At Exchange, Evan Harp sat down with Joe Mallen, chief investment officer at Helios Quantitative Research; Gary Stringer, chief investment officer at Stringer Asset Management; and Eric Biegeleisen, deputy chief investment officer at 3EDGE Asset Management.
Evan Harp: Thanks for joining me everyone! Excited for this full house discussion. Let’s get a run down of your firms, starting with Helios.
Joe Mallen: We are, in effect, insourced CIO solutions. We work with advisors to custom build model portfolios based upon quantitative academic principles that they can white label and offer to their clients.
Harp: How about Stringer Asset Management?
Gary Stringer: We also work with financial advisors and financial planners who implement our portfolios based on our three layers of risk management strategy that blends strategic allocation, tactical allocation with a methodology for raising cash.
Harp: Excellent, and for 3EDGE?
Eric Biegeleisen: A lot of similarity here! 3EDGE is a global tactical multi-asset investment manager. We offer a wide variety of solutions to individuals, RIAs, institutional clients, available on TAMPs and directly through separately managed accounts as well.
Short-Term Challenges and General Overview
Harp: What do you think is the greatest challenge investors are facing in the short term?
Biegeleisen: I would say one of the biggest things going on now in 2023, that we’re focused on, is it feels like the market is pricing in this perfection by the Fed — that we’re in a situation where the market believes the Fed is going to engineer inflation down to 2% without raising unemployment, without causing a recession. We’re seeing that in the market more recently, breaking through the 200-day moving average in the U.S. The real question is, have the lags of all of the aggressive monetary tightening that occurred in 2022 not even really manifested yet in the market, and might be there a comeuppance ahead of us? We still find U.S. equities to be overvalued, by our measure, and we think perhaps maybe the pendulum swung towards non-U.S. international equities, being much more fairly valued by our research.
Stringer: In our view, one of the biggest challenges for investors today is that it’s such a convoluted world with a lot of different agendas out there depending on your source of information. Trying to make sense of these divergent opinions on top of Federal Reserve policy risk, geopolitical risks, valuation risks, and so on. All of this noise has to be the biggest challenge. We’re dealing with things that we haven’t seen in a generation, like the amount of inflation that we’ve experienced and the Federal Reserve policy response. It’s very difficult for individual investors to make sense of all these themes.
Mallen: I echo that sentiment quite a bit, where it’s really trying to find optimism with clients right now. Coming out in 2020, I think the narrative we’ve all learned as to why the market was so strong in 2021 and the latter part of 2020 had a lot to do with spending stimulus and accommodative Fed policy.
We’re entering a new world now where we have higher interest rates, we have a Fed that seemingly not going to quickly put that a level of stimulus back into the market, and pretty high stretched valuations compared to long-term history.
It’s a little uneasy. I think people felt pain in fixed income for the first time ever, for many investors. That has them asking, “What do I do here?” In some respect we’re always there — we don’t know what the future holds. But I think people are a little bruised and scarred right now after the past three years as investors.
Fixed Income Outlook From Exchange
Harp: I’m going to get into a couple of specific questions now that we’ve got a broad overview of who you all are, and what you feel about the general market situation.
Let’s start with the fixed income outlook. How has that changed amid the Fed’s pivot? What do you see as the future of fixed income? Fixed income ETFs are also changing quite a bit, and I’d love to hear all your thoughts on that.
Stringer: We are actually more optimistic on fixed income than we’ve been in probably 15 years. When we look at current yields and our outlook, we think we’ve probably seen the peak in 10-year Treasury yields. So, we think Treasuries are sexy again, or maybe for the first time ever.
We’re more cautious on credit at this point because we do not think the market is discounting the potential for an economic recession in the U.S. and global risks based on where credit spreads are today. The differences between the Treasury yield, for example, and a comparable duration credit corporate bond are quite tight, so we don’t think we’re getting paid for taking that risk. We do think we’re getting paid by high-quality U.S. Treasuries for the first time in years. So that’s where we’re positioned.
Biegeleisen: I would totally agree with all of that. 3EDGE has been out of credit for multiple years now. We totally agree the yield is attractive, particularly at the short end, short maturity on the Treasuries.
We’ve also liked U.S. floating-rate Treasuries, particularly in this rising rate environment — though that may become somewhat unnecessary if we’re topping out on monetary policy tightening. And then, most importantly, we’ve really liked inflation-protected securities. You had, at the beginning of 2022, real yields, as noted by the yield on a TIPs bond, at negative 110 basis points. By the end of 2022, its up at positive 150. So, that’s a 260 basis points swing in one year for real yields. That’s a very large move. But the good news is that those have topped out, and have even come down somewhat. So now you’re potentially getting capital appreciation on your TIPs bond, while also getting over 100 basis points real yield on top of CPI.
Mallen: Well, we’re all quants and systematic investors.
I’ll say two things. First, I think, as a setting, I like where the fixed income market is now. People in the retirement phase in their life are actually earning yield again. Where we were a year and a half ago, earning 1% on your conservative “investment” was terrible. There’s a lot of asymmetric risk to the downside in bonds, I think we’ve reset ourselves back to an attractive starting point. So, with that being said, in more short-term, we’ve been short duration for a long time due to our inflation signals. Now that inflation is coming back down, I think there will be a time to step more into duration.
A contrarian point that I think we have is, many folks are so short right now they’re like, “I can get 4% on a one-year bond.” But the notion of reinvestment risk is coming back into play, and duration can be your friend. It’s one of those things long-term that is countercorrelated or not correlated to equities. I think the fundamentals of building a portfolio are all in our favor again, these things are attractive.
But certain things, like emerging market bonds, where we’re now into global high yield — this is a lot of just trend stuff on those more risky fixed income asset classes. As that trend starts to improve, we’re more comfortable dipping our toe back into those.
Emerging and Frontier Markets
Harp: That’s excellent. Speaking of emerging markets, I’d love to get your takes on China, other emerging markets, and even frontier markets. China has these historic valuations at the moment, but there’s also still a lot of risk there.
Mallen: I think we’ve had this undercurrent for decades of a growing middle-class population coming out of poverty, finding tremendous opportunity, that’s all there — but then you have the political and global conflict risk that you have with that type of investment. I think where we sit now, it’s hard to put overweight China. I do think it deserves a position in a diversified emerging market equity exposure. I think the falling dollar could ultimately help a lot of these emerging market countries that haven’t done well for a few years. Its been a long time since International and emerging markets have been strong performers relative to the U.S., but it could be shaping up.
Stringer: We think we need a breather on some of China’s stuff with respect to the massive jump in China’s equity prices. They are up 40%–50% in just a few months. That’s an awful lot of upside priced in that the market still has to digest. Also, if you do end up in a situation where the U.S. falls into a recession, that tends to pull global asset prices down as well.
The valuation story is absolutely there though. We think it’s more of a tactical trade than a strategic investment theme, and we’re just a little bit leery about how front-end loaded that market might be right now because of the valuations.
Now, on the other side of this, once we start to see some things settle down, we think there’s great opportunities there, especially those emerging markets like Mexico, for example, that are more connected to the U.S. economy. We think there’s a lot of long-term upside to countries like that.
Biegeleisen: Sounds like we all have similar outlooks! China is a tactical play for us as well. From the peak of China’s market, which was in February 2021, it dropped around 65% from then until about the end of October 2022. Our model research indicated it was undervalued. The macro economics weren’t necessarily there, but behaviorally it was so deeply oversold.
Then, more recently, like you just suggested, Gary, we think maybe it’s gotten a little ahead of itself. It’s run up quite a bit. Longer-term, we believe the valuation is still attractive. But it’s going to be touch and go based on what’s going on with zero-COVID policy removal. Are we seeing China return to becoming that global growth engine that it once was before the pandemic? I think time will tell, and maybe we’ll tease that out a little bit in commodity prices as well.
Mallen: That’s a great way to play it, like you both said. In the next 30 years, China and India will grow quickly, but the amount of volatility there is huge. So applying a more technical signal when it’s really oversold will help. I believe, long-term, that there is excess risk premium to be had here. Buy it when it’s suppressed, sell it when it’s overheated. As a U.S.-based investor, we can do that with emerging market debt countries.
Biegeleisen: We haven’t touched on frontier markets. Generally speaking, over the long run, our research indicates these may be attractive markets to include in your portfolio.
Stringer: We actually shy away from frontier markets because you got to wonder about how stable their markets really are. And also, at the end of the day, there’s an individual investor on the other side of every trade that we make, and, if we’re working for a financial planner, or a financial advisor, they’re going to have to explain why Malaysia blew up in their portfolio. That’s a more difficult conversation than if we’re wrong on U.S. consumer staples.
Harp: Do you want to be the tie-breaker, Joe?
Mallen: I like your logic, Gary, actually more than what I was planning to say. We don’t have any direct frontier market exposure. It’s not completely by design — we do more large asset class-based stuff. So we’re going to get that exposure through an emerging market ETF that has some frontier exposure, but I like what you’re saying. I mean, that’d be a good reason not to own a direct Malaysian ETF.
The Energy Sector
Harp: I want to dive into a specific sector. Energy was interesting in 2022. It grew its share of the S&P, but its performance was definitely stronger at the top of the year than the bottom. What do you all make of energy in 2023? As a as a sector, do you think it’s peaked, or do you think it’s poised for a big 2023 as well?
Biegeleisen: I think some of it’s going to come down to China and how reinvigorated China’s economy gets. I think you have a situation where you had the drawdown of the Strategic Petroleum Reserve here in the U.S. and maybe that helps put a floor — particularly on oil and on how low that price can go as we have to restock that supply.
Stringer: We’ve had such a strong rally in energy equities really since the bottom of the pandemic, when futures prices for oil went negative. That’s unusual, right? And so any price above zero is actually good for the energy companies, clearly.
But we think there’s a lot of the good news that has already been priced in, so we actually have pivoted that position into the MLP space because we think the energy companies are much more well disciplined with respect to their balance sheets and income statements today than they were during that build-out in the run up in oil prices in, say, 2013 or 2014 when it looked like overbuilt capacity. Next thing you know, oil goes more than $100 a barrel to $26, and these guys get killed.
The situation is different now, and we do think that the energy complex is fundamentally sound in terms of oil prices. We also think these companies are better managed in terms of their financial situation. So, we’re happy to own the MLPs and collect a nice yield, with some potential upside there too.
Mallen: That’s a good point. Today, we still own energy from a pure quant tactical position. But I just know that it will leave relatively soon due to overvaluation in the run up in 2022. I think they’re often linked to commodity prices, which I also feel are a little overheated at this point in time. Long-term commodities have negative returns, and we had such a strong year in 2022 that It feels like more of an outlier to me. I’m not not bullish on them. There’s a lot of pressure, I mean — clean energy and other more long-term trends that are trying to push down oil demand.
Harp: I want to pivot on that, because commodities is such an interesting topic in and of itself, because what each individual commodity is doing is going to be vastly different than what another commodity is doing. Thinking about things like the wheat harvests being affected because of the ongoing Russian invasion of Ukraine, every commodity is navigating unique circumstances. So, as we sit here in February at Exchange, if you had to choose a specific commodity that you would be more interested in than other commodities, what would it be and why?
Biegeleisen: Maybe this isn’t the answer you are looking for, but we do like agricultural commodities, generally speaking. For the exact reason you said — the Russia-Ukraine situation. Also, you have severe drought conditions around the world, yet people still need to eat. So that’s just not going away. We continue to like that as a potential long-term position.
Stringer: I think that makes a lot of sense as a long-term position. We’re not in gold right now, but it could make an interesting tactical investment as a hedge against uncertainty.
We were just talking about how maybe the markets have run up so strongly, for a variety of reasons. But if the Fed gets it wrong, or if the Ukraine situation blows up worse than it has, we could turn to commodities more. We don’t actually like gold as an inflation hedge, we think it’s better used as a hedge against uncertainty. So, if we are thinking about commodities in this market, gold is likely where we would be most interested.
Mallen: Yeah, I like that answer from a “clients know it” type of perspective. It’s become a more stable position in a portfolio as long-term history shows benefits. I don’t want to steal that one, so I’ll go off the grid a little bit.
This isn’t really a Helios opinion. This is more subjective, based on your question, but I like components of batteries and things like lithium, or anything used in energy storage. I just think that’s going to be a massive trend and limited supply. Makes a lot of sense to me to put those things together. But, full disclosure, I’m not a fan of commodities period, and most portfolios for that hold negative return profiles, as I talked about a second ago.
The State of ESG at Exchange
Harp: These are all great answers, and because you brought up batteries, Joe, let’s pivot into ESG investing. ESG has become a strangely hot-button issue. It’s getting wrapped up in politics. What do you guys think the future of ESG investing is, and is ESG investing dead or transforming into something else?
Mallen: I think it’s all window dressing. I don’t believe it is a long-term factor towards performance. Honestly, I think when you look at actually putting it into practice, how do you determine what companies are good based upon what ESG component you’re looking for?
For example, I know ESG funds that own Chevron, because they’re taking an activist approach on working with Chevron to be more green when a lot of other funds completely screen it out because it’s Chevron. We’re just in this weird world. I think it’s a product to scratch an itch for clients. They want to feel like they’re doing good for the world with their investment. I said years ago, just wait till they have a market drawdown and that desire just kind of goes away. Once you realize you’re losing money, you’re not as interested in saving the world. So I know that might be contrarian, but it’s here to stay. It’s definitely going to be around, people are going to want it, and we’re going to provide it. But I think that’s all it is.
Stringer: We think the future of ESG is really highly uncertain. There are a lot of themes that come out from marketing guys trying to post up and sell stuff, and there’s a lot of gaming that can happen. As you mentioned, Chevron. There’s an argument to be made that, and I’ve heard this from equity analysts in the ESG space, who will say, “Well, you take Chevron and Exxon, Chevron might upgrade their parental leave policy just so they screen slightly better than Exxon.” Then, suddenly, Chevron gets more investment because of something that isn’t actually germane to their business.
So, there’s a lot of ways to game this thing, and there’s very little consistency around what ESG means to people. Is it environmental? Is it social? Is it governance? Which one is more important than the other? We think the jury is certainly out, and the other thing about this is the political side. A lot of our clientele are older and more conservative, but they’re passing their wealth on over to a younger generation that might be more progressive. It may seem highly uncertain today, but maybe in 20 years it becomes a thing, or maybe it just slowly goes away.
Biegeleisen: We run two ESG strategies at the firm, and I think, Gary, you hit it on the head with the fact that there’s just no uniformity here. But I do think ESG will be a factor in the future only because that is going to be how businesses will have to operate to raise capital to sell their products and widgets. Customers — particularly in the United States and Europe, may demand that companies operate with a certain level of decorum around carbon transition and governance, and things of that nature.
Mallen: That’s a good way to put it. I mean, that’s probably the silver lining. All of the demand from the investor side is actually changing companies, at least the way they’re perceived.