Matt Lloyd is the chief investment strategist and executive vice president, head of distribution and capital markets of Advisors Asset Management (AAM). In his dual role, Lloyd helps uncover trends and strategic investment opportunities and leads AAM’s capital markets sales and business efforts.
Russ Alan Prince: What’s your outlook on a potential recession this year, and how are you positioning portfolios to avoid it?
Matt Lloyd: Simply put, the recession that appeared to begin to take hold has been postponed for a bit of time. When it comes to squaring the circle of the historical track record of recession indicators and their near-perfect reliability, questioning the “this time is different” crowd was only slightly less polarizing than the current political environment.
If you do not have a bit of consternation about the balance of metrics and the direction it normally projects forward, you are probably not looking at the totality of the environment and viewing it through a very singular prism. Based on the previous 12 months' economic data and various market metrics, the once inevitable recession has been placated by increased consumption, a rebound in earnings from anemic expectations, and continued government spending at levels not normally seen during an expanding economy.
As it pertains to consumption, which is the biggest component of GDP, the excess liquidity pumped in from the pandemic had a longer shelf life than most expected, especially in an elevated inflationary front that erodes purchasing power. While the nominal numbers in consumption appear more robust, when we value it in volume versus number, a different story comes about.
As measured by the OECD, 2023 saw a negative monthly print for every month as of the writing of this article, which is important for two reasons: first, it occurred at the onset of a recession, and secondly, it points to the most hidden of inflationary erosion, shrinkflation. Shrinkflation occurs when the amount of a good purchased is reduced while prices remain the same, and it has a very hindering and hidden impact on consumption. While this volume-weighted sales number is concerning, the retail sales numbers keep showing strength and beating estimates. While we look forward, it appears there is enough momentum to circumvent a recession in the immediate term, however, when assets are mispriced across the ecosystem, it is prudent to be measured with any optimism and continue to trust but verify the trend of data coming out in the next few quarters.
Prince: How can investors look to best diversify their portfolios, given the rise of AI tech stocks?
Lloyd: There are two axioms in investing that sometimes are somewhat contradictory to each other. The first is always to be invested and do not time the market, the other is to be selective with where you invest. While the advisor who has traversed the landscape over the last three decades can clearly point out those periods and actions needed, defining them is often a bit difficult.
While we currently see some areas that are excessively concentrated in their trading flows and, thusly their above-average returns, it also proves that some areas may be cannibalizing future growth at current levels or be priced on perfect macro execution of expectations. When you have such periods of the herd following, it is a not-so-gentle reminder that with the deluge of information available for investors, we are still heavily influenced by the herd and vulnerable to the FOMO fear versus the historically increased fear of outright losses.
We overall favor quality, cash flow generation and increased predictability in pricing and earnings. We see during periods where historically there is such a trailing concentration of returns that more prudent and diversified among often overlooked asset classes is a palpable choice, which coincides with lower correlation amongst assets in a portfolio. When markets have an overindulgence of reward in lieu of risk balancing, one often be vulnerable to amplified emotional decisions that impact the ability to follow the first axiom: stay invested at all times. We are more favorable on energy, materials, larger financials, select health care, and consumer staples. We also favor commodities, which may offer an optimal hedge on the binary choice of expansion or recession in the global economy. International still has a strong favorable weighting for us as we favor Emerging Markets and select countries in Europe.
Prince: Private markets have continued to grow in popularity among HNW investors. What factors do you believe are driving this trend, and what benefits do they possess?
Lloyd: As we pointed out in our equity-favored sectors, a clear point we are looking for is to lower the correlation of our assets within portfolios. Private markets have been rising in favorability for some time, and the benefits of the vehicle are reasons for some of the ability to generate better risk-adjusted returns.
For those who may recall, there was a study where the higher allocation to Active Share—non-index crossover assets—and longer holding periods was the optimum recipe for higher for longer returns. The private markets, when done with vigilant credit or equity due diligence and longer holding periods, often let the investment become more fruitful, and returns are less likely to be circumvented by investors selling early.
In most cases, the direct negotiations between the company and manager could maintain better investor covenants in a market where these have been reduced greatly over the last decade. The specificity of the investment or sector focus is also a way to not only limit style drift but also help unearth some of those frontier companies that the private manager can begin to invest in earlier than most investors due to availability limitations. In an increased wealth environment, private markets offer not only potentially enhanced returns but a risk-aware vigilance that offers some protections that only come about over longer periods of being invested in them. The rise to date seems only to be a fraction of the growth of the private markets over the next few decades.
Russ Alan Prince is a strategist for family offices and the ultra-wealthy. He has co-authored 70 books in the field, including Making Smart Decisions: How Ultra-Wealthy Families Get Superior Wealth Planning Results.