June 2023
Sasan believes there are many growth opportunities in credit, and there may be higher return in credit than equities. Even though the stock market is up nine percent, only a handful of companies are driving the market upwards like Microsoft, Apple, NVIDIA, etc. If inflation and deglobalization continue and prices increase, companies’ profits will shrink unless they pass costs down onto their consumers. Eventually, Americans will not be able to buy as many goods and services as before, thereby negatively impacting the stock market.
Sasan also says we are becoming more involved in private credit right now because of the regional bank crisis. Since banks have been pulling back, there are more opportunities for investors in private lending.
Another current macrotrend is decarbonization (the shift to renewable energy) which may bring more investment opportunities in natural resources. Sasan recommends listeners to consider researching companies in the mining, extraction, and processing of natural resources.
Finally, another trend that is happening is with capital expenditure cycles- in the past, when commodity cycles boomed, companies would generally invest to take advantage of higher prices. This cycle has been different, though. Companies are fiscally prudent right now and are returning capital to shareholders.
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Ep. 35 Implications of the Debt Ceiling Showdown for Investors
Ep. 36 Modern Finance Advice for Earners - Introducing Modearn
Hello, everybody, and thank you for joining us for another episode of THE FINANCIAL COMMUTE. I'm your host, Chris Galeski, joined by Managing Director of Investments, Sasan Faiz. Thank you for joining us.
Thanks for having me on your podcast, Chris.
So the last few weeks I've talked with Meghan about debt ceiling, and then that spurred a conversation with Kevin Rex, one of our partners and advisors around inflation and and purchasing power of your money. And then it sort of ended with what we're doing about it. Key points are diversification, looking for growth and not being complacent with trying to worry about the debt ceiling and go to cash because now cash is an actual investment asset.
Right. But it spurred a thought that you and I could start talking a little bit around the topic of investing for growth versus income and how or why we do each. And in many, in the simplest form of investing for income, we are managing somebody's a person's wealth. And when they choose to retire, they're going to need to replace that paycheck.
And so we're looking for income opportunities. And that's the that's the simplest reason for investing for income. But you're looking at a lot of different opportunities out there. So talk to us a little bit about how you evaluate the difference between income versus growth.
Yeah, absolutely. So, Chris, as you know, the three tenets of our investments are risk management, true diversification and cashflow. So on risk management, obviously we're looking at downside risk management, and we’re looking at growth opportunities in equities right now. We believe equities are the valuations are stretched. So that concept of risk management really forces us to have a lower allocation to equities going forward.
But what about, say, credit on the public and private side? So we we've done a lot in in private credit over the years and we've gotten a nice return over the years when interest rates were low and zero. As interest rates have come up, now we also see opportunities in the public credit side. So when you're looking at, for example, three and six month treasuries at 5.4, right.
And you're looking at the price to earnings ratio of the S&P 500. So broader equity markets, the inverse of that is the earnings yield. That's almost five and a half percent. So it's very comparable right now. What you can get in the corporate bonds or better in the high yield market on the public side versus what you can earn from stocks. And in the broader, the broader equity market, obviously there are pockets of opportunity in value stocks and natural resources.
But also when we take it a step further where we really differentiate ourselves on the private credit side, we've always done firstly lending in mortgages, right? Very conservative approach since the great financial crisis. Those used to be in the 7.5%, 8% yield. And then you take it a little bit further and we do asset based lending to corporations.
Those are usually about 11%. And recently we've done some more opportunistic investments in private credit, for example, in food lending, where we can make almost equity like return in the 13%, 14% range with a credit profile. But that's an equity like returns. So over the next few years, our preference is still toward credit. I think we can earn a higher return on credit versus equities over the next few years.
And I get that. But, you know, help me understand like let's look under the hood, right? Because, you know, traditionally most wealth management firms only have access to stocks and bonds to help protect and grow and generate income for clients. We don't have just stocks and bonds. We have things like private credit, real estate. You talked about the food lending and we have access to traditional stocks and bonds as well.
But if you open up the hood at stocks, the S&P 500 and you're looking for growth and you see that the market's up, you know, 9% for the year, but you look under the hood, it's not really the case. The market. The market, yes, is up 9%, but that's not because the basket of those companies are doing that great.
Exactly. And your point is right. I think there are seven or eight stocks, the largest market cap weighted stocks in the S&P 500 are really driving the return year to date. So those are your Microsoft and Amazon and Apple and Nvidia and Googles of the world. So about 25% of the index is made up of those seven stocks.
If you look at on the Nasdaq 100 side, which is more information technology focused eight stocks, you see Tesla as well. They make up almost over 50% of the index right. So if you look at the return, so the...
Nasdaq 100 is supposed to be 100 companies, but 54% of it is 8 companies, that makes a lot of sense. Yeah.
So what you said, that market is up almost nine and a half percent or so on the S&P 500. But if you look at the underlying stocks, if you take those seven stocks out, the market is actually flat for the year. Right. So it's important, kind of have that in mind. Obviously, large mega-cap technology companies have done the best, but the rest of the market really has not participated.
So that's something a broadly diversified equity portfolio would not be up as much as a market cap weighted index.
Yeah, that's the point that I'm glad that you hit on is the sense that when you look under the hood of growth even just this year from stocks it's not all stocks it's a select few. But if inflation and pricing pressure and supply chains and deglobalization, bringing supply chains and building or manufacturing from other countries back to the U.S. is really going to continue.
And prices are going to increase. Because of that, a company's profits or margins are going to shrink unless they pass that cost down to the consumer.
Exactly.
Which you only have so much room to grow. And the consumer is getting pinched by housing costs, energy costs, food costs and all these other things. So essentially, you get to a point where the economy or, you know, the people in this country can't continue to buy as many goods and services as they were. So growth from the stock market or those companies might be a little bit lower in the future because of some of these pricing issues.
So I think there are a lot of global concerns. Obviously, the economy might be going into a recession. If you look at the last maybe 15 years or so past the great financial crisis, stocks have done really well because we were running, we all had the tailwind of monetary policy, interest rates being zero, and that propelled valuations much higher.
If you look at the past 23 years, like from 2000 to 2023, return on stocks have been just below 7% for the past ten, 15 years, has been in the low teens. So it's reasonable to think that the return on stocks is going to be lower going forward because the long term it's 7% is the right answer, right return for stocks.
So the macro themes that you mentioned with the now we have, used to have interest rates being a tailwind. Now they are a headwind, interest rates are higher, inflation is higher, margins on companies are going to be lower while the valuations are stretched. So over the next couple of years, at least, those valuations have to get compressed and that's going to lead to lower return for broader equity markets going forward.
Got it. You know, I know. I know we don't have a crystal ball. If we did, we'd probably have a really big boat right and you can hang out on the boat with me. But we don't have a crystal ball. But a lot of these themes that you talked about are real and it's going to take some time for them to play out.
But even with that said, we still want an allocation of stocks. So when you're looking and you're working with our team on, say, how do we allocate dollars for a client in order to get growth, income and protection. You talked about risk management that's being able to find really opportunistic investments in the public and private sort of credit markets or bond markets that are having returns higher than expected returns than normal or what they've been the last 15 years that really competitive against stocks.
Right, Exactly.
And so how do you determine how much you should shift between, you know, growth in stocks and real estate versus others? How do you weigh that balance?
So again, we have different models for different clients based on their cash flow requirements, liquidity needs and their objectives. So different models with allowing clients obviously with different objectives with those different models. So clients that have longer time horizon would have larger allocation to stocks because as you said, we don't wanna necessarily be out of any particular asset class.
Now we're still well-diversified in stocks, but when we're looking at private credit especially right now, we're seeing a lot of great opportunities there that we can earn equity like return in private credit. And one reason really that that's come to fruition is, is the kind of the crisis we've seen in regional banks. So regional banks are pulling back right now and that's really opening up a lot of opportunities in this smaller middle market type companies where they are.
They were not banked properly in the past, but now they really do not have access to capital the way that they deserve. So private lending is going to be a bigger part of our allocation going forward because we see that as an opportunity right now to get equity like return, but with a lending profile.
Yeah, I'm excited about the opportunities that you and Meghan and our team are going to uncover because of what's transpired with this banking crisis. In a lot of these banks, they're going to pull back on some of the creative lending that they've done to businesses or people in the past, and that's going to create opportunity for people like us who do have expertise there.
When you're looking out there in the world today, are there any pockets of value that you're seeing that are attractive right now?
Yeah, I think on the equity side, I see like a lot the natural resources which we have in allocation. Again, concepts that you talked about, the macro themes of deglobalization, which is the reverse of globalization, bringing manufacturing in-house, that's going to lead to higher inflation. The other macro trend is decarbonization. So kind of shift toward renewable energy, not completely, but as we shift toward renewable energy, that's very industrial, metal intensive.
So think about all the industrial metals that go into the production of the electric battery that goes into a Tesla, or electric car. So we think those two macro trends are going to be inflationary going forward. And in that environment, natural resource equities companies are involved in mining or extraction processing of natural resources are going to benefit. So valuations also on those companies have been very reasonable compared to the broader market.
The other thing is the CapEx or capital expenditure cycle. So usually in the past we've had these commodity cycle booms, companies go and invest dramatically to take advantage of higher prices. This cycle has been different. So companies are very fiscally prudent right now and they're basically returning capital to shareholders. So that's I think is going to be positive for the prices of commodities, but also for investors that invest in those type of companies because they can get capital back as well.
So I think that's one area where I'm positive on the and also value oriented stocks. I think they represent a good opportunity because we've had so much growth in growth oriented stocks and but basically natural resources as part of value stocks are my biggest conviction right now.
And so with that the natural resources stocks, you're almost kind of getting a win win. You're getting the opportunity for price appreciation to keep up with inflation. But because they're not taking those profits and reinvesting it back in the business, they're passing on some of those profits or more of those profits to the end shareholder. So you're creating income along the way.
And so it's a way to where you're getting income, but also participating in growth as well.
Yeah, it's generating income from equities as well. And that's a big part of it, which, which I think that that's.
The key to investing that's been missing for quite some time. I mean, when you go back since the financial crisis, 2008, 2009, interest rates were at zero. So investing for income, the only place you could go for income were kind of like dividend paying stocks, right? So you almost only invested in stocks for the last 15 years. But you changed the landscape today to where now safe money earns 4 to 5.
You know, stocks have competition because save money earns 4 to 5. Then you've got other types of fixed income instruments and 7 to 8. You got some private credit strategies that can earn, you know, 9 to 13 depending on the risk profile there. That's true competition for stocks. So there's going to, that's going to attract more money to flow that way.
Yeah, exactly. I think you're right. Stocks for a long time didn't have any competition, but now there are reasonable alternatives to stocks but we want to be properly diversified but when we see opportunities where we can make equity like return with lending profiles, I think we want to take those opportunities.
Sasan, thanks for having the conversation in terms of just how we're viewing the difference between investing in growth versus investing in income, you know, ways that we're trying to be opportunistic but, you know, not miss out completely or avoid a particular area of the market. So thank you for joining us.
Thank you for having me.
Disclosure:
Information presented herein is for discussion and illustrative purposes only. The views and opinions expressed by the speakers are as of the date of the recording and are subject to change. These views are not intended as a recommendation to buy or sell any securities, and should not be relied on as financial, tax or legal advice. You should consult with your financial, legal, and tax professionals before implementing any transactions and/or strategies concerning your finances.
