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TCW is a leading global asset management firm with over 50 years of investment experience and a broad range of products across fixed income, equities, emerging markets, and alternative investments. In each episode of TCW Investment Perspectives, professionals from the firm share their insights on global trends and events impacting markets and the investment landscape.
Welcome to the TCW Investment Perspectives Podcast, where
our investment professionals share their insights and
expertise on how to make the most of your portfolio.
I'm David Vick, Managing Director on the Fixed Income side at TCW.
Today, I'm going to mix it up a little bit and talk equities.
Joining me today are Michael Reilly, Chief Investment
Officer for the equity business here at TCW, and Valeria
Mendiola, one of our equity portfolio specialists.
It's only April, but U.S.
equity markets have been on quite the roller coaster
so far this year, and so far this month in particular.
In January, of course, the view of equity markets
was that earnings would still grow about 9% a year.
And even though the economy was expected to slow,
a soft landing was still widely anticipated.
Of course, now those expectations have been thrown into disarray after the U.S.
imposed much higher-than-expected tariffs on trading partners.
Corporate leadership teams are now reassessing their
business plans as a result of the economic uncertainty.
And not surprisingly, earnings estimates have come down a long way, with
some experts even expecting zero earnings per share growth this year.
So Michael and Valeria, thanks for joining me today.
And let's start with the macro perspective.
Michael, what's your view on the current environment?
What's it mean for growth and inflation from here?
Sure, Dave, I think before we even gauge the impact on growth and inflation,
I think it's important to take a step back and really give some context
to how we got here, and really what tariffs mean for the equity market.
The first thing I'd note is that we do think that
the most draconian announcements are behind us.
There's erratic policymaking, to be sure.
There are going to be some deals announced, there are going to be some
retaliations announced, there are going to be new 232 tariffs, etc.
And all of this does damage confidence, it undermines confidence.
But it's important to acknowledge that the uncertainty
is likely to persist, you know, as a starting point.
The other thing that's important here is to talk about the
transmission mechanisms for these tariffs, what gets impacted.
It's not just, you know, particular goods, it has
important impacts on capital flows, for sure.
The US has been of course, viewed as a safe haven.
And maybe now there's some perception of the US as a more volatile haven.
The other thing is that, you know, we've seen the gyrations
in the treasury market and the equity market, as of April
16th, down 14% from a peak, we saw at the end of February.
So certainly impacting capital flows.
Another important avenue is capital investment.
We're in earning season right now.
And companies are referencing the fact that until the landscape is more certain
and better defined with these tariffs, it's very difficult for them to go
ahead and commit to, okay, we're going to move forward
with this new factory or this new line of business.
So that's important to keep in mind that capital
investment is, in some respects, paralyzed.
And then supply chains themselves have been disrupted, obviously.
And for companies, that's a very difficult calculus, they have
to figure out, first, take a step back, about half of the goods
that are imported in the US are used to make something else.
So is there a domestic substitute?
And the price of this input hike, you know, this input
price hike, can that be passed along to the end consumer?
Is a business model just too fragile to absorb those price hikes?
So that's important in terms of supply chains.
And then finally, consumption.
And this gives us some clues with respect to GDP growth and inflation.
Consumption is going to suffer naturally, because this is a tax on consumption.
So there will be some demand destruction, there will be some substitution
going on, even for the high net worth individuals, and the high end
consumption that'll be impacted by the wealth effect in reverse.
So those are important considerations.
And maybe I can turn it over to you, Valeria, to talk
about where consensus GDP and inflation estimates stand.
Yeah, for sure.
That was a perfect segue for me, I think.
So, you know, when it comes to estimates for GDP growth and inflation,
the reality is that they keep changing and getting adjusted,
given this uncertainty that Michael just talked about, right.
So every policy decision and announcement is truly driving
economists to sharpen their pencils and recalibrate
potential implications on these macroeconomic variables.
So let me take a couple steps back to kind of remember where we were at the
beginning of the year, we started 2025, with estimates that the US economy would
be growing around 2% this year, which was only slightly lower than the growth we
have been seeing in recent years, if you exclude the COVID years, of course.
And so that said, we were starting to see some signs of the economy
cooling down, even before any of the tariffs were actually announced.
Then Liberation Day comes, and you can really see sell side estimates dropping
and more conversations about a potential recession right after that event.
And so let me use this last part to also talk about
inflation, the inflation part of the equation.
There is a lot of debate about whether tariffs could push prices up as a
one time event or for multiple periods, driving more sticky inflation.
And so in the end, I think inflation expectations are also
going to play a big role in this in how these ends up.
And so we were at a place where inflation in the US have
managed to come down a little bit from low 3% to high 2%.
And overall, we have seen consensus estimates around
inflation reaching 3.5% give and take due to tariffs.
But really, the challenging part of this is going to be
how the Fed will react to this environment with higher
inflation, but also lower prospects of economic growth.
So lots of moving pieces and some potential downside
for the broader economy and consumer consumption.
What are the implications for specific stocks for earnings going forward?
How do the uncertainty and the potential
downside impact how those develop going forward?
Sure, you know, our discipline is is very
much fundamental bottom up view of things.
And so our job as active managers, really to re underwrite every position
in the portfolio, and look at is the investment thesis impaired?
Is there an opportunity here?
Is this asset, you know, mispriced this particular stock.
And that's one of our jobs as active managers.
And it's one of our advantages as active
managers, we're able to go through that process.
The fact of the matter is over the long term, there is a strong
correlation between stock prices and corporate earnings growth.
And so we really do anchor to earnings, and earnings
estimates in the aggregate are being revised downward.
As you noted, the outset came into the year at
about the 9% level or so for EPS growth for 2025.
And it's a lagging and lagged process with those
estimates in the process of being revised downward.
Right now, Strategas is at around 4%,
Goldman Sachs is at around 3%, UBS is at 0%.
But importantly, we're in earning season
and companies are updating their guidance.
In some cases, they're pulling their guidance, but companies
are updating their their guidance, they're making specific
reference to tariffs, and these estimates are coming down.
So that's on the earning side of the equation.
And maybe Valeria, you could touch on valuations.
Yeah, I think one thing I would add is, you know, EPS growth is definitely
one of the metrics that we pay most attention to in the equity market.
And then one metric that investors are constantly looking
at as well, which is related to this is valuations, right?
So how expensive or how cheap the market looks, we ended 2024 with a
forward P/E multiple in the market of around 22 times forward earnings.
And so what we are currently seeing is, on the one hand, we have the
numerator P coming down a bit with the market being down this year.
But we also see the market discounting this lower EPS growth
expectations of market that Michael was talking about.
So the denominator of the P/E ratio.
And so in practice, we have seen these two variables moving
this year and combined valuations have actually come
down a little bit to around 20 times forward earnings.
And so it is, of course, very early to say that the market looks cheap and that
valuations are very attractive, but it is definitely one metric impacted by all
these movements in the market this year and these EPS
downgrades that are very important for investors.
All right, great.
So obviously, we're talking sort of broadly, but of course, tariffs
and things don't impact every company, every sector same and
given that we're a bottom up shop, as Michael mentioned.
So what are we doing in portfolios to deal with this, the
uncertainty and the lower expectations going forward?
I'm happy to take this one.
So let me start by saying that, as challenging as this
market environment is, this is exactly the kind of
market where being active investors is very important.
So as active managers at TCW, our portfolio managers have the flexibility to
select stocks and adjust the weights in their portfolios in response to new
developments, such as the tariffs narrative
that is continuously changing right now.
And so it is very clear that this volatile environment
has led to mispricings in the market, and a lot of share
prices are currently not following companies fundamentals.
Now, in these environments, our PMs have been re-underwriting
the investment PCs in all the names in their portfolios,
they have been doing that for several months now.
And so they are looking at which companies have characteristics to remain
fairly insulated from the threat of tariffs, but they're also looking
at companies that could result winners in these environments, right?
So that's how the investment world works.
Sometimes we just look at the value even in environments that are
maybe not ideal and have a lot of uncertainty and volatility.
And just to give you some examples of from a big picture point of view, our PMs
are seeing value in companies whose operations are tied to some sort of secular
theme, which means they don't really rely on a strong GDP trend to thrive.
And to highlight a couple of these themes, you know, artificial
intelligence, we see headlines about this all the time.
Our PMs are really favoring select names tied to generative AI,
especially among those companies that are building out AI capabilities.
So let's remember that there are many companies funding these
build out, and they have some of the deepest pockets in the world.
And they basically see falling behind in the
generative AI mega trend as an existential threat.
So they have no expectations of lowering the cap extending for this
year, and for years going forward as well in terms of this theme.
And so our PMs are really using their stuff speaking abilities to choose those
companies that they believe will be the key winners related to this mega trends.
And then another theme that I would highlight is the supply chain
reshoring theme, which really started several years ago, to
be clear, it is not a new phenomenon driven only by tariffs.
For the past years, companies have been rethinking their supply chains as the
world face some very fragile moments with COVID with geopolitical conflicts and
a lot of other things that they really began to see some evidence of that they
had to do something to move their supply chains and become more resilient.
And so we have really begun to see some evidence of these trends
and companies building manufacturing capabilities back in the US.
A very clear example of that is the fact that manufacturing construction
investment has been surging, and has more than doubled in the past four years.
And so, as you know, there are companies that have been benefiting
and we believe will continue to benefit with this trend.
And our PMs are really looking at opportunities in this space as well.
So a few ideas that we're looking at any parts of the market that we're
looking to particularly avoid, or maybe any of their pockets that
we think are particularly attractive at this point,
other than the couple that Valerie just mentioned.
First thing I would say is there are a number of attributes that we think
are attractive or important in this particular environment right now.
First of all, low debt levels, we don't know exactly
what the trajectory of interest rates going to be.
So anything that allows a company to control its destiny is very important.
A lower percentage of non US revenues, obviously
with what's going on with the tariff environment.
Limited China exposure, I'd say is another important attribute since
China is really at the epicenter of this trade battle with the US.
And apart from that, I'd say resiliency in a slowdown, but
we've just discussed the fact that the economy is slowing down.
And so those companies that have certain defensive
characteristics, we think are best positioned.
So this would be everything from some retailers that
are selling staples or food or other inelastic goods.
We focused on the auto parts sector.
They are certainly not immune from tariffs, but this is, you
know, a relative proposition, the cost of new autos is surging.
And in that environment, replacement parts become relatively attractive.
So that's an area that is looking compelling.
Also, some regulated utilities that are at least
directly direct impact rather from tariffs.
The waste stocks are attractive because of their inefficient.
Instead, what I'd like to say is they're inelastic demand and then drug
distributors and some of the health labs, attractive space, REITs in
the senior living space, some in the health care oriented
space, towers, data towers, that space attractive.
I'd also note that companies with strong
recurring free cash flow are attractive.
Some of the software names, cybersecurity continues to be compelling.
And then you asked about what what's not attractive.
And I think it is a more challenging environment for
some of the more consumer discretionary oriented names.
This is everything from airlines to hotel.
These aren't absolute, by the way.
But in general, airlines, hotels, lodging, home builders, some of
the more cyclical, heavier industrial names where there's capital
expenditure, you know, disruption is an important variable.
And then, of course, companies with high overseas revenues, China
exposed names, some of the more commodity oriented parts of
tech, maybe in the phone space, PCs, legacy servers, et cetera.
All right.
So a lot of things that we're worried about.
Maybe we'll try and end here on a more positive note.
Where do you see upside potential going for
like how could that shake out over time?
Where might there be good opportunities?
And, you know, how might that transpire over time?
Sure.
And I'm glad you framed it that way, Dave.
As I mentioned earlier, we do find individual
stock opportunities that we think are attractive.
And that's one of the opportunities that's
created from this dislocation in the market.
At the big picture level, I would say upside can come from a number of sources.
First of all, de-escalation of the trade battle.
We're not saying that there's going to be some kind of immediate
de-escalation, but this is going to be an iterative process.
And there are going to be some announcements that are retaliatory
in nature and that could be more alarming to the market.
But there will be the announcement of trade deals ultimately that
could provide some relief to the market as well on the tariff front.
Also, there could be Fed rate cuts.
If you look at the futures curve, it looks like there could
be several this year, even though Chairman Powell made it
very clear that the Fed's in kind of a wait and see mode.
So we're not expecting Fed rate cuts to bail out the equity market by any means.
But at the margin, that could be helpful.
I think it's important to keep an eye on this budget
reconciliation process that's happening in Congress.
Remember, tariffs are very much a fiscal contractionary element to the economy.
And anything that provides fiscal expansion in the form of
tax cuts or relief on that end would be very important.
And this whole tariff battle gives greater impetus to
this move in Congress for this reconciliation bill.
So maybe you do get something by Memorial Day there,
and that would be helpful to businesses and consumers.
And then finally, I'd say lower energy prices.
While we don't like an environment in which slower growth is resulting in lower
energy prices, it still is a plus for consumers and and for many businesses.
I would just wrap up by saying that, you know, we don't try to time the markets.
That's that's not our discipline.
And we've all seen the charts where being out of the market
on just a handful of the most favorable days can make
a big difference in terms of investment returns.
That's something to keep in mind.
And the other point I'd make is, you know,
we do expect a divergence in outcomes.
There are going to be winners and losers here.
And so active managers such as ourselves do have the
capacity to sort through these winners and losers.
And, you know, right now, having a well-diversified portfolio
continues to make good sense, given the high degree of
uncertainty associated with the investing backdrop.
All right.
Well, fantastic.
On that note, I think we are out of time.
Thank you, Michael.
Thank you, Valeria, for taking the time to join me
today, especially when there's so much happening.
It's an understatement to say that this market
is certainly keeping everyone on their toes.
For more information on TCW strategies, please visit our website at TCW.com.
Thanks for listening.
And we'll pick up next time, exploring more trends
and opportunities that are shaping global markets.
Thank you for joining us today on TCW Investment Insights.
For more insights from TCW, please visit TCW.com/insights.
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