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Table of Contents

The Great Portfolio Reset

Episode 68 of The Investopedia Express with Caleb Silver (Jan. 10, 2022)

Welcome back and welcome aboard. If you felt a cold wind blowing up from the Potomac River, that was the Federal Reserve last week saying that the easy money is coming to an end. According to the Fed minutes from its last meeting in December, the tapering of those government bond purchases will end in March, which is also when we'll see the first interest rate hike. According to Fed projections, it could be the first of three or even four rate hikes in 2022, according to Goldman Sachs. The year started off red hot with both the Dow Industrials and S&P 500 hitting record highs.

Those flames were doused on Wednesday as the Fed's hawkishness cast a shadow over the market. That change of feathers put a scare into growth stocks, especially tech and other high risk assets like cryptocurrencies. As you know, U.S. equity investors are coming off the best three-year stretch for stocks since 1999. Wall Street strategists have been ratcheting back their forecast for 2022 and individual investors are starting to quiver. But they're still putting money to work in stocks and ETFs. Just because we're sitting on three years of gains, doesn't mean we're not in for another.

Meet Liz Young

Liz Young is the head of investment strategy and a public spokesperson for personal finance company SoFi. In this role, Ms. Young develops and delivers both economic and market insights. She is passionate about educating investors and helping SoFi members get their money right. Ms. Young is also a dynamic public speaker who's able to translate complex concepts and strategies to a variety of audiences. She has been a regular contributor on CNBC and across other financial media outlets.

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The temperature has changed in the equity market. Even though we were dancing around all-time highs to start the year, risk tolerance appears to be fading as the Federal Reserve turns more hawkish amid stubbornly high inflation. The last three years have been very rewarding for U.S. equity investors as big tech stocks drove the indexes to one record high after the other. It's been the best three-year stretch since 1999, but let's not forget about what happened in 2000.

Caleb:

"Many investors have the jitters as we enter 2022 and would-be investors maybe scared to jump into a choppy market in the face of rising rates. We could all use a little guidance right now, and I've got just the right person to help shine the light on our path. Liz Young is the head of investment strategy at SoFi and a regular contributor on CNBC and across other financial media outlets. And she is a very sound source of reason in uncertain times. Welcome to The Express, Liz."

Liz:

"Thank you. Excited to be here."

Caleb:

"Liz, like us, you have so many millions of customers and readers of all ages coming to your platform, in your case, to invest, save, borrow, and run their financial lives. What's the temperature among the investors who use the platform after the past few years of gains as we enter the new year?"

Liz:

"I mean, I think first of all, when you look at across our platform, we probably skew a little bit younger as far as investors go. And there's a lot of newer investors that have come on the platform in the last 18 months since the pandemic. So I would say two things. Generally speaking, a newer and younger investor is more interested in certain sectors than maybe some of us more seasoned... I don't want to use the word old, but more mature sort of investors."

Caleb:

"You can call me old."

Liz:

"Yeah. Well, I'm talking about myself too. The younger and newer investors may be a little bit more skewed towards technology stocks, those higher growth names. Obviously they went through the whole meme theme. So I think that there's a little bit of a different temperature just based on that. But also, I think there's trepidation. And I think there's a little bit of fear in a lot of them because they know... and as we all know, they've never seen a monetary policy tightening cycle, and we're entering what seems to be a sure monetary policy tightening cycle that just keeps getting sooner and sooner. Right? Some of the news that we got recently about the Fed minutes saying that they'd have to possibly move to an earlier timeframe as far as rate hikes go, the calendar just keeps pulling it forward. So I think there's a lot of trepidation, a lot nerves in a lot of investors' minds, not just the ones on SoFi's platform."

Caleb:

"Now you say in your 2022 outlook... and folks, you should check that out... that 2021 was the year of running with the wind at our backs while 2022 will be the year of running into the wind. What's blowing at us this year beyond the rising rate environment and a more hawkish Fed?"

Liz:

"I loved the running analogy. I've been waiting years to write a piece with a running analogy. I finally ticked the box. There are a number of headwinds. The biggest one is obviously rates. The reason that rates are expected to move up is because of inflation. So that's another headwind, but not necessarily a completely separate headwind. Inflation is a headwind for investors, but it's also a headwind for consumers. We're going out into the world and we're creating more activity where we still have a ton of pent-up demand. There's a lot of savings for people to spend. The problem is when they're spending it, they're paying more today for all that stuff than they would have a year ago. So inflation is a headwind not only on our spending, but also on a lot of sectors in the market and just market sentiment overall."

"And then the third big headwind is that we've got tougher competition not just looking across companies, but when you look at the fundamentals... I mean the fundamentals are strong, both economically and corporate fundamentals, but the competition has gotten harder in a lot of areas. And you look at, let's say technology companies in particular, I think the landscape has gotten much more competitive. You have to do so much more. You have to provide so much more and you have to be that much more innovative in order to win in that space."

"And you look at some of the other companies. You look at consumer companies, right? You have to not only knock it out of the park in online retail, but you now have to knock it out of the park in brick and mortar retail because people are excited to go back out into stores. Those are just a couple examples. I think the competition has gotten a lot more fierce. But also, the comparisons have gotten harder. So, we had this huge rebound. And a lot of times, we measure growth year over year. The growth that we saw in 2021 was amazing because it was coming off such a low base. Well, now we get into 2022 and we don't have such a low base anymore. So the comparisons are going to look a little bit more pressured."

Caleb:

"We've seen extreme selling in technology stocks and small caps as the Fed is ratcheted up its taper talk in recent days. For folks, Liz, who don't understand why tech stocks and small caps are so sensitive to rising rates, explain it to us."

Liz:

"Sure. So I'll take tech first. Now, this is not necessarily the way that I would invest in tech this year, and we can get into that a little bit later. But generally speaking, tech broadly is thought of as a 'growthy' sector. And growthy sectors are based on what investors expect for that company to produce in future growth. Now, in order to figure out how much a company is worth today, you take its future growth potential and you discount it back to what you think would be an intrinsic value in the present moment."

"In order to do that discount equation, you have to use a rate of interest. And as rates are really low, that interest rate goes in the denominator. I don't want to get too mathematical, but that interest rate goes in the denominator. The lower that rate is, the smaller the denominator is, the bigger the overall number is. As that rate rises, the bigger the denominator gets and the tougher it gets to look at future growth and think about it being super valuable today."

"So as rates go up, future growth becomes less valuable in the moment. So when you look at tech stocks, you look at the ones that are already trading at high multiples. They're going to see a lot of pressure from the even just the expectation that rates are going to rise. Rates don't even have to move."

Caleb:

"Just a whisper. Just a whiff."

Liz:

"Just the comment. I make jokes about Jerome Powell, whose job I do not envy whatsoever. But we hang on his every word, and we hang on the tone that he uses, right? I make jokes that he could sit at a dinner table with a group of people and ask somebody to pass the pepper. And people would whisper like, 'Oh my God, did you hear how he said that? What does it mean?' The poor guy, he can't do anything without being scrutinized. So anyway, it's just the expectation of rate rises that are going to hurt technology."

"Small caps are a little bit more complicated. So small caps, you can usually think of as being cyclical as a size category. So what I mean by that is as the economy expands, as the economy grows, the cyclical categories usually grow along with it or do better than the non-cyclical categories. And small cap would be in the cyclical camp."

"The issue right now is that because we expect the Fed to raise rates, there's this fear that they're going to make a mistake. There's a fear that they're going to make a mistake by going too far too fast, that they're going to start it too soon, or that it's not a good time for the economy to absorb a raise in rates, and that it could compress growth."

"So if you have a situation where the Fed makes a so-called mistake and it causes a headwind for growth, then the cyclicals don't do as well. So I think that's a lot of what small cap is going through. But I would point out when you look at what happened in 2021, small cap value did really, really well. Small cap growth actually didn't. So it might end up being one of those years where we see a pretty big divergence among styles and sectors across all size categories."

Caleb:

"Speaking of sector rotation, which is something we talk a lot about on this podcast that means either moving from growth to value or vice versa, or from tech to staples or vice versa, depending on the economic headwinds. But it seems that every time the value trade has looked attractive, especially in the past year, tech corrects and makes new highs. How and when should investors rotate responsibly? Should they just do it on the calendar irrespective of what's happening in the market or what they feel is happening in the economy?"

Liz:

"So I would never suggest that somebody should try to chase it or try to time a rotation. What happened in 2021 is we thought we were on this trajectory where the 10-year yield was going to go up and continue to go up. And then there was this invisible level of resistance where it couldn't get above 1.74%. Every time that it went back down, the equity market had to digest that and say, "Okay, well, maybe tech is still okay. Maybe cyclicals aren't the play." So we went through a few different times of thinking that that rotation would hold, and it ended up going back to technology. This year, I think what we have now is that the Fed has confirmed that it's going to tighten, that obviously we're already in the third month of tapering, and now there's even discussion about rolling off the balance sheet."

When yields rise on short-term bonds, they reflect expectations for Fed rate increases. On longer-term bonds, when those yield rise, they signal confidence that those rate increases won't cause a recession.

"So that's three different phases, three different steps of monetary tightening. And it's all but confirmed that every single one of them is going to occur in some way, shape, or form this year. So I think this is finally the year where the 10-year can break above that 1.74% level and can start reaching levels that it hasn't seen in a long time, which then means that a rotation into those cyclical areas should hold for a bit longer than they have in the last 12 months."

"As an investor, I will assume that many people are overweight or at least heavily weighted in tech and in large cap. So we're still early in the year. I know that the market has been down over the first couple of days. It feels like the first couple of days lasted three weeks. But you have a chance to position your portfolio for what you think is to come in 2022. And I would challenge yourself that if it's something you've never done before, that might be okay. And I've used this phrase a lot. It's also the title of a book. What got you here won't get you there. So if you start investing in sectors that you've never favored before, that's probably okay because you're going into an environment that you may have never seen before. So you have to think about what you're missing out on if you stay allocated the way you are."

Caleb:

"Speaking of missing out, we know a lot of people had that fear of missing out either last year or the year before as the stock market has delivered these incredible returns in the face of the pandemic. And we also know that a lot of investors just were so uncertain. They sat on their hands during that time. But let's say you're a new investor. You want to put money to work now as the year begins. How would you advise somebody with say $10,000 to invest right now? You don't have to get tactical into stocks, but just how to build that responsible plan, because that's what you're all about at SoFi anyway."

Liz:

"Yep, absolutely. And I also would say I think it's amazing and I think it's an incredible thing that so many new investors have entered the market and that so many people are more interested in it than they were before. I think there's been this huge assumption that it's all institutions or it's all high-net-worth individuals and the market is not conducive to anybody else. That is no longer the case."

Caleb:

"No longer the case."

Liz:

"And that's a great, great thing. So the other thing that I think is really working for the individual investor right now is that you have so many more options to start than you did 10 years ago. And the biggest option that I think really works for people is ETFs. So number one, they're low cost, right? If you have a small account size, you don't want to have a lot of it eaten up with fees. ETFs are a low cost way to get exposure. They also don't have high minimums. There's a lot of them you can invest in with just $500, maybe even less. So you don't have to put a lot in it. There are stocks out there that trade at more than $2,000 a share. If you're a smaller investor, that's just not going to work for you to invest directly in a stock like that. So by buying an ETF, you can get a much more diversified level of exposure."

"So what I would say is always think about it as a hub and spoke, whether it's $10,000, $5,000, $20,000. I don't care about the amount. The hub is your long-term core allocation. And I'm also going to make an assumption that let's say the investment horizon, if you're a newer investor, is at least 10 years. So you've got that long-term core allocation. That's something where you want to take equity risk. You want to have exposure to what we call beta, which is basically just the movement in the broad market. So you can use something like a broad market ETF. Maybe it's an S&P ETF. I also think an equal-weighted S&P ETF is a really nice option because you don't get as much concentration risk in those bigger names. So you use that at the core. You could also supplement it with something that's a little bit less aggressive."

"I also don't think cash is a bad option. I mean, everybody's like, 'I don't want to invest in cash. It doesn't earn anything.' Right. But it also doesn't lose money aside from inflationary forces. But cash is not a bad option to diversify away some of that risk, especially in a period where bonds don't look all that attractive, right? So core is that base equity exposure. And then the spokes off of that hub are things that you really feel strongly about or ways to tilt the portfolio in favor of the environment that you see coming. So what I would say this year is you've got your core and then you tilt it towards cyclicals, some of those economically sensitive areas, small caps, and I'd even throw a little bit of international developed in there too."

Caleb:

"Great recommendations. You bring up ETFs, which gives me a great chance to plug what we did in the past week. Liz was one of our special guests on ETFs 22. We did it with ETF Trends. We talked to Tom Lydon on the podcast last week. Folks, that was an amazing 90 minutes of learning about ETFs. And Liz helped kick that off. It is available on etftrends.com/webcast. So check it out if you want to see the replay. But we're probably going to do more of those. That was a lot of fun, Liz. Thanks for doing that. Great recommendations for those starting out. And hey, even if you're a seasoned investor, even if you're in the market right now, not a bad way to start the new year."

"You mentioned the millions of new investors who joined the stock market in the past 18 months, either to trade or to start investing for the long term. Do you think most are going to stick through it if we go through some choppiness or a correction in the next few months? Because as you said, and we've talked about on this podcast many, many times, the game has changed. The retail investor has some strength now and can actually move markets, especially in some stocks. But what happens if they go?"

Liz:

"I would say that's one of my biggest concerns for 2022. It's really easy to stay in the game when you're winning. And a lot of people have been winning over the last 18 months, or let's call it since April of 2020. If you start losing, or if things start to look more challenging, it does take a certain amount of stamina to stick through that. And it takes a certain amount of understanding historical market moves to know that those dips don't last forever. Some of them are very aggressive, but generally speaking, you don't see a drawdown over 20% or 25% unless it's coupled with a recession. So if you don't see a recession coming... and I don't see a recession coming... if you don't see a recession coming, the chances of you experiencing a huge drawdown like that, 20% to 25% in the broad market, are pretty slim."

"So when you have these little bumps in the road, I think one of the things that that scares me about it is people get frustrated and there's this theory... it's called loss aversion theory... and basically it means that as investors, we feel that the pain of a loss is twice as bad as the pleasure of a gain. Okay? So losing $5 feels twice as bad as gaining $5. That theory, I think, is something that is really important to be aware of as we go through the year because there may be periods where you see red in your portfolio, you see a negative number in the weekly performance, the monthly performance. Sell, and if you get out, all you did was lock in a loss, right? And that's not to say that you should hold onto everything that's losing."

"I mean, obviously you can end up with what we would call falling knives. But short-term corrections are not a reason to leave. And the knee-jerk reaction just exacerbates them. So I would be really careful about that. If I was a newer investor, I'd be really careful about that. Set your expectations for this year. You are probably not going to get 28% out of the S&P again. And as long as you have the right expectations going into it, I think you can hang on to your stamina a little bit better."

The S&P 500 financial sector gained 5.4% last week, its best five-day start to a year since 2010.

Caleb:

"What's your hot take for 2022? What is no one talking about that could become a very big deal in the coming year?"

Liz:

"I mean, I hate to start this with a risk, but something that nobody's talking about that I think is a risk is the credit market. I mean, the credit market in the sense of consumer credit. So borrowing and the borrowing activity that's going on out there, and maybe the borrowing activity that has occurred as a result of our pent-up demand. So things like auto loans. Think about how many people bought a car in 2020. I mean, we ran out of cars, and used cars were selling for more than new cars, which is bizarre to me. But there were a lot of auto loans that were taken out, some of them for very long periods of time, seven years, 10 years."

"Now, we're going into a period where we've come to a point that the personal savings rate is back to pre-pandemic levels. So that means that people aren't stockpiling cash anymore. That means they're spending it. There's the expectation of a bleed rate in that savings of about $50 billion a month starting in 2022. Now there's 2.5 trillion out there, but 50 billion a month is expected to bleed out of that stockpile."

"I have a concern that people are stir crazy, and they're going to engage in a lot of revenge spending. We probably already have. Right? You buy all the stuff that you couldn't before."

Caleb:

"Yeah, guilty. Guilty."

Liz:

"Yeah. I mean, concerts, traveling, anything. It's like, 'I don't care how much it costs. Just let me go.' Right? So if everybody engages in that and you bleed your savings out, but you don't want to change your lifestyle once you bleed your savings out, you have to borrow in order to maintain that level of spending. But you might have to do it at the exact time when rates are going up. So I have this fear that there's the chance of an overextension in the consumer credit market, probably more in the second half of the later part of 2022."

Caleb:

"That is completely reasonable. And I think you're right. I think a lot of people will want to spend and keep those levels up because they feel like they've been denied or they feel like they still have that savings rate that they had in the past few months. Hey, A-plus to you, Liz. You've been dropping so many great Investopedia terms and explaining things so well. I think we're going to have to put you on the masthead here. So given that we're a site built on those terms, what's your favorite investing term and what's the one that just speaks to your heart?"

Liz:

"Yeah, I know. And I know you want me to choose just one."

Caleb:

"You can have three because you've been so good at explaining things on the podcast."

Liz:

"All right. So the first one, only because it's fun to say, is contango. But I think that's almost everybody's favorite word, right? So contango just means when the spot price or the current price of something is trading below the future price, so the future price is higher than the spot price, and it would mean that there's an expectation that whatever asset you're talking about is going to rise over time. The opposite of that is backwardation. But my real favorite term, which is going to sound kind of boring, but give me a minute, is opportunity cost. And I think that that is a well-timed term right now. We've already talked about it a little bit. Opportunity cost is basically a fancy way of saying FOMO. And if you want an equation for it, it's whatever you gave up minus what you kept."

"So think about that in your portfolios this year. What are you hanging on to? Did you fall in love with something that it's time to break up with? Not because it became a bad investment, not because suddenly the company is bad, but because the environment changed, right? And it's really easy to fall in love with your investments, especially if it's something that you've done a good job on, right? If it was something that you were right about. You may not be right forever, and you do have to take into account the outside forces. So the opportunity cost is what you would be giving up on by holding that one and not having the money available to buy something else that could actually do better this year."

Caleb:

"That is a fantastic term, and so well explained. You're really very good at this. I told you folks, a voice of reason at a time where we really need it. Liz Young, the head of investment strategy at SoFi. Follow her on the social media platforms @lizyoungstrat and read her blog on SoFi. So insightful and so good to have you on The Express, Liz. Thanks so much."

Liz:

"Thank you for having me."

Term of the Week: Runoff

Way back in the day, runoff referred to the procedure of printing those end-of-day prices for every stock of on an exchange onto ticker tape. Final trades were settled the following day and distributed to newspapers to publish them. Since actual ticker tape isn't used anymore and there is after market trading, the runoff period is now used to describe trades at the end of a session that may not be announced or reported until the start of the next session. And that ticker tape, a lot of it was used as confetti for parades through the canyons of Wall Street.

Portfolio runoff, on the other hand, is a concept in portfolio management that describes situations where assets decrease. Sound familiar? Runoff can occur for a variety of reasons, including the maturation or expiration of securities, liquidation of certain assets, or any other situation where assets decrease or are withdrawn from a portfolio, like the fear of a bear market or a recession, like Liz was just talking about.

Great suggestion, Ed. We'll be sending you some socks to the windy city for your next walk through Lincoln Park to pick up a deep dish pizza from Bacinos. I'd love one of those right now.

Article Sources
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.
  1. Yahoo Finance. "S&P 500: Historical Data." Accessed Jan. 11, 2021.

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