2023-07-20 07:15:00 ET
Summary
- Melt-up and crash all in the same year? Michael Gayed runs The Lead-Lag Report and joins us to discuss the macro picture and what sectors, ETFs and stocks make sense for investors.
- The Fed is a follower of the bond market; treasuries will dictate.
- Nvidia and getting perspective on the tech sector.
- International portfolio allocation and gold as the ultimate diversifier.
Listen below or on the go via Apple Podcasts or Spotify .
Michael Gayed runs The Lead Lag Report and joins us to discuss the macro picture and what sectors, ETFs and stocks make sense for investors.
- 2:50 - Melt-up and crash all in the same year?
- 7:20 - The Fed is a follower of the bond market; treasuries will dictate
- 9:40 - How to claddify a bull and bear market
- 15:20 - Nvidia and getting perspective on the tech sector
- 22:40 - International portfolio allocation - what to keep in mind
- 30:55 - Gold as the ultimate diversifier
Transcript
Rena Sherbill: Michael Gayed runs the investing group The Lead-Lag Report and manages a portfolio outside of Seeking Alpha; on Seeking Alpha, he shares salient analysis with us. Welcome to Investing Experts. It's great to have you.
Michael Gayed: Salient is a good word. I appreciate that as part of my description there.
RS: Yeah, yeah. It's I think befitting.
MG: Befitting is a good word too.
RS: We are starting strong. I feel like you're very articulate in how you share your thoughts about the market . So, I'm excited to have you on. Let's get started. How are you? I like to get started with just setting where we are? We're at July 18th, end of the day, Eastern Time, how are you looking at the markets? How are you thinking about things these days?
MG: By the way if you follow me on Twitter, @leadlagreport , you’d know that my articulation has a different tone there.
RS: That’s the world we live in, different tone for a different platform, right?
MG: Yeah, I saw that tweet from somebody. It’s like, my Twitter me is different from my Instagram me, which is different from my LinkedIn me. Okay.
So, just framework wise, after the first week of January, I made the argument that we'll probably see a melt-up and then potentially a crash, all in the same year. Now, I know that sounds dramatic. But let's look at the historical precedent.
So usually in pre-election years, you end up having a very strong market, you end up having a melt-up. Now all that has pretty much played out so far. You've had a fairly sizable run-in the S&P 500. We know what has happened to the NASDAQ and tech with the AI mania that's run wild. So it's been by all the metrics one of the strongest six months to a year in history, let alone in pre-election years. But I've been warning that in the context of that melt up, there is a credit event that's out there.
Now, in January when I started making that argument, I put the timeframe around the latter part of the year under this idea that you have a large number of loans that are going to be refinanced into higher rates next year, and most crises are refinancing crises. Right?
It's on the rollover of debt where typically there tends to be a problem and higher volatility. If that's going to happen and start in earnest next year, if it's going to be a stress point for the bond market, the stock market and bond market won't respond off of it next year. They'll respond off of it this year, because the markets are supposed to be forward looking mechanisms.
So I always put the time frame around a credit event later in the year. I don't know exactly when, because my bet in the way I think about this is that the stock market and bond market will start to worry about what's going to come in 2024.
Now that seems bizarre and seems fantastical because the trend has been very strong. I'd argue that the fact that the trend has been very strong is exactly why you need to have a credit event to break it. It's very hard to break momentum in FOMO like what we're seeing this year in the absence of some kind of exogenous shock. And if history is any guide, it seems plausible that, just like everybody fell for the recency bias up last year, with equities going down, people are probably falling for recency bias now this year. The other way around.
RS: And so what does that mean for investors? If they're looking out for -- I understand that you can't predict the timing and such. But what should they be preparing themselves for if you have that in mind?
MG: So, a large part of what I called my hell last year, as somebody who runs rules based funds, mutual fund, ( ATACX ), ( RORO ) and ( JOJO ), my ETFs, which by the way are totally separate from The Lead-Lag Report investing group. On a side note, I always find it amazing people can't differentiate between me as a analyst, researcher, macro thinker, and me as an entrepreneur launching these funds, which would run the exact same way if I die tomorrow, right? It's not based on my discretionary thinking. So that's an important distinction.
But in practice, what that means is that I suspect that the thing which was, my hell last year, which was the failure of treasuries to counter equity volatility that treasuries end up doing what they historically do, which just serve as a buffer and counter a stock market correction or credit events using that terminology. So from a practical perspective, and then everybody wants to buy and feels tempted to just chase, especially the Nvidias ( NVDA ) of the world and the high flying names in the stock market.
But maybe the best thing to do is actually start to position a little bit more into long duration treasuries, not because you're trying to play it off of yield in long duration treasuries, but because historically, when you have a credit event, when you have some kind of a shock decline, there's a flight to safety. Money goes into the pristine asset, which owns all of us through taxation, which is U.S. government debt, at least for a moment in time. I'm not talking from an investment perspective I'm talking about from a, yeah, allocation perspective in the here and now.
So I think that, if you believe that we are, you know, things are strong, but there's still a risk out there. Then I'd argue that the best way to hedge that is long duration of the treasuries unlike last year, because now you have a higher starting yield to actually protect you against falling markets.
RS: And how does that play into, or does it play into how you're thinking about how the Fed is looking at the markets, playing with the markets, however you want to define that terminology there?
MG: It's funny at the start of the year, I put a tweet saying, the Fed actually wants markets to go up. It wants to prove to the stock market that it threaded the needle for the soft landing or even no landing scenario, right? So, your term playing with the markets I think is interesting because that is - you can argue what they do with their rhetoric.
Now, unpopular opinion, but this is the fact, the Fed doesn't control the long end of the curve. Long duration treasuries, yes, there is a correlation with Fed policy, but it's not 1 for 1. So the Fed can keep on raising rates as they have on the short end, but long duration treasuries can still do well and be in their own world. If you notice, for example, the ( TLT ) 20+ year treasury ETF it’s not made new lows, while the Fed keeps on hiking rates. So, there's one thing to hear a narrative and another thing is to look at the reality.
The reality is that the Fed is a follower of the bond market. I've used that line a lot many times before. The Fed does not own the bond market. The bond market owns the Fed. So treasuries are going to be the thing that ultimately dictate what the Fed is going to do later down the line with a lag.
Now, if you have a credit event, default risk increases, credit spreads widen, that probably marks the end of the bear market, which by the way, I still think we're in. I know this sounds bizarre. We can touch on that maybe in a bit here. But that will be consistent with what you see in highly volatile risk off periods. You would see treasuries move first and then the Fed respond after.
RS: Okay. Get into the bear market a little bit. I'm interested to hear what you think about that. And also if you want to work this in here, I know that you've alluded to it a little bit in what you've been talking about and written about in your recent articles, this index construction discussion that's afoot and the NASDAQ being affected by tech stocks . And yeah I don't want to get, I think I might be throwing too much at you at once, but...
MG: Yeah, no, no, no, it's important. So first of all, we should, like, I put a piece out and I've been trying to stress this as much as I can because it's not just sort of a function of playing with words here, but you know, like the media typically says, you're in a new bull market when the market is up 20% off of a low. Okay, that to me has always been strange because it's not, you’re entering a new bull market. You technically have been in the bull market, right?
If you're going to think of it that way, because you've already gone off 20%. It's in the process of going up 20% when you're in a bull market. But even that to me is not really a proper way to think about the classification what's a bull and a bear.
To me, a bull market is only known with hindsight after you've taken out the prior inflation adjusted high. Inflation adjusted high for the stock market. So if the S&P 500 were to break new highs this year, which by the way is possible. I said that back in January in an interview. I said it's possible that the S&P breaks nominal highs, but it won't necessarily get back to the real after inflation adjusted highs. If you think of it from that perspective, we're still in a bear market, because you're still in a drawdown. Right? You haven't taken out the prior high.
Okay, that doesn't have anything to do with portfolio construction. That's more just about the framework from getting overly excited around how much to allocate, right, to equities.
Now, if – one of the dynamics that was unusual about last year was, there's this saying that markets follow a staircase up and then elevator down. And that typically bear markets end with capitulation. The kind of moment where everybody just sells, and you have a very nasty decline. And that typically is what marks the end of that cycle, VIX spikes to very high levels.
You didn't have any of that last year. So if last year, if October was the end of the bear market last year, it would be historically abnormal given the sequence and given the way volatility itself played out at that bottom.
Now, if we're still in a bear market, a credit event would confirm the end of the bear market because what would a credit event mean? It would mean the VIX spikes , it would mean a very significant sharp decline, maybe slightly breaking the lows of October last year, and again treasuries countering this time around unlike what we saw in 2022.
So, it's more than just semantics. I always go back to, you have to define things properly. Is it a bull market? Maybe, but you don't know until you've taken out the prior high. Until then, to me it still looks like it's a bear market.
You can have a melt-up in a bear market. Bear markets have plenty of very vicious aggressive moves. I hear the argument from people that say, you've never had a bear market rally last this many number of months, I don't disagree. You also never had the fastest rate hike cycle in history like we saw last year.
So my point is, it is more about perspective. We don't know where we are in the cycle just yet, because a lot of things arguably are off. All I know is that when I see the sentiment so one-sided, when I see put-call ratios as low as they are, when I see everybody screaming melt-up when none of these people were around back in October of last year when I tweeted that out the end of the world's bull case, when you have so many people being this adamant, markets do what they do, which is they tend to throw everybody off.
So, I think this is just going to be one of those environments where people do have to be careful with narratives and have to be careful with how much they over-allocate to equities because if this is going to be somewhat fleeting, it can be quite painful to chase a high right before a tail event happens.
RS: Yeah, it seems to me to your point about - also that you know you need to have perspective in order to define things, that seems true of the stock markets and economy - I mean, broader life stuff as well. But I think pointing to both terms like recession when people are screaming up and down that we're in one, a lot of times it seems to me that you don't know that you're in one, until you've been in one. And it takes some hindsight to recognize that.
MG: Right, and I think it's difficult because like now the narrative is, well, everyone was wrong about the recession. So we have to -- everyone has to now admit that they were wrong about recession. Okay, well, isn't that also a prediction that we're not in a recession if you're pointing fun at other people that have said we're in a recession or having a recession?
So if the narrative by the crowd was wrong about the recession a year ago, which again you only know with hindsight, then couldn't the narrative be wrong now that the recession has been actually pushed out? Like, this is my point. The things that people often will argue against, inherently means that they're making a prediction which itself probably ends up being wrong too, right?
So again I go back to the perspective -- again, all that means from a portfolio construction perspective is, I don't know if it makes sense to get overly excited and think about going into, again, Nvidia is my kind of favorite stock to point to, I don't think it makes sense to consider Nvidia a store of value , right, or something that you do put your savings in. A lot of people make a lot of money and don't get me wrong, but you know, if the bear market isn't over and if we're in a manic phase, you can make a lot of manias, the question is can you keep it. That I think is where I think a lot of people are going to get tripped up on if I'm right about what comes next.
RS: Right, Victor Dergunov was on the show, and we were talking about the froth in the AI sector, or the AI part of the tech sector . And he was pointing to Nvidia, which is a high quality company, I think by all measures, except that it's certainly -- the valuation is certainly in a frothy territory at this point. So speaking of perspective, I think, yeah, perspective is key.
MG: Yeah. And by the way I rant on Nvidia quite a bit on Twitter, and it's becoming kind of comedic. I basically said that Nvidia is in – I’m not going to use the word, but is in trouble before the earnings beat. And I was saying that more as an example of the point, which is now being reversed admittedly, that you had all this momentum in just like the number of stocks, there wasn't real broad participation, which by the way, I think that's even still questionable as far as the breadth argument, which we can touch on too.
But I think Nvidia is a symptom of a bigger problem, which is that people think that a stock and a company are one and the same. They're not, right? A stock is one thing, and price movement in Nvidia is not based on AI . It's based on people. It’s based on narratives. It's based on belief, right? And we've seen that with the boom and bust cycles with cryptocurrencies and how narratives keep on changing and then get reversed. So it can be the greatest company in the world.
Cisco ( CSCO ) is a great company. Everyone uses that example of Cisco as the analogy for Nvidia, which could very well be the case. Cisco is a great company and made -- how much money post the Internet bubble of the late 90s, but the stock price went nowhere really since 2000, right? So, to think that history can't repeat and to think that a stock and a company are one and the same, I think is foolish.
RS: Yeah, get into the breadth. I'm happy, as long as we're talking about Nvidia, I'm happy for you to touch on that.
MG: Yeah, I mean look, so first of all, it's funny because I would have argued actually maybe up till recently that if I've been wrong on anything, I've been wrong on the melt-up as I said in January, because up until recently, small caps weren't participating. So there was a stat sometime in April or May, I forgot exactly when I came across that showed that, you know, at this point or that point back then, April, May in a pre-election year, small caps had never been negative at that point in a pre-election year. So, the pre-election script was only playing out for large caps , not to small caps. So now you're seeing, you know, breadth is widening. In other words, you're seeing money now going to small caps and more 52 week highs. The problem is, I think people are misinterpreting what strong breadth should mean.
Strong breadth goes beyond just the number of stocks going higher. It's -- are the smaller, more speculative stocks advancing at a faster pace than the conservative larger cap stocks. Its outperformance is really what breadth is. So as much as you have more stocks participating on the upside, the rate of change of that participation is not beating that of the broader large cap averages. So I look at that, so I probably look at the small cap to large cap ratio as a proxy for that. Small caps are basically just keeping in line with large caps. So, they're participating, but they're not participating adjusted for risk and adjusted for the small size.
So it could be, I don't know, it could be one of those things where maybe they start to outperform, it is possible given how badly they've underperformed, but right now the breadth argument I think is not really, is I think a lot more nuanced than headlines would have you believe.
RS: Go figure. But can we touch on the index construction for a second and your thoughts there and where you think the markets should go, are going, how investors should be kind of preparing for it?
MG: Yeah. So, first of all, it’s interesting, right? Like, at what point is a diversified index no longer diversified, right? So, I put out that tweet looking at the NASDAQ 100 Qs, QQQ , right? And 10 years ago, in 2013, the top -- I think the top 5 names made up 49% or top 10 made up 49% of the ( QQQ ) ETF. Now it went from 49% to 60%. So, it is true that there is more concentration risk in a lot of these big cap headline averages than people realize.
Now, why does that matter? Because if you're going to follow the market, but the market is increasingly being overweighted and that weighting keeps on going higher in a select number of stocks. Well, now it's not a proxy for the market. Now, it's not an index. Now, it's just a couple of stocks that have idiosyncratic risk that everyone's chasing and it's not a true reflection of what's happening with these service.
That matters because if you're going to be a true asset allocator or an investor, you want to be diversified, you don't want company specific risk, and you don't want to be in an ETF that looks like it's diversified, but in reality is just being driven by a select number of names. So that's again going back to perspective. You can make a lot of money that way. Obviously, people have, right? But you're taking additional risks by not realizing that now you've got more company specific risk in what is supposed to be a diversified basket and index abstracting it, than ever before.
RS: Do you think that there are major changes made to this notion?
MG: It's interesting. We're increasingly in a world of oligopolies, right, where a select number of companies run entire sectors and industries. You're increasingly in a world where monopolies are not really broken up. So there's more concentration of power and you're increasingly in a world where there's less competition. So to an extent, you can make an argument that this is the way things are going to continue because the longer term dynamics do not favor an even playing field.
Because the big keep getting bigger and keep taking shares of an industry away from other companies. And by the way, higher rates don't necessarily help with that. Right, so it’s like if you want to increase competition to lower concentration risk by some of these mega companies, you need to have more entrants. Well, now with the cost of capital as high as it is, it's hard to - It's interesting, right?
You can't really - I'd argue that the real way to fight inflation is with competition. But you can't really have competition if the cost of capital is so high. So you end up having more bankruptcies, the very large stay, you know, large, they have cash so you have less players, so the point you end up finding this kind of constant tailwind, right, that favors concentration among the second floor stocks.
Again, you can make a lot of money that way, but my only point is that it just puts you towards far more risk than you might otherwise think looking at the Dow Jones Industrial Average of hold or S&P of hold or Nasdaq of hold.
RS: You're somebody who covers, I mean really a wealth of different parts of the market . One of the things that I wanted to touch on, because not everybody covers the international side of things. How do you talk about the internationals? I mean, I'll let you kind of choose which path if you want to focus on a certain area, if you want to focus on certain ETFs, however, you want to talk about sort of allocation to an international section of the market, let's say.
MG: Yeah, so I think it's important to keep in mind that when you think about internationally, you have to make two distinctions, right? So, one is developed international or emerging. But then on top of that is value versus growth. Okay? So, emerging markets have been dead money for over a decade. I mean, it's -- and I've been very wrong, hoping as -- hoping purposely because my mutual fund tries to play emerging market momentum, it just doesn't want to stick, hoping that emerging markets would lead. And the reality is it's been a game purely of U.S. and not only U.S. but large cap momentum. So, yeah, the last decade plus has not -- obviously not been good for anything international. Now if you believe in cycles, at some point you have to assume, I think, that there's going to be momentum outside of the U.S.
For momentum outside of the U.S. to take place in emerging markets , you have to kill off the tech trade. You have to break the technology momentum because a lot of the emerging market indices and ETFs have a value tilt. In other words, the sector composition for a lot of emerging markets are heavily weighted towards financials, materials, energy, less so tech, which is what's driving them as they can, and the S&P 500 in the U.S. So, if you have a shift away from growth into value, I suspect you will have a shift away from U.S. into international, and in particular, emerging markets.
Now on the developed side, whole different animal, because demographics are horrible when it comes to Europe. They're less flexible, obviously, in terms of -- and less dynamic in terms of their economies. I'm, in general, not a fan of trying to diversify in Europe for a lot of structural reasons. And that value growth story is not as clear as it is with emerging markets as sort of the beneficiary of value tilt.
But I very much do think that we're going to be entering a cycle that should favor emerging markets more than anything else but it's going to be violent and volatile. Part of that thesis relates to commodities, which haven't really done all that much this year, but if you believe in the argument that these are structurally underinvested parts of the investment landscape emerging markets tend to correlate nicely with commodity momentum and strength.
So bet on commodities is also a bet on emerging markets, which is also a bet on value. And all that basically can be summed up into a bet on anything outside of the U.S. where you could have big gains is ultimately a bet against technology as the leader in the US.
RS: And how are you thinking, well, are there specific ETFs that you would advise investors to look at pertaining to the international markets, or ETFs that you feel like investors should avoid?
MG: So I guess it depends on your objective. If you're going to be purely treating a momentum based, the composition is not going to matter as much, because for the most part, you know, in these kind of aggressive momentum moves all the emerging markets would co-move in a similar way.
If you're going to be a longer term investor though, I think there is a lot of merit to the idea of avoiding ETFs and funds that have government state-owned enterprises.
So, try to go for those funds that don't have the government state-owned enterprises as a big portion of their portfolio holdings because if it's government owned by these emerging countries, they don't care about profits. They don't care about shareholders. Right? So there's not a good alignment of interest there when your biggest shareholder is a politician. So, I think, if somebody's going to look at it from the longer term perspective, there’s also interesting funds out there that will weigh emerging markets based on openness and freedom.
So China , obviously, will be among the bottom weighting in products like that. There's a lot of interesting studies that show that countries which have more freedom for their citizens tend to do better among the emerging market landscape. I think that's an interesting area to focus on. But it's still a broader cycle question, right? I mean, as long as technology keeps on fascinating people, momentum is not going to really take place in a big way outside of that independent of whatever you're trying to play it.
RS: Are there tech stocks that you like?
MG: Yes, it's not a function of me being anti-tech, right? It's just a function of where the outperformance is.
RS: No, yeah, that's what I'm curious about. Like are there tech stocks that are worthy of you wanting in your portfolio that are also at a price that you would want to pick them up at?
MG: Yeah, I mean, I don't necessarily do it for my own fund stocks because they’re rotational in the ETF structure. But, yeah, look, it's not hard to see which tech companies have massive cash and have massive dominance and have low valuations, right? Nvidia by the way is not one of those, right? But I'm saying like that's -- it's almost like, you know, if you're going to invest in tech, invest in the blue chip, you know, the names that have, you know, real fundamentals, right, not hype. There's nothing wrong with that by any means, right?
And also, a lot of these mega cap tech companies also, that might have some yield, yeah, I think that makes a lot of sense to consider. It's funny because I think people have this impression that I'm some kind of a luddite pointing out technology momentum. It's not the case.
I'm just simply arguing that when everybody is crowded in any sector, just like by the way, you saw with the energy sector last year, which this year has done, you know, terribly on a relative basis. When everybody is in one part of the investment landscape, the payout is always -- it's usually bigger betting on something else.
RS: So, you would be a fan of the mega cap stocks, you feel like for a retail investor that's a good bet?
MG: I think, again if it's, you use the word bet which is, I think, the right word to use because the bet there is that the idiosyncratic risk doesn't manifest in a very bad way with the concentration of large cap stocks that are driving the large cap averages. I think if you're going to be a real longer term investor, it probably makes sense to be in small caps around these levels. Right? Now, the only caveat there is going back to the credit event, long term small caps, probably do for a period of outperformance because they've done nothing since 2014.
They've underperformed large caps since 2014, so there's a, you can argue a slight mean to reversion play that’s coming. But, there are, it's true, a lot of small cap companies that are “ zombie companies ”, a lot of small cap companies that may not survive rolling over their debt into higher rates. So you have to be mindful of that because a lot of the small cap companies may not exist, you know, in a couple years, which would bring with it recession, unemployment, all that stuff.
So it's a question of timeframe, right? If you're going to – if you believe that we're entering some kind of a highly volatile period, I'd argue actually probably you're going to be more in mid-caps because there's less of the zombie dynamic and there's more diversification as opposed to large cap which are getting concentrated around a select number of stocks. It's just a question of how much risk you want to take for the unknown.
RS: And are you talking about broadly speaking mid-caps or specifically…?
MG: Yeah, broadly, mid-cap 400 or – yeah, exactly, more broadly. Right.
RS: Something we don't talk a lot about on this podcast, but I know that you cover, and speaking you spoke a bit briefly on commodities, is gold . What are your thoughts there specifically on any ETFs and then just broadly speaking the commodity?
MG: Gold is unique in that it doesn't really correlate to very much except flight to safety sequences. So it doesn't have, it makes it, I'd argue the ultimate diversifier, right? Because it doesn't really correlate to too many things. Now, if you think about it from like an institutional perspective, what would cause, you know, big money to position into gold, it would be a feeling that you're in a prolonged bear market. That you're in lost decade for equities, right?
Because if you're in a lost decade for equities or at least if institutional investors believe that, they want less beta. They want less correlation. And there aren't that many things which are truly non-correlated. And the reality is, most things are variations of beta. They’re variations of equities in terms of risk.
So gold, I think makes a lot of sense if I'm right that we're still in a bear market . Right? Because it will be on the realization that we're still in a bear market, which should be a correction not taking out the prior highs and maybe even slightly lower lows. That causes some at the margin some residual money position into gold. So I think it makes sense.
Now the question, of course, is, you know, how much? Right? So, I always make that point. It's not about what you own, it's about how much you own of it. So weighting is always a tricky thing. I'm a fan of the gold ETFs. I get the idea physical versus an exchange traded fund. But the reality is a lot of people, you know, just want the exposure to the price movement as opposed to actually holding it. And so there's merit to that.
I do think there's also an important distinction between gold and gold mining stocks. People seem to be under the impression that as gold goes so too do the miners, it's just not true. Miners are much more dependent upon the price of oil as a driver of their earnings than the price of gold. There's all kinds of studies I could point to that show that. So I think if you're going to be bullish on gold, you're basically being bullish on the timeframe of a prolonged bear market for equities. And if you're going to be bullish on gold, that means you're also bearish on correlation.
RS: Any thoughts on other precious metals?
MG: I think, you can – I think silver would be a part of that, although at some point gold will diverge. You know, it's not something I overly track too much. I think it's good to pay attention to commodities broadly and precious metals broadly. But gold is unique against the other precious metals because of that historical flight to safety perception, right, that causes market -- it's moving to differ from everything else, when you have that high vol.
RS: How would you articulate why it's important to follow commodities and precious metals even if that's not your main focus?
MG: It's also kind of cost-push inflation. Right? So there's a very strong link, for example, between, you know, oil prices and inflation expectations. So as oil rises and inflation expectations rise, as other commodities rise, the idea is that that gets passed on to end products. So it'd be kind of an early warning sign of inflationary pressure, and that matters even for bond investors because if commodities are rising and that puts future inflation in play, then if you're a bondholder, you might want to demand more yield on the possibility that inflation is increasing because of what commodity prices are doing.
So, I think it's always important to look at all parts of the investment landscape. I know a lot of people tend to focus on 1 or 2 parts, asset classes. If you're going to follow kind of a more intermarket approach which is, my school of thought, you want to be aware of the interplay of commodities to stocks, to bonds, to inflation, to currencies, and then how they all affect each other because it gives you a better sense of is the price you're paying today what you should, what -- does the price you're paying today make sense relative to what could be coming in the future?
RS: I appreciate that. Are there specific sectors that you like more than others at this point?
MG: The most boring sector of all, which is utilities. So, I just put this tweet out today, but – so utilities are the most unique sector of the stock market in the sense that they don't suffer from seasonality. Some may go away, dynamics not there.
Utilities are the most bond like sector of the stock market, and utilities have done terribly on a relative basis. If you look at the relationship of utilities against the S&P 500 , you're pretty much at the November 2021 level, meaning utilities have gone a round trip in terms of their outperformance last year. November 2021 is when most people would argue the large cap bear market started.
So, I think, if I'm right that we're in this kind of mania phase and that there's a credit of it out there, and you're going to be long only equities, the sector to be in is the most defensive sector of all which has the highest yields and most boring characteristics which is basically utility companies. So, yeah, I think a rotation out of tech into defensiveness is going to be coming at some point. Utilities is at the least weighted sector of most large cap averages. So, at the margin, big players can't really do too much to allocate there, but if you're nimble and a discretionary trader, that could actually be your best equity play.
RS: Specific stocks that you like?
MG: No, I've tried to prefer -- as much as I can, I try to avoid doing individual stocks. And listen, I mean, I write about individual stocks for Seeking Alpha and not too much on the investment group for the Lead-Lag Report. But I do think it's important for me to realize that the vast majority of a stock’s movement is not because of the stocks, as is of the sector. So, I tend to look at things more from a top down perspective because the evidence shows that you know, is the analogy that everything these – stocks tend to move like a school of fish. You might be able to identify who's going to be at the front of the school fish, but better to bet on the average.
RS: So The Lead-Lag Report, what are the kinds of things that you're, I mean, without getting obviously into the nitty gritty of it, what are kind of the broad things that you’re covering beyond what we've already talked about?
MG: I always say that past matters more than prediction, which is a, I think people don't appreciate that that much, because a lot of people talk about endpoints, right, here's where markets are going to be at year end or what's going to happen. But the dance in between the endpoints is arguably…
RS: It's about the journey not the destination.
MG: Yeah. It’s true. Ultimately it's about the sequence of return. So, I've got the risk signals that are based on these different research papers that I'm known for that won these awards that tell you about volatility, dynamics changing. So that's every start of the week, high yield ideas, macro observations.
My objective is to try to get people to think differently. Now, somebody listening to this is going to say, well, you know, your funds haven't done all that well, especially last year, so why should I listen to you? Well, maybe that's actually why you should be listening to me because cycles exist. Because there's no gurus, only cycles. Right? And in my world, my approach does not do well in cycles which are dominated by pure risk on, because I get whipsaw playing defense risk off.
And I don't do well in cycles that are just dominated by large caps, because, again, the only way you beat large caps is either tilting small or tilting international. So, unless you believe that that cycle is going to persist, which it could, I don't disagree, and if that's the case, by the way, you might as well just buy the S&P and call it a day.
But if you believe the cycle's going to change, then, you know, all the reasons which is why my own strategies have not fared that well gets reversed because the cycle comes the way of the strategies, and that means an environment where large caps are not the only game in town, where risk on is not the only game in town, meter version is still a thing, and to that extent, my hope is that with the research people think differently and at least try to keep an open mind for when the cycle changes, how to take advantage of that inflection point.
RS: What do you think most formed your investing style strategy thesis? What best formed that or what most formed that or what was the series of things that formed it?
MG: I mean there's a lot of family history there in terms of my father being involved in the business. And yeah, but for me, like a lot of my -- a lot of my trauma for lack of a better way of saying comes from 2008 and the way I look at the world, aside from the fact that that was when my father passed, the family business passed, that was also a great financial crisis.
And I say that because I think when you have a confluence of events, which changes the course of your life based on something which is an extreme, you tend to think of when is the next extreme going to happen, right? Because that was the, you know, that was what defined your trajectory in life. So from that perspective, yeah it’s like, I have a natural bias, right? My bias is not to be bullish or bearish. I'm not a permabull. People accused me of being a permabull in October of last year when I said melt-up. They're now accusing me of being a permabear because I'm warning about a credit event.
My bias is to see the flight to safety. My bias is to want to see a tail event where the journey, the sequence of returns, favors, you know, defensive assets for a moment in time so that I can ultimately buy low again. I mean, that's really kind of at the core of my approach. And Siri agrees with me apparently. So, that’s why I'm saying, like Apple's a good stock to consider. But the point is, like, I think, you know, it's like, if all you know in your investing journey is, you know, a smooth bull market, your bias is going to want to see a smooth bull market. In my case, my bias is, I've seen tailwinds, I've lived them. They've changed my life.
So I don't mind seeing those because I think I can take advantage of them now, certainly, I did with my mutual fund, which again has rules based in 2020. In 2020, ATACX was up 72%. Now, it gave all that back, but it was up 72% because I had a tail event in 2020. I had that moment for risk off to really work. So my bias is that. And I hope that those that are listening and that are reading the work that I put out can appreciate that I try to think things differently, think about things differently, and I'm just naturally a cynical person, a skeptical of narratives which may not make sense when the trend is up, but makes a hell of a lot of sense with hindsight when things correct themselves.
RS: Nicely put, Michael, I really appreciate you coming on today. I think Salient is a good word. I think articulate is a good word. I think thoughtful is a good word in terms of the analysis that you're bringing. Any final words that you would want to share with investors in terms of thinking about the markets, looking at the markets, thinking about investing, anything that you would like to leave them with?
MG: Yeah, man, go back to this line, I say often, which is that, opportunity always exists when the crowd thinks it knows an unknowable future. Right? Like the problem that somebody asked me on Twitter, it's like somebody was referencing Chamath and saying Chamath thinks we're in this massive bull market, what would you say to that?
And my response was the problem that I have and that Chamath has is that neither of us can predict the future. It's why I always frame things in terms of conditions, right? I don't know the mile marker I might crash my car, but I know we need to slow down when it's raining. Right? So I would just caution people to not get caught up in FOMO. FOMO works when a crowd is right on average, but they're wrong at the extreme.
If you can identify when the extreme is, or at least a good amount of where the extreme might be ending, early enough, you'll be much more profitable, as painful as it is to not be a part of that FOMO. And recognize that being contrarian doesn't mean that you're just saying the opposite of what the crowd thinks. Being contrarian means you're betting where there are fewer other players betting, which means the expected payout is higher, which is I think another nuance in terms of how to think about going against the crowd.
RS: I like Nuance. You're a successful person on Twitter. Have you moved to Threads, out of curiosity?
MG: Yeah, I'm trying. I mean its - I think, I hope Elon Musk gets it right, but like the -- I think the QA on that app is terrible. I mean, there's bugs everywhere, there's bots everywhere. And it's like, listen, he's not an operator when it comes to the app world, right? He can be the most brilliant guy in the world, but it's a whole different animal, right? It's like Zuckerberg trying to get into EVs, you'd say that's crazy, right? But Zuckerberg knows what he's doing. He's built social media apps. He copied them. That's fine, right? But he still knows how to build them. So - and the network effect is real.
So, Threads to me is, it's like a Twitter backup at this point. I think Zuckerberg has a real chance at dethroning Musk. But listen, I'm running businesses just like Seeking Alpha is, right? You want to have exposure to as many different places as possible because you have different audiences. So, just like you diversify your portfolio, why not diversify your social media cred?
RS: Yep, Michael, I appreciate you coming on. I hope this is the first conversation and not the last, and I hope to talk to you soon.
MG: I appreciate it. Thank you.
For further details see:
Why Michael Gayed Thinks We're Still In A Bear Market