March 11, 2022 | James Sprow | Blue Vault<\/p>\n
On Thursday of the Bowman\/Blue Vault 2022 Alts Week, our keynote speaker was Anastasia Amoroso, Managing Director, Chief Investment Strategist of iCapital.<\/p>\n
Key Takeaways from the Outlook:<\/strong><\/p>\n \u2022 It\u2019s too early to call the bottom of the market. I will take a little longer to have clarity.<\/p>\n \u2022 As difficult as the situation in Ukraine is, if you look at our financial linkages to Russia, they are really quite small.<\/p>\n \u2022 We may have already priced in the worst-case scenario for commodity prices. We\u2019ve already priced in about 64% of the worst-case scenario for oil. Expect oil to be $100 to $110 for the year.<\/p>\n \u2022 Inflation is everywhere and with its demand destruction, we have real potential for a recession.<\/p>\n \u2022 The Fed wants to prolong this expansion by adjusting rates just enough, but not to put the economy into recession.<\/p>\n Anastasia first majored in Journalism with a minor in Political Science and then she switched to Finance. \u201cWhen I think about what\u2019s happening in the global affairs today, it is this cross-section of geopolitics and finance that we just can\u2019t get away from today.\u201d<\/p>\n \u201cWhen we were thinking about our iCapital 2022 Outlook, we were thinking about higher hurdle rates and lower potential returns. We were always expecting this to be an eventful year. I don\u2019t think we were expecting it to be this eventful in such a short time. We\u2019ve got almost 8% inflation, the highest rate in 40 years. We\u2019ve got the Russian-Ukraine conflict. And finally, the Pandemic is coming to an end in the United States. We have to somehow overcome the 8% inflation rate. I didn\u2019t expect the 60-40 portfolio to be down 7% year-to-date but, once again, here we are.\u201d<\/p>\n Near Term Outlook<\/strong><\/p>\n \u201cIt\u2019s too early to call the bottom. It\u2019s too early to call an all-clear. It\u2019s going to be a little bit longer to have clarity. While we wait, what can we do with the portfolios? I\u2019ll have five or six ideas that you can do with the portfolio to withstand some of this uncertainty.\u201d<\/p>\n \u201cThis is a year where little has been working in the market. The only thing that has held up is oil. The NASDAQ is down, the S&P is down. We\u2019ve broken some key trends. What\u2019s happened since the beginning of the year is we\u2019ve broken through the 200-day moving average. Historically, this doesn\u2019t happen often, but once it does, it does take time to find a bottom, it does take time to clear the uncertainty, and it does open up additional potential for a downside. We have to be very mindful of that.\u201d<\/p>\n \u201cThere is a huge bull-bear debate in the market. The silver lining is we\u2019ve taken some of the froth out of these valuations. Most people are split 50-50 on any given day. As a result of the pullback we\u2019ve had this year, we\u2019ve taken out a lot of the froth in valuations.\u201d<\/p>\n \u201cAs difficult as the situation in Ukraine, if you look at our financial linkages to Russia, they are really quite small. The other thing to look at is the massive rally in commodity prices. We may have already priced in the worst-case scenario.\u201d<\/p>\n \u201cTake a look at the massive rally we\u2019ve seen in commodity prices. The last time that happened was in 2008. We\u2019ve looked at the worst-case scenario for wheat and oil. We may have already priced in the worst-case scenario. We\u2019ve already priced in about 64% of the worst-case scenario for oil.\u201d<\/p>\n \u201cThe bearish outlook is as high as it\u2019s been since 2013. Hedge funds have been selling all year.\u201d<\/p>\n \u201cThe most important thing that has to happen is to break this feedback loop of negativity. In order for us to call an all-clear on this market.\u201d<\/p>\n \u201cWe haven\u2019t priced in the ultimate outcome in Ukraine. We might see more escalation first before we see any sort of constructive negotiations.\u201d<\/p>\n \u201cWe have priced in a lot but we may not have priced in all of the downside potential of the situation in Russia and Ukraine. Take a look at the size of Russia compared to the former Soviet Union. If you are Putin, what is the incentive for a de-escalation? The unfortunate most likely scenario is we see more escalation first before we see any kind of constructive negotiations.\u201d<\/p>\n \u201cI don\u2019t think we\u2019ve priced in the duration of the potential disruption. Russia is a significant producer of these commodities. The second-order effects and the unintended consequences of these sanctions are still very much possible and they may result in further supply chain disruption. It\u2019s not just oil, but there are a lot of other commodities provided by Russia.\u201d<\/p>\n \u201cThe topic of the day is inflation. Inflation is everywhere. 7.9% food inflation, 25% energy inflation, 41% used car inflation, and 12% airline inflation, it is everywhere, and it is getting broader. More and more consumers are starting to feel it. With inflation as high as it is, if you are a low-income consumer, 90% of your income is spent on food, housing, and gasoline. As you can see, we have a long way to go to bring that inflation down.\u201d<\/p>\n \u201cThis is becoming a demand destruction issue, potentially. Real wage growth has slowed to a decade low, at a negative 3% rate. Food prices are projected to be up 14%. Consumer sentiment is at the lowest level in 10 years. This is becoming a real concern for the Fed, for the market. There\u2019s a real potential for a recession.\u201d<\/p>\n \u201cWe\u2019ve had a growth slowdown before the situation in Ukraine. This has affected the growth forecasts. Given the sentiment, economists are likely to cut these growth forecasts even more.\u201d<\/p>\n \u201cWe are now expecting a negative growth rate in Q1. We have a negative feedback loop we need to break. Let\u2019s take a look at what happened historically after the peak in data. Most equity indices produce negative returns after you see this peak in data. The US stands out. This is a reason why we shouldn\u2019t expect positive real returns.\u201d<\/p>\n \u201cConsensus earnings estimates for the S&P 500 give you roughly 4,300. That doesn\u2019t give us a lot of potential upside. Maybe it\u2019s not a 19X multiple for S&P earnings. You could potentially have another 10% downside for the S&P. The math does not support a whole lot of upside for the S&P. We could have a positive resolution in Russia and the Ukraine, but that is not the base case, and we\u2019d rather have a certainty first that it does happen rather than say we\u2019ve seen the worst and reached the bottom.\u201d<\/p>\n \u201cWe\u2019re going to see more negative earnings revisions and you\u2019re going to have to see these negative revisions bottom out before we call the all-clear on this market. The only sectors where we\u2019ve seen<\/p>\n positive earnings revisions are in energy, real estate, and info tech. The sectors where we\u2019re seeing downside earnings revisions are the cyclicals. The last time we looked at these charts three weeks ago the consumer discretionaries didn\u2019t have the number of downside revisions that they have today.\u201d<\/p>\n \u201cThese are times when you want to buy into the market with a 12-month time horizon in mind. Of course, patience will be required.\u201d<\/p>\n \u201cOnce the Fed hikes and it\u2019s been 12 months since the first rate hike we do see positive returns, as the market adjusts to the Fed\u2019s more cautious approach. The Fed wants to prolong this expansion by adjusting rates just enough, but not too much to put the economy into recession.\u201d<\/p>\n \u201cReal rates are deeply negative today and they\u2019re still going to be below zero even if the Fed hikes rates 200 bps. By 2023, The Fed is not going to hike into a tight monetary policy, it\u2019s still going to be below zero.\u201d<\/p>\n \u201cOnce we price in more of the recession probability, and once we do that, we\u2019ll see an amazing buying opportunity in this market, we\u2019re just not there yet.\u201d<\/p>\n Six ideas for a portfolio in this situation<\/strong><\/p>\n \u201cWhat do you do in clients\u2019 portfolios to position for this uncertainty now and more clarity later?\u201d<\/p>\n \u201cWe need to get something in the portfolio that can deliver hyper-growth when the S&P is not performing, and two, it\u2019s a set of inflation and rate shock absorber ideas that are clearly needed today.\u201d<\/p>\n \u201cThis has been a very challenging backdrop for fixed income investing. There\u2019s one silver lining for this.\u201d<\/p>\n \u201cOne of our ideas is to look at the private credit market where most of the securities are floating rate, and they offer a yield that is almost double what the publicly-traded leveraged loan market is giving you. Private credit that gives you close to an 8% yield.\u201d<\/p>\n \u201cThe second idea is commercial real estate. This is a $31 trillion market globally. If you look at the performance of real estate inflation going back to 2000, you see NOI growth that outpaces inflation.\u201d<\/p>\n \u201cIndustrial\/warehouse vacancies are extremely low. Multifamily RE is one of the better opportunities in real estate right now.\u201d<\/p>\n \u201cThe median home price rose by more than $100K over the last year. And you have mortgage rates topping 4%. The affordability of housing relative to housing units is now beginning to deteriorate. Now you\u2019re not better off to be buying a house than renting. Real estate rent growth has been close to 11%, over and above inflation. The supply-demand dynamics and higher replacement costs should provide some capital appreciation for rental real estate.\u201d<\/p>\n \u201cDoes real estate do well in a rising rate environment? Today we have strengthening fundamentals of CRE. The spread of cap rates over the Treasury is right at the historical average, but it\u2019s not at the low that we\u2019ve seen prior time periods. I would definitely put real estate as one of the top opportunities right now.\u201d<\/p>\n Another idea is to monetize volatility through options. We are right now in the 97th percentile with regard to volatility. One of the ways to take advantage of this volatility is to potentially buy the security and write a call option on it. Given this volatility backdrop, you\u2019re going to collect these very generous premiums for selling the option which can either enhance the return if the security rallies or it could reduce the loss if the stock goes the other way.\u201d<\/p>\n \u201cWhat might you add to the equity side of the portfolio?\u201d<\/p>\n \u201cVenture capital. Venture capital has had a 600 bps return above the public market equivalent. They are not subject to day-to-day market-to-market volatility. VC funds are investing in innovation. For example, there are 58 times more private companies available that are pursuing AI than in the public markets.\u201d<\/p>\n \u201cThe last thing I\u2019ll say is cryptocurrencies.\u201d<\/p>\n \u201cCrypto: When you can\u2019t trust the central authority to maintain the value of your currency or trust them to allow you to transfer your money because of the government, that\u2019s where a decentralized blockchain or cryptocurrency might be very helpful. Last year was a record year for venture capital funding different crypto applications. Can we create a more secure and more private and more decentralized web than the social media models we have today? Can we reduce the cost by having decentralized technologies and eliminate intermediaries and eliminate an unneeded layer of cost?\u201d<\/p>\n \u201cThat is where we are today, where we have a higher hurdle rate with high inflation, and we have the lower expected returns in the public markets, and that is why we\u2019re looking for these alternatives to add to the allocation.\u201d<\/p>\n \u201cAlternatives have been a mainstay for many years. And if you\u2019re an endowment you\u2019re probably allocating 43% to alternatives and real estate. If you\u2019re an HNW individual you\u2019re probably allocating 14% to real estate. Regardless of their asset level, most of them intend to increase their allocations to alternatives.\u201d<\/p>\n \u201cAlternatives are not just a \u201cnice-to-have\u201d but they are becoming a \u201cmust-to-have.\u201d<\/p>\n \u201cWhere nothing is working in the markets, where 60-40 is not working? There are things we can do, we just have to expand the universe in which we look.\u201d<\/p>\n