Will Higher Rates Kill the Stock Market? (EP. 484)

Animal Spirits Podcast

The episode explores the tension between rising interest rates and a resilient stock market that lacks widespread fear despite significant v

Key takeaways

NVIDIA serves as a poster child for the AI trade, yet an AI-specific basket trades at roughly 15x earnings.
The S&P 500 is near all-time highs even though over 70% of its constituent stocks are at least 10% below their recent peaks.

Main topics

Interest rates and market volatility
AI valuations and the tech trade

Notable quotes

There's a lot of doubt, but basically zero fear.

Conclusion

While economic indicators like rising rates suggest potential volatili

Transcript preview

Speaker 1 (0:04) Today's show is sponsored by YCharts. Most advisors don't have a data problem. The problem is that the data is spread across too many tools. Portfolio data lives in one system, client notes in another, and risk questionnaires somewhere else. So prepping for a meeting means clicking through a million tabs. That's why YCharts built Risk and Proposal Manager, a single place to manage your entire book of business, not just portfolios. It organizes clients by household, connects to the tools you already use, and brings performance, risk, and client context together in one view. For example, you can send a prospect a risk questionnaire, map their answers to a risk profile, and turn that into a personalized proposal. Once they become a client, you can keep managing the relationship in the same place all without ever leaving YCharts. Click the link in the show notes to learn more and get 20 % off your initial YCharts professional subscription, new customers only. This episode is sponsored by Janice Henderson, investing in a brighter future together. At Janice Henderson Investors, we believe working together is the way to work better. Like combining your portfolio plans in our in-depth strategy, your valued assets and our valuable insights, your mission and our vision. Always working in perfect harmony to find the right investment opportunities. Janice Henderson Investors, investing in a brighter future together. Welcome to Animal Spirits with Michael and Ben. Michael, I have a question for you. Go ahead. The market has an excuse to sell off if it wants it. Will it take it? Speaker 2 (1:27) Well, that's a good question. First of all, strap in and stand by. This is a 43-page doc, which is on the longer side. So we're going to go $1.15, I say. I feel like Speaker 1 (1:36) 40s are a new median. Let me run through them real quick. I'm not comparing this to these places, but I'm just showing this. What pricked the Japan bubble? Central bank raised rates. Okay? Dot-com bubble. The Fed was raising rates. 1929, the Fed tightened. GFC, the Fed raised rates into it. Okay? Everyone knows what the biggest risk is right now. And the market is not always right, but I think the market is expecting, pricing in now, the Fed to raise rates to like four and a half or 5%. If the market wanted to, it could use this to sell off. Will it do it? No. Too easy? Speaker 2 (2:16) My experience is that the market usually doesn't give you this long to get out. Speaker 2 (2:22) It kind of reminds me a little bit of April, where we're staring at the straight being closed and the stock market is coming down just a little bit every day. There's no 1%, 2 % falls. We're like, I thought this was the black swan. Why aren't stocks falling? So it feels like that a little bit to me. I think that the way that I'm describing the current market environment is there's a lot of doubt, a lot of doubt, but basically zero fear. Let me make the case. In the doubt column, this chart is from 22v Research via Daily Chartbook. AI valuations. Last week, I said if there's a poster child for the AI trade, it's NVIDIA at 16 times earnings, borrowed earnings. Well, they zoomed out and they have an AI basket, a curated universe of 81 AI CapEx exposed companies spanning 12 market segments, trades in an average EV to EBITDA. Just think of it as like price to earnings of 15 times, which is 1.14 times their pre-2026 historical average. So there's no premium in the AI trade anymore, okay? So a lot of doubt. Earnings versus valuations from duality research. Only one sector, consumer staples, has seen multiple expansion this year. This chart is nuts. Okay. It's not just tech, it's everything. The VIX is at 16. Speaker 1 (3:51) We have to explain this again. Duality looked at all of the sectors. Okay, how many are there? 12 or 13? I Speaker 2 (3:56) think Speaker 1 (3:56) they keep adding some. Okay, 11. And every single one of them, but the consumer staples has seen a multiple contraction this year. In many, it's double digits. Consumer discretionary, double digits. Consumer services, communication services, which is tech, double digits. Materials, double digits. The S &P has a whole double digits in technology and energy, both double digits. And consumer staples is up a smidge. It's up less than 1%. So it's not just like, oh, wow, yeah, tech names. It's everything. Speaker 2 (4:20) Yeah. Speaker 1 (4:20) So multiple compression Speaker 2 (4:22) everywhere. Doubt. Here's the no fear side of it. The VIX is at 16, despite the sell-off, which we'll get to in a second. From JC. Sell-off. It's a sell-off. From JC. Consumer staples and utilities are two of the most defensive areas of the stock market. We would all agree? Yes. When investors get scared, they often hide in these groups. Nobody's hiding there right now. So he has two charts of, two ratio charts of consumer staples divided by the S &P to show how one is doing versus the other and utilities versus the S &P. And they're both at new multi-year lows. There is a lot of doubt, but there is no fear. Let's talk about the sell-off. We are in a very weird market dynamic. where a lot of stocks are going down, and yet the index is near an all-time high. Jason Gepford shows that the S &P has been holding within 1 % of a new high, and yet more than 70 % of stocks in the index are at least 10 % below their highs. The only other time that's happened over the last 30 years is right before the dot-com bubble burst. However, however, critically, Don't taunt the bears, please. Critically, duality research shows that the key distinction of the 52-week low list is that a lot of the deterioration is happening in utilities and staples and real estate. Obviously, not just defensive sectors, but sectors that are exposed to higher interest rates in a bad way. 21 of the 28 names on that new low list came from utilities, staples, and real estate. So it is a market that is full of doubt and also has very little fear. Do you think that's a Speaker 1 (6:15) good way to explain it? Yes. Well, it's funny because the S &P, we're recording this a little later than usual, Tuesday afternoon-ish, lunchtime. The S &P is down 1.4%. Even like small caps actually sound off a little bit. Small caps are on 8%. What's Speaker 2 (6:30) equal? Equal weights over five, I think. Speaker 1 (6:33) Okay. Even the NASDAQ is not even down 2 % yet. So you're right. Like it's totally a reversal of- Well, hold on, Ben. If you are Speaker 2 (6:40) a stock picker, and believe it or not, there are people that own individual stocks, there's Speaker 1 (6:45) a lot of them that are getting their head beats in. Well, so I wrote this after we talked last week about Adam Parker's piece, which I read, which was really good that you talked about. So I decided to look at this using YCharts data. So they have these comp tables and I looked at year to date. The S &P is up 13 % still year to date. 35 % of stocks are outperforming the index. But 40 % of stocks, four out of every 10 stocks is down this year in the S &P. So you're right. So more stocks are down this year and a double digit up here than are outperforming the index. And there's like 20 stocks that are up 100 % or more. So this is a very concentrated market now. So it's funny. Speaker 2 (7:22) It's still, it's the memory names, even though they're off their highs. Speaker 1 (7:25) But we've gone through a whole cycle this year already. We went through a cycle where all the other stuff was working in the mag seven and the big names weren't. And now it's come back and they're working again. It keeps going back and forth. I guess the one thing I said, rising rates are a very good reason for the stock market to sell off. The way that that doesn't Speaker 2 (7:41) - Speaker 1 (7:41) No, not rising, not rising. Straight up. Yes, going vertical. So yeah, the 10-year went from like 4 % to 5.2 % in a hurry. So the way that this doesn't become some sort of equity route or at least correction from that is, well, hey, dummy, they're rising because we believe in the AI trade. We believe that AI is going to continue to spend. Hyperscale is going to continue to spend. That's going to continue to help earnings. That's why the stock market's not selling off. It's because we think economic growth is going to be strong. I was going to get into this later. They have the Atlanta Fed GDP now has third quarter GDP coming in at 5%. That has not always been right. We've shown before that it's been wrong in the past. But if rates are accelerating because it's like, oh my gosh, this thing has legs. It's an economic boom. That's why the stock market won't sell off. That'd be the reason. Whatever happens, we always say this, but it's true. Whatever way it goes, if the market falls 10%, we go, oh, of course, the rates rose like crazy. If the market keeps going up, you go, of course, AI is spending like crazy. It'll be very obvious with hindsight. I tend to think you're probably more right than... than my theory. Speaker 2 (8:48) There's no rules in the stock market, but I do think it's a pretty good shorthand that the market, when it falls, it generally falls fast. It's unusual that everybody is like, stock market's going to fall. We have time to get out. Stock market's going to fall. We have Speaker 1 (9:02) time to get out. Speaking of rules, this is me having fun. So Speaker 2 (9:07) anyway, Speaker 1 (9:07) I Speaker 2 (9:07) could be dead wrong, but I put my timely hat on. I would not be surprised if we get past this bout of selling underneath the market, underneath the indexes, and you get a rip until the year end. I could be very wrong, obviously, we'll see. Speaker 1 (9:20) So the stock market not having rules, because if you learned finance 101, like when I took finance classes in college, a higher interest rate should mean lower present value for financial assets, especially long duration risk assets. The higher the interest rate, the lower the present value, right? That should be obvious. Yeah. Speaker 2 (9:36) The Speaker 1 (9:37) hurdle rate's higher. Yeah. Since... Treasury yields bottomed in March of 2020. They bottomed before the stock market did. I think the treasury rate bottomed like March 9th or something, below 50 basis points. Since that date, the S &P 500 is up 19 % annualized, since rates went from 0.5 % to 5.2%. This Speaker 2 (9:58) is why there's no rules. This is why Speaker 1 (9:59) there's no rules. You're right. So I did this tweet and it kind of went a little crazy, but it's weird to think about the state that we're in. Mortgage rates have shot way up past 7 % again. Right? 7.3%, I think we got. But the unemployment rate is still at 4%. Bond yields are above 5%. Cash yields are going back to 4%. Oil is around $100 a barrel, depending on the day you look at it. Gas prices are crazy high, $5 a gallon. Inflation is like 3.5%. All-time highs in the stock market. All-time lows in consumer sentiment. We're lower now than we were in the 1980s. COVID. The great financial crisis. I know. Speaker 2 (10:34) But Speaker 1 (10:35) here's the thing. The things that don't matter right now, people would start freaking out about them more if the stock market were to fall. Totally. Great thing. It's like people won't freak out about that stuff, at least market people like us, because the stock market is doing well. Right. That is true. Price Speaker 2 (10:52) rules everything around me. Speaker 1 (10:55) Yes. All right. Speaker 2 (10:57) I want to get on my soapbox one more time talking about how careful you have to be as a market consumer. As somebody who listens to a lot of different opinions, you have to be careful. Exhibit A, tech funds, tech fund flows are going straight up. This is from Callum Thomas. We're looking at the rolling 12-month net ETF flows of tech stocks. And it's off the charts. We've never seen anything like this. Simultaneously, we have- This is very surprising to me. Which part? Speaker 1 (11:32) That it's dwarfed the other periods from this cycle by so much. Yeah, not even close. It's like triple the size. The Speaker 2 (11:39) numbers are bigger, but still, even if you normalize it as a percent, it's crazy high. We also have near record retail buying from Robinhood. Sherwood has this chart showing the Robinhood traders net- 21 day single stock purchases as a percentage of the max, meaning the most that they've ever done. They're anchoring to that. So these two charts, Speaker 1 (12:01) everyone in the pool. Speaker 2 (12:02) Everyone in the pool, right? Everyone's okay. Antenna up. Everyone's bullish. Oh yeah? Okay. Goldman. they have a positioning indicator. It fell for the sixth week in seven, moving further into negative territory, the most negative since June, 2025. Speaker 1 (12:23) What do we make of this, Ben? Well, this is, sentiment indicators are completely broken. We can't, you trust, you trust the flows, not the sentiment indicators. You can't ask people what they want to do or what they feel. You have to, what are they actually doing? So the flows matter way more. Speaker 2 (12:36) I agree, but I do wonder if the sentiment indicator is quantitative. I'm guessing it's got to be mostly quantitative. This is not survey-based. The point is, just be careful with surveys, obviously. It's really hard to say everyone is this or that because the rob and a traitor behaves very differently than the Goldman. institutional investor than the Schwab S tax investor. These are categorically different types of people. So it's really hard to say everyone is this or consensus is that sometimes it's easier than Speaker 1 (13:04) others, but right now it's difficult. So I was going to put this in the doc, but I didn't want to, but the Atlantic had this piece where they said that there is a sex recession in America. Okay. I'm going to bring this back to sentiment. and they show that the only people who are still having the same amount of sex, this is married couples, are religious couples. So it's like religious attendees, how much sex do you have? Where do they get this data? Speaker 2 (13:25) Is this on the iWatch? How do they get this Speaker 1 (13:28) data? This was my question. Who in their right mind is answering a survey like this? What is your religion? Are you having sex with your spouse? No one in their right mind is answering these questions. How can you think? These are weirdos. It should say, Speaker 2 (13:41) weirdos are not having sex or whatever. Correct. Who is answering this? Who's answering these? There's no way you can... The average age is Speaker 1 (13:50) what? 68? Speaker 1 (13:53) I just don't know who's answering questions like this. You're right. All right, let's talk bonds a little bit. Let me start with this. Hey, guys, I listen every week and love the show. We got 12 or 13 different emails like this, probably. Shows you where the market is. You said last week you bought bonds. Can you elaborate on that? Did you purchase actual bonds or ETFs? What types of bonds? All fair questions. And again, a bunch of people asked us this. Michael and I are totally contraindicators. And here's the thing that I will say on this bond purchase. Wait, what are contraindicators? Because everyone else is getting in the pool for taking on risk and we're going the other way with a I Speaker 2 (14:27) think I did a lot of Speaker 1 (14:28) people I think a lot of Speaker 2 (14:29) people are Speaker 1 (14:29) turning Speaker 2 (14:29) bullish on Speaker 1 (14:30) bonds. Speaker 2 (14:31) I don't Speaker 1 (14:32) know man maybe Speaker 1 (14:36) So here's what I did. I did this in my brokerage account. And I've never done it in my brokerage account before. My 401k is still 100 % all stocks. I did this in, I bet in ETF. You can buy individual bonds, but it's a pain in the butt. If you're not like someone who knows how this stuff works, you can go to Treasury Direct and buy treasuries right from the US government. But it's an old antiquated website. And I don't know why you would try to buy your own bonds when you can just buy an ETF. That makes it easy. It's low cost. Most of them are very liquid. It's just... It's simple. And the thing is, we are obviously early here. You and I are not going to like, we bought bonds, so that's the top of rates. No, there's Speaker 2 (15:12) definitely not the top. Speaker 1 (15:13) Right? Probably not the top. I never look at, and this is how we think about this with our clients too. I do not look at this from a, I'm trying to time an interest rate market. I think rates are going to fall this much by this date. And like, I don't even care if rates stay where they are. Same. Right? It's a risk reward thing. I like the yield. Yes, I like the yield. That's the thing. Speaking of you. Speaker 2 (15:34) Wait, can I say what I did? Yes. What did you do?