Part 1: We Will Prevail

“There are decades where nothing happens; and there are weeks where decades happen.”

– Vladimir Lenin

The words of Lenin, who led the Russian Revolution in 1917, are ringing true in his own country over 100 years later. Russian Prime Minister Vladimir Putin’s decision to invade Ukraine took the world, and financial markets, by storm. For investors, initial instincts may prompt feelings of worry, and rightfully so.

After all, homes are collapsing, buildings are burning, and civilians are being displaced in what publications are calling the biggest war in Europe since 1945. First and foremost, we empathize with the human concerns and humanitarian disaster resulting from Russia’s full-scale invasion of Ukraine. We believe that a broad understanding of the market’s relationship with geopolitical crises, the state of the global economy, and the war’s impact on broad asset classes will help investors navigate this turbulent time.

This series will aim to address the concerns that arise for investors and global markets during such times.

Weathering the Storm

In an era where G20 nations are accustomed to diplomacy, the impact of war on markets may seem foreign. However, we can turn to history to help distinguish relationships between capital returns and warfare. Below is a chart showing the growth of $10,000 invested in the S&P 500 since 1950, overlayed with a myriad of events.

Exhibit A1

Looking back, the S&P 500 grappled with numerous instances of geopolitical turmoil, nationwide systemic meltdowns, and a global pandemic. Despite these vulnerabilities, notice the trend and direction of that initial $10k: it consistently recovers and grows over time Furthermore, Exhibit B features returns 12, 24, and 36 months after the market bottomed in each war.

Exhibit B 

These charts convey two things:

  1.  Despite volatile periods, investors have generally been rewarded for putting their capital at risk.
  2.  Human beings are incredibly resilient. We’ve lived through arduous events, gritted our teeth, and made it to the other side.

Some people are comparing this conflict to World War II, but we disagree given that the battle is regionally contained and the US is unlikely to become directly involved. The conflict can, and likely will, get worse. But the probability of another world war is low.  

The outcome of Russia’s invasion is difficult to predict. Whether Putin succeeds in establishing a puppet government in Kyiv or a ceasefire is negotiated, we have faith that humankind will persevere and that capital will continue to seek the most efficient allocators, leading to long-term positive returns. In other words, we will prevail.

Phillip Law, Portfolio Analyst

Wealth Advisor, Warren Street Wealth Advisors

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications. Form ADV available upon request 714-876-6200.

Footnotes & Sources:

  1. Chart is not log-scaled and thus understates market return volatility.

What Is Custom Indexing, and Is It Right for Me?

If you’ve ever felt that mutual funds and ETFs don’t give you enough control over the individual stocks you want to invest in — or don’t want to invest in — you’re not alone.

Clients over the years have shared with us that they want to own individual stocks. However, one of the hidden benefits of owning individual stocks are the after-tax returns generated through tax-loss harvesting. You may ask, “why are we hearing about this now?” Well, the reality is the technology did not exist.

The Freedom of Custom Indexing

We have good news: with the addition of Warren Street’s new custom indexing platform, you now have the ability to “custom index” — in other words, set the parameters on the exact types of stocks you’d like to invest your money.

Unlike ETFs and mutual funds that only offer pre-packaged asset mixes, custom indexing lets you personalize your investments to your individual values, preferences, and goals. Custom indexes are implemented through separately managed accounts (SMA), which allow you to directly own a mix of individual securities rather than indirectly owning positions through shares of funds and ETFs.

This can be an especially helpful option for individuals who may want to:

  • Reduce concentrated stock risk (e.g., employer stock)
  • Custom-build a portfolio to support ESG stocks
  • Offset embedded gains with cash or tradable securities
  • Invest in an individual stock portfolio with factor tilt

If custom indexing is a good fit for you, your advisor will discuss your goals, preferences, risk tolerance, and tax positioning. Then, he or she will help you design your custom portfolio from scratch, based on considerations such as asset allocation, factors, tax-loss harvesting, and values-based screens.

Ideal Clients for Custom Indexing

While custom indexing offers you some great advantages in selecting individual stocks, it only really benefits clients that meet certain account levels and qualifications, due to tax and expense considerations.

Ideal clients for custom indexing generally include those with:

  • At least $500,000 in a taxable, non-retirement account
  • Recurring cash contributions
  • A high-income tax bracket (Fed/State)
  • Preferred individual stock exposure over funds

Through direct indexing, custom indexing can replicate broad market exposure by investing in the underlying positions of an index fund or ETF. This helps us efficiently manage your taxes (if you meet the above qualifications) and gives you virtually infinite portfolio customization capabilities.

Interested in learning more? For a full deep-dive into our custom indexing platform, check out the attachment linked below. And feel free to reach out to your lead advisor if you think you might be a good fit!

Blake Street, CFA, CFP®

Founding Partner and Chief Investment Officer, Warren Street Wealth Advisors

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications. Form ADV available upon request 714-876-6200.

Fighter Planes and Market Turmoil

Have you been reading the daily headlines—watching markets stall, recover, and dip once again? If so, you may be wondering whether there’s anything you can do to avoid the motion sickness. 

If you already have a well-structured, globally diversified portfolio tailored for your goals and risk tolerances, our answer remains the same as ever: Your best course is to stay the course. Remember, our investment advice is aimed at helping you successfully complete your long-term financial journey. As “The Psychology of Money” author Morgan Housel has observed:  

“Bubbles do their damage when long-term investors playing one game start taking their cues from those short-term traders playing another.”

The Case of the Missing Bullet Holes

Have we ever told you the tale of the World War II fighter jets and their “missing” bullet holes? Today’s bumpy market ride seems like a good time to revisit this interesting anecdote about survivorship bias. 

The story stems from studies conducted during World War II on how to best fortify U.S. bomber planes against enemy fire. Initially, analysts focused on where the returning bombers’ hulls had sustained the most damage, assuming these were the areas requiring extra protection. Fortunately, before the planes were overhauled accordingly, statistician Abraham Wald improved on the evidence. He suggested, because the meticulously examined planes were the survivors, the extra fortification should be applied where they had fewer, not more bullet holes. 

How so? Wald explained, the surviving planes’ bullet-free zones were not somehow impervious to attack. Rather, when those zones were getting hit, those planes weren’t making it back at all. Survivorship bias had blinded earlier analyses to the defenses that mattered the most. 

Surviving Market Turbulence

You can think about the markets in similar fashion. For example, consider these recent predictions from a well-known market forecaster (emphasis ours): 

“Jeremy Grantham, the famed investor who for decades has been calling market bubbles, said the historic collapse in stocks he predicted a year ago is underway and even intervention by the Federal Reserve can’t prevent an eventual plunge of almost 50%.” 

ThinkAdvisor, January 20, 2022

At a glance, that sounds pretty grim. But read between the lines for a hidden insight: He was also predicting the same collapse a year ago??? Yes, he was: 

“Renowned investor Jeremy Grantham, who correctly predicted the Japanese asset price bubble in 1989, the dot-com bubble in 2000 and the housing crisis in 2008, is ‘doubling down’ on his latest market bubble call.” 

ThinkAdvisor, January 5, 2021

What if you had heeded Grantham’s forecasts a year ago, and left the market in January 2021? Time has informed us, you would have missed out on some of the strongest annual returns the U.S. stock market has delivered in some time. 

Now What?

If market volatility continues or worsens, brace yourself. You’re going to be bombarded with similar predictions. Few will be bold enough to foretell the exact timing, but the implications will be: (1) it’s going to happen soon, and (2) you should try to get out before it’s too late. 

Some of these forecasts may even end up being correct. Bear markets happen, so anyone who regularly forecasts their imminent arrival will occasionally get it right. Like a stopped clock. Or those continually looping infomercials on how “now” is the best time to load up on silver or gold. (Incidentally, many of these same precious metal purveyors are among those routinely predicting the end is near for efficient markets.)  

Bouts of market volatility are like the bullet holes we can see. They’re not pretty or fun. But interim volatility isn’t usually your biggest threat … attempting to avoid it is. The preparations we’ve already made may be less obvious, but they’re there—including tilting a portion of your portfolio into riskier sources of expected return for long-term growth, fortifying these positions with stabilizing fixed income, and shoring up the entire structure with global diversification. 

This brings us to the real question: What should you do about today’s news? Unless your personal financial goals have changed, your best course is probably the one you’re already on. That said, we remain available, as always, to speak with you directly. Don’t hesitate to be in touch with any questions or comments you may have. 

Phillip Law, Portfolio Analyst

Wealth Advisor, Warren Street Wealth Advisors

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications. Form ADV available upon request 714-876-6200.

Bitcoin ETFs: Don’t Forget to Look Under The Hood

Some people hail Bitcoin as the greatest thing since sliced bread, while others consider it one’s worst enemy. Whether your conviction supports or berates the world’s most infamous cryptocurrency, it doesn’t change the fact that buzz around the crypto-space – inclusive of altcoins, blockchain, and decentralized finance – is rapidly growing. 

In fact, the Securities and Exchange Commission just approved the launch of ProShares Bitcoin Strategy ETF (Ticker: BITO), making this the first ever Bitcoin-centric exchange-traded fund. Before you take this as your cue to enter the cryptosphere, our team encourages you to take a good look under the hood.

What is there to find within BITO’s engine? First, BITO does not directly invest in Bitcoin, but buys futures contracts of Bitcoin. What’s the difference? When you buy a futures contract, you’re agreeing to buy Bitcoin at a specific price on a specific date in the future. For example, say you entered into a futures contract to buy Bitcoin on December 26, 2021 at $65,000. If the price of Bitcoin ends up higher than $65,000, say $70,000, you now lock in Bitcoin at $65,000 and are at a $5,000 profit. If the price is lower than $65,000, you will incur a loss.

Chart

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Since BITO tracks the futures price, not the spot (current) price, this can cause deviations in performance. In fact, “Solactive, an index provider, estimates futures have made about 13 percentage points less than bitcoin’s near 120 per cent rise so far this year” (Financial Times). Take for example, the United States Oil Fund (Ticker: USO), which invests in WTI crude oil futures. USO has underperformed the price of WTI crude by 70 percent this past decade. Moral of story: don’t expect a futures-based ETF to track the returns of the underlying asset one-for-one.

At first glance, buying the ETF seems much simpler: you don’t have to find a trustworthy custodian, set up an account, and deposit funds. However, there are nuances to this futures-based ETF that can make it more expensive. First, the expense ratio is 0.95%. Sure, you are paying the manager to decide which contracts to buy (these vary based on expiration dates, price, and liquidity), but this is still significantly above the average ETF expense ratio of 0.23%1. Compare that to a custodian like Gemini, where you are only paying 0.35% per transaction. 

Lastly, another hidden cost in this ETF is something called “negative roll yield.” Since you can’t hold a contract past its expiration date, the contract must be “rolled over,” or reinvested in before expiry. If you want to stay invested but front-month Bitcoin futures contracts are trading above the current spot price, you’ll have to sell your contract at a lower price and buy into the front-month contract at a higher price – generating a loss known as negative roll yield. Negative roll yield is a known culprit for negative returns in futures funds.

On a final note, Bitcoin futures aren’t absolute rubbish. When it comes to crypto assets, futures-based or not, position sizing appropriately can help provide meaningful diversification. However, we would encourage you to hold Bitcoin directly when possible. You can avoid nuanced costs such as negative roll yield and save on fees paid to intermediaries. Our team has the knowledge and tools to help you cross that bridge if and when appropriate. More importantly, the bigger takeaway here might just be: don’t forget to take a good look under the hood.

Phillip Law, Portfolio Analyst

Wealth Advisor, Warren Street Wealth Advisors

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications. Form ADV available upon request 714-876-6200.

Footnotes:

  1. ETFs vs. mutual funds: Cost Comparison

How Interest Rates Impact Your Chevron Pension

Rising interest rates have been a hot topic in the financial press, and many of my clients are wondering what the impact will be on their Chevron pension — specifically, their lump sum. 

As a retired Chevron employee, I understand these concerns firsthand! I monitored rates extraordinarily closely myself until I retired five years ago. The lump sum option is a great one for many people, but it is massively influenced by interest rates. Even a single percentage change in interest rates can dramatically impact your lump sum number via an inverse relationship. That is to say, as interest rates increase, your lump sum lessens. And as interest rates decrease, your lump sum grows. 

This gives you the potential to walk away with a large lump sum when you retire, but it also comes with the risk and emotional drain of fluctuating interest rates. One of my clients, for example, saw his lump sum drop from $1,080,000 to $1,040,000 in a 30-day period. Changes like that can be hard to swallow, and it’s particularly disconcerting when you don’t know how long these rate spikes will last. 

At Warren Street, we follow the tier 3 rates (the IRS segment Chevron uses to calculate your lump sum) extremely closely, so we can help you run projections for your specific case. Everyone’s situation is different, so I encourage you to give me a call if you are nervous at all, regardless of your current lump sum or retirement time horizon. However, in general:

  • If you’re thinking about retiring in the next 12-24 months or so, it might be a good time. Let’s run the numbers and see.
  • If you’re looking at two to five years or more for retirement, these interest rate spikes may not affect you. When they go back down, your lump sum will rise back up. Age and service credits will also help make up the difference from any interest rate changes.

If you’re finding yourself talking to your friends, coworkers, spouse, or others about this topic, give me a call — I will help you run the numbers so you can make an informed decision. The question of, “Do I have enough?” is never an easy one, and I’m here to help you understand all your options with data-driven insights so you can make the best choice for your family.

Feel free to contact me if you have any questions,

What’s Up With That Inflationary Altitude?

We’re officially 16 months into the pandemic. You’re vaccinated and planning your next trip, itching to get out the house. Hawaii, Las Vegas, or Disney World? Bulls will say choose your adventure. Bears will say pick your poison. 

Regardless, nobody can deny that the United States has largely re-opened with certain sectors, such as airlines and travel, reaping both the benefits and consequences of pent-up demand. To give you a better idea of what we’re talking about, check out some of these headlines: 

Some might claim that this is totally expected — and you’re right. Airlines were one of the hardest hit sectors last year; the drop-off in daily Transportation Security Administration (TSA) throughput in March 2020 speaks volumes to this. Fast forward to today, the amount of people being screened daily by the TSA is hovering just below pre-pandemic levels. 

Source: Transportation Security Administration, Data as of 7/11/21

With almost 50% of the U.S. population fully vaccinated, maybe it’s not as surprising to hear that a customer was put on hold for 21 hours with Delta’s scheduling team, that there are staff shortages across major airlines, or that the TSA is offering $1,000 signing bonuses. 

As a result, you have what many people expected – too much demand and too little supply. But this also alters the behavior of consumers who have yet to travel. Even those desperately yearning for a vacation might hold their horses to avoid falling victim to lackadaisical service, unexpected flight cancellations, and expensive airfare. This means possibly postponing your trip in July, to let’s say, September. 

What does this mean for markets? 

This past May, we saw economic data miss estimates (see below),  which sparked conversations about whether a slowdown is due in the second half of 2021. There are likely two culprits that caused these economic indicators to miss their marks: our current supply and demand dynamic and inflation. 

Source: FactSet, Data as of 7/12/2021

Raging demand unfulfilled by constrained supply is prompting consumers to hold back expenditures. For example, if you’re itching to buy a Tesla and it’s out of stock, you probably won’t settle for a BMW. Meanwhile, inflation and rising raw material prices are eroding purchasing power in the short-term. If all-you-can-eat sushi cost $25/person in December 2020 and now costs $40/person (speaking from personal experience), that’s probably one less buffet-like meal you’d want to indulge in. 

Does this mean the US economy is destined for a slowdown? Not necessarily. Going back to our talk about airlines and travel, perhaps deferred demand (e.g., postponed trips) will serve as a silver lining to help drive growth in coming quarters. If so, economic indicators like Retail Sales and Orders of Durable Goods mentioned above could benefit and offset negative data.

As for the two aforementioned culprits – we believe there will come a point where the supply and demand equilibriums balance, but not without the bouts of inflationary pressure we’re already seeing. Whether that inflation is temporary or sticky is an ongoing debate with an outcome that will unfold in due time. 

What should you do?

First of all, take the vacations (budget permitting) you deserve whether that’s in two weeks or in two months. 2020 took an emotional and physical toll on all of us. Making it through such a year deserves celebration. 

At the same, take these trips knowing that your portfolio is built with your long-term asset allocation in mind. Our team is continuously taking advantage of tactical long-term opportunities we see appropriate and positioning portfolios for current market trends. Be reassured that your portfolios are made to achieve your financial objectives amidst all the noise.

What about the Warren Street team?

We’ve got a few trips of our own planned. Keep an eye on your inbox to see where we’re headed for the summer.

Phillip Law, Portfolio Analyst

Wealth Advisor, Warren Street Wealth Advisors

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications. Form ADV available upon request 714-876-6200.


March Market Madness

During this time last year, the NCAA canceled March Madness. With college basketball off the table, we were given a different type of madness: Market Madness. The S&P 500 drew down a total of 34% from peak to trough as COVID-19 wreaked havoc across global markets. This week marked the one year anniversary of that drawdown’s market bottom.

In September 2020, we wrote about the astounding fiscal and monetary policy action delivered by both the Federal Reserve and congressional lawmakers in response to the coronavirus. Although we complimented both the central bank and congress, the 2020 Most Valuable Player award quite honestly belongs to Jerome Powell and the Fed.

Today, after fending off last March’s Market Madness, the ball is no longer in the Fed’s court. Instead, The Fed is embodying a more reactive approach, awaiting signs of inflation to cross their 2% target before considering rate hikes or tools such as yield-curve control. Now, it’s our congressional leaders’ turn to play offense using fiscal policy. Their most recent time-out play is the $1.9 trillion stimulus package with embedded $1,400 stimulus payments expected to boost inflation.

Is Inflation Bad?

Let’s take a step back and consider why the Fed is setting a target with inflation. It’s important to distinguish that inflation isn’t as daunting as what’s ingrained in our history books. Sure, the inflationary tales of Zimbabwe and the Weimar Republic might seem scary, but the truth is such situations are rare and due to mismanaged policy in less-developed nations. Typically, mild inflation is a sign of rising consumption and increased demand. Today, this type of inflation can be recognized as reflation1; and in our case, reflation would signify that a return to normalcy is en route. 

Market expectations for inflation are no laughing matter. A re-opening is expected to usher in increased spending in the form of pent-up demand. Input prices such as lumber and copper are already soaring. The five year breakeven treasury rate, which measures investor expectations for inflation, rose to its highest over point ever since 2014. Bonds, whose kryptonite is inflation, witnessed a sell-off that trickled into tech stocks.

But are markets correct to expect this much inflation? Or are markets overshooting their expectations by falling for this inflation pump fake? Perhaps our stay-at-home habits will prevail in the long-run and spending will not stay elevated, resulting in lower inflationary pressures. If so, we could see a rebound in bond prices and tech names. Nevertheless, this is the hotly debated topic among investors at the moment. 

Run The Play

This brings us back to the analogy with our administration’s most recent time-out-play. The $1.9 trillion relief bill is bringing hope to the workers, businesses, institutions, and communities that have struggled throughout this pandemic. As you can see in the chart below, the $1,400 stimulus payments represent a large percent of the package totalling $422 billion. It makes sense for investors to expect increased inflation as consumers now have higher disposable incomes and propensity to consume – but there is a catch.

Source: Committee For a Responsible Federal Budget (CRFB)

What will happen to actual inflation if these stimulus payments don’t make it back into the economy, but instead find their way into the stock market? A survey by Deutsche Bank revealed that individuals between the ages of 25 to 34 intend on placing 50% of the received payment into the stock market. Ultimately, the survey found that younger and high income earners eyed the stock market as the targeted destination for this income.

Source: Deutsche Bank Asset Allocation, dgDIG, RealVisionFinance
Data presented on 3/08/2021

The Deutsche Bank survey, like any other, is going to be scrutinized for sampling error, but we don’t see something like the above being too far-fetched. The recent retail frenzy with “meme stocks2” like GameStop, Blackberry, and AMC has given rise to retail investing. Popular communities like r/WallStreetBets on Reddit have become a breeding ground for investors to commingle. Even more likely are your neighbors, who watched people get rich on the market’s 2020 rally, itching to pummel some of their stimulus money into the S&P 500.

These $1,400 payments are intended to increase demand for goods and prompt businesses to hire more workers, eventually raising wages. If these payments seek risk-assets instead, we could see a halt in the reflation narrative and a prolonged unemployment recovery.

Another risk to consider is the risk of financial stability. We’re seeing speculative behavior, especially from retail investors piling into stocks with less regard for the underlying fundamentals. At the end of the day, it’s quite possible to see a lack of wage growth in the economy while management teams of inefficient and highly-indebted companies get rewarded for little to no profitability.

The Bottom Line

We aren’t here to debate whether or not you should save or spend the money, let’s leave that to Reddit and Twitter. However, should a substantial portion of stimulus payments see capital markets as a more attractive destination than the underlying economy, the risks to reflation and financial stability must not be overlooked.     

We’ll see whether or not the $1.9 trillion time-out play will win the economic recovery game and prevent further Market Madness… if not, let’s hope it at least takes us into overtime.

Footnotes:

  1. Reflation represents increased price levels as a result of monetary or fiscal policy as a means to combat deflation.  
  2. “Meme stocks” are stocks that have gained traction from retail audiences such as Reddit or investment communities. GameStop and AMC are just a few of the many names with this retail comradery, earning these stocks the nickname “meme stocks” and causing a surge in prices throughout early 2021.

Sources: 

Committee For a Responsible Congressional Budget 

Deustche Bank Survey

YCharts

Phillip Law, Portfolio Analyst

Wealth Advisor, Warren Street Wealth Advisors

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications. Form ADV available upon request 714-876-6200.

Is Tesla Flying Too Close to the Sun?

743%. That’s how much Tesla stock (Ticker: TSLA) returned in 20201. Most of us are aware of the bifurcation between the market’s seemingly invisible ceiling and the economy’s continued disarray, but nobody could have foreseen that Elon Musk and his army of “musketeers” would be amongst those most rewarded for owning increased allocations of TSLA stock.

In fact, 2020 was an eventful year for the electric vehicle company. Among a series of roller coaster weeks, a stock split announcement, and raging debate over analyst price targets, perhaps TSLA’s most noteworthy 2020 phenomenon was its inclusion in the S&P 500 Index – a profound move that has us concerned over the stock’s perceived immortality at the forefront.

On December 21, 2020, the S&P 500 Index committee formally added the “profitable” carmaker to the index after denying TSLA index entry earlier in the year. The circumstances around this inclusion eerily resembles something we’ve seen before. Does “You’ve Got Mail” ring a bell? That’s right – we see multiple uncanny parallels between the TSLA and former net stock giant: American Online (AOL).

Echoes of The Past

On December 23, 1998, Standard & Poor’s announced it would make American Online the first “net” stock featured in the S&P 500 Index. Leading up to the announcement, AOL rallied 510% year-to-date2, before ending the year with a return of 585%. Compare this to TSLA, which had run-up 388%3 by the time the committee made its announcement on November 16, 2020. As mentioned previously, TSLA’s 2020 return was 743%. Notice here that a large proportion of TSLA’s 2020 return came in the last month and a half in the year…talk about upward volatility.

Arguably, the most intriguing similarity between these two stocks is the amount of price action driven by momentum and fear of missing out (FOMO). Investors overlooked red flags related to both AOL’s fundamentals and underlying profitability of tech stocks. AOL eventually lost 91%4 of its market value after a failed merger with Time-Warner cable. Meanwhile, valuations of tech stocks (represented by the Nasdaq Index) peaked in early 2000 before seeing 78%5 of its value disintegrate. Fast forward to the end of 2020, you have Tesla, a company whose “profitability” is primarily tied to energy credits, octupling (8x) its stock price to levels many investors deem uncomfortable.

Will TSLA suffer the same fate as AOL and other dotcom counterparts? Obviously 2021 is a different year. The carmaker makes electric-powered cars, not an instant messaging platform. We do acknowledge that historical performance is not indicative of future performance; and that correlation does not equal causation. However, it’s important to remember that those who don’t learn from history are doomed to repeat it.

How Much TSLA Do You REALLY Own?

TSLA’s inclusion in the S&P 500 Index raises a new challenge for investors: hidden concentration risk. With TSLA now a part of the NASDAQ, Russell 1000, and widely regarded S&P 500, owning index funds inherently carries TSLA exposure. Borrowing from our friends over at WisdomTree, imagine a scenario where Portfolio A holds broad index funds in addition to a few well-known names.

What investors thought was a 2.50% allocation to TSLA is at 4.00%6. I know, I know. 4% doesn’t seem like a big deal. Besides, what investor puts 90% of their equity allocation into only broad U.S. ETFs? (You’d be surprised). The more important point though, is that volatile price action with TSLA can hide how much of the stock you really own.

At the end of 2019, TSLA shares were at $83.67. As of Friday, January 15, 2021 – the stock sits at $824.91 – almost ten times over its stock price just a year ago. Let’s say you owned Portfolio A on December 31, 2019. As of January 15 this year, TSLA would comprise 19% of Portfolio A’s exposure (see Appendix A). Obviously, price appreciation and concentration risk create their own problems (e.g., skewed returns, tax consequences), but when the underlying rationale for that price appreciation is in question by the investment community at large, you could have an even bigger problem on your hands.

 Will TSLA Fall Back Down to Earth?

Today, it seems as if TSLA has really shot over the moon, multiplying its stock price ten times in a little over a year. Will the carmaker continue to defy odds throughout 2021? Or, is Tesla a ticking-time bomb waiting to explode?

We at Warren Street Wealth Advisors aren’t equity research moguls here to publish a Buy, Sell, or Hold on this highly debated stock. However, we do acknowledge that no company is immune from idiosyncratic risk. Whether Tesla can stay above the influx of foreign competition (e.g., NIO, Volkswagen), or whether or not valuations are outstretched represent just a few of many risks to the company’s stock price.

One observation fueling TSLA’s controversy is that despite having a much larger market cap relative to other established vehicle manufacturers (see above), the company only generated $28.2 billion in sales7. Compare this to a combined $1.1 trillion in sales7 for all its auto competitors listed above. How can a company, which does a fraction of its competitors’ sales, be worth more than all of them combined? Again, TSLA isn’t just a car company – it’s thought to be a generational leader driving the next revolution in clean energy; but nevertheless, some food for thought while you’re on the road.

Tesla’s ride sure was wild in 2020, and nobody can guarantee what will happen in 2021. However, as prudent investors, it’s important to not overlook the implications that a high-flying stock can have on client portfolios. We’re not here to argue whether Tesla’s run has just begun or if the stock’s price is dangerously inflated. But if the latter of those two ideas rings true, the world could be shocked when it sees electricity and a bubble come together.

Footnotes:

  1. YTD total return as of 12/31/2020 sourced to YCharts.
  2. YTD total return for 12/23/1998 and 12/31/1998 sourced to historicalstockprice.com.
  3. YTD total return as of 11/16/2020.
  4. AOL’s market cap plummeted from $226 billion to roughly $20 billion in 2003, sourced to Bezinga.
  5. NASDAQ percent off high spanning 12/31/1997 to 12/31/2003.
  6. 4.04% is the summation of multiplying TSLA weight in index by index weight in portfolio.
  7. Trailing twelve-month figures.

Appendix A

For any questions regarding international investments, emerging markets, or wealth management, please call 714-876-6200 or email phillip@warrenstreetwealth.com

Phillip Law, Portfolio Analyst

Wealth Advisor, Warren Street Wealth Advisors

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications. Form ADV available upon request 714-876-6200.

How Will Emerging Markets “Emerge” From 2020?

It’s no doubt that U.S. equities remain the protagonist of the past decade. The longest U.S. economic expansion, coupled with the blossoming of numerous tech stocks like Amazon and Tesla, helped the S&P 500 climb to record highs. That was soon followed by the U.S. stock market’s astounding recovery in 2020, which continues to capture the attention of global investors.

Many forget, however, that the decade before looked entirely different. Back then, we had an entirely different “darling” called emerging markets which left the S&P 500 in the dust.

Data spanning 12-31-1999 to 12-31-2009

During the 2000’s, emerging market investments drastically outperformed the S&P 500 by 188.1% on a total return basis. Steadying economic data and optimistic outlooks for EM nations including Brazil, Russia, India, and China, or the BRIC nations, painted narratives of a new global convergence. Meanwhile, U.S. stocks continued limping from the aftermath of the dotcom bubble.

The Case for Emerging Markets

EM investments invest in the securities of a less developed country with improving economic conditions and increased involvement with the global economy. Aside from the BRIC nations, this includes countries such as Vietnam, Indonesia, Africa, and Argentina. EM regions are attractive for the following reasons:

  • Growing Contribution to GDP: Over the past few years, emerging economies contributed an increasingly higher percent share to global productivity. EM contribution to GDP was 56.9% in 2019, while advanced economies contributed 43.1%. The International Monetary Fund (IMF) forecasts this trend to continue into 2024, making emerging markets an attractive long-term investment opportunity.
Data as of 6-30-2020. Source: IMF
  • Favorable Demographics: 85% of the world’s population, or about 6 billion people, reside within emerging countries. Over 50% of the global population under the age of 30 live in EM nations. This will fuel a rising-middle class in years to come. Increased productivity amongst large-working populations will also uplift the region’s standard of living.
  • Hot Spot for Disruptive Innovation: Emerging markets typically lack the infrastructure and technologies of developed nations. This presents ample opportunity for the region’s younger, more tech-savvy population to embrace innovation. Global leaders including the World Bank have also recognized the tech disparity and have provided funding for infrastructure enhancements.

COVID-19 in Emerging Markets – Some Juggle While Others Struggle

Contrary to expectations, emerging markets have weathered the pandemic better than expected. A younger population and lower obesity rates have helped certain emerging countries wither down mortality rates. Accommodative fiscal and monetary policy through asset purchases and fiscal stimulus modeled after developed nations helped keep many economies afloat.

East Asian countries, China in particular, have exemplified great handling of the Coronavirus. As a result, EM has rallied 24.3% since the market bottomed (data spanning March 23 to December 8). China is also the only country expected to report positive GDP growth for 2020. Although it’s best to view Chinese data with a skeptical eye, investors cannot deny the nation’s swift return to economic activity.

Data as of 12-08-2020

Nevertheless, China’s success isn’t shared by all. Developing nations dependent on oil exports, tourism, or general commodities have and will continue to struggle as trade activity remains low. Certain EM hotspots including Russia and Brazil are also finding difficulty with containing virus spread. Highly indebted economies face risks of debt sustainability with limited room for policy enactment.

The Emerging Markets Story…to be Valued

EM equities experienced a mass exodus in March as investors questioned whether the infrastructure and economic inexperience of developing countries could properly combat the Coronavirus. Fund flows faced pressures until investors began acknowledging fruitful economic and health responses to COVID-19. Even after rallying this year, the long-term valuations for emerging markets look attractive.

Data as of 9-30-2020. Source: StarCapital

According to StarCapital research, emerging markets have the cheapest cyclically adjusted price to earnings ratio (CAPE) and price-to-book (P/B) ratio relative to developed countries over the next 10-15 years. Factor in the expected structural improvements, emerging markets exhibit ample opportunity for value appreciation should the demographic and technological trends fall in line. You may also find comfort in knowing that emerging markets are expected to have the sharpest recovery post COVID-19.

Data as of 10-16-2020. Source: Wall Street Journal

What Will the Next Decade Look Like?

Despite some commendable pandemic responses and attractive valuations over the next decade, it is imperative to consider COVID-19’s impact on the region’s secular trends. Take China’s “Great Rebalancing,” for example. After years of export-driven GDP growth, the country adopted a “Great Rebalancing” plan to generate their economic prowess from organic consumer-driven activity rather than overseas trade.

When the Coronavirus struck, both Chinese businesses and consumers halted activity. Unwilling consumers, shocked by the events in Wuhan, emptied the streets as factories shut down. Once a recovery was en-route, business activity quickly climbed back to pre-pandemic levels, but scarred consumers left their homes thrift-conscious and hesitant. This led some to believe that China’s “Great Rebalancing” plan was at stake.

The Chinese customer today, has regained confidence, mainly from the government’s ability to eliminate almost any possibility of second wave. As we said earlier, China’s success is not shared by all, and whether or not secular trends will hold in other emerging nations — who have varying health and economic conditions – will be a mixed bag.

Bringing It All Home

Although prudent investors can exploit opportunities in countries that have exhibited short-term resiliency, the ability to maintain a long-term perspective and understand the landscape of your investments is keen. Here at Warren Street Wealth Advisers, our focus is not only to avoid home-country bias and to uncover the next areas of outperformance, but also to educate our clients about our long-term decision making.

For any questions regarding international investments, emerging markets, or wealth management, please call 714-876-6200 or email phillip@warrenstreetwealth.com

Phillip Law, Portfolio Analyst

Wealth Advisor, Warren Street Wealth Advisors

Investment Advisor Representative, Warren Street Wealth Advisors, LLC., a Registered Investment Advisor

The information presented here represents opinions and is not meant as personal or actionable advice to any individual, corporation, or other entity. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Nothing in this document is a solicitation to buy or sell any securities, or an attempt to furnish personal investment advice. Warren Street Wealth Advisors may own securities referenced in this document. Due to the static nature of content, securities held may change over time and current trades may be contrary to outdated publications. Form ADV available upon request 714-876-6200.

Gold Rush of 2020

In 1848, thousands of people grabbed their shovels and crossed land and sea to Sutter’s Mill with hopes of striking gold. Almost 150 years later in 2020, a similar parallel is happening not in San Francisco, but rather in the investable market for this hot commodity.

Year-to-date (YTD), gold has experienced more inflows than other broad stock and bond funds, including SPY and AGG which track the S&P 500 and Barclay’s Aggregate Bond Index, respectively. Amongst a myriad of asset classes, investors are choosing gold as their choice for safekeeping, thus driving gold prices to an all-time high. This year alone, gold is up 33.53% YTD compared to U.S. Stocks at 4.69% YTD and U.S. bonds at 7.83% YTD. But why exactly is a gold rush taking place in 2020?

Source: YCharts

Data as of 8/05/2020

You may attribute the surge in gold prices to the pandemic, but mine deeper and you will find more.

Source: YCharts

Data as of 8/05/2020

Source: YCharts

Low Yield Environment: Earlier in March, the Federal Reserve cut the federal funds rate to 0 – 0.25% to stimulate the economy amid an economic crisis. As a result, treasury yields fell drastically. The 10 Year Treasury rate started the year at 1.88% and now only yields an all-time low of 0.52%, or -1.05% adjusted for inflation. Although treasuries are often used as a safe haven during uncertain times, negative real yields alongside inflation expectations might make gold a more attractive store of value.

Inflation Expectations: Fiscal stimulus through a $2.2 trillion package, rapid money printing, and unprecedented quantitative easing has prompted investors to seek gold as an inflation hedge. Current levels of inflation, however, do remain low at 1.19% year-over-year relative to the Fed’s target of 2.0%, and are likely to stay low in the short term (due to aggregate demand and supply shocks). While there is no tell-all sign indicating future long-term inflation is upon us, the following is certain: whether gold investors are overreacting or whether U.S. inflation is a ticking time bomb remains to be seen.

A Weakening U.S. Dollar: With fiscal debt as a percentage of GDP and M2 Money Supply at an all-time high, confidence in the U.S. dollar is diminishing relative to other currencies including the Euro. This comes at a time where the European Union appears to maintain a tighter grasp on COVID-19 outbreaks, alongside newfound unity in the form of a centralized stimulus package and debt mutualization. Overall, supposed weakness in the U.S. dollar has turned investors towards gold to maintain the purchasing power of their greenbacks.

With this context, it seems like anyone would jump at the chance to own gold; but to avoid grabbing a handful of pyrite (fool’s gold), let’s evaluate gold’s performance and properties as an asset class. During the 1980’s and 1990’s, gold yielded less than ideal returns. In the late 2000’s, the metal’s performance accelerated as investor confidence faltered during the Great Recession, but subsequently dipped in the 2010’s when the U.S. economy proceeded onto its longest economic expansion.

Source: YCharts

Data spanning 1/01/1980 to 12/31/2019

Based on history, we can draw two conclusions: 1) gold’s volatile nature indicates that its current run may not be sustainable over long periods of time and 2) gold’s performance suffers when investors regain confidence and begin to adopt a risk-on posture. To see gold’s performance coming out of recessions, see Appendix A. (link)

5-Year Correlation Matrix (Rolling Monthly Returns)

Data as of 8/07/2020

Source: YCharts

Gold generates zero passive income, so why do investors hold it? One reason is simply because it’s different and provides a diversification benefit. This metal exhibits less correlation compared to broader asset classes, meaning it simply behaves differently. A correlation of 1 indicates that the assets’ return behaviors are identical, while a correlation of -1 means they move in completely opposite directions. Given gold’s weaker correlations, it is likely to thrive when stocks or other asset classes experience large drawdowns. In other words, gold zigs while others zag.

Having understood the nuances of gold as investable asset and its diversification benefit over a long-time horizon, Warren Street Wealth Advisors previously made the decision to maintain gold exposure through Gold Minishares (GLDM) in our Diversifiers sleeve. Our investment strategies are now reaping the benefits of gold’s recent rally and allow for different courses of action. For example, with current gold prices bid up relative to historical levels, we can trim profits to invest in cheaper assets classes with higher potential for appreciation. This in essence, is buying low and selling high.

Gold prices will likely stay in the headlines and continue to gain traction in coming months. Regardless, we encourage you to start with your long-term asset allocation in mind and refrain from overthinking market entry/exit timing on any specific asset class. Preventing permanent capital impairment and building portfolios for your short term and long-term needs remains our top priority. We will diligently tax loss harvest and perform recurring rebalances along the way to take advantage of tactical long-term opportunities we see appropriate. That to us, is striking gold in 2020.

Appendix A:

Phillip Law

Portfolio Analyst, Warren Street Wealth Advisors

Warren Street Wealth Advisors, a Registered Investment Advisor. The information contained herein does not involve the rendering of personalized investment advice but is limited to the dissemination of general information. A professional advisor should be consulted before implementing any of the strategies or options presented. Any investments discussed carry unique risks and should be carefully considered and reviewed by you and your financial professional. Past performance may not be indicative of future results. All investment strategies have the potential for profit or loss.