Opinions Larry Berman CFA, CMT, CTAA Comment -- General Comments From an ExpertA CommentaryCOMMENTDec 01, 2025
Larry Berman CFA, CMT, CTAYou might be interested:
The message, loud and clear, in recent weeks of earnings is the market is becoming more selective. Companies that delivered that earnings that would have been exceptional a year ago, are now facing pressure--strong earnings are no longer enough, but also need to justify high valuations, sustainable profitable, and a tangible return on AI. That enthusiasm about AI has shifted to seeing returns on investment and cash flows. This is healthy for the broader market, happening during surprising resilient economic growth. However, there's rising inflation above the US's 2% target. She's looking at companies' underlying cash flow and watching the bond market. Overall, the market looks constructive and you don't need to be defensive.
Based on polls, it looks like Trump will lose the House which will turn him into a lame duck president, then he will default to more executive orders. Meanwhile, central banks will keep raising interest rates. Yesterday, Google got hit, so the market is asking who will pay for AI. Overall, he's trimming and pull back, including Google after more than doubling, energy and precious metal.
For new money, telcos (as well as REITs and other sectors) have been hit as interest rates keep rising. The telcos, though, have aleady cut dividends, so they are relatively defensive. Getting more income into your portfolio now makes sense. So these sectors act like a bond proxy, which are buys.
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The market expected today's Bank of Canada interest rate hike to 2.5%, given rising inflation fueled by rising energy prices from the U.S.-Iran war. It probably won't impact the TSX much because the index is heavily weighted in commodities and financials, which may actually benefit from higher rates. The hike follows the U.S. one. AI stocks are driving the market and there's a lack of market breadth. About half the S&P is tied to AI and data centres. But two-thirds of the S&P are trading below their 50-day moving average, mostly those not linked to AI, but that's where opportunities lie. He also likes energy.
The market is volatile. Everyday there is a sector or theme that works: one day AI works, the next AI isn't working, then it's energy or the hyperscalers, then not. We're all slaves to the algo trading and causes people to lose focus on long-term investing. He doesn't trade every two seconds; he focuses on the fundamentals, on quality businesses, over 3-5 years, companies that can grow EPS 10% annually and cash flow. He won't overpay for the enthusiasm for potential AI growth. He's attracted to niche US software and IT now, and the hyperscalers.
There's still room to run in global stocks in this rotation period, shifting away from U.S. tech, because investors are adding up the costs and returns in tech--and it isn't adding up. So, the shift has been to the opposite: energy, just energy thrived in the sluggish 70s. Washington: How lame duck is Trump? We'll likely see a Democrat Congress, though who knows what will happen to the Senate? Probably, we'll see gridlock, which markets like. Markets would be more bearish if things shifted entirely to the left, because of tax policy. Trump lowered corporate taxes, but there won't be tax changes for at least 6 months.
Anthropic IPO: Few surprises in today's prospectus and so far, so good. US Midterms: Historically, gridlock is good for stock markets, but what's different now is the colossal amount of US debt. Expect a shutdown in the first few months, but he hopes it won't be too disruptive. AI: Democratic states don't want new data centres in their backyard (NIMBY), which will force companies to adjust their building plans. This week, the Bank of Canada is expected to raise interest rate to keep pace with other central banks, given inflation. The world needs more housing supply and for wars to end.
Anthropic will IPO next month. Revenue growth per employee is far higher in the Mag 7 then the rest of the S&P 500, which has flatlined for the last 7 years. A chart of profit margins over that span is the same, with Mag 7 far outperforming the S&P 493. Anthropic touts AI is the most important tech to ever hit the planet given better productivity. Among the AI ETFs, AIQ is the passive way which outperforms when things are bad, but BAI outperforms when things are good. Both ETFs are the same now, and they both include SpaceX. Like SpaceX, he expects huge volatility from Anthropic, but buy the dips for a long-term hold.
It's a day-by-day thing: one day, tech rotates in, another day it rotates out. We haven't seen a full rotation though, because AI remains a dominant theme, but investors are asking when and what the returns will be, and when the capex spending will end. Who knows? Capex is massive, not since the railroads of the 1800s. He solds some Meta, Alphabet and Microsoft which he entered last spring. A lot of businesses are sitting on their hands, uncertain, like the car and steel sectors. We will feel this impact in the next few quarters.
Until very recently the market became very narrow, with only the largest of large-cap tech hanging in. As of this week, about 45% of companies in the S&P 500 are down more than 30%. With 60% down over 20%, 80% down over 10%.
The index has been looking pretty resilient, but there's a lot of weakness under the surface. Part of that has been from companies hurt by rising rates (defensive assets such as staples, utilities, etc). For companies that borrow fairly heavily, their borrowing costs have been going up.
In particular, the strength has been from companies generating lots of free cashflow and showing pretty steady dividend growth. Those have been his firm's focus.
Inflation Indicators
Last week we heard a whisper out of the White House that Kevin Hassett may be the next Chairman of the Fed. We don't know for sure, and he certainly hasn't been vetted yet.
You have a cooperative Chairman of the central bank. You have a Treasury Secretary who understands how commerce works. They're going to come together and manipulate the market in a midterm election year to keep a strong economy going however they can. Treasury might adjust the way funding's done. The Fed chair will be an active participant/leader in the next FOMC. We'll see how that goes.
From a market perspective, what it means to him is what is the market perception of inflation going forward? One of the best indicators out there is one that many Fed chairs have talked about. It's the 5-year, 5-year inflation swap.
The Federal Reserve economic database (FRED) is managed by the Federal Reserve Bank of St. Louis. It's on their website, and Larry's posted a link to it on today's blog. The 5-year, 5-year inflation swap is the expectation of what inflation will be over 5 years, 5 years from now. They look at market-based pricing to make this calculation.
Looking at that chart going back 5 years, you can see that long-term inflation expectations have relatively been contained. There have been periods of concern (such as Covid) when it seemed that it might be breaking out, but then it came back into the range.
Right now and recently, it's been trending down. And that's what's been supporting capital markets for the last number of months -- the thought that future inflation expectations are contained. If Hassett becomes head of the Fed, and if the indication of how they're going to fund deficits going forward is stimulative to the economy, we have to then be very concerned that longer-term inflation expectations rise and break out of this channel again. All the debt out there would really cost the US government a lot.
Scott Bessent said let's focus on the 10-year, let's make sure the cost of capital to the US taxpayer is as low as possible. They can't afford long-term inflation pressures to get an anchor. Which it would if Chairman Powell and the Federal Reserve were listening to President Trump and were cutting aggressively when the economy was running hot and didn't need it.
There's a debate going into the first half of next year. There's probably enough support for the Fed to cut in December. The worry is about their other mandate of full employment. Inflation and employment comprise the Fed's dual mandate. If you could tell him how that's going to play out in the next 6 months, he could tell you exactly what policy is going to be taken and almost exactly what capital markets are going to do. But we don't know.
If the long end of the curve comes unanchored, and we have to worry about that long-term debt funding, then that's bad for all capital markets across the board.
You can watch the 5-year, 5-year forward inflation return indicator online, and if it starts to move to the upside, anxiety levels will follow.