Welcome to Something More with Chris Boyd. Chris Boyd is a certified financial planner, practitioner, and senior vice president, financial advisor at Wealth Enhancement Group, one of the nation's largest registered investment advisors. We call it Something More because we'd like to talk not only about those important dollar and cents issues, but also the quality of life issues that make the money matters matter.
Here he is, your fulfillment facilitator, your partner in prosperity, advising clients on Cape Cod and across the country. Here's your host, Jay Christopher Boyd. Welcome and thank you for being with us for another episode of Something More with Chris Boyd.
I'm here with Jeff Perry, who is my regular co-host, and Brian Regan, who is, we're off with the AMR team of Wealth Enhancement Group, and Brian is our senior portfolio manager, always giving great perspective on market conditions and economic circumstances and how we might want to navigate that with the way we do our investing.
And Brian, you recently had a great article that you posted or had published through Retirement Daily on thestreet.com, a great topic for us to talk about because markets have been quite volatile over the last couple of months with tariffs are on, tariffs are off, well, 90 days anyway. And then, well, we've got all these different sort of variables coming in, you know. So how is an investor to navigate these challenging various possible circumstances? So maybe you can walk us through.
How should investors be thinking about these circumstances? Yeah, thanks for having me, guys. It's a pleasure to be here. I really like doing this. I think it's always fun when we have good discussions. So if you guys are familiar, Chris, I know you are, you own a boat. If you're familiar with the Atlantic Ocean or Cape Cod Bay at all, you know that the winds can change unexpectedly, and before you know it, you're in eight-foot surf waves on a 20-foot boat.
And that's basically what I feel like has happened in the economy in the last couple months, right? Now, it doesn't necessarily mean that you're going to sink, and I think that's the metaphor that I use at the beginning of this article. How do we position, how do we drive our financial boat in order to get through difficult times? And as you guys know, that's how we think about asset allocation. We're not static with our approach.
We do what we call active allocation, which typically means that we're going to reconsider the asset allocation every quarter and make changes subsequently. So this article was really about how we approach the new situation and what we did about it. So with that preamble, what did we do? It was a difficult situation. I thought that it was a very binary situation.
We did this exercise at the Wealth Enhancement Group where we were trying to game out different scenarios that could happen, and the more and more I thought about it, the more and more I realized that there's really only two scenarios. This tariff situation continues to be bad, and we have a recession, and the markets go down pretty good. Or we start to reverse everything we've done. And to my pleasure, that's the tact that has been going on so far.
But I think when you think about asset allocation as a whole, I think it's a good idea to think about your duration and your fixed income positioning first. And the reason for that is because the yields and yield curves will change what's going to happen in the equity market. So it's a good idea to get a, where am I comfortable with my fixed income position? And then contrast that with how you want to position your equity portfolio.
So when we started with the fixed income portfolio, there was a lot of questions right at the beginning. Tariffs are depressionary, and they depress the market, but they depress growth, but they're also inflationary at the same time. So what does that mean? Well, it means the longer end of the curve should probably come down because of less growth, and it means the shorter end of the curve should probably go up because of inflation concerns.
And that means either a flattening curve or even an inverted curve again. So you couple that with the fact that we might have issues with bond vigilantes, foreign currencies, foreign countries deciding they might want to put the U.S. Treasuries in the penalty box. Slowing imports, which you might not think that should affect the Treasury market, but the United States exports dollars, and those dollars end up being recycled into U.S. dollar denominated assets.
So less imports may mean less capital availability to buy things like Treasuries. And what if inflation expectations rose due to increased taxes? That's ultimately the big one. So when you put that all together, I had no feeling or no confidence that I could make a judgment on where the long end of the Treasury curve was going to go because you have all these inflationary and technical factors, but you also have the fact that you would expect growth to slow.
So what we expected was a very, very volatile Treasury market, and that has been what we've had over the last month. So with that analysis, the decision was to stay very short in investment grade bonds in our fixed income portfolio. Maybe elaborate on when you describe the prospects of a flat or a flattening or possibly even inverted yield curve, why that gives merit to the idea of emphasizing more on the short end of the yield curve, shorter term bonds. Are they benefited in that circumstance?
Yeah, I mean, I don't know if that's necessarily going to be the case, but let's take that. Let's take that as the base case, right? That we're going to have some kind of inverted yield curve, which means the shorter end of the curve, which takes less interest rate risk. There's less risk in the shorter end of the curve is going to pay a higher yield. That's as close as a free lunch as you're going to get in this business.
So you're going to get paid a higher yield and you're not going to take as much risk. The benefit of an inverted yield curve is that process of the longer end coming down could be beneficial. You could get a capital gain from that as interest rates fall. But I think what I struggled with is it's tough to decide because of the technical factors that I mentioned, like bond vigilantes or foreign countries holding the U.S. government accountable or increasing deficits or slowing imports.
All those things could make it so that expectation of a falling longer term treasury may not happen. And that has not happened, right? At least over here in the last couple of months. So, you know, either way, I want to be short on the curve. I don't think that risk is worth it. And the benefits, you think, in terms of the amount of disparity and what you're getting further out on the yield curve versus the shorter end, you think that the benefits outweigh the risks, essentially?
So let's just take a money market fund, right? I'm getting four and a quarter. If I buy a 10-year treasury today, I'm getting 460, but that's high compared to how it's been in the last month or so, right? So I was getting closer to four and a quarter. So I could take very little interest rate risk and get four and a quarter, or I could take a lot of interest rate risk and get four and a quarter. That math is getting more attractive for the longer term every day that ticks by here in recent days.
But the math just didn't make sense. You want to get paid for more interest rate risk, which is why the yield curve is typically a little steep. You should get a little bit of a liquidity premium for holding longer term bonds. And just for our listeners, we're recording our conversation on May 22nd in case things change materially in the next few days. It's important to timestamp everything these days. Yeah, just in case.
Well, so that gives us a flavor for how you're thinking about bond positioning. How are you thinking about positioning stocks? And as you talked about, we're asset allocators. We do believe in long-term investment positioning, but we also, on the edges, like to do some modest tactical adjustments. We're not trying to time the markets and jump in and out with our equity exposure. But there are things we do to try to be responsive to what's happening in the world around us.
So how does that work its way into your thoughts around equities today? Yeah, it's a great setup, Chris. And I think that's important to know that these are not wholesale changes. We're not getting far away from people's risk profiles. We're trying to make active decisions within people's risk profiles. And ultimately, the risk profile is going to decide your, more or less, your long-term performance.
So I think we're a little unique in that we don't silo our thinking with fixed income and equity. I think that's very common. If you talk to other allocators, they'll have whole separate teams that think about fixed income, whole separate teams that think about equity. Even in the home office at WEG, that's generally how it's set up. And that's fine. I'm sure there's good reason for that. It is the norm.
We're a little unique in that I think that you need to consider your duration position when you make your equity position. And since we're short in duration for fixed income for all the reasons that we just talked about, I want to be a little bit long in my beta. So what does that mean? Beta is a measure of relative volatility versus the market. So if I own a stock with a beta of 1.2, well, it's 20% more volatile than the S&P 500. That's a simple way of thinking about it.
It's important to note that that's based on backward-looking data. So even if you look at a one -year beta or a three-year beta or a five-year beta, they'll be different. But quantitatively, this is a reasonable way to think about positioning your portfolio. But I also think you need to do it fundamentally, and I'll get into that in a minute. So why do I think you need to take more beta exposure if you're very short in duration?
Well, if interest rates fall, right, longer-term interest rates fall, I won't get a tailwind from my fixed income because I'm very short in duration. It will be minimally affected. I'll get my coupon and that's it. But the cash flows on my equity will be discounted at a lower rate, which means that stocks should go higher. So even though I'm not getting much from my fixed income, I'll be getting a benefit from my equity, and that's the great thing about diversification, right?
You don't necessarily hit it out of the park in all aspects because you're not really diversified. But what you want to do is you want to balance the risks so that you can do well under a lot of environments. Now, what if interest rates rise? My fixed income won't suffer, right? But under that same logic, my equity will likely be hurt, but at least I'll be buffered a little bit by my fixed income. Both of them won't be hurt at the same time.
Now, if interest rates rise because growth increases, well, then I'll probably benefit on both sides, right? I won't get hurt on my fixed income as interest rates rise, but the earnings expectations on my equity will probably go up, so I'll win there. So under falling interest rates, under rising interest rates, I think I'm better off if I have more beta during short duration. Now, of course, the downside to this would be what if rates fall due to decreased economic growth?
I could be challenged on both sides. I'm not going to get the benefit on the income side, and I'm going to get hurt on my equity side because my earnings expectation is going to go down. Now, when I say I'm not going to get my benefit on my fixed income side, I'm not going to get a huge capital gain, but I'm also not going to lose anything.
So I think this is the best way to position for both the upside and the downside, and since we're in this binary situation, that's something that you need to consider, right? I want to protect on the downside but also participate in the upside, and that's the delicate balance that we're doing here. Now, if you really want to avoid that last scenario, right, where interest rates fall due to decreased economic growth, then I need stocks that will grow during all environments.
So even if the economy falters a little bit, I want stocks that will continue to grow. So I think that eliminates small cap, for example, and that's one of the reasons why we eliminated small cap in our portfolio. I think they're going to be more economically sensitive.
Now, that does bode well for some of the biggest, largest stocks with minimal debt that are capital light asset allocations that have subscription predictable revenue growth, or in other words, predictability with growth, as you guys know that I always preach, right? It's my favorite thing. So you can look at high-quality businesses, and you could do it that way, right?
And we've expressed that in ETF mutual fund portfolios through an allocation in MGK, which is a Vanguard mega cap growth index, and the top names include Apple and Microsoft, Nvidia, Amazon, Meta, Broadcom, and Eli Lilly. These are all blue-chip household names. Another way that you could increase your beta and you could do it with a smaller allocation in your portfolio is by doing more speculative investments.
So, for example, the ARK Innovation Fund has a beta of two, so I could allocate, in theory, a whole lot less to that and still get my beta up. The problem with that is I don't think that's reliable growth. I don't think the companies in there are as solid, so that's why I choose not to do that. The top names there include Tesla, Roku, Roblox, Coinbase.
So that might be a matter of preference on how you want to get your beta up, but for me and my clients, I'd rather focus on the higher-quality companies. Is there a difference in – oh, sorry, just real quick on the follow-up. Is there a difference in concentration in the way those two portfolios approach their selections? Well, they're both fairly concentrated, so that's something that you want to keep an eye out for whenever you get more granular in your asset allocation.
But in this case, we're actually trying to look for that, right? We want to concentrate in the higher-quality names. Okay, Jeff. Brian, in the article that you referenced at the beginning of the episode, you noted a couple of sectors that you felt might be attractive, semiconductors and aerospace and defense. Do you want to comment on why you selected to include those in the article?
And by the way, we'll put the article in the show notes, so if you're listening and you want to read the whole article, just look at the show notes and you can click it. Yeah, so I think it's important to focus on growth like we just talked about with increasing the beta, predictable growth by staying in good businesses. But you can really also focus on the predictable part of that growth allocation. And if you want to participate in the upside and the downside, I think that's important.
And it's also always important to know that beta is a backward-looking instrument, so it's not – there's no guarantee that this is going to hold true on any given day, month, week, quarter, whatever your timeframe is, right? So I think it's also important to take stock in the current fundamental environment. And I've taken the approach that I think if we want to participate in the upside, we need to be more granular in the sectors that we think are going to outperform.
And the way that we're going to do that is by expressing preferences in aerospace and defense through semiconductors as well as utilities. So the beautiful thing about that is I can take more risk in those sectors that have higher betas by allocating to something very predictable like utilities. That's bringing down my beta at the same time, so you can control your beta in that manner. You don't have to just put all your chips in front of the table. You can massage it a little bit, I guess.
So why do I think aerospace, defense, and utilities are going to do well as well as semiconductors? I think semiconductors is the modern-day oil, and what do I mean by that? Most of them are manufactured overseas. In the 70s and the 80s, we had an oil embargo. Most of our oil came from the Middle East. What did really well during that time? Well, domestic oil producers did exceptionally well.
So by the similar logic, you would think that semiconductors, which are pivotal for our high -tech technology companies and our military, would benefit under any kind of geopolitical or domestic political situation that we're going through today. You've already seen that a lot of the tariffs have been scoped out in and around semiconductors, so they're expected to continue to benefit. It's the same thing with aerospace and defense.
The administration has come out and said that a lot of the reason that they're doing this is for national security purposes. So what are they telling you? Well, they're going to continue to prioritize the defense industry, and you can see that as the Pentagon budget continues to get funded. So I think these are good places where you can have more predictability going forward despite larger historical betas. Thank you.
All right, and one thing you didn't talk about in the article that I know we've talked about is how sometimes there can be a tactical consideration of using high-yield bonds in lieu of equity as a way to maintain some equity benefit, sensitivity, risk, whatever the right way to put it. But with less risk than actually being in equities. You didn't really include anything about that in this article, but would you offer just a comment or two about that?
Yeah, I think that's an exceptionally good question. So when you think about your fixed income allocation, your very short duration should have low or no correlation to equities. Your longer investment grade correlation should be low to negative. But your high-yield allocation will have a positive correlation with equities. And why? Because the spread that makes up the difference between the yield paid on the bond and the treasury will move with the stock market.
So given the fact that it's a debt instrument and not an equity instrument and it comes first on the waterfall of payments, it's going to be less volatile, but it is going to be positively correlated. So that's why I think this is something also that's unique to our team that we are willing to do that isn't necessarily ubiquitous across the industry. When high yield gets high enough, we'll happily decrease our risk in all our equity portfolio and take the large yield on high yield.
Now, we did get that opportunity. We saw a pretty good blowout in high yield where we were getting close to the yield on long-term equity returns as we were getting – that we weren't getting just a month prior. So to me, that was a reasonable trade. I'm going to get equity-like returns and take less risk. That's something that we've done in the past.
It's a particularly good move during high-stress environments because as your equity portfolio is under more risk, you can actually de-risk the portfolio and lock in some good expected forward returns. I love it. All right, great stuff. Jeff, anything you wanted to add before we wind down? No, I love your metaphor of the boat. Of the ship and the waves. It was right on. It makes you get a good visual of what you're talking about. Well done, Brian. Thank you, Jeff. All right. Thanks a lot, guys.
Until next time, everybody, keep striving for something more. Thank you for listening to Something More with Chris Boyd. Call us for help, whether it's for financial planning or portfolio management, insurance concerns, or those quality-of-life issues that make the money matters matter. Whatever's on your mind, visit us at somethingmorewithchrisboyd .com or call us toll-free at 866 -771-8901. Or send us your questions to amr-info at wealthenhancement.com.
You're listening to Something More with Chris Boyd Financial Talk Show. Wealth Enhancement Advisory Services and Jay Christopher Boyd provide investment advice on an individual basis to clients only. Proper advice depends on a complete analysis of all facts and circumstances. The information given on this program is general financial comments and cannot be relied upon as pertaining to your specific situation.
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