Ausbiz: Opportunities in aerospace and rate-sensitive sectors as recession risks fade

Well, let's now focus on what we're seeing on Wall Street at the moment. Sam Ruiz joining us from T. Rowe Price. Sam, good to have you back in the studio. 

In fact, that session just got more records, the S&P, the NASDAQ at record highs again, week after week. We're seeing that what's actually driving this at the moment.

We're going to talk of FOMO and Momo, But I mean, obviously, there's a lot of focus on the Fed, the rate cutting cycle, 100% expectations they will start cutting again next week.

Yeah, I think the FOMO momo dynamic is real. Meme stocks are real, something people should be concerned about. But underlying that, things are decisively more positive than where they were say in April. So we've got an economy that's re accelerating.

In fact, we're looking at the third quarter in the US where people are really worried about things that Trump were doing. We're going to be bad for the economy now expecting 3% year over year growth for the end of this third quarter. That is very different to recessionary scenarios.

We're seeing earnings growth, people expecting those to be as low as very low single digit have now reaccelerated back to around double digit or maybe even very high single digit.

We're also seeing not just US earnings growth, but broadly we're actually seeing other regions reaccelerate to faster earnings growth in the US emerging markets actually reaccelerating quite strongly.

We haven't seen EM earnings growth be stronger or expected to be strong in the US for some time. So economy is much more resilient. Corporates are making more money, people are more optimistic, valuations are higher. And then as you said, the rate cuts are potentially coming as well, which just fuels that fire.

Well, of course, the reason the rate cuts are coming is because the economy has slowed. We've seen that in jobs in particular.

So have you discounted the chances of recession? So I just think that recession odds are very unlikely from here.

The underlying momentum of the economy is very, very strong. As I mentioned, GDP growth is actually fine.

There's some things happening in the labour market that could be quite positive, whether it's in reaction to a slow down of the economy, I'm not sure whether it's potentially in just that corporates are becoming more productive could be another thing.

Some of them have been mentioned that they are just finding more productive uses of AI that can displace some jobs. I think that the underlying uncertainty is, is warranted.

What you're alluding to less about we're concerned about it slowly on the economy, but potentially that there is still some workings to go through from tariffs.

And we've spoken about even about six weeks ago on the program here that there is still a lag effect of tariffs that people don't really know what the true effect is because there was delays, there was pauses, and then there's now these residual agreements that we've got.

So still, I think people have to have one eye open at night while sleeping.

In terms of whether that does result in a broader slow down, we're just not seeing that yet when speaking to companies.

Do you feel as though that tariff effect has been overstated?

I don't think it's overstated. I mean, we're retooling potentially global supply chains. The US is basically saying we want to have a different role and we want to have a different relationship with our allies. So I think it's worth people being fearful about that.

I just think that the nuances and how it's not as simple as saying putting a 20% tariff feeds through straight to the consumer.

It depends on what components, depends on whether some companies actually take the hit to their own margins, whether they pass that through, how resilient the sort of elasticity of demand will be to that.

So that's going to be very different for each company, for each consumer good and the relationships between whether companies can even actually find out whether they can retool supply chain to another country or not. So very, very different.

And I think how you mix that together to a net average for what that means for the economy is impossible and which is why it's a little bit more wait and see.

So when we talk about the valuation of the US market at the moment, is it price of infection? Is there a risk there?

It is in in pockets. So I think the real, the real challenge in having that sort of notion of how is the market value versus the past is the, the way that the index or the market is made-up now is very different to the past.

You had previously a lot of B grade stocks that made up the index and their average of the valuation was what it was. Now you have A plus stocks that are much larger and driving the index. So yes, the index should be worth more.

The index is nothing like what it was in terms of valuation, what we saw in the late 90s in terms of bubbles. But there are pockets of the market where you're just seeing the market that FOMO, that meme stock type of dynamic, really pushing valuations to extremes. Stocks like Palantir we've talked about before.

I think they're even sales ratios above 100 times when you look at the average company in the market, it's much more reasonably valued. And I think that that's really interesting because you've really had this dichotomy of AI and everything else.

AI is driving much higher valuations for the broader index because index concentrations much, much stronger. But the real economy that that's sort of let's just call it the non digital economy, the analogue economy has actually been not firing on all cylinders.

We've had a PMI recession for some time. The fact that rates have been really high, I've held back things like the housing sector in the US particularly that is a part of the market that's much more reasonably valued and we actually think presents opportunity if that, if that gets re accelerated from rate cuts.

Now, so much of this has been driven by AI and more recently, you've had companies like Broadcom essentially just gone, Oracle shooting the lights out, essentially near record highs, if not beyond. How sustainable is this? I mean, a lot of comparisons made with the tech bubble back at the beginning of the century. Is that an unfair comparison? Is this different?

I think you need to compare it to that. We do think it is a little bit different. This is a cycle so far that has been funded primarily by free cash flow. So if you think about the 90s, it was very much a leverage cycle. A lot of debt went into laying fiber in the ground, and we found out we just didn't need to use all of that fiber.

You have a lot of companies now making big bets that either AI is going to be so huge in the future that it's going to need a lot of computing power and capacity, or that if these companies don't invest in AI enough, that basically there'll be a massive threat coming their way from someone else that comes up with a better competing product.

If you're Microsoft, if you're Google, you are investing everything you can because if you don't have the best product, someone else will displace you. I think that that just means that if this does end up being an overbuild, let's call it AI capacity, we build too many data centers.

The fact that this isn't yet basically fuelled by credit, fuelled by debt, basically having all the private credit players and banks come in and lending to everyone and anyone to build this infrastructure just relatively contains the other side of this.

It won't be great for companies like the hyperscalers that are investing so much if people figure out that there's no return on investment. But I think it contains that quadrant versus sweeping through the economy.

That's what can happen when credit basically fuels some of these cycles. It's just not happening this time.

So where do you want to be then? What are some of those companies that you're actually looking to get greater exposure to?

Yeah, so the AI, I think we cover that really quickly. We've talked about it so much earlier stage and I think people can appreciate Oracle's numbers were incredible.

Our analyst covering Oracle has not seen this in his entire 20 year career.

So they have actually gone from a backlog of demand of USD 68 billion in 2023 and now looks like they're going to be at USD 500 billion by the end of next year.

That is not even a company. People were talking about 18 months as one of these hyperscaler data center AI winners.

I think though, what I've alluded to is you've got this AI economy and then the rest of the real economy. And I think that the prospects of rate cuts coming through, it's expected we get a cut next week by the Fed and an additional 2 on top of that by the end of the year could really unlock parts of the economy that are tied to rates like housing.

And that also flows through to parts of the economy like manufacturing and the industrial sector, which have been incredibly weak. We've had a PMI recession for, I can't remember the exact number of quarters now, but it's probably about 18 months, 24 months.

So we're, we're thinking about then AI still feels great, but where can you get some real economy, sort of real tangible earnings exposure?

And an area we haven't spoken before is actually in aerospace. So aerospace has the likes of Airbus and Boeing that have more than 90% market share of making commercial aircraft.

But there's a whole ecosystem of companies behind them that need to supply engines, supply fastness, supply, you know, simple alloy, sort of little bit of bits and flaps that go into engines and even servicing of aircraft.

So very, very succinctly, what happened is in COVID, air traffic clearly fell off a cliff. Companies or airlines delayed ordering new aircraft and airlines that basically had very few people flying delayed servicing the aircraft for as long as possible.

Now what you have is we're kind of getting a little bit back to normal. And just as a quick data point for you, aircraft and Boeing used to manufacture about 1600 planes per annum and that was in 2018, 2019.

Now they're running as hard as they can and they can only get to 1200 because of supply chains. But we think that 1200 is going to go back to about 1800.

And if you are actually an airline that wants in your aircraft is a 10 year plus backlog to get that aircraft. That's how when we look at how durable and visible, we actually see this thematic and if you want to get your aircraft serviced, there's a two-year backlog.

So normally people worry that in aerospace it's quite cyclical and people can just cancel orders. But if you were running an airline today and you thought maybe we're not unsure about ordering that new aircraft, you're much less likely to cancel if you know you have to get to the back of a 10 year queue.

We just think that means more resilient earnings, more durability, more forecast ability for us in terms of this space going forward.