Your Life Simplified

Cautiously Optimistic: The Market Is Fluctuating, But Our Strategy Isn’t (26:45)

September 10, 2019

Brian: Hello and thank you for downloading another episode of Your Life, Simplified. My name is Brian Leitner, and I’ll be the host of this podcast. And today we have a very exciting podcast. There’s a lot of talk about related to what’s taking place in the market right now, the volatility that we’ve experienced this year. Today is going to be a great episode, because we have our chief investment strategist and head of equities, Jeff Krumpelman, from Mariner with us. Jeff, thanks for joining us on the show today.

Jeff: Thanks for having me, Brian.

Brian: So, Jeff, before we jump right into the financial markets and the economy, can you maybe spend just a little bit of time articulating what your role is within the organization?

Jeff: Absolutely. So, I have a dual role. The title is probably longer than it needs to be, but it’s chief investment strategist and head of equities. And, so I have both my feet in the macro backdrop world and also in the granular; the security selection and security research and a portfolio management role as well. As the investment strategist, I author the investment strategy commentary on a monthly basis about equities, and it’s my job really to look at the fundamental’s evaluation and the technical kind of backdrops of equities in general and the various asset classes within the equity world. And at the same time, I manage a team of about seven folks, and we manage internal strategies, large- and mid-cap strategies and individual equities. We have about five different strategies that we run each with a different risk-return profile and objective that we manage to. And I think that having that dual role actually keeps me honest and that it’s one thing to go out and have an opinion and write thought pieces about what you think is going on. It’s another thing to actually employ that thinking, manage money and generate results. And I think by having that accountability, it keeps me and the team that I work with pretty darn honest.

Brian: That’s great. Jeff, certainly appreciate the work you do and know you write for the advisor newsletter that comes out every month. And for those who are interested, if they’re not reading it now, can sign up on our website to receive that and start reading it and gaining your insight. So maybe now to jump into the fun stuff. I mean, we’re in early September and the returns in 2019 by and large have been great. Right? I think we’re certainly up for the year in a variety of different aspects of the market. But at the same time, it’s been a bit of a roller coaster ride here in 2019. Maybe even over the past 12 months, we’ve had a variety of different areas of volatility and fluctuation. You know, it’s enough to make investors a little crazy and how that plays on investor psychology.

And we just sort of reflect on what the media has been putting out over the past 12 months. We’ve read headlines like “Worst December Since 1931” or “Best start to the markets since 1987,” which was through April only to be followed by, “The worst May since 1960s.” So, the press obviously wants to grab eyeballs. This is something that they are good at, and it’s enough to make us a little bit crazy. When we think about what’s taken place certainly in August, which probably had the most volatility, I feel like we’re starting to get some sort of negative karma and fear around recession talks that we had back in December. Which was around that whole Santa Claus Swoon and things of that nature. So, maybe just from a big picture perspective, how are you advising clients today? What are some of the conversations that you’re having as it relates to that backdrop?

Jeff: Brian, you just bring up a great point. And in the most recent newsletter, the investment strategy commentary that I just penned, we always have a quote, and the most recent quote is from Ben Graham: “The investor’s chief problem—even his worst enemy—is likely to be himself.” In the end, how your investments behave is much less important than how you behave. So, I think in this head-spinning environment that you just relayed, temperament and perspective is very important and staying focused on the data. You’re correct in that it has been had spinning and roller coaster-like, and the wild ride continued in August. The volatility and price swings and investor psychology doesn’t seem to be letting up. And after that schizophrenic, but profitable, first half that you just outlined, it was the best first half of a year in 22 years.

July was solid and we hit all-time highs and recouped all those losses that we had back in December around Christmas time of 2018, and moved on to higher highs. But August is now tested again, and it’s the result of fears on the trade and tariff front primarily, we believe. The S&P 500 was down over 4% during August. Daily volatility averaged more than 1% most weeks of the month. And we experienced three days in the 30-day period in August in which the index dropped 2.5% or more, and we haven’t seen that in more than eight years. And yet the market, again in this kind of a volatile roller coaster, would rally 2.8% in the final week of the month, paired losses to 1.8%, left at 3%, both all-time highs. And with these early gains in September, we’re just 1% below the highs. And you know, wha5t’s funny is, that’s not a correction. That’s not even a blip.

And despite that, the general feeling is that we’re experiencing a correction based on the headlines suggesting that recession is imminent. So, the bottom line is, and reviewing the data, we remain cautiously optimistic and actually look for additional gains in the upcoming 12 months in U.S. equities, and we do not view near-term recession as a base case. And recent data releases that just came out illustrate the resiliency of the economy and that yes, it’s moderating, yet it’s still expanding. And we saw that in the ISM purchasing managers data for non-manufacturing companies. The payroll reports that come out this week have been solid. The auto data for August, you know, just really solid. So, in this kind of whirlwind world in psychology, we think our mission in the market is to keep investors from suffering from whiplash. And it’s been these rapid swings in psychology that have caused the rapid swings in stock prices over the last nine to 12 months despite the fact that the market is up handsomely. We’re up close to 20% this year, and we’ve referred to this roller coaster ride in trading activity and headlines as the wash, rinse, repeat cycle. Folks are going to read about that in the investment commentary. And its investors’ anxieties about trade and Federal Reserve policy issues that are leading to a sell-off. We call that the wash cycle. And then when the ensuing positive economic and earnings data is released and appreciated by investors, we call that the rinse cycle. The market is rallying sharply to take us back to where we should have been all along and eventually to higher highs.

And we’ve seen that time and time again. We saw back in December, when folks were drawing parallels to 1931, and were saying, “We’re going to have a calamity close to the Great Depression.” And then when the data was released on earnings and the economy in the first two quarters of the year, the market rallied handsomely. We see this in August and September, where folks were saying, “Oh, the yield curve is inverting. That must mean recession.” And then the data’s released, and it’s pretty solid, shows continued expansion, and we get this rally again. So, in this environment, what to do? We think that balance in client portfolios is the key thing. We think it’s just as likely that the market melts up in the near-term, as it is that we see further weakness.

And to ignore the risks of policy error would be like sticking one’s head in the tiger’s mouth, but to ignore the solid fundamentals and the possibility that policy may make a better than feared landing, similarly, could cost one gains from here. So in these internal equity strategies that I manage, we are working to ensure that we have a blend of offense and defense, a blend of exposure to the cyclical economic senses of equities. But we want to couple that with plenty of exposure to more defensive, consistent earnings growers that are less tied to the economic swings. We do not want to, in heroic fashion, be positioned in extremes to one of those views. We want to have the offense on days when the market’s rallying, but we want to have the defense as a buffer on days when it’s deciding to sell off and be pessimistic. So that’s kind of where we’re at, at this point in time—balanced.

Brian: Jeff, I appreciate the viewpoint of being cautiously optimistic. And your focus is really staying glued to the data and the facts. You know, to really make sure that we’re not at one extreme versus another. We’re not letting our emotions take control of our portfolio. Having said that, there is still a lot of talk about recessionary risk that’s out there, and I know that you guys have this sort of recessionary watch list that you constantly review with your team, understanding what those signals are so you can act on data as it changes. Can you talk a little bit about that?

Jeff: I sure can. And we do think it’s just very important. We all need an outlet. Whether it’s yoga, running, racquetball, tennis or squash, you need to have something to take that blood pressure down. And this recession scorecard that we look at is what does it for us. It gives us the calm that we need to make the decisions that we need to make. So, there are about a dozen indicators on our recession scorecard. I’ll give you just a couple here to give you a sense of what they are. In the employment area, we looked at jobless claims and the unemployment rate, and both of those tend to spike significantly prior to recession. We look at credit spreads. They also tend to really widen out, and we see those dislocations in the credit market prior to recession. Everyone’s talking about the ISM, the purchasing manager’s report, and I think I’m at the point where my 93-year-old mother now will ask me, what’s the PMI doing, Jeff?

We look at manufacturing and service purchasing managers reports and both of those tend to go into decline prior to recession. We look at consumer sentiment. So, all of these factors; it’s not just yield curve. It’s not just one thing. Yield curve is part of this. And yield curve, one would have to say, is cautionary at this point, but it’s the plethora, the mosaic of these factors that we focus on. And on the scorecard, Brian, we look at all prior periods, and green says that they look to be an expansion mode. Yellow is cautionary, red is negative. All of these were factors in ’07 and in ’01. Going back into the early 90s, they were negative decidedly and flashing red prior to those recessions. Most of these are green and several are yellow. We have none that are really red in nature. I wouldn’t even include that, with regard to the yield curve. Has it inverted? We can talk about that if you want to do a follow-up, but that’s probably the most negative of all of these factors. But we don’t base our decision on one thing. It’s the mosaic.

Brian: Thanks Jeff. I appreciate that.

Brian: Thanks again for downloading this episode of Your Life, Simplified, which is produced by Mariner. At Mariner, we’re here to serve as your advocate. We help people chart a course to reach their personal and financial goals so that they may have greater peace of mind that may lead to a more fulfilling life. We do this by always putting our clients first. As you listen to this podcast and have questions about your own financial situation or you would simply like a second opinion, or you have an idea for a future podcast, please go ahead and email us at [email protected]. If you found the information on this podcast valuable, please go ahead and share it with a friend or family member that you think might benefit from this information. And please don’t forget to subscribe to this podcast so you don’t miss an episode. Thanks for listening. And now back to the episode.

Brian: You know, let me just play devil’s advocate with you for just a second. Because I’m sure there are a lot of listeners out there who are fearful. The market’s done quite well over the last number of years. And I understand you don’t see some of the significant recessionary types of signals that we saw back in ’91, 2000 or 2007. But there is a decent amount to worry about. At least that’s what the financial media would lead us to believe. Right? You think about how we’ve been in this long bull market, you know, maybe the earnings have peaked. Valuations are now expensive. You just mentioned the yield curve and it inverting, and we keep hearing about that. And every time you turn on the nightly news, you have different trade negotiations. And you know, there’s commentary on that almost hourly.

You have issues with North Korea, Iran and other countries and things of that nature. So maybe just to put a bow on this for you, I’ll ask you two questions. Can you give us some insight on maybe just a couple of these issues? And with that, with all these issues, you still maintain a fairly constructive outlook over the next 12 to 18 months. So again, I know you have the metrics that you look at and the data, but what gives you that level of comfort to feel this way right now?

Jeff: Sure. I know it is a sometimes head-scratcher when you see this big wall of worry and yet you hear this cautiously optimistic kind of message. How can that be Jeff? What’s going on? And you just have rose-colored glasses type of thing. And, the answer, Brian, is interesting. In my 30 years of experience in this industry, the time to really worry is when there is no wall of worry. And you know, we can think back in times where you didn’t have these items and when PEs are over 20, and people are euphoric, that’s generally when there’s trouble. So, when you have this wall worry, that means that folks are respectful of risk. They’re skeptical, and therefore valuations are reasonable and there’s runway or additional growth in the market. And the other high-level thing I’ll say is goes all the way back to the beginning of this recovery.

I’ll never forget folks who, back in 2009, didn’t want to get reinvested in the market because all the worry at that time was bank stress test, the consumers in a cave never spending again. You know, it’s all about cost-cutting. There’s no revenue growth. I could give you all kinds of wall of worry themes. And that continued through 2011, Arab Spring, 2012 fiscal cliff, and on and on. There’s always been this wall of worry and that’s why this market has continued in steady-eddy fashion decline the wall of worry. And I think it’s a healthy thing. So, that’s a very high-level thing. The other fact then to come back and when you explore these individual wall of worry items, which is what we do, that’s our mission, to take a look at them and see what we think about them. But then we see if it spills over into the data. And, it’s not until it’s spilled over into the data and you see consumers not spending, employment rising, all those ultimate signs that make us negative.

So, let’s explore a couple of the ones that are out there right now that are front and center. Yield curve would have to be one that folks continually read about. And so here are our bullet point thoughts on yield curve inversion, as an example. Don’t get us wrong. We think it’s very important to look at yield curve, because it has been a nice leading indicator. But even so, it usually inverts, on average, about 18 months in advance of recession. And, the market tends to do quite well in that lag period before you see it, on average or the median, return. Over those 18 months after inversion, the market, over the last cycle, is up 21%, on average. So, you have time after inversion. I would actually argue with the fact that it’s inverted. I mean today it’s re-steepened. It’s un-inverted. We look at the two-year Treasury versus the 10-year Treasury and now that is in positive territory right now, that slope. So, when it has inverted, it’s been inverted for a nanosecond by a milliliter. It’s been very small. I would be cautious and calling it an inversion. The other thing that I would tell you is that, in the past, when we’ve seen inversion, and this is the power, and I think what is the key, it’s been accompanied by two things that are absent today. It’s been accompanied by credit market stress and a widening in those spreads and dislocation in the credit markets. And that’s simply absent today.

In the credit markets, there’s plenty of liquidity, and they’re quite healthy. Spreads are tight. The second thing that’s happened is that, inversions occurred when the level of interest rates has been far higher and restrictive in nature. Points in time at which rates were high enough, and the Federal Reserve was hiking rates to choke off credit growth and caused economic activity to slow. Right now, the Fed is pretty accommodating. So this is more of a what’s known as a bull market flattening, meaning that long rates are dropping faster than short rates, similar to 1998. And we think the reason that these long U.S. rates are dropping is driven more by the low international rates you see in Europe and foreign countries and that’s drawing the attention to the U.S market. And people were buying U.S. Treasuries like crazy, because it’s the best game in town.

That’s compared to a bear market flattening where the Fed is hiking rates and you see short rates rising faster than long rates and it’s that type of bear market flattening that tends to end economic expansion. So, you know, we’re saying it’s not different. I hope I’m not accused of saying it’s different this time. It’s the same. What we’re saying is normally you would see accompanying high credit markets a dislocating and that’s not happening. If anything is different, I think this time it’s that the quantitative or algorithmic traders are pushing the market around on slow announcements of sustained yield curve inversion that that really isn’t happening right now. But we’ll keep a sharp eye on this because it’s something to follow.

Brian: I know you will, and I appreciate the insight. And just for listeners to know, this conversation came at a request from several different listeners over the past 30 days, and they wanted to know if we could address the market. We appreciate, Jeff, you coming on the podcast. We also appreciate the comments back from listeners and if there are other listeners who would like to hear other topics, we have no shortage of guests and topics that we can discuss. And that’s really what this podcast is all about. In addition to that, just thinking about the headline risk and your average investor, how they’re making trades based upon what’s on the news and what’s in the financial media. Those short-term decisions can have a dramatic impact on their long-term financial plan. And so, for everybody listening, just to understand, you need to sit back and think about the big picture…where do I want to be in the future, what are my goals, and how do I accomplish those goals? And then trying to stay the course.

Have a diversified mix inside of your portfolio, pay attention to the location of those assets from a tax perspective, and then stick to the plan and manage your overall individual investor biases. I mean, we all have them. And it’s important if you can’t manage them on your own to simply work with a wealth advisor who is qualified to do so. So, Jeff, I greatly appreciate the insight. Hey, before I let you go, I’m going to ask you the same question we ask every guest. And that is, what is the worst financial decision you’ve ever made? And I know that you being in the role that you’re in, you’ve probably made zero. But having said that, there’s got to be at least one.

Jeff: You know, I thought we’d be able to get away without having that question thrown my way Brian. But that’s okay man.

Brian: Nobody can dodge it.

Jeff: It is important to review mistakes that you make. We try and do that in the portfolios that we look at because we obviously have successes, and we have disappointments. We try and learn from those mistakes. And one of the books that I love is, “Big Mistakes: The Best Investors and Their Worst Investments,” by Michael Batnick. A wonderful book, and I think we all could probably learn from that. Personally, you asked me about probably the biggest regret, the biggest mistake I’ve made financially. It goes back to the housing market, the housing boom. And, I did buy a home at the absolute peak in the market, and I think we’re now, 10 years later, just about back to cost in this market. Now, the good news was I sold a home where I made a nice little fortune from my standpoint to finance that purchase. But certainly, it was painful.

Brian: Well, Jeff, if it makes you feel any better, I can assure you that you were not alone in that crisis and potentially when you bought in. At the same time, of course, you know, houses can be very different than an equity that you buy, right? I mean, just from the utility perspective and hopefully you’ve been able to create great memories in that house with you and your family. So, I appreciate you sharing that. It’s humbling for everybody, but we all make them. Guys, that wraps up another show. Jeff, again, thank you very much for your expertise and insight. So, everyone, thanks for listening to the show today. If you have questions, ideas, comments for the show, please go ahead and email them to [email protected]. Thanks again for listening.

The S&P 500 Index is a market-value weighted index provided by Standard & Poor’s and is comprised of 500 companies chosen for market size and industry group representation.

This transcript is limited to the dissemination of general information pertaining to Mariner Wealth Advisors’ investment advisory services and general economic market conditions. The views expressed are for commentary purposes only and do not take into account any individual personal, financial, or tax considerations. As such, the information contained herein is not intended to be personal legal, investment or tax advice or a solicitation to buy or sell any security or engage in a particular investment strategy. Nothing herein should be relied upon as such, and there is no guarantee that any claims made will come to pass. Any opinions and forecasts contained herein are based on information and sources of information deemed to be reliable, but Mariner Wealth Advisors does not warrant the accuracy of the information that this opinion and forecast is based upon. You should note that the materials are provided “as is” without any express or implied warranties. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. Past performance does not guarantee future results. Consult your financial professional before making any investment decision.

The views expressed are for commentary purposes only and do not take into account any individual personal, financial, or tax considerations. It is not intended to be personal legal or investment advice or a solicitation to buy or sell any security or engage in a particular investment strategy.

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