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Oscar Pulido: As we welcome a new year, we reflect on 2024 as another strong year for equities with inflation, interest rates, and the ongoing impact of artificial intelligence. Still very much in the spotlight. 2025 is shaping up to be an intriguing year for equity investors. As we discovered in the 2025 outlook from Jean Boivin, we have entered a transformative era of investing with the strong performance of equities over the past two years. In this episode, we're looking ahead to what this year holds for investors.
Welcome to The Bid where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm Oscar Pulido.
Today, I welcome back a Bid regular. BlackRock's Global CIO of fundamental equities, Tony DeSpirito. We'll discuss the factors driving the market where he sees the biggest equity opportunities and some of the challenges that lie ahead.
So Tony, welcome back to The Bid.
Tony DeSpirito: Thanks, Oscar. It's, really nice to be here again.
Oscar Pulido: Tony, you're a stock market investor and I have to imagine that you're in a good mood. 2024 was a great year for the stock market. tell us, do you think this is going to continue in the new year?
Tony DeSpirito: We've been through a pretty nice run actually. So, we've had two years in a row for the S&P 500 where it's been up more than 20%. That's actually pretty rare by historical standards. we went back and looked over the last a hundred years. Happens roughly 12% of the time that you get two years in a row like that. now three years is even more rare, of 20% plus. in fact, the only time that in the last hundred years has been in the 1990s, the late 1990s. So, I'm not expecting another 20% plus year, but I see no reason why 2025 shouldn't be a nicely positive year for the market.
Oscar Pulido: It is pretty rare to see the stock market do 20% plus returns as you point out. So, a third year would be unlikely, but doesn't mean that stocks can't still have a good year. it seems to me like there are a few topics that are going to be big drivers of whether stocks do well or not. and I think these are some of the familiar topics that we've had recently. Things like inflation, interest rates, artificial intelligence. Where do you stand on these topics and what does it mean for the stock market?
Tony DeSpirito: So, they're all important, and they'll continue to be important. So, let's go through them one at a time. let's start with inflation. I think the fed's done a remarkable job with respect to inflation, right? We've brought inflation down without triggering a recession. and that's pretty remarkable. but I don't think we can just check it off our list of things to watch and worry about.
First of all, inflation is not yet down to the targeted rate, so there's still more to go. And that last mile, so to speak, is awfully tough, is what we're seeing. Policy's also a risk, whether that's immigration policy or tariffs, depending on how they're implemented, that could be a risk for inflation. And I've seen research on this that inflation tends to come in waves. If you look over history, whenever we've hit a big wave of inflation, there's usually been followed by a second wave roughly within two years. And so that's the base rate that we're dealing with. So, all those things tell me that yes, inflation's in a great place right now, but let's keep an eye on it and let's watch it.
And with respect to rates, I certainly think a lot will depend on inflation. With respect to real rates, we do have to consider government deficits. Both in the US and elsewhere within developed markets, government deficits have grown and are large relative to GDP. One of the things that was interesting about 2024 is that interest rates, if you look at the 10-year treasury went up during the course of the year, normally you'd think that be, might be a problem for, the market, multiple. Certainly in 2022 that was, that really didn't affect market multiples in 2024. In fact, the market multiple expanded during 2024. So that's something I certainly view as potential risk out there is multiple contraction due to higher rates if they occur.
Then with respect to AI, that's been certainly the most exciting thing that's happened economically, at least since the iPhone, if not, longer than that. So, there's a lot of opportunity both from the point of view of the economy, as well as the point of view of corporations, right? And so, I think that's an exciting area for us as investors. I don't think this is an area where you want to set it and forget it. I think there's going to be lots of shifts, lots of changes. I think you need to be stay nimble. So, I certainly think of AI as a huge opportunity, for the folks, the active equity folks
Oscar Pulido: And AI is definitely one of the reasons why the BlackRock Investment Institute has used the word transformation. In talking about the 2025 outlook, we recently had Jean Bana who mentioned that this is not your typical economic cycle.
And in fact, when you mentioned inflation, how it came down in 2024 without triggering a recession, I think that was another example that Jean used to point to how different this economic cycle is from the past. Talk to us a little bit about how should the stock market investor be thinking about opportunities in this period of transformation?
Tony DeSpirito: So, I definitely agree with Jean's point that this cycle's very different, from other ones. Whether it's inflation coming down without a recession, we had an inverted yield curve historically, we would've thought of that as a great recession indicator - throw that one out the window.
Same with the Somme rule, which is that if unemployment ticks up by 50 basis points in a short period of time, that also has been a historic predictor of recessions. Again, throw that rule out. And in fact, I think what we've seen since Covid is mini rolling booms in busts. Whether that's in terms of goods, we certainly had a boom in terms of goods, during covid and then that's rolled off.
You see that in semiconductors outside of artificial intelligence. Semiconductors are actually in a recession where we overbuilt semis for autos and industrials and appliances. Now they have too much inventory. So now they have to under produce to draw those inventories down.
Same with housing. We saw a housing boom during Covid. Now if you look at housing turnover, that's in a bust. Even tech was in a bust prior to AI, and AI really brought technology out of that. So, I do think this sort of mini cycles is what we're seeing as opposed to one big economic cycle.
Certainly, we've talked a lot about the mega forces, and I do think that those are really important drivers of investment returns going forward. But when I hear the mega forces, whether that's digital disruption, a fragmenting, world, demographics, future finance, et cetera. What I hear is change. And from my active equity investor lens, I view that as a real positive for active investors because that's what we're good at, is being nimble, being active, adapting to these 'cause none of them are going to evolve in a straight line. There's going to be puts and takes along the way, and that's where we come in as active investors.
Oscar Pulido: And you mentioned these cycles. One of the boom cycles that, seems to have really accelerated in recent years was the boom around artificial intelligence. you mentioned semiconductors, which semiconductors associated with artificial intelligence have definitely seen a boom. And there seems to have been a boom in interest around technology stocks, which have dominated the headlines. how do you see the technology sector and just the AI investment opportunities evolving in the new year?
Tony DeSpirito: If you look at the early stages of AI the initial stage was all about that hardware layer. The chip companies, Nvidia, for example, big winner. Also, some of the cloud service providers like a Microsoft, like an AWS, alphabet, meta, et cetera, et cetera, increasingly we're seeing though the opportunity set broaden out. There's been a huge boom in power companies this year. Why? Because AI requires a lot of power to operate.
So, we've seen independent power producers do really well, and of course they require equipment. So, the equipment suppliers have done well. Same too with data centers, they require equipment like cooling, for example. So those companies have done well, Increasingly, we're going to continue to see that opportunity broadening out. I think a lot about the models themselves. The initial models are large language models that are mostly publicly available. what we're going to see is companies develop more narrowly tailored, smaller models that are more efficient, but that are very much focused on certain verticals. And there's going to be winners and losers in that, and that's part of our job as investors is to identify those companies.
I think about the data layer. Many companies have their own proprietary data, much like we do as a firm. and other companies sell their data. That's their business model is selling data. In some cases, that data will be replaced by AI, the importance of that data. In other cases, that data will be made more valuable by AI. Let me give you a few examples there. If you look at Reddit, that was an IPO in 2024. Very successful. What did they do to drive their earnings growth? They started to sell their data or their customer's data to the AI companies, and that's what drove their success with their IPO.
I think about companies like legal databases. It's a market where, it's an oligopolistic market where these companies sell their data and they make junior attorneys more efficient, in terms of their research. Increasingly what you're seeing is them putting AI layers on top of that database. Now it's not only the junior attorneys becoming more efficient researchers, but they're becoming more efficient at drafting legal arguments, drafting legal briefs, et cetera. And so, they can charge more for that. and so we'll see in this space, again, winners and losers. I. similarly I think about the applications and services that are being developed and will be developed over time.
When you think about software, again, winners and losers, some software will be replaced by AI, others will be enhanced by ai, and we'll be able to charge more for that. one example early on is that many companies have fixed budgets that they're going to spend on it. The more they spend on AI, the less they can spend on other things.
And so, in some cases that's hurt software companies. Going forward, what we're seeing is, AI agents being added to software. On our desktops an early example is Microsoft's CoPilot. We'll see more and more software companies come out with things like that over time and they'll try to charge for that. So, as we go through this, it's a lot of detail, but I hope you get the sense of one, why I'm so excited about AI as an opportunity, but also in particular, given all these puts and takes, why there's so much opportunity for active investing.
Oscar Pulido: Tony, we've talked a lot about the US so far. The US has, tended to benefit it seems like from the AI theme, it's had better growth in many parts of the world. The stock market has done very well. You mentioned the S&P up more than 20% two years in a row, but you have a global lens in the seat that you sit in as a global Chief Investment Officer, Tell us what is peaking your interest abroad.
Tony DeSpirito: Certainly the returns of the US market have been quite exceptional. Some of that has been driven by earnings growth. So, the US has had better earnings growth, than the other developed markets, but without a doubt, some of that's been multiple expansion as well.
So it's been a mixed story there. When I think about it, I think less about choosing one country going forward and more about choosing the right stocks increasingly. I do see pockets of opportunity where you can find similarly situated global companies that happen to be headquartered outside the United States and therefore are trading at a discount because of that. It's almost like the baby getting thrown out with the bath water, so to speak.
A couple opportunities that I've tried to exploit. One's in the integrated oil space. There are a couple of integrated oil companies in Europe and the UK that have very similar models to the integrated oil businesses in the US yet trade at very large discounts.
In the pharmaceutical space, we think a lot about what's the value proposition, it's that patent portfolio. And how long does that patent portfolio last? there are a number of companies in the US that have a problem with a patent cliff. In Europe, we're seeing less of that. And so, when we look at the duration of that portfolio, the duration of that patent, it's just on average, longer in Europe than it is in the US. Yet when you look at the pharmaceutical companies across the globe, they're trading at pretty similar multiples. So again, that's an example of one of those opportunities for stock picking.
So again, I don't think it's about choosing so much one market over the other. I think it's much more about trying to exploit opportunities like that because of geography.
Oscar Pulido: It seems like another maybe similar area of the market that is perhaps misunderstood and that you see an opportunity. I know you recently wrote an outlook about the opportunity in large cap value stock. So, tell us what is it that interests you about large cap value stocks and maybe just define when we say a value stock, what are we talking about there?
Tony DeSpirito: Yeah, so let's start with the definition. Value stock is stocks that are trading at low multiples relative to their intrinsic value. Typically, low PE stocks, maybe low price to book stocks, but stocks that are cheap for one reason or another.
And when I think about particularly the S&P 500, there's certain ways that the S&P 500 is stretched. And I think about value stocks as being the anecdote for that. So let me give you some examples by what I mean by that. Certainly, one area of the market might be considered stretched would be valuations. If you look at the PE multiple, the S&P 500, it's not at its all-time high, but pretty close -
Oscar Pulido: And Tony, when you say PE ratio, you're basically talking about the price to earnings ratio, which is a way of valuing companies or stock markets and getting a sense of whether they're cheap or not.
Tony DeSpirito: Exactly. And so, value stocks are definitely an anecdote to that. Now, you might say, value stocks are always an anecdote to that. But what's interesting in the market today is the valuation spread. So, value stocks always traded discount to average stocks.
That discount today happens to be particularly wide relative to historical averages. Another anecdote is concentration, right? I think there's been a lot of ink spilled about how concentrated the S&P 500’s become. For example, if you look at the top three stocks in the S&P 500, they now make up 20% of the index. That's a record.
If you look at the Russell 1000 Value index, which is a commonly used large cap value index in the us. the top three stocks in that index make up only 8%, and that's actually off of all-time lows, by the way. and similarly, if you look at, industry concentration or sector concentration, on a reported basis, the S&P 500 is 32% tech.
I think that actually understates the real exposure of technology. If you look over the last, a little less than a decade, the index providers have been reclassifying companies away from technology to other sectors. For example, Amazon has been reclassified from tech to consumer, discretionary, meta, and alphabet from tech to communication services, PayPal, from tech to financial services, et cetera.
And there's a list of them. If you take all those stocks that have been reclassified away from tech and added them back to the index in tech, the tech weight would be closer to 45%. I don't know that there's anything necessarily to be concerned about, but certainly from a diversification perspective, you can see how value stocks would really add diversification.
Where the tech weighting is much lower, and actually the largest sector there is more like 23%, which is financials, by the way. And then finally, if you think about trying to balance your portfolio and you put 50% growth and 50% value, the growth stocks have gone up more over the last two years, and therefore your portfolio has gotten out of alignment with your original setting.
So I think there's an opportunity there just to get back into balance. And even if you own a core index, say you own the S&P 500, even that index has become more growthy recently. So, we use our risk models to classify companies into growth, value and core. And when we do that, the weight of the growth stocks in the S&P 500 has gone way up and the weight of the value stocks have gone way down.
Again, suggesting an opportunity for investors to get back into balance, which I think is just prudence. And you might knee jerk reaction think, oh, the best way to do that is just buy an index. But look at the Russell 1000 value index, even that has gotten, I wouldn't say it's gotten more growthy, but it's certainly gotten more core than it's been historically. So, if you want to get back into balance, you really need to look to an active value manager that is stuck to a value discipline.
Oscar Pulido: You talked about the concentration of technology. You mentioned a couple companies, and I can't help but think of the term, the magnificent seven. Which have been these top companies in the s and p that have dominated a lot of performance in recent years. do you think they're more stretched in terms of price? do you think all the good news is already priced in or how do you think about the performance of that very concentrated top of that index as you go into the new year?
Tony DeSpirito: Without a doubt, you're right. The Mag Seven has dominated performance of the S&P 500 over the last two years, and it's because of fundamentals.
Those stocks have outgrown the rest of the market by a wide margin. If you look in 2023, they outgrew the mag seven outgrew the rest of the S&P 500. That said, that gap has been shrinking. And in fact, if you look at expectations for next year, that gap in earnings growth should narrow to less than 10%.
So fundamentally, yes, they've been a lot stronger, but that gap is closing, yet the valuation gap is still really wide so I would expect the market to broaden out. Compare the first half of 2024 to the second half of 2024, you see in the first half returns were really dominated by the mag seven. In the second half it was more equal and I would expect that to continue going forward. So, I do see a broadening of the opportunity set.
Oscar Pulido: Tony, we've been talking a lot about the equity market and the stock market in a very positive light, strong returns, the fundamentals, the opportunities and value stocks. But presumably as chief investment officer, you also have to think about what are the risks out there and what could go wrong. So, what are some of the challenges that you think equities could face, this year?
Tony DeSpirito: There's a long list actually, and don't get me wrong, there's always a long list. In fact, that's what markets generally do is climb that wall of worry. And we've talked a lot about a number of those things, including immigration policy and tariffs, which we mentioned could be inflationary, so there are a number of ways in which markets, could appear to be stretched.
We've talked a little bit about government deficits and what that could mean for rates and what that could mean, for markets. So, I do think, that's a risk. With respect to AI. We haven't talked about this, but there's always a risk of a digestion period or an AI pause, and that would have real, implications for the market, inflation, the potential for that to return, right?
There's a number of things that we're looking out for. I would add to that list geopolitics, it seems like the world's getting more dangerous and not less dangerous. So these are all things that we have to consider as investors. And my advice to investors, and I think if you look at the long history of wealth creation and generation, it's been by staying invested. So, I think that's important recognize the risks, do what you can to protect your portfolio from those risks, but stay invested.
Oscar Pulido: And Tony, every time that you and I have spoken, I always am impressed by the long history that you've had as a stock market investor and all the sort of fun facts you have about, historical market performance.
You shared with us even at the very beginning, just how rare it is for stock markets to be doing as well as they did the last couple years. But it is a new year, and this is often a time of reflection. perhaps any closing thoughts or any words of wisdom that, that you want investors to think about?
Tony DeSpirito: I think given where we've been with markets, having had markets that are so strong, the words of wisdoms are really about staying prudent and a reminder that it's really slow and steady that wins the race. Certainly, we've had a really strong bull market for the last two years, and when you have bull markets like that, I.
It's easy to have a fear of missing out because without a doubt it's always the riskiest investments that do the best. And so, my advice is to fight that impulse to chase things. but to stay the course and to stay prudent, stay invested, but do so in that, very sensible, prudent way. Focus on the long term, I think also been a message that you've shared with us in the past.
Oscar Pulido: Tony, thank you for sharing your outlook with us and we'll have you back at some point to see whether in fact, the US equity market continues on this, string of, strong performance. But good luck this year and thank you for joining us on the bid.
Tony DeSpirito: Thank you, Oscar pleasure.
Oscar Pulido: Thanks for listening to this episode of The Bid. Next week we'll discuss infrastructure, a critical theme for 2025. Jay Jacobs will provide insights into the demographic trends influencing the housing market, the reshoring of manufacturing, and the bipartisan support for these developments.
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