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Podcasts from Confluence Investment Management LLC, featuring the periodic Confluence of Ideas series, two bi-weekly series: the Asset Allocation Bi-Weekly and the Bi-Weekly Geopolitical Report (new episodes posted on alternating Mondays), and a new monthly Q&A format called the Confluence Mailbag.
Hello, and welcome to the twelfth episode of the Confluence Mailbag Podcast. I'm Bill O'Grady, advisory director at Confluence Investment Management. Joining me today is Mark Keller, CEO and CIO of Confluence. We're recording this podcast on September 15. The idea behind this podcast is to replicate the question and answer sessions that Mark and I participated in for the past twenty five years.
Bill O'Grady:To submit questions, email us at mailbag@Confluenceim.com. Each month, we select four or five of the most common, provocative, and interesting questions we receive. Mark and I will address them. So without further ado, let's tackle question number one. So how will rising interest rates affect the bond and stock markets?
Bill O'Grady:Well, you've seen a lot of attention in the media, especially the financial media over interest rates. And, you know, 5% has become on the ten year treasury has become sort of a line in the sand, not just for this administration, but for the prior one. Remind listeners that in 2023, Powell and Yellen took steps to try to prevent the ten year from staying above 5%, and they were generally pretty successful. The Treasury reduced its borrowings in the long duration part of the yield curve. The Fed, which had been in a tightening cycle, signaled that its tightening cycle was over, some thought prematurely.
Bill O'Grady:And lately, we've seen Treasury Secretary Bessent, you know, looking like he's clearly concerned about 5% too. We honestly don't know why 5% seems to have captured the imagination of the last two administrations, probably partly due to round number issues, but it clearly has had an effect. And it's making people nervous. Very prominent commentators and hedge fund managers are burning lots of electrons to discuss the issue. So with with this question, I thought we'd try to step back a little bit, take a couple of ideas that investors can, can think about.
Bill O'Grady:Mark and I have always told people that you should worry about what's going on in the markets, but the trick is to worry about the right things. And too often, there's concerns about things that are just not that important, and that's what we kinda wanna do here. So I'll I'll start with bonds. Kind of intro to bonds, bond prices and their yields move inversely. So when the price of a bond is falling, its yield is rising.
Bill O'Grady:What has got people concerned about the Treasury market is really the the size of of The US debt. It's currently above a 100% of GDP. The last time we had debt at this level was, due to the spending during World War two. You'll hear people say, oh, this is the highest peacetime deficit in history. My retort to that is define peacetime.
Bill O'Grady:I think we're in a war of sorts. So in in that regard, you know, taking on more debt makes sense. The issue is is are you spending that money to actually defend yourself? And thus far, it looks like we're spending the money mostly on Social Security and Medicare with a rising percentage of interest payments. So the government has an incentive to keep interest rates suppressed to reduce its borrowing costs.
Bill O'Grady:Now, obviously, there are other things the government could do to reduce its borrowing costs, like borrow less money. And that could be done either by raising taxes or by cutting spending or some combination of the two. The the problem with the federal budget now is that so much of it is entitlements and interest that there really isn't a whole lot left to cut outside of it. And we all find our hobby horse of, well, this department should be eliminated or that department should be eliminated. But if you look at the actual spending, even if you did, it wouldn't matter a whole lot.
Bill O'Grady:Social Security reform is something that probably needs to be done. And again, the essence of politics is to who do you assign the benefits and the cost to. That's it in a nutshell. We can't have them come up with a politically expedient way of doing that, So we keep kind of plotting along. The bond market is starting to tell us, you're gonna have to figure this out.
Mark Keller:The search for an austerity constituency in Washington, DC is a futile one. There seems to be no one who's in favor of any sort of austerity on either party. And I think that's one of the things that's spooking the bond market as much as anything. They're just like, who and when? And the answer is, well, not now.
Mark Keller:And that's yeah. And to be
Bill O'Grady:fair, when Volker did his austerity in the late seventies, early eighties, you can just tell by the market reaction nobody expected that one either. You know, you don't get a rally that we saw in the dollar without everybody being on the wrong side of the trade. And, you know, one of the anecdotes I always like to remind people is six days before Volker unveiled his Sunday night massacre where he stopped targeting interest rates and started targeting the money supply. One of his predecessors, Arthur Burns, delivered a paper in Eastern Europe saying that there was no possible way that any central bank would be able to ever implement austerity. So it it was unexpected when it happened.
Bill O'Grady:And it's possible we're going to get that again. But I will tell you, things probably have to get a lot worse before that happens.
Mark Keller:I would agree. We we we both were young men at the time that the seventies were going on, and it it just didn't seem like there was it it was like today. There was really a lot of talk, but no constituency for austerity. And it it did shock everyone. And I hate to say it, but I think it's going to be a while before we see that austerity.
Bill O'Grady:So one of the things I wanted to touch on with this question too that I think is going to be interesting to watch, there's a lot of people out there saying, Hey, if the Fed raises rates, everything's gonna rally. And I don't know. I've been around long enough to look and say, gee, I wonder how often that happens. Not very often.
Mark Keller:A quarter point, that's not austerity. Know, I mean, 50 basis points is not austerity. Yeah. And that's that's the thing. You could get a little rally.
Mark Keller:Hey, the Fed knows there's a problem, but it isn't gonna last.
Bill O'Grady:My hunch is you should fade it.
Mark Keller:Yeah. Yeah.
Bill O'Grady:So what about equities with this?
Mark Keller:Well, you know, equities generally don't like high inflation, and they don't like high interest rates for a couple of reasons. There's a huge swath of the market cap whose customers depend on financing options. The whole housing industry is probably the best case there. But any big ticket consumer durable need, you know, does better when interest rates are low. That's hard to, you know, you you know, when you get in a high interest rate environment, those kind of companies, and that's a huge bunch of market cap, and I'm not just talking about housing here, talking about all kinds of stuff.
Mark Keller:You know, inflation, higher inflation, higher interest rates mean, yes, their customers are pressured, but also their own cost structures are pressured. So there's kind of a double whammy on a big chunk of the market when both inflation and interest rates are going up. And again, what we saw during the 70s was that interest rates in policymakers are always behind the curve there. They're they're reacting. They're not fighting.
Mark Keller:But generally, rising inflation and interest rates put downward pressure on the PE multiple. Now, I want to talk a little bit about duration. We're used to talking about duration in the bond market, interest rates hit long duration assets harder than they do short duration assets. That's kind of math. That's just math.
Mark Keller:But but there's a there's a sense of duration in stocks as well. A defensive stock with a high dividend, whether it's a food company or utility, if the dividend is that is, you know, is a shorter duration asset. In other words, you're getting more of your cash return to you upfront versus a long duration stock would be a growth stock, something a very high PE and no dividend because people expect long term growth. They expect growth out there. You're going to get your payback down the road, it's going to be big.
Mark Keller:Those stocks tend to get hit the hardest in the long run. But there's an exception to that. We're actually living in that exception right now. And that is when excitement about those growth stocks is really, really high, it can overwhelm what's going on in the interest rate world. That was just, you know, if you think you're gonna make, you know, thirty, forty, 50% a year in some AI stock, what do you care if interest rates go from 5% to 6%?
Mark Keller:Doesn't make any difference because your your your sentiment level is just so high. When that rolls over, however, and usually for some reason other than interest rates, then all of a sudden, now that long duration stock starts being pressured by the interest rate environment, and we're we're not there yet. We're not
Bill O'Grady:there. I think that's the nature of it. Let's move on to question number two. The war in The Middle East continues. What do you expect from here?
Bill O'Grady:Well, first off, I didn't expect we'd be here now. Still talking about it. I think a lot of people in Washington feel the same way. There was some New York Times reporting last weekend that radical elements of the Iranian Revolutionary Guard Corps have gained control of the government and of the war, and I get a lot of evidence to to support that. I think if you look at the MOU that the two parties looked like they'd agreed to, it was I mean, I've John Meersheimer referred to it as an American surrender document.
Bill O'Grady:He may be a little out there on that, but it was heavily favorable to the Iranians, and it still wasn't good enough for the elements of the Republican Guard that have taken control. When you do a decapitation strategy, this is the risk that you run. The idea of removing the leadership is that the leaders underneath them are not capable of managing their government and things fall apart. Or you hope like you had like what you had in Venezuela, where it really had the same crew still running the place, absent Maduro. But they don't wanna have the same treatment, so they they go along with you.
Bill O'Grady:And I think that's what the Trump administration was hoping for, and it just didn't work out that way. Instead, what we've done is we've cleared out the older heads, and we've replaced them with the firebrands, and the firebrands are dominating. It's pretty clear they wanna escalate. And then so this makes I mean, to some extent, we're not even sure who we're negotiating with at this. And that's really hard because you go to the government as it exists, and you think you have a deal, and then you don't.
Bill O'Grady:And so if you look at the behaviors that we're seeing, we're kind of in this extended stalemate where the Iranians are steadily expanding the conflict. The Houthis have now pretty much able to significantly affect Red Sea shipping, which was one of the key relief valves to prevent oil prices from going up. There's also been attacks coming from elements that the IRCG runs in in Iraq. So this is this is this war is expanding, and it's making it more difficult to contain it. Frankly, I I don't see an obvious end in sight.
Bill O'Grady:Now it's pretty clear that the Iranian economy is suffering greatly. In fact, you could argue that it's probably not functioning. Is that going to be enough to get the guys running the place to back down? The other element of this that gives me great concern is that supposedly the new Supreme Leader is the son of the Ayatollah Khomeini. No one's seen the guy.
Bill O'Grady:It's rumored that he was severely harmed during the killing of his father. It's possible that he's not making any decisions. And so don't really know who's in charge. We don't know who's in charge. You don't know how to manage this.
Bill O'Grady:On the other side of this, China still has the ability to cap prices. And right now, we're seeing a lift in prices. Some of this is because China's replenishing its product inventories, and they're boosting demand temporarily. I don't think it's gonna last very long, but it's even having an effect here. You know?
Bill O'Grady:You're starting to see $6 prints a gallon on diesel, out on the highways. Not enough to put The US economy into recession, enough to make people mad. But the bottom line here is is that there's really not an obvious end in sight. And that doesn't necessarily mean we're gonna have $150 oil, but it does mean oil prices remain elevated.
Mark Keller:I was over in Europe a few weeks ago, and everywhere I was in five different countries, I never saw a gas station with less than €2 per liter, which works out. Mostly. I probably average is about €215 per liter, which works out to about $10 a gallon. And yeah, not a lot of happy people are the ones, at least the ones who have to drive to work. Of course, they're much more diesel dependent than we are.
Bill O'Grady:Yes, They are.
Mark Keller:As you well know, the residual fuels like like diesel are are really starting to tighten up.
Bill O'Grady:And an element of that too is the Ukrainian attacks on Russian refineries. They have played a role in this as well. So oil prices for the most part have stayed pretty calm. On the other hand, if you look at the current price of diesel, that's pretty much equivalent to $150 $160 barrel crude under normal circumstances. So we're kind of there in terms
Mark Keller:of product. Are in terms of product. I continue to think that, as you point out, there's really no clear exit here. We don't know how long this is going to last. I continue to think energy stocks are still your best hedge against things getting worse because oil prices, thanks to, you know, inventory management in China, are not really as high as we expected.
Mark Keller:And the fact that multiples are still pretty low in that sector. You know, it kind of moved up with the pricing, but there's really been no, what I'll call moonshot in that sector at all. I think it's a really good hedge, particularly oil and the refiners, but also LNG plays, even coal and natural gas plays. But I I think I think it's an important hedge in in in a portfolio right now. And at worst case, it all goes gets peaceful and then next, you know, few months, and and maybe you lose 10 to 20%.
Mark Keller:That's about the worst. But the the it's a it's an asymmetrical risk reward right now because the upside could be substantial, and you don't need the the situation necessarily to get worse. You just need people to run out of crude and product. Right. And then you start getting to scramble.
Bill O'Grady:Yeah. In some respects, it's an unusual situation. Geopolitical events in energy usually have a huge price spike in crude oil, and then the prices roll over. In fact, the adage has always been the best money is made fading the rally. This one's a little different because the Chinese capped it, and it turns out that your best hedge is not owning the commodity.
Bill O'Grady:It's been owning the stocks. Mhmm. And that's because the stocks actually flourish without the big spike in price because the big spike in price attracts attention. You get talks of windfall profit taxes. You get demand destruction.
Bill O'Grady:But the secondary effects of all this, I think, is going to be for most countries because I guess, in my long term view, this is the ramifications of a fading hedgeman. And if you're a middle country in Asia or in Europe, you're starting to look at this and say, well, I need every type of energy I can get my hands on, nuclear, solar, coal, biomass, whatever, because you need diversification. I mean, this is a theme that we have been harping on for a long time that as the world becomes more unstable, security trumps efficiency. So even the secondary stocks, uranium stocks, coal stocks, clean energy stocks, all should benefit.
Mark Keller:And it also trumps your desires to have completely clean energy
Bill O'Grady:Oh, sure.
Mark Keller:Too. You know, mean, as as Germany is discovering. Right. Clean energy has, you know, if one, it doesn't produce carbon dioxide, good for it, but it's intermittent and in too high quantities can produce instability an electric grid.
Bill O'Grady:Destabilizes the
Mark Keller:Yeah. It destabilizes the grid. And if you've cut off your hydrocarbon sources or in Germany's case, even their nuclear sources of energy, you're in kind of a bad way. Europe right now, especially Central Europe, is just praying that we have a warm winter.
Bill O'Grady:Yeah. Fortunately for them, this is an El Nino winter. Yes. Probably
Mark Keller:El Nino came along in the nick of time.
Bill O'Grady:Probably gonna end up saving us all. It'll be bad if you grow grain in South America, but other than that, large swaths are going to be really in good shape.
Mark Keller:But you said it. The all of the above energy strategies are what's needed, and I think every country should be getting that message right now.
Bill O'Grady:China is the poster child for this. They are a huge consumer of coal and a huge producer of solar panels and windmills. You know? And what they figured out is that it's not the energy that matters, it's the security that matters. You know?
Bill O'Grady:If I can secure this with my own border or with a friendly power, that's what you need to do. And this is what puts Europe in such a difficult spot because they have no secure nor friendly powers around them. And every place they get energy from has some degree of geopolitical risk.
Mark Keller:Absolutely. Absolutely.
Bill O'Grady:The third question, the gold. Oh, yes. What are your thoughts on gold in particular and precious metals in general? Gold in the short run has been trading opposite of oil, which is a little weird. Very weird.
Bill O'Grady:Yeah. And I attribute this to the fact that gold is becoming a reserve asset. A cursory glance of history tells you that for most of the past three hundred years, gold was the primary reserve asset. We have been living in a world, especially since 1971, but especially since 1980, where a sovereign debt instrument has become the primary reserve asset. What do you want of your reserve asset?
Bill O'Grady:When things get bad, I can convert that into stuff I need. That's what a reserve asset does. And as more and more countries have become concerned about the stability of US Treasuries, they've now migrated to gold. But the issue is, for the past forty years, if a central bank or a reserve authority bought gold, we all just kind of assumed that gold is off the market, and that's because it was. That's not true anymore.
Bill O'Grady:As countries need to get liquid to buy key things like fertilizer and grain and oil and LNG, they're using gold to pay for it, and this is putting pressure on gold. This is just going to be a fact of life going forward. We're we're going to have more volatile gold prices. At the same time, there doesn't seem to be anything at this juncture to that makes me think that, number one, that there's an alternative to gold or treasuries. I mean, look, there always might be.
Bill O'Grady:One of the things I've been kind of wondering about is, are we going to see foreign countries decide to draw their own US Equities rather than US treasuries as reserve asset. And that, you know, if you said that twenty years ago, people would have looked at you like you had screws loose. But with the advent of indexing, we've created this unusual situation where you can trade huge blocks of stock pretty quickly. And so remember, the whole point from a reserve manager's view is, I take this asset and convert it into liquidity quickly? Stocks are starting to actually be able to do that, especially in developed markets and without question in The United States.
Bill O'Grady:So that's a possibility.
Mark Keller:Yeah. It's a possibility. Twenty years ago, you're right. I would have said you're crazy. Yeah.
Bill O'Grady:Well, you were.
Mark Keller:Well, I and I was saying that, but that was that's that's besides the point. Yeah. That's that's nothing to do with this subject. The the but the Swiss National Bank is the only central bank in the world that's really been executing on that strategy. Yep.
Mark Keller:Yeah. I mean, should own tons and tons of US stocks. And, you know, may maybe that's something that could happen. But you start searching around for debt instruments that could replace treasuries. You know, what are you gonna buy?
Mark Keller:JGBs? You know? I mean, Japanese bonds are are and one is they don't pay a lot. And two, they're falling like a rock because interest rates are going up, finally going up over there. And in Europe, you can't choose.
Mark Keller:I mean, that's the only thing I could imagine. And it would be risky as if the as if the Chinese government decided to start selling their Yes. Federal debt to the rest of the world.
Bill O'Grady:The the problem for China, if they did that, was they'd start running trade deficits. Yeah. Yeah. And, you know, the the Chinese aren't stupid. They've seen what we did, and it's like,
Mark Keller:I don't think I wanna do that. I I so I don't expect that. So I think gold still sits in a really good situation as reserve asset. You're right. People are gonna sell it, especially when it doubles over a few years like it has recently.
Mark Keller:And, you know, you need you need arms or you need grain. Yeah. You can you can tap your gold reserves, but it looks to me like we're kind of migrating back to the future, so to speak, back to the old days.
Bill O'Grady:Well, here's another way of thinking about it. We, for years, have bought gold as a geopolitical hedge. Probably don't wanna do that anymore. When things get calm, gold prices are going to go up.
Mark Keller:Yep. Yep. That's that's backwards from what we've been trained to That that that's really
Bill O'Grady:a responder. Yeah. And it and it's because we're actually using it as a reserve asset as opposed to like a a secondary reserve asset, which we've done since '71. And you gotta think about this differently.
Mark Keller:Yeah. Well, I'll I'll introduce another aspect of gold. It's and that's to look at The US policies, particularly nonmonetary policies right now are are you know, they're dollar bearish. And and that's to be expected if
Bill O'Grady:Right.
Mark Keller:Your administration wants to make US manufacturing more competitive. Right? Right. I mean, that's what you want.
Bill O'Grady:That's it.
Mark Keller:You want dollar. Okay. How do you how do you play that from an investor's point of view? Well, gold is one of your best means. I mean, non US assets and commodity, like international stocks are also a good way to play it.
Mark Keller:Many commodities, not necessarily all, but many commodities are a good way to play dollar bearishness. But but gold is kind of an old reliable in that regard. It's a currency of sorts.
Bill O'Grady:Well, it's the old weight to value issue. Yeah. Right. Bob Friedland was on Odd Lots. Great, great interview.
Bill O'Grady:Tracy and Joe do a great job in their podcast. That's why it's one of the most popular ones in the PodSphere, but he was on he's he's always a blast.
Mark Keller:He is one of the I I missed that. I'm gonna have to look that up right away. He's one of the best for those of you who don't know about Friedland, he is the CEO and founder of Ivanhoe Minerals, which is a copper producer. And he is probably he's the evangelist of Oh, yeah. Of of of the copper bull market.
Bill O'Grady:Yeah. Yeah. Well, you listen to him and you wanna sell your firstborn for copper, you know.
Mark Keller:Yes. Yes. He's very effective. Sorry about that, Dennis. But but he's he's very effective.
Mark Keller:And so your his was was there anything new he brought up in that interview that
Bill O'Grady:Well, he just he just makes the case that, you know, we need a lot of copper to do what we wanna do. We we have an aversion to mining it anywhere in the first world. We're seeing yields grades continue to deteriorate, which means that you have to mine a lot more rocks to get us ever smaller amount of copper. But the other thing you pointed out, which I think gets lost a lot, is the best copper deposits seem to be in places where there's no water. And you need about, I think you said, two tons of water for every one ton of rock that you process.
Bill O'Grady:You know, to do the one in Chile, they're having to pipe desalinated water from the Pacific, up 12,000 feet. I mean, it's you know, as we've developed, as societies in the developed world, we've gotten further and further away from how stuff actually gets produced. And it's one of the great things about life in the developed world is you never have to get your hands dirty. We're kind of getting to the point where we're not going be able to do that anymore.
Mark Keller:Oh, and there are a lot of great copper deposits in the first world. Mhmm. And we just won't dig them up Yeah. Because
Bill O'Grady:Well, he spent a lot of time talking about the resolution mind. I think it's twenty five years they've been trying
Mark Keller:to
Bill O'Grady:get
Mark Keller:that permanently. Out in the Arizona Deserts speaking of the water. You know? And but, yeah, Arizona is one of the great copper locations in the world. Yep.
Mark Keller:But we stopped mining it decades ago, and now we're trying to again. But, yeah, again, Western world just doesn't wanna destroy the landscape, don't don't wanna
Bill O'Grady:There's always somebody opposed to it. Yeah. The other thing I'll I'll mention on that podcast is also his main business is copper, but he's also very big into geothermal. Yeah. Mhmm.
Bill O'Grady:And he's he's doing stuff on that too, which which is pretty fun.
Mark Keller:Geothermal's we can get off on that, but I did wanna say something about copper and and go yeah. One is I don't think anybody listening to this is gonna go out and buy a ton of copper and bury it in you know, under their basement. It's just, you know, the value
Bill O'Grady:Weight to value.
Mark Keller:Weight to value is just too high. So you need to own copper stocks. That's the way to do it. And frankly, with gold, however, you can own the metal and you can own the stocks. And during the early years of this rally in gold, it really really got started in '22.
Mark Keller:The metal outperformed stocks pretty handily, but stocks started catching up after a couple years, and now they're actually doing better.
Bill O'Grady:Yeah.
Mark Keller:And one of the reasons for that is the price of gold has been somewhat stable in the, let's call it, 3,900 to $4,400 per troy ounce range. And that's a price at which just about every company in the world makes a lot of money. Yeah. And they don't need it to go up a lot No. From here.
Mark Keller:I mean, it just goes sideways for a few years before it goes
Bill O'Grady:up there. Do fine.
Mark Keller:And they are we're seeing a lot better capital allocation in the sector. Much like in the energy sector, gold mining companies, shareholders really held management's feet to the fire, and the gold mining companies are just managing their their financial structure and capital allocation well much better than they used to. And so, yeah, gold stocks acting well and I think continue to be a good play.
Bill O'Grady:Last question. So we've been watching the broad equity indices, let's say, the S and P 500. And we're kind of in a time of the year where markets usually stall. September's not usually a good month for stocks. We're also in the mid year or the midterm year.
Bill O'Grady:This is the time of the year in the midterm year where stocks usually lag After Labor Day, the average person starts paying attention to politics, and you start saying, Oh my gosh, we're going to get change in government, all that. So it's not uncommon at all for stocks to stall here. But one of these days, are going to see a broader market decline. And defensive sectors are a place where people go when they start looking for places to remain in the stock market, but have less exposure to what is you know, like the growthier parts of the market. So of the defensive sectors, first off, let our can tell our listeners what you'd characterize as the defensive sectors and Yeah.
Bill O'Grady:What do you like? What do
Mark Keller:you Defensive sectors. Defensive sectors kinda have two qualities. One is they tend to not be as economically sensitive as some other parts of the economy. That's why they're called defensives. Kind of a classic defensive is is a utility company, for instance.
Mark Keller:You know, you you pay your utility bill as long as you own the house, really. And and the other thing they they kind of defines defensives is whatever's hot for the day, they're usually out of that stream. Okay. And it's easy to know what's hot today. And we're we're in the big we're in the biggest capital spending cycle that any of us have ever seen.
Bill O'Grady:Right.
Mark Keller:And it's powering the AI trade. It's as big, perhaps bigger. I listened to a guy the other day who's arguing to me that it's this is bigger than the railroad. It's big.
Bill O'Grady:It's it's bigger than the railroad. It's probably not quite as big as the canal boom. Okay. But but and this is all the issue with this, you always have to scale it. What you pick for your scaling variable is critical.
Bill O'Grady:But just compared to GDP, we're we're doing Erie we're doing the Erie Canal.
Mark Keller:Yeah. Yeah. It's it's remarkable. And and I wish I could remember as I was listening to an interview with a hedge fund manager a couple months ago, and he he had a very interesting just a way to categorize stocks. He says, you got the AI trade.
Mark Keller:The AI stocks. Companies are right in the middle. They're benefiting from all this capital spending and all that stuff. And then you got the AI disrupted companies. That is the companies who AI might crush.
Mark Keller:And we all know that for most of 2026, the software stocks have been hammered and many of them cut in half because people worry that they're going to go away. And then you've got the AI agnostic stocks. You know, these companies that AI may help in terms of their productivity and margins, but by and large, their daily business got nothing to do with with AI. You know, a guy who's like and a home builder, for instance, you know, AI isn't gonna build a home for you. Cool.
Mark Keller:Yeah. Yeah. Well well, maybe one day robots will be crawling over your house or putting roof on your house.
Bill O'Grady:Actually, you you joke about that, but I I would I built it just built up my first house. I've been giving advice to anyone who's ever done it. Don't do it.
Mark Keller:Don't do it. I would say congratulations. Sure. But I was
Bill O'Grady:talking the company that we work with has a mechanical roofer similar to like a Roomba. You put this thing on the roof and, you know, it can't do like the valleys and it can't do the ridges, but like the mass going across said it was astounding.
Mark Keller:That's pretty interesting. Pretty interesting. Well, getting back to this defensive issue, now, AI agnostic stocks are pretty defensive in my view. You know, there tend to be low valuations and low risk. But the classic defensive stocks would be, well, we mentioned utilities.
Mark Keller:They would also include consumer staples, food companies, beverage companies. You can't live without those things. Health care is defensive. You need health care when you need it, not when the economy is good necessarily. Some parts of the consumer durable space have become rather defensive, particularly apparel sorts of retail, you know, footwear, many sorts of retailers.
Mark Keller:I think the consumer durables also includes things that are very cyclical like housing. So that's kind of a mixed bag. Energy is generally considered a defensive category. The primary reason for that is you need energy, kind of like utilities. You need you need you know, if you if you fail to fill your gas tank up, you won't be going to work.
Mark Keller:There are some cyclical aspects to the energy business, but by and large, it's pretty defensive as well. Of these categories, probably the one that looks best to me, and I already talked about this, was energy. Even though it's up, fundamentals are strong, but valuations are still quite reasonable. But I would put healthcare right up with it. Healthcare is really out of favor for a long time.
Mark Keller:In the early stages of AI in particular, it's, you know, the only sector of healthcare that's really been hot have been the diet drugs, the weight loss drugs, which kind of came out of diabetes research. A handful of companies that are involved were there, but the rest of the health care sector has kind of been out of favor. But lately, money has been flowing back to this. In fact, and I won't say I won't call a top to the AI. I've run enough to know not to do that.
Mark Keller:There's still plenty of money going into that category. But you've probably noticed that the AI stocks have not been as strong recently. The mag seven is actually trailing the equal weighted S and P year to date. We're starting to see a lot of value stocks and value indices start to outperform growth industry. So I think the the AI trade is getting long in the tooth, and money managers are seeing this and active management starting to allocate to some other categories.
Mark Keller:Healthcare, which is also a favorite of the growth in growth managers is getting some love. I think valuations are still pretty. So I would put that right up there with energy is a real interesting category. I'm not terribly wild about utilities right now in parts because a lot of the particularly if you're an index buyer because a lot of the high a lot of the high market cap utilities actually get caught up in the AI trade because of the great demand that AI requires from the electric utility industry. And the rising interest rate environment to win right now, while it kinda hurts everybody, it particularly hurts utilities.
Mark Keller:Utilities, as a category of stocks, can't decide whether they're stocks or bonds. Their stocks sometimes, the AI trade, they were acting like growth stocks. And but but when interest rates start rising, sometimes they act like bonds because of their high yield. Staples fundamentals are just kind of flat there. They're cheap, but not my favorite group just because I think it's just going sideways at a cheap level, which is great.
Mark Keller:They say never sell a dull market, but I I would own some, but I I wouldn't be I wouldn't be overweighting them relative particularly to to energy and health care. I mentioned before the consumer durables can have some some cheap areas. You know, apparel and footwear aren't terribly expensive and some other discretionary and some retailers look kinda interesting. But if you're an index buyer, I would be careful because Amazon and Tesla are about a quarter of those two stocks alone of most of the most of the consumer discretionary ETFs. And so you you you've got some AI exposure there.
Mark Keller:So I I would also you know, I I would play some of the more defensive stocks within the consumer discretionary area, but as an index, I wouldn't I wouldn't go into it terribly strongly. Well, Mark, I
Bill O'Grady:think it's a pretty good place to close for today. As a reminder, if you want to submit a question, send one to mailbagconfluenceim dot com. Today's discussion is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.
Bill O'Grady:Our audio engineer is DaneStole.