On Friday, the S&P 500 surged to its biggest rally since June of 2020, and the Nasdaq 100 climbed more than 3% on the back of Apple's blockbuster quarterly earnings report. The iPhone maker rung up $123.9 billion in sales last quarter and says those supply chain issues, not such a big deal. Both Apple and Microsoft reported robust earnings and pretty optimistic outlooks last week, and as they go, so go the markets. At least that's the way it's been working for the past few years. But investors have been losing their conviction. Currently, 32% of the S&P 500 is down 20% or more, and nearly 70% of stocks are off their highs by at least 10%. That's a correction, and traders remain bearish, trying to hedge on smaller and smaller declines.
Hopes that we might have learned that at last week's FOMC meeting were dashed when Fed Chair Jerome Powell gave a press conference after the Fed meeting on Wednesday. He said all the right things with the right temperament, except a couple of key items that didn't sit right with investors. Number one: inflation. It's running hotter and lasting longer than the Fed thought it might. Number two: rate hikes. We went into last year thinking we might see three. One month later, and the Fed is indicating as many as five rate hikes this year. How much and when they will come remains a mystery. Number three: shrinking the Fed's balance sheet. It stands today at $8.9 trillion dollars, more than double where it was before the pandemic.
Meet Anastasia Amoroso
Anastasia Amoroso, CFA, is the chief investment strategist and a managing director at iCapital, wherein she provides insight on private market investing opportunities for advisors and their high-net-worth clients. Anastasia was previously an executive director and the head of Cross-Asset Thematic Strategy for J.P. Morgan Private Bank. She also managed global tactical multi-asset portfolios and performed investment due diligence at Merrill Lynch, in addition to providing consultative financial advisory services to high-net-worth families and businesses She is a regular contributor on CNBC and Bloomberg TV and is often quoted in the financial press.
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Investors have not felt the chill in the markets like the one we're experiencing since, well, March of 2020, and that was not a pleasant experience. A reckoning has hit the U.S. equity markets as risk is off the table and the fear trade is firmly in place. For most long term investors, the recipe stayed the same. Ride the waves of volatility, don't bail out on your portfolio, and hope this correction corrects itself. But somehow this shake up feels a little bit different, and staying the course seems even harder than ever.
We need some expert advice right about now and some perspective. We also need some more New Mexico in our lives. We always do. That's why we're talking to Anastasia Amoroso. She is a managing director and the chief investment strategist for iCapital and a voice of calm amid the fear we are all feeling. Welcome to the Express.
"Hi, Caleb. Good to see you."
"First of all, I gotta know, since I'm a New Mexican too: red or green on your enchiladas, or are we Christmas?"
"We are Christmas, which most people probably don't know what it is, but it is mixed. Christmas and probably more green chili fan than the red chili."
"A little lean leaning into the green. I like that. I'm Christmas, too. All right, Anastasia. Investors hate uncertainty. It's kryptonite for us, but we're swimming in it right now. The Fed met last week and instead of calming the waters, Fed Chair Powell's comments added even a little bit more uncertainty to some. What did you hear or what didn't you hear that may be contributing to the confusion?"
"Well, I think what the Fed chair did is he did contribute a lot of lack of clarity, a lot of confusion, and frankly, it feels like the Fed themselves are not exactly sure what direction the policy is going. They're not exactly sure how many rate hikes there's going to be on the table. They're not exactly sure if it's going to be at every meeting. They're not exactly sure if there's going to be 50 basis points in March, and the list kind of goes on. So, the Fed is in sort of this calibration process of figuring out what exactly the path of policy will be. And Caleb, as you said, the markets hate uncertainty. So, that's why we've seen this pretty bad turnaround in the markets after Fed Chair Powell spoke."
"Now, I will say that I don't think the spirit of uncertainty is going to last for the rest of the year, let's say. I think at some point—and maybe it's the March meeting—they will have figured out what the path of policy should be. And I think if they were to tell us that they're going to hike rates at every meeting, that would actually be OK too. Because let's keep things in perspective. The real rate today is deeply negative. The core inflation is running at 4–4.5%, so the real rate is deeply negative. If they were to hike by even 250 basis points, that would just get it back to neutral rate for the economy. So, that would not have been tightening just yet. So, I think once we know where the path is, once we know where the sequencing is, I do think that the markets can find their footing."
Chair Powell indicated that the Fed would like to bring its balance sheet back down to size, which means the Fed will go from being a buyer of government securities to a seller. This would mean the loss of the buyer of last resort for U.S. government bonds and the safety net that has made it safe for investors to walk the tightrope of one record high after the other.
"It's OK for them not to know. We're in a really confusing time. This is the other side of the V-shaped recovery: aggressive growth. We just had the GDP print, some of the fastest growth we've seen in 40 years. Also, inflation at a 40-year high. So, it's OK. But the Fed has been very transparent and pretty clear, I thought, up until recently. And then when you heard those words, 'there's plenty of room for rate hikes,' that kind of turned that meeting around, and I think it contributed to the uncertainty. So, the Fed's job though, as you know, and they say it all the time, its dual mandate is not really to worry about the stock market. Its dual mandate is maximum employment, 3–4% unemployment, and reasonable inflation, something between 2–3%. But the wealth effect, Anastasia—where investors and asset owners spend more if their assets are growing—that feels like it's in jeopardy right now, and we're feeling the consumer sentiment. Is that a fear we should worry about, or is that something that's just going to go away as soon as we get to some level of normalcy?"
"Well, I do think the Fed needs to keep it in perspective, and they need to keep it in the background of their decision making. And it was a little bit puzzling, Caleb, that that did not come across that given the drawdown that we had in certain stocks. I mean, some stocks were down 50, 60, 70%, and that didn't seem to unnerve the Fed whatsoever. I think there's a couple of reasons why that is. The main one is that we have not really seen any sort of material credit stress creeping to any parts of the market. So yes, certain stocks were down, and I think you could argue that we needed to see a valuation shakeout in those stocks. So, in fact, the Fed might actually be happy with that from the macroprudential standpoint. But what they're also happy with is you saw some credit spread widening in parts of the market, but you didn't see that significantly. So, if you look at the overall financials conditions indicator, it is not tightened significantly. So, that's why the Fed is not worried about it."
"Now, I will also say, just like there's room to raise interest rates, as Powell pointed out, I think there's room for the net worth effect to have a little bit of leeway here. And I say this because household net worth in the United States is 25% above where it was pre-pandemic. So, if the average 60/40 portfolio is down 7% or so year to date, we can probably absorb this."
"And the last thing I'll say to that is, I do think that what we're experiencing today is a period in time, a period in 2022, but that doesn't mean that's what's going to happen for the rest of the year. And we have the uncertainty from the Fed, we have the uncertainty for those supply chains, but what's really happening is there's a lot of poor market structure dynamics that are at play right now. If you look at liquidity and what the dealers are willing to offer, that liquidity has dried up. I mean, it is as bad as we've seen it in April of 2020. And at the same time, you had a lot of positions that have got extended, and they needed to be sold. They needed to be liquidated. So, everybody from hedge funds to commodity trading advisors to volatility-targeted funds to just regular investors, they've been behind this tide of selling pressure. So, you got bad liquidity, a ton of selling pressure, so what's going to happen is going to exacerbate the moves to the downside."
"So, I think that's what's been happening as well. And you had one buyer that is typically the largest buy in the market that's been missing, which is the corporates. So, the corporates should come back once the earnings seasons come down. So, I think we might see a pretty different February than we did January."
"Right. And these things come in waves, and they come in phases. And this, again, is the result of kind of where we've been... a lot of money poured into the system. You mentioned it's not a liquidity crisis in that households are doing just fine, right? We've had a rise in asset prices. So, we also had a lot of government distribution in the form of stimulus checks and others. So, households, personal income, all of that is in decent shape. This is no 2007–2008. At the same time, investors who have been in this market 10–12 years, they've never felt this before. And you mentioned it, but a lot of errors come out of the tech sector. Meme stocks, crypto, and everywhere else risk is really in play. Are we oversold in those areas, or do you think they could fall further?"
"I think we found what's close to a poor level in some of those names. And it's really interesting, even though this was a very volatile week and you've seen a lot of downside during parts of it. What's actually interesting is the software stocks, and part of the technology sector has done quite well. I was just looking at the numbers and the software sector is up 2% week to date, and energy is the only sector that's leading it."
"So, I do think the amount of valuation reset that we've had in the tech sector and the amount of outflows that we had from the tech sector has made it for a much cleaner slate, a much cleaner starting point. And that's why, while the rest of the stocks are still kind of experiencing this adjustment, I think the bulk of that valuation adjustment has been done in the tech space."
"Now, I would be somewhat careful about what parts of the tech sector I would be looking to. You probably don't want to go into the highest flying and the highest multiple stocks. Still, you want to go in reasonably valued stocks. We have confidence and visibility of cash flow. And so, when I think about secular trends like cloud computing, for example, or maybe even the metaverse investing or artificial intelligence, I think a lot of the software companies that are riding that tide, and we've seen Microsoft report very strongly this last week, I think a lot of those companies are going to be well positioned, and their valuations have been set a lot lower. So, I would be comfortable adding to select names there with a 12-month time horizon."
"Yeah, you need that time horizon. It's not like things are going to pop right back to where they were. That was an unusual time. Your 2022 outlook—which folks, you should take a look at on iCapital—you recently published, it's calling for a 10% rise in the S&P 500. We're down about sevenish percent for the year we hit the end of January. Are you saying 10% from 2021 close or from here?"
"Well, the the initial estimate was 10% from 2021 close, and I will admit that 10% was probably always going to be on the higher end because... the reason why 10% seems reasonable as a starting point is because that's where the earnings growth for the S&P 500 is projected this year, and we feel strongly and confident about that. But the wild card in this 10% outlook is, 'What is going to happen to the multiples?' And we got the answer in January. What happened to those multiples? They reset significantly lower."
"Now, having said that, if we look at the last three or four rate hiking cycle, we typically see some downdraft in multiples, but it's actually not that much. What happens more often than not is multiples do not expand, of course, when the Fed starts hiking interest rates. But what we got this year so far on top of it is we've got a multiple contraction exacerbated by poor market liquidity. So 10%, I think, is the best case scenario for full 2022. And I think we're probably looking below that given the starting point that we had this year."
"So, Caleb, the broader point of the outlook was that, if we get to 10% (and by the way, 10% is not bad), the challenge is, let's say, for a lot of the investors, that's the 60% of their holdings, they allocate to equities. And let's say, they allocate to the S&P The 40% that are allocated to fixed income, well, that 40% would have been down close to 2% last year. This year, if you look at the performance of fixed income, everything across the board is down except for leveraged loans. So, once again, if we're a blended 60/40 portfolio, it could be a pretty benign outlook in terms of returns. And that's what we wrote about in the outlook; when inflation is still running at 4% or 5%, you have to deliver at least that much in order to make forward progress on your portfolio. And given our expectations for a blended 60/40, I mean, we might just get to 5% best-case scenario. So, we do look for other things to do to supplement."
The S&P 500 posted an intraday range of at least 2. 25% every day last week, according to Bespoke. The benchmark index stayed in a 1% trading range for over a year until the recent turbulence.
"Well, I'm glad you brought that up because a lot of investors... look, we've been so heavy into the equity market, into growth, for the past 10 years or so. Very low interest rates. You have this productivity coming from these technology companies. You have these $2–3 trillion companies leading the market: Microsoft and Apple. Tesla joining that, obviously. But there is a lot of retail money in the market. So many investors join the stock market just in the last year or two years, but really over the last several years because, as we say in this business, TINA, right? There is no alternative. There has been no alternative. With the amount of money in the market and sort of passively invested through 401ks and whatnot in the S&P, is there a level that sets itself because investors are just so heavily in it that it is their biggest asset in some cases, if they don't own a home, that the market does have a threshold?"
"Well, 'there is no alternative,' that was definitely the motto of last year. And I think this year, investors, as they survey their allocations, we can't count on the same winners that were the winners in 2021 to be the winners this year as well. And specifically what I'm talking about... and for example: the pandemic trade. I think we all hope the pandemic trade is over. We all hope that we can put that behind us in 2022. And so, it's not going to be as easy as buying the Pelotons and Zooms and some of those other names. So, we have to put that aside."
"Then you've got the reopening trade, and I do think there's more legs to the reopening trade like the airlines, for example, which you know what? Parts of the reopening trades are not cheap. If you look at certain spaces like hotels, for example, the multiples have adjusted higher. So that's not quite as easy to do either. You've got semiconductor demand that's still solid, but it's likely to step down. So, as I survey the market, or even financials (they did a blockbuster year last year), but that was in the back of strong M&A and IPO volumes that may not be repeatable this year. So, the bottom line is that as a lot of these investors who are quite overweight (U.S. stocks) and were overweight (tech), I think they're going to look for other areas of return. And one of the things that we are thinking about, 'How do we supplement the more lackluster returns of the S&P that we expect?' And we do look to the private markets, and we look to the venture capital space that historically has delivered close to 700 basis points of outperformance versus the public markets."
"Yeah, it's it's a good year to be a Metric Capital or even PE blockbuster a year and a half, two years, in those markets. And you do mentioned six ideas for potential hypergrowth. We're not going to get into all of them, but I am going to list them. And folks, do check out Anastasia's blog on iCapital. Venture capital, you talked about it; the crypto ecosystem; private credit; real assets, including real estate infrastructure and farmland; hedge fund arbitrage strategies; and the premium now on put options could make selling those options attractive. So, these are some, I would say, slightly more advanced ways for investing for kind of retail investors who are just scared enough buying stocks. How are you counseling individual investors given all that, given the volatility when they're looking at some of these ideas and going, 'Well that saying seems a little exotic for me.'"
"Well, it can be a little bit exotic because you're right that typically investors have not trafficked in some of these ideas that have been reserved for the institutional space. But more and more, we believe that it shouldn't just be the institutions who benefit from this expanded toolkit of enhanced returns and VC, for example, or additional uncorrelated source of returns like you have in some of the hedge fund strategies. So, more and more, some of these tools are accessible to non-institutional investors."
"But you're right, Caleb, there's a fair degree of education that's needed. So, the way that I would characterize why do some of those ideas make sense is, in order to beat this higher hurdle rate that we now have in a portfolio, higher inflation, there's two types of ideas that we need, which is, 'How can I get a hypergrowth into the portfolio that could outperform the S&P?' And this is typically what happens: If a company is growing at a pace that's higher than the S&P, multiples notwithstanding, over time that company could actually outperform. And so that's why we look to the venture capital space."
"And speaking of hypergrowth, for example, while the S&P revenues normally track in line with GDP growth, maybe a little bit more, you can find companies that are VC-backed companies that are growing revenues 30, 40, 50, 60%. And so you can imagine the return potential for those is much higher than that. And then the other types of categories that you need, which is the bucket of inflation and rate shock absorbers. So, that's where we need to get into the portfolio. Well, how do you do that? Well, you might want to allocate to floating rate structures, which you can find in the public markets like leveraged loans, but the spreads have compressed there too. So, if you look at something like private credit that offers you a floating rate, plus a spread of 500 to 800 basis points over, that's a pretty strong return stream to potentially absorb some of the volatility."
"So, I would say that second bucket is really designed to be a placeholder for cash flow in your portfolio because, if we're going to have this volatile environment of gives and takes this whole year, then we need to have something that is working now that things are not in cash flow. Whether it's private credit or real estate, cash flow could be one of the things that work well in this environment."
"All right, I'm going to put two scenarios out because we have listeners from all ages on The Express and readers of all ages on Investopedia. But for 20-to-30 year olds with that really long-term investing horizon, how would you approach the U.S. stock market right now?"
"I think you have a very interesting investment opportunity in the U.S. stock market right now. So, what I would say there's a two-pronged approach that I would deploy in the stock market right now. The first one, when things are not working, make sure you get something in the portfolio that is working. And so, that's the cash flow that I talked about, and you can find that in private credit and real estate. You can also find it in public markets as well. So, focusing on dividend paying companies that give you 3% or 4% cash flow while you wait for the markets to stabilize, I think that's an important part of the barbell approach to the portfolio."
"The second thing I would do is be a contrarian investor when it comes to things like technology and innovation. That is on sale right now. And no, I'm not saying that we need to buy the most high-multiple, high-flying companies with no earnings visibility. But you have so many great opportunities in the software space right now, in the semiconductor space, where valuations have reset materially lower, but where you have revenues that are still projected to grow 27% over and above the S&P 500 in the next 12 months. So, I would be constructing a shopping list, some of the top names, reasonably priced, cash flow visibility, that you have a strong conviction in."
"Let's flip the script, and let's say you're a 60-to-70 year old nearing or at retirement. What's your best advice for investing right now?"
"My best advice is that it is not too late for rotation opportunities within the portfolio because, if you think about a portfolio of somebody who is at close to retirement age, it is most likely more heavily skewed towards fixed income. And so, as much time as you spend on the 60% of the portfolio, we need to spend time on the 40% of the portfolio that is in fixed income. And if you have a fixed income portfolio, you probably have a lot of Treasury exposure. You might have some corporate bond exposure. But either way, that is fixed coupon, fixed income, which is going to struggle in a rising rate environment."
"So, it is not too late to add floating rate structures to the portfolio. And as I mentioned, there is a number of ways to do that. There is a public market equivalents like leveraged loans, for example. There's private credit, which is a floating rate structure, but, again, with higher yield opportunities. And there's also yield in real estate that could be thought of as this diversified, enhanced fixed income option. So, real estate, for example, that may not outperform the stock market this year, that may not outperform technology stocks, but it is going to give you yield that also has inflation factors. So, that would be my focus for that cohort of investors because, really, rate and inflation shock absorbers for more fixed-income-skewed portfolios are top of mind."
"What's your hot take for 2022? What are folks not talking about that they need to think about, or what do you think could happen here out of nowhere that's important to focus on?"
"Well, given the amount of uncertainty and volatility that we talked about, maybe I'll go with something a little bit more positive that people are not now talking about. It was all about COVID. It was all about omicron. It was all about the pandemic. And in the last month or so, we've barely talked about this because there's been so much focus on Fed policy. I think this is the year, we're all hopeful, that this pandemic finally shifts to the endemic status. And with that, there is a return to the new normal. And if you think about why that should occur, why should that be the case, between the vaccination rates across many different economies and the vaccination rate that will rise in emerging markets and just the natural immunity that we have acquired—a lot of us, globally, but certainly developed markets, have a rather high level of immunity. So, I think this is the year where we will return more fully to the offices, where we will resume activities. And this is why this is the year that the Fed should also normalize the policy. So, as the economy exits from the pandemic, it only makes sense that the Fed also exits from its pandemic measures as well."
I hope you're right on all that. It'd be great to see what normalization looks like from a monetary policy standpoint. Feels like we haven't had that for a very long time, but hopefully we'll all stay healthy and it'll be a better year and we'll have a new new normal. I remember the new normal from the last great financial crisis. This is time for a new new normal. Last question for you, Anastasia. We're a site built on our investing terms. Everybody knows that. You've been in this game quite a while. What's your favorite investing term and why? What's the one that just rings true and just makes your heart sing?"
"I will give you an investment formula, how's that?"
"I'll take that. We love formulas here at Investopedia."
"That's right. My very simple investment formula, which, by the way, can be applied to a bullish or bearish scenario, is valuation plus positioning plus a catalyst. Amidst all the noise out there, and amidst all the headlines, that's the formula that I always come back to. It is, 'where's the level of valuation today?' Is it a compelling entry point, or is it off the charts like we talked about in the software sector? Then you look at the positioning; is everybody crowded in the same trade or has the tech sector been sold and unloved and thrown out like a baby with the bathwater? So, you can guess where we are today. And the third point is: Valuations, positioning kind of help us gauge the setup, but you ultimately need a catalyst. Will you have a catalyst to dislodge the expensive valuations, or will you have a catalyst to buy cheap stocks? And I think today, as we talked about, this might be the year we get out of the pandemic, and so there's going to be this rotation. But as we emerge on the other side of the new normal, they're going to be growth that's going to be a little bit slower than it was before. So, I think a lot of investors will once again look to pockets of secular growth, which is going to be in technology and innovation. So, that's the investment formula that has served me pretty well over the years."
"I love that. It's simple. Nothing is that simple, but it's very simple. And I think something we can all look at, no matter what market you're looking at, if we're in a volatile time or even in a sort of quasi-quieter market, that's a very good formula. And I think we need to put that on Investopedia and name it after you. That's why we called you on here, Anastasia. Anastasia Amoroso, the chief investment strategist at iCapital. Such a voice of good common sense. Find her on CNBC, you're a contributor there. Read the blog and follow her work with iCapital. It's such a pleasure to have you on The Express. Thanks for joining us.
Term of the Week: Bellwether
It's terminology time. Time for us to get smart with the investing term we need to know this week. This week's term comes from Deepak in Boston, who suggests bellwether, and we like that term, given Apple's blowout earnings report last week. Well, according to my favorite website, a bellwether is a leading indicator of an economic trend. To investors, a bellwether is usually a company that is worth watching closely because its earnings logically suggest a larger economic trend. A company's stock may also be a bellwether if it's viewed to be pointing towards an upward or downward trend in a sector.
FedEx is often considered a bellwether for the global economy because it handles a good chunk of the movement of goods for businesses. But we can't deny that Apple has become a bellwether for the U.S. stock market, given the staggering amount of sales it generates, its $2.8 billion market capitalization, and how widely held it is across mutual funds, index funds, hedge funds, pension funds, and ETFs. Apple and Microsoft are the two largest U.S. public companies and the two most-widely held stocks in the world. As we said at the top, as they go, so goes the stock market. They are bellwethers. Great suggestion, Deepak. Socks for you, my friend. And we'd like to see a picture of you sporting those on your next trip over to the North End for a bowl of wicked-hot clam chowder and a lobster roll.