We're talking opportunities in Europe's digital sovereignty on Motley Fool hidden gems investing. Welcome to Motley Fool hidden gems investing. I'm your host Tyler pro and today I'm joined by longtime full contributors Lou Whiteman and Matt Frankel. So today we're going to hit a couple of listener questions as we like to do here on Tuesdays and it's been a kind of a slow news week at least from companies issuing press releases. So we're going to do two whole segments based dedicated to listener questions. We're going to talk about valuation. We're going to talk about how we use our cash and our dry powder or investing strategies. But we want to start today with a couple of news articles that I'm going to string together into a theme that we're going to call Europe's digital sovereignty. And we'll start off with a big story that came out today related to Apple who's in a bit of a to use the British parlance a row with the European Union about its digital privacy rules and its Siri Siri AI assistance. Basically Apple's not looking to get an extension or a waiver an exception and EU's like no follow our rules. So basically it's going back and forth and it's not pretty. But the bigger theme here because this is one story of many that we've seen recently around Europe and it's this theme of like digital sovereignty. I want to say nationalism. That isn't quite the right word. But basically Europe is looking like they want to make a more concerted effort to own things to be a bigger player in a lot of the discussions that we have around things like AI semiconductor manufacturing payment rails social media. And they're looking to build their own products. And this isn't just Europe either. This is kind of a worldwide thing. China announced earlier that it's deploying a 250 billion dollar fund to make a bill data centers nationwide. And for its kind of we'll call it its home cooked AI inside of relying on the anthropics or the open eyes of the world. Now the Chinese digital market has always been kind of a walled garden with the by dues and the alababas not necessarily playing as well with you know US companies. So there's that's not much of a game changer when we talk about AI and digital development here. But does the emergence of these rules and these European initiatives to put kind of wouldn't say full on gates but screen doors I guess you will around European markets kind of alter the thesis on big tech companies or AI deployment or anything that you've been seeing recently. What do you say Matt? It's not surprising that Apple's not thrilled by this. I mean Apple intelligence and several of its newer features have been either delayed or limited in the EU in recent years. Google, Meta, Amazon are also dealing with all this. It's not just Apple. It's also not surprising on the other hand that Europe wants more digital sovereignty. We're doing the same thing. For example when it comes to the chip makers you know the investments we're making like Intel's foundry and things like that. Nations are realizing that depending on foreign suppliers for critical infrastructure and technology needs it's a national security concern. But as to the question of does this change the thesis my short answer is yes but not as much as you might think. So all the companies I just mentioned Apple, Google, Meta, Amazon they all depend on Europe for anywhere between 20 and 30% of their revenue. And if we see their sales declined by 10 to 20% or their margins declined by 10 to 20% which I view as kind of the worst case scenario by this news it wouldn't completely change my thesis. Smart investors like you said already assume that China is essentially a closed market when it comes to evaluating these stocks but I don't think the same thing is needed with the EU here. I'm not rethinking any of my big tech investments on this news. I don't know if you have to rethink your investments but I'm not sure that just looking at today's profit and loss statement and extrapolating off of that is really the way to look at this because I think there could be less foreseen if not consequences. Part of what makes Apple Apple is iOS is just everywhere. It's ubiquitous. It feeds into the Apple Store development and it feeds into the network effect that it's enjoyed. To the extent that this trend towards regionalism instead of globalism causes kind of a balkanization of tech, I think it makes every company including Apple's products just less powerful maybe less profitable over time. This isn't just a tech story. It's playing out all over the place. Automotive is a real one where it's definitely happening. You kind of just have the US market and the global market going in separate directions. The big picture here is like the 80s, the 90s vision of globally dominating companies is getting overhauled by just geopolitics about what's going on. US companies can evolve and survive. I don't think it's again, I'm not sure I'm going to change investments right now but I'm watching this because make no mistake. The status quo that has been in place over the years was highly favorable to the US tech champions, to US companies. I am doubtful that whatever replaces the status quo will be as favorable to the US brand, the US companies. I do think it could have really, really hard to predict or hard to quantify right now changes. I do think it could change the thesis for some of these companies over time. To that point too, obviously it changes the thesis and not necessarily a good way for the big companies. If I were to flip the script a little bit here, it does seem like there would be some opportunities because if Europe wants to build out the capacity for the things that we're talking about here, chip makers, AI tools, things like that, there should be an opportunity for the building and the infrastructure. You could call them the champions of this build out in Europe similar to what we've had in the United States. Perhaps they haven't quite emerged yet but I'm just thinking along the lines of it is such a nascent market relative to what we see globally. I saw a quote from ASML, the builder of the lithography machines that basically etch the chips and they're like the soul maker in the world. He said, 80% of my sales are to Asia, 1% of them are to Europe. Clearly, this is a very, very small market and that leaves us an opportunity. If you were to start looking at the tea leaves, maybe thinking about companies, perhaps opportunities where Europe is building out this, it doesn't necessarily have to be American companies either, opportunities where this redundancy or this European digital sovereignty, digital infrastructure, national, regional infrastructure, where do you see some potential opportunities? The one thing I would say is that digital sovereignty means that there's going to be a lot of duplicate infrastructure throughout the world. We're seeing this in the US. I mentioned the chip foundries that are being built here, data centers, other things like that. There are a few types of winners that I see. There are some companies that produce equipment and software and things like that that are so unique that there's literally no equipment. Applied materials comes to mind. You already mentioned ASML is a company that I think is just an opportunity just in itself, no matter what. Data center infrastructure, companies like Verdive, ticker symbol, BRT, quanta services, PWR that do the electrical work for data centers. They're more obvious beneficiaries, hundreds of billions of dollars in new data centers, networking companies like Cisco, European infrastructure, if the digital sovereignty continues, it'll still need switches and routers no matter what. I see a lot of opportunities throughout the market, but those are just some that I could think of off the top of my head. I think there are opportunities. For some of these, like the infrastructure companies that are in the US, they only have so much capacity and they may not have that capacity in Europe. They're unlikely to fly all their workers over to do Europe. I do think, look at the European champions. Snyder Electric is a great company that is doing a lot of business in the US because there isn't this business in Europe. I think you could see them switch Le Grand, which I think does the electrical cabinets that all these things go in. That is, again, a European champion that could benefit. We're not going to see comfort systems get a boost because they need more air conditioners in Europe. That's just not going to go to them. I think all in selectively, this should end up with more spending, but also less efficiency. The bigger picture thing is to think about where a company sits on the value chain, whether or not it's going to be good or bad, whether they will be less efficient or have more opportunity and make decisions based on that. I might have to do some real follow-up deep dives on the European... Actually, companies that are traded on the European markets here because this could be an interesting story to follow in the coming months and years. Coming up after the break, we're going to jump into listener questions. Hey, everyone. As we get into our questions here, just a quick reminder. If you want your question asked on air, go ahead and email us at podcasts at fool.com. It's podcasts with an s at fool.com. We'll try to answer it as best as we can. Our three requests is always keep it foolish, keep it short enough, we can read it on air, and we can't give out any personalized advice. Try to ask it in a sense of what would an investor do in this situation? With those rules in mind, here, our question to start out today is from Nwenda Wikramashinga. I hope I said that right. I apologize if I got it wrong. Her question is, the current Schiller-Cape ratio in national debt has made me a bit nervous, and I want to know what your thoughts on about adjusting the portfolios are correlated. This is a sign to start increasing cash or rotating investments into defensive companies. Some of the ones that you've mentioned here, we have waste management, next-era energy, Berkshire Hathaway, and saying, doing this rotation to cite strong earnings in the S&P 500. Thanks. Before we get started on this, Matt, I don't know if everyone's necessarily familiar with the Schiller-Cape ratio. Just give us a quick rundown of what that is before you get into the thoughts on valuation related to it. If you're not familiar, Cape stands for cyclically adjusted price to earnings ratio. Essentially, it takes the market's collective PE ratio, which is one of the most common valuation metric used. Instead of using the trailing 12-month earnings, it uses 10 years of inflation-adjusted earnings. The idea here is that you're comparing current valuations against what we would consider normalized earnings across many market environments, not just earnings that result from recent trends like the AI infrastructure boom, for example. The listener's right. The Schiller-Cape is very high right now. It's about 38. That's more than twice. It's a long-term average, which is 16 to 17, depending on what time period exactly you're looking at. In the dot-com bubble, it peaked at 44 just for reference. My short answer is that this is not a reason to be worried all by itself. For most of recent history, meaning my investing lifetime and I'm in my 40s, the Schiller-Cape has been above its long-term historical averages. If you had become defensive every time it crossed, say, 25 or 30, you would have missed out on a ton of upward moves. Having said that, I use an elevated Cape as a sign that I should expect more moderate returns over, say, the next five to 10 years. But on a short-term basis, we've seen time and time again that an elevated ratio doesn't really predict much. Yeah, I'd push back a bit. I think it is a reason to be worried, but I think what Matt's saying, and I agree with it, it's just not actionable. I really worry about the market today. I think we are more likely than not near a top and probably closer to the end than the beginning, all of those cliches. The thing is, though, the Cape was at 37 a year ago, and so I had just as much reason to be worried then. In fact, I did think, wow, how long this could go on then. Would have been a mistake for me a year ago to adjust my portfolio due to those worries in hindsight. Maybe now is the time to take action, or maybe we'll be having this same conversation another six months to a year. I think the listener is correct to be noticing this, and we can talk about maybe how you think about this in terms of what you do with your money. I don't think it's time to throw all my money under a mattress because these things can remain this way for a lot longer than I would think. I thought we're going to list off as many cliched end-of-the-line questions. Nine thinning end-of-the-line, rotting off of the sunset. We'll just throw them all out there to make sure that we covered all our bases here. We talked about the valuation thing, but now talking about the idea of rotating into defensive companies or maybe businesses that aren't necessarily as exposed to a lot of the trends that we're seeing in the S&P 500, which is, let's be honest here, the AI infrastructure build out, the Mag7, a lot of those companies. To the companies that were asked here, we got waste management, next there are energy, Berkshire Hathaway companies like that. Is that the move that you would do when you see these elevated valuations or is that just a milk toast way of doing it? It's like, yeah, we're getting into these. They're overvalued, but they're safer. Is this the rotation you would do or is there something else that you normally do in these situations? First of all, defensive companies aren't immune to valuation-related concerns. The stocks mentioned in the listener's question, companies like Waste Management and Next Era, they actually trade for somewhat high multiples compared to their own history right now. They could actually be a little compressed as well. I'm going to give a more financial planner type answer to the question. Ask yourself a few questions. Number one, ask yourself if your asset allocation right now makes sense for your investment goals, your time horizon, and your willingness to withstand an occasional 30% drawdown. If it doesn't, then move a little bit more defensively, regardless of what the CAPE ratio or any other market indicator is doing. Second, ask yourself if you're confident in the businesses that you own in terms of their ability to survive a recession. Finally, I would say if you're investing consistently, regardless of what the market is doing, because averaging into stocks over time, it's a great defensive mechanism against valuation risk, because you're going to end up buying more of your shares at cheaper prices over time regardless. Yeah, my answer for this is I'm always defensive. It's kind of just like my philosophy on investing. I'm always trying to find the opportunities that I think are out of favor or at least not fully appreciated by the market. Not the use of term, hidden gems, so to speak. I don't want to chase momentum. Over the past year, I've been buying a lot more financial services companies. I've been buying industrial companies that just don't have the multiple. It's not because I think that the tech is going to crash. It's just I don't want to chase momentum. I want to go where I see value. I can't time the market, but I can try and avoid getting caught up in the market's current mania. It doesn't insulate me because as Matt says, when a downturn comes, everybody seems, it tends to feel it. It's not like you escape things going down, but I feel like it can help avoid total wipeout. Yes, I am looking at the case. I am looking at where tech is valued, and I am investing elsewhere. That's not really because I think the sky is falling or the things are going to come down right now. It's because I just don't find a lot of value in things when they are, say, fully loved by the market. Investing optimistically, but underwriting pessimistically in the sense of, yeah, of course I want my things to go up, but I'm going to make my investments based on the idea that they could go down and trying to build in some sort of, as using Seth Clarman's book, Margin of Safety, built into the valuation that he used, can be pretty effective in at least helping to ease some of those valuation concerns. Coming up next, we'll talk about how cash and the dry powder are investments actually also included in valuation and how we use that first strategy. It's Tuesday. We're going to do two investor questions here. Our second one comes from Matt Popek, and this is related to basically your cash position. Now, the question is, I know that there's some discussion of money market funds recently and how much cash is available, as he quotes, on the sidelines. Is there any downside to using a money market fund? He gives the example of Vanguard's money market fund. Basically, most brokerages have their own some sort of money market fund, either Vanguard, Fidelity, you name it. Is there a place to park the vast majority of savings or in this case, cash for a brokerage? To the Lou and you Matt specifically, where are you keeping your dry powder for future investments these days? Money markets don't fund, don't fit quite like the stock market, at least to Matt here, even if it isn't a brokerage. Before you guys answer, I just want to kind of give a little bit of context to Matt and hopefully it'll better understand this. When you hear the term money on the sidelines, either here or I think I hear it all the time on CNBC, I think it's one of their most common used terms. That is money actually in money markets funds. It is actually what the Federal Reserve Bank of St. Louis tracks. Now, it might not necessarily reflect all available money to invest in the stock market, because maybe some people are using certificates of deposit or longer dated treasuries, but money market is a decent approximation. According to the Federal Reserve Bank of St. Louis, about $8 trillion worth of money is in money market accounts today and $2.2 trillion of that is actually in retail investors, you, me, Lou, Matt, all of us. That is in those sort of accounts. So after that little long background, guys, do you use money market accounts? Is this like the best way to do it? What are some of the other strategies? If I'm being honest, most of the time I'm fully invested or at least pretty close to it. I like to contribute money to my brokerage account pretty much every time I get paid and allocated where I see the best opportunities and there always are some, there's always cheap stocks somewhere. But in times where there's either a lack of attractive opportunities or just nothing that's getting me excited or elevated uncertainty in the market, I do often let my cash accumulate for a little while. Right now, I have 7% of my portfolio in cash. I sold a couple of stocks not that long ago. And that's a lot for me. My cash management strategy isn't that different from money market accounts. My broker happens to also offer a high yield savings account and I can easily transfer money between those two. So that's where I put any of my uninvested cash. Right now, I get a little more than 3%. And I'm fine with that at times when I want a little bit more financial flexibility to save for opportunities I really want. Yeah, first off, Tom Gludge gave that kind of explanation. And this question kind of shows why that statistic that CNBC loves to cite is so kind of imperfect because people do use money market funds for a lot of things, including cash savings, and that they might not be looking to deploy. Some do though. For me, I consider cash, cash and investments and investments to never to show meat. So in a way, I guess I am always fully invested because I don't think of my cash position as headed towards the market. I try and keep a significant amount of cash for upcoming expenses, emergency funds. I'm a believer in that nothing in the market you might need in the five-year rule. So I do need to park cash in a lot of places. For me, it's spread between treasury bills, and I have three online savings accounts with three different banks. I don't use money market simply because treasuries just pay better, and there's no expenses. The Vanguard fund that Matt mentioned, it's currently yielding 3.5%. I can get a little over 3.7% in a six-month treasury, and I don't have any expense ratio on that. So that's kind of just a personal preference. I do think there's nothing wrong with money market funds. They do tend to pay better than most online savings accounts. You don't have all of the protections, but you have a lot of protections. Just for me, treasuries are the go-to choice because you do get maybe 20 basis points better yield. When it comes to effort, lose cash management. It's certainly much more than mine because I'm definitely the lazy investor. It says, yeah, park it in the money market. That tends to be my strategy, at least, although I have been accused at times from being a little bit of a lazy investor and doing things like that. To Matt's point, Matt, the listener, the question, yes, money markets, technically they're not FDIC insured, but they tend to be invested in things like overnight, very, very short-term treasuries. At least that's what your broker does, and then they transfer a decent amount of that yield to you. So they're getting a little bit of the spread by investing your cash, and then they pass on significantly all, I wouldn't say all of it, but enough of it that they're giving it back to you. And so those rates for money markets will tend to fluctuate over time based on federal reserve interest rates. I think we can all really remember in the 2010s, money market rates were maybe 0.05% or something like that. It was definitely not the attractive option that it has been in the past couple of years where it has been a 3% range. So do keep that in mind. If we go back to the 2010s again, everyone's going to be looking in their cash, and being like, this is doing absolutely nothing for me. So money markets can be effective when they're doing in a higher interest rate environment, but they can also cut both ways. As always, people on the program may have interests, the stocks they talk about, and the Motley Fool may have formal recommendations for or against. So don't buy or sell stocks based solely on what you hear. All personal finance content follows Motley Fool editorial standards, and it's not approved by advertisers. Advertisements are sponsored content provided for informational purposes only. To see our full advertising disclosure, please check out our show notes. Thanks to our producer Dan Boyd and the rest of the Motley Fool team for Lou and Matt and myself. Thanks for listening, and we'll chat again soon.
