In this bonus episode of Wealthy Behavior, host Sammy Azzouz asks Heritage Chief Investment Officer, Bob Weisse, this question and more. Listen to hear Bob’s thoughts on the likelihood for further declines in stocks, why he doesn’t suggest investing in TIPS despite current inflation levels, and how investors should be thinking about rebalancing their portfolios in the current environment.
Wealthy Behavior: Is the worst behind us for stocks or is this a good entry point?
This automated transcript may contain grammatical errors.
00:00:10 – 00:05:01
Welcome to Wealthy Behavior, talking money and wealth with Heritage Financial. The podcast that digs into topics strategies and behaviors that help busy successful people build and protect their personal wealth. I’m your host, Sammy Azzouz president of Heritage Financial, a Boston based wealth management firm working with business owners, executives and retirees for more than 25 years. Now, let’s talk about the wealthy behaviors that are key to a rich life.
Welcome to another investment bonus edition of the wealthy behavior podcast where I sit down with our chief investment officer, Bob Weiss to discuss what’s going on in the markets and the investment universe right now. Last month, Bob and I talked about the FAANG stocks, why they were struggling and what to do about it as an investor. Today we’re going to pivot more to the broader market. The beginning of this week had the S&P 500 crossing into bear market territory before staging a bit of a comeback. There’s a lot of talk of recession, hard landing, soft landing, and we all know the high inflation that we’re facing. So in my mind, there couldn’t be a better time to chat with the chief investment officer who oversees a team that manages more than $2 billion for individual investors. So Bob, at the end of our FAANG podcast, I asked you what you were thinking about from an investment standpoint, so to speak, what’s on your desk? And you said inflation, the fed, and whether we can have a soft landing. What have you seen in the last month? Yeah, so that continues to be the story with markets, inflation, and people keep talking about it. And when you look at what is working with investments, inflation sensitive assets are where we’ve made good money for our clients. That’s held up quite well. So since then, I think the market’s pulled back a little more and naturally you say, okay, stocks are down a lot. They’re down 20% let’s buy. But you’re looking at traditional portfolio and your bonds are also down. So we’re starting to have the perspective that maybe we saw peak inflation. And investors have bid up those assets and maybe it’s time to take some chips off the table with inflation sensitive assets and start to buy some of these other assets that are more beaten up. So while we’re here and talking about inflation, sometimes typically markets move ahead and are forward looking. So just because inflation is in the headlines doesn’t mean now is the time to invest based on the headlines, if that makes sense. Yeah, it makes a lot of sense. There’s a lot there to unpack. Let me try to get at it a little bit in order. Because I was going to ask you about that. We’ve seen some reports this week that inflation expectations are moderating and maybe some numbers are coming in indicating we’ve already achieved peak inflation. Is that what you were referring to with your talk of inflation sensitive assets? Exactly. We had an 8 plus percent print a couple of months ago. And while it’s still high, will it continue to trickle down? Will the fed slow down the economy enough that inflation will get to a more normal level over time? So what are inflation sensitive assets? TIPS are common one, treasury inflationary protected securities. We don’t invest in TIPS. We’re more focused on real estate. And then broad real assets, the way we invest it includes farmland, timberland, and infrastructure. So if you just think that assets that will appreciate typically when inflation is high. So if inflation is high, the price of corn probably goes up. The value of farmland goes up for real estate. It’s very much in the formula for inflation. So that’s what we look at as inflation sensitive assets. And those have done well this year? They have done nicely. Okay, and so I guess a little bit of a side bar for people who might be interested. Why not TIPS? Well, TIPS are government bonds and overall they have a low yield or really no yield. So your entire return is based on CPI, but what you see is when inflation is high, when CPI is high, bond yields go up. So an overall demand for bonds goes down, so typically it’s a decline in price. So inflation helps dampen, helps offset the decline in price, but you’re still not looking at a great return over time. Got it. Future return expectations, which makes a lot of sense. So you shared that earlier this week we trimmed a little bit in real assets and added to stocks. But I think what you were getting at when you were talking about stocks being down and unfortunately bonds being down to start the year is that as an asset allocator, portfolio allocations were pretty in line with where we wanted them to be. This was not like March of 2020 when stocks sold off by 30 plus percent, bonds were up, and we rebalanced and we ended up buying a lot of stock. This is more incremental because portfolios are kind of in line with where they should be from an allocation standpoint. Yeah, so we just trimmed profits taking positions back to target.
00:05:02 – 00:10:07
What we’re looking at is if you rewind a little bit, each year we look at capital market assumptions, which are long-term ten year forecasts for asset classes. And we build a portfolio based on those return assumptions. We’re revisiting that now because if you reduce prices in the stock market by 20%, you increase prices in real assets by 5%, you reduce prices and bonds by 10%. All these are major moves. So does that change your expected future return? It does, does it change it enough to warrant a more strategic change to the asset allocation? That’s what we’re looking at right now and might be making some changes in the near term or intermediate term. So Bob, when you made that kind of slight rebalancing move, I guess I would categorize it as that wasn’t some kind of prediction that the bear market or the market that we touched on in terms of a 20% decline early this week is over. This was more just executing and a process. Exactly. Traditional rebalancing one asset is down, one is up. You take profits from the one that’s up and buy the one that’s down, and that’s just how we operate. That’s standard rebalancing. And I guess do you think the worst is behind us? I mean, the markets are up 5 or 6% from the bottom this week, and I know you hate the terminology we’ve talked about in the past correction, bear market, you know, all these artificial thresholds. Do you think this is a bear market rally? Or do you think the market is maybe getting optimistic like you are that inflation is at least heading in the right direction? Well, that’s a tough question. Let me check out the crystal ball. Now, I mean, honestly, of course, it can go either way. And on one side, I do think there’s a very realistic possibility that inflation remains elevated. The fed increases rates, 50 basis points, then 50 again, and gets the fed funds right up to 2%, even closer to 3%. And that could send us into recession. I don’t know that the economy can tolerate that. That could be tough. And will they even pop the inflation bubble in doing that at different angles, inflation stays elevated and they can’t slow down inflation. But when you get away from the macro, because that’s all macro. And you start to look at companies, valuations are starting to get attractive. So if you look at individual stocks and you see things like Google below 20 times earnings, Google was at 35 times earnings last year, financial services like banks, like Citigroup, below ten times earnings. So when you look at the stocks and where valuations are, it’s attractive. So on one hand, the macro backdrop is ugly. But as an investor, investments are starting to look good, starting to look pretty cheap. So will we skate out of this okay? Will there be a soft landing? I don’t know, but maybe a different way of thinking about it, if I can restructure your question, if you buy stocks now, will you be happy with your return over the next 5 to ten years? I think you will be. I think this is a good entry point. Will there be a storm coming to the next 12 months or so? No one knows. I’m not going to say I know. Whether or not it gets bumpy, I don’t know, but valuations are looking good these days. Yeah, and that’s what makes investing so difficult. And if you had, by the way, had a very clear crystal ball projection, I’d walk over to your office and see if you were still the same guy. So it makes investing so difficult because the macro is impossible to predict. It’s impossible to know. And the bottom’s and the top’s are impossible to call, but you’re saying, as an investor, directionally, when things become attractive, you should invest in them. And the market volatility that we’ve seen earlier this year or that we’re seeing right now has caused stocks and bonds to become more attractive. So a long-term investor should feel comfortable getting in. But expect more volatility ahead. Well said. Well thank you, Bob, I appreciate that. So in terms of that and I mentioned the bonds, you didn’t necessarily. But you’re also, I think, of the mindset that bonds are also more attractive after the first few months of this year. Yeah, definitely, the ten year treasury got up to about 3.25%, which was a healthy yield, it’s at 2.75% for right now. If you look over the last ten years, it touched 3% a couple of times, but hasn’t really gone much above that or even sustained levels above 3%. So seeing a risk free asset getting you 3% is pretty good. And when you think about treasury yields and where they should be, one thing to consider is the U.S. government has about $30 trillion in outstanding debt. They don’t want to be rolling over that debt that rates of 3% and 4% because then you’re looking at just interest payments alone of close to a $1 trillion.
00:10:07 – 00:15:00
So I know the fed’s supposed to be independent. But yields are probably going to be low. They should be low. You also look at a global economy overseas. In Europe and Japan, bond yields are very low. So that creates foreign demand. So just in general, the idea that US Treasury bonds are going from three or 4% versus are attractive at three. I do think they’re attractive at three and credit spreads have widened as well. So I think the bond market is starting to look good. Can you explain a little bit more on that credit spreads have widened? What does that mean and why does it matter? Yeah, so people including me just commonly talk about the treasury market. So say a ten year treasury is at 3%, but not everyone buys treasuries. You could buy corporate bonds, municipal bonds, asset backed securities, mortgage backed securities, anything but treasury bonds and when you do, you’re taking credit risk because treasury bonds don’t come with credit risk unless you think the treasury is going to default. So when you’re taking this credit risk, you deserve a premium, a spread in return. That spread ranges over time. So typically what you see is when investors are bullish and risk seeking that spread is narrow. When people get concerned, that spread is wider. And that spread has widened right now, so people are getting what I would call well compensated for taking credit risk. Spreads could widen more, but it’s definitely looking better than it has since that March of 2020 COVID crash. Understood, no, I get that, and that’s a great explanation. Thank you for doing that. And you touched on this a little bit with international markets. We’ve been focused so much on this podcast so far about the U.S. and our last one about the FAANG stocks was obviously U.S. centric. But we are global stock market investors. And I’d love for you to explain just at a high level why you think it’s important to be a global stock market investor. And then maybe we can chat a little bit about what’s going on in the international markets for the listeners who don’t follow it as closely as the S&P. Yeah, that’s a great point. People are related to the U.S. markets, including myself, so it’s easy to talk about. But being a global investor is important. About 60% of the world’s stock market is in the U.S., the other 40% of market cap is overseas. And there are great opportunities overseas. You also typically see better valuations. So we are seeing good opportunities overseas when we talk to our managers. The foreign managers are kind of pounding the table on how cheap things have got. One example that we’re hearing managers like is it really Chinese equities that that tech sector sector, their Internet stocks have just gotten hammered. With everything that’s going on in the world, and then you add to it, the Chinese government. And their policy. So some of those stocks, like Alibaba, it’s down around 60% from its peak. So the story there is a bit of what used to be a high-tech growth stock is now a value stock. So we think there are opportunities there. And we are putting money to work in that space. It’s a small portion of our client portfolios, but it’s a different driver of return over time. Got it. And what about developed international? What are you seeing in Western Europe, Canada, Japan? Yes, we’re seeing opportunities in foreign investments, one example is developed international markets where one of the funds we own, our larger allocation, is at a price to earnings ratio of 12. So when you’re paying 12 times earnings for a company, you think of how that is as an earnings yield, you flip the 12 to one over 12. That’s about an 8.3% earnings yield so that’s your starting point for a return and then any growth builds on that 8.3%. So in looking at the attractive valuations overseas definitely stands out as a good place to invest. And that’s one of the reasons why we have a global allocation. And what are your thoughts, I get this question a lot in review meetings and I’d love to hear your perspective. What has the war in Ukraine done in terms of the volatility that we’re seeing right now or is that kind of coincidental to the inflation and rising rate story? Yeah, I think the war in Ukraine has done two things. One is it has increased energy prices and energy goes through the economy, not just as energy hitting inflation, but all that goes through the supply chain and every part of the economy. So that has helped push up inflation, which was already high so there’s the impact on inflation and then second, just global instability, uncertainty, negativity, investors don’t like that. So that’s just more sentiment driven. People just being more concerned, more cautious and it’s tough to measure that.
00:15:01 – 00:20:00
But having a war, a geopolitical disaster, that we’re seeing overseas isn’t good for markets. So you’re probably with the energy prices and inflation feeling pretty good about the Tesla and the solar panels that you have added to your life lately. Absolutely. We have two cars, one is a Tesla, I haven’t obviously needed gas for that one, but I did for my other car filled up gas, $90 since I filled up gas in probably two months. But yes, yeah, at my house we don’t pay any electricity or gas for most of our driving. Yeah, and you had a great blog post on that on the www.heritagefinancia.net site on the kind of economics of investing in solar panels in your home. So if you’re interested in that topic as a listener, I definitely recommend checking it out. So Bob, where do we go from here? I mean, in terms of you touched on it a little bit earlier when you talked about updating our capital market assumptions and seeing if it was going to drive any bigger asset allocation changes, that’s a process that’s in the works, but elaborate on that a little bit and where do you go from here as an investor and a chief investment officer? Yeah, so investing, I like to say it’s all relative with investing its relative value. All these different investments you can choose from and you have to put a portfolio together to look to deliver the best return for the risk you’re taking, so as these inputs change relative value changes. So we’re looking at seeing equity returns go up because prices have gone down. So your expected return in stocks is higher now. And bonds, the math is pretty simple. With bonds your expected return is basically like yield, yields are higher expected returns are higher. So stocks are more attractive, bonds are more attractive. The picture in alternatives and real assets hasn’t really changed much. They’ve done well. We’re not going to say that a downturn is coming, but also I don’t think they’re any more attractive now than they were months ago. So if you just hold those three variables and to get more attractive one is the same, then naturally you might see some rebalancing, some move of assets from the one that stayed the same, real assets, to the two that are more attractive right now – being stocks and bonds. So you’re fairly optimistic, which is, I think, one of the investment paradoxes that the worst the markets get, the more attractive they can become longer term. Yeah, exactly. You know, just stepping back, one of the things we talk about with new clients is behavioral finance and I like talking about the fight or flight mentality. I think it really is fascinating and how human DNA is wired. Something’s good, you want to be there. It’s bad, you want to run away and I’ve been telling that to clients for years. And this is about as bad as it has been. Minus the March of 2020, COVID crashed. And there’s so much negativity out there. So you just take all the negativity, clients are not coming in and saying, “buy stocks I want to invest. There’s so much good going on.” That just when you see valuations looking attractive, you see all the negativity, sentiment is terrible, it just starts to make you think maybe it’s a good time to put money to work or at least be positive about investing. Let me push back on you a little bit, if I can. One thing that a lot of people have attributed the great market run we’ve had since 2009 to is the fed and how accommodative they were, how easy monetary policy was, how dovish they were, whatever financial jargon you want to use. The fed in a lot of people’s opinions was helping markets. And maybe pulled back from previous attempts at hiking rates or tightening monetary policy because the market just didn’t react well. Now it seems because the fed is late to the game and maybe were wrong last year about inflation, that they basically told the markets, we don’t care about the volatility. We don’t care about the sell-offs. We have to get inflation under control, don’t look to us to kind of bolster stocks. We’re moving forward and ignoring everything else. Would that make you more bearish? Yeah, so that’s all fair. And I think that is their perspective. They are moving forward and to some extent they don’t even say it directly, but I think they want the stock market to go down. I think the phrase they use is “tightening financial conditions” and to some extent that just means it pushed the stock market down, people have less wealth on paper, they spend less, they don’t pay as much for housing, etc. and that helps push stocks down. So that definitely is the scenario where inflation stays high.
00:20:01 – 00:23:18
The fed continues to hike rates, they’re relentless attacking inflation. And that’s not a good economy. We head into a recession, corporate profits go down, unemployment picks up and it’s a messy picture. But I guess that the one reassuring thing is if you think right now, if we’re down about 20% already from the peak, are we halfway there? Are we two thirds of the way there? We’re certainly part way there. A lot of that is priced in. So yeah, maybe we see another 20% down from here. And I know that that would be tough for a lot of investors to stomach, but we’ll recover. So trying to time these things is more of a full scan. It really could go either way. None of us know. If it recovers, you’ll be a fool to sit on your hands and miss it. So I think you want to invest now to catch the upside. And if it gets worse, I still think these are pretty good entry points looking out if you have a long-term time horizon. And you can rebalance again. If things get worse from here, what else are you looking at these days from an investment standpoint? It’s not as if what you already shared isn’t enough. But is there anything else that you’re finding either interesting or compelling as an investor? We’ve pretty much hit it. Stock markets getting attractive, opportunities around the world you’ve heard me talk about a couple of times. As value investors, we’ve been pretty much talking down the FAANG stocks for many, many years and now, not as a basket, I wouldn’t go ahead and buy them, but some of them still look pretty pricey, but some are starting to become almost more value companies. So that’s new to us. The Chinese tech story, we’ve been way underweight to the point of even not owning those companies. And now those are more entering our universe of what I’d consider attractive so that’s what’s new lately. Beyond that, we are looking at private equity markets this year. I think those are interesting because capital has dried up there, managers are having a harder time raising money, valuations have come in. So I think we might be finding some opportunities there and that’s what we’re working on right now. But if that’s not enough, that’s what’s keeping us busy right now. I think that’s definitely enough, Bob. Nobody can say, hey, get to work, you definitely have a lot on your plate. So thank you for walking through this with me. I thought it was a fascinating conversation and very helpful to investors and listeners. Sounds good. Thanks, Sammy.
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About Wealthy Behavior: Heritage Financial Services
Wealthy Behavior digs into the topics, strategies, and behaviors that are key to building and protecting personal wealth and living a rich life. We’re Boston Massachusetts-based wealth managers who have been helping busy, successful people pursue their financial goals for more than 25 years. Hosted by Sammy Azzouz, President of Heritage Financial, Wealthy Behavior digs into the topics, strategies, and behaviors that are key to building and protecting personal wealth and living a rich life.