The prospect of a recession loomed large over many conversations at last month’s Schwab Impact conference, as advisors wondered how a post-pandemic slowdown might influence many industries and regions around the globe.
Many of the advisors at the Denver event last month seemed delighted to be returning to live events after meeting over Zoom for the past two years. But even so, everyone realized they are now living in a different world. Indeed, it seemed that one of the only places likely to be exempted from a recession was the advisory profession, though it has been confronted with an entirely different set of problems.
If the RIA business is to sustain its current rate of growth, firms will need to hire 75,000 to 80,000 new advisors and other support professionals in the next five years, according to Bernie Clark, Schwab’s managing director and head of advisory services. Financial planning programs are enjoying growing enrollments at many universities, but firms are going to have to look at other pools of talent to find that many skilled people. Still, if the slowdown in the economy turns into a full-blown recession in 2023, RIA firms may benefit from people looking to switch careers.
Advisors formerly affiliated with TD Ameritrade, acquired by Schwab in 2020, will face their own challenges next year when their accounts are transferred to the Schwab platform. Schwab CEO Walt Bettinger was blunt with attendees, warning them that the transfer of millions of accounts at that scale would inevitably run into glitches. An estimated 2,500 advisors were in attendance at Impact, including about 1,000 first-timers. Many of them presumably had previously custodied assets at TD and were kicking the tires at their new custodian.
Liz Ann Sonders, Schwab’s chief investment strategist, told attendees she believes the best-case scenario for the U.S. economy would be a “rolling recession” of sorts, where different industries and regions of the country experience declines in output at different times so that the business cycle doesn’t go into a free fall all at once. But she didn’t offer any guarantees.
Five key indicators she cited—the housing market, CEO confidence, the Institute of Supply Management’s manufacturing orders, consumer sentiment and the S&P 500—all are exhibiting sharp declines in 2022. If one removes the energy sector, corporate profits are already declining, and many think the shrinking has only just begun.
Unless there’s an equity market rebound in the final six weeks of 2022, RIAs with asset-based fees could experience their first meaningful decline in revenues since 2008. Still, after 13 years with only a few quarterly declines, this year’s revenue shortfall should be manageable.
There was a sense that the next investing decade ahead would look very different. Sonders sounded a little less bearish than she did earlier in the year, but others were glum.
DoubleLine Capital CEO Jeffrey Gundlach told a room packed with advisors that he thought stocks would end the year about where they stood on November 2, though he added that tax-loss selling could change that forecast. Gundlach, one of the few asset managers to call the subprime housing crisis in 2007, said the Fed’s aggressive interest rate hikes this year had “doomed” both housing and housing prices. He did not say precisely how serious the damage might be, but he pointed to surging credit card debt as a warning sign and predicted millions of layoffs.
Gundlach voiced little confidence in the Fed’s ability to achieve a soft landing, saying he suspected the central bank’s goal at the start of the pandemic was to raise inflation to 4% and “they overshot by 500 basis points.” Why should anyone believe that when they miss a target by that much “they are going to nail the landing?” he asked.
True to his often contrarian nature, Gundlach urged advisors to look at beaten-up sectors, from Treasury bonds to emerging market stocks. He said the latter could outperform the S&P 500 by as much as 100%, which they did in the first decade of the current century.
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.