Value Stocks Set To Outperform Tech Into The End Of Year? | Lance Roberts

Lance Roberts · RIA AdvisorsBullish

Berkshire Hathaway B shares are a buy as part of a shift toward beaten-up value stocks.

Lance says his firm bought the B share class of Berkshire Hathaway in the same week it harvested tax losses in smaller-cap, rate-pressured names and added to other value holdings. The buy is part of a broader move toward value stocks that have been beaten up, which he expects to rotate back into favour. Adam notes that Berkshire is mainly an insurer but sits in the financial category. The reasoning is brief and rests on the value-rotation thesis rather than a company-specific case.

“We bought some Berkshire Hathaway this week, BRK, the B share class of Berkshire Hathaway.”at 1:25:15

Lance Roberts · RIA Advisors

Expects rotation from mega-cap growth into value, equal-weight and small caps into year-end.

Roberts' firm did a full portfolio rebalance shifting from growth to value because of widening divergences. The equal-weight S&P 500 has triggered a buy signal and sharply lagged the cap-weighted index. Money has piled into the most overbought mega-cap growth, semiconductors and high-beta tech, while developed international, small-cap value, financials, industrials and utilities are starting to turn up. He calls the rotation early and not yet a big move. He cites historical Q4 averages of about 6.6% in midterm years and 16 positive midterm years out of the last 19, but warns averages are not guarantees. Cap-weighted indices may stay flat while other areas do better.

“we did this full rebalance shifting from growth to value... And it's because of these divergences that are building up in markets in particular.”at 8:08

Lance Roberts · RIA Advisors

Stock valuations imply roughly zero real returns over the next decade, below 10-year Treasury yields.

Roberts says valuations imply expected real returns on stocks of roughly -2% to +2% over the next decade. Since a 10-year Treasury yields 5.3%, buying bonds nearly doubles the expected return. He says this does not mean every year will fall in that range. Instead there will likely be big rallies and big declines along the way, driven by valuation-related factors. He cites valuations as the basis for the view.

“Right. So I'm to buy a ten year treasury at 5.3 and nearly double my rate of return on stocks for the next decade. That's just what valuations tell you.”at 27:23

Lance Roberts · RIA Advisors

Stocks at 38x valuations near highs are a poor entry; another secular bear drawdown is coming, likely in the 2030s.

Lance argues investors are repeating a mistake by piling into stocks after a big run, when stocks trade at 38 times valuations near all-time highs. He says buying should happen after a 50% blowout, not at these levels, and that equities should not be bought without risk controls. His thesis is another secular bear drawdown, not in the next couple of years but probably in the 2030s, driven by a variety of factors.

“But that's when you want to be buying stocks, not when they're sitting at 38 times valuations and near all time highs. This isn't the time to really be piling into equities without some risk controls in place.”at 45:14

Lance Roberts · RIA Advisors

Higher rates pressure small and mid-cap stocks, which lack cash flow and face refinancing risk.

Lance says rising interest rates are putting heavy pressure on small and mid-cap stocks. They lack the cash flows to absorb higher rates and face refinancing problems. He is less concerned about junk bonds, since CCC issuers were already near bankruptcy, so higher rates are not the main factor weighing on them.

“because interest rates are going up, it's putting a lot of pressure on small and mid cap stocks because small and mid cap stocks don't have the cash flows to deal with higher rates.”at 50:02

Lance Roberts · RIA Advisors

Beaten-up value stocks like utilities are set to rotate back into favour; his firm is adding to them.

Lance's firm rebalanced out of tech after big runs in AMD and Nvidia, pulling profits back to target weights. It then added to value stocks such as utilities and other value names it describes as beaten up. He expects a rotation from growth into value, and his firm is positioning for it. The thesis is that the value sector has been heavily sold off, so a reversal toward it is likely.

“We also added a bit to some of our other value stocks like utilities, etcetera. Just because again, as I was showing you earlier, those are really beaten up and we're expecting to see a bit of rotation maybe into that value sector.”at 1:25:29

Lance Roberts · RIA Advisors

The 10-year yield near 5.3% reflects growth, about 3% inflation from oil, and a 1% term premium.

Roberts builds the 10-year yield from the bottom up. Nominal growth is strong: the Atlanta Fed still projects near 4% growth for Q3, down from 6%. That growth keeps prices elevated, and oil on top pushes inflation to around 3%. Adding real yields and a term premium of about 1%, set by inflation expectations, gives about 5.3%, which is where yields are trading. He says headlines only mention Treasury yields when an auction goes badly, and the recent 10-year and 30-year auctions were strong, with foreign buyers participating.

“you slap oil on top of that, you're going get inflation running around 3%... You slap all that together, it gives you a 5.3% yield, which is exactly where we're trading.”at 23:14

Lance Roberts · RIA Advisors

Yields of 7% to 9% are far-fetched because higher rates would destroy the economy.

Roberts disputes the view that rates will rise to 7%, 8% or 9%. Interest rates are a function of real growth and real yields. Higher rates are already destroying demand, and the economy is near flat once capex is stripped out, so the real economy would collapse before yields got that high. He argues the long-term trend is disinflationary because of debt and deficits, not inflationary. He is not forecasting the path of yields, only saying extreme rates are implausible.

“So the idea that we're going to go to 7%, eight or nine percent interest rates is pretty far fetched only because you're going to destroy the underlying economy.”at 26:03

Lance Roberts · RIA Advisors

10-year yields tend to peak when three standard deviations above the monthly average, before economic damage cuts rates.

Lance shows a monthly 10-year Treasury chart back to 1994. He says 5% is about normal historically, and that whenever the 10-year has been three standard deviations above its monthly moving average, that has basically marked the peak of rates. Nearly every peak lined up with an economic shock (Asian contagion, dot-com, financial crisis, pandemic), because high rates eventually hurt growth and that pushes rates lower. He also argues the 2020 half-percent 10-year was an artifact of QE and zero rates, and that rates are now normalizing to growth as the Fed hikes.

“any time that you've been three standard deviations above the monthly moving average, that has been basically the peak of rates.”at 40:06

Lance Roberts · RIA Advisors

Bonds are undervalued now; 5-10 year Treasuries locking in about 5% should beat stocks in the next secular bear.

Lance says bonds are currently undervalued relative to markets, while stocks trade at 38 times valuations near all-time highs. His firm buys 5, 7 and 10-year duration bonds that kick off about 5%, so half a portfolio in bonds at 5% provides a dependable return. He expects another secular bear drawdown, probably in the 2030s, during which yields fall on disinflation and recession and bonds outperform stocks, after which investors should move fully into equities. He hedges that he does not know whether bonds will outperform over the next two years.

“Right now bonds are undervalued relative to the markets. At some point you're going to have all the potential premium baked in.”at 44:23

Lance Roberts · RIA Advisors

Bonds now cover 53% of the return needed for goals, versus 12% three years ago.

Roberts argues bonds are in a much better position to deliver set returns for retirees and investors seeking safety. Bonds now provide about 53% of the return a portfolio needs to reach its goal, versus about 12% three years ago. He says the focus on the level of rates is a mistake. Bonds should be judged by their income stream, return of principal and volatility role in a portfolio, and by their yield to maturity.

“today bonds will provide you 53% of the rate of return that you need to reach your goal versus about twelve percent three years ago.”at 31:11

Lance Roberts · RIA Advisors

Bond ETFs track rate direction and never mature, so they fail capital preservation; mortgage bonds are worst.

Roberts argues bond ETFs do not mature, so their price is a function only of the direction of interest rates. Buying one is effectively a stock trade on rates. For investors who need capital preservation, individual bonds held to maturity are the right tool. Mortgage-backed securities are worse because principal and interest are paid down over time, and those bonds eventually go to zero. He warns that a portfolio focused only on price will find owning bonds miserable.

“ETFs are solely a function of the direction of rates. You are basically making a stock trade on the direction of interest rate. ETFs do bonds and ETFs do not mature.”at 34:59

Lance Roberts · RIA Advisors

Credit spreads are widening only at C and CC ratings; no broad stress until the rate of change spikes.

Lance says C-rated and double-C spreads have moved up, but on a long-term chart spreads are barely visible and widening from very low levels. He says the level matters more than the rate of change, and that the rate of change is not something to worry about. He treats credit spreads as the best leading indicator. Triple B, A, double B and single B spreads are not moving much, so there is no risk beyond the junkiest debt. Trouble would show up as a spike in the rate of change moving up the rating ladder, then markets deteriorating, as in 2008.

“This is not a rate of change to worry about. What you're looking for is a spike in the rate of change. That tells you there's trouble in bond land when that occurs.”at 51:10

Lance Roberts · RIA Advisors

Muni-to-taxable yield spread is too tight to pay for muni credit risk; spreads should widen in the next downturn.

Lance argues that the tax-equivalent yield on munis barely exceeds the muni yield relative to taxable alternatives, so investors are not being paid for the credit risk of muni bonds. He says munis carry real risk, like high yield and corporate bonds, but currently the market sees almost no risk in them versus Treasuries. He expects the spread to widen during the next market downturn, when credit risk reappears and weaker municipalities start to default. He plans to buy munis after that repricing, and says that in a major correction money will flow into Treasuries and other yields will blow out, leaving good munis at lower prices and higher yields.

“Right now, you're not really getting paid. The spread between the tax equivalent yield and the muni yield is not really justifying taking on the risk in muni bonds, it's too tight.”at 1:16:36

Lance Roberts · RIA Advisors

Negative sentiment, sidelined retail and underweight CTAs leave room for a year-end rally.

Roberts argues sentiment is negative: the CNN Fear & Greed Index is in fear, and retail investors are on the sidelines rather than chasing markets, with little aggressive call buying. CTAs are underweight equities. Buybacks are returning after a blackout window, which he says restores liquidity. Together with the earnings season, he sees this as a supportive setup for the market to run through year-end. He hedges that Iran or the midterms could undermine it.

“Sentiment is pretty negative. Take a look at the CNN Feared Greed Index, it's in fear. Retail investors are not chasing the markets right now... CTAs is a good example. They're kind of underweight exposure.”at 16:10

Lance Roberts · RIA Advisors

Bond yields are pulling capital out of equities; bond inflows this year could accelerate and hurt stocks.

Lance argues that after 15 years of excess monetary policy forcing people into equity risk, bonds are now a good alternative that will start extracting capital from the market. He says this is already happening, with a huge amount of flows into bonds versus equities this year. Adam adds that this must continue, and if it accelerates it becomes a problem for markets.

“Now that [the] good alternative is going to start extracting capital from the market potentially. Now we're seeing it somewhat this year.”at 59:58

Lance Roberts · RIA Advisors

Retail speculation with leverage and prediction markets is rising, reflecting Fed moral hazard.

Lance argues that after 15 years of conditioning investors that there is no alternative to equities, money is moving into the riskiest corners of markets. He cites prediction-market and betting apps drawing assets from markets, plus 2-3x leveraged equity products and zero-day options. He calls this moral hazard: the Fed has given markets insurance, so every dip gets bought. He asks what happens if the Fed does not step in on the next correction, and says Gen Z investors are taking increasingly destructive risk.

“But even in the financial markets, they're taking on two, three times leveraged equity risk to get more return out of the market. Options trading, zero data exploration options.”at 1:04:46

Lance Roberts · RIA Advisors

REITs and utilities set up for a decent trade if oil falls back toward $80.

Roberts expects a reflexive trade if oil falls back to around $80 for some reason. Lower inflation pressure would pull yields down and lift interest-rate-sensitive sectors such as REITs and utilities. These sectors have badly underperformed and sit far below their long-term means, including financials, real estate and industrials, which typically gives at least a decent trade into year-end. He calls it a trade, not a long-term hold. His firm restructured its portfolios with this setup in mind.

“If we get oil prices back down at the $80 range, we should see a decent rotation into some of those more interest rate sensitive sectors, REITs, utilities. That's been another area that's been just grossly underperforming.”at 10:06

Lance Roberts · RIA Advisors

Q3 earnings season starts on strong footing given record number of guidance raises.

Expectations are high going into earnings season, with big banks reporting next week and mega-caps a week later. Roberts argues that beats and higher guidance would support the market. Evidence: 72 companies have raised guidance for this year versus 44 that lowered or held it, a record count of upgrades. He says this gives the season a strong footing and provides the catalyst for the market to run through year-end, though he notes it does not have to happen.

“The expectations are very high. So if they come in and beat those estimates and guide higher... we've already had 72 companies report higher guidance for this year versus 44 reporting at or lower guidance for this year.”at 16:58

Lance Roberts · RIA Advisors

Likely Democratic Congress with Republican president is the weakest S&P return setup for next year.

Roberts reviews historical S&P 500 returns over the next twelve months under each midterm outcome. Returns are positive under any combination. Gridlock, with a split government, gives the highest average returns, around 13 to 17%. A Republican Congress with a Democratic president comes next at about 7%. The lowest is a Democratic-controlled Congress with a Republican president, which polls currently suggest. He links this to the policy agendas: higher taxes and more restrictive market regulation under a Democratic Congress. These are averages, not guarantees.

“Right now, it's shaping up that Democrats will take the House and the Senate and you'll have a Republican president, which is the lowest expected rate of return out of all the possible combinations.”at 19:04

Lance Roberts · RIA Advisors

Economy near flat ex-capex, with consumer demand destruction; a real slowdown comes when capex ends.

Roberts argues that higher rates are already causing consumer demand destruction. Ex-capex spending the economy is close to flat, despite Atlanta Fed nowcasts near 4%. He expects capex spending to end within about two years. When that happens the real economy will come under pressure. That is when rates and yields will reflect a very different story.

“we're seeing consumer demand destruction as we speak. The only thing really, if you strip out the CapEx spending in this economy, we are close to flat... once that CapEx spending ends and that will end in the next two years, then the real economy is going come under that.”at 26:23

Lance Roberts · RIA Advisors

Deficits and debt do not drive interest rates; they are disinflationary and push rates lower over time.

Lance says most commentators treat debt and deficits as the driver of interest rates, and he argues they are not. He cites a 10-year Treasury chart since 1994, when deficits and debt rose steadily while rates fell over time. He says debts and deficits erode economic activity and growth, which has been trending lower, so they are disinflationary and ultimately push rates down to fund the debt. He argues investors should focus on the factors that actually set rates.

“The vast majority of people I'm listening to right now are focused on the debt and deficit as a driver of interest rates. These do not drive interest rates.”at 36:03

Lance Roberts · RIA Advisors

At 7.5% mortgage rates, home-loan demand is drying up and commercial lending is stagnating.

Lance says nobody wants a 30-year mortgage at about 7.5%, so mortgage activity is drying up. Commercial loans are also declining, and the traditional loan market is starting to stagnate, though not dramatically yet. He contrasts this with private credit, where demand for loans remains strong. He is using the rate level to explain why traditional lending volumes are falling as yields rise.

“Like I just talked about earlier, nobody wants to get a thirty year mortgage right now because it's 7.5%. So we're seeing mortgages dry up a bit here.”at 1:27:08