(Bloomberg) — Former Federal Reserve Chairman Alan Greenspan famously used the phrase “irrational exuberance” to describe the euphoric investor sentiment that sent tech stocks soaring in the late 1990s. knows what happened next.
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Now, history seems to be repeating itself, as some of the disruptive and innovative companies that were market darlings during the time of the pandemic lockdowns are being hit with a “dose of realism,” said Aoifinn Devitt, chief investment officer at Moneta, which oversees more than $32 billion in assets.
Devitt joined “What Goes Up” to expose this and more. Below are lightly edited and condensed highlights from the conversation. Click here to listen to the full podcast and subscribe to Apple Podcasts or wherever you listen.
Q: I want to ask you about the nature of defensive stocks: how do you play defense in this stock market?
A: Ultimately, the way to be defensive at the portfolio level is to have a well-diversified portfolio. And by that I mean all asset classes, including bonds, including alternatives, including cash flow generators, including real assets. And that’s our best way to ensure an all-weather bag. When it comes to stocks, defensive stocks is perhaps a bit of a misnomer because, ultimately, we’re in stocks, which are a higher risk-reward asset class. They will be mark-to-market. They will experience volatility. We can see stocks with a high correlation with each other, especially when there is a sell-off event. But with that said, there are still sectors that could be considered value stocks that, unlike growth stocks, have fallen out of favor over the past few years. And there have been times where investors have come into value in that big growth value rotation that we might see. But those rotation periods have actually been quite short. So, we shouldn’t be under any illusion that these defensive stocks are somewhere to hide if there is a dramatic stock market correction, but they should be somewhere investors can go on a flight to safety.
However, the added complexity around these so-called defensive actions is that traditionally, when interest rates go up, they are perhaps viewed as proxies for bonds or have been viewed as proxies for bonds. Therefore, they tend to see funds flow when interest rates rise; they are actually not that defensive if we see a rising rate environment. So everything is relative. Are they more defensive than a high growth portfolio? Absolutely. Will they protect your capital in a stock market downturn? Not necessarily.
Q: We have this unique reverse cycle now. How do you play that, especially considering the last few weeks?
A: Just as we can adapt to anything, any new normal somehow quickly becomes the norm. We saw that with the Covid restrictions: how mask wearing became the norm, how restrictions became the norm. When it comes to inflation numbers, something that was perhaps surprising in a 40-year high begins to normalize very quickly. I would be surprised if we see high single digit inflation persisting, maybe for a few more months, maybe into the middle of the year. Ultimately, we have to remember the base effect on some of those numbers and some of the contribution from the shock energy increases, and some other components in there that were perhaps not likely to hold. Food prices would be an example. So the key question around all these inflation numbers is stickiness. There is a huge amount of risk right now in the markets and they are all inter-related, but equally, any one of them could grow exponentially to become a serious problem.
Those are the problems around inflation, around rising interest rates. And you mentioned the other way around, that’s a great analogy because there’s a lot of things that just don’t make sense today. We usually talk about stagflation, which maybe when we have a rising inflationary environment, it’s accompanied by high unemployment. And that’s a perfect storm that leads to recession. We do not have a high unemployment environment today. In fact, we have a very strong labor market. In fact, we have low unemployment numbers, which are back to pre-pandemic levels, so it doesn’t look like a recipe for recession. Similarly, when we have a high inflation environment, we often have a weaker dollar and now we have the opposite: we have a dollar at two-year highs. So what does that tell us? Perhaps, yes, the dollar should be under pressure due to the inflationary environment, but our central bank is taking action that other central banks are not, and perhaps it only appears strong because every other currency in the world appears fairly weak. So we have a lot of interesting factoid juxtapositions right now, and it’s challenging for markets to understand.
Q: People are still spending like crazy. Chipotle raised prices and it didn’t hurt them at all. Are there sectors of the consumer economy that you think are less vulnerable to rising prices and others that don’t have as much pricing power and could see their margins squeezed?
A: We can look at normal circumstances of what inflation would mean for different sectors and then look at the current context. The level of assets in money market funds peaked just after the pandemic due to stimulus payments, the CARES Act, etc., and the fact that consumers couldn’t spend their money, the unemployment benefit improved and the fact that there was nothing to really spend money on. They couldn’t use the services; they did consume goods in a very robust way. So because of all of that, there is this pent-up purchasing power, or dry powder. Every day it is less because obviously inflation erodes cash. Therefore, it will erode that real purchasing power. I think that’s where the interesting dilemma lies.
Normally I would say that would be things like discretionary spending, spending on, say, hospitality or travel, where I would normally see the consumer being more vulnerable. And ironically, Chipotle is probably in that restaurant price point, the fast food or enhanced fast food segment, where people tend to downgrade, rather than eat at a finer dining establishment. So it’s probably still in that category which is probably pretty robust and supported. But recently we saw United Airlines come out and say that they actually expected demand to be buoyant. And we have seen that fuel prices have translated into higher prices for airline tickets. But nonetheless, there is a pent-up demand to take that vacation, to take that trip abroad. And I don’t see that diminishing.
So, as I said, it may be that that artificially prolongs the strength of the consumer, these savings, plus the sense of fear of missing out or having missed the normal spending pattern for two years. It’s very hard to say at this point. Where we can see clearly are things like Netflix, Peloton, areas that they would have spent money on during the pandemic that are no longer adequate substitutes for the real thing, or going out and spending in theaters or taking that bike ride. Those are areas that were perhaps overbought during the pandemic. It’s an interesting dilemma as to how this purchasing power effect is likely to work.
Q: You spoke to Cathie Wood recently. What did you take away from that conversation with her in terms of her strategy? Is she in jeopardy over the next two years, or what must be in place for her to regain the kind of superior performance she saw?
A: We are seeing a wave of critical thinking. And that was really where I focused my discussion in the interview with Cathie Wood. I really wanted to challenge some of the growth assumptions that were built into some of the models that they make in segments like self-driving cars or artificial intelligence, or the adoption of digital wallets or the price of Bitcoin. I asked her about modeling her and the odds there. I also asked him, in the past, how their modeling had worked, and if there had been a case where they had been too optimistic, because often that would be the criticism with some of these models: that they were too optimistic.
I don’t think our fascination and obsession with innovation will go away anytime soon. What we have probably introduced is a dose of realism. And the irrational exuberance that Alan Greenspan was referring to, maybe there was an undertone of that around some of these projections. If you think about it, probably not five years ago, we all thought that today, 2022, we would have driverless cars. That is not a reality today. Sometimes technology is inherently very difficult to model. We are dealing with the adoption of technology models. We are dealing with modeling the impact of climate change. Many of these models have so many different inputs that are often interrelated that there is going to be a huge element of a funnel of possibilities and a funnel of doubt with any one of those models. So what we’ve seen is a dose of realism around some of the projections. It’s probably no coincidence that this has happened at the same time we’ve seen some of the shine come off from tech stocks that may not be great innovators.
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