Branstad: Hi, everyone. Thank you for joining us today for Thrivent Asset Management’s Capital Markets Perspective. I’m Jeff Branstad, your host for today and a portfolio manager here. I’m joined by Steve Lowe, our chief investment strategist.
Let’s talk a little bit about your broad outlooks. Let’s start with equities.
Lowe: Yeah, certainly. You know, equities typically rally with the Fed pausing, or expectations that it will. We had a strong start to the third quarter. As we’ve talked about, markets struggled with higher rates, but they’re still up very solidly on the year.
Earnings have beat expectations – that’s part of it. Earnings expectations have been very low, so it’s been a little easier to eat them, then. Margins have held up a lot better than people expected. I think people were expecting margin compression with inflation coming down. Also, a part of it was investors who are very pessimistic in their underweight. We had a lot of people covering their shorts which drove the market up.
We continue to have this very narrow breadth where the mega cap tech names are leading the market. The market cap indices have outperformed equal-weighted indices. So, if you equal weighted every stock in the S&P 500, that’s underperforming market cap weight pretty significantly.
Large caps have been driven by support for quality – so, that’s stronger balance sheets and stronger cash flows. You see that when people get more concerned about the future. And the mega caps are very, very profitable. They kick off a lot of cash.
Growth stocks have been outperforming. Small caps have lagged pretty significantly. Valuations are better than they were – they had been pulled down by rates in 2022. Nasdaq is a little rich right now. I think the S&P 500 is higher than its long-term median average, but not incredibly so. And small caps look cheap.
Branstad: How does all of that boil down to actual positioning in portfolios?
Lowe: It’s always about earnings in the long run, and those have held up well. If you look at expectations, they’re about flat, or are expecting to be flat this year – maybe up by 1% or 2%. Expectations are for about a 12% increase next year, so that should help markets. The key issue is how the economy holds up, and therefore how earnings hold up.
If you look at our own positioning, we’ve been neutral to our long-term strategy which is to be overweight equities, and we've had a bias toward quality and growth, which has worked well this year. So, we expect to maintain a small overweight now. But we expect to get more cautious heading into 2024 with a slower economy and, eventually, weaker earnings.
Long term, we’re very positive on the markets – in particular, the U.S. market. So, if we do see a significant correction next year, we would look to add significantly, particularly if there are signs that the economy has bottomed and is starting to turn up.
Branstad: Can we drill into some of the asset class decisions you’ve made? Let’s start with growth versus value.
Lowe: As mentioned, growth has outperformed versus value very significantly this year, and we expect that to continue. Particularly, quality and growth are supportive. People are looking for companies that can survive in a slowing economy – those with strong cash flows and strong balance sheets. Value and cyclicals really need a clear path to an upturn before you’d really want to get in.
Small caps have trailed. That segment looks inexpensive, but it also tends to be cyclical – it’s best to buy in front of a cyclical upturn. What’s interesting about small caps is, as a long-term trend, the privatization of companies. Private equity companies have bought up a lot of small-cap companies. That reduces the pool within the public markets. Considering how they exit – are they small caps? Are they IPO, or are they just traded to another firm? That’s had an impact on the quality, I think, of the small-cap segment. And there’s also a growing advantage of scale that hurts small cap companies over time.
Branstad: So, small caps are always lower quality versus their larger peers, but now it’s possibly even to a greater –
Lowe: – Yeah, depending on where we are in the cycle, a large percentage of them have no earnings because they’re losing money, typically.
Branstad: How about domestic versus international?
Lowe: Yeah. We’ve been overweight domestic and intend to stay so. We’re expecting domestic equity to outperform very significantly over the long run. International looks cheap – it always does.
Europe and emerging markets (EM) – China in particular – have trailed this year, partly because global growth and trade have slowed, and they’re very tied to that – manufacturing, in particular. The European Central Bank (ECB) is still raising rates. They’ll probably stop soon, but inflation is very, very sticky there. Also, both of these areas have long-term demographic trends.
When you consider why the U.S. has outperformed, it’s because the markets are more innovative – we have more tech here.
Branstad: Let’s close it out with a quick discussion about your views on credit markets.
Lowe: Yeah. So, when we talk about credit, we’re talking about high-yield bonds and investment-grade corporates. We favor high quality. Spreads are tight – that’s the risk compensation you get for owning credit with default risk and volatility. You’re really not paid at the current levels, I think, for the deterioration in credit quality. Companies are more leveraged, and we expect defaults to rise over time.
We like higher-quality investment-grade corporates. High yield looks good, but you have to be able to withstand mark-to-market volatility.
Branstad: Well, thank you so much, Steve, for sharing Thrivent’s perspective on the capital markets. And thank you all for joining us today. We’ll see you again soon. Thank you.
Lowe: Thank you.