TRANSCRIPT
BEN VASKE: Hello, and welcome to the quarterly Q&A Vlog. My name is Ben Vaske, senior investment strategist, and with me this quarter is Orion's Chief Investment Officer of Wealth Management, Rusty Vanneman. Welcome Rusty.
RUSTY VANNEMAN: Thanks, Ben.
BEN: So let's get this kicked off with a quick review of of last quarter. We saw interest rates start falling again. We saw some lagging areas in the market really pickup speed as we enter the end of 2023. Rusty, what were your main takeaways from last quarter?
RUSTY: Well, first of all, it was an amazing quarter. I mean, the expectations were we would get a decent quarter, given just historical seasonal patterns, given what the market usually does. And during the presidential cycle, it tends to be a good quarter. The market was oversold, so again it suggested above-average returns. Sentiment was also weak, which again suggested above-average returns. But I would say given, even despite all those things, it was still even a better quarter than we expected. And it was a great year too.
I know a lot of people are looking at not only their quarterly statements but assessing performance for 2023. And I think the thing about 2023, which course, in the end, was a great year, is that it was kind of like three different time periods to assess performance. It wasn't like this monolithic performance over the course of the year that was very linear.
I mean, we did have the Magnificent 7 stocks, primarily due to all the enthusiasm over artificial intelligence, really dominate the first half of the year. And in the end, really sort of dominate the year-to-date numbers as well for 2023. But really, that strong, strong performance was right through midyear until the Federal Reserve came out and talked about issuing more long-term debt.
That was really an inflection point in the markets. Interest rates started to go up. We saw relative performance change. There were different strategies, different portfolios did better in that environment.
And then when the Fed sort of pivoted and said that, “No, we're not gonna do that long-term debt. We're gonna do more short-term debt,” then the market was back off to the races again for the fourth quarter, for the last two months of the year. One thing I think was really notable, and because it really was a driver of performance, was interest rates and expectations of what interest rates would do. The 10-year treasury, for instance, skyrocketed up to about 5%, it just briefly flirted with that. Its highest levels in over 15 years. Some treasury maturities, highest levels in 20 years.
Expectations for what the Federal Reserve would do in terms of cutting rates were very, you know, for very fast and sharp cuts as well. Interest rate then would go down to 3.75%. So that was also a humongous tailwind for the market, and also from certain sectors in the market.
Just thinking about performance here. I mean, a couple of things to point out is it was a strong market again for U.S. market, for gross stocks. For real assets, there was sort of a mixed performance. Commodities were down, but real assets and, really, small cap value stocks in general, had an incredible fourth quarter. I mean, REITs were up 15% in the fourth quarter as well. And, of course, the thing is, we've already sort of talked about it, is the bond market, because interest rates dropped so much. The overall bond market for the fourth quarter was up nearly 7%. That's an amazing return. That's like two years of returns for a bond market packed into one quarter to really save the bond market from having a loss for the year.
Bonds, however, are still down over a three-year time frame, which is very exceptional. You very rarely see that. So those are just some very quick thoughts. Do you have some additional thoughts on performance in the fourth quarter, Ben?
BEN: I think the real key that you honed in on there is the bond market. You know, we saw this incredible environment of rapidly rising interest rates in the first half of the year, and it looked like we were gonna see a repeat of 2022 and have another struggling bond market two years in a row, which I believe may have been unprecedented, two years in a row of negative bonds. And so the fact that they got that rally towards the end of the year, I think, was one, an interesting story, and two, great for balanced portfolios, and three, really helps provide some of that risk-adjusted return to portfolios that people expect to get from their bonds.
RUSTY: You and I definitely talked to a lot of advisors late in the fourth quarter and really the back half of the year — really all year — talking about, “Why not just go into T-bills and chill?” right? And, of course, our message was that, “Look, if you're a long-term investor, there's reasons why you don't want to put all your fixed income into cash. Reinvestment risk is a huge consideration.” And in fact, the fourth quarter just shows why you don't want to just go up entirely in T-bills and chill.
BEN: Absolutely. So, Rusty, that all was a great backdrop for my next question. And you covered a lot of different asset classes there. And as we all know, Brinker Capital takes a multimanager, multi-asset approach to creating portfolios. As we've had, and as you mentioned, 2023 and also 2022, a few real interesting years in the markets, it feels like a lot more advisors and investors are trying to learn more about the outlook for different asset classes that we're leveraging in our portfolios.
So my next question is, how are you and the rest the team thinking about the six different asset classes over the next quarter and over the next year?
RUSTY: Yep. Great question. I love this question because, of course, the Asset Allocation Committee, which we're both members of, we introduced the Brinker Capital Six Asset Class Barometer in 2023, which really captures our thinking on the six primary asset classes that build Brinker Capital portfolios.
We do meet as a committee a couple times every month. We talk about, obviously, the stock market and these six different asset classes. It's a pretty spirited meeting. You know, we even give an award to the Maverick, somebody who's bringing different ideas to the table.
And, obviously, this is a tool we introduced, and it isn't just capturing our thought, which is not only capturing our thoughts, what's articulated in our portfolios, but also talking points for people to use when describing what's going on in the portfolio. So we think it's a very handy resource.
So let me just tell you about our outlook. So coming into the year, first of all, we are slightly negative on the U.S. stock market, and that is primarily driven because of the concentration risk in some of the top names in the markets.
And, you look at, first of all, there's the whole concept of concentration risk. Historically, when the stock market gets this concentrated, what follows — it doesn't mean it's going to be next week or next month or next year, but it has always historically followed — is where the concentration risk does set up, where the leadership breaks. And then the leadership of course spreads out, diversified portfolios do a lot better. So we're worried about the concentration, but it's also the valuation that is in those top names, which, really impacts the valuation of the overall market.
The U.S. stock market is expensive in the aggregate. And that is our concern. So when you look at sort of the TV benchmarks — when we talk about TV benchmarks, it's the ones you always see on TV. It's the S&P 500, it’s the Dow Jones, it's the Nasdaq. Those are in a way sort of, you know, unofficially the benchmark when a lot of people look at their portfolios.
But all those are actually flawed benchmarks. And I think that when you build globally diversified portfolios, you have to think outside of the TV benchmarks. And those TV benchmarks are expensive. Now that to say, there are opportunities, within the markets, global markets, not only in non-U.S., but also other parts of the U.S. market. The types of international equities, international equities are much cheaper. The relative valuations are at multidecade wides.
You can just keep it simple and just make just blanket, to say non-U.S. is cheap versus the U.S., but you could break it down to developed is cheap, emerging market is cheap. You can even get more granular than that. It's almost like shooting a fish in a barrel if you're just simply looking at relative valuations. Core fixed income we’re bullish, and core fixed income is arguably the most attractive it's been versus the stock market. It’s kind of a function of stocks being expensive. It's also because core fixed income has higher interest rates than they've had in nearly 20 years. Again, it depends on the maturity. So we just look straight up bonds versus stocks. Bonds look pretty attractive.
When it comes to diversifying asset classes, this is something that makes Brinker Capital a little bit different than other multi-asset managers. Those last three asset classes — global credit, alternatives, and real assets — we call those all diversifying asset classes. Strategically, we tend to have more of those three than other multi-asset firms. You could say roughly we have 20% of portfolios in those. Really depends on sort of the risk target of a portfolio, but let's call it 20%+.
We're officially neutral on all three of those. I mean, there's opportunities in all of them, but there's also concerns in all of them as well, and I'm sure we'll spend a little time kinda talking about all of these in the pages that follow.
Well, we don't have pages. We're gonna stick on this page. Let's talk about these asset classes!
BEN: Absolutely. Well, I'm going to start with valuations there. It obviously is a huge story over the last year. And I'm going to use this as a shameless plug to point out one of the opportunities, or I should say one of the resources, that our team produces, called the Starting Points Matter Chart Pack. And we've got a link at the end of the presentation, so you can go check it out.
But it's lots of charts. So you can really look at some of these real relationships that we're talking about, value versus growth, international versus U.S., small caps versus the whole U.S. market to really see what we're talking about in terms of some areas of the market are incredibly extended, when we look at their multiples, but some areas are very attractive.
Rus, did you want to talk a little bit more about positioning within domestic equity and how we're really leveraging some of those more opportunistic areas?
RUSTY: Well, I'll give you one great example. So first of all, thanks for putting in that plug about the chart pack. So we do produce a lot of proprietary chart packs on the investment team. The one that actually has a public face is what we call Starting Points Matter. As Ben said, it's looking at relative valuations going back to the beginning of the century. It's an excellent resource for helping diversify portfolios, but the one relationship that stands out, we've talked about this in various webinars, it's just looking at small cap names.
And if you go back to the beginning of the century, on average small caps have traded at roughly a 20% discount to the overall market. They're currently trading at a 50% discount. So small caps are on sale. We've probably seen headlines in the press, talking small caps are the cheapest since X.
You know, it depends on the valuation, depends on the time frame, but you can even get more sensational headlines than just saying “the cheapest of the century so far.” Also over that time frame, on average, it's a 20% discount, sbut mall caps can trade at par with the overall market depending on where we are in the market cycle. So that's one huge example. And of course, if small caps are on sale, that would also suggest that active managers should have a tailwind in performing versus passive strategies as well.
BEN: Absolutely. Now as we look to international equity, I think something that maybe hasn't been talked about as much in the last few months, but something we're still watching, is the U.S. dollar. Obviously, the U.S. dollar is very pegged to this relationship between international versus domestic outperformance. So Rusty, how are you and the team really thinking about the effects of this kind of volatility, maybe potential weakness that we're seeing in the dollar going forward?
RUSTY: Well, the dollar did sort of tail off toward the tail end of the year, of course when interest rates went down. The dollar is usually one of the top reasons why international will outperform U.S. stocks. So it is a key variable.
We already have relative valuations in place. So we just kind of talked about that relationship with small caps. If you look at international, so again, the same chart packs, if you look at emerging markets, they penetrated a 25% discount to the U.S. market; they're currently at a 50% discount. You look at developed markets, they're about a 25% to 30% discount on average, and they're currently at a 40% discount. Everything is on sale. So you need the catalyst, and the dollar is usually one of those big catalysts.
The dollar right now is very expensive. There's a couple different measures of looking at if it's expensive or cheap. Well, I like to defend valuations, as you can even use it as a timing tool in shorter time frames in the U.S. market, even as short as one year. It is pretty poor, looking at the currency. So you need to look at other things, such as trends. You need to look at movement and interest rates. And so that's going to be a key variable coming into the year.
One other thing about the dollar that makes it vulnerable; a lot of people are talking about — and we're talking about the Asset Allocation Committee, too — is just the amount of debt, of course, in the U.S. Obviously, this has been an issue for years, but it's never been as great an issue as it is now. With interest rates higher, it's gonna just take more to pay off those bills. It's going to eat into fiscal spending for other areas. And so all this means all the higher debts would suggest a weaker dollar. So that is something we're watching, and that is a potential catalyst.
Another potential catalyst, of course, outside of the currency, goes back to the Magnificent Seven and the concentration risk in the U.S. So again, if the Magnificent Seven breaks down, even if the U.S. market is sort of hanging in there, you would see at the aggregate level most likely outperformance by non-U.S. over U.S.
BEN: Great, thank you. And you just touched a little bit through the dollar. We're talking about interest rates, another huge story over the last year. And that leads us to core fixed income. You know, our reading here is slightly bullish on core fixed income. There's the argument of starting yields, starting higher. Gives us a higher expected forward return for core fixed income.
And the other thing you mentioned earlier in our video here is, why not T-bill and chill? We've seen money market rates really spike up, as interest rates have gone up. A lot of investors and advisors have been flooding to these, you know, very nearly zero risk instruments to get close to 5% yields. So how should we be talking about, why not T-bill and chill? What what's the what's the benefit of using core fixed income over cash?
RUSTY: Well, first of all, how we define core fixed income, it is U.S. investment-grade fixed income, but it is also cash. So T-bills and chill would fit into that. As a reason why we are slightly bullish, you hit it on the head. The biggest reason is starting yields. And again, it’s the most attractive cash has been a long time, but also really through all the core fixed income asset class, it is the highest yields have been in some time. Expected returns are the best they've been. You match that up with evaluations of the U.S. market. That's the reason why we like core fixed income.
Our positioning has been pretty strong in this this year. We were basically neutral on it in short duration, which means we had less interest rate sensitivity. We had shorter maturities in the overall market that benefited. We really sort of nudged this into the more positive area. And while we're not overweight duration yet, we did extend duration really coming into the quarter, which really helped us out. So we've been pretty fortunate in terms of directionally about how we've been thinking about it.
As for reinvestment risk, it tends to be, if interest rates had the big move up — and they do tend to look for an area where they're going to have sort of a new ceiling for a while — really, when you look at all segments of fixed income versus cash, over the next 6, 12 months, 3 years, 5 years, basically cash comes in historically last place versus everything else. So when reinvestment risk is really important, particularly if you're a longer term investor, it doesn't really make sense to move everything into cash.
Of course, if you have near-term liabilities, of course that should not be exposed to the stock market or extremely long maturities. You should obviously sort of immunize that, and if you've got liabilities next year, it should probably be in cash. It depends on what your financial planner or your own financial plan says. But, anyway. So we like core fixed income for a combination of reasons.
One last thing about that is credit. So investment grade credit does fall into that classification. Investment grade credit, on an absolute basis, yields do again look attractive. But on a relative basis, you look at credit versus treasuries. Investors really like that space.
Spreads, which is really looking at the relationship between the yield of corporates versus Treasuries is really tightened, not quite as attractive as it has been historically. So we’re a little more neutral on credit.
BEN: So now as we point to these final three pieces, our diversifying asset classes. I think we'd be remiss to not talk about inflation.
Over the last year, inflation has come down drastically. We saw kind of the end of the Fed's hiking cycle, at least for now. I'd like to hear your thoughts on real assets, real assets specifically and how inflation, potential geopolitical stress that kind of keeps popping up over the last 12 or so months, how are we thinking about positioning within these diversifying asset classes?
RUSTY: Yeah. So, again, right now as a team, we are basically neutral on real assets. That's kind of in the zone of 7.5% to 10%. And how we define real assets, there's really four different sub-asset classes that fall into that.
First of all, it's kind of the easy one, commodities. A lot of people know that, but it's also commodity-based equities, natural resource stocks. So that could be basic material or energy stocks. It could also be real estate investment trusts, it could also be infrastructure stocks. So there's really four different categories that fall into that.
One area, for instance, that looks pretty interesting, and it kind of goes back to all the relative valuation work, are natural resource stocks. And, again, the relative valuations are extremely attractive right now. But really getting to your inflation question, real assets is one of those asset classes that tends to do well when in inflation is moving higher. When inflation is surprising to the upside. When there's volatility in the inflation data. So it isn't talking about necessarily a trend. We're just talking about the volatility. Real assets tends to outperform in those market environments.
Traditional stocks and bonds, which most investor portfolios are primarily entirely consisted of, they underperform in those environments. And so real assets is a way to diversify that risk and kind of smooth out overall portfolio volatility and ultimately make portfolios more resilient.
Now as for an inflation call, you know, we don't officially produce an inflation call, but we obviously talk about inflation quite a bit. And we do kind of think about, so it isn't about predicting as much as it is preparing portfolios. And inflation has dropped quite a bit, from their highs a couple years ago, but I might say inflation is dead yet. The target wants inflation at 2%. It's still it depends on the inflation metric. You're looking at a time frame, but we're calling a 3% right now.
There are cross currents of things still moving lower, but there are things that could still be moving higher. We think real assets still deserve consideration in this environment. But again, particularly in an environment where we're getting a lot of volatility in the economic data, including inflation, real assets, again, deserves consideration in multi asset portfolios.
BEN: Great. Thank you, Rusty. Any final thoughts, on asset classes?
RUSTY: Well, so 2024, as always, should be another fascinating year ahead. It is an election year, and I'm sure everybody has read various studies on election cycles. In the absolute sense, it should be a good year for the markets.
Historically speaking, some of the things we've talked about have tended to do well in election years, which include small cap stocks. Value-oriented stocks tend to also do well.
Again, there's always a classic study that, don't invest off your political affiliation. You know, just want to be all in on that. That historically has impaired returns over time. So, it should be another fascinating year ahead.
BEN: Absolutely.
Well, thank you all for tuning in to this quarter's Q&A vlog with myself and Rusty. If you need anything at all from our team, we have a few different emails listed on this page here, that reaches our whole team if you need, really anything from us.
We also have a link to the Investment Strategy Thought Leadership website. On that page, you can find the chart pack that we referenced earlier, along with a few other webinars, videos, and other helpful resources. All of our contact information is here.
Thank you again for tuning in. We'll see you next quarter.
RUSTY: Thank you.
