Black Swans and Bubbles: The Bearish Case for the Markets

This is a conversation that is meant to give our financial advisor audience a little bit more of the so-called Minority Report, right. We know that the bull market's been intact for quite some time. Tom Cruise's movie and that allusion to it is maybe a little bit tongue in cheek, but there are always risks in the marketplace and there are always reasons why you may want to be a little insured on some of those positions that you have for your clients. That's the reason why this panel exists. So, gentlemen, thank you both for being here with us. David, Rosie, I'm going to go to you first on this because you have been a voice talking about the possible downsides that could exist in the market and the economy. For a good while, you have been a person who's been cognizant of all of those risks. Can you take us through what you're seeing right now and why investors should have a little bit of worry in the back of their mind? Well, look, I've been saying for a long time that well valuations are not a timing tool. At any given moment in time, they either provide an investor with a headwind or a tailwind. And so you know we're at a 21 forward multiple. So Dom, it's telling you there was a lot of hope and aspirations on what earnings are going to be doing in the coming year to justify these lofty valuations. So you know this is the top 10% in valuation, the top decile in multiples that we've had historically. I like to invest with the wind at my back instead of you know staring me in the face and I know that the market that has been ripping, but you know this is a a sentiment and price earnings multiple expansion driven market for the most part. Not that earnings haven't been decent, but the pricing has so far outstripped you know what the what the earnings have been doing. I would say that you know what could upset the applecart any earnings disappointments. If you remember ultimately what brought the the tech media to an end in 2000 with Cisco starting the trail of of missed earnings estimates, that's point #1. the Fed higher for longer. I mean you're getting paid over 5% to be in cash and the earnings yield in the stock market is basically 4.64 point 7%. So the higher for longer to me is a is a is a risk or if the Fed dares to raise rates again, but by not cutting them I think that gives cash money market funds a a continued advantage on a risk reward basis. Outside of that, you know everybody is thrown in the towel on the recession call that would be that would be the big surprise is that the recession that nobody now sees coming actually ends up coming at some point in the next 12 months and that brings on earnings recession and commensurate multiple compressions. So those are the three primary risks. Now it's interesting Brandon, because if you look at the the way things have played out, like David just pointed out, this has been a market that's been incredibly resilient in in spite of I would say the rising interest rates that we've seen even with risk free yields either in savings accounts or in the US treasury market topping that 4 to 5% range. There are folks out there who are still adding to positions in the market and that's the reason why we sit a stone's throw away from record highs. You at Universa and your firm have been called Perma Bears in the past. Is that the right way to characterize what you guys are seeing? And if so or if not, how would you characterize what universe is doing in its approach to investing? Sure, It's a great question and thank you for having me. And David, nice to meet you. Certainly we get this misconception of being called Perma Bears, right? You know we have our our main position here is is is benefiting from crashes. You know we protect investors against crashes. But you know describing you know what we do or people that invest with us solely as Perma bears is is really not the right way to think about it. You know, we are much more in the realm of you know, providing strategic risk management, strategic risk mitigation and and the reason being is we are very skeptical of our own ability to to forecast markets, right. You know we can look at a lot of the same data that you know David shared and agreed that valuations are very high. You know by Tobin's skew we're at the highest valuation metric ever. But you know that doesn't necessarily lead you to the correct investment positioning. You know a a, a parable that I, I, I gave before maybe a year ago we came on air and you know we've been actually very bullish on on on equities is thinking about you know you could have your macro forecast perfectly right. You know, all of the things that you think would happen a year ago, you know, thinking back to 2022, if you knew that interest rates were going to go up 2% and you knew that there was going to be war in Ukraine and you knew that there was going to be, you know, this this uncertainty in the Middle East. The last thing you probably would have thought to do was to add to your equity position. But you can get your macro forecasting right and you're positioning entirely wrong. So we try to help people think through things differently and you know, protect against the risks that really matter, which are the really big losses, the ones that you can't recover from the, you know, the the grand financial crisis type of positions where your wealth is destroyed for a decade. This, this is one of the reasons why the the audience here might be a little bit more interested, Brandon, in in hearing the strategies that you employed. And we all know that there are tail risks, right? This, this idea of the unforeseen and the debilitating drawdowns in the market, the likes of which we saw during the great financial crisis and to a maybe lesser extent, but still very, very harmful 1 during the COVID pandemic and the pandemic lows. Then how exactly then do you insure portfolios and what kind of a cost is associated with it if you were to continually so to speak by that insurance protection for that unforeseen debilitating type effect, I mean that's that's entirely correct. That's the right way to think about it. Because where people get risk mitigation wrong is they only look at the benefits that risk mitigation provides in in in drawdowns, right in COVID or in the grand financial crisis and they ignore or they minimize the the cost the rest of the time. You know the the biggest risk mitigation strategy that people use, it's simply bots, right? I mean a a traditional, you know, you know, portfolio, your traditional wealth advisor that's in the audience is likely something like 6040, you know, maybe with those percentages changing based on, you know, the the, the age of the of the underlying investor or the goals of the underlying investor. But you know what is that 40 doing? You know that 40 is providing you risk mitigation in these drawdown periods, but it's also costing you wealth when nothing is happening, right? Or when the market is rallying. You know how much has a 40% allocation cost you relative to a stock allocation? You know in 2024 or 2023 or even in 2022 when you your risk mitigation didn't provide the type of statistical correlation that you were hoping for. You know, so we help investors to think about, you know all of the decisions that they're making in portfolio construction really have a cost benefit associated with them. It's just more of an opportunity cost when they're ensuring their portfolio rather than explicit cost with something like we do with which which is options. Now we certainly wouldn't advise any, you know people to go out there and try and do derivative or option strategies on their own. You know, at A at a minimum we try to make sure that people are just aware of what these different things are in their portfolio and how certain things are are maybe providing more cost than benefit. The cure shouldn't be worse than the disease. Gotcha. OK. So that's an interesting point there about looking at some of the costs whether they be explicit in terms of options premium or the opportunity cost of being elsewhere in the market. I do have David A, A, a question coming in from the audience, in our financial advisor audience and this one is from Mark. It's a, it's actually a good one. To address your your point about valuations, Mark wants to know if it's realistic to look at earnings for the market inclusive of the Magnificent 7 stocks, you know the mega cap tech and com services ones. Isn't the market considerably cheaper X MAG 7 and therefore pointing us to a strategically different type place? That's an interesting point, David, what do you think? Well, you know, usually economists get laughed at for, you know, when we talk about excluding this and excluding that, looking at core CPI, so you exclude food and energy. So people always laugh that, well, you don't eat and you don't drive. So there's the Economist. So here the question is about do we strip out, you know, you know, a 30% share of the market and and the answer is yes, they those are the most overvalued segments of the market. And I think that you can find areas where there is greater value if you're sector specific. But let's face it, so much of the flows are just going into passive index investing. So yeah, you can't ignore the fact that the SCU of 500 and it goes back to the question, not only is hugely overvalued, overvalued because the greatest overvaluation is in the highest concentration. So yeah, I would say that if you are an active investor and if you want to focus on some of the sectors that are more defensive and perhaps less expensive, then that's what I would be advising. But you can't just take out a, a chunk of the index and say well that's that's the overvaluation extreme if you're looking at the overall market. Your initial question to me, Dom, was about the overall market. Yes. So I would, I would completely agree that if you take out the most expensive parts of the SP of 100, by definition the rest of it isn't so egregiously overvalued 100%. OK, let me follow up on that because this is kind of ripped from the headlines, right, guys? David, I'm going to follow up with you because it is a timely discussion to have on a day when many traders and investors are looking towards one company in particular to help set the tone for the coming weeks and even possibly quarters. They may sound melodramatic, but it's because of the outsize impact one stock has on the entire market, whether it's the S&P 500 or the NASDAQ 100 and that is NVIDIA. NVIDIA has been an AI darling and it is reporting earnings after the closing bell. Today the options market is already pricing in what could be a less than volatile report from them historically versus the last eight quarters. How important is the NVIDIA story to this over valuation or fair valuation argument in the market, David? Well, I think that today's report will be a watershed. I mean NVIDIA really was single handedly responsible for this last leg of this bull market and it's the poster child for general of AI writ large. So it reminds me almost of as I said earlier, what was the one stock, the one company that missed on its earnings and up by a lot and guided lower back in 2000 that ended the tech mania was one company and it was Cisco. I guess you could argue that Cisco was the Invidia of the day. So I I would completely agree that today's report is definitely going to help set the tone for white swaths of the market today since there's so many other, you know, derivative plays off of AI that this could have a a very, a very important spreading impact. And Brandon, I'm going to give you the last word here with regard to positioning Allah, what's happening with NVIDIA in the market today? You mentioned that you use options related strategies. How exactly are you positioned right now for your clients and how would you view what Nvidia's role is going to be in the market narrative going forward? And how would you be positioning you and your clients for that kind of a possible trade? Oh, sure. I mean I think that you know one of the things I thought was interesting that David had said earlier was just talking about sentiment, right. You know when we, you know our clients as a whole are much longer equities relatively to people that don't have tail risk sketching because having you know a a much larger or excuse me a much smaller potential loss in your portfolio, it allows you to take you know more and greater risks. So you know I'd say by and large irrespective of the the NVIDIA story, our clients are are longer equities and you know and they've been particularly long since you know the start of 2023 because we were looking at sentiment and you know sentiment was about as bearish as we'd ever seen it. Yet you know the typically the rashes occur when sentiment is is much more bullish, not always but yeah but but typically and you know we've kind of seen, we were pretty alone in in that call and we've kind of seen sentiment slowly turning right. You've seen these bearish forecasters. I think you know Wilson from Morgan Stanley's the most recent that have kind of capitulated and say hey now we're going to be bullish and we think stocks are going up. All of this is, is is reflective of sentiment and and NVIDIA certainly is a is a poster child for that sentiment changing. We don't feel that it's totally changed yet in terms of you know the potential for the market to have legs. But our forecast could be wrong and it it doesn't really impact you know our clients because over the long, you know over the next 5-10 years, you know there'll be lots of NVIDIA earnings and in in the stock market will likely be much higher. It's it's surviving the interim that matters. It's surviving through those big drawdowns and crashes. So if you know today's the day and NVIDIA sparks some you know, horrible, you know, market defining crash tomorrow, our clients are well positioned for it. But they are equally positioned for NVIDIA to have positive earnings through protecting their downside.