Talking Markets Podcast: Broadening Delivered. Now Prepare for Volatility.

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Host/John Przygocki: Welcome to Talking Markets with Franklin Templeton. I'm your host, John Przygocki, from the Global Marketing Organization at Franklin Templeton. Today I'm joined in the studio by Chris Galipeau, Head Market Strategist with the Franklin Templeton Institute. The Institute is a research-centric organization at Franklin Templeton focused on delivering unique macroeconomic and capital markets insight to our clients.

As we get started, I'm going to frame our conversation. Since January of 2025, the Franklin Templeton Institute has been making the case that the equity market leadership would broaden beyond the mega-cap tech companies, commonly referred to as the Magnificent Seven. In the Institute's most recent research paper from Chris and his colleague Lukasz Kalwak, their statement is that the thesis has been delivered, but there is a stark warning that investors need to prepare for a more volatile, demanding phase. Chris, welcome.

Chris Galipeau: Good to be here, John. Thanks for having me.

John Przygocki: Before we get into the new research piece, can you give listeners a brief summary of what broadening means and why it's been this defining story of the last year and a half in the equity markets?

Chris Galipeau: Yeah, sure. So, when we use the term broadening, what we're talking about, as broadening suggests, is the movement from domination of earnings power and a domination of returns from a handful of names, i.e. the Mag Seven plus a couple others, to a situation where many more stocks are participating in the rally.

So, you're really moving from almost a one-trick pony to something that is much more participatory. And that's also bullish, by the way. And that's really what we called for as we came into January of 2025. And largely that has played out.

John Przygocki: So, Chris that's fantastic. Let's rewind a bit. In January 2025, as you mentioned, you published “Get Ready for a Broader US Equity Market.” What was the core conviction at that time? And, frankly, did you get any pushback in the market with your perspective when the Magnificent Seven stocks were driving everything up, up and up?

Chris Galipeau: Yeah. So, the catalyst for us to write the paper, John, was pretty simple. We took a look back at every period in US history, in the last 50 to 75 years, where we could get the data and we wanted to evaluate and understand the characteristics that are in place before the stock market actually runs out.

And there were four variables that we focused in on—in no specific order. It was easy monetary policy. So we were experiencing that. The Fed was cutting rates. Earnings estimates were being revised higher. The economy was fine and expanding. And you always had a high concentration. So, when we ran through that checklist of what normally is in place before the tape broadens, we had all of those four variables.

So that was the start of it. In addition, we were formulating our view for calendar year 2025 and we had done a lot of work—this is globally now—around forward earnings growth and forward earnings power. And so, what we saw in the data was a very clear message that from 2020 to the end of 2024, the Magnificent Seven companies drove the lion's share of earnings growth in the S&P [500 Index]. They drove virtually all the performance in the S&P. And when you took those seven companies out and recalculated the data, what you would see is that the S&P had de minimis earnings growth over that time period away from those seven names. And so that's where we put our flag in the ground and basically told our clients, if you believe that stocks follow earnings over time (because they do), then you probably need to take a look at how you're how you're positioned.

Knowing that and being able to show them that, the earnings power looked much better outside of the US than it had in probably 15 years. The earnings power inside the US, so by major index in the US, looked much better than it had probably since coming out of COVID. So, the combination of all that led us to send that message to clients.

Now, getting pushback is an understatement. We got a lot of it. And if you take the call to get exposure outside of the United States, we focused on EM, Japan and Europe, the pushback there was, “We've had exposure there for the last decade or two decades, and it hasn't worked. And, you know, we're very, very hesitant to put this trade on.”

Because in the day-to-day reality of a financial advisor, they're meeting with clients, of course. And the clients would say, “Why do we own this emerging market portfolio or why do we have exposure to Europe? Why don't we just keep it all in the United States?” Because the United States had dominated returns, and not by coincidence the United States also had dominated in terms of earnings growth. So, you know, once bitten, twice shy. They didn't want to go back to that.

There also was this general belief that in order for EM to work, you needed the dollar to weaken significantly. And our pushback to them was: “Yes, a weaker dollar will help in the translation of returns.” But our argument was: “That is not necessarily the foundational piece that you need. The foundational piece that you need is the earnings power.” And we could show that, you know, very easily to clients. And we did.

To be honest, the same argument was given to us with regard to small cap stocks in the United States. Same sort of pushback from the client base. “Hey, you know, this is always just a trade. It never really works.”

And I understand their arguments, because, for the last 15 years, they've been right. But I think it's on me and on our team to present the data, the empirical data, and let that drive our opinions, not the other way around. And, so, a lot of investors are always fighting. I understand that too. But it's my job to look through the windshield and say, “Hey, this is where the puck is probably going to go.”

And, you know, that's what we spent our time on. And, you know, we got a tremendous amount of pushback on that call all through 2025. And to be honest, Wall Street got on the call in the first quarter of ’26. Now people were realizing the performance has been outstanding since we started the call. And they kind of, you know, started to grab onto it.

And all we did was re-show our clients the exact same data that we showed them in the fourth quarter of ’24 as we wrote that paper and as we were in the process of teeing that call up. So, yeah, a lot of pushback and that's perfectly fine. And the call ended up being a world-class call.

John Przygocki: Absolutely. And that data-driven analysis and insight right on the money. Fast forward a year later, in January of 2026, you sharpen the thesis to identify where that leadership would emerge. As you mentioned, US small caps, equal-weighted, emerging markets. Walk us through the evidence that said that broadening was becoming a place to allocate to and not just some abstract idea.

Chris Galipeau: Yeah. So, great question. So we went right back to the same data set. And what I do with our clients is: I don't want to give them just my opinion. And so what we could show them conclusively is that forward earnings on a compounded annual growth rate for calendar ’25, ’26, ’27 (and I can even incorporate ’28 in there now if I had to) showed and proved that in the United States, for example, the strongest earnings growth for calendar ’26 and ’27 came from the Russell 2000, both Russell 2000 core and growth and value. So all three of those sub-buckets of the Russell were in the pole position when it came to earnings growth. And we know that that is the primary driver. That was the first thing.

Second thing was (and this is kind of anecdotal), but we knew from conversations with clients: all through 2025 vis-a-vis the pushback that we got, that the average advisor in the United States was underweight emerging markets substantially and also underweight the Russell 2000 substantially, and even the S&P 400 mid-cap index.

So we really used this data just to try and make sure that they were aware that the earnings picture was getting much better, much broader, and that should lead to much better participation.

And we've seen that, right? So, small caps and Russell 1000 value leader in the clubhouse here year-to-date. They’re the leaders in the clubhouse from Jan of ’25. The equal-weight S&P is outperforming the cap-weighted S&P here year-to-date. And that's essentially what our message was in Jan of ’25. Fast forward to August of ’26 (now September 1st of ’26), that's still the message. And so it's not an abstract idea. We built it with the empirical data.

And I think that approach is welcomed by our clients. It keeps us objective. We don't have an ax to grind. All we want to do is help them protect capital, John, or to make money here, right, for clients and do it in an informed way. And that's what we set out to do. And I think that's what we accomplished.

John Przygocki: Chris, you mentioned some of those numbers right there. And really the performance numbers for some of the indices are quite striking when you look at that January 1, 2025, period through midyear, June of 2026. As these returns were materializing over that span of time, was there a moment you thought to yourself, “This is exactly what we drew up?”

Chris Galipeau: Honestly, yes. And I think back to the 25 years I spent as an analyst and an equity portfolio manager, as a growth manager, I was uniquely keyed into a few fundamental factors that generally drive stock price movement: revenue growth, earnings growth, EBIT margins, net income, and then ultimately EPS growth.

And so what we saw on paper really did materialize. And you could see that right away in the first quarter of ’25. And then it really just started to build up steam. And then I think most advisors would say to you that this thing started in the first quarter of ’26. I think that's probably when a lot of people noticed it, because the performance really snuck up on people.

But we could see it early in 2025. And you go through the tariff situation there in ’25 and the world gets knocked around and markets get knocked around. We never wavered from the call. Look, this is generally how it works, right? If you go back to 1950 and you plot out earnings growth for the S&P over that 75-year period, and then you look at S&P price return relative to earnings growth, what you'll see there is the correlation is spot nine five [0.95]. We've done it for every index, different time periods. The correlation is not always that high but it's always above spot eight zero [0.80]. And there's no coincidence there. Stock prices follow earnings over time. So thankfully for us and mostly for our clients and for the end client, that puts their trust in the FA teams to help them preserve their wealth or grow their wealth, whatever the goals are, that worked very well. So we're happy with the way it played out.

John Przygocki: Terrific. Chris, a skeptic might say that it was just mean reversion. The laggards simply caught up because they were cheap. How do you distinguish a genuine fundamental broadening from a simple valuation snapback?

Chris Galipeau: Yeah. Great question. So, if you think about the last 15 years, the message that's been communicated to investors around, let's say, Europe or emerging markets. (You can even make the case in small cap companies that are profitable.) The argument was simple. You need to own Europe and EM because it's cheap, right? That's the argument. And in theory low correlation to the US, which is actually not true. Correlations are not low. However, believe me, I have learned this the hard way as a PM. Stocks can remain cheap for a long time, and just because something is cheap does not mean it's going to work. That's a fallacy. What you need and what we had coming into ’25 was the combination of low multiples: Europe and EM versus the US, for example. We also, for the first time in 15 years, had a catalyst that is needed to unlock the valuation discount and cause those markets to rerate.

And so, the argument of you need to own because it's cheap didn't work. It shouldn't work, John, because there's no catalyst to cause the rerating. And this is what caused the pushback, right? “Now Chris, we've been told this for ten years, 15 years. And we did it and it hasn't worked. And I’m never doing it again.” I get it. But right now, present day (this is January of ’25 and still today), you have the catalyst to cause these markets that are cheaper on a multiple basis relative to the US, maybe even relative to their own histories, to cause those multiples to go up. And that's always the case, right? That's always, always the case. And so, I don't view that as a mean reversion at all. This was fundamentally driven. This was driven by earnings.

And if you actually decompose the earnings stream in the US for calendar ’25 and calendar ’26, what you'll find is, this year, 100% of the return in the S&P has been driven by earnings growth. The multiple has actually come down, because the earnings power has been so strong. And that's true basically around the world, certainly in the US: that earnings on a reported basis drove the tape in ’25 and are driving the tape here year-to-date. And it can be hard in our business. You know this is true. It's hard to focus on the variables that actually matter, because we get bombed with headlines 24/7/365. The negative narrative dominates the headlines everywhere you go.

And, in reality, the variables that move stock prices starting in Jan of ’25 were incredibly positive. And that's what we focused on and that works. So I don't think it's a mean reversion, John. I think it's a classic case of low multiples meeting a catalyst. And that's when you can really make some money. And that's exactly what happened.

John Przygocki: Bear with the variables that actually matter. That's a great line, a great thought and great insight. Chris, care for volatility now is at the heart of this newly published paper. So, a shift to a more demanding, volatile phase in the markets. Why does a validated broadening thesis, if it does, lead you to expect more volatility not less?

Chris Galipeau: Yeah, okay. So, great question. I think there's a couple things at play here. First and foremost, I'll give you just an update on the recovery we've had or the rally we've had since the Middle East conflict started. So, the S&P is up about 24%. I'm rounding a little bit. It's 23 spot seven four [23.74]. So, if you think about long term rate of return in equity markets, 8 or 9% annualized. So we just got two-plus years of S&P returns in five months. So that's the first thing.

You've also got in some pockets of the market probably peak rate of change in EPS growth. And so once you start to get that you enter into a period of volatility. Because now investors are pushing and pulling on “Hey, we think we're talking about max rate of change in earnings power here.” That's one view. And the other view might be “No, we think it has legs up to 2030” or whatever the case. And so that causes some inherent friction and causes some volatility.

We're also entering into the most volatile months of the year here. And I think everybody knows this. But September is one of the weakest months, if not the weakest month of the year. There's an old Wall Street adage about the quote unquote October massacre, I think, you know, tends to grab us in the first couple weeks of October. And then, of course, it's a midterm year. And we know historically that midterm years produce higher levels of vol[atility], so on and so forth.

So that's what we expect here for the next couple of months. We're still bullish. Don't be surprised if the tape pulls back here. And you know, John, quietly, this year there have been four S&P 500 pullbacks between let's say 4% and 9%. The nine-percenter was in March with the situation in the Middle East. It's perfectly normal to get another one.

And so I think we're entering into a period here where we should expect some chop for the reasons I mentioned. I think investors want to be prepared for that, number one. And number two, you want to be a buyer there because, you know, the third year of the presidential cycle is very positive historically.

So I think there's a lot going on in the soup here, nothing to be overly concerned about. But we just want to let our clients know that, “Hey, for a lot of reasons, you should expect a little more vol here. Be prepared for it, one. Be prepared to buy it, two.”

John Przygocki: Makes sense. I was actually going to follow that up with a question on recovery from the March lows, but I think you covered it.

So let me transition to the next one here. One of your key signals is liquidity, and you define it specifically as the aggregate stance of major central banks easing versus tightening. Where does that gauge, that trigger, sit for you today? And does it matter today more than it did six, seven months ago?

Chris Galipeau: Yeah. So, what we did in the paper was take a look at all the major central banks around the world. Simple ratio or calculation, the number of banks cutting rates versus the number of banks that are hiking rates. And so, we plot that data in the paper. And then what you can see is that the raising of rates, if we have a net amount of central banks raising rates around the world, right, let's say we've got ten central banks that we're watching and six are raising rates or seven are raising rates. So, you've got a net bias there to raise rates. That's raising the cost of capital. That's raising the cost of financing. That is a very good lead. It's a leading indicator of future earnings growth. And so the lead time from central bank activities to the impact on earnings growth is about 14 months. And so right now it's basically unch[ang]ed. It's nothing to worry about here now.

But you think about what Warsh talked about last week. And you think about market-based pricing mechanisms of a Fed hike here by the end of the year. It's better than a coin toss chance. The odds just went up a lot here in the last week. So I don't have a crystal ball. But the net effect of the majority of central banks or more central banks raising rates versus cutting rates is a pretty good predictor. And it's a good correlation to how that ends up impacting companies and ultimately ends up impacting forward earnings growth.

And if you think about, you know, what we just talked about earlier about accelerating earnings power in the US and around the world in calendar ’25, ’26, ’27, this is something that we need to watch and watch closely, because it's got pretty good predictive power in terms of forward earnings growth. And we know that that's the variable that really matters.

So, it hasn't changed a lot in the last six months. But it's something that we need to watch. And it's not as easy as it was a year ago. Meaning there are more banks cutting rates in the last 24 months than raising rates. And that's starting to shift a little bit. And we need to be cognizant of that, and we need to understand the impacts.

John Przygocki: That makes sense. I was going to ask you about the mechanics there and if there was anything that you would be looking for that would be highlighting those strains. I mean, I think you covered it.

Chris Galipeau: The one thing that strikes me as we're talking about this is the old Wall Street adage: three steps and a stumble. And so, that adage is talking about the Fed raising rates three times or more. And once you get to the three, kind of the threshold there, that's when problems can occur, right? Meaning the Fed takes policy rate into a restrictive stance. And we need to be cognizant of that. It doesn't guarantee there's going to be a massive GDP slowdown. It certainly doesn't guarantee there'll be any sort of recession. Think about coming out of COVID, where they cranked rates up almost at an unprecedented pace by size. And in a short period of time, everyone thought the world was going to end. We didn't. There was no recession in ’22, and people were, you know, guaranteeing that. So it doesn't guarantee anything, John, but it's something that we need to watch here as a forward indicator of earnings power.

John Przygocki: So clearly something to watch. Amid the caution, it is very clear that from your perspective earnings continue to provide strong support. What's giving you confidence on the earnings front? Is it the level of growth that we see, or is it the breadth or maybe both?

Chris Galipeau: I think that it's both. And so, if you think about the first six months of this year, Q1 on a year-on-year basis at the S&P 500 level now, earnings were up about 27, 26 to 27% year on year.

That actually accelerated sequentially into Q2, where at the bottom-line level, if you include everything. (And what I mean by that is if you include kind of the one-off items by some of the Mag Seven companies that had, you know, marked to market their gains in companies like Anthropic and OpenAI, earnings accelerated to plus mid-40s. If I take those one-time items out, it takes the number down to about 30-ish. That's still excellent. And on a reported basis, earnings in the first six months of the year were significantly, substantially ahead of street consensus. So that's the first part of it.

As we move forward, that rate of change is going to slow. But if you look out through the balance of this year, ’26, if you look to 2027, if you look to the consensus estimates at the index level for all the major indices—I've already done the work—earnings growth is going to continue. Now, it's not going to be at the same pace we just saw in the last six months. But unless something comes out of left field, you know, a black swan like COVID, which we can't predict, or you get the three steps and a stumble thing from the Fed, you know, knock on wood, I think that you were still in a bull tape, an earnings-driven tape. The tape’s not expensive, right? The S&P’s 19 times next year's earnings. And it's like 16 or 17 times ’28 estimates, which I don't want to go there because it's too early, and 21 times this year’s number. I can't make an argument that says that's really cheap, John, but I can make an argument that says it's not that expensive.

And the earnings power looks very good. But I think this, this concept of super strong for six months and peak rate of change there is another (we talked about it earlier), but that's another reason to expect higher levels of volatility. So I think it probably gets a little more choppy here. And that's fine. And that's especially fine if you are prepared for it and ready to act on it.

John Przygocki: So it sounds like it's volatility that we could expect but we can endure, that it's just a volatility event taking place within a larger bull market. And it's not the sign of something more.

Chris Galipeau: Agree. Agree.

John Przygocki: Makes sense. Let me transition here to a slightly different topic going back on earnings. What would have you change your perspective to become more defensive?

Chris Galipeau: Okay, so, knowing and having stated and can prove that stock prices follow earnings over time, that's the variable that we want to keep on. Well, there's really two. That's the primary one that I worry about. What does forward earnings growth look like? So I just covered that. That looks okay.

If something were to come along to dent that. Going back to watching the amount of central banks that are raising rates versus cutting rates, so that's one thing that we need to be keyed in on. There's no real evidence of any problem there yet. And there might not be, right? There might not be.

The other thing that we need to watch for, and we're pushing those levels here now, is, higher long rates will put pressure on multiples at some point. Now, I don't really think it's 4.75 on the ten-year, John, but if we trade north of five and we stay there for a while, the stock market's not going to react well to that. Now, that doesn't mean that that's going to knock the earnings stream offline at all. But what it will do is put pressure on the multiple.

And so we haven't really seen that either. But it's the combo of those two things. Something to derail forward earnings growth. Remember that the stock market is a discounting mechanism. It looks forward, not backward. So that's why we're looking at forward earnings power. If something comes along to dent that, then you know we'd have to be objective, which we will be, and change our tune. But that's not the case now.

John Przygocki: So, Chris, you clearly have described this as a more demanding phase. What does this demand of investors in practice? Is it more selectivity or active management, more patient?

Chris Galipeau: I think it's all that. And I would summarize selectivity, maybe active management and patience into one word: discipline, right? So, you just got two years of return in six months. All of that's been earnings-driven. That's the good news. We have to contend a little bit more now with higher long rates and also entering into a more volatile period.

So, I think it's discipline, is the most important thing here. And, in practice, I think what that means, John, is, when you look at your portfolio—so for me as an equity PM, I know what I own, obviously. I know what I want to add to on weakness. I know what I might want to trim on strength. And I have a whole list of names that I probably don't own or I don't own enough of, and I want to increase those weightings.

Investors, financial advisors, individual investors can all use that same tool of discipline. And knowing what your entry price is doing, what your exit price is, knowing how to manage the risk of the portfolio, making sure that you've got some diversification in there, all those things. But I think what people also need to remember, and this is maybe an easier way to think about it, that, as stock prices go up, generally the risk in owning them goes up a little bit, right? Because stock markets moving in advance of the fundamentals that investors believe are ahead of them. And the more a stock or an index rallies, the more you need to be on guard for signs that it might not continue. And the flip side of that is also true, that when stock prices come down, you know what else is coming down? The risk in owning them.

It's very easy to lose sight of those things, that people will chase performance. When you go through a drawdown, people start to panic emotionally and they abandon their long-term plan and they lose their discipline. And so it's discipline over emotion.

And, again, just a big move on the books here in the last five months. Don't be surprised if the tape consolidates this and pulls it back. Look, the S&P has gone sideways for the last two months. So it’s already doing it.

John Przygocki: So, Chris, as we look to conclude this afternoon's conversation, I've got two final questions for you. First, if you were to give our listeners just one thing that they should keep their eye on in the coming months, what would that be? And then close it out for me with where our listeners can find your complete new published paper.

Chris Galipeau: Prepare for volatility in the next couple of months. That's the first thing. In the context of a bull tape with positive macro backdrop, do we have some things to watch out for here in terms of the Fed? Yes, definitely. But the earnings power looks very good.

Prepare for future volatility. Prepare to put capital to work on any significant pullback. Be aware that the third year of the presidential cycle, S&P averages somewhere around 30% return. The hit rate of positive returns is 100%. So, I think that that's the message here. Just prepare the ship for a little bit of a rougher ride.

And, in terms of where investors can find this white paper that we're discussing, you can find it on Franklin Templeton's web page. You can find it on my LinkedIn as well. And if you're a financial advisor, you can certainly get it from your Franklin Templeton market leader.

John Przygocki: Thank you, Chris, for your time and thoughtful insight today. To all of our listeners, thank you for spending your valuable time with us for today's conversation. If you're interested in learning more from Franklin Templeton, please visit franklintempleton.com. You can also subscribe, as Chris mentioned, to his weekly newsletter, by following him on LinkedIn. Simply search for Chris Galipeau with Franklin Templeton on LinkedIn. If you'd like to hear more Talking Markets with Franklin Templeton, please visit our archive of previous episodes and subscribe on Apple Podcasts, Spotify, and YouTube.