Despite the 2022 bear market, U.S. stocks have performed so well over the last 15 years that advisors may be overlooking the entirety of clients’ balance sheets, notably housing. Jamie Hopkins, director of retirement planning at Carson Wealth, noted in an interview that housing was still the largest part of most Americans’ net worth. Yet it probably represents only 1% to 2% of the advisor-client conversation. Hopkins said he wasn’t a fan of using home equity to invest in the stock market, but he did say it makes sense for advisors and clients to discuss different financing options annually, even if the client ultimately does nothing.
Diversification away from U.S. stocks into bonds and global assets hasn’t helped portfolios much this year. That doesn’t mean advisors aren’t looking at options to redeploy clients’ assets. Perhaps reflecting investors’ new desire for more diversification, the exhibit hall at Schwab Impact was filled with managers of numerous alternative investment strategies.
Sonders also moderated a session on asset allocation featuring Omar Aguilar, CEO of Schwab Asset Management, and Sebastien Page, T. Rowe Price’s head of global multi-asset and chair of the firm’s asset allocation steering committee. The panelists spoke about diversification and asset allocation in a year when both bonds and stocks have been trounced and nothing seems to work for investors. Page noted that the historical correlation between U.S. and international stocks has been between 0.3 and 0.4, but when everything starts falling all at once, correlations go to 0.9. “What most people don’t realize is that [diversification] works best when you don’t need it,” he said.
When a skeptical advisor asked the panelists about all the alternative asset manager exhibitors in the hall looking to win over RIAs, Page’s response was blunt.
Alternative assets “have their place,” he said. But he warned of two specific strategies used by some managers in the space, specifically those that either sell options or seek to smooth returns. “You can double a Sharpe ratio by selling options” and get away with it for a long time until it all blows up, Page noted. “Smoothing returns” and delivering clients steady returns of 8% annually is another tactic clients love, but investment graveyards are littered with victims of funds promising high and stable results.
Nor was Page encouraging about the Fed’s ability to avoid a recession. “The Fed has never managed to lower inflation by 4%” without triggering a recession, he said.
The expectations that inflation could fade fast might also be misplaced, in his view. Most countries wrestling with an 8% inflation rate find that it falls to only about 6% one year later, Page told attendees.
Private Equity’s Debt To Bear
Most RIA firms have little debt and have the financial strength to ride out a recession and bear market. But private equity aggregators have borrowed heavily to purchase hundreds of RIA firms in the last five years. Ominously, some have used floating-rate debt, which has grown very expensive this year, to finance their acquisition sprees. At present, there is enough private equity money to bail out any aggregators who overleverage themselves, but that could change if the buyout industry sours on the space.
The topic of debt took center stage in one of the last general sessions of the Schwab event. Stephanie Kelton, an economics professor at Stony Brook University and a leading advocate of modern monetary theory, contrasted the response to two recessions—the Great Financial Crisis in 2008 and the pandemic in 2020.
Kelton identified a chasm in the vigorous responses of Presidents Trump and Biden to the pandemic and the more moderate reactions of Presidents Bush and Obama to the real estate and banking debacles. Citing measurements of the economy like income, wealth, employment and output, Kelton implied that the aggressive policies following the pandemic revealed public officials learned some lessons after recommending weak medicine 15 years ago and getting an anemic recovery as a result.
It is certainly true that both the labor market and overall output have rebounded faster this time around. But some critics believe the pandemic-related stimulus was excessive and is a leading cause of the worst inflation in 40 years. The faster countries can expunge the current bout of inflation, the more likely policy makers are to embrace modern monetary theory after a future crisis.
For advisors, the so-called Great Moderation of 2009 to 2020 appears in hindsight to have been a golden era, one in which easy monetary policies produced extraordinary wealth for clients.