Aptus Quarterly Market Update – Q3 2024

Browse 3 Minute Executive Summary Here. Full Video Transcript:

Derek

Good morning, 1st of October, early for you on the West coast, but it’s 11:00 for me here in Charlotte and there’s lots going on in the market.

Anyway, I want to thank you for joining us. I’ve got quite the Aptus all-star team today. Founder/chief investment officer, JD Gardner, is here. Dave Wagner, head of equities, is here. John Luke Tyner, head of fixed income, is here.

We’re going to go through a bunch of stuff, what has happened and more importantly, what might happen going forward and how that impacts clients.

We know it’s that time of the year. We try to do this as quickly as possible end of the quarter because a lot of people stack meetings early in the quarter. With the election and everything going on, I’m sure clients have rational and irrational questions to tackle and so we want to be here to at least give you coverage on that and these slides will be available.

Let me do a quick disclosure.

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 2, which is available upon request.

It was a good quarter. Another good quarter. It’s been a great year. One of the best in many years. Had a couple of little bouts of volatility early in the months of, I guess, August and September and now, we’re getting another one in October. That seems to be the trend of late but fire away wherever you all want to start.

JD

Perfect. Thanks, D. Hern, and thanks to everybody on this call.

It’s cool to see the growth of these quarterly calls here recently. Probably some good reasons for that. But either way, we appreciate the time.

Our goal today is really going to cover, hey, what happened, what we think about the backdrop of the markets, and how that impacts clients.

I usually don’t get invited to be here. So guys, thanks for letting me crash the party.

To kick things off, I’ll make two points and I think we’re going to talk about the macro. We’re going to talk about earnings and election and everything else, but I think the biggest thing to keep in mind is what matters is higher compounded returns.

That’s what clients want. And everything that we do is focused on allocation. I know you all have heard us say that. How can we create portfolios? Can we create strategies to impact allocation? Because that’s the lion’s share of what matters. And so if we can be good there, we can make mistakes elsewhere.

With that said, the two things I want to touch because I don’t think people touch on this enough. Risk adjusted.

I always give the example. Let’s say Dave generates a 10% compounded return. Let’s say John Luke generates an 8% compounded return, and you give a client, “Hey, do you want Dave’s 10 or JL’s eight?” Most clients are going to say, “I’ll take the 10,” and JL says, “Well, wait a second. Wait a second. My Sharpe ratio is higher. I’m here. This is my opinion. That’s my disclosed statement. It’s my opinion.” No client cares about their Sharpe ratio, they care about their higher compounded return with the reality of, hey, but what is my potential for drawdown, because clients view risk as drawdown. And I can’t stress this enough.

At Aptus, one of our things, the point of emphasis that we make is we think we’re generating higher CAGRs, higher compounded returns, but we’re not doing that to the detriment of drawdowns.

So when a client says, “My million bucks turned into 600,000, I’m concerned about that.” Our whole thing is more stocks, less bonds. We’re going to dig into why that is because I think the backdrop is just further evidenced that we’re not wrong.

But the big thing is like, okay, if it’s more stocks, less bonds, how can I be risk neutral from a drawdown standpoint, and we’ll talk a little bit about hedging and what that means.

That’s the first thing. Risk adjusted. When you adjust returns by risk, I think it needs to be adjusted by the one that matters to clients. And again, I think the allocation impact is critical when it comes to that concept.

Last thing from me to kick us off, and I know if you’ve read anything that we’ve put out here recently, this is a drum we’re beating and we’ll continue to beat. This is the hardest conversation for me personally to have is breaking the chains of, hey, my treasuries are safe, my CDs are safe, my cash is safe.

Obviously, what you’re looking at is by which is a proxy for what we would call risk assets, AG, which is a proxy for conservative or the traditional definition of safe assets.

The CPI running horizontal is the cumulative total of CPI over the last 10 years. What this chart is showing you that there is a significant difference between risk assets and conservative assets, again, traditionally defined and we think the backdrop is one to where this discrepancy is only going to increase.

And so what clients need to hear in my opinion is your risk is not some period of short-term volatility. Your risk is your purchasing power being confiscated from you. I think you solve this problem. You solve longevity issues that are impacted by what I just said at the allocation level. This is like…

Everything we’ll cover today boils back down to this chart again. Again, there is a very, very strong inertia force of, well, my treasuries are safe. I’m sure JL is going to make the point. If you’re getting four and a half, 5% from a treasury bond and our deficit spends 8%, they ain’t safe. I can assure you that.

That’s what I wanted to kick us off with is, hey, we do think higher CAGRs adjusted by drawdown is a metric that makes the most sense to harp on from a risk adjusted standpoint. And then be careful defining safe because I think a lot of people have the wrong anchor when it comes to what is safe.

Dave, I’ll turn it to you.

Dave

Thanks for that introduction there, JD.

I think one of the coolest things about Aptus is if you go out there and listen to really anyone talk, they talk to you about the problems of the world, the wall worry that investors always climb. They tell you what the problem is, they don’t tell you the solution, what we believe is the most efficient way to take a problem of what we recognize and get to the solution where it actually has a tangible effect for you all to make decisions at your allocator level itself.

That’s why everything that JD just talked about right there, myself and John Luke had a fixed income discussion, we’re going to kind of intertwine it with a lot of our macro and fundamental commentary.

Obviously, Dave Wagner here, I do equities here at Aptus.

Equities are hot right now. They’re so strong right now. Risk assets just continued their history during September and obviously, for the quarter as a whole. In fact, they continue their history because the market’s up 22% year to date.

I’m using that word hit streak here very purposefully because I’m a Cincinnati guy. Pete Rose, famous Cincinnati native, who holds the MLB record for most hits in a career. He unfortunately passed away last night. That hits me hard.

But much like Pete Rose, the market is very polarizing to people right now as there’s always this wall of worry for investors to climb, especially as we’re only 36 days away from a presidential election. But like Pete, I’m going to continue to bet on stocks.

Obviously, JD just mentioned our Aptus allocation series, more stocks, less bonds, risk neutral because I always wanted to take the home team because Pete Rose, he always bet on the Reds to win, and I think that betting on stocks, they’re considered to be the home team.

That’s exactly what won this past quarter, specifically the more relatively cheap areas of the market. Think U.S. small cap, think international, those were the winners.

I think that the best way to explain the 43 different all-time highs that the market has witnessed this year is that they’ve all come from now different whys. We’ve had 43 new highs but we’ve started to see from new whys.

That tells me that the character of this market really started to change here in this third quarter, but the direction remained the same because the market finally started to see some breath out there.

Many people have asked us if this is more of a less powerful rally, but I would say the data suggests otherwise. This is still very much a bull market and it’s just a market that has started to broaden.

You had the equal weight S&P 500 up about nine and a half percent on the quarter, which outperformed the S&P 500 by 3.6%.

The broadening rally to me it’s more of an encouraging sign for stocks, especially following the concerns that the market could be vulnerable to some type of reversal and this cluster of text proxy names propping up the market really fell out of favor. This is a very, very healthy development for myself and risk assets.

You saw utilities, staples, real estate really drive this market higher but not only that, you actually had earnings come in much stronger across the board. The market’s pricing in a 10% earnings growth this year and 50% earnings growth next year, and much of next year’s earnings growth, yeah, it’s coming from margin expansion.

But sales growth is still a very strong across the board at 5%. We all know that when margins are expanding at the S&P 500 level, it’s tough to get in trouble with the market.

That’s really one of the reasons why I’m going to continue to be like Pete Rose and bet on risk assets over time. But I always have a saying or a phrase on a quarterly basis. All right?

Last year was it pays more to be patient than clever. But I think the one for this quarter is actually going to be coming from one of our different partners that we work with and he said something along lines, “I’d rather be right until I’m wrong than wrong until I’m right.”

I say that because it feels like there’s just a lot of investors out there that are trying to be more clever than patient, potentially eroding capital from an opportunity standpoint.

That’s really just a blessing to our Aptus structure as a whole because we don’t need to be clever to win. We just want to own as much beta as possible with guardrails because that’s the best way to compound capital over longer periods of time.

But as many of us on this call probably know… I believe Aptus is, obviously I’m biased, we do a lot of things very, very well, whether it’s running active ETFs, our amazing services, our sales team, our ops, our trading but I think one of the most overlooked aspects of Aptus is the material that we put out to clients to give advisors as many arrows in their quiver to make sure that their investors and their clients remain invested, because we all know it’s your time in the market and not time in the market as a whole.

That’s why this chart really sticks out to me here is really walking you through what the S&P 500 returns. We’re looking through the windshield, not the rearview mirror, after the fed cut rates within a 2% all-time highs.

I’m just going to focus quickly on the right side, the farthest right chart, basically saying that stocks are up 100% of the time. It’s a 20 out of 20 hit rates of being positive one forward year in advance when the fed cuts rates within 2% of all-time highs.

Obviously, we all know that the market’s up 43% off the recent market low of October 27th of last year, and a lot of people are trying to be clever and trying to time the market top because that’s fun, but they’re not being patient.

This chart right here helps people, hey, you know what? Let me remain patient. What the data says, this is 100% hit rate, 20 for 20, that the market’s higher when the fed cuts, if the S&P 500 within 2% of all-time highs.

But just because I believe that it’s really hard to be short the market right now, especially headed to election and John Luke will touch base on a lot of the monetary policy and the fiscal policy, really injecting liquidity in the market, doesn’t mean that there’s not going to be pullbacks in the market as a whole.

This chart really shows you that going back to 1928, drawdowns are healthy. They’re necessary. It’s a great reset for the market as a whole. This is something that we all know that in fact the average drawdown in a calendar year going back to 1928 is 16%. We’ve only seen one 8% pullback and that was during the yen carry trade debacle of early August. But we all know that the market on average tends to see one 10% pullback per year and three 5% pullbacks per year.

If we do get some choppiness ahead of this election or into the end of the year, even though I say that it’s hard to be short the market given the liquidity bazookas out there really propping up this marker right now, is that pullbacks are healthy, they’re normal, especially from a seasonality perspective.

The last thing I’ll say in the last 20 seconds or so is leave you with this on the equity front. Be like Pete Rose. Come increase your chances of winning the long-term game because you got to get a lot of hits in this industry.

We work in an industry where you do not get rewarded for home runs, you get rewarded by having more bats at the plate and more opportunities to get hits.

Be like Pete Rose, maximize your hits.

That’s what I believe our allocation does because we trust our defense by owning hedges so we can have more hits than any other player out there. That’s something much like Pete would probably do here. That’s something I would bet on.

JD

JL, not to jump in, but Dave, the two things that you said that I think are worth stressing would be, number one, our emphasis on additional beta. Additional beta versus a benchmark or versus 60/40 turn it into 80/20, that additional 20% we advocate just simply beta. We want to understand the risk that we’re onboarding and that’s critical.

The other thing that you said, you wrapped with it, Dave, but I really liked, “I want to be right until I’m wrong rather than wrong until I’m right,” because that’s what we see the biggest mistake in investing is like, “Well, I’m going to hold this cash in T-bills because the election or because…” You can come up with a million different reasons. But that’s what I think we overlook sometimes is the hedges that we have in place, there’s no correlation that you have to guess about. They have a negative correlation.

Do they cost us to own them? Heck, yeah, they’re going to cost us to own them but that cost allows us to own more of the risk asset. And if equity markets do sell off, if we’re wrong, then we have the brakes in place to prevent that.

I think you’re not going to avoid volatility, nobody’s saying that but I think, again, back to the drawdown measure, I think you’re going to be happy with it.

I just wanted to get that out.

John Luke

And on that note, JD, I think it’s perfect because you look at stocks obviously had a great quarter, it was a little bit of chop to get there but bonds had probably the best quarter that they possibly could have. Only Q4 of last year was better in recent history. Bonds measured by the AG up about 5.3% longer duration bonds like LQD did even better.

With that positive correlation continuing to be in check between stocks and bonds, does that mean that bonds are going to be reliable to be those breaks? I think we would argue that it’s not.

One other shout out for Dave, for someone with such a good saying of patience over being clever, you do have some clever quarterly sayings, so kudos to you on that, Dave.

But what a quarter for bonds. The two-year rallied 111 bips. The 10-year rallied about 68 bips to finish at 3.64 and 3.78 for the 10 year. The yield curve obviously is uninverted, spent a little over two years with a pretty steep inversion that finally came through with the front end of the curve coming down and the long end maintaining.

You also had the 50 basis point fed cut. I know we argued at the end of July or at the end of Q2 in June and early July that we thought that the fed would cut in July and obviously they didn’t. That was followed by some pretty weak labor data, some bad revisions, and data that just was not terrible but not great.

You’ve got this dynamic of the fed coming in, cutting 50 bips, architecting 200 more basis points of cuts, the market’s pricing in about eight cuts by the end of 2025 and about three more cuts for this year. That involves one more 50 basis point cut at some point and I think markets are obviously pretty hopeful that that comes.

What you really have seen is a shift from the focus on inflation to a shift in focus of the labor market. Unemployment has gone from 3.4% at the lows to 4.2. Obviously, that’s a pretty big move in terms of just absolute numbers but when you think about 4% unemployment, historically, that’s been full employment and that’s really nothing to bat an eye at.

Obviously, there’s some caveats with immigration and things like that but the fed has certainly bypassed their focus on inflation. Remember inflation as measured by core is still closer to 3% than it is 2.

One of the key ingredients that we’ve talked about the last 18 months is in order for the fed to get this soft landing, it does look like we’re potentially going to get that inflation is going to have to be tolerated at two point something rather than two on the dot. It does seem like that that’s in play.

Moving forward, I think the couple biggest things to watch is… The fed’s obviously got a lot more ammunition to cut rates if they need to. The fed put is certainly in place if you see the economy deteriorate.

I think the market’s seeing that and it’s probably somewhat reflected in stock prices, but inflation is still not necessarily a problem but it’s still elevated. I think that it could be a problem if the Fed does get too lackadaisical and ease too much into the backdrop that we’re in.

And to start the quarter, I guess, really started last week, you’ve got the Chinese stimulus that’s coming into play. If China is stimulating and growing, that’s going to pressure the global economy in an upward direction.

I think as you put really everything together, it does seem to me like the long end of the curve has probably rallied too much. What you tend to see, especially going into a soft landing, is that the market front runs the bulk of the rate cuts before the rate cut actually happens.

You’ve seen that. The 10-year dropped almost 70 basis points in a quarter. I think what that means is it’s pricing in this pretty aggressive cutting cycle and are you going to get an aggressive cutting cycle if the economy has a soft landing. I think our thoughts would be probably not.

I’ll sum it up to this is when you think about what your return is from a bond, historically, the income level has been a very good indicator of what that return is going to be. Well, you just had a quarter where longer-term bonds returned six or 7%, the 10-year treasury did extremely well.

Well, moving forward, is that going to continue? Are you going to continue to see rate decreases like we saw last quarter? We would argue probably not.

And then when you look at your bond return, you have to, of course, remember that it’s a nominal return that you’re getting after accounting for inflation, after accounting for taxes. Yields have been substantially lower.

In the chart book that we have, we had a great chart talking through after-tax returns of treasury bonds over time and it’s not something that you’re riding home about, loading the boat to buy treasuries on.

Thanks for pulling that up, Dave.

I don’t want to get too much off the fence on the fiscal side because I think we could get going. It’s been a huge driver to the economy to keeping things in place from a debt perspective. From the fed perspective, the huge increase in interest rates obviously substantially increased their interest burden, especially relative to what the securities on their balance sheet were yielding.

As this chart shows below, just the net interest cost of our government debt has surpassed defense spending and it’s been substantial. And if you take it a step further, we’ve been issuing a ton of T-bills at the front end of the curve, which have been the highest yielding part of the yield complex. And so it’s expensive.

As we continue to chop through that, I think you’re going to see more of that continue to pressure the long end or back end of the yield curve a bit, but just there’s no way to deny that when you’re running six or 7% deficits, maybe even higher depending on how you’re accounting for it, it’s just awful hard to get a substantial decline in the economy and we continue to see that play out.

Obviously, it’s an election year, so you maybe get a little bit more of that pulled in but a lot of these fiscal packages that were put in place the last several years, they’re coming through and dripping on this economy for the next several years.

As you continue to factor in, it’s hard to get a recession when you’ve got a strong labor market. We still have a pretty strong labor market. You’ve got net worth at all-time highs.

You’ve got a huge chunk of the economy that’s driven by baby boomers who hold 70% of the net worth of our country. That have changed after COVID. They’ve got more of a propensity to spend, a YOLO type of mentality.

I think that you’ve got so many things that are going to continue to push and elevate the consumer to keep this economy churning.

And then on the backside of that, the fed’s got all the ammunition in the world if we do get any weakness to come in and start punching.

The backdrop, I think, as good of a quarter as it was for bonds, there’s probably not much more in the tank.

I’ll stop there.

Derek

JL, it ties in a little bit to one of the questions that came in about the Fed.

Mortgage rates have come down, but not… They haven’t come down since the fed. We’ve had a couple questions and I’m just going to paraphrase, but can the fed really drive mortgage rates lower and does it matter if mortgage rates don’t go lower? That’s the rate that it seems like most people look at as potentially a tailwind or headwind.

John Luke

Yeah. Look at the 10-year yield when you’re comparing with mortgages. The fed fund rate doesn’t really matter with mortgage rates per se.

But they’re not going to be able to cut it enough to get the people with two or 3% mortgages back in the money. But I do think if they get it, if rates can get somewhere in that low fives, mid five range that maybe you can incentivize folks to move that are golden handcuffed into their mortgage. But I do think it will stimulate for newer home buyers and give them a better opportunity and make housing more affordable.

So if anything, lower rates should continue to keep that fire lit under the economy to balance things out, make things more affordable, etc.

Derek

Awesome.

Good, bad, ugly, but Dave, I know you always put a lot of thought into this with the team, so fire away.

Dave

We actually had a lot of change here too. This quarter tends to be pretty static over longer periods of time, because I love when you try to block out as much noise as possible and actually only focus on what matters. Much like what JD was talking about our asset allocation, focused on max drawdown and your cumulative compounded return over longer periods of time, that’s what you need to be focusing on.

But this is a gauge of what we believe that investors should be focusing on, not just in the near term but over the long term, because we know over longer periods of time, there’s only a few things that’s going to drive the market higher or the market lower, yet there’s so much noise out there in the market. You have CNBC or Fox or whatever it is for people to get afraid of stuff in the market, such as this East Coast port crisis that we’re on the brink of potentially just today. I do believe that’s noise.

These are the six things that we need to be focusing on. And this slide, the good, the bad, the ugly was obviously based off of the Clint Eastwood movie from 1967, and we try to be as balanced as we most possibly can with this because obviously, we want to think holistically from a big picture perspective to make sure that we prepare for what we can prepare for and make sure that we’re also prepare for what we can’t prepare for.

That came out wordy there, apologize.

But I think one of the more recent things that came on this slide here is probably the labor market.

The labor market’s really starting to see some cracks. This is a new addition to the good, the bad, the ugly for the third quarter of 2024. Obviously, this past quarter, we had a few revisions, two very important revisions in my mind from the government data itself.

First came on the labor side of things is basically establishment survey. The non-farm payrolls that comes out on the first Friday of every single month. Those jobs were revised about 818,000 jobs lower than initially expected just over the past 12 months.

That’s pretty substantial. I think that’s just starting to show you some signs that the labor market is starting to see cracks.

That’s important because if you start to see the labor market to see some cracks, you’re going to start to see wage growth come down. That’s going to have a cause and effect that’s showing you that, hey, overall economic growth or GDP growth is also likely to come down on its own.

I think the second government revision that I just mentioned or that I’m about to mention here is going to be in regards to the savings rate. I think everyone knew about that labor number revision, but a lot of people don’t know about the revision to the savings rate number that the government just put out actually just last week. I think it definitely goes on the side that the U.S. consumer continue to be very much more resilient.

The data that we’ve seen from the savings rate over the past year two, three years is that it’s been well below historical normals about a savings rate of 3% is what the market or is what the government is telling us over the past few years when the historical average is closer to five, these revisions came in and actually said you, “Hey, you know what? We actually calculated the savings rate wrong, that the savings rate is actually much higher than that 2.93% that we’ve continued to state over the past few years.”

I think that’s telling you that the consumer actually means very much more resilient than what people have prognosticated over the past two, three years, and that could be the point moving forward in the future that’s going to propel the economy and the market up because if the consumer’s resilient, if the consumer has a lot of healthiness on their balance sheet from a net wealth perspective, they’re going to spend.

I would never bet against the propensity for a U.S. consumer to spend the capital that they have in their checking account because if it’s there, they’re probably going to spend it.

More importantly, momentum is very real that they’ve continued to spend, in financial technical terms, a crap load of money really coming out of COVID since they had so much stimulus out there that they don’t want to slow down the momentum of that spend. So momentum’s a real thing.

I think that could continue to prop up the S&P 500 earnings holistically well into 2025, which we’re already expecting 15% growth.

John Luke

Yep. We’ve had a number of good discussions on the savings rate side where it’s just accounting for the nominal dollar saved. It’s not accounting for the return on those savings. So even if the savings rate was three, if you’re getting 5% on your money market, your savings rate’s much higher than that three level, and it also doesn’t account past return from savings as well when you’ve got networks at all-time highs, equity values, home values, etc.

I think to piggyback on that a bit.

The lags from policy will always be a concern until they’re not. Many have thought that rate hikes were less impactful on the economy this time than they necessarily were guessed that they would be. And so the question there bodes well, were they or is there more of a lag?

I tend to think that they were less impactful due to a lot of the terming out of debt and things on the fiscal side.

But if we did see some type of impact of the lagged policy, the nice part is the Fed has the position here that they can defend against it and so the fed puts alive. It’s like we’re turning one of those bad or uglies into, yeah, it’s not that bad.

Derek

Since we have this up, this is a good time for a question that came in. How do we prepare for your ugly?

JD

Yeah, I’ll take that one.

I think this is really at the heart of what we do.

I think the ugly in most people’s minds is markets are down 20, 30%, whatever it is, and the first thing is how do you protect against that. We build strategies designed to increase the beta exposure of portfolios. So if you give us a portfolio X, we want to turn it into a portfolio Y. What’s the difference between X and Y? It’s going to be more beta exposure.

The question is if we hit this ugly period and equity markets risk assets sell off, how do we protect against that?

We’re huge advocates of owning the thing that carries no correlation risk, meaning they are hedges. They go up when equity markets go down and they do that very convexly, meaning the payoffs are multiples of the risk put on or the cost to own them.

I think the presence of that payoff gives us the confidence to own more risk and that’s how you have your cake and eat it too in that, number one, do you help fight against drawdown when it shows up? Of course.

But more importantly, my definition of ugly is not a two month 20% sell off in the market. My definition of ugly is people being fooled that 4% or 5% on their cash is safe.

I think you prepare… To stress what Dave said earlier, we can paint a backdrop that you’re like, “Well, man, that seems pretty bleak.” It’s the opposite. The backdrop leads to you better own more risk assets, because when your deficit spend is what it is, when the money supply is going to do what it’s going to do, risk assets are most likely going up and we better own them.

Again, I think you overallocate the risk assets, let’s be right until we’re wrong and when we are wrong, we own those things that have convex payoffs.

And again, not saying anything in particular here other than we build strategies that we’ve now been around long enough, the track record of our strategies, the ability to impact allocation, it’s… I think we operate some of the best strategies in the market and the impact has been pretty significant on allocations and we continue to think that that’s going to be the case.

And last thing that I’ll say about that is if we’re completely wrong and what does that mean, it means we’re probably going to be pretty benchmark like. I think that’s one of the things that we have when it comes to strategy, when it comes to portfolios that incorporate some of our strategies.

I always say the difference between a good player and a bad player is your good players’ lows aren’t very low. Your bad players’ lows are extremely low.

We think we’re building strategies and portfolios that when we’re off, we’re going to be roughly in line where there’s no performance discussions because really for everybody on this call, the only thing we want to do is to position you as to be as valuable as possible for your client.

I think a huge part of that is can I produce higher CAGRs? The other part of that is can I produce a very compelling message that my clients can digest? That’s really… If you said, what are the things we spend our time on? It’s number one strategies and number two, messaging around why the use of strategies is there.

That’s maybe longer-winded than you want, D. Hern, but that’s my answer. I’m sticking to it.

Dave

I’ll take it quickly from there too.

You know our investment philosophy. More stocks, less bonds, while remaining risk neutral.

I think anyone can have a great investment philosophy that sounds qualitatively awesome. I think ours does, but there needs to be a proof in the pudding to make sure and show people that we are executing on our investment philosophy.

If you have a great investment philosophy and no follow-through, I could care less about your investment.

Our investment philosophy, what I have pulled up here, we want to have more stocks, remain risk neutral, enhance our income, we can show you that there’s proof in the pudding, that we execute on this structure from a qualitative standpoint and also from a performance standpoint.

There’s no better way to look at it than just our Aptus moderate allocation and we benchmark that against the iShares growth. We’re 75% stocks, 25% fixed income.

Another way, we’re 15% overweight stocks relative to the benchmark at 60/40.

But if you look at our standard deviation, we actually have a standard deviation that’s in line with the benchmark actually slightly lower right there. So we’re able to give you more stocks, less bonds and obviously, have a risk neutral standpoint from a standard deviation perspective, but also a max drawdown perspective.

To go back to exactly what JD was talking about at the forefront, let’s focus on what your clients expect and what they want, tune out the noise, let’s make sure that we have the best max drawdown possible, and also the best compounded cumulative return over longer periods of time.

This chart right here, it just shows you that there is proof in the pudding from an execution standpoint on our investment philosophy.

JD

Derek, I see that the question that just came in, I’d like to touch on that.

The question, do we need to think about using a different term for owning more risk assets based on the last 10 years? It was riskier to own bonds than stocks. So if I wanted to own more risk assets, I would own more bonds.

My answer is exactly, but that’s a hard thing to say to your Mr. or Ms. Jones that just want to save four or 5%. But yes, that is the point.

We think is the greater risk 10 years from now that you own too many stocks or you own too many bonds. I think it’s that you own too many bonds and that’s…

Yes, I won’t call you out, but my answer is yes, that’s the right way of thinking about it, but we have to work within the boundaries that we’re dealing with, which are most people do not see the world that way. They view risk as stocks, they view safe as bonds, and I think that’s backwards.

Derek

And we do-

Dave

Here’s a wild statistic for you actually.

Let me stir this in here, D. Hern. I’ll try to get it right, but it’s like investors should be mindful that long duration exposure in the fixed income space can come with equity like volatility, especially actually the nine of the last 12 years have seen long duration treasuries post a larger intra-year decline than the S&P 500.

Mind-boggling.

But it’s showing that exact point from that question and JD’s point there.

John Luke

And over that 10-year period, risk assets or nine-year period risk assets have compounded at double-digit returns. That’s just a few drawbacks.

Dave

On your slide here.

John Luke

Yeah.

Dave

That’s why your slide here, John Luke, it’s unbelievable.

Look at the Bloomberg U.S. aggregate over the last three years, five years, and 10 years. It’s almost a goose egg on five years. It is less than a goose egg on three years. It just tells you that, “You know what? Let’s make sure we own as many risk assets as possible.”

JD

I think this should go without saying but I think it’s probably timely.

Whatever happens in November doesn’t change our opinion. We’re not going to say, “Well, if this outcome happens, we’re going to have a different story to tell you.” The backdrop for what leads to what we’re saying is it doesn’t matter, right, left, wherever. I still think this is going to be the theme for the next five plus years is, to a lot of JL’s points and a lot of what Dave said, risk assets should be higher.

Derek

On that note, this is where we start our one-hour discussion of the election.

JD, I know you’re going to lead that one.

I’ll say too on the risk thing.

One of the things that I think we’ve always been pretty clear on and we’ve tried to put messaging out there is there are two types of risk. There’s drawdown and longevity.

It’s a constant battle between making sure clients just stick through it and get through the near term drawdowns and obviously, we try to provide strategies for that versus the long-term longevity risk of outliving their money.

Risk is a very arbitrary word and I think that question hit it pretty well.

JD

Yeah. Not to continue to beat the drum, but what we always ask is let’s say, “JL, let’s be conservative and say 7% deficit spend.” We think that that’s a pretty good proxy of what you need to earn on your capital to preserve purchasing power for long periods of time.

So if it’s like, okay, if the hurdle rate is 7%, forget CPI for now. But if the hurdle rate is 7%, what asset class is going to give you that.

Bonds is not in that answer unless you want to hold your nose and buy some high yield bond that you might regret buying.

I think in aggregate, your basic allocation options are bonds, stocks, or cash, which one of those three can give you that hurdle rate? I think we know the answer.

And the other thought like this liquid alt conversation, because we get this a lot and we get grouped into that territory, but anything that is a “alt,” especially a public market vehicle alt, just to stress, I know we touched on this, there is a significant difference between a diversifier and a hedge.

Diversifiers are positive carry and you cross your fingers and hope that they show up when you need them to. Hedges are negative carry and you do not have to guess what they’re going to do.

We are in the camp that if you want to spend time and energy trying to find diversifiers that are going to give you positive carry, that’s actual real return and protect you when you need it, you can go spend your time doing that. We’d just rather own more beta and protect the extra risk that comes with that.

I think that’s an easy, very simplified solution because the obvious thing is hey, if we can produce an additional few hundred bips or whatever additional of CAGR, that’s great for your clients, that’s great for your business and you won’t fire us. We like those three things.

Derek

I’m going to let one more question in.

We’ve had a few questions strategy-wise about the funds and we’re going to avoid tickers here directly because we do want to share this and as compliance causes extra hurdles in doing that. We’ll hit all of them. We see the questions, we’ll definitely hit you, and we think we got some fun stuff to talk about there.

A question that’s coming in a couple different forms and maybe you guys can just do a quick touch on this is questions have come up about international and emerging markets and other asset classes. I guess I’d paraphrase that in saying is there a consideration of adding other exposures like that or changing other exposures and where do we sit on that?

John Luke

I know Dave’s got a great chart on this to start. Dave, leader off and I’ll come behind you.

Dave

Thank you.

I’m trying to find this chart right now if you give me one minute, please.

Well, as I look forward, basically, obviously, international has worked here lately. Obviously, you had the EM up here six, 7% on the month just given all the China stimulus out there.

But I like to rephrase and rethink international a different spectrum. Obviously, the catalyst or the thesis to own international here lately is from a valuation perspective.

We know that over longer periods of time, international has traded an 8% discount to the S&P 500. Yet today, it’s trading closer to a 50% discount as a whole.

I think one reason why you’ve started to see this decrease in evaluation relative to the S&P 500 is simply that there’s been a valuation rerating and no one’s talking about it. They don’t want to say, “Hey, you know what? We want to own international or increase our exposure there because the valuation gap relative to historical norms is going to compress it.”

I just don’t believe that to be fully the case right now. I think you get full rallies much like what you’ve seen out the international market here as of late, but it’s been rerated lower because if you think of the U.S. economy and the constituents within the S&P 500 and then constituencies within like an MSCI EAFE, over there in Europe international, it’s just so service oriented, service focused, lower margin businesses relative to what we have here in the United States.

Obviously, tech proxies like the Magnificent Seven dominate the S&P 500 but they have growth and they have margins and they have increasing margin. They have operating leverage. Something that international does not have.

If you actually rerate the characteristics of the MSCI EAFE into the same sector exposure as the S&P 500, the S&P 500 only trades at about a 12% premium to international markets. But you dovetail that and compare that with what actual growth you’re getting between these two economies and markets, you’re getting three to four times more growth here domestically than you are international.

I think that you can almost own small cap as a better way here domestically to play that valuation mean reverting mechanism, but you’re actually getting U.S. type of growth within the U.S. small caps.

If you wanted to play international, I think the more palatable way to do this is actually owning U.S. small caps.

John Luke

I have two comments.

First on the China part, you look at the long-term returns of China and they’re pretty much zeroed out since the 1990s. It’s been very hard to make money in that, which is a huge slug of the EM space. Hard to chase that piece.

And then you look at the international markets and you had Mario Draghi, however, you say his name, come out last week and talk about the competitiveness of the E.U. and their solution to be more competitive is more regulations. If you look at… They’re overburdened with regulations.

I think many of those things like… You’re just basically relying on the dollar to weaken to get the returns that you want from international and it’s just tough to really bite into that as a long-term game.

I think Dave laid it out beautifully.

Derek

Awesome.

Dave

I would say that our full slide deck is going to be available today too. It’s about 40 pages in this market update.

At Aptus, we’re a bunch of athletes and we just don’t like losing. So we like to have our presentation, our allocation, and market update presentation out there day one and really beat anyone out there. That’s why we’re having this conversation on day one too. So be on the lookout for the overall presentation that you’re seeing today just with a lot more verbiage in it and a lot more depth.

Derek

There’s a lot there.

And I’ll just say, if you’re new to Aptus and are just getting a taste of us, I would just go to apt.us, go to the top, click on the Blog. These guys just crank stuff out. We’ve got probably four to six pieces a week of just different materials, some of it evergreen, some of it very market sensitive about what’s going on with the fed and the election and earnings and everything. But I would definitely hit apt.us, go to the blog, sign up there. We do a weekly summary of it that goes out on Fridays.

And for clients, obviously, you’re already getting that and you’re used to our services but any of these topics, we will spend hours on them if you need it, but we want to be respectful of everyone’s time. We’re at 45 minutes today.

We do appreciate everybody for joining us and we will send a recording of this with all of those slides, because I know there’s a lot in there.

That’s all I got. Thanks, guys, for making the time.

JD

Great job, D. Hern, right there.

John Luke

Thank you, everyone.

JD

Thanks, everybody.

 

 

Disclosures

The opinions expressed during this Webinar 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 2, which is available upon request. ACA-2410-6.