The Stock Market is Twice the Economy: What Now?

[00:00:00]Emily Roland highlights the disturbing reality that the stock market is now twice as large as the actual economy, creating a momentum freight train detached from traditional fundamental roots. She asserts that true diversification is now a myth as even value and emerging market indices have been cannibalized by a giant tech ETF structure.

[00:00:20]>> You have it has to be there, doesn't it?

[00:00:22]I mean, you your cap you have to conserve capital as well as make you get a return on capital. I always I always think that that makes uh Emily sort of uh not more cautious, but but maybe more realistic. And and reading what you're you're saying about the current market, Emily, it was almost like a a calming salve. Like a You know what a salve is?

[00:00:41]You put >> I do like ointment.

[00:00:43]>> Like an ointment.

[00:00:44]So, >> It's >> you basically I'm going to summarize maybe your thinking, but I should probably let you.

[00:00:50]But it was a short squeeze from those March lows. I mean, that that for the for the record books. I mean, 30% in in in most of the indices. So, this is not probably a huge surprise to get a little bit of a pullback, especially uh it if rates are not coming down while all these IPOs are coming where where you need money or capital or easy money, accommodative Fed. So, so that that's a headwind at this point.

[00:01:17]>> Yeah, Joe. I mean, we have been on a momentum freight train since the market lows back in in late March. It's hard to even remember all the all those headwinds that we had faced. So, certainly seeing some overbought conditions and we weren't overly surprised here to see a little bit of a pullback, but of course, we wake up this morning and this is a dip buyer's dream market. Even with the geopolitical headlines not overly positive overnight.

[00:01:43]So, this is a market in which we want to participate, but the biggest challenge right now seems to be not having enough risk. We want to think about managing that. There's a lot of FOMO in the conversations over the course of this week that I had with advisors. So again, it's really about a risk management managed approach, but momentum is feast or famine. We want to be there, but we want to think about almost a race car analogy of drafting the market, participating without going over our skis and taking risk.

[00:02:13]>> It's confounding that to see it move so much with with oil moving higher, inflation moving higher, a war in in the Middle East, but you point out it it was a legit fundamental catalyst. The earnings season that was so strong.

[00:02:27]>> Yeah.

[00:02:27]I mean, analysts >> Yeah, go ahead.

[00:02:30]>> Oh, I was going to say analysts had penciled in 13% for this earning season.

[00:02:34]That's good, and it came in at 28%. So we are firm believers at Manulife John Hancock that over time stock prices follow profits. And frankly, the earnings engine in the United States is on. The biggest challenge though is we've seen this massive amount of wealth accumulated, and we're at the point now where the stock market is almost two times bigger than the economy itself. So in a really odd twist versus the way a lot of us grew up, the stock market's become the most important thing here.

[00:03:07]Now, at the same time as that, you've got this tidal wave of IPO activity coming through. There's a lot of liquidity that liquidity that's being demanded right now, and you've got trillion dollar high free cash flow companies that are tapping the equity market for issuance here. And I would say that the other big force that's that's sort of dominating markets is that central banks globally are staring down this idea of potentially tightening into all of this. So pretty interesting backdrop, really unusual one, Joe, that we're looking at today.

[00:03:41]>> You want to talk to her or >> I I do have a question.

[00:03:43]>> And Kelly.

[00:03:45]>> So Emily, here's my question, and it's about Super Micro. I don't know if you saw yesterday they were down, call it 30% rounding up. A company that was a $17 billion market cap and it had $39 billion worth of orders. It has to do an $8 billion equity raise basically in order to meet demand. And it it's it's like the company is is struggling under the weight of this. It's It's kind of a blessing but a curse. And so the earnings momentum that we've seen up until now, the incredible AI boom and all that.

[00:04:15]What happens if all of these companies are struggling under the weight of the CapEx that is required?

[00:04:24]>> Yeah, I mean that's what's so remarkable about this. The demand for power, the orders that are coming through, it's absolutely insatiable and the earnings are are are really phenomenal. What we need to do here is participate in it but come up with a plan B. That's really hard right now because the entire global stock market has become a giant tech index. Um you know, you look at the S&P 500 for example, 39% of it is in tech.

[00:04:50]Technology, you add the mag seven that's not in tech. All of a sudden you're at 52. I used to be able to come on here and say, "Oh, you should buy international stocks. You should buy EM.

[00:04:59]You should buy a small and mid cap."

[00:05:01]That's a giant tech ETF. Emerging markets, 42% of the index is in tech.

[00:05:06]28% is just three stocks. You look at US value stocks. I'm getting a lot of inbound calls. My clients finally want value. The top two stocks in value now are semiconductor names. Going down in market cap, it's semis. So plan B is about finding something else to add to portfolios.

[00:05:24]>> saying you're looking at the industrials. You're You're looking at industrials but I hear people even saying they're They're like the Russell 2000 is also an AI play which is you like, all right, well, but so you're looking at industrials.

[00:05:35]>> Yeah, so that's one area where we can think about diversification. So it's defense spending. These are beneficiaries of the one big beautiful bill which is encouraging CapEx investment. Um you've got onshoring activity that's helping. The economy's holding in pretty well. You saw that in some of the PMI data uh this week, especially on the manufacturing side.

[00:05:56]So, industrials can also see their earnings extending longer than other sectors due to the fact that a lot of it is long-lived contracts. So, it's industrials, healthcare we would sprinkle in there. That sector's starting to show some relative strength, even a little bit of utilities. So, I wouldn't say we're getting overly defensive here, it's just about drafting the market. You don't want to be that lead race car right now that can run into the wall. You want to be right behind.

[00:06:21]>> And you know, I don't know. We got to go. We got somewhere to go. I don't know. Nowhere that important, I I don't think. No, it's always important. So, we got a lot of news, a lot of news. That's what we're co-anchors always. Um, high-yield spreads were so tight where where from from really tight as they've been, record levels. We're 2.73% now. You say three to four is a is is when you get worried.

[00:06:43]Over four, you're saying that's when it would be a liquidity event, not just an overbought condition that we're seeing. So, you're not you're not like ready to pull in your horns necessarily right now, not yet. Would that cause you to do it if we saw spreads widen?

[00:06:58]>> It would. We we really have two canaries in the coal mine that are we're looking at to see if there's something more sinister going on. High-yield spreads are one. We're really contained right now. The credit markets are saying everything's fine. No worries about defaults picking up, no concerns about a financial accident. So, that canary's singing. The other one's the labor market. We look at initial claims out on Thursday mornings. We'll get that shortly. The labor market's holding in as well. If we see some weakness in either one of those, that's going to cause us to get more defensive or dis count