Sizing Up the Markets
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Hello, everyone, and welcome to Barron's Live, our weekly webcast and podcast. I'm Lauren Rublin, Senior Managing Editor of Barron's. Thanks for joining us today for an update on the markets and a look at the stocks in the news. I've been tied up over the past week moderating the annual Barron's Roundtable and editing an account of the proceedings, which runs over three weeks on barrons.com and in the magazine.

My guests on Barron's Live today were both at the 2025 Roundtable. Barron, senior editor, excuse me, Barron, senior writer, I just promoted you, Nick. Nick Jasinski is helping me with some of the editing. And David Giroux, chief investment officer of T. Rowe Price Investment Management and a manager of the T. Rowe Price Capital Appreciation Fund, the manager of the fund, is one of our Roundtable panelists. And I am so eager to get their impressions of the event and to talk

more about David's market outlook. So welcome, David and Nick, and thank you both for joining Barron's Live today. Thank you for having me. Thank you, Lauren, and thank you for the promotion. Fantastic. So, David, I'll start with you. Were there any big surprises from your view at the roundtable, other than the fact that so many people were so bearish? I don't think so, Ashley. Again, I think it's a really great crowd of investors who are

who have non-consensus thoughts quite often. So I don't think there was, I think the only thing that was a little surprising to me was this concept of American exceptionalism.

It feels like this and I've been talking for a while. We don't really like international stocks versus US stocks, but it was interesting how almost every member of the panel this time seemed to buy into that concepts. And so even though I still believe that, I still believe that American stocks, American markets, American economy is stronger long term than Europe, Japan, Australia, other markets, emerging markets.

It's just I think that's becoming a little more consensus, I would say. So I think that was the only observation from the roundtable. You know, it was interesting. Our internationalist on the roundtable, Rajiv Jain from GQG, highlighted some of the bargains in non-U.S. markets and made a good case for non-U.S. markets. But I agree there was a there was an intense focus this time on U.S. markets. I wanted to ask you to.

Talk a little bit about your roundtable remarks. I kicked off the conversation with you last Monday thinking that you might be on the sunnier side of the street. And I think we were all somewhat surprised by the bearish tenor of your comments and the detail you gave us in terms of the market's valuation. So if you wouldn't mind, can you summarize those comments for our audience and then give us a read on the market's selloff this past week?

Well, I don't, I, I, yeah, I would, I would say a couple of things. One, you know, we, we actually tend to be a little bit more contrarian, uh,

with regard to markets, like during the COVID crisis, we were buying stocks in the summer of 2022, and every time we had a recession, we were buying stocks. So we tend to be a little bit more contrarian to the fact that we've had two strong years of very strong equity markets, causes us to be a little bit more circumspect about equity markets, especially the equity markets relative to fixed income markets.

And again, we talk about this kind of five year view where we model the VSP 500 on a company by company basis through the end of the decade. And we're getting returns today that are, at least on Monday, that were kind of sub 5% returns for the equity market. And that's really low. And I contrast that when we were doing the same analysis

in the summer or fall of 2022, those returns for the market on a five-year forward would have been more like 12% or 13%. And I would also say it's not just that the market's at 22 times earnings or the market was at 22 times earnings. It was more of a function of,

Everywhere you look, the market's expensive. So you can, we talked about this analysis, okay, the market's at 22 times, but even if you take just the growth stocks, they normally trade for about 29 times earnings, now they're at 32 times earnings. If you take out the growth stocks from the index, that traditional growth stocks, which are at 44% of the S&P 500, the rest of the market's like 18 or 19 times versus historical average of 15 times. If you look at heavily cyclical companies like,

banks, insurance companies, industrials, kind of trading is 17 times or as a historical average of 12 to 13 times. Really the areas of the market that are attractive, or at least were attractive a week ago, are much more narrow than we've seen in the past, right? So it's really just like software, healthcare,

GARP area. That's the only area of the market that looks attractive to us. It's just like the most narrow market we've seen in a long period of time. So you mentioned a week ago, a lot has changed in the past week. The market has come down, had a pretty nasty sell-off. Where do you think this leaves us? Do you see further selling? Do you think that the bear case will be appropriate for the next month and then stocks will rebound? How are you reading the current setup? Well, I think you give me too much credit. Again,

I struggle trying to come up with six month or one year views, let alone one month views. What I would say is I think what we said at the round table was if you look at like a 290 number for the SBA of 100 for 2026,

and you put like an 18 multiple on it, which I think is where it would be the actual right multiple, that would get you a price target for the market at the end of the year, kind of 5,300. And even though we've rolled off, we've come off a little bit of the highs, we're still a good distance from that level. And again, normally you want to have some upside to that level.

Yeah, we would really need the market to probably go to 5,000 or even below 5,000 to get to 500 to want to get more aggressive. If the market went to 4,800 or 4,900, the forward return for the market would get more like high single digits. And that's kind of a level where you'd want to be adding tech exposure. But I think we're a long ways away from that. That would be a painful journey. It would be. It would be less painful for our investors though.

Right. So I want to ask you about the backup and bond yields. That's been the big story of the year and the reason for the equity sell-off. The 10-year treasury yield is now approaching 4.8%. Are those higher yields a reflection of the economy strength or are they a reflection of something more troublesome? I think it's a combination of multiple things. The unemployment report on Friday was stronger than a lot of people thought.

And plus we've had like four or five, we had like a period of time, we had three or four months there, kind of the middle of the year where rates kind of, you know, it felt like we were on a nice trajectory back down to the low twos. And then the last couple of months, whether you look at the inflation numbers or you look at the CPI or the core PCE, it's just been a little bit less good, if you will. It has kind of been stagnated here for a little bit. So people are losing confidence a little bit.

I think there is an element of policy perspective, right? Increasing tariffs is an inflationary move. Reducing immigration is an inflationary move, even if it's on the margin, it's inflationary because it reduces the amount of supply for the workforce.

And I think there is a sense that we will probably, you know, we're not going to, you know, a lot of the tax cuts that were supposed to expire at the end of 2025 will not expire. That will probably be, you know, drive faster GDP growth as a result of that. But it will also probably drive deficits a little bit higher than it would have been otherwise. So it's really a combination of multiple factors that have kind of driven that up.

that inflation or the 10-year treasury to be, as you say, close to 4.8% today. So we had a question from a listener, Tom, who wants to know where you think the 10-year will be by, say, June. And more broadly speaking, do you think the 10-year is going to go much higher than this? I think it could. But what I would tell you is when we think about the 10-year, like what is the right 10-year rate for

on a longer term basis. I'm not sure where we go by June, but we kind of think the right tenure rate is let's call in the low to mid fours. So let's call it, let's say 4.25. The way we build up 4.25 is, is if we still think inflation won't get all the way back to 2%, but it'll probably be in the round, let's call it somewhere between

Two and a quarter is probably our base case, longer-term inflationary rate. A two and a quarter kind of gets you to a 3% Fed funds rate. And then if you look at the historical relationship between the Fed funds rate and the 10-year, that would kind of get you to four. And we think a little bit higher deficit over time.

We're in a world where deficits are probably 6% of GDP versus 4%. That probably gets you to kind of, let's call it 425 to 435. That's kind of the way we build it up. So we actually look at a 10-year day at 4.8%, especially in the context of a still extended equity market. We see good value there in the marketplace. And again, I know it doesn't feel like it today.

But, you know, if you had a recession sometime in the next three or four years, the 10-year will probably do really, really well. If you had a dust-up with China with regard to Taiwan, the 10-year is going to do really well in that environment. So the 10-year still is an insurance policy where you're actually getting a real yield today. That's a lot higher than that real yield's been over the last decade.

decade plus. So we actually see a little bit of value today in the 10 year. And I'll tell you, we actually added to the 10 year exposure on Friday. Interesting. That is very interesting.

We will come back to that, but I want to ask Nick something. Nick, you're our resident Federal Reserve reporter. The Fed has been cutting interest rates while market yields have been rising. Inflation has yet to be vanquished, as we know. We have that jobs report that David spoke of. We have CPI coming this week, which will be very interesting. The Fed meets again on January 28th and 29th.

You'll be in Washington for Powell's post-meeting press conference then. What is the Fed's playbook this year, or at least in the near term, from what you can see? You know, Lauren, I think the Fed is back to this data-dependent, wait-and-see approach to setting interest rates, which was really the stance between the middle of 2023 when the Fed –

delivered its last rate hike of the cycle. Rates were at a two-decade high, and they kept them there for a little bit over a year. So for really the second half of 2023 and most of 2024, inflation was high, rates were high. The Fed was waiting to see enough progress on reducing inflation to start lowering interest rates. They did that by a full percentage point in the last four months of 2024. There was a parade of Fed speakers last week, and a lot of them have called this a recalibration of policy.

It's recognizing that there's been progress on slowing inflation, especially in the late summer. The trend in the labor market looked like it was going from these overheated levels of the COVID recovery to something softer.

But really, since September, not much has changed. The unemployment rate has been at 4.1% or 4.2% in all of the past five months. If you look at the core personal consumption expenditures price index, which is the Fed's preferred inflation measure, excluding food and energy components, that has been at an annual rise of 2.7% or 2.8% for all five of those months. So really, since the Fed started lowering interest rates, nothing has changed. They recognize that over the year before that, when they

interest rates peaked until last September, things had changed a little bit. Now they've recalibrated interest rates for this new backdrop. And now it's this wait and see game again to see what's gonna give first. Is it that inflation is gonna resume its progress lower? Is all these risks that we're gonna continue talking about, about the policies from the new administration, about growth inflecting around the world, is that gonna lead inflation to rise again?

It's really the data and the policy coming out of Washington are going to be the guide for the Fed this year. And there's a lot more questions than answers there right now. So the Fed, I think, is wait and see mode. David, do you have any thoughts about that? You must. No, I think we are kind of in a wait and see mode with the Fed. I will say, I think the Fed still, and I think Powell still, have dovish tendencies about

And so there are some short-term things that have kind of contributed, I would call artificially to inflation staying a little bit higher.

The way we measure financial services in this country, inflation is very counterintuitive. Equity markets go up, the fees on mutual fund assets or ETF assets or brokerage accounts that are fee-based, they go up. That creates a little bit of inflation. That might be 20 or 30 basis points.

of kind of inflation, that's not real, right? The fees on a strategy goes up 25% 'cause the market goes up 25%. That's not a real inflation, but that's how we measure inflation. And I do think the second derivative of owner's equivalent rent is still going the right way. You have a lot of supply hitting the market last year and this year.

So I think owner's equivalent of rent goes the right way. Some of this financial services kind of nonsense and how we define inflation goes the right way. So I'm still a believer that the 2.7 core PCE that Nick referenced, that number goes lower. Core CPI goes lower. The only wild card, and again, the only wild card is if we do put some kind of crazy amount of money

excuse me, a tremendous amount of tariffs that hit this year. Again, I think the tariffs would hit, but we'll see. But again, even if you raise tariffs, it's a one-time price adjustment. It usually does not, it would not be a change in the long-term move of inflation. It would kind of be a one-time step up. There's a lot of talk of tariffs at the round table and a lot of mixed opinions on what the impact would be.

So I thought I found that was interesting. I want to talk about earnings, which, of course, are the most important driver of stocks. Nick, fourth quarter earnings season kicks off this week with some big bank earnings. We'll be covering all the earnings as they come out. Can you give us the big picture view of earnings season and then we'll drill down to some of the particulars?

What is Wall Street expecting from this earnings season and what will you be looking for as companies start reporting? For me, perhaps this is a truism, but it's a show me the money earnings season with stocks at high valuations and the past week notwithstanding this post-election optimism driven rally. So just to give you some numbers for it.

The consensus estimate among analysts surveyed by FACSET is for 8% S&P 500 earnings per share growth from a year ago, which would be exactly the same as in the third quarter, although companies tend to beat by a couple points, so it may end up being faster than that, and for revenue to be up about 5% from a year ago. As usual, especially in the earnings season that comes at the very beginning of the year, it's going to be more about the guidance and the outlook

that management teams give for the year ahead more than the numbers from the quarter that was just reported. But still in that period, we'll be interested to hear about, we just mentioned tariffs, are manufacturers or importers, are they pre-ordering to try to get goods into the country ahead of those potential tariffs? Is that demand that's being pulled forward from future quarters?

um any commentary and that will be interesting and also it seems like it'll be a good earning season for the retailers consumer focused companies um some of the credit card data that we saw from the holiday spending season was very strong um and and again there may be this post-election optimism surge that led to more spending so i think retailers will be and they'll be a good barometer for the for the overall economy as well and the health of the consumer

And then what else am I listening to in the commentary? What management teams are talking about, the strong U.S. dollar, what higher interest rates mean for their businesses, for their margins. And then as I was going through some of the analyst previews this morning, I thought it was some interesting stats from B of A Securities,

where last season, last earnings season, third quarter earnings season was really, they called it a stock pickers earnings season. The average move on the day after earnings for companies was 5.3%, which was a record high in the history of the data that they had. And this quarter, the options market is once again, pricing in around a 5%.

implied move for companies reporting. So there should be some divergence in the companies that impress investors and those that don't. And that'll be followed by pretty big stock moves the day after. So that's interesting to me.

Lots to write about. Lots to listen for. Absolutely. What about the bank earnings that kick off this week? What are the expectations for JPMorganCity, Goldman and the rest? They're expected to be quite strong growth from a year ago. For the S&P 500 financial sector, which includes banks, insurers, some other things, it's supposed to be expected to be up 18% earnings per share from a year ago. And that's really driven by the likes of JPMorgan, Bank of America, Morgan Stanley,

I'll note that a good chunk of that has to do with the year ago period having some loan loss reserves. These are non-cash charges that banks take in advance of expected losses on policy. So that makes the year ago period look pretty bad. And so the part of that is the strong growth. But again, it'll really be about...

The outlook. Bank stocks in particular have just rocketed higher since the election. And that's a combination of expectations. Some of it is that there's going to be a lighter regulatory burden on financial institutions during the Trump administration. There's also expectation of a rebound in M&A and IPO activity that generates a lot of fees after a couple relatively slow years for that.

And the yield curve, which plots the maturities of treasuries of different maturities, tongue twister there. Anyway, that's back to a positive slope, which helps the net interest margins of big banks, the bread and butter business model of banks.

borrowing short and lending long, that makes more money when the yield curve is positively sloping. So I'm really interested to hear what some of these masters of the universe at the top of the nation's biggest banks have to say about the economy and the outlook. And I'm sure that will make plenty of the headlines as well as the, more so than the results for the quarter itself.

- Right, I think you're right. And I'm looking forward to that as well. David, what is your take on earnings growth? - Yeah, so I think the expectation for the market for earnings growth for 2025 seemed to be a little bit elevated relative to history.

As Nick's alluded to, I think next year should be a pretty good year for financials earnings. There's no FX pressure, net interest margins are going higher. It should be a good year for M&A and capital markets. So financials should have, let's call it above trend earnings growth. But I think if you take a step back from the market, even if we end up beating, as Nick said by, let's go, that 8% in Q4 turns into a 9 or 10,

to get to the consensus number for 2025, you basically need 13% EPS growth off a higher number than the basis. Again, assuming the basis is up a little bit higher than what we have today, it's more like 242. To get to 273, 274, you really need kind of 13% EPS growth and actually 14% EPS growth

EPS growth, XFX. Remember FX was going to be a slight tailwind three months ago. Now FX for the S&P 500 will probably be a one point headwind to earnings growth for the market now. So that's a little bit of a headwind. We should note FX is currency. It's one currency. Yes. So that, you know, given the weakness we've seen in the Euro, the weakness we've seen in the pound, weakness in some emerging market currencies since the Trump election,

that the translation of those companies, S&P 500 companies profits overseas into US dollars is gonna be a little bit of a negative for the market next year. So again, we have a lower earnings expectation for the market next year. It's still more like 10, 11% kind of EPS growth, but not the 13 or 14% the market's implying. - So if companies are gonna earn 10% more, it's hard to sort of reconcile that with a forecast that's quite a bit lower. How do you do that?

That is a stock market forecast that's lower. It's actually company by company analysis. So again, there's some weird things if you look at the SP500. So oil prices right now, even after this little rally, are not that different from what they average for calendar 2024. But oil prices are heavily correlated with our energy earnings. But energy earnings are expected to be up pretty nicely next year, which doesn't really make a lot of sense.

There are a number of companies that are analysts on the sell side who have not reforecast earnings expectations for FX movements. So industrials, maybe some parts of healthcare where you haven't really

really reset those interest, those tax rates, not tax rates, you have not been able to reset the FX rates yet. That's gonna be a little bit of a headwind. And I would just say, generally speaking, if you look at where estimates are in like October, November, they tend to be two to 3% too high. And so you'll see companies probably resetting their numbers lower and then hopefully set up to beat those numbers after Q4 earnings are released.

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So one of the stocks to discuss is something you recommended at the mid-year roundtable in July. That's Aurora Innovation. The company is a maker of autonomous trucking technology, and the stock has more than doubled. Aurora recently struck a deal with NVIDIA. Investors got very excited about it. Two questions from me. What does that deal mean for Aurora? And more broadly, what do you see ahead for autonomous vehicles?

I think, let me answer the first question. The agreement they have with Nvidia and it's actually an agreement with Nvidia and Continental. It was just a, it wasn't really anything truly incremental in that news. That was, they already buy Nvidia chips. So the stock bounced pretty hard on that, but I don't think there was anything really incremental there. But that isn't, we still really are big fans of Aurora.

This is a company that is going after a $1 trillion TAM where they have clear market leadership. It's interesting, it can be like Waymo, who used to be trying to get in the trucking market as fast

has kind of de-emphasized that part of their business. I think they view that Aurora really is the leader in technology. They have a LiDAR that goes twice as far as the competitors, and they have a relationship with two of the three largest trucking companies. So they're in a really good spot. And again, the economics for Aurora are really, really compelling. The average driver today costs a dollar a mile,

And there's a driver shortage where the Aurora system costs 65 cents per mile. And, you know, it is just the economics for the carriers are really compelling. And I think over the next three or four years, you're going to see Aurora and autonomous driving really take off. And I would also say this is the year, really 24 was the year, but I think it's 25 people are starting to realize that autonomous has kind of been de-risked.

autonomous driving has kind of been de-risked. I mean, we see today Waymo. Waymo is driving, I don't know, somewhere between five to nine times better than a human driver. We see Aurora operating, you know,

everyday routes very, very safely. I think there was a lot of hype around autonomous driving probably five years ago, but I think that hype has turned into reality today. And whether it be Waymo or whether it be Aurora, I think they're going to be the market leaders in autonomous driving over the next 10, 15 years. It's going to be a fascinating development to watch. Absolutely.

Absolutely. So another area I wanted to talk to you about is data center energy needs. This has become a very hot topic on Wall Street with the growth of AI. And some utilities like Ameren and NiceSource have become data center utility plays. What is this all about? And how will data centers drive growth for these sorts of utilities? Well, what's really interesting to me is if you look at utilities,

over the last 15 years, power consumption in this country has been relatively flat. You have more needs for power, but then offset by efficiency. So it's really, it hasn't been a huge need for power, but now we have this kind of this twin benefit

EVs are going to be a small part of the benefit as EVs become a bigger part of the car park in the US, they drive a higher consumption of power. But I think really it's this data center, right? And not just data centers, but AI data centers that are led by the cloud manufacturer, cloud providers, the hyperscalers, the Azure and Microsoft, the Google Cloud at Alphabet and AWS at Amazon.

at Amazon. These are the companies that are building data centers at a very, very healthy pace to try to meet this very strong demand, at least right now, for AI. And what you're seeing is the projections are that AI, data centers say about 3% of power consumption in this country. In the next five years, we think that'll probably triple or more than triple, basically 9% or 10%.

And again, not all states and not all utilities are equally well positioned for this. You're not putting a lot of data centers in Florida. You're not putting a lot of data centers in California for obvious reasons. You're not putting a lot of data centers in the Northeast. A lot of these data centers are going in places, right now more in the Midwest, Wisconsin, Missouri, markets where you have a lot of

It's easy to bring on new power consumption. You have a lot of, let's call it a raw land. You're not overly congested. Power prices are lower. It's a little bit colder. And a company like Nisource, which is right outside of Chicago, they may double their electric consumption

capacity over the next decade because of this. That's kind of unheard of to double your capacity and potentially because of data center demand right outside Chicago. Ameren is working on, I would say at least a dozen, if not more kind of data center opportunities in their markets in Missouri. So these are companies historically would have produced let's call it six systems and EPS growth.

But I think over the next five or 10 years, you could probably dial in seven to eight, nine source, maybe eight to nine. And so you have these utilities that still traded a pretty big discount to the market that are getting structurally fast, becoming structurally faster growing with lower volatility and still trade for a big discount to staples, which really doesn't make any sense. Why should a staple company, you know, a Procter and Gamble trade a big premium for lower growth, more volatility,

and lower dividend yields really doesn't make any sense to me. So we really think that utilities are going to be big beneficiaries of data centers.

Again, we think utilities will structurally trade for a higher valuation over time than they have historically. And over time, we think utilities will trade for a higher multiple than staples because they grow faster, they have higher dividend yields, they have less earnings volatility. It's really quite a change for utilities and utility investors, isn't it? It is. It is. They are no longer your parents' utilities. These are fast-growing, structurally more attractive businesses than they've been in the past.

Yeah, it's been fascinating to watch. All right, let's go to some listener questions. I think you may be the Barron's Live guest who has the most questions I have seen in a long time. So a lot of people want your opinion on things. We'll start with William, who notes that you manage allocation strategies that balance equities and bonds.

And he also notes that Barron's had an article this week that it might be time to ditch bonds. And he wants to know whether you disagree with that and how you would balance these allocations at this point. Basically, what's your take on the bond market and owning bonds at this point? I think bonds are...

are reasonably attractive right now. So we have been adding to our bond exposure. A couple of years ago, we had only 17% of the portfolio in bonds. And today that is 34%. Now again, of that 34% in fixed income today, about a third of that portfolio is in leveraged loans, which are, that actually benefit from rising rates. So if you think about that 34, you remove the 11% of leveraged loans, we're at 23% in true bonds. But what I would say is,

is if you really believe, so right now the market's saying, hey, inflation is never going to get back to 2%. I would argue, and I talked about this earlier, there are some idiosyncratic things in how we measure financial services inflation in terms of the lag effect on the second derivative owner's equivalent rent that I think should push inflation

you know, inflation X tariffs, which should be a one-time issue lower. And that probably means, you know, I would take the, if you think about the people say, oh, the fed's only going to cut one more time or not cut it at all. I would still take the over on that. I think the fed will end up cutting more than the market thinks today.

And if that's the case, I think bonds look attractive. And I would just also just go back to this idea of an insurance policy, right? We don't value insurance policy as much as we should. But if you look at how 10-year treasuries have done during crisis, during COVID, during the great financial crisis, and these crises, we never know when they're going to come.

but the equity market is good on 20% and bonds go up 10 or 15%, that can provide real diversification. So again, a 10 year at 4.8 looks a lot more attractive to us than a 10 year at 50 bps. So we see more value today. And again, equities are pretty expensive. They're very, very expensive. So we're seeing some more value again, we're not,

going crazy but we are adding on the margin uh to uh to the tenure right now that's interesting good question good answer we had a question from john wondering what your take is on the energy sector for 25. we talked about it a little bit but wonder if you could elaborate i i would say i think again energy was one of the worst performing sectors last year so every all is being equal that kind of that makes that peaks our interest if you will

I would say that the company, we historically have not liked energy a lot. First, the earnings tend to be very, very volatile. You also don't have a lot of earnings growth. And we try to find companies that are growing earnings at least in the high school digits, plus their dividend yield.

I would say the one company in energy, which again is a name I mentioned last year in the Barron's picks, is CNQ, Canadian National Company. It's a Canadian based company. They have a 29 year reserve life versus a nine year reserve life for a lot of their peers. They generate, they're really good at capital allocation. They do really good deals. They pay the dividend yields like four to 5% today, probably closer to 5% today.

and you get 2-3% production growth, and they buy back a little bit of their stock. So you can generate high single digit returns even if energy prices are lower. If energy prices go up or something ever happened in the Middle East that was negative, they have a very long supply of energy, a very long 29 years reserve life. So we really like CNQ. CNQ is one of our larger holdings.

But we don't like all of energy. I would say we don't really like the majors, but we really like C&Q quite a bit. Okay. Another good question there. Now we have a question about the dollar. TJ notes that the U.S. dollar index, I guess the Dixie, is approaching 110. What is your outlook for the dollar from here?

So it's a really good question and also a very difficult question. So if you look at most of the academic analysis would say, based on all the correlations, the dollar is probably 1.1%.

10 to 20% overvalued versus a basket of developed market currencies. But at the same time, if you do agree with the idea that, hey, US companies are better than non-US companies, US markets are better than non-US markets, US yields are much higher than yields outside the US.

economic growth will be stronger over time than in the US and non-US. All those things are all dollar positive. The question really is, on a long-term basis, you want to be long the dollar versus other currencies. In the short term, are we a little bit too high? Maybe. If the Fed starts cutting rates,

the second half of the year, which I think they could, maybe that's negative for the dollar in the very short term, but on a longer term basis,

you know again even if we're a little bit ahead where we should be i think the dollar is more attractive than euro the dollar is more attractive than most developed market currencies and obviously much more attractive than a lot of the emerging market currencies i just i want to second that i think that the dollar is relatively high but it's reflective of fundamentals of the economy and the businesses in the us and yields is that that american exceptionalism again as we were discussing yeah

All right, Nick, I want to ask you the next question. It's from Thomas who wants to know, with interest rates expected to remain higher for longer, how significant is bankruptcy risk for investors in small and mid-cap stocks in the coming year? Any thoughts about that? Sure. Bankruptcy risk may be a little strong, but it's certainly smaller companies tend to

seek financing at higher rates and have more floating rate debt than larger companies. And so certainly higher interest rates are a bigger drag on their earnings and their profit margins. That's just a big general statement about smaller companies versus larger companies. Another topic that came up at the roundtable last week was how in the Russell 2000, there's a large proportion of companies that

um, either have no earnings or are burning cash. Um, so I would recommend in a high interest rate environment, if you're looking at small stocks to look at the kinds of companies that David likes, those are quality companies with plenty of free cashflow and the ability to either finance their own growth without needing to borrow or with plenty of cashflow to cover their, their debt, um, and their interest payments. Um,

rather than those that are more reliant on external financing for growth, biotechs, early technology companies that are just more sensitive to borrowing. And so when interest rates are higher, they earn less. End of story. Makes sense.

All right. We have another question for David. We had a couple of questions about the California fires, which, of course, are very tragic and very upsetting. But not to be insensitive, do you see implications here for the insurance industry? Do you see drastic changes in terms of how the industry will operate in the future?

No, again, unfortunately we've gone to, this is going to be probably a, the last figure I saw was maybe a $50 billion kind of loss

But we've seen, unfortunately, we feel like we see these kinds of losses all too frequently today from weather across the globe. So this will make the market a little bit harder market, right? And you will see some losses here that's going to be reported either Q4, Q1, or Q1 probably, from the insurance companies who have reinsurance exposure, just traditional commercial or personal lines insurance. But again, I think it just,

It kind of highlights that weather continues to be a challenge that puts a little bit of upward pressure on insurance rates. Insurance rates have been rising at a rate well above inflation, and that is especially true in a place like California where weather has been a disproportionate problem. There are some parts of California where you cannot get insurance.

So it's going to be a challenge in the short term, but I think it actually puts upward pressure on insurance rates, which actually, again, you don't want to be insensitive at this time. It is probably a moderately good thing for insurance brokerage companies like a Willis Towers Watson or an A.J. Gallagher who kind of benefit from higher rates on insurance.

Okay. There'll be a lot of questions that will be coming out of this awful situation, but a lot of different stocks over time. We had a question from Jason who knows your funds well. He says, is David finding any opportunities in convertible bonds and writing call options as he has done in the past? It's a very good question. Very good question. I would say one, the

The convertible market has really shrunk dramatically in the last decade. So we don't do as much convertible bonds as we did when I took over the fund in 2006. There's just less issuance. So we don't really do very much on convertible bonds. Unfortunately, we'd like to do more, but there's just not a lot of product out there for us to do in the large cap space. With writing calls, absolutely.

We tend to write calls on a one year basis, so a lot of our names that we wrote calls on in last January, we're going to probably redo that process here coming up in the second half of January. And again, in an extended market, writing calls makes a lot of sense where you're willing to give up 10% upside,

in return for a 3% to 4% incremental yield, that produces really good risk-just returns. So I think you'll see us continue to take advantage of that opportunity with pretty aggressive call writing in the second half of January. Okay, glad that question was asked. And then we'll wrap up, David, by asking, there are a number of questions about what is the optimal allocation for the year ahead.

And how do you address that issue between stocks, bonds, large cap, small cap, tech, other stocks? A lot of things thrown into the mix there. But what would you see as kind of an optimal allocation given where the market is and where it seems to be heading?

Let me answer it in two ways. I'd say one, if you are only investing in the market, right, and you're not picking stocks or you don't have the ability to pick and choose what's attractive, not attractive. Again, I'll just tell you where we are today. We are positioned, we're about 58% kind of equities on a kind of a Delta option adjusted basis. That's about 400 bps below normal. We're about 34, 35% fixed income. Again, all that fixed income, about 11 or 12% of that is in leveraged loans.

and about 14% of that is in treasuries, almost evenly split between five and 10 year treasuries. But again, I'm a stock picker, I'm a fixed income investor, stock selector, or fixed income selector, I guess if you will. So we do see good value in parts of healthcare,

Managed Care, which is doing well today, Life Science Tools, which is doing well today. We see good value in software companies, the Workdays of the world, the Microsofts of the world, Autodesks of the world. We see good value in those kind of names. We see good value in utilities, even though rates are high, the Amarants, the Nisources of the world, the CNPs of the world, we see good value. So even though, I mentioned this before, even though the equity market only has potential to do

mid-seed legitimate returns through the end of the decade, there are a plethora of really good opportunities in the marketplace can generate low to mid-teens, or maybe mid to high-teens kind of return over that next five year period of time. But you have to buy what the market doesn't like right now

And that's where we see a lot of value at healthcare, life science tool, software, you know, afford of where we see really good value in the marketplace. - That seems a perfect place to end the conversation. Also, we're out of time, but David, I wanna thank you so much for joining us today and Nick, thank you as well. - Thank you both. - My pleasure. - I wanna thank our listeners. You are close followers of David's work and his fund and certainly close followers of the market. Thanks for the great questions.

Barron's Live will be off next week for Martin Luther King Day. Our next call will take place on January 27th when my colleague Ben Levison will be back and hosting the conversation. He'll be speaking with some experts on the energy market and he'll be taking a look at energy stocks

So for those interested in energy, this will be an important call. Also, we will have many more earnings reported by then, and he'll be talking about the corporate earnings outlook, what we've learned so far. Thanks, everyone, for tuning in today. We appreciate it. Stay well and have a good two weeks. We'll be back on the 27th.