Cornerstone Macro's Trahan: Why the U.S. bull market can go the distance

After conquering issues with consumer leverage and the budget deficit, the U.S. economy is shining while the world grapples with structural issues, according to Francois Trahan, founding partner of Cornerstone Macro. But what risks lie ahead?

[MUSIC] This week on WealthTrack a recent American citizen is also a patriot on the U.S. markets. Cornerstone Macro's top ranked investment strategist Francois Trahan explains why the U.S. bull market can go the distance, next on Consuelo Mack WealthTrack. [MUSIC] Well because the elements that have supported the rally are still in place. We're one of the few countries in the world that have addressed our structural issues. If you think about the litany of things that people complained about five years ago. Consumer leverage. We've come a long way. We had a big budget deficit problem. The sequester got rid of that. We're now starring at a two percent deficit to GDP ratio. We had, we have zero percent Fed funds rate. But I think the process of unwinding is already in place. And we have an under investment cycle in the US. We're starting to see a capx cycle which is very labor intensive. And so, the rest of the world is dealing with structural issues. Ours are largely behind this. But I would argue that the world's problems are also America's opportunity. Europe's issues is having an impact on US interest rates. It is artificially depressing US interest rates, helping the consumer. China's issues is having an impact on commodity prices. We have oil at $90 today, also helping the U.S. consumer. Which is low, right? Which is low. Right. [CROSSTALK] It's down from $108. Right. You know, little over six months ago. And so it's an incredible backdrop. And you have a U.S. dollar that is now rallying. People are, you know I, I keep encountering people that believe the U.S. dollar is about to melt. Right. The reality is. Everybody else's problems is lifting the US dollars. If we did nothing in the US the dollar would go up. Just because of Europe's problems, of Japan's problems, of China's problems, of everybody else's problems. And a rising dollar means rising PEs. And so I would argue that the, the elements that have been in place now for a few years are still very much intact. The market's not as cheap as it as. You know and so i'm not delusional. The PE of 16 is different than a PE of 11. Right. But you know, P of 16 is where we were in 1996 when chairman Greenspan made his famous irrational exuberance speech. And if he got out of the market then, you missed the best four years of equities in the last century. And so to me, you know this might be the cheapest market we see for the last five years. Marker will be expensive when the story starts to change and right now I think it's still just beginning. What are the risks to your scenario? Well the risks are misperceived first off- Mm Hm. On the part of the street. If you remember a year and a half ago. The sequester was gonna be the end of the world. Everybody thought it was gonna be the end of the world. And people didn't appreciate that when you take the deficit from negative eight to negative two. US dollar goes up. Dollar goes up, PEs expand. The sequesters are one of the reasons why the market went up as much as it did last year. It was incredibly bullish. It wasn't perceived that way. I would argue Fed tampering is the exact same thing. I don't understand this fear of tampering. If you remember a year ago, on the day the Fed was expected to taper, the S&P; was sitting at an all time high. If tapering was bad, I assure you the market would have been down. The reality is when the Fed moves towards less accommodative conditions and the rest of the world does the opposite, the dollar goes up. The dollar goes up, P's expand. And so the Fed is not your enemy here. The Fed is your friend. In a P driven world, more often than not the market does great in a Fed tightening cycle. The risk, in my opinion, is that Europe gets its act together, and that rates start to go up, or that China finds some sort of stimulus, gets investments going again. It's hard for me to see how this happens, but, you know, it's always possible. And that all of a sudden commodity prices start to rise again that to me is the probably the biggest risk for the US right now. I don't know what you're forecasting you know S&P; earnings are gonna be at Cornerstone Macro. What will drive the, the PE expansion if in fact your earnings don't. Grow or don't expand that much. Well, what gross earnings is economic growth. For small cap indices, economic growth in the US is a great proxy for small cap earnings. Obviously for an index like the DOW or the S&P500;, where 40-50% of your top line comes from abroad. US earnings will carry you, you know a certain way. Only so far. But, only so far, you're going to have a drag from what's happening in the rest of the world. So for an index like the S&P; 500, it's hard to see how you're going to see double digit earnings growth, no matter how strong the US is. Because of these drags from overseas. For small caps, last year we got 14% earnings growth on small caps in the US. And so I think it is still an incredibly you know, amazing opportunity. That's a contrarian call, because everyone else is saying, forget small caps. Obviously the Russell has peaked, and has, is corrected, has corrected. What, what is your view on, on the small cap. Outlook. I think there was a big element throwing a wrench in the size trade this year. Interest rates came down. Normally in an economic recovery in the US, interest rates go up. Yes. But because of this bond yield conundrum, because, I would argue, of what's happening in Europe dragging down rates around the world. Well, lower rates tends to benefit the companies that have the most debt. They happen to be the large caps. And so if this had been a normal year small caps would, would have outperformed no doubt. I would argue this bond yield conundrum has really helped the large caps significantly. One of the contrarian calls as well that you're making at Cornerstone Macro, and we talked to Nancy Lazar your parter and the head of the economic team about it last week. Is the fact that you all think that multinationals are not gonna do well, and therefore you're actually as a strategic recommendation are saying that we should sell multinationals. Why the top quality companies that pay dividends, that everybody's been flocking to, why are they vulnerable? Well, quality is where earning's growth is going to be. Being diversified globally used to be a good thing but when the world decouples, all of a sudden it goes from being a tailwind to a headwind. And so I would argue the best growth you're going to find is US centric investments and there are some large cap companies that are US centric. Obviously the lower you go on a capitalization scale, the better you are going to do. So again, this year, the multinationals, the large caps, were, were helped by this bond yield conundrum. And obviously won't last forever. You know, at some point I think the small caps are gonna really. If you're able to look out over the last several years, not just the next several months or quarters, I think you're gonna win out with, with U.S. small caps. [MUSIC]

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