Portfolio Intelligence podcast: why U.S. stocks could continue to do well in 2025

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John P. Bryson

Hello and welcome to the Portfolio Intelligence Podcast. I'm your host, John Bryson, head of investment consulting and education savings here at John Hancock Investment Management. Today is December 2, 2024. And as we round up the year—a year of exceptional equity returns, I've invited Sandy Sanders of Manulife Investment Management to the podcast. Sandy is a senior managing director and senior portfolio manager at Manulife, and he is the leader of the U.S. Core Value Equity Team, which manages large-cap value, large-cap core, all-cap core and global equity strategies. Sandy, welcome to the podcast.

Emory W. (Sandy) Sanders

Thanks, John. Great to be here.

John P. Bryson

All right. Hey, listen, you manage a number of portfolios for us. Give us an overview of your investment approach so we can set the stage for the audience.

Emory W. (Sandy) Sanders

Well thanks. We look at companies that have a sustainable competitive advantage. And we're basically a core investor in that we essentially can look at both growth and value stocks together to build a core portfolio. And that flexibility over the years has allowed us to, we think, have an edge because there's more flexibility. We're not essentially stuck in one style box.

And that essentially, coupled with … approximately 50-stock portfolio, so good active share and with a team that's completely dedicated to our philosophy and process. So it's more of a boutique structure. It's focused and that allows us to really rinse, repeat, and constantly trying to get better every day, honing the same investment process year after year.

John P. Bryson

Nice. So you mentioned process, you mentioned rinse and repeat. When our investment consultant team is talking to financial advisors, we often talk about having a definable, defendable, and repeatable process. Can you bring us deeper into your process?

Emory W. (Sandy) Sanders

Absolutely. So what we do is we first start with companies that earn above their cost-of-capital, say they have a good return on invested capital. So this is it. Basically focusing on the quality companies, no matter if it's a growth or a value business. And essentially think of us as avoiding the areas that are lower quality, like generally airlines, automotive, telecom, utilities, metals and mining.

We will shy away from those areas, but then we'll go out in the field. We'll do about 700 meetings a year approximately, meeting with company management teams. Then essentially we'll come back to the office and go through our seven-step process, and it takes a month of work … essentially starting with competitive advantage … understanding what is that business’s sustainable competitive advantage.

And then looking at industry and growth drivers. Financial statement analysis … a management team assessment. And really, the heart and soul of our process is really step number six. This is where we do four scenarios. We do a best case, base case, a bear, and a worst. And these are five-year minimum discounted cash flow models. The base case is what we think the stock is worth essentially today … or …that's the intrinsic value. Or in other words that's 100 cents on the dollar. So that essentially for across all four cases, we use a 10% discount rate. So no matter if it's a company like a consumer … large-cap consumer products company that's a slow, mature business, or it's a high software, a high-growth software business, it's the same discount rate.

So we're leveling the playing field. And essentially what we're doing is that allows us to understand the opportunities out there at any given time. So that base case essentially is that 100%. So let's just say we think a stock's worth $100 in our base case. And the stock this morning is trading at $70 …  so 70 divided by 100.

The stock's $0.70 on the dollar. So we're looking to buy stocks at 70 cents and then sell when we get to 100 cents. We do this with low turnover to approximately about 20% to 25% turnover per year. So we follow about 250 stocks that we vetted in our seven-step process. And every single morning we can look at our inventory of names that are actively vetted and they're ranked by cents on the dollar each morning. And that really essentially allows us to have a repeatable, we think, process that we can hone each year and continue to work on basically building a great portfolio. Approximately 50 stocks that has good margin of safety. At the time of entry, we’re buying stocks again less than 70 cents and selling when they get to 100 cents.

John P. Bryson

You know, it's really got the hallmarks of a classic actively-managed approach, you know. It's going out and meeting with managers, doing your homework, being very thorough. Repeatable process over and over again and then taking a more concentrated portfolio to … to deliver active share and active return. So it's great. It's consistent with a lot of things that we talk about with investors.

So let's, let's dig in a little bit, dig deeper into the portfolio. You’ve basically been overweight consumer discretionary stocks. What do you like about that sector right now?

Emory W. (Sandy) Sanders

When you look at consumer discretionary it really starts with the health of the U.S. consumer. And essentially what we have here basically is, in a U.S. economy that's growing quite nicely, approximately 2.5% to 3% in 2024. And we think it maintains that healthy level of growth next year. But essentially that is being driven by the underpinnings of the economy … s yet two thirds of our GDP is from consumer-related spending and that we are the largest, generally, the largest developed economy growing at this rate.

Other areas like, Canada, Europe, Japan are definitely not growing at the rate we are. So it's a fairly healthy setup that we have with the consumer. Then, we do think that there is growth in the consumer's, wallet. So essentially what you have is full employment, and you've got a, you know, demographic where if you look at the wage earners by quintile, basically the bottom 20% of wage earners, approximately, only represent about 8% of total retail sales.

So the bottom 20% of wage earners, you know, while you get all the bad headlines on, on the television regarding, you know, what's happening out there, paycheck to paycheck and, but the overall impact is fairly modest to the size of the economy. It's only 8% of total retail spending. So, the bulk of folks who have jobs actually have good balance sheets.

They have, wage growth and that essentially that demographic, they essentially think of it as the middle three buckets, that 60% of wage earners in the middle, they represent approximately 75% of all retail spending. So that's where the tonnage is. And that's what keeps me constructive here. For the last couple years, actually. And that's, you know, the market's done well 2024, 2023.

And we've been there at the stress points adding to some of these names when essentially the market panics. But we've fallen back on … say look, the consumer is in good shape here. I don't see any reason why we're going to go into a hard landing. And so that seems to be playing out. So we like online retail. We like some of the home builders, and some of the more, consumer discretionary-related stocks. So that essentially is the crux of it is the strong health of the strong U.S. consumer today.

John P. Bryson

All right. Well, Sandy, I want you to know the Bryson household is doing its fair share. Over the last weekend with Black Friday we have been spending! So we're here to help. Excellent. Hey, listen, let's talk about a couple of other sectors or industries that you find interesting. What else is getting you excited about today?

Emory W. (Sandy) Sanders

When you look at the … where we are in the cycle, we think that the essentially with now Trump, having been, you know, reelected, we do think the overall capital market cycle is likely to kick into a higher gear next year. And that essentially whether it's IPOs, secondaries, mergers and acquisitions, essentially there's been a drought in this activity, essentially in 2022 or 2023 and 2024, you know, as the Fed raised rates aggressively in 2022, they really shut off the capital markets.

And so we do like the investment banks, the large ones, based here in the U.S., seem to be very well positioned. We also like the private equity companies as well. Also, when you think about technology, software and semiconductors continue to actually gather market share in general. So when you think about the way things have … in your daily life, everything that you're doing now is more digitized.

This requires software and semiconductors. And so essentially, even the car today, the cars are becoming much more advanced. And that's, not … not only digital semiconductors, but also analog semiconductors that can sense temperature, noise. And so things like you'll be able to sit in the back of your car in a few years and they'll be a separate music sound.

You know, these are the types of things that I'm sure, you know, when our kids were younger, these were definitely a nice feature or a nice upgrade. But those types of technologies are coming to the market and that really requires software and semiconductor. So we do like technology. In addition to financials, consumer discretionary, and lastly, comm services, digital advertising really is continuing to grow.

You know, there is risk out there basically from the, you know, the government with regards to big tech, we do think some of that noise will start to die down in 2025 in general. But you know certainly is a risk out there. But overall I would say those are the four sectors we'd like. Yeah. Today. And … and that's where we're spending most of their time with this portfolio now.

John P. Bryson

All right. Hey you mentioned technology. I want to hit a couple of things. We've certainly seen large-cap growth perform well. We've seen the market be really narrow in the tech and tech-related companies. If you think about that and you think about high equity valuations, where do we go from here?

Emory W. (Sandy) Sanders

Well, you know, this this is a, you know, a very strong as, you know, market because what's happened is that … that Magnificent Seven essentially, you know. We are at basically 33%, the top names represent, you know, a third of the market today. And what's happened is, is that these companies are producing more free cash flow per dollar of revenue than their peers when the market was this concentrated back in the 1970s with the Nifty 50, as well as in the industrial area back in the 1950s.

So, basically they're twice as or more profitable than their predecessors. And so that's why, you know, with these companies, they're earning these premium valuations because of this enormous profitability. You know, just think of the devices that you use every day and how much margin there is in those devices and how, predictable they are with regard to getting you to upgrade to the next version, you know, every couple of years.

So that's what's different, I think, is that these companies are just extremely strong, extremely high barriers to entry, very difficult to dislodge them. And they're enormously profitable. However, with that being said, we do think that there is a nice set up here with regards to the market broadening out. And I do think that, while these companies—I don't see them collapsing—the Magnificent Seven, I do potentially think they could take a little bit of a breather as you start to see rotation into some of the smaller-cap size companies. And we think more performance is likely to come in a market that's broadening out versus, the domination of this top seven names. So we do see that likely to occur, in general over the next 18 to 24 months.

John P. Bryson

Okay. And then if you think about, new Trump presidency and the Federal Reserve going forward, what are your thoughts on that for the overall markets as this where they from where they stand?

Emory W. (Sandy) Sanders

Well, you know, I think that, it's basically a bullish signal. Honestly, when you look at Trump's agenda, it's essentially for the markets. It's in a matter if you like him or you don't like him. You know, what I see as an investor, looking to allocate capital with an investment process and a team, as we see that the markets go to view this favorably, essentially lower tax rates on the corporate side, is a direct benefit to earnings.

And we were bracing, for this if the … if the presidential election went the other way, we were going to have to reduce our numbers, as you know, basically on higher tax rates, but we don't have that. So that's bullish. Less regulation potentially is also another bullish indicator. And I do think that you're going to see a pickup in mergers and acquisitions.

And so in general … and what we're seeing is that this earnings growth likely, next year, remain strong. We do think potentially a double-digit earnings year in 2025 for the S&P. And that clearly, is a you know, is a positive indicator. And then, you know, when you just take a step back, right.

Trump is you know, he's … he's judging himself by how the market does. You know, that's his report card. And you know, and it's interesting though, when you look back at the various presidents, you know, the performance under Biden as well as under Trump, you know, approximately was very similar with regards to the S&P per year annual return.

So we do think that, you know, we'll see how this shakes out. But as of right now, all the signs are that the bull market is likely to continue.

John P. Bryson

Excellent. Well hey, Sandy, really appreciate an overview of your process, how disciplined it is, how, repeatable it is. And it's really interesting to hear about your enthusiasm around the consumer and the opportunities going forward. So, thanks for joining us on the podcast. We always appreciate hearing from you.

Emory W. (Sandy) Sanders

Thank you. John, thanks so much for having me on.

John P. Bryson

You got it. And folks, if you want to hear more, as always, please subscribe to the Portfolio Intelligence podcast on iTunes or wherever you download your favorite podcast. You can also visit our website JH investments.com to read our viewpoints on macro trends, portfolio construction, alternatives, business building ideas and much, much more. Thanks as always for listening to the show. Have a great rest of 2024.