In this episode of The Acquirers Podcast, Tobias chats with Vincent Deluard, Director – Global Macro Strategy at StoneX Group Inc. During the interview Vincent provided some great insights into:
- Nuclear Winter Of The 60/40 Portfolio
- Inflation Is Good News For Value Investors
- Value Is Becoming Momentum
- Impossible Hypergrowth
- Healthcare Will Be The Biggest Driver Of Returns For The Next Decade
- Keynes, Inflation & Money Illusion
- Can You Hedge Against ‘MAGA’ Stocks?
- Duration Is The Biggest Risk In Your Portfolio
- Automakers Are The Most Impacted By Inflation
- Will Value’s Recent Run Continue?
- The Impact Of Renewables Will Be Inflationary, Then Deflationary
- The Labor Market: Structural Change & The Gig Economy
- The Next Decade Will Be Secular Inflation
- Physical Gold Or Mining Companies
- StoneX The Biggest Firm You’ve Never Heard Of
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Tobias: Hi, I’m Tobias Carlisle. This is The Acquirers podcast. My special guest today is Vincent Deluard of StoneX. We’re going to be talking about value, we’re going to be talking about gold, we’re going to be talking about the MAGA stocks, and what the next 10 years is going to look coming up right after this.[The Acquirers podcast theme]
Vincent, you are from StoneX. What’s your role at StoneX, and what is StoneX?
Vincent: Sure. I’m the Director for Global Macro Strategy at StoneX. My role is to try to come up with something interesting to say about markets every week, which seems easy, but is a lot harder than it seems, because a lot of people think they have interesting things to say about the markets, so it’s a crowded field. We advise pension funds, institutional investors on topics like asset allocation, sector selection, country rotation. I do road shows, presentation, I write a report every week, which I’m sure we’ll discuss later. In general, yeah, it’s lot of fun. I don’t tell my employer, but I would probably do it even if I were not paid, because that’s what I’ve been doing all my life. That’s what I enjoy doing. I’m very fortunate to do that.
StoneX The Biggest Firm You’ve Never Heard Of
Vincent; As far as StoneX, StoneX is probably the biggest firm you’ve never heard of. It’s actually a Fortune 100 company where I work for the broker dealer division. We are a global financial service firm. We have a big commodities group with whom I work sometimes. I go to places like Kansas City and St. Louis, and actually meet a lot of very smart people there. We have a big currency management unit. Then, I work for the securities group. Lately, most of my clients have been Latin America. I work it out with pension funds in in Chile, Peru, Brazil, Colombia, and it’s really given me a very interesting perspective, very focused on real stuff whether it’s commodities, grains, ags– Yeah, the firm’s growing very fast. We are listed on the NASDAQ ticker symbol, S-N-E-X. I think we’re doing good.
The Next Decade Will Be Secular Inflation
Tobias: I love the notes that you write, and as I was telling you before we went live, I read through and laugh every time I read them, because I find them– mostly because I agree with you on most of the things that we’re going to talk about in a moment. Let’s start with an easy one. Inflation, transitory or here to stay and why?
Vincent: [laughs] Well, I think today’s a good day for me, because it’s not transitory will be my answer, and we’re starting to see– It’s possible that we get a soft patch just because of base effect. I wouldn’t be surprised if the next couple reports are a little– they’ll slowdown, but I think–
Tobias: Base effect in the sense that a year ago or 15 months ago now, it was the low of the whole COVID crash.
Vincent: Correct. I think that’s part of the– Even in the way you framed the question, the answer is both. It’s transitory and secular. I think there’s a level of dishonesty ingrained in the Fed. When I mentioned, oh, it’s all Bayes’ effect, and yes, these things are here. No one’s questioning that. But you have also other secular dynamics. So, my outlook for inflation is, yes, right now, indeed, I cannot agree that the biggest driver of inflation is what you’re describing, which is a year over year effect on the commodity, because not so long ago, we had negative oil prices. Today, we’re about 70.
So, infinite growth rate. And it’s lumber, and it’s copper, and it’s semiconductors and all the things. So, that’s what’s hurting right now. Yes, maybe some of that will subside. By the way, I’m not sure it will fully subside. I think, for example, if you look at the price of oil, yeah, sure we went from minus 40 to 70, I don’t think we’re going to go to 150 in it, but I could very easily see oil prices stay in that 70, 80s range. Same thing with a lot of commodities, we have these structural supply issues that that will not get solved. The fact that it’s a lot of it is from commodities doesn’t mean it’s going to go away. It’s going to slow down, but then I think what’s going to happen as we progress once a year is we’ll see this almost smooth, seamless transition between this cyclical invasion and second inflation.
Second inflation being driven by things such as labor shortages, wage price spiral, rents, the stickier parts of the CPI are going to take over, and I would stress that these things matter a lot more. Commodity is like what 10% of the CPI, shelter is 40%. People love to point out that, “Oh, it’s all because of oil prices, take that off.” Well, what people don’t realize is, we have the exact other effect on the shelter part of the CPI.
Because as a result of COVID, we had all these rent moratoriums. So, we’ve seen massive disinflation in rents. Rents used to be running at 4% pre-COVID. They fell to 1%. You know how the Fed computes this high-quality BS number, but they call it the owners-adjusted rent equivalent. Really, that which effectively tracks rents, not the Case-Shiller index, which I think is wrong, because at the end of the day, people, when you buy a house, you pay the market price, you don’t pay the Fed construct. But whatever, let’s not even get into that.
The point is that fell from 4% to 1%– Now, I hear a lot of people say, you got to take out the commodities, because it’s COVID story, and it’s overestimating to get– I hear no one saying, well, you’ve got to correct for the rents and the rents, we know is going to correct because, of course, the monitoring is going to end in the fall, and if you’ve been in the market for buying a home– you’re in LA– Now, it’s everywhere. It used to be the big cities. Now, it’s everywhere. Yeah, I think that the story of the next decade is going to be secular inflation, and we are at the very dawn of it. We had what, four months of it, but before that we’re four years of these inflation. As far as where portfolios are, where investors are, where risk is, we are at the very, very early stage of this move.
The Labor Market: Structural Change & The Gig Economy
Tobias: One of your notes has the seven best arguments against inflation, and the second point that you raised is labor slack. Just anecdotally, I’ve been driving around, or on the Twitter, or on the internet. You see lots of references to people having difficulty hiring, and having difficulty hiring at old rates. They may have to pay more to hire. What’s driving that?
Vincent: I think part of it, the common answer is, government paying people to stay home and watch Netflix. It’s kind of a Fox News talking point. There’s some truth to that but to me, I think it’s changes in behavior from COVID, structural changes. One study that I thought was eye opening found that Americans took, I think it was two pounds per month of lockdown– in California, what… lockdown. So, that’s about 22 pounds that people took. We’re starting from the base of the population, when you have 30%, 40% of the population that’s morbidly obese, and that can be debilitating. Anyone who struggles with weight loss knows that. It’s not just because you can take off the mask that suddenly you’re going to lose the weight.
Another stat that I found scary was on mental health. 40% of teenagers report struggling with severe anxiety or depression. And again, these are debilitating disease. Then, this is not just because, Mr. Fauci say, “You can go out. Now, it’s all good. That’s going to go away.” I think we’re going to be scarred by COVID for a very long time. The labor market coming out is going to be very different from the labor market coming in. Which is why I think there’s a bit of a bad faith when you hear like Neel Kashkari, or some of the [unintelligible [00:09:42] at the Fed say, “Well, can’t have inflation, because unemployment rate is 6% and what, 3.5% half before COVID. So, we’ve got to run that baby hard until we get to 3.5%.”
Well, that assumes all else equal, ceteris paribus. It’s not ceteris paribus. The labor market has changed, and I think that fictional thing that economists talk, the NAIRU, non-inflation accelerating rate of unemployment, national rate of unemployment, which you only know after the fact. I think before it’s probably possible that the Fed overestimated the NAIR, could go lower, but now it’s probably under estimating, meaning that the true NAIRU was higher than what it is because people have struggled from the pandemic and also some people have just changed your priorities. It’s like, “Hey, I don’t need to work anymore. I figured out a way. I rent something on Airbnb. I can drive an Uber here and there. I need to take care of my kids. I need to take care of my parents.” This is a major event that will change people’s behavior. The Fed again, we don’t have a precedent, don’t have a model for that, so I think the Fed is just ignoring it.
I will also stress one last thing about the labor market is a structural shift that was pre-COVID, that was accelerated by COVID is the rise of the gig economy. I think that changes the dynamic in the Phillips curve. Historically, I think the intuition behind the Fed’s mandate is you have this rate of inflation, unemployment is basically, “Hey, if you don’t work, you don’t eat.” Once the economy goes into recession, people don’t have a job, because they don’t have a job, they start bargaining less for wage, and then wages fall, and that’s the regulation mechanism of the economy. I can argue it’s a very barbaric one, or I would say it is. It’s sad that in order to run the economy, you need to threaten 20% of population with starvation but that’s how it’s been for millennia.
But again, the labor market has changed. It’s no longer this black and white employment and unemployment thing. Now, you have this gray zone of gigs. So, you lose your job, well, I can just log on my cell phone, and sign up to be a Uber driver, I can start running tomorrow or don’t actually– So, this gray area where I think if people lose their job, then they’re not going to come back to take a job for 10 bucks an hour, because they have that option. That’s going to change to the Phillips curve, and I would argue that it’s going to make it less elastic.
The Impact Of Renewables Will Be Inflationary, Then Deflationary
Tobias: One of the arguments that you put forth that I found reasonably compelling is that there is going to be this deflation as a result of technology, which does seem to have been the case over very long periods of time. Why is that not a valid argument?
Vincent: It is a valid argument. Over time, that’s the main reason why prices don’t go for the moon, is because humans are smart. Knowledge is cumulative, and we get better at doing stuff, and historically, shortages of stuff have been replaced by human creativity. You can think about the Industrial Revolution. England ran out of wood, so they had to dig coal out. Coal was a better source of energy than wood. Then, you move to the oil age, and maybe you want to move to renewable age. So, yes, I believe in that over the long term.
Over the short term, I do not really see it, if anything, I see this this massive push to go into renewable as extremely resource intensive, at least initially. Because you’ve got to redo the grid. If you get a windmill, it’s a lot of steel. Battery, it’s a lot of cobalt, it’s a lot of nickel. Thinks, by the way, we don’t have a lot of. We don’t know how to– because these things are fairly at least in terms of the volumes that we’re going to need. So, even if you want to be a techno utopian, and then think we’re going to go all drive electrical vehicles, and then renewable, there’s going to be massive investments required to do that, and it will be inflationary first, deflationary later.
Nuclear Winter Of The 60/40 Portfolio
Tobias: You’ve made a pretty compelling argument, I think, for inflation. What do investors do when they’re confronted with this? You’ve written a note where you break it down by asset, sector, factor, and some stocks, but let’s talk about from an asset allocation perspective, how do you approach a problem like that?
Vincent: Well, the first thing that investors need to realize and seriously think about is what I call the nuclear window of the 60/40 portfolio. The 60/40 portfolio has really been the bread and butter of our industry, and frankly, a lot of people are very wealthy working very little in the asset management industry, because yeah, things just went up. What was it? 4-4-4 for bankers, where you charge, I don’t know 4% on loans, I forgot the other one, and then you’re on the golf course by 4 PM, right?
Vincent: That’s how it’s been the asset management industry. “Yeah, okay, give me your money, I’ll buy stocks and bonds. Don’t look at it. [unintelligible [00:15:07] 1% management team, and we’ll all be good.” I think that’s over. It’s over just because the [unintelligible [00:15:14] irremediably broken the bond allocation is– I was looking at VBTIX, which is the world largest bond mutual fund by Vanguard, and I found that 99.9% of these bonds yield less than 4.5%. Now, why 4.5%, because that is the return assumption that Vanguard builds in its target date retirement calculator. So, they tell you, “Come retire with us. You’re going to earn 4.5%,” but then they put you in a funds where 99.9% of bonds are less than that. It’s a joke.
The other part that’s broken in that 60/40 portfolio is a negative correlation between the two assets. For a long time now, yields have been low. But you would still want bonds, because of the diversification. You are not getting much return, but because you reduce the volatility of your stocks, you still improve your risk-adjusted return, your Sharp, and you could even add on leverage because of that.
Well, for the first time in about 20 years now, the trading six-month correlation between stocks and treasuries is positive. Again, this is what you see in an inflation environment. This is the norm– There’s nothing normal about the prior environment, or this one, or whatever. That thing flips based on inflation. In the 70s, in the 80s, all the way up to the mid-90s, stocks and bonds were positively correlated, which is where we are today. Which means that more likely, we’re going to see both stocks and bonds drop at the same time, and people who are in 60/40, or even the leveraged version of it, which I would argue is what disparity is, are going to be facing losses on both sides of the portfolio. So, that’s the first lesson.
Duration Is The Biggest Risk In Your Portfolio
The second lesson, obviously, is to underweight bonds and then long duration. I think duration is the biggest risk in your portfolio, and I think duration is a very creepy thing. People think of duration only as a 30-year bond. Now, you have a lot of duration in biotech, you have duration in many of the growth names. May be the longest duration asset could be Tesla, or it could be even 50% of the Russell 2000 index that doesn’t have any earnings, it’s not even able to cover interest expense. So, you have a lot of duration hidden. Even the duration of bond indices has increased, again because agents respond to incentives. So, when you have flat yield curves and very low yield, people take on debt, and they take long-term debt. So, if you look at the duration of the Emerging Market Bond Index, it’s all-time high. Duration of the junk bond, all-time high also. So, that is I think the biggest risk in duration.
Then, in terms of assets, so you take off bonds. There are areas that are like Latin America, for example, I think short term, Mexico, Brazil, you get potential for currency upside rerating, but that’s very narrow. I also like some of the Asia, the Chinese government bonds, and then smaller markets around it, but that’s not 40% [unintelligible [00:18:08] your portfolio.
Keynes, Inflation & Money Illusion
Then, if we go to stocks, stocks initially do fairly well, when you have a bit of inflation. I think that’s due to the inflation illusion, something Keynes wrote about. At the beginning of inflation, “Oh, I’m getting richer. I’m getting a pay raise. So, everybody’s happy,” which I think is where we are. Then, you realize, “Oh, everybody else is getting a pay raise, and [unintelligible [00:18:34] grocery store are 20% higher.” In that initial phase, which is where we are, inflation feels good.
Then, stock multiples, CPC, peak when inflation goes from 2% to 4%, up until yesterday. Now, we are at 5%, but before we’re at 4%. Then after that, if you look at the relation between stock multiples and inflation, it starts falling, because people realize, “Oh, inflation is here. Margins are going to compress.” Then, generally, again the duration argument, I think inflation shrinks the time horizon, increases the preference for the present, and any long duration assets, which stocks are, end up suffering from inflation.
I actually, I want to– One of the difficulty about inflation is that most of the data that we use for back test is less than 40 years old. It’s very hard to run a– And we had 40 years of these inflation, so most people do not even have the ability to test what inflation is for so. I was lucky. I went to the Fama and French website on the Dartmouth.
They actually reported industry returns all the way to the 1920s, which got me four inflationary episodes. The ones during World War II, the one during the Korean War, then one in the 70s, and then the little bout we had between 2003-2008. I found that of the 30 industries that they have, 27 have a negative correlation of inflation. That’s my point. Inflation is bad– I feel I should not have to say that, but the market clearly doesn’t seem to understand that. For most industries, inflation is bad. The only three that had a positive relation were coal, which no one wants to touch right now, oil and gas, anything wholesaler was a third one.
Automakers Are The Most Impacted By Inflation
Vincent: The one that had the most negative relation to inflation was automakers, which I find interesting in the context of one large electric vehicle manufacturer. Because car manufacturing, your COGS, Cost of goods sold are 80% of your– and selling price. So, you don’t have that much leeway, like, if the price of steel goes up, your margins go and it’s also a very competitive industry.
Back in the 70s, we had the European, we had the Japanese industry who always apply a low pricing power. Yeah, by and large, I don’t think stocks are going to be a good hedge against inflation. Obviously, with stocks, I prefer materials, I prefer gold miners, I prefer energy, but these are tiny. The energy sector is 2% the S&P 500. So, the stuff that will benefit from inflation is going to be outweighed by the long duration complex in the stock market, and I think as a whole, inflation is going to be negative.
Inflation Is Good News For Value Investors
Tobias: What about from a factor perspective? You took a pretty close look at that, and I thought there were some interesting outcomes from that.
Vincent: Yeah. The one that works best during the inflationary period is value, which at that– [crosstalk]
Tobias: Yeah. I’m happy to hear that. That’s why I raised it. [laughs]
Vincent: [laughs] Yeah, you need all the love you can.
Tobias: That’s it.
Vincent: Oh, yeah. I think it’s going back to the duration argument, ultimately. If you thought of duration of stock like you would of a bond, value stocks are low duration. They’re low duration, because the high dividend yield means you get your capital back faster. It’s like the duration of the one with high coupon is lower than that with a bulk bond. So, same thing.
Then, also some of that value is immediately realized, because you’re getting a low price to book, so the assets, right away, you’re getting a claim on real assets that you can cash today. As opposed to growth stocks, where the cash flows are going to come far out in the future, and then even the assets, which most often are intangible will only materialize their value later. So, when REITs go lower and then yield curves flatten, that helps growth. Conversely, when you have inflation, steeper yield curves and higher rates, that helps value. I think that’s the reason why you see the value anomaly.
By the way, I’m not sure about the term ‘anomaly.’ If you look at the Fama/French data, most of the returns from the value factors came from these short periods of inflation, the 1970s and the early 2000s. I will not say that it’s anomalies, just a normal ebb and flow, inflation favors value, deflation favors growth. We came from 40 years of deflation. Now, we’re switching and I think that’s why you’re going to see value do better.
Value Is Becoming Momentum
The other one that that I find interesting is momentum. I have my doubt about the Fama-French study, but every academic quotes it. Clearly, I don’t have a Nobel Prize, so I’m not going to question them here. But the return that they found for the momentum is actually so high that it’s hard to believe. It’s 8% [unintelligible [00:23:26] alpha, whatever. But let’s assume that’s right. Momentum worked in both inflation and deflation. I think the reason is, because momentum is not really a factor. It’s a chameleon.
Momentum, by definition, goes with what works best. For the past 40 years, momentum got you into big tech, the platforms, the biotech, and so forth. As we’re doing this transition, momentum is shifting. You can see that in the largest momentum, ETF, MTUM, massive rotation, just rebalanced. I think three months ago, it was 80%, big tech, pharma, work from home, the pandemic stuff. Then now, it’s banks, energy, material, and I think that adds water to my mill, the fact that the momentum strategies now are picking up the value factor and you’ll have this intersection, value is going to be momentum, and it’ll be a little bit like a snowball.
Healthcare Will Be The Biggest Driver Of Returns For The Next Decade
Tobias: One of the things that you point out as being a potential beneficiary of an inflationary environment is the US healthcare companies that sell into that system. So, can you take us through that argument?
Vincent: Yeah. Okay, I have this philosophical view before that. I hate the US healthcare system, but I think– [laughs] I hate it because it is so good at squeezing money out of patients. I do think that over the next– it seems to me that every decade is defined by one macro theme. When I came of age, the big story was the internet and TMT, and that was the story in the 90s. That’s what drove your returns for a decade. After that, in the 2000s, the big story was the rise of China, emerging markets, the bricks commodities, all of that at once. So, that was another decade.
Then, 2010, it was kind of coming back to the 90s, but with a more pro-business, pro-platform. Instead of the wide-eyed optimism, it was the Facebook and the Google, the big tech platforms. I think healthcare is going to be that for the 2020s, just because of demography, because of patents, government spending, because of even people’s preferences, especially, after COVID, the importance of health. I think we have this massive crisis in how we eat, how we live. So, that’s my view that healthcare is going to be the driver of secular returns for the next decade or so.
But specifically on the point of inflation, I came to healthcare just by running a screen on Bloomberg. I looked for– my idea was– I call that the pricing power portfolio. I wanted to look for companies which had expanding margins despite rising COGS. You have inflation in your COGS, but you’re able to pass it to your customers and some more. I look for companies which pay the dividend, because when you have inflation, you want dividend, because dividends grow and coupons do not.
You can think about a swap between an asset that’s growing and one that’s fixed, it’s a good thing. I look for companies that have long long-term debt, because if I’m right about inflation, that long-term debt is going to be paid out by inflation, cancelled out. So, that’s a good deal. Finally, I look for also a company that has some financial resilience. Meaning that, they had a high interest coverage ratio, that was really to weed out a lot of the small caps, Russell 2000 like companies where you have a lot of debt, but you don’t have the cash flow to support it.
I ended up with a portfolio of about 70 stocks, which I call pricing power portfolio, and 60% of that was into healthcare. That fits well my experience, because the pricing power of healthcare is infinite. We’re joking earlier about our experiences being foreigners and having babies in the US. I still remember when I had my first baby, literally, I have this child in my arms, he’s bloody and screaming.
Get a call, “What’s your credit card number? It’s $80,000.” I almost dropped the baby, I come from France, I’ve never had to settle a bill, $80,000. Then, I asked for an itemized bill. They couldn’t even itemize it because it was a BS number. So, they put stuff, or we did this. No, you didn’t do that. I was there. My wife was there [unintelligible [00:28:14] of birth. I know these things didn’t happen. But then they’re like, “Why are you in here? You’ve got insurance. You’re out of pocket is already down, it’s not your money.” I’m like, “Maybe, it’s me being French, but–” I was like, “No, no. I just don’t like being taken advantage of.”
But anyway, long story short, in healthcare, prices is not driven by inputs. It’s driven by the power relation between the predator, which is the hospital in this case, and the prey which is the patient. That power relation is not going to change if you look at healthcare CPI over time versus the regular CPI keeps going up. I think it’s also an area where you’re going to keep seeing more money. Spending money on healthcare, it’s like for Catholics going to confession.
Doesn’t accomplish much what you feel better after that for– Especially for Democrats, oh, let’s put more money into healthcare, and everybody’s happy with that. It’s also a way I think– when people think about the stimulus, they have this 1930s view of it, the Tennessee Valley Authority is going to build dams. No, you live in LA, I’m in San Francisco.
How long have we been talking about the high-speed train between our two cities? 30 years. I think it’d be like five miles within Modesto and Stockton. This is not the age of big infrastructure investment. You got the NIMBY, you got the environment, none of that stuff’s going to happen. If we’re going to run these for $3, $4 trillion deficits every year, the easiest way to spend money is either bailing out states or spending on healthcare, and in a way it’s good. Healthcare spending is good. It’s good, middle class jobs that don’t go to China, pays good benefits. So politically, it’s a smart thing to do.
Tobias: Yeah, that’s fascinating. The thing we haven’t really discussed that I really want to chat to you about– Let’s talk about this is an extremely expensive market, what are the chances that we go into some bear market, and how do you think about that process?
Vincent: I think about it a lot with great apprehension and in great confusion about what I see in the market right now. Yeah, you look at any valuation measure, whether it’s Tobin’s Q, stock market cap to GDP, Shiller P/E, we were way higher than we were even back in March 2000. Not only that, but it’s also more widespread. Like 2000, the growth complex was expensive, but the value stuff was okay. In the bear market, if you want value stocks, you actually did fine. Not so much today.
I can think energy and material are still cheap, but outside of that, it’s really widespread overvaluation. It’s to a level that’s absurd. I think you’re referring to a study that I put out on Twitter recently on what I call the hyper-growth stocks. I was thinking about a certain actively managed ETF. We have a very charismatic portfolio manager talking about this amazing technological revolution that’s going to happen, and you want to get in now. It’s growth at any cost. The idea is, if you bought Amazon 20 years ago, it didn’t matter what else you do, just because of that, you’d be rich today. So, let’s find the next Amazon and let’s just do that. Okay, fine. I am actually somewhat positive– on some of the technological stuff, I’m in agreement with that crowd. I think it will happen. It will be amazing. The question is, can you capture these returns by buying stocks today? That’s the question I want to answer. My answer was no.
So, what I did is I looked at all the stocks that trade at more than 10 times sales. I call that the hyper-growth stocks. There’s about a couple of hundreds in the US right now. Then, I projected on that the growth path of Microsoft, Apple, Google, and Amazon, and what growth are we talking about? These guys have seen amount of their revenues multiplied by 56 in 17 years. Think about this. Everything that I learned about economics was shattered. The diseconomies of scale, marginally decreasing return, margin [unintelligible [00:32:35]. These guys have grown revenue so much, and still they maintain 20% to 30% profit margins, in some cases increasing. These are extraordinary companies.
Again, it’s a unique time. It’s rise of the internet, rise of the e-commerce. A complete failure of antitrust to investigate or do anything. What a period. So, I put that on, and I say, “Okay, these hypergrowth companies are going to follow the path of Google, or Amazon,” and then I composite– Then, I’m going to assume that because they’re so good, they’re going to trade to the same valuation at the end of the high growth period as the MAGA stocks today, Microsoft, Apple, whatever. Then, I discounted that by 10% to the present to get a result.
So, I got two things. One, for 20 companies, the result that I got was so absurd that it made no sense. Their sales would be bigger than US GDP, so that’s not going to happen. Then, for another 60, I found the current market value was higher than that. The market was only discounting Amazon in my scenario and some. Then, you’ve got to pause here, and you’ve got to be like, 60 Amazon in a year. It took us four decades to get four of these companies, and they’re arguably the four most successful businesses since maybe Standard Oil or the East Indian Company. How is that going to happen? It can’t. It can’t.
Can You Hedge Against ‘MAGA’ Stocks
Tobias: We’re confronting an extremely expensive market. The interesting part of the market, which has been the hyper-growth, SaaS stocks, MAGA-type stocks seem to have– There’s a little room left to run in there. How do you hedge that portfolio? How do you protect yourself? What do you do?
Vincent: Well, it’s very, very hard, because traditionally, your hedge was long-term treasuries, and that’s not working. I don’t think it’s going to work, because of that outlook on inflation. 60/40 is not going to work. Now, you go to other alternatives like, “Well, I can buy puts, right?” I don’t know if you’ve done some of that. I have, spent premium every month [laughs] never happens, the market never corrects, and also that the implied vol is quite high. Typically at a market peak, you should be looking at a VIX of 10,12. We’re in the 20s, maybe less today, but generally we’ve been pretty high. Especially, if you look at out of the money puts, SKEW are very expensive. SKEW index in an all-time high. Paying premium, that’s the most efficient hedge obviously, because if it falls, you get your money. But that is very expensive, so that’s not a good solution.
Then, if you look at even traditional risk of assets, not so great. People haven’t noticed, because there have been very few corrections, but I actually ran a study of looking at how various risk-off assets have performed when the market’s dropped by more than 1%. So, I ran it for the gold, long-term treasuries, the yen, the Swiss franc and bitcoin and all of them fell when the market fell. Personally, I feel like gold, maybe it’s my ideological bias, I’m willing to give gold a pass. I don’t know why. But yeah, it’s harder. That’s what typically happens when people talk about crypto being uncorrelated. An asset is uncorrelated until it becomes so successful that then you get institutional adoption, and then it becomes correlated. So, people are extrapolating from the past, which I think is wrong. But it is going to be very, very difficult to hedge.
The one thing I would suggest though is taking a broader view of risk, rather than thinking of risk as [unintelligible [00:36:24] moving the S&P 500 daily return, what are truly the risks of 2021? And I have… with the list the five. Rising yields, rising spreads, rising inflation, stock market decline, or blowup of the growth complex. For every sector, I ran a regression analysis to see how these things respond to these risks. I took the sum of all these five risks and looked at what protected you best.
What I found was the best protection came from the most cyclical stuff in a way. Energy, materials, commodities. But also, the cheapest stuff, which is I think the great news, is that buying hedges, if you have this extended vision of risk, not just 1% of the S&P 500, actually the big risks, which is rising inflation and associated consequences, you can hedge that with inflation-sensitive assets, which are still cheap. Conversely, the things that had the most exposure to these five risks were technology and consumer discretionary, where we’ve seen the biggest runs of the most expensive stocks.
That is, to me, the greatest news. The only piece of good news for investors in 2021 is they understand risk correctly, they realize that hedging that risk is cheap, and these are also the sectors where you get the most earnings growth. I think more than half of the earnings growth in the S&P 500 next year is going to come from energy and materials, coming back from very low base, of course. So, I can see this complex where you have protection, cheap valuation, positive earnings growth. This is really the trifecta. You really see the stars align so well.
Will Value’s Recent Run Continue?
Tobias: That sounds like a reasonable argument for value over the next period of time. Not that I want to talk my own book much, but that does sound like a pretty good setup for value.
Vincent: It does. Yeah. Like I said, we had, what, four or five months since November, maybe the election and the vaccine news, all right, six months. We had 40 years of decline before that. If you think about the cycle as this long-term pendulum swing, we barely started the move. Indeed, if you have to have an equity portfolio, I think value because of its low duration, because of its sector exposure, is probably going to keep you out of trouble. I would expect the market correction to play out very much like the 2000s when the NASDAQ was on 80, the S&P was on 50, but if we only looked at value, we’re barely down on the year and then you recover a lot faster.
Tobias: I think value has had pretty good run since, whatever it was, September or November last year. It seems to have stalled out a little bit over the last month. That’s been my observation and the market feels a lot frothier and more speculative recently. Why do you think that might have happened?
Vincent: I don’t really have a good answer, but I’ve noticed that I think that the value and the performance comes from the fact that yield’s topped out quite a bit. Like 1.6, 1.5. I think if you look at the growth to value performance, it seems to follow yield especially, I think part of it is because financial decision a big part of value indices and financials respond to the slope of the yield curve, so as that has fallen, value has done less well. I think just be patient, things are never linear. Obviously, you’ll get pars, you’ll get pullbacks, I’m thinking of gold right now. You had a big pullback from gold from 2,000 to 1,700, now 2,000 is close again. If anything, I think that will be a time to accumulate more so than selling.
Physical Gold Or Mining Companies
Tobias: Do you have a view on gold? The commodity versus the miners, does either perform better in the environment that we might go into?
Vincent: Yeah, typically, miners are the most leveraged you can think of on inflation, because, obviously, they’re tied the price of gold,… over financial leverage on top. One is the inflation of mining costs versus the price of gold. You want to invest in gold mines, when gold prices are rising faster than the input cost of gold. So far, that seems to be the case. I’m not worried, like you want them to be able to preserve their market, but it could be that 5, 10 years down the road, because of labor costs, because of shortage of steel, yada, yada, but that dynamic is going to change. For now, it’s not a problem.
Second thing is discipline. Capital allocation. Typically, gold mining industry, I’m sure you’re familiar with that. It’s a bunch of cowboys. Money burns a hole in their pocket, and they have a dollar spent and that’s what the industry has done for the past 20 years. The market has rechastised them, and we’ve seen massive consolidation over the past decade, big focus on returning capital, then dividend. So, again, not a risk. Then, the last part is valuation.
Obviously, with any investment. Your return is going to depend in large part from the price you pay to get in. I would argue that multiples in the gold sector are not too high. We can find that good, very solid company trading for 12, 13 times cash flow which compared to the rest of the market is a bargain, especially, if you think as I do that this cash flow is going to increase massively in the next decade.
Tobias: That’s fantastic. Vincent, we’re coming up on time. If folks want to follow along with what you’re doing or get in contact with you, how do they go about doing that?
Vincent: Twitter is the best. I don’t like big tech, but I’ve got to say Twitter is where it’s at for finance. My handle is @Vincent Deluard, V-I-N-C-E-N-T D-E-L-U-A-R-D d. You can follow me there. If you go to my pinned tweet, that have a link where people can sign up for a free trial of my work. We grant it to everybody. You don’t have to be an institutional investor. And then, you can DM me. If you trade commodities, if you trade futures, if you trade stocks, StoneX, that’s the best way if you already have a relation with us and we’ll be very happy to get you on my list or to get you to talk to some of my colleagues on the trading side who can help you open an account.
Tobias: Vincent Deluard, StoneX. Thank you very much, sir.
Vincent: My pleasure.
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