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hello and welcome to the baron streetwise podcast i'm jack howe and the voice you just heard that's fran canary he's the head of investment at vanguard's advisory research center and in a moment he'll talk to us about corrections we're in one what does it mean where's it headed what should we do we'll also hear from david steinbach he's the global chief investment officer at a real estate company called heim but first i'll say a few words about wall street price targets
Listening in is our audio producer, Alexis Moore. Hi, Alexis. Hey, Jack. I am holding in my hands, you will see, a Choose Your Own Adventure paperback. Have you seen these before? This one's number five in the series. It's called Mystery of the Maya. Have you seen those? Yeah, it's been a while. It's been a little while, right? I'm going to skip the story and I'm going to go right to two endings. I'm going to give you a choice. You want the ending on page 115 or the ending on page 122? Let's do 115. Okay.
It just says that night you contact him. Big mistake. You vanish into the angry sea. Oh, you want 122 instead? Yeah. Can't be worse than that. Oh, no. I was worried you'd say that. It says it's the end for you. You are to be sacrificed. Oh, my God. So either way, I die. OK, that's actually not that unusual. I found a data visualization blog.
Looks like it's called flowingdata.com and there's a huge chart here. Someone has analyzed all the possible plot paths. Not from Choose Your Own Adventure, Mystery of the Maya, but from Choose Your Own Adventure, Journey Under the Sea.
And there's like more than a hundred possible paths you can take. Just eyeballing this chart, it looks like your chances of a bad ending are about 10 times higher than your chances of a good ending. I think maybe just the macabre endings were more interesting than the happy ending. So they put a lot of them in the books. So don't feel bad that you chose wrong twice.
Thank you, Jack. Believe me, I've been swallowed by anacondas and overrun by hairy spiders. I've drowned in submarines. And I think once I was zapped with a freeze ray and there was a big stamp put on my forehead that said human meat galactic prime. That's kind of a thinker that ending.
Not a good thinker. I think reading those books when I was a kid might explain why I became more of an index investor because so many of my individual choices seemed to go wrong. But now looking back, it all makes sense. I am reminded of the Choose Your Own Adventure series.
by what I see from Wall Street these days on price targets, because a lot of them are putting out, maybe you've seen this, they say, here's our price target. We're going to give you not one, but three. We're going to give you our bull case, our bear case, and our base case, which is like saying I'm supposed to decide among them, but I thought that's what I was going to the stock market forecaster for in the first place. Aren't they supposed to tell me?
Here's JP Morgan this past week. They put out a note saying their base case for the S&P 500 is 5,200. Let me look at the time of this recording. I almost hesitate to look. Okay, it's 5,208. So their base case is doesn't move. Bear case is it drops to 4,000. Bull case is it rises to 5,800.
What stands out to me about these cases, it's not just that it's maybe not fully enlightening to have three different numbers. I know that it's difficult. I mean, you might even say it's futile to try to predict where the stock market is going to be a year from now. I think of these things as more about a framework for thinking. So I don't begrudge any analyst out there for not knowing exactly what to say about where the market's headed. But what bugs me a little bit is the bear case, 4,000 on the S&P 500.
So if we look where we are recently, that implies a decline of 23%. And that sounds like a polite figure for a bear market, for a worst case scenario, right? But I don't feel like it is. I mean, I think the purpose of a bear case is not because you want to panic and not because you want to think this is what's going to happen, but because if you're an investor out there, you want to make sure that you are prepared for the worst case scenario.
So you do want to think from time to time about how bad could things get. And I'm not sure $4,000 on the S&P is the number, and I'll tell you why. The way J.P. Morgan gets that number is this. Last year's earnings for the S&P 500, the earnings underlying the index, were $240 per index share, if you want to call it that.
And so they assume we're only going to rise a little bit to $250 next year from $240 last year. That's a pace of growth so slow that it's not even beating inflation. Okay, that would be bad. And they also assume that the index then comes to trade at 16 times that level of earnings. Remember, it was only a short while ago that the S&P 500 was trading at 22 or 23 times earnings. So a decline to 16 times earnings sounds plenty bearish.
Here's the problem. A small rise in earnings, to me, doesn't sound like a worst-case scenario. It was just a short while ago that the White House rolled out these punishing worldwide tariff figures. The president ran down a chart of all the numbers, and Bank of America Securities said these tariffs would cause a decline in S&P 500 earnings of anywhere from 5% to 35%. The range is so wide because there's so much you don't know.
What effect would rising prices here in the U.S. have on consumer demand? How would countries around the world retaliate? What effect might that have on our manufacturing and jobs? There's a lot of moving parts. I think their broad point was this is going to make earnings go down potentially a lot, and nobody really knows the exact figure.
So if we were there just earlier this month, how are we anticipating a bear case where earnings go up a little? Isn't it possible that earnings could go down? Also, 16 times earnings. I wonder if investors are suffering from a little recency bias. That is the tendency when you want to predict what's going to happen in the future to really weight your expectations in what has happened in the very recent past.
Stocks have recently been expensive, but that's not the way they have tended to look on average throughout history. There was a study on this by the Kansas City Fed way back in 2000, and they looked at 128 years of stock market data, and they found that the average trailing P.E. ratio was 14.5. Maybe 14.5 is normal, and maybe the 25 years since 2000 have been a little bit puffed up by
rising global trade and prices held low in the U.S. and falling interest rates in the U.S. and ballooning corporate profits and money flowing from other markets into U.S. assets. It's kind of difficult to say. Stock market strategists sometimes use the term equity risk premium to basically mean how much people are willing to pay for stocks. What are their expectations about future returns?
And there's this camp that believes that the equity risk premium has fallen over the years, that people are now willing to pay higher prices on an ongoing basis for stocks. Why? Well, they might have come to expect that when times get bad, policymakers will swoop in with a fix. That in other words, the market always comes right back. And that might make them feel that stocks are safer than they used to be. They might be willing to pay more. Or it might just be that things have been high for so long that we forget what normal looks like. I don't really know which is which.
But I think if you want to lay out a bear case, I think it's reasonable to assume just off the top of my head, you know, earnings could decline 10%, some modest figure like that. And instead of investors wanting to pay 16 times earnings, maybe they get real gloomy. Maybe they only want to pay the average of what they used to pay, 14 and a half times earnings. And if you do that math, you get to a level for the S&P 500, not of 4,000, but of barely over 3,000.
31-32. That's a level that would mean a year-to-date stock market decline of 47%. We're nowhere near that. Again, this isn't me saying everyone's wrong, stocks are going to tank, run for the hills. This is me saying I'm not sure that when Wall Street puts out its worst case scenarios, that those worst case scenarios are gloomy enough. Now I know there's a pause on the tariffs, a 90-day pause. It was announced by the president on his social media platform.
And the White House press secretary came out and said this was the plan all along and we in the media missed it.
Many of you in the media clearly missed the art of the deal. You clearly failed to see what President Trump is doing here. You tried to say that the rest of the world would be moved closer to China when in fact we've seen the opposite effect. That sounds comforting. I guess it was the art of the deal all along. And the president himself had kind of a different comment about the timing of the tariff pause. Well, I thought that people were...
Okay, so people were getting yippy and the president announced the pause and there was immediate stock market rapture. Prices ripped higher for the rest of the day and then fell the following day.
But the pause announcement coincided with a sell-off in the bond market. That's a serious thing. The bond market is very tricky. I was watching it, but if you look at it now... Stock investors, as we all know, are super flaky. We let our emotions run wild. We get carried away. But bond investors aren't supposed to be like that.
Bond markets are supposed to be level-headed and calm. Sudden bond markets sell-offs are serious because they can lead to systemic breakdowns. They can make a bad situation worse in a hurry. UBS put out a report on the pause saying, the damage isn't all undone. With the pause, the sky-high tariff rates are gone. They're replaced for now with a 10% global tariff rate, except for China. They have a special rate of over 100%.
And UBS says, if we assume that the 10% rate for most of the world holds, and we assume that the rate for China comes down to 50%, then that's still going to make a big dent to U.S. demand. And earnings for U.S. companies, which were recently predicted to grow at double-digit percentages before all this tariff business, they're now expected to grow at a low single-digit percentage, possibly zero, says UBS.
That outlook is not nearly reflected again in consensus estimates. I don't think it's reflected in the level of the stock market. If that's the new base case, we better hope we can avoid the bear case. Let's bring in part of my conversation with Fran Connery at Vanguard. I asked him about corrections and bear markets and whether Wall Street projections look reasonable.
30% of the time, the market trades in correction territory, which is down 10%. The reason why there's an equity risk premium, which is strong equity returns over bonds and over money markets, is because of this volatility, right? And so we saw in COVID, the market dropped 40% very quickly. 2008, 2009, the market was off more than 50%.
You go back to the internet tech bubble and the market was off more than 40%. So, again, if you have that kind of diversification, investors should be able to withstand those type of pullbacks, which they did in the past. And then again, as I said, coming out three-year, five-year after those events, portfolios have tended to almost always have a positive real return for those investors who stayed the course.
That sounds reassuring, but it's hard, right? It's hard to stay the course. You know that the market has bounced back in the past, but isn't it hard in the moment to just forget about what's going on around you and stay the course? That was the right thing to do during COVID. But when Disney World suddenly shut down and gas stations and roads were empty and people were walking around with masks, didn't it look like, hey, maybe this is the time that things don't come right back. Maybe this time it is different.
Of course, in hindsight, you should have just stayed the course. But what about now? Is it possible that this tariff upheaval is part of a more lasting shift? I asked Fran. You have a market downturn along with volatility, and then you have what I'll call the narrative. And you kind of created that narrative, whether it be COVID. It always seems like it's different this time. Like this is going to be the one time where
that it plays out differently, that this is changing of the world order. I would just caution investors that, you know, the story and the narrative always follows the downturn. Staying the course is not easy, but it is rewarding for those who are investors who've been able to do that. Thank you, Fran. Let's go to a quick break. When we come back, we'll hear from David Steinbach at real estate company Heinz. Think about a bicycle.
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Welcome back. Let's hear from David Steinbach at real estate company Heinz. I spoke with him right after the tariff pause was announced. The market was reacting violently in a good way. David talked about what he expects in terms of changes going forward, including some lasting trade frictions. You'll hear him talk about the investing outlook changing from downhill skiing to cross country skiing. For a man in my physical condition, that sounds alarming, but it's not that bad. David is mostly optimistic.
let's hear part of that conversation so at the time of this conversation first of all everyone was very afraid about these tariffs the markets had been tumbling but there was an announcement and there's going to be a delay on a big portion of the tariffs 90 days what do we what do we think of this well i'm coming at you know the markets certainly from the private investor perspective right so the public private dynamic there's there's a lot there
This is part of a broader meta-narrative that's been playing out for several years now of deglobalization. And this is just what deglobalization feels like in terms of how that unbundling and reworking is going to look.
The deeper thing here though is that, you know, the friction cost of trade is going to be higher. I'll say the next few years, maybe even 10 years versus the last 50.
in many ways you know the way i look at even the tariffs you know it's really hard to put the toothpaste back in once it's all squeezed out and so and so even if we have you know forms of negotiate agreements which i know there will be you know there will be elevated friction costs in the system what form does that take friction costs i i worry that we have this big announcement the president goes down a chart with some enormous numbers on it for tariffs that we're going to put on friends
and frenemies and all sorts of different countries. And now we go and we say, okay, we're going to buzz on that for 90 days and we're going to negotiate
But are there countries out there saying, wait a second, the U.S. just doesn't, they're not doing business the way they did in the past. I mean, maybe we should wait and see. Are things a little, you know, I don't want to use the word flaky, but things seem a little volatile right now. Should we rethink that investment or that plant we were going to build? I mean, or is this...
Just the kind of move that has been a genius negotiating tactic, and now we're going to get favorable terms. Is there any permanent damage done if we move forward from here and we never see those super high tariff rates?
Well, there's a lot there, a lot to unpack there. Look, as an investor, I try to look at things not in terms of, you know, damage done or, you know, kind of what's the air quotes right path versus how does this change the state of play for the global economy and its actors?
And, you know, to me, there's a couple themes that draw out of what you just said. One is, I think without question, you know, as we move into this de-globalized world, which again has been a trend we've seen for several years now, so this is nothing new. I think one of the elements of that that we're now seeing in this next chapter is after COVID, you know, the world woke up and said, wait a minute, supply chains, we have risk, we didn't realize China plus one became a dominant theme for a lot of actors.
And China was an important economy, but the plus one was an element of having resiliency around China. I think that now it's going to be U.S. plus one as well. U.S. is an important economy and the global markets will continue to strive to serve it.
But having a backup plan, having other elements to safeguard your supply chain, I think is going to be a theme we're going to hear. When we talk about the past, let's call it 25 years, 30 years, what have you, globalization. On one hand, it's been great for the stock market, financial assets, investors. It's hard to argue that. On the other hand, I know it hasn't been good for everyone, right? There's folks out there who've lost jobs and who've struggled. And many people in the U.S. have struggled.
What's going to change going forward? You talked about some new paths and new opportunities. Is the opportunity for financial returns, you think, going to be as good going forward over the next 25 years as it has been in the past 25 years? Or did that period of globalization, was that just a sort of special opportunity? How do you feel about the coming decades?
Yeah, I think it's going to be different. I think the last, let's say 40 years, right, I would describe as downhill skiing in terms of the monetary policy that really became a tailwind around a lot of areas of the economy. Combining that with deflationary forces of leveraging the global supply chains in new ways was an accelerant to that that really drove returns in a lot of different factors.
Now, to me, the sport is shifting from downhill skiing to cross country skiing. Oh, that sounds like such a drag. That's the one where you've got to like you got to hop and puff. You got to be in shape. You got to be in shape. I mean, you got to be in shape for downhill skiing, too, if you're going to do it all day. But cross country skiing, boy, you can't do 20 minutes of that without being in shape. Right.
Well, it is a different game. I mean, it's a game that can be won, but it's just a different game. And I think the markets are still digesting what that means. Just in my world, one way I think about it is if you think about return attribution,
Where are the returns going to come from? And in downhill skiing, I think the search for beta was a dominant theme. Certainly financial engineering of a capital stack, moving quick. It's about adrenaline. You know, those elements create outsized returns.
Now I think in cross-country skiing, the scarce resource is alpha, alpha generation. And that's going to be more about, in my world, more about income growth, more about how you're working assets. It's frankly, it is going to be a bit harder work, but that's the entire system. And so then how do I outperform relative to others in that system?
And so the second thing, the one last thing I'd say too, is when you think about how the dynamics of inflation, monetary policy, interest rates, debt levels, all those things do play into the cross-country skiing game next decade. My view is that we will have an era of a bit higher inflation than we're used to. I think we have real risk of 1970s repeating, even though nobody goes into that with a desire to, but having a slower growth, higher inflation rate,
maybe higher rates. That is a possible outcome here based on higher friction costs in the system. And in that world, you have to look at what you have to go back in time to an era that frankly, no active market participant today has really lived in.
and so i think that's a very interesting way to look at the historical context in which we sit i mean i mean these are big moves happening in the market that um the the players don't necessarily know and there's going to be a element of recency bias i think that a lot of people are going to fall prey to in the next call it quarters as well as what's happening plays out and i think you really need to be able to
put that question things in a new way and check yourself. Am I, is this just recency bias playing? Is this my 08 playbook I'm trying to get out? What do you mean by that recency bias in what form? So, yeah, I mean, you know, the market players today, the people controlling the money, they've lived through a couple cycles. But we saw,
Certain dynamics occur when they happen. Stocks always bounce right back. Somebody always comes to the rescue, no matter how bad. I don't care if they close down Disney World because there's a pandemic and there's no flights. Somebody comes to the rescue and the market always bounces right back. You're saying it doesn't always work that way.
Exactly. Doesn't always work that way. Our debt levels have continued to pile on. The debt has to be rolled. All that will have a cost. All that takes time. But yeah, I mean, I think the other element too is there's a certain element of, you know, speed and how things work too. And I think that at least in the real estate world, a lot of the monetary policy in 08 became a tailwind.
And this time it's a headwind. And so how do you, how do you invest into that? I think is what people need to get their head around. Thank you, David and Fran, and thank all of you for listening. If you have a question that you'd like played and answered on the podcast, send it in. It could be part of a future episode. Just use the voice memo app on your phone. Send it to jack.how that's H O U G H at barons.com.
Alexis Moore is our producer. Alexis, out of curiosity, I stopped at my little town in our local library and I went to the kids section. I asked if they have any choose your own adventure books and the librarian led me to a few of them and she said, you know, it's a funny thing. You're the second person this week that asked for these.
Who do you think it is? Do you think it's a Gen X dad with the nostalgia? Or is it the JP Morgan Global Strategies team looking to freshen their model? We don't know. You can subscribe to the podcast on Apple Podcasts, Spotify, wherever you listen. If you listen on Apple, please write a review. See you next week.
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