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Is David Sowerby and Core portfolio manager here with us on this Boxing day. I guess not in the US but around the world sales you're celebrating, I know, but we're supposed to celebrate.
With the Dale Canada too. It's Canada as well.
Well, said CommonWell, my neighbor to the south.
Yes, right, David, great to speak with you, and I want to start just by before we look ahead, looking back on this last year. What lessons will you carry over from the way the market performed this year? And if you kind of think of this as chapters, how much is the story of the same here going into twenty twenty five for you?
Enough of the same, But one very good same is never underestimate the ability of solid US companies to deliver superior capital allocation shareholder value creation in the face of higher interest rates, questionable fiscal policy, time and time again, bet on US companies. That's been the rule of thumb for thirty plus years.
David, you know, am I gonna be lazy in twenty twenty five and just hang on to my mag seven?
Or should I take a little bit of a roll up my sleeves a little bit.
Maybe take a look at some small caps, some mid caps, maybe some sectors or factors that haven't really performed over the past two years.
Well, Paul, I don't root against the MAG seven, but I think you have to think broader, more participation in the markets. We saw this rotation since July eleventh, where small caps outperformed quite well, value outperform growth, the MAG seven lied or lagged excuse me, And here we go into December Mag seven right back on the treadmill. Small caps have still modestly beat large caps since July eleventh, ten percent for small caps up seven percent.
For the S and P five hundred.
It's that two steps forward, one step back, one step back in December, but I think we're back to small caps having very good turns in twenty twenty five relative to some of the megacaps.
David count me among those who hears that watchword are those watchwords small caps and just sort of wonders what to do with it. Where are you looking when we talk about small caps? Where is there opportunities you see? What's your counsel to your clients about what sectors, what types of companies? Are are of interest in that world, A.
Proven process for twenty plus years. Two buckets to look into first spinoffs small company spins out of a larger company on lock shareholder value.
Look at the Bloomberg Spinoff.
Index in twenty twenty four, it's up better than sixty sixty percent.
That's the first bucket.
The second bucket is under followed companies where there's only two or fewer Wall Street analysts following the company compared to the previous story on Apple. So an example is National Cinemedia ticker symbol NCMI. Only two analysts follow the company. They do that advertising when you go to the movies hate it and you get there early, and you see that active audience for advertising at National Cinemedia over one
thousand theaters they're in. There's an idea for an underfollowed small cap stock.
And that stock's just ripped.
It's up a sixty percent year to day with a market cap of about just six hundred and twenty five million dollars. So that thing has worked here. David, how do you think about valuation here? Because I've got a fed that I think maybe they're going to cut a couple of times in twenty twenty five.
But I think that's it.
It feels like earnings have to be a real driver of this market going forward. How do you feel about earnings visa the evaluation?
These days?
All valuation rich, no other way to describe it. If you go on a free cash flow basis and value the market that way, not as rich, still opportunities for the investor, but you nailed it.
It's a tug of war.
In twenty twenty five, earnings, pre cash flow dividends will all be up ten percent or better. That's pulling on the upside. But valuation is stretched. And I looked back to nineteen ninety there have been nine years in a calendar year where valuation went lower, and in those nine years the market only finished positive four on in nine years when valuation slipped a bit. So that's the tug of war for twenty twenty five rich valuations. I hope
they don't go lower. With earnings and free cash flow up double digits.
I could detect what my friend Paul Swiney was saying, some disdain or eagerness to stop talking about the Fed Reserve as much as we have been over the course of this last year. What's the role that it's going to play in twenty twenty five as you see it. I know you were listening closely to that press conference
just a couple of days ago. How much is it going to be continuing to drive things going forward here as you look at valuations, as Paul suggests, other facets of investing beyond what the oracles down in the Echos building are telling the market.
Well, you're in New York, so let's borrow from a famous New York investor, Reggie Jackson. The FED is a straw that stirs the So if the market only gets two interest straight cuts next year, I don't think the Fed should do anymore. Their number one mission should always be price stability, and if the market doesn't like it in the near term, you have to grind through it. But at the same time, if inflation is not brought even a bit lower, just look at what the market
did from nineteen sixty five to nineteen eighty one. It was flat on an inflation adjusted basis, it dropped forty to fifty percent. So we have to be encouraging that the Fed States committed to inflation, and that's going to be a story in twenty twenty five. In that Tuga war relative to the I think favorable earnings, free cash flow, and free cash flow margins that'll still exist.
David, I've been doing this Wall Street thing since nineteen eighty six. One of the really interesting markets to watch develop has been private credit. Talk to us about Ares Ares Management Corporation.
Areas is one of the largest private credit publicly traded companies, so bank loans in particular, and that has been an insatiable appetite for pension funds. I sit on the City of Detroit's Investment Committee. My alma mater, Wayne State, I chair the State of Michigan Pension Fund for a number
of years. The demand for private credit continues to grow because the expectations are you can get near like public equity returns without the same volatility, and that plays into a name like Ares, which is one of the largest private credit publicly traded companies.
You know, let's take advantage of the fact that you're there in Michigan. I'd love to get your sense of sort of not not the politics of the election per se, but what issues were front and center, particularly in your home state, and what that tells you about what to focus on here in the years to come.
The economy first and foremost, that cumulative inflation was up better than two twenty percent since early two thousand and twenty twenty one, and I think that's why Michigan, perennial swing state, swung back for incoming President Trump relative to twenty twenty twenty sixteen.
We end up voting with our pocketbook.
The other matters, the other factors matter, But I think that was the key reason for Michigan going back to Trump the way they did in twenty sixteen.
David, when you and your team woke up the day after election day, did you change your investment outlook for twenty twenty five at all?
Generally no, because I can't predict politics, Paul, But my axiom in predicting politics is never never expect.
Washington to do the right thing. They do the least amount to fix a problem.
That said, after the election, you saw small cap stocks the day after pop three to four percent. That was validation at animal spirits, we're going to be resurrected. And we saw that November NFIB Optimism index take a decided spike higher. That can be a factor that bodes well for the market next year and in particular animal spirits and small cap cyclically sensitive stocks.
You can't predict politics.
Let me just ask you about geopolitics in terms of what you're watching and how that maybe colors your appetite for, say, assets outside the United States, equities overseas, other opportunities are Are you staying pretty closely focused on the US or do you see opportunity across the Atlantic.
Outside the US.
It's interesting, but the bias is still in US domestic portfolios. And since the end of nineteen eighty seven, US stocks have compounded five five percentage points better compound analyzed return superior than the MSCIEFA. That goes back to the superiority of US companies delivering shareholder value. The bar is high to have meaningful assets oute of the US. You get enough diversification here given our indexes.
So, David, what's your message to your clients? You have a thematic message to your clients for twenty twenty five.
I'm generally not that creative other than keep your head down buying good companies that are generating capital and free cash flow to the investor. And at the end of the day, I'll have the same five risks that every wall street analyst has on the street, but ultimately it's always going to be the risk you don't know that bites you the hardest.
David, Do you still have clients who are on the more conservative side of things, who are part of that six trillion dollars cash pile, who are reluctant to get back into this market? And if you do, what's the council you're giving them to jump in?
Generally, no, but if there are some you just want to take a look at the potential for the S and P five hundred, or the average stock and the S and P five hundred to compound seven to eight.
Percent over the next three years. You're not going to get.
That in treasury bills or treasury notes, and the probability is probably better than eighty percent that the US and the S and P five hundred, the average stock will compound better than cash.
I like those odds. The next calendar year flip a coin.
But the next two or three years you feel like equities will still meaningfully outperform cash.
All right, David, thank you so much for you Always appreciate getting a few minutes of your time. David Sowerby and Core Portfolio Manager from the Great Midwest,