(Bloomberg) — Former Federal Reserve chairman Alan Greenspan famously used the phrase “irrational exuberance” to describe the euphoric investor sentiment that sent technology stocks soaring in the late 1990s. Everyone knows what happened next.
Most read by Bloomberg
Now history seems to be repeating itself as some of the disruptive and innovative companies that have been the darlings of the market during the pandemic lockdowns are being thrashed by a “dose of realism,” said Aoifinn Devitt, chief investment officer at Moneta, which oversees on more than $32 billion in assets.
Devitt joined “What Goes Up” to explain this and more. Below are lightly edited and succinct highlights from the conversation. Click here to listen to the entire podcast and subscribe to Apple Podcasts or wherever you listen.
Q: I want to ask you about the nature of defensive stocks — how do you defend in this stock market?
A: Ultimately, the way to be defensive at the portfolio level is to have a well-diversified portfolio. And by that I mean all asset classes, including bonds, including alternatives, including cash flow generators, including real assets. And that’s our best way to ensure an all-weather portfolio. When it comes to stocks, defensive stocks may be a bit of a misnomer because we’re ultimately in stocks, which are a higher risk and return asset class. They will be mark to market. They will experience volatility. We see stocks with a high mutual correlation, especially when there is a sell-off. But that said, there are still sectors that could be considered value stocks, which, unlike growth stocks, have been quite out of favor in recent years. And there have been times when investors have cycled to value in that amazing growth-value rotation that we could be seeing. But those rotation periods were actually quite short. So we shouldn’t be under the illusion that these defensive stocks have somewhere to hide if there is a dramatic correction in the stock market, but they should be somewhere where investors can flee in a flight to safety.
However, the added complexity surrounding these so-called defensive stocks is that traditionally when interest rates rise, they have been seen as perhaps bond proxies or have been seen as bond proxies. So they tend to see money flowing out as interest rates rise — they’re not as defensive when we see an environment of rising interest rates. So it’s all relative. Are they more defensive than a high-growth portfolio? Absolute. Are they going to protect your capital in a stock market downturn? Not necessary.
Q: We now have this unique reverse cycle — how do you play that, especially considering the last few weeks?
A: Just as we can adapt to anything, any new normal will somehow quickly become the norm. We saw that with Covid restrictions – how wearing a mask became the norm, how restrictions became the norm. When it comes to inflation numbers, something that may have been dazzling at its 40-year high is quickly becoming normal. I’d be surprised if we saw high single-digit inflation continue — maybe for a few more months, maybe halfway through the year. Ultimately, we have to remember the base effect in some of those numbers and some of the contribution of the shock surges in energy, and some other components in it that probably wouldn’t be sustained. Food prices could be an example. So the main question around all these inflation numbers is stickiness. There is a plethora of risks in markets right now and they are all interrelated, but equally each of them can grow exponentially to become a serious problem.
Those are the problems around inflation, around rising interest rates. And you mentioned it upside down — that’s a great analogy, because there’s a lot of things that don’t make sense these days. Usually we talk about stagflation, that when we have a rising inflation, it might be accompanied by high unemployment. And that’s a perfect storm leading to a recession. We don’t have high unemployment today. We actually have a very robust job market. In fact, we have low unemployment rates, which are back to pre-pandemic levels, so that doesn’t look like a recipe for a recession. Likewise, when we have a high inflation environment, we often have a weaker dollar, and now we have the opposite — we have a dollar at the two-year high. So what does that tell us? Maybe, yes, the dollar should be under pressure because of the inflation environment, but our central bank is taking measures that other central banks are not taking, and maybe it only looks strong because every other currency worldwide looks quite weak. So we have a lot of juxtapositions of interesting facts right now, and it’s challenging for markets to understand.
Q: People still spend like crazy. Chipotle raised the prices and it didn’t hurt them at all. Are there parts of the consumer economy that you think are less vulnerable to rising prices, and others that don’t have as much price power and could put pressure on their margins?
A: We can look at what inflation would mean for different sectors under normal circumstances and then look at the current background. The level of assets in money market funds peaked right after the pandemic due to incentive payments, the CARES law, etc., and the fact that consumers couldn’t spend their money, the increased unemployment benefits and just the fact that there was really nothing to worry about. to spend money on. They couldn’t use services; they consumed goods in a very robust way. So because of all that, there’s this pent-up purchasing power, or dry powder. It is decreasing by the day as inflation clearly erodes money. So it will affect that real purchasing power. I think that’s where the interesting dilemma lies.
Normally I’d say it’s things like discretionary spending, spending on things like hospitality or travel — where I’d normally see the consumer being more vulnerable. And ironically, Chipotle is probably in that price range of restaurants — the fast food or enhanced fast food segment — where people tend to downgrade as opposed to eating at a more fine dining establishment. So probably it’s still in that category that’s probably pretty robust and supported. But we recently saw United Airlines come out to say that they actually expected demand to be strong. And we’ve seen that fuel prices have been passed on in higher airline ticket prices. But despite this, there is a pent-up demand to take that vacation, take that overseas trip. And I don’t see that diminishing.
So, like I said, that may be artificially prolonging consumer power, these savings, plus the sense of fear of missing or missing the normal spending pattern for two years. That’s very hard to say at the moment. Where we can clearly see things like Netflix, Peloton – areas that they would have spent money on during the pandemic and that are no longer adequate replacements for the real thing, or for going out and spending on the movie theater or that bike ride. Those are areas that may have been bought over during the pandemic. It’s an interesting dilemma about how this purchasing power effect is likely to turn out.
Q: You spoke to Cathie Wood recently — what did you learn from that conversation with her about her strategy? Is it in danger in the coming years, or what needs to be done to bring back the kind of outperformance she saw?
A: We are seeing a wave of critical thinking. And that’s basically what I focused my discussion in the interview with Cathie Wood on. I wanted to really question some of the growth assumptions built into some of the modeling they’re doing on segments like driverless cars or artificial intelligence, or the adoption of digital wallets, or the price of Bitcoin. I asked her about her modeling work and the opportunities in it. I also asked her how their modeling had been in the past and if there had been a case where they had been extremely optimistic, because that was often the criticism of some of these models — that they were too optimistic.
I don’t think our fascination and obsession with innovation will disappear anytime soon. What we’ve probably introduced is a dose of realism. And the irrational exuberance that Alan Greenspan was referring to may have had a hint of it around some of these projections. If you think about it, probably not five years ago, we all thought today — 2022 — we’d have driverless cars. That is not reality today. Sometimes technology is naturally very difficult to model. We struggle with modeling technology adoption. We struggle to model the impact of climate change. So many of these models have so many different inputs that are all often interconnected that there will be a huge element of a funnel of possibility and a funnel of doubt with all of those models. So what we’ve seen is a dose of realism around some projections. It’s probably no coincidence that that happened at the same time that we’ve been seeing some of the gloss coming from tech stocks that may not be great innovators.
Most read from Bloomberg Businessweek
©2022 Bloomberg LP