Our PMs spend a ton of time on research and portfolio reviews, and I’ve made it a habit to grab 30 minutes to ask what they’ve been seeing. Together with what we’re hearing in conversations with advisors, it’s a great opportunity to tackle the most common things on advisors’ minds. Joining me:
- JD Gardner, CFA, CMT Founder/CIO
- Beckham Wyrick, CFA Equity Analyst/PM
- John Luke Tyner, CFA Fixed Income Analyst/PM
- David Wagner III, CFA Equity Analyst/PM
Key topics covered:
- Performance Dispersion
- Valuation Compression
- Earnings Outlook
- Supply Chain & Inflation
- Bond Selloff
- Risk Mitigation
- Volatility Environment
- Stocks vs. Bonds
- MegaCap vs. Broader Opportunities
Always fun for me, but ultimately for the benefit of the thoughtful advisors who keep us busy supporting their efforts. Full transcript below, beware transcribing errors and verbal slips!
Derek:
Good morning, this is Derek from Aptus. I hope everyone had a wonderful Easter holiday. We are just
about to kick into the heart of earning season and thought it’d be a good time to get the crew together
as we do every quarter and just talk about what’s going on in markets. What has happened, what is
happening, and what we think could happen over the next couple of months. Earning season will
obviously be a big thing, but there’s a ton of macro drivers, and we’ve got the right people here to talk
about it. I’ve got four CFAs. So I won’t repeat that for each of them. I don’t have one, but the four guys
on here are sharp. We’ve got JD, who’s the founder and chief investment officer. We’ve got Beckham,
who kind of organizes all the asset allocation and portfolio construction process.
Derek:
And then Dave Wagner’s the equity analyst and portfolio manager. John Luke is our fixed-income guru
and portfolio manager. So we’ll just, we’ll cover all topics. I got a quick disclosure I have to read. The
opinions expressed during this call are those of the Aptus Capital Advisors investment committee and are
subject to change without notice. This material is not financial advice or an offer to sell any product.
Forward-looking statements are not guaranteed. Aptus reserves the right to modify its current
investment strategies and techniques based on changing market dynamics or client needs. More
information about Aptus’ investment advisory services can be found in its form ADV Part Two, which is
available upon request. So obviously, there’s been a lot going on. We’ve had a war, Fed changing its
policy, companies trying to react to it. Inflation and the headlines nonstop probably makes sense to start
with, maybe just what’s going on in the equity markets. And I know everyone has opinions. Whoever
wants to jump in, go for it and kind of tell us like where we’ve been and where we might be going.
Dave:
Well, I think everyone knows that I have a lot of opinions, so I might as well just go first here, but Derek,
great job of really setting kind of the landscape of what the market has had to go through just for the
beginning of the year. Obviously, we’ve had the Fed start a tightening cycle. We’ve had an exogenous
geopolitical war. We’ve seen interest rates spiked almost 3% on the 10-year, over 5% on the 30-year
mortgage. So there’s a lot of stuff going on right now, but I’m going to back it up a second here. Right?
We put out our 2022 outlook back in December, and what did it stake, right? We all know that the total
return comes from three return drivers, dividend yield, earnings growth, and valuation expansion or
contraction. And we knew heading into 2022 that valuations as measured by the S&P 500, was at 21 and
a half times, putting it in the 95th percentile versus its historical averages.
Dave:
So valuations were very high. We knew that going into 2022. We knew that growth would also probably
start to pare back. So what we were looking for this year in 2022 was let’s just see if earnings growth can
insulate the degradation that we’re going to see in market valuations, and that is exactly how it started
to happen this year. Just this quarter, we saw valuations come down from 21 and a half times earnings
to now below 20 earnings as of mid April. All right. The S&P 500’s down about 8% thus far, and the
market returns has been solely due to valuation compression. Because, in fact, thus far this year, since
the beginning of this year, we’ve actually seen earning growth for the S&P 500 increased by 7%. And a
lot of that has been basically on the back of basic materials and specifically energy really driving that
earnings growth moving forward.
Dave:
So exactly what we started to prognosticate. What the market may see in 2022 has exactly happened
thus far in quarter one. Valuations have come down, growth is trying its best to insulate the mark total
return for the S&P 500, but it hasn’t done that so far, hence why the market’s down 8%. So, that’s what
has happened during this quarter. That’s where we stand. But more importantly, as we look through the
windshield, maybe what can we see for the rest of the year? Will we continue to expect to see
valuations come down to more normalized levels? Potentially to an 18 and a half 19 times turns level
throughout the remainder of the year. But that means that we know that we believe pretty fully that
could happen, but more importantly, we really want to start focusing on growth for the rest of the year.
And Derek said it best, hey, we’re starting to head into the earning cycle.
Dave:
We’re really going to start to see quarter one performance, but more importantly, guidance from
management teams on what they’re expecting moving forward through the rest of the year, given all
the macro uncertainty going on. Inflation is running high rates are skyrocketing. Maybe you’re
purchasing power is substantially lower. So we’re really starting to focus on that moving forward for the
rest of the year. And that’s probably our biggest driver of the market for the remainder of 2022, is that
we know that valuations are going to continue to come down. So let’s continue to focus on growth
because we know that the market has a difficult time performing well if you start to see EPS revisions
really start to come on down. So we believe that we’re going to continue to see a lot of volatility here in
the market moving forward.
JD:
Derek, I would say that one thing that might be on some investors’ minds. There has been pockets. And
we’ve said this for quite some time, especially if you have a rising rate environment, that the equity
markets, obviously we’ve talked about fixed income and duration being an issue, which JL I’m sure
you’ve got some thoughts on, but the really kind of long duration equity place, we’ve seen those. Like
they’ve mentioned, the S&P’s down 8%. There’s certain pockets of the market down significantly more.
And most of it is those extremely long-duration plays. So that’s probably worth pointing out that there
has been some serious damage in certain sectors of the market.
John Luke:
Yeah, no. I think if you start, and you look at Q1, and we’re a few weeks into Q2 now, but just the
carnage in bonds has been real. The stability that investors look for with their bond portfolio to help
insulate against equity markets has basically been nil. I think, if you look at it day to day, the AGS
actually down more than the S&P is. So, the insulation that you’ve had from bonds has been really tough
to stomach, and I think some of the alternatives out there have been just as bad. If you look through
yesterday, the AG has given away about three and a half years of income based off of the price return,
that the price loss from the bonds of the impact of rising rates for the first call it, three and a half
months of the year.
John Luke:
And so, that’s big. We’re talking three and a half years of income to make up for the price loss. And if
you think that rates could continue to move higher, that obviously gets worse and worse. So, as we look
moving forward from here, the impact of fixed-income and portfolios, especially given sort of the
inflationary backdrop that we’re faced with, it’s still not a compelling case. Our biggest thought on when
fixed income looks attractive again is really based off of when we can start to see inflation peaking, and
we just haven’t seen that yet. And I think one of the biggest things or the couple biggest points that
we’ve seen, for the quarter, as far as interest has been on supply chains and inflation. And when you
look at the supply chain backdrop, we’ve obviously seen this huge pull forward of goods, which has
basically lasted since the beginning of COVID and the stimulus that’s occurred.
John Luke:
But really, what you continue to see is sort of, this tug war with the supply chain, where like last year we
had the omicron virus and then this year we’ve got China, re-locking back down. And so you’ve got this
fight going back and forth that’s keeping sort of the supply chain from being back normalized. And then,
on the other side of that, we do see the shift from goods to services, as far as the economy goes, which I
think will continue to help lower some of the inflation pressures that we’re facing. But again, just like the
PPI number that we got last week, which PPI typically leads CPI. It’s not peaked yet, and neither has CPI,
I guess, in saying that. But I think that the prices paid index will continue to lead the way for CPI. And if,
if, if we see sort of a peak inflationary environment, I think that will probably allude to it.
John Luke:
The other biggest point of Q1, I think, was the yield curve inversion. Our thoughts on the yield curve
inversion was that the magnitude and the duration were probably not enough to really scare us. We
talking about the yield curve inverted for about two days by about max of seven basis points. And right
now, if you look at where we’re at on the two-year treasury, we’re about 2.5, and the 10-year is over 2.9
like Dave alluded we’re, we’re knocking on 3%’s door, but the real news for the year, in my opinion, has
been just the shift in rates that we’ve seen the two-year treasury’s gone from 70 basis points to over 2.5,
the 10-year treasury has gone from 1.5% to over 2.9. These magnitude of moves are not something that
typically happens over three months. And how it’s sort of impacted other valuations, how it sort of
impacted the markets has been eye-opening. And so, our thoughts on how this sort of plays out is,
again, you have to see some sort of peaking and inflation to sort of claim the rise and interest rates that
we’re seeing. So that’s sort of the quick and dirty fixed-income spiel.
JD:
Yeah. Derek I would point out, too, the one thing you didn’t explicitly touch on John Luke, is mortgage
rates. Anybody that watches this that’s in the market for purchasing a property, they’ve literally 60 days,
my math might be slightly off, but you’ve seen a significant… And we’re over 5% on a mortgage rate,
which not long ago, you could lock in a 3% mortgage rate. So I do think that impacts a lot of things, just
the cost to borrow funds has gone up because of some of the decisions, just the environment,
inflationary environment, Fed decisions, all that.
Derek:
Yeah. And there’s a lot of dynamics just between what the three of you have talked about. I think people
have obviously ridden the 60/40 portfolio for a long period of time thinking that equities, they’re going
to go up over the long term and if things get rough, my bonds will at least protect me. That obviously
hasn’t been the case, and I think bonds have actually done worse than stocks, depends on the day that
you pick, but they’ve been going neck and neck in the wrong direction. That said, there’s a lot of
dispersion. Obviously, energy’s been hot, and we get a lot of questions about, what do we do about all
this? Gold and energy. Do we try to time sectors? I don’t know if anyone wants to touch on that. I know
we have a bit of an aversion to try to time and be extremely dynamic and tactical about flipping from
one sector to another based on short term activities, but if anyone wants to touch on kind of that
backdrop and some of the things that we think are actually achievable ways to improve the portfolio,
have at it.
Beckham:
Yeah. I can jump in there, Derek, and I think I can just kind of touch on how we’re positioned currently
and kind of the four themes that I see that have helped so far this year. And then these guys can jump in
from there, but like you said, a traditional 60/40 has been beaten down this year. I think it was down
over 5% in Q1, a lot of that being led by treasuries having their worst start in 50 years. I think bonds in
general were down over 6% in Q1, and just with minimal yield coming from that side of the portfolio, it’s
been hard to combat the rise in interest rates, which has hurt on the price side of things when you’re
looking at bonds.
Beckham:
So, current positioning for us, I think the highest level message that we want to get across is that we’re
comfortable right now. And there’s really four reasons that I see that kind of give us that comfort level. I
think one, and probably most importantly, is just that we have less reliance on traditional fixed income
as a return driver in the portfolios. When you think about what’s the worst thing to own in a highly
inflationary environment, it is a fixed payment. So structurally, having exposures in the portfolio that are
able to benefit from volatile environments allows you to rely less on fixed-income and more on equities,
where we do think there is more potential return given that there will be heightened volatility as well.
Secondly, I think just having more exposure to value-oriented areas of the market has been beneficial
and will continue to be beneficial.
Beckham:
I think JD mentioned kind of the long duration equity plays as far as thinking about through the more
growth-oriented sectors of the equity market and how they’ve been beaten up somewhat to start Q1. I
think, on the other side of that you have value, which typically do better than those more growth-y
oriented sectors in a rising interest rate environment where more of a focus is put on profitable
companies cash flow. And that’s where they have an opportunity to come into favor. And that’s
something that we’re focusing on, both at the stock selection level, but also at the allocation level where
we’ve moved and have seen benefits from small-cap value, equal weight S&P exposure, those types of
exposures that get you more down the market cap spectrum, those have been great kind of inflation
hedges, and they’re also, from a valuation perspective, looking pretty cheap right now versus large caps.
Beckham:
I think thirdly, having kind of an explicit inflation protection in the portfolios is helpful. One, through a
higher exposure to stocks over bonds. And then also two, having direct exposure to companies that
stand to benefit from higher inflation has been beneficial in the portfolios. And then I think thirdly, and
lastly, and this has less to do with inflation, but more just kind of geopolitical risks and kind of the macro
that we’re facing right now is that we see or feel that an underweight to international markets will
continue to be beneficial. Yes, valuations are attractive overseas, potential for a rebound is there, but
given kind of what’s going on with the Ukraine and Russia and how that plays out on energy and just the
economies over there, we think being cognizant of those risks is important and having kind of hedged
exposure to those areas of the market gives you kind of, the potential for participation there. If you do
see your rebound, but also kind of takes in line and into account the risks that are present right now. So
kind of highest level, I think that, you guys correct me if I’m wrong, but I think that we like our current
position in going into Q2.
JD:
Yeah. The only thing I’d reiterate on that is asset allocation decisions are the most important that you
make, they carry the biggest impact. And so, like Beckham mentioned, a defense against inflation, you
mentioned, number one, you don’t want to own fixed payments in an inflationary environment. And
two, we have more defense by potentially owning equities. And the reason is really because there’s
obviously growth in underlying equities, or hopefully, the ones that you own that’s helpful, but also,
stocks have the ability, companies have the ability to pass on some inflationary pressure to the
consumer, whereas fixed-income doesn’t. So I don’t want to start the kind of let’s beat up on bonds, but
all of the reasons bonds have been beneficial for the last 40 years, and we’ve been probably early on this
because I think we’ve been saying this for the last six or seven years now, but there’s not a lot of reasons
to be really attracted to bonds even with this pickup and rates.
JD:
And so I think the allocation decisions in portfolios, you really have to make sure at a very high level
exposure to, if you’re still dependent on that kind of 60/40 mindset to be as beneficial as it has been,
that, we just don’t see that being the case. And obviously, we’re not, at least, hopefully, we don’t think
CPI will print eight and a half, like it has recently, we think that will come down, we just don’t think it’s
coming down to 2% like it has been for the last 20, 30 years anytime soon. So…
Derek:
Although the one thing that we haven’t touched on, and we are a long Vol shop, I mean, everyone here
is talking about volatility as an asset class. We haven’t really seen a spike in volatility, given all that’s
gone on. And given the fact that markets are down, we obviously had a rise in volatility early in the year,
and then it’s kind of faded back and hasn’t really resurged. I don’t know if anyone wants to touch on
either the environment for Vol or what Vol can do for portfolio, but I think that’s a useful topic that
advisors are always interested in too.
JD:
Yeah. It’s been a difficult year for long Vol. Really. I mean, January started with things dropping, Vols
rising, and then you had like a 45 day period of go nowhere markets and volatility was, kind of, sucked
out of the market. And you didn’t get that big spike in volatility where your long Vol exposure would
really pay off, but I think the two things to your question, number one, is the market prone for more
volatility? We would argue, yes. I think that having that exposure should be helpful in that environment.
But number two, kind of, going back and Beckham mentioned this, owning this long Vol, if bonds are
traditionally, your conservative asset class and stocks are, traditionally your risky asset class and,
obviously risk and return are connected at the hip. So if you’ve got more risk, you should have more
return. If you have less risk, you should have less return.
JD:
But if that’s the way we think about things, what Vol does in this environment, if we think those
conservative asset classes, bonds, are no longer beneficial, it gives us the freedom to own more of the
risky asset class. And inject more potential for return without being really worried, that’s, kind of, the
theme of Aptus is, can we own more things that look attractive, less things that don’t, but can we do so
without injecting so much risk? And that’s really what, it’s not going to be perfect, but in periods of
market stress and true volatility, it’s a really beneficial allocation to have. And even if you think about
this year, Derek, as ugly as bonds have been, owning less of those has been, that should be beneficial.
We think that should be beneficial moving forward because we don’t think, I think if you’re looking for a
return, you almost have to go to more equity allocation.
Derek:
Cool. All right. Well, I mean, I think we covered the basic environment for markets, and we’ll probably
see a lot more as far as how companies are dealing with it and some of the comments about, what their
cost of goods and all that kind of stuff. We’ll probably have more to say and share. And tune in to our
posts. The guys have been pretty prolific as far as communicating their thoughts and just kind of sharing
what’s going on out there. So, we appreciate the interest, and I appreciate you guys hopping on for a
little bit just to talk about what’s going on
JD:
Derek, one more thought that I should have said, but if you are going to have more volatility out in the
markets, owning Vol is really the only way to potentially generate capital to deploy when the
opportunity is more attractive. And that is that’s a huge point to make. So if you have, because the
economy’s coming along right now and if you get a market shock or whatever, and valuations depress
even further or compress even further, Vol is really the only way that outside of keeping cash on the
sidelines, which is a difficult thing to do when inflation’s running like it is. So that’s one thing I would
stress owning Vol is the vehicle that allows you to potentially have capital to deploy when the
opportunity is much more attractive.
Derek:
Awesome. Cool guys. If no one has anything else to throw out there, we’ll cut it there and move on. Appreciate the time.
Beckham:
Thanks Derek.
John Luke:
Thank you.
JD:
Thanks everyone.
Dave Wagner:
Thanks.
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