Andy D’Souza:  Welcome back to The Investment Conversation. I'm Andy D'Souza, partner and chief marketing officer here at Lord Abbett. As part of our 2025 investment outlook, we're going to talk with our investment leaders about key themes for the markets in the year ahead. In this podcast, our guest is Lord Abbett's director of equities, Matt DeCicco, a partner at the firm. Matt, great to have you here today.

Matt DeCicco: Thanks. Happy to be here.

D’Souza:  Matt, as we sit here early January looking ahead to 2025, I wanted to build off some of your thoughts at the end of last year and looking ahead and what to expect in the equity markets overall. Why don't we paint for the listeners just the landscape currently in the equity markets? And as we think about the landscape overall in different metrics, you might look at different factors. What are some of those factors you're thinking about as you think of the markets going into 2025?

DeCicco: Sure. I think the equity markets are positioned positively and for further upside. There are really a few things that I'm focused on. First off, the momentum of the market remains positive, whether you look at the NASDAQ, the S&P 500, or even the Russell 2000.

All of those markets are in good, positive uptrends, meaning they're showing consistently higher highs and higher lows. Also, the market breadth is still strong. It's not as high as it was at the peak in November of 2024. But it's certainly well above the lows that we saw in September of 2023.

So, first reason to be optimistic about markets heading into next year is just the momentum, the trend in the market itself. The second, and a big factor over the last two years, has been the moderation and inflation. The preferred measure that the Fed [U.S. Federal Reserve] looks at, of course, is core PCE [personal consumption expenditures, excluding food and energy costs].

That was as high as 6%. And the most recent reading in November, six-month annualized core PCE is at 2.3% or 2.4%. So, within spitting distance of the Fed's 2% target. The third thing I'd highlight is just liquidity. We went through a period in 2022 where the fed was aggressively hiking rates into 2023.

We actually got a few cuts in 2024 where the Fed took out about 100 basis points. And now we are at a place where the Fed at a minimum is going to be neutral, we think. And just historically, looking at data over the last 70 years, a definitive study that we've seen by RenMac [Renaissance Macro Research] is that the market does well when the Fed is easing.

The market does well when the Fed is on hold. It's really when the Fed is hiking, so think back to 2022, where market returns are pressured. And so we look at this as an environment where the Fed is most likely to be, at a minimum, neutral and very unlikely to be hiking.

D’Souza:  Great. Thanks, Matt. And so, it sounds like we're looking at things like momentum. We're looking at inflation, liquidity with the Fed moves recently, and the outlook for the future to be at least maybe accommodative moving forward. Definitely not restrictive, it seems like, in the near future in your outlook here. What about earnings?

DeCicco: So, earnings are another positive driver for the market. And I guess, first and foremost, you have to highlight that the tremendous earnings growth and a driver for the market not just over the last couple years, but, really, over the last 30 years is just the power of the technology revolution.

So, the latest iteration of that, of course, is generative AI [artificial intelligence]. But over the last 30 years, the Internet, the smartphone, and the mobility boom that happened because of that, cloud computing and now generative AI. So that is driving positive earnings throughout the market.

But what is particularly, I think, exciting about earnings as we look into '25 and 2026 is that the earnings growth, which in '23 was very concentrated in just the Magnificent Seven, is really starting to broaden beyond just those seven mega-cap tech stocks.

So, for example, in 2023, the Magnificent Seven grew their earnings by about 35%. And, really, the rest of the market, the S&P 493 [the S&P 500 excluding the Magnificent Seven] had flat earnings. And if you go down to the Russell 2000, earnings growth was actually negative. Now that gap began to narrow in 2024 and, certainly, in the second half of 2024, it narrowed even further.

And as we look out to 2025, the Magnificent Seven will still have very good earnings growth. But that earnings growth will decelerate down to somewhere around 20%. And the rest of the market is seeing accelerating earnings growth to low double digits.

But the net of this is the last couple years, the S&P 500 has shown good growth. We think the S&P 500 will grow earnings by about 12% next year. But the distribution of that earnings growth is going to be just much more balanced as we head into '25 and '26 than it was certainly in 2023, which I think is good for the market. Mega-cap tech stocks can still do very well. But you could also see the market continue to broaden like we started to see last year.

D’Souza:  You're painting a picture that's pretty bullish, in general, for the markets overall looking ahead here in 2025 across the multiple factors that you've mentioned. We see a lot of all-time highs in different industries across the globe. What about those that say, "you know what? It's a little long in the tooth. I'm not sure about this.” Any thoughts on sort of the bear angle here?

DeCicco:  Yeah. And there's a few things in there, so I want to hit on a few of those things. I would say there's always risks. There's always bricks in the wall of worry to climb. Geopolitics are one. A return of inflation is another. An economic slowdown is one.

And you also highlighted valuation and, perhaps, that the market is already long in the tooth. So maybe just on that last one, the length of the bull market. If we mark this bull market as starting in October of 2022, that means we're about a little over two years into this.

Just if you look back through 90 years of market data, the average bull market has lasted three years and has gone up 100%. That's just an average. So, if we just apply that simple average, that means that this bull market, if it's an average bull market, has maybe another nine months to go and the S&P 500 could get to 7,000.

That would be a 100% return. So that's not bad for the next year. If you think, like I do, that this bull market might be better than average, and if you want to compare it to the Reagan-Volcker bull market from '82 to '87 or the post-GFC [global financial crisis] bull market from '09 to '15, or best yet, the '90s bull market, the Internet boom, which also coincided with a Fed rate hiking cycle ending, those bull markets did something like 250% bottom-to-top and lasted about five years.

So, if you apply that to this market, then you could say this could be S&P 500 12,000 by something like 2028. So, I think it's a little early to make the argument that the bull market is long in the tooth, even if this is an average bull market.

And like I said, because of the conditions I described earlier, I think we're really positioned where there's reasons to believe that this bull market still has trend and still has momentum. I want to come back to you on the valuation argument, but I just want to make sure I got that before I jump right to valuation.

D’Souza:  It makes sense. And so, if you look back to those bull markets again, you drew some parallels. And one of the major ones that you talked about earlier was sort of, I guess, the Fed and their role in all of this. And it seems like at that point, especially Volcker, they had finished their hiking cycles and that was sort of in the rearview mirror. And it feels like you're of the same thought here, that the hiking cycle is sort of in the mirror.

DeCicco:  I do. I think, well, a lot of times throughout history, people tend to fight the last war. If you think back to COVID, after COVID ended, people were always looking for the next variant. After the GFC, people were always looking for the next crisis.

And I don't think that we should be discounting inflation whatsoever. But I think you just have to realize that the inflation that we fought in 2022, which caused the Fed to take rates from zero to 5.25%, that was the largest and most aggressive Fed tightening cycle of my lifetime.

And so, it's possible that the Fed may have to adjust their accommodation somewhat, but I just think it's unlikely that inflation is going to become so significant that you have to fight the same battle that we did in 2022 with such an aggressive tightening cycle that you are coming off the zero bound [zero interest  rate]. So that's the distinction that I would make there.

D’Souza:  Is there one of those factors -- we spoke about momentum, inflation, liquidity, and earnings. Maybe you just said it, in a sense, but is one of those the most concerning, in a sense, that would get in the way of your bullish thoughts of the market overall? Does one of these things say to you, "This one would be the one I'd be most worried about if I was worried"?

DeCicco:  So, the short answer is no, that it's always a multi-factor view of what drives equity markets. And the things that I describe, the trend of the market, the inflation, liquidity, earnings, or even just the concept of how powerful technology is, those are the factors that are driving this bull market.

It's very possible that something new would drive the next bear market or the bull market. For example, inflation was really not something that we paid a lot of attention to for the last 25 years until 2022. So, I can't pick out any one single of those things that I'm particularly focused on.

But despite what I just said about saying that I don't believe, based upon the leading indicators I'm looking at, that inflation is going to be a problem again, that's the big one. If that were to come back and my view is wrong that the Fed would have to be very aggressive, we just saw what that did to equity markets.

That's just a very difficult environment for equity markets. So, I don't think it's a high negative possibility, but I do think it is something to be aware of, because if it comes back, then the impact on the market would be significant.

D’Souza:  So, to use your terminology, it's just one more brick in the wall. Maybe it's a larger brick, but it's still just one brick in the wall of many.

DeCicco: Well said.

D’Souza: Matt, if you wouldn't mind, let's go back to your comments on valuation.

DeCicco:  Yes. So often, you'll hear today a bear market argument that stocks are more expensive today than they were historically. And very specifically, people will say the stock market today trades at 21 times forward earnings. And historically, over the last 50 years, the market has traded at 17 times forward earnings.

This is a P/E ratio on next 12-month earnings. And my response to that would be, well, the companies today are much better than they have been over the last 50 years. And here's a few reasons why. First off, the number of asset-light businesses in the S&P 500 has increased dramatically, while the number of manufacturing businesses has come down dramatically.

The specific numbers are 50% of the S&P 500 is asset-light today compared to 20% in 1994. Manufacturing businesses were 45% and they're now 20% of the index. So that's the first thing. The second thing is the S&P 500 companies now consistently grow [earnings] much faster than U.S. GDP growth.

This was not always the case. For 30 years, up through 1995, the S&P 500 grew about 200 basis points slower than U.S. GDP growth. Over the last 30 years, the S&P 500 has put up earnings growth that is about 400 basis points faster than U.S. GDP growth.

So, the companies in the S&P 500 are growing faster. And then finally, the capital returns to shareholders have improved dramatically. The ROE [return on equity] of companies has gone up from 12% to 20%. And about 75% of those earnings are being returned to shareholders in the form of dividends and share buybacks.

So, when somebody says to me, "The premium that you're paying for the market is 20% higher than it has been historically," I say, "Yes. I'm fine with that because the companies are much better." I just would not use that reason, a 20% premium to historical valuations, as a reason not to be invested in this market.

D’Souza:  Matt, another topic I want to talk to you about is something you read a lot about in the press. And I'm not really sure what to make of the headlines and what it all means. I look for your thoughts on this, for sure. And the theme really has to do with the private markets versus the public markets.

You read a lot about companies like SpaceX and other companies staying private for longer these days. Some headlines out there would say that if you go back to around 1996 or so, there were 8,000, roughly, public companies out there to invest in.

And today, it's only about 4,000. You read a lot about “dry powder” for private equity, a couple of trillion dollars there. M&A [merger and acquisition] activity is slow. The interplay in the public and private markets in equities, how does that make you feel? How do you make sense of all this?

DeCicco:  Sure. Well, first off, companies are definitely staying private for longer. I've seen a statistic that it used to be that the venture incubation period was six to 10 years and now it's more like 10 to 14 years. So, companies are staying private for longer.

I think the cost of being a public company is higher through regulation and a number of things over the years. Another statistic I have for you is that about 20% of the companies in the 1990s IPOed [had initial public offerings that placed them] in the Russell 1000, so that they were larger cap stocks.

Now that number is as high as 30%. So, more and more companies, when they come public, are actually coming public at a higher valuation. They're coming public in the market capitalization of a Russell 1000 stock rather than a Russell 2000 stock.

I will say, though, that this is very specific, really, to technology. In most other sectors, companies are not staying private that much longer. But a self-funding technology company, especially, those companies can stay private for longer and they have been.

And I will say maybe the valuation premium, too, is because of the scarcity value. If there were 8,000 companies that you could invest in before, and now there's only 4,000, well, maybe that means that those 4,000 should be worth more. So maybe it ties into what we were talking about earlier.

I also think there's a cyclical component to this, too. Going back to what we said before about rates going up, the IPO market slammed closed in 2022 and 2023. It started to open up in 2024. The M&A market slammed closed in 2023. You've had a very, I'd say, aggressive FTC U.S. Federal Trade Commission], which has lessened M&A activity.

So, I think as you look out to 2025, something that we're anticipating is that the IPO market should continue to pick up, so we'll have more companies come public, and you should see M&A pick up as well. So, I guess my answer to your question is there are a few things.

There are secular things that are driving this. There are also cyclical things that have impacted the last few years. And it is likely now with good equity markets, with, perhaps, a change in leadership, a little bit of deregulation, that you could see some of those at least cyclical forces improve a bit.

D’Souza:  So, would it be fair to say it's not necessarily one of the bricks in your wall of worry, but it's a factor in the marketplace to be aware of, but not sort of harming or hurting your opportunities that define great stocks out there?

DeCicco: No. It isn't. I think if you look back last year, a few companies that came public, Reddit was a company that came public. Astera Labs was a semiconductor company that came public. Loar Holdings, an aerospace company, that came public. Arm Holdings, a semiconductor company that came public.

Well, first of all, they all had excellent returns once they came public, which, generally, when the IPO market does well, that leads more companies to come through the IPO window. But of those four, three would have come in at a market cap that's in the small cap range.

Arm Holdings would be the exception. It really came out as a large cap company. So, I view that as very high-quality companies are coming through the IPO market. And those are good opportunities for us. The other thing that occurred, too, is a lot of companies that came out in '21 came out at valuations that were just too high.

They came back down. So maybe they were mid-cap or large cap stocks. We weren't interested then at that level. And they came back. If they were a large cap stock, they came back into the mid-cap range. We could buy them in our mid-cap portfolio, or they started as a mid-cap, came down to a small cap range, we could buy them in our small cap portfolio.

So, there were a lot of IPOs in '20 and '21 that ended up coming down quite a bit, which created an opportunity for it. So, I think the other aspect of this, I guess, that I'm trying to convey is there is something of a timing aspect, too, of when they become good opportunities for us. If those companies stay private for longer, and they ultimately do come public, they become an investment opportunity for us. It's a matter of when, not if.

D’Souza:  Makes sense. And again, I keep asking you questions in terms of putting bricks of worry in the wall here for you.

DeCicco: Yes.

D’Souza:  But to your point on opportunities, where are the pockets in the market that you see in 2025 that you're most excited about?

DeCicco:  Yeah. So first and foremost, have to start with generative AI. I know I mentioned it earlier. But there is still earnings upside from companies benefiting from generative AI. And there's really two parts of this, I would say. The first part is the buildout of the data center and the power grid that's required for this compute.

So those are companies in the semiconductor industry, of course. But it's also the industrial companies that allow for the buildout of the data center, as well as to make sure that our grid has the resiliency and transmission required to power those data centers.

The second part of it in generative AI are the use cases, which really favors, I guess, first off, digital advertising. You think of the major social media networks and how they're using generative AI to make sure they deliver content to you that you're most likely to engage with.

But the second aspect of use cases is in enterprise software. So, putting these tools using this compute at the data center that allows you and I to be much more productive in our everyday work. And I would say that first opportunity, the buildout of the data center, is further along.

And the use case is the second opportunity is really just getting started. But both still have opportunities as we look into 2025. I think infrastructure globally is an opportunity. This is whether you want to call it on-shoring or near-shoring or just updating beyond the power grid, updating infrastructure.

This is not just a U.S. phenomenon. This is a global phenomenon. And some are investing in companies, especially in the industrials or in the materials sector that are taking advantage of this. Aerospace, and especially the aerospace aftermarket, is an opportunity that we see continuing to be a place where there's upward earnings revision potential in '25.

European defense companies is an area especially for our global portfolios where there's opportunities. Something you mentioned earlier about M&A, and then I spoke on a little bit more about IPOs, well, those things are good for the wealth management and the M&A advisory shops.

So, the capital markets being healthy and more M&A and more IPO activity, that's good for companies in the financial sector. And then finally, in health care, we like companies in minimally invasive medical technology. So, these are companies that can do procedures in a way that's easier for the doctor and less invasive for the patient.

And then there's also a lot of innovative things happening in biotechnology in areas like rare diseases and in cancer. So, I think that was seven or eight different areas, but there's no shortage of good opportunities in equity markets both here and outside the U.S.

D’Souza: Matt, you mentioned capital markets stocks. Could you go a little deeper in terms of where you see the opportunities there and why?

DeCicco: Sure. And it relates back to what we were talking about earlier with, at least in our opinion, the likely strength in the IPO market in the year ahead, the return of M&A in the year ahead, as well as the health of capital markets, in general. So that's good for wealth management companies. That's good for M&A advisory companies. And it's good for a number of other stocks in the financial sector as well.

D’Souza: So aside from the certain sectors and industries around the globe that you mentioned for opportunities in 2025, are there certain regions around the globe or countries that you see opportunities in?

DeCicco:  Yes. And I should clarify that those industry and sector themes I called out, many of those are happening globally. Infrastructure, generative AI, of course. Specific regions as well. India remains a very attractive growth market and we think has very good growth ahead of it for the next decade. Corporate reform in Japan has been a tremendous source of alpha for our strategies. We're finding a lot of good ideas in the Japanese market, and we think that'll be a source of alpha for us in 2025 as well.

D’Souza: Thanks, Matt. We started off the podcast talking about a lot of macro top-down reasons why to be bullish on the markets and the equity markets looking ahead for 2025. And the broadening opportunity set overall came home at the end here when we talked about the different individual opportunities, more bottom-up in terms of which sectors and areas of the market and regions of the market you like.

And so those two things combined, it looks like a great combination for what should be a pretty fruitful and exciting 2025 ahead for equity. So again, thank you for your time today. It's been fantastic. Always love talking to you about this stuff. Thanks, Matt.

DeCicco: Thank you.

D’Souza: Thank you all for listening. Be sure to visit the insights section of lordabbett.com to find our complete investment outlook and other market commentary.