, it’s a good time to look for pullbacks.
Caroline Woods:
Okay. So I was going to ask then based on that flows data, do you chase for semiconductors because that’s where the momentum is. Or do you look at software as the opportunity because that’s where it isn’t.
Sonali Basak:
I still think hyperscalers have room. I think hyperscalers have room. And with this great shift and trades that are going on with in the AI ecosystem, who doesn’t have their eyes on falling token costs, right. So when you look at the hyperscalers, they have more insulation to those declining token costs than, say, some of the frontier labs may have than some of the NIO clouds may have.
Sonali Basak:
And by the way, they have longer term financing structures underneath. So you have to worry a lot less about their cash burn. And as we know, CapEx estimates are rising. So that makes hyperscalers, safer, still attractive trade as the ecosystem changes pretty rapidly.
Caroline Woods:
But how are you thinking about earnings season because you mentioned micron actually ended the week lower after its earnings. As we think about this upcoming earnings season the eye bar is very high.
Sonali Basak:
It’s very high. And some of the tailwinds that existed the last couple of cycles don’t exist as rapidly this time. I think, you know, we wrote in the middle of the year, beware the one hit wonders, those tax benefits, those onetime gains tied to surging valuations and private equity investments that a lot of these hyperscalers had. We knew that anthropic and OpenAI had been surging in valuation the first half of this year.
Sonali Basak:
That growth rate tends to start to slow down, particularly as we know about those token costs declining and that uncertainty that exists around those business models with those declining token costs. So don’t count on the one hit wonders anymore. But you still have very healthy earnings growth that’s expected coming out of many of these hyperscalers. And in fact, you look at a subset of companies and it’s expected to between Nvidia, Broadcom, alphabet, Amazon and a few others.
Sonali Basak:
It’s 50% of the earnings growth that’s expected. The overall season is expected to have earnings growth EPs growth that’s slightly lower than the prior quarter which is what we expected. I think when we look around the corner here, you’ll see that tech is still propping up a lot of that earnings growth. And so it draws a lot of question about the other sectors.
Sonali Basak:
In fact I think energy is probably among the most vulnerable because energy will have the potential to really shine this earnings season. But should we start to see a decline in oil prices? I think that becomes a little bit more difficult to support the energy trade that has been supporting a lot of this year.
Caroline Woods:
So you’d avoid energy here.
Sonali Basak:
I’d be very cautious about energy growth.
Caroline Woods:
Where else would you be cautious?
Sonali Basak:
I would be cautious in parts of tech. I think we’ve been talking about the bullish areas of tech that we still are because they have been left behind for so long this year. But I will say that I would be wary of momentum chasing as it comes back. Remember, we this summer had a meaningful momentum washout. We’ve had a real deleveraging of levered asset managers, hedge funds.
Sonali Basak:
And we’re sitting here in a moment where you can see when we had a moment of calm in the macro. Once we start to get more clarity around the rate hiking cycle, once we get more clarity around earnings, momentum might start to come back. So let’s beware of chasing those rallies again.
Caroline Woods:
So instead of stock picking, just have maybe broader index exposure to tech. How would you like.
Sonali Basak:
To see people having broader index exposure? But I actually think that when you think about the stock picking that you can do moving forward. Again, pullbacks are where you get in, nothing against semis. But you know, this is where we like private markets moving forward. If you are in a data center investment and not all of them are the same, you are getting exposure.
Caroline Woods:
To.
Sonali Basak:
Technology companies. But without that equity market volatility. So we are seeing people play the trade closer and closer to the center of that AI ecosystem. I just don’t know how much room there is near-term to run in the areas that have already run up, that are closest to the center of the semi trade. And by the way, Nvidia is not one of those companies that have been super left behind, if you think about it, relatively speaking.
Caroline Woods:
Sure. I do want to ask you about market breadth really quickly, though, because we talked about financials being a weak link in September. But ten of the 11 sectors in the S&P 500 closed lower tech obviously carried this market. Is is that a concern at all. Do you expect that that will continue to be the case. Obviously you think financials will catch up.
Caroline Woods:
But what about the rest of the market?
Sonali Basak:
I’m rooting for market breath. I think one area in addition to energy that we’re cautious about is the consumer. And into earnings season, there are consumer focused companies. Discretionary and staples are expected to have pretty sluggish earnings growth. And I think that’s worth watching. When you look at the macro, you’re looking at real wages that have really fallen behind.
Sonali Basak:
And if you are worried about the consumer at all, we think it’s going to show up in the consumer first, especially because look at jet fuel, right? There are other areas of your pocketbook. Look at mortgages that are going to be more impacted as the year closes up. And so some of that breadth might be hard to achieve.
Sonali Basak:
We think small caps also is going to be a choppy trade, especially with higher for longer interest rates. And so while you want those areas to come back, I think it won’t be a rapid jump back unless we see a meaningful change in the interest rate trajectory moving forward.
Caroline Woods:
So you sound pretty bullish though overall. So give me the bear case. We get to December and the S&P 500 is giving up a chunk of its gains. What happened.
Sonali Basak:
You know it’s interesting you and I when we talked a little earlier this year I think since then a lot of people have been feeling very pressured to up their price target to the SB 500, and we kept a range that ended a little closer to 7800. We may end a little above that. Our bull case is 8200.
Sonali Basak:
That’s still a while away. I feel comfortable having left us where we were because, again, I did think that we were going to be choppy throughout the year. We haven’t hit the midterms yet. We still have uncertainty around the rate hiking cycle. I think we will have kind of, Easy as she goes. Returns for the S&P 500 for the rest of the year.
Sonali Basak:
There’s no doomsday here from where I’m sitting, but I also don’t think there are going to be tremendous gains left for the rest of the year.
Caroline Woods:
What would get us to 8200? What would you have to see is this earnings season? Is it the fed not hiking anymore?
Sonali Basak:
I think you would have to see gangbusters earnings gangbusters earnings from not just big tech but the rest of the you know for 93 different sectors not just financials also consumer. And you take it from there.
Caroline Woods:
All right. I think it’s a great time to pivot to a rapid fire round of this so that you know how to play. Quick questions, quick answers. No hedging. You got that bull market alive and well are on shaky ground.
Sonali Basak:
Alive and well.
Caroline Woods:
New money today. Put it to work or wait for a pullback. Wait for a pullback. Stocks are 5%.
Sonali Basak:
Treasuries stocks.
Caroline Woods:
Q4 risk on or defense.
Sonali Basak:
Risk on. When you see a pullback.
Caroline Woods:
And the best way to play defense.
Sonali Basak:
Hedge.
Caroline Woods:
Mega cap tech or equal weight S&P 500.
Sonali Basak:
Today mega cap has wins in its favor.
Caroline Woods:
Best place outside of tech financials industrials are health care financials. Semiconductors are software. Software selectively large caps or small caps.
Sonali Basak:
Mid caps, if I could say so. I don’t know if people are paying attention to.
Caroline Woods:
Consumer discretionary or consumer staples.
Caroline Woods:
Staples for income dividend stocks or bonds.
Caroline Woods:
Bigger mistake right now chasing the rally or sitting in cash.
Sonali Basak:
Chasing a rally.
Caroline Woods:
Better opportunity. Market leaders or stocks left behind.
Sonali Basak:
Stocks left behind.
Caroline Woods:
If you can only make one move before year end, add stocks or add bonds.
Sonali Basak:
Add stocks.
Caroline Woods:
Finish this sentence. The biggest opportunity on Wall Street right now is what?
Sonali Basak:
Wow private markets.
Caroline Woods:
The biggest risk on Wall Street right now is bonds and fill in the blank. Investors should be blank right now.
Sonali Basak:
They should be ready for anything right now.
Caroline Woods:
Sonali you played by the rules. Appreciate the quick responses. Thank you so much for your insights into your picks as well.
Sonali Basak:
Thank you.
Caroline Woods:
That’s Sonali Basak chief investment strategist at Eye Capital. If you enjoyed this street talk check out our full interview with Will McGough. He reveals the six stocks he’s betting on right now.
