How ETF investors should view the ‘great expectations’ of earnings season

[00:00:00]Earning season is often running, but we're still a week away from the busiest period for quarterly results. There's a risk, of course, that expectations are so elevated that even if you get better than expected results, they're just disappointing. Joining me now is John Mayer, chief ETF strategist at JP Morgan, and Cynthia Murphy, director of research at VettaFi. It's nice to see both of you today. Look, I want to get your perspective on what we've seen so far from earnings, and can we apply it, John, do you think for the rest of earning season to come?

[00:00:32]>> You know, it's been a great earning season, as everybody knows. The banks have reported, about 50 companies have reported. Now, uh solid There's been solid reward for beats so far, 1 day after earnings announcements. But, that's a positive. We also know there's a tremendous amount of money that's being spent uh by the hyperscalers that's filtering through to many different sectors, whether it be industrials and materials, um and energy sectors. So, we are expecting that the this this season's going to be pretty robust.

[00:01:05]>> We've seen a sort of a broadening in terms of who's gaining in the market.

[00:01:11]And, Cynthia, when you're looking at how earnings have come through so far, FactSet says 88% of S&P companies that have reported have reported uh earnings that beat expectations, sometimes by double-digits here. So, what's your expectation moving forward through the rest of earning season?

[00:01:30]>> You know, to to John's point, I think uh this this broadening, this trickling effect, is really important. We're all watching for that this time around. If you think about what has really driven the equity markets, look at the tech stocks, the Mag 7, the mega-cap technology. The expectations for combined earnings for these firms is around 28, 29%, which is massive compared to the S&P 500 overall, but it's much smaller than it was last quarter. So, there is a sense that that gap between the top seven and the 493, if you will, is is narrowing. So, the broadening is in effect. So, we're all going to be watching for the signs of this trickling into other sectors, into other parts of the the market of that earnings benefit from all this cap ex spending and and AI we've been chasing.

[00:02:22]>> You know, that's great, Cynthia. Also, the banks are like telling us a few things.

[00:02:29]So, they are indicating that the consumer is strong.

[00:02:33]Um capital markets have been crazy, super strong. So, that leads me to believe that that's going to there's going to be a broadening out in the marketplace for these these earnings reports that are coming out.

[00:02:45]>> So, when the banks give you an indication that American consumers are still spending, look, I cover the travel sector. And what I've heard from travel companies is that even if people are holding onto their cash in other areas, maybe they're trading down at the grocery store, but they still want to travel. It it it is a pervasive signal of strength in these American consumers. How do you play that when you're choosing your ETFs? What sectors, Cynthia, do you look for to say, oh, the American consumer is doing surprisingly well?

[00:03:21]>> You know, that's a great question. And what's really interesting about that is that we see a little bit of this dichotomy between consumer sentiment data showing really, really low readings. And then we see consumer spending still really strong. So, you know, a fund like IBUY, for example, you know, online retail and then all on spending, an interesting play. We also see a lot of these kind of luxury and consumer focused names like a Walt Disney Company, for example, in a fund like VFLO, which is looking at high quality companies that are benefiting in this market, you know, generating really high free cash flow, really high growth prospects. There's a lot of these types of names in this portfolio, which is performing really well. So, it's not a direct, you know, luxury spending play, but you see a lot of these names in these kind of high quality portfolios as well.

[00:04:14]>> Are you, Cynthia, seeing any areas of weakness that could foretell disappointing results in some of the keystone companies that we watch?

[00:04:24]>> Yeah, I think you know, I think what I I echo John's sentiment here. The broadening is a big story. So, I think it's it's been interesting for me to watch. I'm really amazed at the persistence of the semiconductor and memory play. So, as much as we like to say this is really overrun and you need a correction and, you know, we've seen headlines about chips being in a bear market. Now, I mean, we still see a ton of money flowing into this part of, you know, the hardware infrastructure of the AI story. That's still running. Is it going to run forever? No, but the concept of the bottleneck remains a big strong driver of asset flows and performance. So, that's been really interesting to watch.

[00:05:03]>> The There's just so much appetite as well. I mean, if you look at the DRAM here, here's a brand new ETF that comes out focused on memory and it goes from zero to $60 billion in flows already. I mean, what do you make of the just incredible hunger there is for this space?

[00:05:24]>> Yeah, it's a little bit less than that, but it's it's a an area that is is very exciting. So, the technology area uh probably received about $60 in flows this year. Last year >> of technology, not just the DRAM.

[00:05:37]>> And $40 last year. So, it's increased a lot. You know, what I find and from my experience working with financial advisors and clients is that people like these exciting things. Like, "Wow, I want to have these 100% returns." There's a FOMO that exists. Now, with that comes a lot of risk. That's why, from my perspective, having an active manager, which is JPMorgan, we are active managers, we do bottoms-up research, we may focus on some of these memory companies, we may focus on some old-line companies, depending on the kind of the strategy. By having these managers looking at really where the earnings are coming from right and the valuation too high or low, that's where you can benefit as an investor buying an ETF like JTEC, JTEK is one of our technology ETFs, by not just being exposed to very a very narrow segment. It's enticing, though.

[00:06:33]>> But but Cynthia, do you agree like is there a hedge against volatility that happens if you remain in ETFs that have broader exposure than these slices within the greater sector?

[00:06:47]>> I I think it's you can have both ways.

[00:06:50]So, if we look at the broad market performance and our expectations for earnings and everything, we're talking about the broadening. We're talking about beware of high concentration. The market is very concentrated and anytime you're you really heavily you have 40% of your portfolio in 10 stocks, you're going to be really exposed to volatility, which is what we've seen all year long. So, the story of broadening is a story of good investing long-term, especially if you don't want to have a lot of heartburn.

[00:07:20]The bottleneck story is a little bit different. Like, if you really focused on say the AI memory opportunity of of a fund like DRAM, that's a kind of a growth component. It It shouldn't be your core portfolio. It can be like a thematic play that you would add on top of your broader technology segment. So, you can do both things, but anytime you choose concentration, you are choosing potentially higher risk and higher heartburn any given day. So, you got to be aware of those choices.

[00:07:52]>> You know, Cynthia, most most clients' money kind of sits in that moderate moderately aggressive area.

[00:07:59]Now, also most clients don't necessarily have a stomach for volatility. And volatility right now is relatively low.

[00:08:06]It's about 8 the VIX is 18 or 19 or so.

[00:08:09]But if you actually drill down and look at the individual companies, some of those companies, and particularly the mag seven or the top 10 in the S&P 500, volatility is relatively high, but volatility could be lower from some of the other companies. So, that kind of sort of cancels it out and bring vault brings volatility lower. Now, if an investors are looking to lower their volatility, they can look to things like derivative income.

[00:08:34]Um we have a fund JEPI, JEPI, which is the second largest actively managed ETF.

[00:08:39]It has a volatility of about 60 65% of the S&P 500. It's not designed to return what the S&P 500 returns because it has lower volatility.

[00:08:49]>> Well, what's what's the return on it?

[00:08:51]>> The The return is uh first of all, you get an income of around uh 7 to 9% right now is about 8%. And because it's lower volatility stocks in the underlying, brings down volatility. Because um of the option overlay, brings down volatility. You can get that 60 65% and you are getting that eight approximately 8% distribution on the fund.

[00:09:15]>> Can we talk a little bit about industrials here and the way those have been lifted by the AI data center ambitions of a lot of these companies?

[00:09:26]And And how that's how we're seeing ETF funds react, Cynthia?

[00:09:33]>> Yeah, I mean, with with Cynthia, my industry really is part of the infrastructure play.

[00:09:38]You know, AI is a tech play, but nothing happens without the build out of the infrastructure as we know, whether it's data centers, we see that in energy grid. There's a whole backbone infrastructure that needs to be built, and that has really pushed up industrials. If you look at XLI from State Street, the sector spider, it's the valuations are really high relative to the S&P 500. It's as high as a tech.

[00:10:06]So, it really is a sector that has really had its moment in the sun and picked up a lot of attention, a lot of flows because nothing else is going to happen without a lot of focus on infrastructure and in the build out that comes with it. What's interesting is that's that not only the AI driving performance here, but also just geopolitics and the the concept of defense. So, that has also supported industrials. So, it's been a really good year for for industrial stocks, and there's a lot of tailwinds there.

[00:10:37]>> Yeah, good point, Cynthia. The flows really have been strong, $17 billion.

[00:10:42]On the active side, 34% of all the flows into industrials have been actively managed.

[00:10:48]The CapEx spending is really kind of feeding into that industrial component.

[00:10:53]Security, we talked earlier about cybersecurity, security and resilience is really important, and that's going to play even bigger and bigger of a role.

[00:11:00]>> And that's one reason why insurers, in fact, are looking at the data center build and everything from the very first shovel that hits the ground on through operation, and there are opportunities now for coverage. But probably, I would In fact, a global reinsurer CEO just told me today, there's probably not enough capital in the space right now to handle some of these projects. That provides opportunity moving forward in the future.

[00:11:26]>> Absolutely, and I think, you know, the market is always forward-looking, and that's really what a stock price is, a cash flow of future earnings. so >> Uh we that we just heard from the Fed chair last week. Uh talk to me a little bit about what we're seeing with bonds and in fixed income.

[00:11:40]>> Well, first of all, the fixed income the bond market overall is an act in active market for the most part. ETFs generally have grown up passive, but if you think about like how the baskets are constructed, you're trying to even if it's passive, you're trying to find a basket that's similar to the passive index. It's not exact. Now, active managers and the active ETF market has largely always been active, um typically outperforms because the agg only has half the market. There's this portion the securitized market, which is not in the agg or just a little bit, um which can find you can find real alpha, um duration and yield in that market.

[00:12:23]So, the active market is really important. Now, with respect to the Fed, um inflation is a little bit higher. Um that could be a one-off or could be declining a bit. We are seeing indications that it's declining as energy is declining. Tariff noise the tariffs are coming down, so those things could bring down inflation. Uh uh the Fed is only one of the chairman of the Fed is only one vote out of 12 votes. So, he would have to do some persuasion for the other 12 voting members to increase rates.

[00:12:54]Um to decrease rates. He's not going to decrease rates.

[00:12:58]Could he increase one or two? Possibly.

[00:13:00]>> What what do you think, Cynthia? One, are you seeing more investors turn toward active ETFs for bond adjustments?

[00:13:06]And two, what are you expecting from the Fed?

[00:13:10]>> So, I the the Fed last week when the the testimony to Congress, I remember Walsh saying, you know, we are going to deliver price stability. The expectation is for rates to come up, maybe neutral this year and higher next year. In that sense, what we've seen ETF investors do, we're seeing almost record amount of money going into bond ETFs. Over 35% of all flows year-to-date have gone into bond ETFs, but we're seeing that money being allocated either in the very short end of your cash-like defensive positioning or, you know, on the other end, but it's mostly to to John's point, securitized debt, some credit, avoiding that treasury duration because rates are expected to potentially go higher. So, we're seeing a kind of a barbell approach that is looking for the short end and then securitized debt and alternative fixed income sources on the other end. And it's been really interesting because it's defense, it's income generation, things to to John's point, JEPY and and funds that are generating that equity income that is not fixed income related at all, but trying to manage expectation for higher rates coming up.

[00:14:20]>> Yeah, and if you look at the treasury rates, they've been kind of hovering at 4.5, 4.6%. So, that gives you a sense of inflation expectations. And, you know, I manage the guide to ETF program at JP Morgan. We have a really cool slide that looks at flows with different duration metrics. And you'll see on the long end of the curve, very, very little money going into the long end of the curve.

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