Evan Harp sat down with Stringer Asset Management’s Gary Stringer. They discussed fixed income, behavioral finance, and what 2024 and beyond could hold for investors.
Stringer’s Fixed Income Strategy
Evan Harp: Fixed income has been a big topic in 2023. How has your firm been incorporating fixed income ETFs into your strategy?
Gary Stringer: We exclusively use ETFs for the fixed income portion of our Strategies. We are finding a wealth of opportunities to implement our investment ideas. For example, a couple of years ago we thought the markets did not properly appreciate the amount of inflation we would experience. So, with one fixed income ETF, we were able to implement an inflation protection strategy via Treasury Inflation Protected Securities. And that really worked out great. That’s the ease of use we want, where a single ETF can give diversified exposure to an entire fixed income sector. This same ease of use can be applied to style, duration management, credit quality, etc.
In fact, we use fixed income ETFs for everything from asset-backed securities to bank loans, corporate bonds, Treasuries, and even taxable munis. We feel like if investors are just using the old corporate bond ladder or something similar, they’re really missing out on the number of fixed income ETF options available that can add alpha and manage risk — much more so than we could in the past.
Harp: As fixed income ETFs grow in popularity, what are some of the main benefits for investors?
Stringer: There are so many benefits, but one of the most important has to be accessibility for the average investor. Building a well-diversified fixed income portfolio with individual bonds can take a sizable investment. Not only have ETFs really eliminated the size limitation problem, but they also provide access to just about the entire fixed income universe. As fixed income ETFs have grown in popularity, more high-quality products have come out. There are a lot of great choices available today as well as more liquidity in the space. At the end of the day, fixed income ETFs give investors the opportunity to implement a lot of different types of strategies, easily and cost-effectively.
Harp: Terrific answer. Let’s pivot over to behavioral finance. How would you define it and how are you incorporating it into your work?
Stringer: Behavioral finance is a field of study that helps us understand the many biases that we all have as human beings that can result in cognitive errors. Errors that often result, ultimately, in investment mistakes. Behavioral finance is really at the core of our work. It’s the reason we started our investment process and why we started the firm to begin with.
The way that we incorporate it boils down to just three things. Behavioral finance teaches us that volatility matters: downside market volatility affects people at least twice as much as the euphoria of a gain. When markets are down, people tend to panic or make emotional decisions. Making emotional decisions rarely ends up with a good result. So, volatility matters, right? We take a risk-averse approach and monitor the betas or lower beta just to help smooth that ride. Thus, the first thing is volatility matters, so we pay attention to it, and manage it to the extent we can.
Secondly, people have a craving for action. Especially in today’s 24-hour news cycle, it looks like the world is moving fast and investors want to know that their portfolio management team is at least trying to navigate these markets. It’s important to incorporate some kind of tactical elements to our work. The buy-and-hold, set-it-and-forget-it kind of strategies just don’t work these days. We learned that decades ago really, when you think about going from the tech bubble into 2000, 2001, and 2002. You had three straight down years in the markets, and if you just had a buy-and-hold strategy, you probably would have been fired. So, it’s important to have some kind of tactical element to our strategies that allows us to be opportunistic when we think there’s a way to add value or to manage risk, and to satiate that craving for action people want to see. But you need to balance it right, because you don’t want to be a market timer — we know over time that doesn’t work. But there is a sweet spot there, and we try to focus on that.
The third component is that market crashes do happen. It’s important to have a plan in case of an emergency ahead of time. You can’t ignore that 2008 happened, and you can’t ignore that 2000 to 2003 happened. Those strategies that say you must be fully invested all the time ignore that kind of black swan market and, ultimately, many investors panic or make decisions that probably won’t help. Or, they’ll make emotional decisions in the middle of a crisis, which is not likely to work out well.
We have a plan in case of emergency, so our process satisfies that requirement. Our Cash Indicator is a quantitative tool, so it’s unemotional and rings the bell for us to say, “Hey, this is very different, and it’s time to raise significant cash.” Just knowing that a plan is in place can help investors rest easier.
Harp: That makes a ton of sense. I imagine that knowing that there’s a safety net gives people a lot of extra comfort and makes them less prone to wanting to push for an aggressive action at the wrong time.
Harp: Related to all of this, what are some of the biggest mistakes you see investors make in this environment?
Stringer: You know, it’s almost always some element of behavioral finance. In October of last year, when the market was selling off, people were afraid of the market, right? Fast forward nine or ten months and you’ve got a handful of stocks that are really driving the market higher. Now you’ve got this fear of missing out and people are wondering, “Why isn’t 30% of my allocation in these really expensive and speculative type stocks?” There are great businesses out there, but the stocks have just run. Again, it gets back to that behavioral finance element, that fear of missing out is what’s going on today. That’s one of the biggest issues, people feel like they’re missing out, and they forget to be patient.
The 2023 market has been very narrowly led by just a handful of stocks. But it’s also this area of the market that has run so hard that it has actually become very expensive. We know from history what happens next, as we’ve seen this time and time again. For example, just out of the pandemic, you may remember the stay-at-home, or the work-from-home stocks rally. They left everything else in the dust, and then it kind of went sideways for a while and the rest of the market was able to catch up. We don’t have to look that far in history to see these market scenarios. And it happens every few years where you get some small sector of the market really takes off, so valuations tend to get stretched.
For example, the growth sector of the US equity market, based on a P/E is trading at more than one standard deviation above its historical norm over the last 10 years. It’s only been more expensive than this about 15% of the time over the last 10 years, which means it’s been less expensive than this about 85% of the time. That’s a big deal to pay attention to.
Or even more striking, when we talk about this particular statistic, for a lot of folks it just blows them away: the S&P 500 Index is trading at about a 10% premium to its 10-year average P/E ratio. Now, this Index is cap weighted, so the biggest stocks have the biggest contribution to performance. If you take those same 500 stocks and equally weighed them instead, you will get a 10% discount. So, you’re not trading at a 10% premium anymore, you’re actually 10% less expensive than average by equally weighing those same stocks. It’s just really interesting watching this year’s market leadership.
The biggest mistake that we’re seeing right now is people piling into those same few names that are now very expensive. We’re not saying those aren’t great companies that have real business models. It’s not like the dot com bubble, where we had pets.com and others trading on invisible earnings. But are these companies really worth that premium? There’s something going on. Either these earnings estimates are ridiculously too low, and all these professional analysts have no idea what they’re doing, or the market got ahead of itself, and these guys are expensive.
What is likely the case is probably somewhere in the middle, with respect to these particular stocks. But meanwhile, the rest of the market has been ignored. There’s plenty of opportunity out there. We think that currently the biggest mistake is that fear of missing out. That has people chasing what worked for the last few months and forgetting that valuations ultimately matters and that reversion to the mean is a real thing.
When you buy something that’s very expensive, you tend to not get as much return out of it going forward. We favor the things that aren’t as expensive, which is basically the 493 other stocks in the S&P 500 that haven’t run.
Harp: That that makes a ton of sense. Given that this Meet a Strategist, I have a question that plays into all of this but takes it out of investing a bit. When we talk about Behavioral Finance and emotions and biases, where does this kind of work directly impact your life outside of investing?
Stringer: Oh, absolutely, yeah, there’s all kinds of stuff where I see it. Often in just little things. Like when I’m driving through a parking lot and see everyone trying to cram into the same spots by driving around and around looking for an opening. If you just go a couple rows over, there’s plenty of parking spots available that nobody’s even looking at. I see that herding all the time.
It’s actually these behavioral errors that come up in our lives constantly. We are creatures of habit and once we form these habits, it’s hard to shake them off. Just being able to take a step back by virtue of having some knowledge of how people are generally hardwired can be huge. Then, you can try to make more rational choices in your life and save some time, for example when you’re going to the mall. You don’t need to chase the same parking spots as everyone else is. Just go a couple rows over where there’s plenty of parking available, and you’ll probably get to the store quicker.
Gary Stringer on Upcoming Excitement in 2024
Harp: That’s an amazing answer — thank you. I have one more question for you. 2024 is right around the corner. What’s the most exciting thing to you about the coming year?
Stringer: For us, it’s not just the coming year but in the coming years. We think the next business cycle — especially for the US — is going to be the most high-quality and long-lived business cycle we have seen in probably 30 years. We have such solid fundamentals in the US that it’s really exciting. And what we’re really talking about are a few things that have a tailwind for the US economy. First, one of the myths that we’ve been taught for years is that the US doesn’t manufacture things anymore. I remember when I was in middle school hearing from one of my teachers that no one in the US makes a color TV anymore. We certainly don’t make the textiles in volume like we used to. That’s why you interact every day with things that are made overseas. And it’s easy to think about those behavioral biases, when you interact with them every day. You touch a brand that has a label that says it was built in or manufactured in another country.
Yes, it’s true, we don’t make as many T-shirts as we used to. But when we look at high-value add, the US is the second largest manufacturing economy in the world, just behind China. We are well ahead of Japan and Germany, the number three and four ranked countries out there. Where we’re specifically leading is in high-value add stuff, which makes sense because if you’re going to be a wealthy country you have to continue to drive up the value stream. So we lead in areas like high-end computing, high-end automobile manufacturing, and high-end pharmaceuticals. That high-value add gives us a very strong foundation.
Secondly, the US is rare among developed countries in that it has a large and growing labor force. If you’re going to grow the economy, one of the key components is to have a large and growing labor force. The other thing that leads to growth over time is the productivity growth of that labor force. Here’s the thing that we think has been underappreciated. The amount of investment in domestic manufacturing, or just industrial capacity in general, has been booming for years now. There’s been a lot of headlines recently, with the Inflation Reduction Act and CHIPS Act that were passed last year, but the private sector had already started to increase investment there.
What we saw in COVID, with the supply chain disruptions, just really shone a bright light on an issue that had already been discussed a lot. Global supply chains can be fragile. US companies had already started increasing domestic capacity in terms of investment in plant and equipment. Now we are just piling it on with the additional government support there. Additionally, with respect to private sector investment and R&D spending, spending on research and development had stagnated for the better part of a decade, up until about 2015. One of the reasons why we haven’t been seeing a lot of productivity growth in the US was because private sector R&D spending had been lagging until about 2015. And then since, there’s been accelerating investment in research and development spending. We’re going to see more new innovations that will make our lives that much better and our labor force that much more productive.
To summarize, we’ve got a solid manufacturing base already, we’ve got a large and growing labor force, we’ve got massive investment in industrial plant and equipment to drive increases in capacity, and we’ve got more investment in R&D spending. The businesses in the US are investing heavily in the private sector and development. That payoff is going to be coming for years down the road. We’re very excited about what 2024 and the years after are going to look like, economically, for the US.
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