Contrarian View of the Current Stock Market (Episode 27)

Great question. I think the first thing to say, Kate is that whatever uncertainties ever uncertainties you can read about in the newspaper like supply chain or the response of the federal reserve and raising interest rates that is reflected in the prices that you pay for all securities. And so, you know, the price you pay for Microsoft today reflects, you know, the uncertainties around, you know, COVID in China for example, or increases in interest rates. So in a way the simplest thing is to say, it's already discounted. And if your portfolio objectives are consistent with a certain allocation to equities, I don't think retail investors really need to worry. And the second thing is to really point out that nobody knows how these things are gonna resolve themselves, and it is easy to see the downside. And, but I think that people sometimes underestimate how much downside is discounted. And if any of these things eventuate better than what we think right now, stocks can move positively and catch people off guard. So I think the, my answer would be, there is certainly no need to overreact if you have the right asset allocation for your circumstances.

This? I think it really is. And one thing I always keep in mind is when we're going through a difficult patch is to recognize that this is precisely why equities have a long-term excess return because you have to stomach the uncertain environments where they go down. In other words, if they were always going up, they didn't react to uncertainty in the world, then you wouldn't get compensated for them in the long term. So I think sort of, I know it does, it sounds a little F but I think, you know, keeping in mind that what these are precisely the periods that make equities attractive for the long run,

Yes, I do too. I was alive.

Yes. I think I can remember even into 11 and 12, because even after the us had come out of that crisis or was sort of past the worst of it, we had the crisis in the Eurozone in the summer of, of 2011. We had, you know, the treasury refinancing crisis around the same time. So no it's, you know, markets are sometimes slow to price in turns. And I think that the good news is that. And one thing that, you know, that I've been focusing on is that earnings for corporate America have actually been really strong and really resilient through all of the, you know, supply chain issues that we had the labor cost increases last year. And so if I asked, you know, a hundred people, whether they thought S and P earnings as of today for the end of the year were up or down versus January one, I'll bet you, 80% of the people would say they're down. And in point of fact, they're up 5%. And so that tells you that, you know, the fundamental backdrop is pretty good despite all of the bad headlines.

That's exactly right. And we have to remind our clients all the time that, you know, the companies that have accidents in their quarterly reports are the ones that get all the headlines in the wall street journal. And Netflix is a perfect example. Whereas 90% of us companies in, or S and P companies in the first quarter actually reported better than expected numbers. Um, it so happens that the disappointments get all of the tension. I don't mean that you shouldn't pay attention to those because especially something like Walmart is definitely a straw in the wind. You know, when they say their customers feeling decreased, real disposable income, that's something we all need to, and, you know, Netflix has 200 odd million subscribers. And so if those people are pushing back on price increases, I don't think we should ignore them, but I don't think, you know, at the end of the day, they should overwhelm the decision about, you know, whether to be,

So one thing that I always find helpful is to think about, you know, what do we really expect equities to do? And, you know, everybody has a number in the back of their head about what they want out of equities, but I think something, a realistic number would be, you know, somewhere between five and 8%, it might be, you know, it may be seven and a half now because we've gone down. But, and if you look over longer timeframes, you know, the past 10 years, the S and P has delivered 16, all right. Compounded annually. So if we go through a couple of bad years that still, you know, keeps people in line with a long term expectation for what equities should do, that's one way to, to sort of, uh, sort of hold confidence in the longer term.

Sounds horrible.

Yeah. But you know, when interest rates are, you know, the real 10 year rate is negative, you know, of a seven is really about all you can ask for, I think, and maybe, you know, the past 10 years, number one, we're, you know, coming off it started with like you pointed out depressed sentiment. And number two, we had a very strong tailwind in the form of falling rates and, you know, globalization. And so maybe we pulled forward returns. And so it's probably a good idea to, you know, remind ourselves that equities don't do 16, you know, forever. They tend not to do

Yeah. I mean, that's a doubling in 10 years, right. And that can really produce a retirement nest egg. You know, if it's adhered to, it's like the worst thing you can do is have an aggressive investment plan. I know, you know this, but, you know, have an aggressive investment plan and maybe one that's more aggressive than you could tolerate and then change horses in the middle of the stream. And, you know, you basically get the worst of both worlds. You actually realize the downside volatility of equities and never get to enjoy the actual upside.

So, you know, cliff asked us at AQR has this, um, expression of, he says about tactical. He says, it's okay to sin a little meaning. Tactical is a sin, but it's okay to do it a little bit. And I sort of agree. And that is, I think that there are times where you can tilt your portfolio. You can lean into certain sectors. And, but I try to be very humble about the potential effectiveness of that. And so we, my firm hurdle Callahan, we do make, uh, tactical decisions, but they're rare. And then when I say rare, I mean once or twice a year, I don't think, I think the more frequent the trading, probably the lower threshold for conviction you have, in other words, wait for very high conviction and also don't do it in a kind of size that can wipe you out. So for example, I'll give you an example.

We've we have been underweight duration in fixed income, meaning we've been underweight to the Tivity of rates in our bond portfolios. We've had, you know, shorter maturities in our bond portfolios and that's, you know, we've had that position for a year and a half or since the beginning of 21. So maybe 15 months. And we at with treasury rates backing up now to almost 3%, we've decided to take some of that off. So that was a, that gives you a sense about the timing, you know, the, the frequency of these, uh, what I think about tactical? Was that a fair, uh, answer to your question?

Yeah, exactly. And bearing in mind that you always, whenever we do a tactical move, we always think, what are the consequences if I'm wrong, or in other words, what are the parts of my portfolio that will work if I'm wrong in this direction and how much will they work? So I think having a, a risk management sense, like, you know, a planned loss and a return for a tactical trade is a really good practice.

That it's important to recognize the limits of asset allocation. And by that, I mean, you know, almost every financial asset is exposed to the economy. And so you can put different labels on things. You can label things, rates or defensive or consumer growth or so forth, but effectively there plays on the economy and then you can label things, fixed income and have, you know, high yield bonds and government bonds and mortgage back bonds. But they are effectively bets on interest rates. And so our strategic framework is have as much exposure to growth as you can. So in other words, if you know, you are young and have, you know, high income prospects, that might be 85, if you're closer to retirement, that might be 60. So have as much exposure to growth as you can, and be really cautious about diversification in terms of labels. So in other words, just because something is called a REIT and it owns real property, don't think that means you're buying a defensive asset because we, as we saw in the pandemic, REITs became, went from being a sort of defensive income asset to being at the center of the storm of the economy. That's one observation about strategic asset allocation. So because wall street likes to put labels on, you know, rappers on products that make you think you're getting diversification, but it really it's just a repackaging of something you already have.

Well, you know, for example, there, you know, whatever trend is popular at the moment. So for example, energy transition or infrastructure or ESG, those are very popular themes and justifiably because people understand, appreciate that. You know, we are making a transition to, you know, a fossil, a less intensive fossil free economy. They understand that, you know, the world needs more infrastructure to accomplish that. So for example, in terms of the grid, in terms of the road and bridge infrastructure, so those are appealing concepts, but effectively they are exposed to economic growth, just like everything in your portfolio is already. So they have less diversification possibilities than you may think, just because something's called an infrastructure equity. Well, if you know, traffic goes down on the bridge because fewer people have jobs and fewer people are commuting. Guess what? You know, it's going to go down in a downturn. And I think that's something people, you know, are less aware of.

Yeah, absolutely. I think, you know, with all due respect to Kathy wood and innovation fund might sound like a great theme, but if all it does is own electric vehicles and uh, genomics then, and maybe alternative energy sources, that's a really concentrated bet. It's not innovation.

So yeah, it's clear that energy has been extremely strong this year and to a little bit lesser extent, commodities related producers. So, and we have exposure definitely to energy companies, both EMP and refining and marketing, and we have exposure to commodities producers. Those have worked very well. The thing I think it's important to bear in mind is that they are extremely sensitive to perceptions of economic growth and that if the fed is hiking and if the fed is perceived just to go a little bit too far and tip the economy over to recession, those can rapidly reprice. So I would say, you know, obviously you want to be exposed to energy and commodities, but I'd be cautious about betting too heavily in them. One thing that I think, you know, on the contrarian sense, that is an opportunity emerging is in secular growth names that have been, uh, so this is, you know, software medical devices.

Some of the payments names have been hurt on the thesis, that interest rates going up damage the long term cash flows more than the ones that are shorter term. And we don't think that's actually that argument holds water. And so the sell off in secular growth names, I think we are leaning our portfolios more into those. So that's, those are names that, you know, are sometimes household names like Microsoft, Amazon, PayPal, visa, MasterCard, and sometimes little bit less known names like, you know, intuitive surgical and Thermo Fisher and Danaher that you know, are long term growth stories that have just been, I think, maybe unfairly treated in this pullback. And so at the margin, I would say be a little cautious on the things that have worked really well recently, which is energy and maybe, you know, lean into the secular growth areas.

That's exactly what I'm doing right now is building the watch list. And I think being prepared with a list of names so that, you know, if we do get a real capitulation that you've done the work and you can feel confident, you knew you were gonna buy, you know, visa when it was down, you know, 25% year to date and you can sort of be prepared to act,

Sure. So hurdle Callahan is an outsource chief investment officer. Our clients are both high net worth families, as well as the philanthropic institutions they support. So endowments and foundations and you can contact us on our website at www dot hurdle, callahan.com and I'm sure they can find that information in the call notes.