Pollyannaish Thinking About the Impact Of Interest Rates

During their latest episode of the VALUE: After Hours Podcast, Taylor, Carlisle, and special guest Zach Abraham discussed Pollyannaish Thinking About the Impact Of Interest Rates. Here’s an excerpt from the episode:

Zach: Yeah. Maybe that’s the way this goes, right? Maybe it’s a wave hits this and a wave hits that. The only problem is because the market cap waiting situation has gotten so extreme, when tech gets hit– This has been our thesis, really the whole way along, which felt dicey, because it really cuts against the grain, but we’re really supposed to get our cues from the S&P 500. It’s the biggest index. It’s the most broadest reaching. We haven’t been doing that since the end of 2021. We’ve been tracking the NASDAQ, and it has worked on a technical level. It has behaved much better in terms of understanding what’s coming at you on a technical basis. It’s adhered to the levels much better.

Tobias: What do you mean you track it? What do you mean?

Zach: Well, so, when we get into an environment like this, we’ve got several different risk management techniques. But if we’re really worried about market downsides, we really pay more attention. When it comes to hedging our positions, we really pay more attention. We’re value oriented. Our value portfolio, that’s how we pick everything. But we really rely on technicals on the hedging side.

We made that decision, which felt a little bit crazy at the time, to use the NASDAQ as our indicator when to hedge and when to manage risk, as opposed to the S&P 500. We made that call at the end of 2021, and it worked much better. There were just several times where you had fake breakouts on the S&P. The NASDAQ was bumping up against the top of the range. It got beat back down. Where if you’d have been tracking the S&P, it would have told you to pull the insurance off.

Tobias: What’s the reason for that? Just more people are playing around on the NASDAQ than in the S&P 500.

Zach: Yeah. We have an interesting, and you know this, Toby, but we deal with all retail investors. So, we look at a lot of positioning. We look at a lot of 401(k)s coming in. And as you’d expect, everybody’s loaded up on these queues. This fund queue, it’s been great for us.

Tobias: It was great crushing it.

Zach: Yeah. So, you look at these people underlying portfolios, and they’re 40% to 50% in the queues, and it’s just that self-reinforcing wheel. It keeps going up and they’re outperforming. And so, we just keep feeding it, feeding it, feeding it. That’s how you get in this crazy situation we’re in. So, it feels to me like that tide is turning. When you look at valuation, all the different stuff that we’ve talked about and macro and all these different things, but I don’t know. I’ll throw it back to both of you guys on this. The risk management side for us, we’re pretty good at that. We’re usually very good at limiting volatility and holding in there. So, I’m not as worried about that. I still think that, at least in my position, I think that money managers are the most afraid of not buying the dip in queues again. I get it. That’s my fear. It’s just been free money. You think about all the research time that guys like us have spent in–

Jake: Wasted.

Zach: Oh, my gosh. Like I said, even when we’ve been right. Company like PACCAR, they double their dividend and increase revenue by 50%, and the stock doesn’t go anywhere, where all you got to do is come out and say, “You’re getting into AI and your stock will double.”

Tobias: [laughs]

Zach: It’s [chuckles] crazy times. So, anyway.

Jake: This too shall pass.

Zach: I think it is. I think we’re getting there, but these things always take longer. I go back to 2008 too, and I remember that.

Jake: Yeah. They take longer and then they happen faster.

Zach: Yeah, it sure seems like that, doesn’t it? You just have this period of denial and then all of a sudden, the dam breaks. The other crazy thing, and we don’t need to go down a macro path because I really don’t even think this is a macro discussion, I just think people are being very pollyannish about the impacts of having 0% interest rates for 15 years, amassing the greatest pile of debt in the lowest rates in human history, and then jacking rates to the roof and not expecting things to break. But they have to. I don’t think you need higher rates. I just think you need more time at these rates.

Tobias: 5% is not a super– Traditionally, it’s not even quite the average. The average is around 6%, I think. That doesn’t mean that the impact is not going to be material because people are planning on the basis of very, very low interest rates. When rates go up like this, obviously, that must change the plans materially. I think my money on deposits. Just my rates gone down to 4.4%, but I think you can find better rates out there. I think that Alpha Architect box, which is a really interesting ETF, has a sort of– They give you something like the Fed market rate using a box.

Zach: Yeah.

Tobias: It’s a little complicated. I don’t fully understand how they actually execute this thing, but they give you basically cash rates. They’re close to like 5.67 with running an ETF. So, there’s no flow through that’s contained inside the price.

Jake: Tax advantage [crosstalk] real.

Tobias: Yeah, tax advantage. There’s no income flow either. So, it’s all capital gains. They’re transmuted into capital gains, which is ideal. You have the tax impact at the time, you sell it.

Zach: Yeah.

Tobias: But that’s 5.67. You start looking around at equities that give you more than reliably think will give you more than 5.67 are enough to justify the–

Jake: The risk.

Tobias: Yeah, the risk of being in those equities. There’s not a lot that gets over that hurdle at the moment in my world, anyway. I don’t know what everybody else is looking at. What do you guys think about that? Is it time to just jump into cash and write out the volatility?

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