Barron's Streetwise

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Torsten Slok: We came into this year in the market expecting a recession. Everyone was underweight the S&P 500. Everyone was underweight credit, and as we went through week by week and the recession never happened, everyone had to catch up.

Jack Hough: Hello and welcome to the Barron's Streetwise podcast. I'm Jack Hough and the voice you just heard, that's Torsten Slok. He's the chief economist at Apollo Global Management. He says, "Forget about a hard landing for the economy. Maybe forget about a soft landing. There might be no landing," and that's mixed news for the stock market. We'll hear from Torsten and from Anastasia Amoroso, the chief investment strategist at iCapital, about what investors should expect next. And we'll say a few words about why if you're not getting at least 4% on your cash right now, you can do better. Listening in is our audio producer, Jackson. Hi, Jackson. Did that noise come from you just now?

Jackson Cantrell: Yeah, I sneezed.

Jack Hough: It sounded pretty animated. I wasn't sure if you had Tom and Jerry playing in the background.

Jackson Cantrell: Yeah, you got me.

Jack Hough: What do you want to start with, cash yields or some big moving stocks?

Jackson Cantrell: I'll take big moving stocks.

Jack Hough: Let's play my big mover sound effects. That's a mover. It's a moving truck, so it's not a real fast mover, but okay, let's start there and we'll replace it if we find something better. Let's start with Bed Bath & Beyond. I'm sure you've seen that one this past week.

Jackson Cantrell: You say Bed Bath & Beyond and I think the 2006 film called Click. Have you seen it? It's with Adam Sandler.

Jack Hough: You say 2006 like you're recalling it from memory. You're not at all looking at it on the screen, right?

Jackson Cantrell: No, no. It's not like I have Wikipedia in front of me or something.

Jack Hough: It's a 2006 movie. You recall the cinema title was-

Jackson Cantrell: I don't want to get these facts wrong. I got to have something in front of me. I know we're trying to do this off the cuff.

Jack Hough: Okay, what happens in Click?

Jackson Cantrell: My recollection is Adam Sandler goes to Bed Bath & Beyond and he goes to the beyond section and finds a remote that can fast-forward and pause life.

Jack Hough: High jinks ensue.

Jackson Cantrell: But then he ends up fast forwarding his life too fast and gets old and sad.

Jack Hough: I'll check that out. I'm not sure about the ending for the actual Bed Bath & Beyond. There was talk, you will recall, about an imminent bankruptcy filing for Bed Bath & Beyond. It hasn't happened. There is a lifeline from a financing company called Hudson Bay Capital and it involves selling stock, so it's going to dilute shareholders. That led to a wild ride in the stock. If you look this past week on Monday, stock's up 92%. Hooray! Everything's fixed. Bed Bath & Beyond, they're back in business ready to take on Amazon. The next day, the stock's down 48% and the day after that, it's down 13%. So the good news is that Bed Bath lives to fight another day. The bad news is they obviously have some competitive pressures, which is a nice way of saying that people don't like to go there to buy housewares as much as I'm sure the company would like. They go to Target or they buy from Amazon. So they need to ultimately find a way to attract customers. They're shrinking their store base for now. Let's move on to a firm. You're familiar with a firm, Jackson?

Jackson Cantrell: Yeah, buy now, pay later.

Jack Hough: Buy now, pay later. Everyone that you talk to, well, old cranks like me, at least, they all say the same thing about buy now, pay later. This won't end well, because it's like it offends their sense of... That's not how it should be. You should buy now and pay now or my favorite, just don't buy. It's a financing company and that stock took a big dive this past week. It was down 17% on Thursday.

Jackson Cantrell: Is that because people are buying now and paying never?

Jack Hough: No. No. Importantly, no. That's what the concern was in the part of investors. So far, delinquencies seem to be under control. The problem is that interest rates were near zero for a while, which made financing attractive and now rates are significantly higher than zero and financing is not as attractive as it used to be. So it's just a good old-fashioned problem of not as much growth as the company would like. Not as much spending out there. So nowadays, to adjust it, they announced that they're cutting 500 employees. That's 19% of their workforce. They're saving money. They're downsizing, but so far, it has not been this credit problem that people are worried about so far. That part of it at least seems under control. Lastly, I'll mention Disney.

Jackson Cantrell: Yeah, we talked about Disney a couple of weeks back.

Jack Hough: We talk about it like every three weeks. Some would say too much. You can never talk about Disney too much. We talked about the activist campaign, right? Nelson Peltz has big plans for the company, wanted a board seat, hasn't gotten it, but he did get a big announcement from Bob Iger who has returned as CEO about, really, I think pretty aggressive cost-cutting there. Five and a half billion dollars of cost that they're going to cut, 7,000 jobs. If you recall, under Bob Chapek, he was CEO for a period that was so brief that you're almost tempted to call that period a Chapek going forward, like the CEO was there for two Chapeks. Anyhow, one of the things that he did was reorganize the company's creative output in a way that investors don't seem to have loved. Bob Iger doesn't seem to have loved it either because he undid it.

Jackson Cantrell: What did he undo?

Jack Hough: The idea is to get the people responsible for making the content also the people that feel the weight of the financial output of that content. It makes sense. If you're going to make a big movie, whether that movie's a hit or not should fall on you, for good or for bad. Iger's words were it's going to make people managing creative activities feel empowered.

Jackson Cantrell: Empowered to sweat under the immense pressure of turning the Goofy Movie 3 into a box office hit.

Jack Hough: Or to get the back pats when things go well. So a big change there. I've seen some smaller tinkering at the parks to a consolation of people who say price has been going up too fast at the parks. Nothing major there, but that is Disney's reshaping for now. We will see, I'm sure in the days ahead, whether Nelson Peltz feels like that's enough or not enough. If I were him, if the stock goes up from here, I'd say, "You see? I got involved and I made it all happen." And if it doesn't go up, I'd say, "If only they'd given me that board seat." But that's me. We'll have to see what he does.

Jackson Cantrell: Now onto bank yields.

Jack Hough: You want to talk about bank yields? Give us a number. What kind of a yield, man like you, a guy who's in the know, a guy who's over there pulling the levers of the financial system to get the best deal for himself, what are you getting on your cash right now?

Jackson Cantrell: I have a high-yield savings account.

Jack Hough: I'll be the judge of that. Go ahead.

Jackson Cantrell: 3.75%.

Jack Hough: It's pretty good. It's pretty good. Did you say a high-yield savings account? Is it a checking account or-

Jackson Cantrell: It's just an online bank account.

Jack Hough: Okay. You're-

Jackson Cantrell: But I do hear a rise in your voice there. I (inaudible).

Jack Hough: I got a little high. I got a little inquisitive.

Jackson Cantrell: The voice crack of disappointment. Tell me what I'm doing wrong.

Jack Hough: No, you're doing fine. You're doing fine. I wrote about this this past week because rates have gotten weird in the past few years. If you go back just two years ago, short-term interest rates were near zero and money market rates or money market fund rates, let's be specific because that's different from a money market account, a money market fund, that's something an investment company has. They have to invest the money in these short-term, very safe instruments and have to pass that income along to investors. Money market funds paid next to zero a couple of years ago and all of a sudden, you could find the best yields by going to a bank for a savings account or something, what they would call a money market account, which is just a fancy name for a bank account. It sounds like a money market fund, but it's totally different. It's just a bank account. The bank makes up the rate, and banks can make up the rates that they want to make up. It doesn't have to be pegged to some underlying instrument. They have to make money on the thing, but other than that, they have some leeway. So what you would find is you were getting near zero on a money market fund, but if you went to a money market account at a bank, maybe you could get 1%. Suddenly the best deal in town was a bank. It's not supposed to be that way because bank accounts are FDIC insured. That's a higher level of safety. A money market fund is a very safe thing. It's designed to maintain a stable share price, but they can deviate from that stable share price. It's rare, but it has happened in the past, so it makes them technically not as safe as an insured bank deposit. It's a bit less safe. You should get a bit of a higher rate. So it was unusual two years ago when the highest rate was at the banks. That is all done. That's changed. If you look at the shortest part of the treasury yield curve, the one-month treasury yield, that was 0.04% two years ago. Now it's 4.66%. That is a dramatic increase in a short amount of time. I think that that's like the benchmark for what you should shoot for in your cash. Not quite that number, but take that. You subtract a little bit for money market fund fees and basically, you should be getting 4%. You can find it out there. If you're not getting it, you could probably do a little better. I think you're okay, Jackson. Don't beat yourself up over that. But one rate that stood out to me was at Schwab. Schwab has bank accounts, brokerage accounts. They have these cash sweep accounts. On the bank side, the latest yield I saw was 0.48% and on the brokerage side, they're paying you 0.45%. They have something called a purchased money fund. All you have to do is ask for it. You say, "I want to put the money in a money fund instead" and an ordinary one of those pays 4.47%. In other words, you make a phone call or a couple of clicks and you're getting four percentage points more on your money, which if you got $50,000 sitting in cash, you're talking about around an extra $2,000 a year in income. First of all, money market funds are back to their rightful place of paying more than banks, but it's a lot more because those have responded right in step with the bond market, but banks are slow-footing it.

Jackson Cantrell: So why is it? Why are they able to have these low rates in their checkings and savings account? Why isn't everyone just moving their money into at least higher yielding bank accounts?

Jack Hough: It's an excellent question and I think it's still an open question. Look, let's be fair to Schwab here. First of all, we reached out to a rep there and they point out that they're not telling people to park investment money in the bank sweep. They make the money market funds available for purchase, which is true, and they point out that their yield, low as it seems on their bank sweep, let's use the 0.45 as an example, that that is 45 times higher than what some other banks are paying on their savings accounts. And that's exactly right. You can go right now and look at accounts offered by Chase and Bank of America and you can still find 0.01% yields on those accounts, which is, it's shocking to me.

Jackson Cantrell: Yeah.

Jack Hough: Let's say you're someone who's generally informed about the subject of finance, but you spend your days thinking about stocks and bonds and maybe doing podcasts and talking with Jackson because you're a busy person and you just hadn't paid attention to just how quickly the rates had moved. You should probably make a change, and Schwab has a term for this. They call it cash sorting. I don't know why they call it that. It's a weird term, but cash sorting is what they call the people who shop around for a higher rate. That's actually, if you think about it for Schwab, this is an enormous advantage, getting this low-cost funding and being able to put it to other purposes like lending. The analyst at Bank of America on Schwab stock double downgraded the stock to underweight back in January. The reason he cited was an increased chance of cash sorting now that bond yields have moved so quickly. For investors eyeing Schwab stock, look and see the next earnings report. Look and see what they say about cash sorting. There's this expectation or concern that some customers are going to get out of that lower rate and get into some higher rates and maybe that'll cut into margins for a while. If so, let's see what effect that has in the stock price. If it does cut into the stock price, it might be a buying opportunity for people who have been eyeing the stock for a while. And if it doesn't, I think it'll probably say something even bigger about the strength of the company. I want to touch on what some of the other brokers are doing. We checked around a couple of them at Fidelity. Fidelity spokesman there says their main sweep account is this Fidelity government money market fund. That's the default. The ticker is SPAXX, S-P-A-X-X. The yield there, the recent yield was 4.18%, not as good as the Schwab yield, but okay, you're over four. That's decent. The only thing is they have this thing called FCASH, which is another option, which if you're opening an account, you have these boxes to check. Maybe you see the phrase money market fund and maybe you think, I don't want the risk, and they see this other thing and it's labeled taxable interest-bearing cash option. You say that's pretty good, FCASH. I don't know what the F stands for, but I feel like it must be forgotten because that thing yields 2.32%, barely half of what the other money market fund pays. I'm unclear on who out there has the FCASH and is looking at the difference between that and the yield and the money market and doesn't want to make the switch, especially because let's just say that the general money market wasn't good enough for you. They have money markets that have only treasuries or narrower assortments of securities that have even higher levels of average safety. The treasury money market fund at Fidelity, it's got the same quoted yield, 4.18%.

Jackson Cantrell: You mentioned that these money market funds are a tiny bit riskier than a savings account.

Jack Hough: Well, there have been examples of money market funds in the past, what they call break the buck. In other words, they're supposed to maintain a share price of a dollar a share and they come some amount below that. Maybe it's pennies, maybe it's 10 cents or more. Those examples, there haven't been any of the companies that we're mentioning here. They have been exceptionally rare and there have been regulatory changes that have happened in the wake of past instances of money funds breaking the buck that have made these funds even safer. We wouldn't call them guaranteed. We wouldn't call them insured because they're not. They can change in value, it's just that they are designed for stability, so those cases of breaking the buck are exceedingly rare. I just want to mention Vanguard. Vanguard, I don't know what you're doing over there. Your old-fashioned, Vanguard. You get a regular money market for your sweep and you're giving people 4.49%, giving the store away over at Vanguard. Vanguard is testing, we should note, a new FDIC-insured option for cash deposits, and it appears that the rate on that will be something lower than what it pays on that money market sweep account now. We don't have all the details on that because it's not on the market yet. I think it might launch in about a month or so. We'll see. Okay, so we want to get to Torsten and Anastasia. Should we go right into that or you want to do a break first and easy?

Jackson Cantrell: Let's do a break.

Jack Hough: Welcome back. Stocks have been on a tear so far this year. Maybe that's understandable given that they took a beating last year, but I noticed some dicey stuff has been running up the most. Stocks like GameStop, AMC, the meme stocks, these are companies that are out there trying to do business fine, but the stocks themselves are maybe not the top quality assets on Wall Street. Then you get stuff like Bitcoin and Dogecoin and ARK Invest, the Cathie Wood investment vehicle. We've had Cathie on the podcast a couple of times. It's just that she buys some things that, how would I characterize them, Jackson, they are for risk-forward. They are for go-getters. They're for people who don't mind a bit of a wild ride in their portfolios. That fund has been up tremendously this year because of gains in some of the underlying things it holds. Coinbase is up a ton. Carvana is up a ton. Anyhow, when I see this, it makes me a little nervous. Are we getting ahead of ourselves on these gains? Is the fact that some of the what you might call the lower quality assets that they are running ahead of the rest of the market, is that something that should make me nervous? I wanted to talk with some people about that. I reached out to our friend, Torsten Slok. He's been on the podcast before. He is the chief economist at Apollo Global Management. What do I make of this wild rally in stocks that we've seen since the beginning of the year? Everything's running and it seems like the lower quality it is, the more it's running. Should I be terrified now? Should I be lightening up stock holdings?

Torsten Slok: No. What's very important about what has happened is that we came into this year in the market expecting a recession. Everyone said a recession is coming. The probability of recession from the consensus was at the highest level in literally 40 years since they started measuring this. And as a result, when everyone came in expecting a recession and it never materialized, so that's why everyone was underweight risk. Everyone was underweight the S&P 500. Everyone was underweight credit. As we went through week by week and the recession never happened, everyone had to catch up. That's why the market was rallying, not because growth expectations and earnings expectations were different, but simply because the expectations going into this year were so negative.

Jack Hough: Is there something you could see here that would make you nervous in that regard? In other words, maybe this is the catch-up period because people's expectations about the economy were too low. But what if it continues for another couple of months? What if we go right back to the meme stock craziness? Would you be concerned then?

Torsten Slok: Yeah. One thing that has really changed was the employment report last Friday. Because for a long time, the market has been pricing in that this was a soft landing. People were worried about a recession, but instead, it turned out the data at least, it looked like a soft landing. That changed quite dramatically on Friday when the unemploy rate now stands at the lowest level since the 1960s. That's not an economy that's slowing down. What's slowing down is the interest rate-sensitive components of GDP. Housing is slowing down. Orders is slowing down. Durable goods is slowing down. Washers, dryers, furniture, anything that requires financing is slowing down. But the problem is that the good sector or those things that require financing only make up 20% of GDP. 80% of GDP is services and services is still very strong and that's what the employment report last Friday showed you. Most jobs came in leisure and hospitality, in healthcare, in education. And with services still paying strong, making up 80% of GDP, we have just not at the macro level seen this slowdown that the Fed has been looking for. So the answer to your question, Jack, is that at this point, the risk for markets really is that we get instead into the no landing scenario, the scenario where the economy just doesn't slow down and therefore where the Fed needs to step even harder on the breaks by raising rates more, and therefore, then we get that the trading environment that we had in 2022 that we thought we had left behind could be coming back because the Fed is just not done yet.

Jack Hough: Well, what might that look like? Because everything you said sounds like great news, all these jobs, the economy strong, certainly no hard landing, maybe as you say, no landing at all. So what are the risks there? What ill could come of that?

Torsten Slok: The biggest risk is inflation persistence or in plain English, more sticky inflation. That doesn't go down to the Fed's 2% target. Housing inflation is very important. That's coming down. But the latest data in housing is showing that traffic of prospective bias is beginning to go up again. You're also seeing data for the National Association of Home Builders sentiment intakes that home builders are getting a bit more excited. So maybe if housing is beginning to thaw a little bit here, we could run the risk that we will not get inflation down. So the answer to your question is sticky inflation is the problem.

Jack Hough: Let's stay with housing for a moment. What should someone think about that? It seems like these conflicting signs. It's good that there is more activity because there's... Well, somebody who's selling a house, they see more demand. But then if we have more inflation and rates have to stay higher for longer or move higher, then eventually, maybe we get up to a mortgage rate that hurts demand. How do those net out? What should someone think about the environment for housing demand over the next, let's say couple of years? Is it going to be healthy? Is it a problem?

Torsten Slok: We came into the pandemic with relatively low inventory of homes for sale. That meant that the home prices really went up a lot because there was not many homes for sale and therefore, the housing market actually did really well during the pandemic, of course, in combination with people leaving apartments and going out and buying new homes. But at the moment, of course, with mortgage rates going up from 3% mortgage rates during the pandemic, peaking at seven and a half to now six and a half percent mortgage rates, that's still holding back demand. We will not get the slowdown that we saw in 2007 and '08 and '09 because the inventory of home for sale was much better this time around. But it's very clear that with mortgage rates at these high levels and in particular, if the risk is that mortgage rates now could be at risk of going up again, if inflation is sticky, then the housing market is unfortunately still quite vulnerable to interest rates staying elevated.

Jack Hough: Thinking as long-term investors, is there anything about this economic backdrop that should really be concerning to someone to the point where they would think, wow, maybe returns or opportunities going forward are just not going to be as good as they've been in the past? Maybe America can't generate the same growth that it did in the past. Maybe American companies can't provide the same returns that they can in the past. Is there anything out there like that or do you think that for the long-term saver, this still appear if you're investing for the next 10 or 20 years that you can do so with confidence?

Torsten Slok: Yeah. This is really important. With a very long horizon, the main headwind is really demographics. We have an aging population. We have more baby boomers and people have fewer kids. So demographics are not helping for returns in the stock market with a very long horizon, say 10, 20-year horizon. But thinking about it over the next one or two years, you and I could say, well, okay, but maybe I should just be buying the S&P 500 and go and play golf for two years and then I'll come back and hopefully things will be better. The problem with that strategy is that well, maybe you should actually wait another three, maybe even six months before you do that. In that sense, the entry point or the entry price matters, as we say at Apollo. It becomes very important when you step in and buy because if you do that at a time when inflation is not over and the Fed is not done, you run the risk that you're too early and therefore that the stock market could fall more and credit spreads could widen further simply because the inflation problem has not been solved yet. With the last employment report being so strong, there are now more signs that we are, at least for now in a no landing scenario, meaning that the inflation risks are likely to come back again.

Jack Hough: It looks like, here, the market hit bottom. Now, it's bounced back. Maybe we're on the road to recovery. Is it possible that this is a false recovery for stocks and that we might see more testing of that downside going forward?

Torsten Slok: Absolutely, because the biggest risk, in plain English, the inflation problem is unfortunately not solved yet. What was the outcome last year when the inflation problem started popping up? Well, that the Fed had to step hard on the brakes to slow down consumer spending, slow down cap spending, slow down hiring and ultimately, slow down earnings for corporate America. If the Fed needs to slow down earnings further in addition to what they already have done, well, that obviously means that the outlook for equities and also for credit is more volatile going forward.

Jack Hough: Thank you, Torsten. For a different perspective. I reached out to Anastasia Amoroso. She's the chief investment strategist at iCapital. iCapital specializes in alternative investments, things like private equity, in other words, buying stakes in companies that are not the same as the listed shares that we usually talk about on this podcast. Anastasia views these alternative investments as good options for even ordinary investors, but she also had plenty to say about stocks and bonds. How do I invest for this backdrop then? The news seems good. If we're not going to get a hard landing, if the economy is okay, that's good. If we have plenty of jobs, that's good. If corporate profits and growth is at least stabilizing, that's good, but we could get maybe this additional downturn because maybe interest rates will have to stay higher for longer. So what do I do? Do I buy conservative assets? Do I buy my usual mix of things? What do I buy?

Anastasia Amoroso: Equities in particular, they're not super cheap, but they're also not expensive as they were at the start of last year. So they sort of down the middle. And some parts of equities, like software stocks for example, have corrected a whole lot. The reason why I bring this up is because the longer term, it's all about your evaluation starting point. If you were starting to invest in the S&P when the multiple is 10 or 20 to 22 times, well, your forward-looking returns would've been flat or slightly negative over the subsequent one-year and five-year annualized, but if you're starting to invest from 16 to 18 times or preferably below 16, then your forward-looking returns would've been positive. Bringing this all together, what I would say is investors right now have the luxury of being both defensive and opportunistic at once. What I mean by that is investors can be defensive by looking to cash, cash equivalents and part of the fixed income markets to get paid while we wait out this volatility and uncertainty and while we figure out whether it's a soft landing or something else or not. So whether it's getting paid four and a half, close to 4.75% in cash equivalents, or looking at an investment grade corporates and getting five, five and a half percent yield, that's attractive for investors, or maybe even looking at alternatives and things like private credit that gives you closer to 10% or 11%. I think if investors are methodical and deliberate about deploying capital into whether it's software or semiconductors or REITs or whether it's opportunistic real estate or buyout private equity, if investors do this and dollar cost average into it over the course of the coming year, I think we might pick up some pretty good valuations along the way.

Jack Hough: Let me bring it full circle back to the plain vanilla 60/40 investor. It's the 60% in S&P 500 fund, the 40% let's say in just a generic bond fund. Do that saver expect that asset markets in the US are going to be as healthy, as generous going forward? Are you optimistic for the long-term saver?

Anastasia Amoroso: I am optimistic for the long-term investor. The expected returns in the 60/40 portfolio for the next 10 years on average have improved a lot over the last year. If you ask me, is 60/40 dead? No, I don't think so. It is back from the dead. It is alive, and I think there's also ways to improve that. There's beyond the 60/40. But just speaking purely why a 60/40 portfolio may still produce return for investors, if I look at some of the capital market assumptions for public equities, for example, they have moved up significantly to the point where the expected forward-looking returns are close to 9%. Again, that's a big step up from probably 5% or 6% that you saw in years past. Same thing for something like a US aggregate bond market expected return was close to 2% in late 2021, and it has been increased to four and a half percent again on average for the next 10 years in some of the most recent capital market assumptions. So putting the two and two together, a traditional investor can expect to hopefully do better as prior returns would've suggested.

Jack Hough: Thank you, Anastasia and Torsten, and thank all of you for listening. Do you want to have one of your questions answered on the podcast? Do you want to turn on this podcast one week and hear your own voice and be a hero among your friends and family, be the envy of your community? It's as simple as taping on your phone. Use the voice memo app. Send it to jack.hough, that's H-O-U-G-H @barrons.com. It should probably be about finance. That's what we do on this podcast. Jackson Cantrell is our producer. Subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcast. If you listen on Apple, write us a review. If you want to find out about new stories and new podcast episodes, you can follow me on Twitter. This is what we call a dramatic pause in the podcasting biz, Jackson. Twitter handle is @jackhough, H-O-U-G-H. See you next week.

Jackson Cantrell: That really was dramatic.