Finding Bargains In An Overvalued Market | Rise UP!

And not all equities are the same today, because some things are more expensive than others. Welcome to Rise Up, another wild week. I'm Peter Buchbauer, the Chief Investment Officer with OnePoint BFG Wealth Partners, and I'm happy to be joined by my colleague Andy Schwartz and David Mandelbaum. Welcome, guys. Hey, Peter. Good to see you. So another wild week. The dominant news story were the inflation statistics. CPI came out, that was in line, but that it was not hotter than expected gave a big sigh of relief to the markets, and we had a big day on Tuesday. That was then followed by a much hotter than expected PPI. And while the markets were initially ruffled by it, we ended up closing flattish. But bonds did sell off. And is this the first sign or the early sign that maybe tariffs are working its way through the inflation data and the broader economy? That's the big question that we all have to answer. We went through a lot of earnings calls over the past month trying to decipher the trends in the US economy, and it's a very mixed bag. You have pockets of strength, certainly anything related to AI spend, which is enormous. The capital spending numbers out of all the big hyperscalers were tremendous and will continue to be that way all through the year. That upper income spender continues to spend, particularly travel, leisure, restaurants, and so on, unperturbed by higher inflation. Those that are bothered by it, lower to middle income consumers, they seem to be more challenged by it with the cumulative effect of inflation over the last couple of years. And then we also have government spending, which is still pretty robust. Now, with the inflation numbers coming both hot on PPI, inline, and CPI begs the question, what does this mean for the Federal Reserve? There's certainly a lot of political pressure on J-PAL to cut interest rates. And I think that the weaker than expected jobs number a few weeks ago clinched a rate cut. The question is, is what happens after that? And I don't necessarily think we're going to get an answer from J-PAL. I think we'll focus on the September meeting and take it from there. But I'm going to take a step back because remember that interest rates by the Fed influences, on the other side, the interest expense that the government pays, but also the interest income that the receiver pays, the receiver being the consumer. So, Andy, we've had a gift since 2018 for our clients on the fixed income side. After 15 years of basically zero rates, 40% of the average portfolio stretching for income. And now that we finally have got interest income, the Fed, after cutting 100 basis points last September through the end of the year, is about to start cutting interest rates again. What does that mean for our fixed income portfolios? What does that mean for clients that are benefiting and enjoying interest income that's about to get trimmed a bit? Yes. So I think that it was certainly welcome after 10 years or more of basically zero rates where clients were forced to take risk and there was no income, at least in the fixed income side, for clients to be able to create income for retirement. We're in a situation now where we've enjoyed that for the last several years. It does look like most likely rates will continue to come down, at least modestly. Obviously, it'll be interesting to see what happens on the next CPI and PPI prints. For us, what it means is that we're starting to rethink duration. We're starting to think that we might want to start to lock in a little bit more duration. We don't want to go long in duration, but we want to lock in. We're also really looking for maybe other alternatives to fixed income opposed to just say traditional treasuries, communities, or quality corporates. Private credit has become a very, very popular part of the fixed income market. Again, less liquid than the traditional fixed income markets. That's ordinary income tax, so we'd like to try to find qualified plan opportunities for that. But also, there could be some real estate opportunities, some floating rate preferred opportunities, which can get us a little bit more yield than what we're probably going to be getting in a shorter-term high-quality fixed income in the near future. Just to quantify, right now, the bond market, the Fed Funds Futures market is pricing in that September cut almost 100% and expecting another cut by year-end, and then in the first half of next year, adding another two more cuts. We totaled about 100 basis points of cuts priced in through the end of the year. It begs the question of how does the long end of the yield curve respond to that? Because the noteworthy characteristic of the treasury market, when the Fed cut 100 basis points in the back half of last year, is long-term interest rates went straight up. If that were to happen again, that would potentially dilute the impact of lower short-term interest rates, particularly if you're looking to buy a home and relying on a 30-year mortgage. So the big question within that is who's going to be the next Fed chair. Jay Powell's job ends in May 2026. We've just lost a Fed governor that's going to be replaced by Stephen Myron. And Trump has put together, or Besant, has put together a list of about 11 candidates. Trump said the other day that he's narrowed it down to four, and we'll see who that next Fed chair will be. Now, I want to talk about tariffs again, because we know that flows through the inflation stats in the broader economy. And ask David a question, since healthcare is a broad sector that you follow. It's not just pharma, biotech, healthcare insurance, but also medical supplies. And I would not think that all US medical supply companies source all of their product in the US. I have to believe that some of that sourcing takes place outside the US. Therefore, they're sensitive to tariff rates. What have you seen in your companies and others in that space that might be influenced by tariffs? Yeah. In the medical supply space, they're absolutely exposed to tariff impacts. And as you noted, it depends considerably on where they're sourcing, which countries. A lot of these companies have made steps to onshore production and supply here, but it's a very extended process. These supply chains have been established over many, many years. So it's certainly going to result in disruption. Some of the companies, however, have quantified the tariff impacts and that has been supportive for their stocks, but there's still an enormous amount of uncertainty. Again, these supply chains are very complex and you can't just flip them on a dime to re-onshore production here, despite considerable efforts that are underway. Well, let's extend that to pharma because pharma, of course, is a big focus here as well. The desire on the part of the administration to onshore the production of certain pharmaceutical products and ingredients and so on. It seems like we've outsourced a bunch to Ireland, and we derive what, 85% to 90% of the ingredients we need from China. How do we get from here to there and how does tariffs influence that process? Yeah, it's going to be tough. As you noted, Ireland, China, India are where a vast majority of API, the raw ingredients that go into pharmaceuticals are manufactured. Pharma companies have announced billions in new manufacturing investments in the US, but it's going to take time. These facilities have to be approved by the FDA. It's a very complex process. On the positive side, we can talk about this as a factor that's been depressing the healthcare sector's uncertainty around the pharma tariffs. We should get some clarity hopefully in the next several weeks, but the administration has teased that these tariffs will start at, quote unquote, a low level growing over 12 to 18 to 24 months, which will give companies more time to adapt and adjust and bring the manufacturing here. But all things being equal, it will lead to shortages and higher prices for pharmaceuticals. Interesting. Well, in the broader market, we've obviously seen a tremendous year so far. Valuations, I always say don't matter until they do, but we still have to acknowledge valuations. Right now, the S&P 500 is trading at 24 times 2025 earnings. The rest of the market is definitely cheaper, particularly smaller and mid-cap names. A lot of this rally this year has been the AI tech trade that has gotten a second wind. Just over the past couple of weeks, more participation from other parts of the market on hopes that that rate cuts. Andy, I want to ask you, when a client comes to you today, an existing one or a new one, and says, okay, I want to put money in the markets, how do you juggle that, knowing that the market's very expensive, we've had a nice move already, but still the desire on the part of the client to invest in the markets? So how do you sort of balance that out with terms of getting expectations and how to sort of allocate it? Yeah, it's a great question. I mean, first, we want to understand what timeframe we're looking at. If a client is looking for a six-month to a 12-month timeframe, which is too short to be in this market, then we would be really, really cautious just because of valuation. As long as it's investable capital, five to 10-year time horizon, then not everything is expensive, as I think you were alluding to a little bit before, that today was a really difficult day in the market, but the overall index is pretty flat. And the reason for that is a few of those usual suspects were holding the market up, and lots of other companies were being killed. So there are plenty of stocks out there and plenty of EV categories where they're really not overpriced that we would not mind making investments today. If people are talking about buying the Mag 7, which maybe is more like the Mag 10 or 11 now, then we would want to be cautious, consider dollar cost averaging in. We don't want to pile in at these prices, for sure. So I would say, be cautious. Again, we'd like to be diversified in our portfolios. And not all equities are the same today, because some things are more expensive than others. Yeah. And one part of the market that's benefited tremendously this year have been stocks outside the US, particularly Europe and Asia. And we have client money invested outside the US. And also not just the appreciation in those particular markets, but we've also gotten sort of an extra kicker with the weakness in the dollar. So tell us more about sort of the international exposure and how you balance that with US exposure. Yeah, we've had international exposure for quite a long time. It's been painful at times, because the big winner up until this past year over the last 10 years has clearly been the S&P, and particularly the growth portion of the S&P. Certainly this year, some of the non-US equities that we own have doubled the performance of the S&P. Still, multiples are much, much cheaper. There does seem to be a little bit of a trend. And it doesn't mean that we don't still outweigh our portfolios in US equities. We do. In the US market, we still think it's the greatest market. There's the greatest innovation. And we will always have an overweight to US markets. But at the same time, we'd like to have about 25% of our equity exposure in global assets and non-US equities. We like Asia. We like the demographics. And again, we like the overall earnings per share ratios of a lot of these stocks. So we will continue to own non-US equities. And it also gives us a little bit of a hedge for the dollar as well. Yeah. As part of that theme, I always like to remind investors that 75% of the world's GDP takes place outside the US. And 96% of the world's population lives outside the US. So while certainly there are many great US multinationals that benefit from that economic activity outside the US, there's still a lot of high-quality companies that are domiciled outside the US that provide opportunities. And over the last couple of years, as Andy said, that there's been a lot of underperformance until this year, even up until last year, relative to the US. But I think the pendulum is beginning to swing in the other direction. And just because of where a company is domiciled sometimes just penalizes their multiple relative to those in the US. And sort of that pendulum swinging in the other direction, I think that could be sort of a multi-year process of sort of valuation adjustments, where the US just dominated to such an extent that maybe there's some catch-up to be had overseas. So with that, we'll turn to our second topic. And that sort of ties with the labor market and just some general questions about the data and the reliability of it. So I'll push it to Andy and David to ask some of those questions. So the first question comes from Robert in Baltimore asking, first, do we have a data problem? He says it does seem like we have been getting large revisions, particularly recently. The past six months in various economic data, there have been huge revisions. So I guess the question, Peter, do we have a data problem? All right. So I'm going to get into a bit of the weeds here. But I think it'll be helpful in understanding how the government compiles the data and how the government needs help from the private sector in getting that data. So obviously, the question of data being reliable obviously came with the payroll number. Payroll number being the first Friday of every month, the Bureau of Labor Statistics releases the numbers. And keep in mind that the first Friday of every month is only a few days after that month ends. So we just got the July number in early August. So it's very difficult for the government in just a few days after a month ends to know exactly what the jobs number was for that month. So the survey period typically ends in the middle of the month. And what the government does, the government has two payroll surveys. One is the household survey, where they essentially send questionnaires or they call people up at 60,000 different households. And they're literally asking people on the phone on a questionnaire, do you have a job or don't you have a job? Did you just get hired? Did you just get fired? That household survey is where the unemployment rate is derived from. Then they have what's the establishment survey, where the government reaches out to about 120,000 different businesses and asks them, did you hire people? Did you fire people? And they net that out. That is the side where there's the questions of reliability. Because pre-COVID, when they send these out, you never get in that first month 100% response rate. But pre-COVID, the response rate was pretty good. It was in the 70, 75% sort of range. Post-COVID, that response rate has fallen to, I think, like the mid-50s or even lower. It's usually in the second month where that response rate gets into the 90s. So hence the revisions, because the government can't get all the data in that first month. Sometimes it takes them two, sometimes in three months to collect all that information. So what the government does in that first month is they take the data that they have, which like I said, has been shrinking in response rates, and they estimate the rest. A lot of the estimation comes from what's called the birth-death model. The birth of businesses versus the death of businesses, and they net that out. And what we've found over time and historical moments is that in inflection points, inflection points defined as when the labor market starts to slow or the labor market starts to bottom. When it starts to slow, the government in the birth-death model overstates job growth. At the bottom, when we're coming out of a recession into recovery, the government tends to understate jobs growth. So that big revision for July is basically taking away a lot of those birth-death model additions to the jobs market. So it's not a data reliability issue. It is the timeliness of the data response that was the cause of some of these big revisions. So I don't think anybody is playing with the numbers. I just think we need to maybe get people to respond quicker to the questions that are being asked. But how are you going to get someone to do that? There's only so much we can do to get a faster response. Now, this is an issue, but it's what we got, and hopefully we can maybe encourage businesses to respond quicker. We'll have to see. And David, I think you had a question as well from a viewer. Yeah, a related question from Ron in Providence, who makes the point that the new appointee for the BLS is a supporter of quarterly data instead of monthly. What are the pros and cons of shifting to a quarterly reporting cycle? So technically, the quarterly, as I mentioned, the response rates improve in the subsequent two months. So by looking at it over that three months, you do get a very reliable number, even though there's another revision a year after, what they call the benchmark revisions. But for this purpose, three months is a good amount of time, a good amount of time to get all those responses in. The problem with that is markets don't want to wait three months to get a jobs number. They want the jobs number every single month. And so I think satisfying the markets is never easy. But anybody that's been doing this long enough knows the jobs market is revised the next month. It's revised again the following month. It's revised again the following year. But this is just the system we have. But hopefully, maybe through technology, through some incentives, we can get businesses to answer these questions in a much more timely way. But luckily, also, the BLS is not the only sort of voice on the labor market. The Wednesday before the Friday number, we have the ADP employment report, which ADP as a payroll processor, they have a lot of payroll slips in hand. So they have a huge amount of data from a few million businesses, many millions of businesses of what that monthly job increase, job decrease, and netting amount to help us. We have soft data. We have the ISM employment report and manufacturing also in services. We have weekly jobless claims. We have weekly continuing claims. Or a lot of input. So I guess my suggestion to investors is to look at all these jobs numbers holistically and not just rely on that Friday number, at least the first report on that Friday number, understanding that that's inevitably going to be revised because it's almost impossible to get 100% response rate just a few weeks after a survey period ends. So I'll stop there. We'll switch it up and go back to health care. As I said earlier, the stock market has been extremely bifurcated, just as the US economy has been very, very bifurcated. We know that anything related to AI, economically speaking, and anybody benefiting from that build out has seen not only economic growth of substance, but also the stocks have done tremendously well. Whereas those parts of the market like manufacturing, retailers catering to lower to middle income consumers, other areas of capital spending, global trade, housing has been challenged. Those stocks haven't done that well either. And also what has not done so well are those sectors that are defensive, less cyclical, health care, and also consumer non-durables, particularly food stocks, which have been terrible. So David, health care, it's lagged the rest of the market. And is it part of that investors want fast growth and they want the sexy stuff of AI? Or is there something fundamental that's impacting health care stocks? And with that lagging group relative to the rest of the market, does that create a lot of opportunities for some big catch up here? Yeah. To put some numbers around this, health care has underperformed the S&P by 30% over the past 52 weeks. So just tremendous underperformance. And as a result, the sector is now trading at historic low valuations relative to the market. It's at a historically low sub 9% weighting in the S&P. So really a lot of damage. And there were three reasons, three causes for this. One is technical, the point that you noted, Peter, which is health care serves as a disproportionate source of funds into this very narrow AI theme trade. But the other two are fundamental. The UnitedHealth and Eli Lilly are among some very high profile selloffs in the sector that have impaired sentiment for very different reasons, by the way. But UnitedHealth all year, Eli Lilly last week had a tough week. And that's impaired sentiment, as I noted. And then the third are these just pervasive policy overhangs. First were the NIH doge cuts, then the Medicaid cuts and the OBBB. And still out there are issues related to drug pricing, the pharma tariffs that we discussed, and a most favored nation policy that the administration has floated. So those three factors have led to very dramatic underperformance. And we think, to your point, Peter, have created at least selectively some very interesting, exciting opportunities going forward in the sector. So to get more detail, because we know health care is just a wide swath of things. You have the providers, you have the drug makers, the medical supply companies, the insurance companies. Are there any particular areas that stand out to you in terms of those opportunities? Yeah, I would note three. First is MedTech space that we talked about of having some exposure to tariffs, but you can navigate that and isolate that. But these are companies, there are companies in the space that are generating volume-driven, double-digit organic growth, addressing huge, huge market opportunities, innovating like crazy. But that have gotten caught up more recently in the broad-based selloff in the sector. Secondly, our second or third would be areas that have really been beaten down because of some of these issues we noted. One is growth pharma. And I think once we get clarity on the policy issues, which I suspect is approaching, it will set the stage for investors to re-engage with the space. And there are some very exciting companies with huge growth that will continue to grow regardless of whether the economy slows or not. And their valuations have been compressed very materially. And again, differentiate growth pharma from value trap pharma that are facing enormous patent cliffs with no visibility of growth beyond that. But so again, you can pick stocks and find the right ones. And then thirdly would be some areas that are derivatively related to pharma, life sciences tools. These are the companies that provide all the picks and shovels for scientific research that have been under pressure because of the NIH funding that the data shows is starting to improve. Concerns about what pharma will do from an R&D perspective if drug pricing gets hurt really badly. So as we start to get some clarity around those issues, we see some very exciting opportunities in those three areas. I mean, that really is the interesting part of investing in healthcare broadly is because the US via Medicare, Medicaid is such a dominant payer, you really have to get both the fundamentals of the company right, but also have clarity on the regulatory policies that are out there that are influencing a lot of this. Now, you had mentioned that you see hopefully soon some clarity on this. What gives you confidence of that? Well, they've been teasing the pharma tariffs now for a while. And now that we have the chip tariffs out of the way, that's really the last major sectoral tariff left. There seems to be indications from the company side and otherwise and the Washington analysts community that the companies have been negotiating with pharma. Lilly today announced they're raising their price for Munjaro in the UK for out-of-pocket spend. They reached an agreement with the National Health Service there for a very dramatic price increase to get ahead of the most favored nation policy that may be implemented. The administration sent some letters to the pharma companies a week or so ago, which actually suggested a more limited scope for that policy, which is encouraging. But I think in speaking with folks in DC, the companies, I think we're getting close and it sounds as though the companies are discussing with the administration ways to do this so everybody can win. Okay, that would be very helpful for investors for sure. All right, so with that, we'll look to next week. I've always found in all my years of Wall Street that the last two weeks of August are probably the two quietest weeks of the year outside of Christmas to New Year's. Physically, people check out and certainly mentally, people check out. And it also coincides with a big tail off in earnings reporting and certainly the economic data. I mean, next week's economic data is some housing stats, which are not going to be market moving. We do get from S&P Global, the US manufacturing and services PMI, that's going to be relevant because each of these data points, we're digesting the state of the economy. The first half GDP, if you average the two quarters, which everyone should because of the lumpiness related to tariffs and the pull forwards of trade, only averaged one and a quarter percent growth. So the back half of the year, all eyes are on it, particularly the influence of tariffs. And then we'll see eventually what the influence of monetary policy is going to be on the broader yield curve. But outside of that, it is relatively quiet. So Andy, I know you're going to be physically and mentally checking out over the last couple of weeks. Is there anything particular that you're looking at or it's really just let's wait for after Labor Day to start honing in on things? Yeah, I really think the game starts again after Labor Day. Most clients will be checked out. I mean, personally, I'll be on vacation last 10 days. It's always a really quiet time unless we get some surprising reactions. I know there was some data that could get something started, but if there isn't something started to the downside today, which I'm certainly not suggesting there will be, then I think that things will probably be pretty flat. Volume will probably be pretty low. And this whole thing will kick up again starting in September. Yeah, the August, September into October seasonality always provides some surprises and we'll be watching out. Now, David, for your companies, both the ones you own and the ones that you follow, is earning season pretty much over or is there anything to come in the next couple of weeks? It is. There are a couple of reports next week. Medtronic still is reporting next week, but for the most part it's done. But the policy regulatory news never ends. So we may get some more visibility on the issues we talked about. We'll get some news on Medicare Advantage rates looking forward to 2026 with the star ratings probably early September. That will be critical to whether the managed care space that's really taken in on the chin can start to recover or not. So in healthcare land, it's never a dull moment. Yes, I can say that for all of us. There's always something to keep us on our toes. And with that, I want to thank everyone for watching. Thank you, Andy. Thank you, David, for your very valuable insights. And until next week. Thanks, Peter. Look forward to seeing you again. Thanks, Andy.