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Jacob: U.S. and China trade talks are heating up here to talk about the implications of those talks on your portfolio is Josh Emanuel, chief investment officer of Wilshire Funds Management Management. Josh, thanks for being here.

Josh: Oh, thank you for having me.

Jacob: So S&P 500 is up 19% year to date. How much can progress on trade talks push up equities from here in the U.S.?

Josh: That's a great question. Uh, in order to answer that question, I think investors have to consider four specific factors. The first, uh, is economic growth in that, uh, if a trade deal gets done, how is that likely to impact economic growth? And I think the answer to that is it's likely to be a positive impact. Now obviously there's some uncertainty as to the terms of what that deal could look like if it got done. But the expectation is it would be a positive impact in that it's likely to boost, uh, corporate confidence. What we've seen on a year to day basis is the consumers healthy. But, uh, sentiment in the corporate sector started to deteriorate and it's reasonable to expect that company management is going to sit on their hands until there's some clarity with respect to, to trade going forward. So, so that is likely to serve as a boost to economic growth.

Josh: Now the spillover of that however, is interest rates. And as we all know, interest rates have continued to move lower and equity valuations or equity prices have been very much supported by the expectation that the Fed is going to continue to cut rates are going to start cutting rates more aggressively. And today the market's pricing in two to three rate cuts, uh, more close to three rate cuts, uh, by the end of the year that is supportive of equity valuation. So to the degree that we get a trade deal done with China and expectations of economic growth improve going forward, there is a reasonable probability that investors need to price in a fewer number of interest rate cuts. And that actually can serve as a headwind to equity valuations, particularly in those parts of the market where valuations are more rich. So the third piece of this is valuations and I think the interest rate sensitivity that we see in equities today is much greater than people may appreciate.

Josh: And so the opportunity that exists is going to be in the more attractively priced parts of the market, many of which are more cyclical today. And so in the same way a positive economic growth expectations are likely to boost more cyclical sectors. So when you look at, you know, value as a style, you look at the financial sector versus technology as an example, the dispersion evaluations is very significant between those two parts of the market. And I think investors likely will be, you know, could be, could benefit from a more material upside in the more value oriented parts of the market relative to the growth oriented parts of the market. That is true on a global basis as well. So U.S. equities may actually not be the primary beneficiary, uh, from an expected return perspective going forward to the degree that we get trade done. As an example. uh, you know, China, uh, valuations today or emerging market evaluations today are very attractive relative to U.S. as an example relative to history. So, uh, you know, investors and, and further to that from a sentiment perspective, emerging markets are very under owned today. So, uh, getting a trade deal done, uh, you know, some type of resolution could actually serve as a boost to emerging markets even more than than U.S. Markets today.

Jacob: Now in the U.S. you're mentioning that if we get a, if we get a really, really good comprehensive rich agreement, you know, stock investors have priced in a lot, that's number one. And number two, you know, the, the earnings multiple on the S&P 500 has expanded. We still have pretty low earnings growth expectation for all of 2019. You know, I guess even if stocks go a little bit higher down on an agreement, is there a lot of upside?

Josh: Again, it's hard to get excited about, uh, you know, upside in the near term on the broad market. But the nice, uh, you know, the nice thing about this environment is there is a lot of dispersion in valuation. So, so if you're working with a professional money manager who knows how to identify those parts of the market, uh, active management I think will benefit in this type of environment to a greater degree. But you're absolutely right. Earnings expectations for 2019 for the full calendar year are roughly 2.3%. Uh, and that assumes a very, uh, you know, meaningful pickup in earnings growth in the third and fourth quarter. So to the degree that the guidance is negative or to the degree that, you know, trade continues to weigh on, on earnings or, uh, you know, wage growth or even dollar strength, uh, these are factors that could impact that.

Josh: And, and one other point is that in 2020, your earnings growth expectations are, you know, 10, 11% on the S&P500, so, you know, into 2020 where many are expecting perhaps slower levels of growth, there is still very high earnings expectations. So, you know, and that is driven by, you know, certain parts of the market that are a loftier from a valuation perspective because of very high earnings growth. But again, there are parts of the market that are very cheap and very attractive. And so I think investors could still make money in the, in this, in marketing environment. It's really about understanding where those opportunities are.

Jacob: Josh, really great insight. Really appreciate it. Thank you.

Josh: Sure.

If all goes well on the trade front when the U.S. and China meet this week, the major indices may rise, but the gains may ultimately be most concentrated in financials and cyclicals, rather than in growth tech. 

"The opportunity that exists is going to be in the more attractively priced parts of the market, many of which are more cyclical today," Josh Emanuel, chief investment officer at Wilshire Funds Management said. "So when you look at value as a style, you look at the financial sector versus technology as an example, the dispersion in valuations is very significant between those two parts of the market." 

Before we get to why all of that may be so, let's go over some important facts first. Earnings growth is expected to come in at roughly 2.3% for 2019. Meanwhile, the average forward earnings multiple on the index is around 17, higher than the 10-year average of 14.8, as the index has risen 20% year-to-date, in part because the market believes further tariffs are out of the question. Emanuel doesn't disagree that's not exactly an attractive combination. 

But "I think investors likely could benefit from a more material upside in the more value oriented parts of the market relative to growth oriented parts of the market," Emanuel said. 

Right now, banks and financials trade at roughly 11 times earnings, versus big tech, which can range anywhere from the low 20's for players like Facebook (FB - Get Report) and Amazon (AMZN - Get Report) , and above 40 for other stocks exposed to the cloud and software. This is a normal difference, but perhaps financial stocks have slightly slimmer valuations than usual. Citigroup (C - Get Report) trades at 0.91 times book value. Bank of America (BAC - Get Report) , Goldman Sachs (GS - Get Report) and Wells Fargo (WFC - Get Report) all trade at roughly 1 times book value. Meanwhile, fewer rate cuts would mean there will be less of a floor on tech valuations. 

Investors will have to weigh the net effect of falling interest rates and potentially improving economic growth expectations on any trade agreements for bank stocks. But as Emmanuel noted in a previous interview, better growth expectations with any trade deal would likely prompt investors to price in fewer rate cuts, another positive for the banks. 

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