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. Everyone knows what happened next.
Now, history seems to be repeating itself, as some of the disruptive and innovative companies that were market darlings during the time of pandemic lockdowns are being clobbered by a “dose of realism,” said Aoifinn Devitt, chief investment officer at Moneta, which oversees more than $32 billion in assets.
Ultimately, the way to be defensive at a portfolio level is to have a well-diversified portfolio. And by that I mean across all asset classes, including bonds, including alternatives, including cash-flow generators, including real assets. And that is our best way of ensuring an all-weather portfolio. When it comes to stocks, defensive stocks are perhaps a bit of a misnomer because ultimately we are in equities, which are a higher risk-reward asset class. They will be mark-to-market. They will experience volatility. We can see equities with a high correlation to each other, especially when there’s a selloff event. But that said, there are still sectors that might be considered value stocks, which, as opposed to growth stocks, have been quite out of favor for the last number of years. And there have been pockets of times when investors have cycled into value in that great growth-value rotation that we might see. But those rotation periods have actually been quite short. So, we shouldn’t be under the illusion that these defensive stocks are somewhere to hide if there is a dramatic equity market correction, but they should be somewhere where investors may go in a flight to safety.
The additional complexity, though, around these so-called defensive stocks, is that traditionally when interest rates rise, these are seen as perhaps bond proxies or had been seen as bond proxies. So, they tend to see funds flowing out when interest rates rise — they’re not actually that defensive if we see a rising-rate environment. So, it’s all relative. Are they more defensive than a high-growth portfolio? Absolutely. Are they going to protect your capital in an equity market downturn? Not necessarily.
Q: We have this unique upside-down cycle now — how do you play that, especially given the last couple of weeks?
A: Just as we can adjust to anything, any new normal somehow quickly becomes the norm. We saw that with Covid restrictions — how mask wearing became the norm, how restrictions became the norm. When it comes to inflation numbers, something that was perhaps eye-popping at a 40-year high starts to become normal very quickly. I would be surprised if we were to see high-single-digit inflation persist — maybe for a few more months, maybe through the middle of the year. Ultimately, we have to remember the base effect in some of those numbers and some of the contribution of the shock rises in energy, and some other components in there that perhaps were not likely to be sustained. Food prices would be an example. So, the key question around all of these inflation numbers is stickiness. There is an abundance of risk right now in markets and they’re all interrelated, but equally, any one of them could grow exponentially to become a serious problem.
Those are the problems around inflation, around interest rates rising. And you mentioned upside down — that’s a great analogy because there are a lot of things that just don’t make sense today. Typically we speak about stagflation, that maybe when we have a rising inflationary environment, it’s accompanied by high unemployment. And that is a perfect storm that leads to recession. We don’t have a high unemployment environment today. We actually have a very robust labor market. In fact, we have low unemployment numbers, which are back to pre-pandemic levels, so that doesn’t look like a recipe for recession. Equally, when we have a high inflation environment, we often have a weaker dollar, and we have the opposite now — we have a dollar at two-year highs. So what’s that telling us? Perhaps that, yes, the dollar should be under pressure because of the inflationary environment, but our central bank is taking measures that other central banks are not, and perhaps it’s only looking strong because every other currency worldwide is looking quite weak. So, we have a lot of juxtapositions of interesting factoids right now, and it’s challenging for markets to make sense of it.
Q: People are still spending like crazy. Chipotle raised prices and it didn’t hurt them at all. Are there any pockets of the consumer economy that you think are are less vulnerable to rising prices, and others that don’t have quite as much pricing power and their margins might get squeezed?
A: We can look at normal circumstances of what inflation would mean for different sectors, and then look at the current backdrop. The level of assets in money market funds reached a peak right after the pandemic due to stimulus payments, the CARES Act, etc., and the fact that consumers couldn’t spend their money, the enhanced unemployment benefit, and just the fact that there was nothing to spend money on really. They couldn’t use 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. It’s getting less by the day because obviously inflation erodes cash. So it will erode that actual purchasing power. I think that’s where the interesting dilemma is.
Normally I would say it would be things like discretionary expenditure, expenditure on, say, hospitality or travel — where I’d normally see the consumer be more vulnerable. And ironically, Chipotle is probably in that price point of restaurants — the fast food or enhanced fast-food segment — where people tend to downgrade to, as opposed to eating in a more fine-dining establishment. So, probably it’s still in that category that is likely to be quite robust and supported. But we saw United Airlines come out recently to say that they actually expected demand to be buoyant. And we’ve seen fuel prices passed through into higher airline ticket prices. But notwithstanding, there is a pent-up demand to take that vacation, take that overseas trip. And I don’t see that subsiding.
So, as I said, it may be that that’s artificially prolonging the strength of the consumer, these savings, plus the sense of the fear of missing out or having missed out on 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 which are no longer adequate substitutes for the real thing, or for going out and spending on cinemas or taking that bike trip. Those are areas that were perhaps overbought during the pandemic. It’s an interesting dilemma really as to how this purchasing power effect is likely to pan out.
Q: You talked with Cathie Wood recently — what did you take away from that conversation with her as far as her strategy? Is it in peril for the next couple of years, or what needs to be in place to bring back the type of outperformance that she saw?
A: We’re seeing a wave of critical thinking. And that was really where I focused my discussion in the interview with Cathie Wood. I wanted to really challenge some of the growth assumptions that were built into some of the modeling they do on segments such as driverless cars or artificial intelligence, or the adoption of digital wallets, or the price of Bitcoin. I asked her about her modeling and the probabilities in there. I also asked her about, in the past, how their modeling had worked out, and whether there had been an instance where they had been wildly over-optimistic, because that often would be the criticism with some of these models — that they were overly optimistic.
I don’t think that our fascination and our obsession with innovation is likely to go away anytime soon. What we have probably introduced is a dose of realism. And the irrational exuberance that Alan Greenspan referred to, there was perhaps a shade 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’s not a reality today. Sometimes tech is inherently very difficult to model. We are grappling with modeling adoption of technology. We’re grappling with modeling the impact of climate change. So many of these models have so many different inputs that are all often interrelated, that there’s going to be a huge element of a funnel of possibilities and a funnel of doubt with any of that modeling. So what we’ve seen is a dose of realism around some of the projections. It probably is not a coincidence that that has come at the same time as we’ve seen some of the sheen come off the tech stocks that perhaps are not great innovators.