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, we figured 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:
- Breadth Correction Spilled Over
- Valuation and Growth Outlook
- Supply Chain & Inflation
- Bond Selloff
- Risk Mitigation
- Anchor Hedges
- The Fixed Income Challenge
- Allocation Considerations
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:
Hello, welcome to the Aptus recorded market commentary. Here we are in January 21st of 2022. Lot’s been going on. My name’s Derek. I’ve got four of us here from investment committee, JD Gardner, CFA, CMT, Chief Investment Officer. I’ve got Dave Wagner, Equity Analyst and PM, CFA as well. John Luke, CFA as well, and a Fixed Income Analyst and PM and Beckham, another CFA Equity Analyst and PM. We’ll just kind of bounce around. There’s obviously some usefulness in talking about 2021, but really with what’s happening already in January, probably more important to get into January and think about where we’re positioned and where the rest of the quarter could possibly shape up.
Derek:
I have to read a disclosure to keep compliance happy. “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 conditions, dynamics, or client needs. More information about Aptus’ investment advisory services can be found in its Form ADV part two, which is available upon requests. You can always hit us at aptuscapitaladvisors.com to find that stuff too.” Whoever’s ready, wants to talk about kind of how we got to where we are fire away.
Dave:
Yeah, no doubt guys. Dave Wagner here. It’s been quite an interesting start to the new year, but I’m going to start off kind of talking about 2021 recap. I’ll be very brief there because as I just mentioned, a lot has happened since year end. We know last year, it was basically very easy to make money. The S&P 500 was up about close to 30% and it more importantly, it did not witness more than a five percent pullback. Really everywhere you looked there was green on the screen. But for all the talk of a resilient market in 2021, under the surface, the churn in terms of drawdown was very significant. The average stock at the end of the year was down about say 13%. But at that time, the market was just coming off of all time highs. This means that the returns from last year was definitely driven by the largest of the large mega cap companies.
Dave:
So rotational corrections are preferred over the bottom falling out all at once. But there is a risk that indices at some point reflect more of the weakness that has persisted under the hood of the S&P 500 during last year. And that really brings us to today. Last year, as I said, we had green on the screen. Now all you see is the perennial bears really coming out saying that the market is going to continue to go down because so far every sector within the S&P 500 is down year to date, except for energy. More importantly, investors have not really started to buy the dip, which was really definitely what happened the last year, as they probably was about the dip 10 times as the S&P 500 would always bounce off the 50 day with some buying support.
Dave:
But it’s still very early in what to make of this correction that we are having. As of today, which is Friday, January 21st, the market has seen almost a seven percent pullback. More important, than NASDAQ is actually officially in correction territory. I.e it’s down more than 10% from its previous highs. This is the largest drawdown since November 2020.We think that the market is really finally taking note of rising real rates, coupled with slowing growth potentially in 2022.A market with full valuation on modest EPS growth is not a cut cocktail for explosive total return, even if rates prove to be lower for longer, which we do think that they will be, but a hawkish fed into a slowing economy is a cocktail for volatility. And that’s what we are seeing today is volatility. But keep in mind we’ve had an amazing run in the market not only since the pandemic bottom, but really over the last three years, the annualized return for the S&P 500 is say 25% over that period off of 12% earnings growth.
Dave:
But more importantly, there’s a lot of reasons to be pessimistic in this market right now we definitely hear at Aptus have our concerns also. A market transition, a midterm election year, inflation, and more importantly an anxious Fed, but the market is up a lot or saying that we’re due for correction should never be one of your driving worries. This means that investors need to continue to remain balanced. Don’t get too bearish or too bullish stick to your plan, own areas of the market that have actual return drivers utilize volatility to your advantage. As you’ll see from our commentary on this call from whether from JD, Beckham, Derek, or John Luke know we haven’t been more excited for how our asset allocation sets everyone up for success in this type of environment.
John Luke:
Yeah. Dave, that just, you, it’s a great point.
Derek:
John Luke is chomping at the bit to talk about rates. So I don’t know if you want to probably chime in there J.L?
John Luke:
No, I think how you finished Dave was just exciting as we’ve met internally with how our portfolios are positioned and really last year was the fourth negative year for the AG since its inception 45 years ago. So while the years with positive, only few with negative. And we’re off to that hot start again, the AGS down two percent for the year so far. And if you look at the yield of the AG, it’s only 1.25%. So you’re already at a year and a half of income payments just to break even to the price return that you’ve gotten so far for, for the first part of 22. So I think how we’re positioned in our portfolios to avoid fixed income. I know we’re beating a dead horse, but it’s just so important of how it allows us to alter our allocations and be positioned across these different asset classes that, that we think can outperform bonds.
John Luke:
And you’ve seen bonds’ red, stocks’ red to start the year and that’s different. Like Dave said, I think that we look towards the next couple of months and the markets real giddy about fed hikes. And you’ve seen this in the short end of the yield curve where we’ve seen the two year go from about 25 basis points to start Q4 of last year to over a percent and relatively short order that’s like less than four months. And what that’s doing and telling us is the market is anticipating the fed to be less accommodated to come in and remove some of the liquidity and the financial looseness that we’ve seen and markets are starting to price that in. So the biggest things that we’re keeping an eye on this year is what happens with rates.
John Luke:
Do we see a quick move like we saw in Q1 of last year that really sort of spook the market when you had this massive value trade in play. And we’re starting to see that a little bit here at the beginning of the year with growth massively underperforming. And then the other thing is the inflation story you ,can’t look past last year without talking about inflation. It was probably the most highlighted topic when you looked at any sort of financial publication and our thoughts are, do we continue to see the persistent sticky inflation that we saw throughout last year? And, and if so, how does the market react? We’ve obviously seen we’re in a midterm election period. Inflation has become a little bit more political than normal, and no one regardless of party is happy about paying higher prices. So how the fed reacts to the inflation peaks and what actually happens with how long inflation stays at these elevated levels is something that is going to be important to watch.
Derek:
Cool. Thanks. You know, one thing that’s interesting too about the early part of this year is this, both stocks and bonds have gone down which as you mentioned, investors aren’t necessarily used to. I know we talk about volatility as an asset class. There’s not a whole lot of places to hide as of late. So if anyone wants to talk a little bit about how we, how we handle that, that’s, that’s probably an important topic.
JD:
Yeah. I think that’s probably the biggest thing to talk about today. And JL mentioned this, what is obviously everything’s red to start the year and the areas of the market that have really been hurt is really what we’ve been saying for quite a while now, which is if rates do actually start to rise, you’re going to have the more growth end of the spectrum within the equity markets exposed, because they’re more sensitive to duration, just like everybody refers to duration risk in the fixed income space. We’ve been talking about it in really like what we thought was an inflated growth area of the market. And you’re starting to see some repricing there. Obviously it’s been the queues have struggled more than the spy has struggled just because they’re natural tilt towards growth.
JD:
But what I wanted to mention is 2021 was a great year. We still have in our portfolios, we have anchor hedges and then we have hedges around those anchors. And in everything that we’re doing we talk about owning volatility as an asset class, like Dave has mentioned earlier in this call using volatility for your advantage. And so I think that we are we’re most likely going to see elevated balls in 2022 which January has to we’re 21 days in as we’re recording. And that has been the case. The way that our anchor hedges work is when port, when the markets are dropping, we’ll have, we’ll be effective on that first 4 or 5% down. But it’s when you really get further down is when the anchor hedges really kick in and the effectiveness of the hedges start creating that separation, like the separation that we saw in the COVID crash of 2020.
JD:
The one thing that I would note is this is an environment that we welcome. Volatility is something that our portfolios welcome because we are long volatility. We have splashes of long volatility. So we can benefit from that. A great example is Q4. So 2021, like Dave mentioned was a pretty non-volt straight up year.
JD:
Well, we had a couple pullbacks in the 4th quarter and the way that we’re managing our long volatile exposure, we can typically use that to our advantage. So having the spy close, the S&P close up 11% or so on Q4 and having our portfolios performed like they did was a great way to end the year. So the only thing I wanted to kind of stress was our exposure to long vol and the effectiveness of it as markets continue to drop if they do. Maybe they don’t, there’s a lot of uncertainty out there. I obviously, but I think the areas of the market that are most prone to rising rates, to some of the things that may be spook in the market, I think we’re, we’re more than prepared for, and I think owning volatility in 2022 is going to be a heck of an asset class to, to have in portfolios. And it’s an advantage for us.
Derek:
Cool. I think given those stocks as a whole have gone down along with bonds, people are always concerned about, okay, do I need to own international? Do I, or, or do I own more domestic? And do I own more small versus large? And these are obviously things that you guys think through constantly, don’t make a ton of changes at the portfolio level, but I’m just wondering if there’s anything that has stood out to you over the past couple of months or that you see as opportunities going forward throughout 2022.
Beckham:
Sure. And that’s something that I can dive in on. And I think some of the specifics on small versus large and international, I may kick it back to you on Dave, but I think at, at a high level, just to wrap things up and bring together some of the components that, that everybody’s touched on today, we are as comfortable with our allocations. I think as we, as ever been. It’s no secret that 21 was very strong market, low volatility, stock market was kicking. And I don’t think any of us on this recording would be disappointed with how our allocations stacked up in that sort of environment. But so far in 22, and owing to some of the fact that these guys have touched on we’ve seen volatility, we’ve seen risk and even in element of fear entering the market, and these are the types of environments that we have built business for, and that we feel we bring the most value in.
Beckham:
When you talk about a hawkish fed, elevated inflation, extreme equity market valuations, heightened volatility, and equity markets. These aren’t typically words that are going to get you excited about the markets, but kind of owing to the structure of our strategies and the way that we’re able to harness volatility to our benefit. These are environments that we don’t fear but we actually embrace, perhaps we really do feel like that’s where we can benefit the people that are working with us. So shifting at the highest level, shifting away from fixed income where we think there’s very little return being able to take on more equity exposure while also, so recognizing the elevated volatility risk that comes there and being able to harness that for our benefit, that’s a formula that worked for us in 21. That’s a formula that’s worked so far for us in 22.
Beckham:
And we really don’t think at this point that any of the inputs to that formula are changing. You know, and that’s obviously something we monitor and will shift as market conditions dictate, but we feel really strong about our positioning at the highest level at the asset allocation level going forward. And we’re just looking forward to tack on this market. And I know Dave can dig in and kind of give some more specifics on international small cap thing like that where there are some areas for potential return.
JD:
I would, I’d chime in and say like our objective is to compound capital. So everything that we’re saying, nothing is like, Hey, we’re finding the hottest sector. We’re going to outperform benchmarks by, our objective is to position the portfolios that have been entrusted to us to compound at a rate that is sufficient. And the biggest friction to doing that is to get in front of serious drawdowns. We think that obviously bonds are probably a negative returning asset class. Just because inflation is running where it is, yields are, where they are. So you almost have to own equities. The problem is equities in this environment have that potential for drawdown. So like we can talk international small and all these things. But I think the objective to really drive home is can we compound capital? And can you avoid the biggest friction point to doing that with which is serious drawdown.
JD:
And so from a return standpoint, our asset allocations have made that shift from a risk standpoint. That’s why we own volatility and we get to do so with small slivers of capital. So very small slivers of capital that can really increase in value because of the convexity of those payoffs when markets actually do sell off. So we’ve definitely made some tweaks in the asset allocation space from like to Derek’s point and to, to Beck’s point you have to own a broadly diversified portfolio, but our objective is within a broadly diversified portfolio to make the right shifts towards return and away from risk. And that’s exactly what our allocations are doing.
Derek:
Awesome. Well. I appreciate you guys taking the time. Advisors love these videos. So I know we only do them once a quarter and, and they probably eat them up if we did them once a month but once in a quarter has been sufficient, if we need to step it up, we will give given what’s going on in the markets. But I know you’re busy managing allocations and everything for advisors, so thanks again and we’ll see you all shortly.
JD:
Thanks guys.
John Luke:
Thanks Derek.
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