Inflation Data and the Fed Keep the Market's Attention

0:00to discuss the trends moving the markets. Let's welcome in our next guest joining us Mike Dixon the head of research at Horizon. Mike great to have you on the show. Thanks for taking the time to join us from the nice floor today. How are you looking at the market action that we're getting today? We got the Treasury buyback announcement this morning. We just had apples release of the foldable iPhone. The much anticipated iPhone and the most anticipated one. The heavy line for today of course is that Treasury announcement and then of course rates going into the out of the direction. I think one of the drivers of that is maybe some commentary from Besson. Kind of got folks a little more hopeful than what we actually got delivered today. As we head into of course inflation tomorrow in the fed next week. I think this sets up really nicely for while everybody's been talking about the fear of a rate height. Frankly I think you could actually look at that as an opportunity to stabilize some of the volatility on the long end of the curve.

1:00Simply by showing that the feds ahead of the curve and has control of that. Some of the longer yield rises has been due to some uncertainty around that fed framework. That might go a long way to help stabilize things and something that I think could be very helpful in this market right now. Mike is your expectation for a hold then for a hike or is it all contingent upon the data that we get in the inflation picture? Well for sure if we get anything remotely on the hot side it will be certainly a done deal. I think you have to tilt slightly to the fact that we're going to have a hike next week. But the reality is I mean the two years trading at 4.4 whether it happens in September or later in the year I don't think makes too much of a difference except to potentially instill some confidence that the fed has control of at least their main mandate which we heard from Warsha Jackson Hold just to help get inflation under control. But where it sits now I think you have to tilt to a more likely a hike here in September.

2:00But I don't really think it much matters for equities at the moment except for that confidence issue. So if it doesn't much matter then is the bigger risk that we should be focused on this persistent inflation? Is pushing longer term yields higher? Could it eventually overwhelm the strength that we're seeing in earnings? Well you know not that you mentioned earnings I mean that's certainly something we have to talk about right? And one of the byproducts of a really strong growing economy is higher interest rates. And if we just zoom out and not just look at the last couple of months but you know take a little bit longer view of longer term yields you know what we've seen is the real interest rate you know stripping out that inflation component has been the dominant driver of the rise in yields and that's really due to the fact that there's just more productive investment opportunities available in the market. I think overall it's a very strong sign that in spite of higher rates you've seen such a resilient equity market. I think it's an excellent example of just how strong earnings have been. You know Frankl we've come off two quarters in a row of some of the best earnings beasts that we've seen you know in many many years

3:05and it's not just in AI stocks it's not just at the top of the market it's really broad based and that's going to that breadth is very very healthy as we head into the second half of the year and it's something I think that we need to look for you know under the surface of some of this top one volatility. And Mike how are you looking at that breadth because I mean we certainly saw a major broadening in terms of performance. Do you view this as the beginning of a durable rotation away from the mega cap winners? Well it has really been a durable rotation you know all year and you've had fits and starts where you've had this handoff from the AI leaders on the hyperscale or on spending side to the infrastructure play you know in the first half of the year. And frankly something that we've seen you know so far this quarter is some of the strength and recovery and a lot of the software names which presents you know a certain a different type of company that can really take the baton as the AI theme matures and that's companies that are going to be able to take AI bring it down to the user basis and show that they can actually make money and drive

4:08drive earnings through AI actually making money off of this not just building and that's really important because a lot of those fears that we saw earlier in the year this all software sell off I think now set up to present opportunities we saw really strong reports you know from Salesforce and intuit around this we have Oracle and Adobe tomorrow to shed some more light. And so I think the next phase as we look for the second half of the year here is going to be finding these companies that are actually able to bring AI to the market and really show they're able to make money and turn this into higher operating margins and earnings and not just drive that top line revenue growth. And so most importantly though money is staying in stocks and I think that's something that investors need to be aware of. And you imagine software there I mean there's this ongoing narrative of this this has occurs pretty much over but we're still having the conversation about which names are going to survive which names are going to be disrupted versus which are going to use it to become more productive and benefit from AI. Are there software names that you like when you look at that sector. Yeah I mean I think one of them that I just mentioned Salesforce is a great example where they have their you know AI agent technology that's driving real solid earnings growth that type of those types of metrics hearing hearing how AI is able to actually drive those earnings by you know having these very installed user bases I think what we've seen with a lot of the software reports this far is coming to the really willing to integrate AI into the systems if it's kind of already on platform a little bit more.

5:35Reluctant to just completely switch gears but I think some of these software names will certainly be challenged but you know when you look at the broader AI trade and semi key notters up as much as they have been and some of the memories side up as much as they have been this year software is barely positive on the year I think it sets up really nicely for this productivity story to feed through first the software stocks because they're closest to the users they're already integrated and I think that's we're going to be the real opportunity is. For the second half and another group that you like for the productivity play here is quality small caps whether you start with the lower margin you've got more opportunity to generate some operating leverage from AI with these names what type of small caps are you looking at that you think are best position to translate that productivity into earnings. Yeah I mean this quality small caps have been you know a really strong trade this year I think if you look at broad diversified indices you know the S&P 600 for example was up you know around 22 23% which is well ahead of the Dalvin Azak in the S&P 500 and this is in spite of you know a higher rate environment we go back just a couple years this level of the 10 year would absolutely destroy small caps but overall when you look at what's been leading in that small cap space it's companies that have well well martin's

6:58substantially but have been growing margins substantially and I think that plays in very nicely as we think about this type of technology sifting through the broader economy because we start with lower operating margins and you know specifically the percentage of revenues that are dropping to the bottom line any improvement there just gives a bigger bang for your buck and as far as what overall earnings growth looks like and so it's a really nice setup but you got to look for high quality earnings so you know cash flow generation strong measures of profitability healthy balance that are able to weather the market. Some of the highest interest rate environment that we have now but it's certainly been rewarded strongly thus far and it's got a wonderful set to diversification industrial and consumer discretionary stocks and financials as well really a pure pure play on the domestic economy here and the strong growth that we've seen this year and I think it's a good point to continue and brought out from there. And Mike you also like health care services because of the potential for AI to reduce labor administrative costs another productivity story here I haven't had as many conversations about this as an AI play though do you think health carry is is under appreciated right now in terms of being a way to play AI.

8:10You know I do I think there's two channels there right one of them is that increase in operating margins out of things just like you mentioned with kind of the health care services I mean starting margins there are very low there's you know a lot of opportunity for improvement and then you know if you look kind of on the pharmacy things there's a lot of R&D productivity enhancements that could play a major role there and you know as a as a result you know health care has a couple different ways to win it also you know doesn't doesn't as a sector doesn't trade it very cyclically. Often has defensive characteristics and so provides a little bit of a ballast from you know some of the other names like software small cap you know quality stocks like I've mentioned before so in the spirit of diversification I think it's a really nice place to play the still allows a couple different ways to win but also has you know some less cyclical exposures that might provide a little bit more balance to a quarter before fully right now. Mike great to talk to you really appreciate you taking the time to be with us today that's Mike Dixon the head of research over at Horizon thanks again Mike.