Current Market Volatility, Capital Spending Conundrum, and Elections

In this video, Terry Gardner shares his thoughts on the stock market’s current volatility and sector rotation, capital spending conundrum, and policy and election impact on markets.

Hey everyone, it’s Terry Gardner from C.J. Lawrence coming to you from our global headquarters here in Midtown Manhattan. It’s Wednesday, the 24th of July, on a pretty volatile day in the equity market. I thought I’d come to you with some thoughts following today’s market action.

I want to cover three things today. First, I want to talk about the sector rotation and the sentiment change that’s happening inside the market. Second, I want to talk about what I call the CapEx conundrum. And then third, I’d like to talk a little bit about policy and election years.

Let’s focus first on the sector rotation that’s taking place in the equity markets.

You can see it with the winners and losers today. The top sector performers were healthcare, utilities, energy, and consumer staples, which came at the expense of technology, consumer discretionary, and communication services. This represents a complete shift into defensive value from what has been working, which is some of the growth and more offensive sectors.

We’ve got precedent for this. We’ve seen something like this before. I think it’s instructive to reflect on when this happened the last time, which wasn’t too long ago. If you think back to 2022, we were facing in the markets the prospect of higher interest rates and the chance, and the growing possibility, for recession. Higher interest rates were putting pressure on high multiple stocks. We had this massive rotation out of technology, which had worked particularly well, and into energy in particular, but more defensive in value sectors. It wasn’t based on anything necessarily fundamental. It was more macro-driven. It was driven by the prospect for higher interest rates and what the market playbook says that does to high multiple stocks, which is to compress them. I’m going to use Microsoft as an example to illustrate the point that you can look through these episodes if you focus on the fundamentals.

I’m not recommending that anyone go out and buy or sell Microsoft, but I’m using it as a proxy for technology stocks that had worked particularly well and had a sell-off in 2022 in this market rotation. From the beginning of 2020, so including the pandemic, to present, Microsoft is up 182%. In the period of time from 2020 to 2022, it was up 116%. Going into 2022, it had a great run. However, it sold off in 2022, falling about 28%. If you look behind the curtain at sales and earnings, though, revenues were growing at a double-digit pace, and earnings grew about 11% in the calendar year of 2022. Microsoft didn’t do anything differently to precipitate this sell-off in the stock; it was really precipitated at a higher level.

The point that I want to make is if you had held Microsoft from the beginning of 2022 through now rather than sell into the decline in sentiment and the fear of this rotation, you’d be up over 40%. If you sold it, you missed out on the upside that’s been experienced since then.

Are we going into another period like that, like 2022? I don’t know. I could draw some parallels, and it kind of feels like that. The point that I’m trying to make, though, whether we are or not, is if you focus on the companies of stocks that have the best fundamentals, that have secular tailwinds, and that are disrupting industries and investing in the future, ultimately, you’ll be rewarded. You may go through some short-term volatility, some market rotation, and some sector rotation, but ultimately, the fundamentals will win.

That’s the illustration I wanted to make using Microsoft and thinking through where we are in this market environment, because some of the stocks that sold off today and may sell off again tomorrow are growing, at 15 to 20 to 25 to 35 and even higher growth rates. We are selling off some of the fastest-growing companies in the economy, and that’s going to create some opportunities.

Secondly, I want to talk about the CapEx conundrum. Capital spending is kind of a necessary evil in some industries, and a competitive advantage in others. In energy, you don’t like to hear capital spending because the light at the end of the tunnel is kind of dim, and you’d rather see energy companies return capital to shareholders than redeploy it back into their businesses that don’t have the greatest long-term prospects. For industries like technology and healthcare, we believe that high levels of capital spending is actually a competitive advantage. It separates the pack, and it deepens and widens the competitive moat between those that can and those that can’t spend.

Looking back, the big spenders over the past couple of years have been Amazon, Alphabet, Microsoft, and Meta, and not far behind them is Apple. They have been the big capital spenders over the last several years, and I would suggest that they have achieved a reasonable return on that capital spending.

What we saw with Google today suggested that they were going to be maintaining a high level of capital spending. In this kind of environment, the market didn’t like it because the market wanted a nearer term return on that capital, so the stock sold off. What that means for Google shareholders in the longer term is probably a higher return on invested capital, so long as they’re investing their capital in the right places. To our eye, they are in terms of their artificial intelligence investments and so on. That’s what these leaders are investing in.

We don’t view high CapEx levels as a liability; we view it as an asset. We view it as a competitive advantage if capital spending is deployed and employed in the right areas.

Finally, I want to touch on what has really been in the backdrop over the last couple of weeks with the assassination attempt on the life of former President Trump, President Biden’s decision to exit the presidential race for the coming year, and the elevation of Vice President Harris as the candidate for presidency from the Democratic Party. I should back up a step to include the naming of JD Vance as the Vice President candidate on the Republican ticket. All of these announcements and events, one of which was particularly tragic, have filtered into the psyche of the market in one way or another. They can push and pull the market on a short-term basis. The point that I want to make is that policy and elections don’t have long-term impacts on the market.

I did an interview earlier this week on Yahoo Finance with my brother Brian, who is the Washington Policy Analyst at Stifel. He had some unique perspectives on different industries and how the congressional mix matters more than actually who’s sitting in the White House. I focus more on the market side, and that’s what I’m going to do today. By the way, if you missed that interview and want to see it, I’m happy to send you the link.

If you look back in history at how markets performed after events, elections, crises, etc., the market ultimately finds its footing. For this exercise, this analyst used the Dow Jones Industrials because we went back a number of years. But we can look at a couple of events in our nation’s history, like the Cuban Missile Crisis, which many thought was an existential threat to the US back in the early 1960s. Six months after the crisis ended, the market was up 24%. After JFK’s tragic assassination, six months later, the market had returned 16%. After President Nixon resigned, we were in a time of constitutional crisis. In the mid-1970s, the market returned 12.5%. Consider the Asian stock market crisis in 1997. Six months later, the market was 25% higher.

I can look at periods of time in our nation’s history, in our economic history, and in our market history and make the conclusion that over longer periods of time, investors look through crises. I usually use the term looking across the valley and finding solid footing on the other side. Markets can perform well even on the back end of very difficult periods in our history.

If you have any questions about any of this, or you want some of this data, give me a shout at 212-888-6403 or email me at tgardner@cjlawrence.com. I look forward to hearing from you, and hope everybody has a great rest of the week.