Sponsored by Global Beta Advisors
Over the past 18 – 24 months, the U.S. stock market keeps hitting new record highs. How do investors participate in a market that seems to keep grinding higher but is currently very expensive?
The market is probably in the second phase of what I would call a 15 to 20-year bull market. The first phase, as we have seen in the past, was created by market stimulation from lowering interest rates in order to pump money into the market. That phase lasted from the '09 lows to probably 2016 or 2017. The market is really being driven by modest increases in both revenues and earnings. In some cases they're rather strong which could be a result of the stimulus from tax cuts and regulation. Right now, the consumer is really the one driving growth.
The rising indexes are primarily a result of growth coming from 10% of the companies in the index which are Facebook, Apple, Amazon, Netflix and Google (FAANGS). Google, Facebook and the rest of them have done very well, except over the last quarter we’ve begun to see them tire out. This is not unusual. We’ve also seen so much money pile into cap-weighted index strategies like the S&P 500. It's become somewhat of a self-promoting rise in the market that is beginning to dislocate from economic reality.
The majority of stocks, I’d say about 60% to 70% of the stocks out there are probably undervalued. I recommend that investors not mindlessly place money into cap-weighted indices because I believe we're going to go through a rotation. More importantly, I think investors need to be mindful of valuations. Take for example, the valuations of the S&P 500 or any index in the U.S. — the highs are probably not sustainable to achieve returns that are anywhere near what we've experienced.
Based on market history, I would say that investing in the cap-weight S&P 500 is not prudent given its current price-to-sales ratio, so if you think about valuations today, investors should spread out their investments and go beyond the big winners over the last 10 years. I’m not saying to give up on them entirely but investors should start thinking about what we would call the contra trade into stocks with lower valuations, including well-known companies that will benefit from global expansion. My recommendation to investors is to think about valuation, rotate out of the cap-weighted strategies to focus on strategies with valuations with ratios of 1.5 price-to-sales and not the current 2.3 price-to-sales ratio.
The Fed raised interest rates four times in 2018, only to then go on and cut rates three times in 2019. Did you agree with the Fed’s initial actions and then their reaction? How do you believe that will impact the economy and the market going forward?
In 2018 many professional investors were expecting some type of increase in interest rates. But what actually happened — which is a first in my 35 plus years in the business — as the fed raised rates, the market yield curve came up a little bit on the short end and it took a deep dive at the 5, 10, and 30-year periods. Normally, you see the yield curve stabilize before interest rates drop.
The Fed seemed to ignore the signals given off during the rising-rate period. By the time we got into December, the Fed chairman began to signal the market and articulate his rationale for the pull back in rates. I'm not a professional trader, I'm a professional investor. When I heard what he said, I knew it was going to create panic in the markets and it did. It created almost a 20% drop in the stock market.
All the Fed said was that, "We need to get back to a normalized yield curve." Now, that is a little scary coming from the Fed chairman because what is a normalized yield curve in today's environment? Are you talking about the last 30 to 40 years where interest rates have been the highest they have ever been in the history of the United States? The Fed basically said, "We got to take that average and bring it back.” That’s scary.
What really concerned investors was that the Fed was going to reverse the stimulus that they had created by buying mortgage securities, treasuries and other bonds from the banks to create liquidity and now they were reversing course. Everything that supported the economy, the stock and bond market for the past eight years — the Fed was going to reverse all that and put it on - you ready for this — put it on autopilot. Autopilot. Who puts tightening on autopilot?
Those two things together crashed the market. Investors lost confidence. And one of the things that all of us were depending on with the tax cuts, particularly the corporate tax cuts that were provided, was that there was going to be real strong capital expenditures which is a major part of any bull market. Instead everyone just pulled all risk off the table - investment risk in the stock and bond market, and investment risk in capital expenditures. And it nearly caused a catastrophe. I think most professional investors began to question if the Fed knew what they were doing or are they just in an academic bubble that the rest of us are missing?
We were in an environment similar to the 1880s and the early 1900s where there was an incredible amount of productivity gains because of technology. I mean, Amazon alone, I could talk about how much inflation has been taken out of the market just by Amazon. If you look at all the technology that is now embedded in almost every corporation in America, even small businesses like myself. The non- inflationary environment is something rare that may occur once every 100 years. I believe we're in one. People don't realize that in the late 1800s, or the early 1900s, during the Industrial Revolution, we actually had deflation.
The original purpose and intent when the Fed was created in 1913 was to control the money supply based on productivity and inflation, it was not about having a normal yield curve, who comes up with a normal yield curve. They just pulled this out of thin air.
What investors should be watching and care about is that the Fed is actually keeping an eye on inflation. We don't really care what they think about the market. Their role is to worry about inflation. The rest of the American economy will take care of itself. Hundreds of years of currency history and experience went into creating the Federal Reserve in the first place. All they need to do is stick to their intended purpose which is to watch out for inflation.
This became a global issue with many countries beginning to look at their central banks to manage their currencies. Now all of a sudden, we're changing from going on autopilot and normal yield curves. We need them to stabilize. We had a 1.8% inflation rate — that's a 2% target. Just worry about that. And just keep your eye on that. That's what we need them to do.
In my opinion, the Fed has made themselves too important. It's not that they're unimportant. They should be looked at as to what they are — the regulator of money supply which should not be regulated by arbitrary reasons, no matter that Trump was yelling that rates shouldn't go higher. I mean, I understand he's the president, but we shouldn't be listening to him either. We should be listening to unemployment numbers and if they are too high, we have to lower rates.
The American economy, small businesses and corporations, mostly small businesses, the collective wisdom of all these men and women that are running businesses will take care of unemployment as long as the money supply is regulated on a rational basis. The supply is designed to prevent bubbles, to prevent inflation and to make sure there's enough money to grow the economy at any rate.
For example, if we're growing at 4%-- we haven't been there but if we went to 4% or 5%, that's not a reason to increase interest rates because we're growing faster than we thought. What is a reason for increasing interest rates is if we jumped from 1.8% inflation rate on a consistent basis over a year or more. Not one quarter, but a year or more while we're hitting 3.5% or 3%. Now you want to be concerned and raise rates. That's the only thing that they should be focused on.
It is not their job to do anything else. I'm not just some long-term investor who's stuck in the past. Hundreds of years of currency trading, countries dealing with one another on trade issues, the development of the American economy, hundreds of years of history went into the creation of the Federal Reserve. To change that for contemporary reasons that are some of the same issues we’ve experienced in the past before the Federal Reserve was created is not a reason to change. The Fed should concern themselves with inflation and stay out of our lives and forget about manipulating our currency versus other currencies. It's just about inflation, nothing more.
Global Beta is a fairly new firm, but the management team has a pretty deep background. Can you talk about management’s background and what Global Beta’s philosophy is?
Previous to founding, Global Beta Advisors, I had been a professional investor and money manager for more than 35 years. I managed one of the largest brokerage groups by assets under management (AUM) at Smith Barney which back then was part of Citi. I left Smith Barney in 2004 and founded a firm called VTL associates in 2008. We created exchange-traded funds (ETFs) under the name Revenue Shares. My team, including Justin Lowry, grew Revenue Shares to be approximately a $2 billion business. In addition to that, we consulted and help launch six or seven other exchange-traded fund families, Crane Shares is one. We managed the assets in those funds for quite some time up until we sold VTL Associates to Oppenheimer Funds in 2015. We also worked with Oppenheimer Funds for two years assisting them in developing their own exchange-traded funds. After that, we launched Global Beta advisors in 2017.
The driving force behind why we launched Global Beta is that I'm beginning to see a dislocation in the market that occurs every now and then. We saw it in the late 90s. What we are seeing is easy money being made by just piling dollars into low cost calculated index strategies. It is a kind of mindless trade. It's a crowded trade.
We believe these investment opportunities only come along every 15, 20, or 30 years. This is a 20 to 25- year opportunity where we wanted to bring our philosophy to the market as opposed to buying high price-to-sales stocks which substantially lowers forward-looking returns. We launched factor-based strategies and a dividend strategy together with the S&P with whom we partnered to develop our revenue weighted strategies.
I would like to mention that 15, 20, 30, and 40 years ago when I first got into the business, a lot of hedge fund managers and other professional investors were able to gain information before the general public. They were able to add real value buying stocks, creating new investment strategies and trading. They had a tremendous advantage over the general public because we didn't have the rapid dissemination of news that we have now. Now the news is instantaneous and available to everyone at the same time. This advanced knowledge that professional investors use to have on the markets has completely gone away. Global Beta’s fundamental philosophy is that superior returns are no longer coming from having advanced knowledge. Like other strategies, Global Beta is going to include most of the S&P 500 because we use that as our benchmark, however, what differentiates us is that we are disciplined investors.
We believe that the winners going forward are going to be disciplined investors. It is about discipline and not knowledge in my view because you're not going to get an advantage over the next person and extract return that way. We now live in a global economy where you have to pay attention to valuations. That is how we try to model our strategies.. Global Beta’s strategies provide investors with exposure to the markets coupled with our experience as disciplined investors. We have built a lot of low cost index strategies over the last 15 years. We know what we're doing.
Over the past 10 years, there has been a significant influx of ETF strategies that have come to market. What is Global Beta doing to differentiate themselves from other issuers involved in factor based strategies? What is compelling about Global Advisors?
What differentiates Global Beta is that it is what we have been doing for a long time. We have a track record of over 10 years managing money, both with building ETFs as well as creating separately managed accounts for institutional clients.. I can give you an example of our discipline in action. We had a large client that we managed $15 billion is assets for during the crisis in 2007, our experience told us to pull out of mortgages. We did not own one collateralized mortgage in the portfolio of the $15 billion we managed of which $10 billion was in fixed income. Had we indulged in the euphoria that existed in asset back securities at that time and not followed our principles when evaluating market valuations, the portfolio we were advising on would have suffered greater losses during the 2008 financial crisis. It is our ability and the strength of our team to look at what is rational in terms of pricing. We bring this discipline along with research around value, growth, small-cap, mid-cap and low volatility factors, styles and sectors. We have a long history working across these market caps and factors.
In our portfolios we measure when price-to-sales rises and falls so we can determine when the portfolio becomes overpriced — low volatility can become overpriced, growth can be overpriced, even value can became overpriced. We have developed charts of when these factors become overvalued. Global Beta is the only asset manager that I know of that is using price-to-sales to provide us with the underweight and overweight of these various factors.
The charts don't only look at the economy. We let the market tell us when one of these factors has too much exuberance in it and then we begin to reduce our exposures and increase our exposure to the other parts of the market. Because all these companies are viable. And it becomes like a contract trade in which we use a very specific barometer that forces us to employ our disciplined approach.
What is Global Beta’s base case scenario for the economy and the markets over the next year? How would you recommend investors best position themselves?
History has shown that it is very rare in the presidential election cycle that you end up with the bear market although it's possible. Looking at all the probabilities, I don't think anything is going to happen this year because of what happened in 2018. There is political risk surrounding the impeachment. If all of a sudden, some smoking gun popped up around Trump and the Ukraine, and shifted the Senates view that could potentially create a crisis.
At Global Beta, we don't expect anything to happen but let me give you an example. In September of 2019, the Fed fund rate went from like 1.6% to 10% overnight, an anomaly occurred that many investors didn’t even realize happened, there was a freeze on banks and repos overnight. No one has really figured out why. These unknown systematic risk are popping up because we're becoming a global, interconnected economy in which small events can trigger a crisis.
If you go back in history when we have had a real crises, there are instances in which some events have created a technical crisis of 10%, 15%, 20%, or even 25%. But the real crisis that can create a major correction this year and into the next is when the public loses confidence. Every time there is a trigger in the market, there's a confidence loss.
In my view, the current administration has been a cheerleader for businesses which causes investors to take more risk. Trump has been more of a cheerleader where Obama wasn't a cheerleader for the business community. And you can see that. If you go back in history and look at all the presidents and you see the ones that were cheerleaders for business, I mean I know this sounds ridiculous but it's about confidence. If you look at the American economy, businesses take risk when they are confident. They build and expand. We believe that Trump will remain a cheerleader for business, however, if that changes which could happen remains one of the risks.
We do believe that there's going to be a rotation. We've been saying this for two years and it hasn't happened yet. But I'm betting if you looked at the markets back to the 1800s, there has probably been a spread between growth and value that was unsustainable. An example is putting growth stocks that have extremely high price-to-sales into cap weighted strategies.
We believe that there's going to be a rotation into more commodity-oriented stocks and strategies which is due to global expansion in China. China’s economy is being stimulated as is Europe’s.
Eventually, all of that stimulus is going to create a global expansion. Once that happens, there's going to be a flattening out of high price-to-sales stocks. It is going to be like a free-for-all for all the companies that have been cutting cost for the last 5, 6 to 7 years. We believe the incremental increase in global economic activity is going to hit their bottom line. It is then our estimation that it is going to effect value, small-cap, mid-cap, and maybe even emerging markets. We see a rotation effecting the bottom line, given that there is no major catastrophe with a rotation out of growth-oriented strategies into more rationalized price-driven strategies is what we believe is going to occur. The other period that I would compare it to would be from '99 through 2009 when technology stocks flattened. We had some inflation back then. We had great global expansion. Small-cap, mid-cap and emerging markets dominated, however, the very largest companies flattened out. That's my view.
See Important Disclosures: https://globalbetaadvisors.com/disclosures/