Tech

3 portfolio managers lay out the alternative investments they’re making as equities look overextended — and explain how they’re using value stocks to position for higher inflation

  • Stocks have thrived thanks to a favorable backdrop in 2021, but some investors are getting uneasy.
  • Panelists at a Mid-Year Macro Investing Outlook event shared alternatives to richly valued stocks.
  • Invest in quality companies and value over growth, but watch out for meme stocks and crypto.

US stocks have enjoyed a “Goldilocks and the three bulls” scenario in 2021, thanks to easy

Federal Reserve
policy, generous fiscal stimulus, and a robust reopening economy. 

That just-right backdrop has led to a strong 17% return for the S&P 500 this year, said Cliff Corso, president and chief investment officer at Advisors Asset Management. He was one of the guests at the recent Mid-Year Macro Investing Outlook event moderated by Julie Biel, portfolio manager at Kayne Anderson Rudnick.

But as GDP and earnings growth likely peak in Q2 after an unprecedented economic reopening, investors must ask: is the setup for stocks too good to be true?

“A lot of people feel like they’re missing out and want to jump in,” said panelist Robertino Coury, president at The Coury Firm, a Pittsburgh-based wealth advisory outfit. “… Near-term, we want to be risk off and cautious.”

Even in a time where so many questions about the virus, vaccines, policy, and inflation appear to be resolved, the market is as complex as ever and full of apparent contradictions.

Coury said he sees “a lot more risk than reward” now with market valuations at historic highs, especially in technology stocks, but he added that historical valuations keep climbing and the pandemic accelerated innovation, which brings into question whether tech really is overvalued.

No clear risk appears likely to derail the market, Coury said, adding that many of his clients want to take risk off the table anyway. He recommends investors take caution, but notes how eager people are to get into stocks, as dip-buying follows every pullback. The whole situation is “tough to wrap your head around,” Coury said.

The confluence of conflicting factors may leave stocks range-bound moving forward, Coury said, adding that it’s a great time to rebalance one’s portfolio. He recommends ditching high-yield bonds for private credit, adding that investors who can afford illiquidity should check out private market investments like real estate bridge lending and multi-strategy hedge funds, which are market agnostic and can do well regardless of what’s next for stocks and the economy.

Below are more observations from panelists on value vs growth, inflation, and a warning about meme stocks and cryptocurrencies.

Value should outperform again

According to panelist Doug Cohen, managing director and portfolio manager at Fiduciary Trust International, value stocks were overdue for a rally after lagging their growth counterparts since the financial crisis. He noted a two-to-three standard deviation in cheapness between value and growth.

“If you believe in reversion to the mean over any significant time frame, it’s likely that value will do better,” Cohen said.

But the value-over-growth trade has unwound in the last two months as fears of hot inflation in a strong economy subsided and bond buying resumed. Yields on the US 10-Year Treasury Note, which fall when bond prices rise, collapsed to 1.3% from 1.7% in mid-May. But the move came too far, too fast, Cohen said, adding that value stocks should bounce back as yields rebound to 1.75% to 2% by year’s end, barring a surge in the COVID-19 delta variant in the US. 

However, Cohen said that investors focus too much on the “value vs growth” juxtaposition and instead should focus on investing in quality stocks over non-quality stocks. Firms with strong returns on equity, healthy balance sheets, and reliably high profits have trailed their unprofitable peers since COVID-19 vaccines were announced last November, but Cohen said that will change.

“Don’t fight the Fed”

The consensus among investors and economists is that inflation is temporary, as the Fed has insisted, and is driven by supply and demand mismatches as the economy reopens. Panelists agreed that price surges should subside, but Coury called for caution if inflation rises past 5.5%.

The Fed is letting inflation run hot because, for two decades, economists were puzzled that prices weren’t rising as expected. Powerful disinflationary forces like technology and globalization kept prices in check, Cohen said, adding that inflation may hit 3% but will likely moderate again as the US gets through what’s been an unparalleled downturn.

Fed critics have clamored for an earlier end to rock-bottom interest rates and the central bank’s $120 billion of bond purchases per month, which have kept bond yields in the cellar. But US bonds are attractive relative to negative-yielding rates in Europe and Asia, Corso said, and panelists noted that fading the Fed’s moves has been a losing strategy.

“In this entire

bull market
, the rally has been driven by ‘Don’t fight the Fed,'” Cohen said.

Bond buying has been driven by technical factors as well as pensions shifting money from stocks after their furious rally, Corso said. He expects higher interest rates in Q3 and said fixed-income investors should focus on credit and structure instead of duration. Corso prefers value in fixed income, adding that bank equities and bonds offer opportunities.

Meme stocks, crypto could come crashing down

Meme stocks and cryptocurrencies are top of mind for investors after outsized gains in 2021, Cohen said. Highly speculative assets’ outperformance has come from

liquidity
, he said, but as the economy normalizes that trend will fade.

Tech stocks’ recent resurgence has drawn comparisons to the 1999 tech bubble. While Cohen sees some similarities, he said those comparisons are flawed — but still urges caution.

“I don’t think it poses a major systemic risk to the market,” Cohen said. “[But] I don’t think it’s going to end well. There’s a lot of speculation.”

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