ETF Edge - 48 Hours Until Fed Decision, Health of Housing, Dean of Valuation on Apple 9/16/24

Episode Date: September 16, 2024

We’re two days away from one of the most consequential Fed meetings in recent years. Will the market get a half-point cut or only 25 basis points? We’ll look at the latest odds and what it means for investors. Plus, Brown Harris Stevens CEO Bess Freedman joins us ahead of the decision with what it will mean for the housing market. And the Dean of Valuation, NYU Professor Aswath Damodaran, is here with his take on Apple and the three companies facing life cycle challenges. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by InvescoQQQ. Let's rethink possibility. Investco Distributors, Inc. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange, traded funds, you are in the right place. Every week we're bringing you interviews, market analysis, and breaking down what it all means for investors.

I'm your host, Bob Pazani. ETF Edge is live from the Future Proof Conference in Huntington Beach, California. We explore the hottest trends to watch in the ETF world. Here's my conversation. With Marlina Lee, the Global Head of Investment Solutions at Dimensional Fund Advisors, John Mayer is the chief ETF strategist at J.P. Morgan, and Jan Vaneck is the CEO of Vaneck. Jan, this is the third year. I think you've been to all three, haven't you? Just last year.

Yeah, okay. So you've been at two. But it's exploding in size. Well, tell us a little bit about what's going on here. What are you seeking to get? And the organizers say they're trying to do a new kind of investment conference. Does this feel new or fresh to you? Well, the magnet, right, that brings everyone here to the beach, to this beach, I think, is Josh Brown and the RIT Helt people and their podcast coverage. They're listened to by a lot of RIAs. So I think that's the magnet.

There are a lot of trends going on with registered investment advisors, independent advisors. One is the explosion of large advisors. It used to be an advisor that had a billion dollars under management was big. Now there's some with two and three hundred billion dollars under management. I mean, those are very, that's really big. And then second thing I like to comment on is just the use of model portfolios, which is people not really picking and choosing their own ETFs, but choosing a bundling of ETFs.

And I think all three of us are involved in that to one extent or another. And it's driving some estimate up to half of the flows in our industry into ETFs. So Marlina, you know, this is all about sort of connecting, it seems like, with these younger RIAs that Yahn was talking about, you have had a lot of success, Dimensionals had a lot of success, converting to ETFs. You're the, I think, the seventh biggest provider out there,

we've got $155 billion, something like that, and assets under management. Your philosophy, dimensionals philosophy, is essentially, I call this indexing plus. Maybe you have another word for it. It's indexing with factor overlays like value and size. Does that message that you have behind your investment philosophy, does it resonate with these younger RIAs? Can you explain what you're doing to them?

Oh, yeah, I think so. And you can tell the story and flows, right? So active ETFs are the biggest growing segment of ETFs. Dimensional is the number one active ETF issuer. But even though active ETFs are systematic active, if you want to say, more of the factor-based approach, even though we're only still 8% of ETF assets, almost a third of the, the flows are going into active ETF. So it's certainly something that's resonating. I think the reason it's resonating is, you know, it's great if you want to invest in a plain vanilla index

approach. But I also think that some people are realizing that there are some inefficiencies associated with it, some hidden costs, and having an approach where you can have really well-diversified portfolios, low turnover, but also have a chance to outperform the market in a really reliable robust way, that's the name of the game. Just to be clear on this, I have a little bone to pick with the industry when we talk about active and that's active. Systematic is a correct way to look at it. When I think of active, I think of old school, you know, alpha generating, stock picking guys.

In here, when you say you're active, you're indexing, but you have a systematic method where you look, for example, like for value, look for a small cap. That's systematic. Such a great point, Bob, because, yes, we're actually not indexing because the point of an index fund is to just track the index. So they're actually prioritizing low tracking error. And because of that, they're forced to buy and sell at certain times. There's inefficiencies associated with that. Instead, there's a better approach, and it's all based on, you know, more academic research.

Instead of being active to try and pick stocks or time markets or figure out just what's over or undervalued, We don't believe we can do any of that at Dimensional. Instead, we're relying on decades of academic research to say what areas of the market have higher or lower expected returns have had those returns show up over many, many decades, and pursue those. So that's, as you pointed out, small cap stocks, value stocks, and stocks with higher profitability, all tend to outperform. Yeah.

John, let me bring you here a huge year for ETFs. We now have, the industry has $10 trillion in our, assets under management. I mean, really that is quite an accomplishment. But it's not just inflows into low-cost index funds, as Marlena was pointing out. The ETF industry has been on a massive product development binge this year. Marlina referenced active ETS, but we have synthetic income stuff. Your JEPI was an enormous hit for the last couple of years. We have buffered products. We have leverage and inverse products being introduced. Give me a high-level picture. You're one of the thought leaders in this space.

the ETF industry going right now? Well, the ETF industry really, Bob, has changed over the past five years since the ETF rule, which really leveled the playing field for all market participants, whether if John Mayer wanted to come to market and start my own company or JPMorgan or dimensional, it made it easier to come to market and there was more tools available to managers to manage capital gains inside a portfolio. Since over the past five years, we've seen 1,700 ETFs come to market. 1,200 of those ETS have been active.

And now the reason that's the case is just because some of these changes. And also there's just this great pool of talent out there in terms of active managers, whether it be equities or fixed income to leverage. And this, the investor now has so many more tools and options available to them. You're seeing fixed income. Fixed income in this area that is just seeing

a tremendous amount of trends flows right now. It's because of the rate environment. And that likely will continue. the Fed is probably going to cut rates either 25 or 50 basis points later in the week. Money market funds, there's about $6.5 trillion in money market funds. Much of that will flow into either longer duration fixed income or, you know, some in other areas of equities. But what you are seeing is there's just a lot of different types of products out there and more availability to the end user. And that's the real difference over the past five years

where the number of issuance has really doubled. Yeah, it's confusing to the viewers. That's the problem. Now, when you're dealing with north of 3,000 ETFs, John, the average viewer says, all right, so I got a, I have an S&P, I have a mid-cap, and I have a small-cap value fund,

and do I need an options overlay program on top of it? It's confusing navigating, and this is why this program exists, actually, because we saw a need to try to explain to people what these products are all doing. You've been one of the most, those you don't know, you should know, VanX is one of the most innovative of the ETF people.

You own a whole bunch of suites of different products, semiconductors and gold, and you started out as a commodity. Yon's family has been in the commodity business for ages and ages. Where do you see the business going? I know it's easy to just say active, but you also bring out innovative products yourself. Yeah.

Lich products. You know, VanX investment approach is what I call macro, which is sort of trying to talk to investors about what are the biggest concerns that they should be having with respect to their portfolio. So number one, fiscal spending in the U.S. is going to be a big deal over the next 12 months. Can the government continue to stimulate the economy and spend so much more than they're taking in the tax receipts? Our answer is that's going to cause a lot of uncertainty.

Gold and Bitcoin are great hedges for that, and that's what we're talking to investors about, number one. Number two, there are a lot of rules I call it systematic or rules-based. strategies. We have one as well, our wide mode ETF, that has to look through the market environments, right? The market was very distorted about a month ago. Mega Cap Tech was really way too much of the performance. And if you just allowed the market cap S&P to guide you, I think that's not enough. All three of us have different answers to that question, but just buying the S&P alone, I think, is a dangerous strategy right now. You have to really have a more

diverse setting. The over concentration is a real problem. I mean, I think it is. Because you saw at the beginning of this quarter, growth so extended versus value on a historical basis. It was almost like it was. On the S&P right now. It doesn't, it's, we just, you know, listen, I just call it. It was growth versus value was like it was in 1999. Like they only ring the bell a couple of times, but when you can look at a multi-decade chart and say, wow, that really stands out. So anyway, So I think investors should look at their equity book and say, how should I construct that to ride through the cycle of the next year? Well, let's look at your fund.

Your biggest fund is the core equity too, right? This has a small cap and a value tilt, but its largest holdings, you look at it, the mega-cap tech is there, maybe not in the proportion of the S&P, but Apple and Microsoft, and we can put that up. Apple's 5%, Microsoft's 5, and Vida 5, META's 2% here. Your investment philosophy, though, still very much believes that in the very long term, value will do better than growth. Yeah.

Of course, small cap will outperform. But with a very few exceptions, that hasn't happened in 15 years. So the viewers go nuts about this. They always message you. Bob, what is it with the small caps outperform value, small cap, outperform big cap, value outperforms growth? Why don't we see it? Why don't we? Well, what happened?

First, we don't see it in the U.S., mostly because of some of what Yan was just. talking about we have had just a tear in the returns of some of these large growth tech names but that's a US specific story so if you have a globally diversified portfolio which I absolutely recommend for all of the investors as they be diversified small premium value premiums have shown up outside of the US very strongly in the recent periods so it's worked there where it hasn't worked is the US mostly because we do have these names that have just done really well over the last 10, 15 years.

But that's not to say that they'll continue to do well. In fact, when you look at their prices today, their valuations, usually that means that they're gonna have lower expected returns on a go forward. They probably have some very high, lofty expectations around future cash flow growth as well, but that's already built into the price.

So the example you gave, DFC, it holds everything in the market, almost everything. And we do try and weight them a little bit differently than how you'd hold your market portfolio, just because it doesn't make sense that all stocks have the same return. Do you buy into the idea, you know the ETF haters what they say. You know, I'm a famous value fund manager. I used to make a lot of money in value. If I bought a stock for $10 and thought it was going to be $12, it would go to $12 eventually.

I'd be rewarded. Now I'm not being rewarded. Why is this happening? Why am I not being rewarded as a value investor? It can't be because my methodology is wrong. I'm a genius. It must be because there's something wrong with the market. It's got to be those people reflexively buying, you know, those silly plain vanilla S&P 500 because it's got a growth tilt and that's ruining the value play. Does that make any sense to you? Well, these are the haters, remember.

They are the haters. They don't want. They don't like passive funds because it's taking money away from them and they feel it's ruining their play, their game. Is there any truth to any of this? So I love the flow of assets into lower cost solutions because I do think that lower cost solutions are better for investors than really expensive ones. So I buy that that's why we're seeing a lull in the value premium. It doesn't explain the flow of returns.

So as Jan pointed out, we've seen these valuations before through the tech, boom, bust. We've seen very weak value premiums or negative value premiums, very strong value premiums, all throughout we've seen a growth in index funds. So I don't think the pattern really matches the data or the explanation matches the data at all. You're the, the, either one of you, there is an interesting academic question around how much would it take for passive investing to so dominate the market that it becomes less efficient, that active managers don't, can't influence the market? It's an interesting academic question.

It seems to me that we're not even close to being there yet. I just want to give you a give you a chance to respond to what we were just saying here. You know, I think ETFs play a significant role in our overall marketplace in terms of liquidity. So I looked at ETFs as a percentage of overall volume, overall market volume, and over the past 15 years, it's been about 28%. Now, during periods of extreme volatility, like the energy crisis, taper tantrum, or say, COVID, you'll see the ETF as a percentage of overall volume spike, as along with volatility. And what that tells me is that the market is absorbing the liquidity through the ETF structure.

You look at what happened during COVID, the Fed purchased high yield ETFs and the investment grade corporate ETFs because the underlying prices there was none. So the ETF became that price discovery mechanism. So I would argue that ETFs are adding liquidity to the market, not subtracting liquidity to the market. And that's something that I just is so misunderstood. To your point earlier, it's not sapping liquidity from the market. The indexing doesn't mean long and hold by, long and hold buy-only investors. Yeah, yeah.

Well, we saw, I know you want to jump in, but we saw this when the haters said, oh, these stupid products, they've got these bond funds that don't, they have illiquid bonds in them. Wait a little anything happens. It's all going to seize up because the underlying, the market makers aren't going to be able to create and redeem the shares. Well, it turns out, actually, that wasn't true. The market not only funk, the tail wag the dog. Yep. It was the ETFs that set the prices.

And we saw this with the Chinese market. When the Chinese market was closed, the ETFs here, the China ETFs traded as if there was an underlying market that was still open. It was magical. It really worked. But it turns out it's a very efficient pricing. The market gets it directionally. You want to jump over here.

Yeah, I think that, right, ETFs add liquidity to markets. They trade tighter often than the underlying. So I think that whole argument is not that interesting. anymore, but one of the big things I was at the All-In Summit last week and one of the things that one of the presenters from KOTU talked about is there's 1,400 private unicorn companies, so 1,400 companies worth over a billion dollars. Why are they not going public? And the one fault about ETS is they don't buy IPOs, right? So with the death of active management, who's buying IPOs anymore? Like who has that discretion? And a number of hedge fund guys have talked

about that. I think that's a very interesting discussion. It's hard to kind of prove anything, but, you know, I asked a group of like 60 people last week at a client conference who'd bought an IPO in the last year, five years, and one hand went up. No one's buying IPOs. That's a separate question. We need to get more IPOs. John, I want to ask you about international investing because Marlina referenced this briefly. J.P. Morgan has a great suite of international products, beta builders out there that invest in Europe, they invest in Japan, they invest in Canada. You've got a whole big suite of these ETFs out there. But the inflows in the international funds really have been pretty modest. In fact, negative in some cases.

Everyone is just interested in the U.S. Why can't we get any investor interest in international? Sure. Well, first of all, everything's a cycle. And right now, the U.S. is doing rather well, and we're going to be in the easing cycle. So small cap companies are going to be benefited by lower interest rates. But international is an important part of an overall portfolio. And we are seeing flows into our international funds.

Ones that, you know, they're active and they take small bets in terms of, you know, not huge tracking error, approximately 100 based on which of tracking error. And I think dipping into international in a balanced portfolio is certainly relevant and important. You have, most of our clients are U.S. in the U.S., but you typically have some exposure to international, whether it be emerging markets are developed as well as fixed income. So I do expect

flows to continue in international picking up a bit. We are seeing fairly strong flows, though. Doesn't it make sense? Flows follow prices, right? I mean, people are trend followers. The price has not been good and Europe's been flat. Japan's had a good year. China, mainland's, they're terrible. this year. But that sets up great bull markets, right? These cycles are long. They can last 10 years plus, but then people completely hate asset classes. They forget about them.

It's impolite even to talk about like natural resource equities or small cap value or whatever it is. And that sets up a great bull market, right? You want the last seller to be out of there. And so I think that, you know, these cycles are long. People get frustrated. I get it. I have to say, I'm looking at China.

I mean, this is sort of a vicious loop. there going on. The economy is not in good shape. People don't seem to have a lot of confidence in real estate or the stock market. The savings rates are through the roof there because they're all, they don't believe in investing. They are on the cutting edge of so many technologies, Bob, and that was what's been missing, I think, in a lot of conversations, electric vehicles, solar, now nuclear, driverless cars. You know, we talk about two cities having driverless cars. I saw some in San Francisco recently. They've got millions of users. Like, we are missing.

I know the property market stinks there, and it's crushing commodity prices and lots of other things, but that there's a part of the story. So you're bullish on China. No, but there's a part. I'm not saying investors can profit from it, but there's a story about China. I think that we are completely missing. But how do investors profit from it? And if you're, you're seeing bullish.

Eventually, those tech companies will be good, you know, will be good. If I could put some perspective on just the size of China, it is a very big country, it has a very big economy. but in a global market portfolio, it's about 1%. So it is a tiny part of the market portfolio. Is that market cap? Market cap. So an MSCI AQUI Index, for example. You put it into a balanced portfolio, it's even less.

So we do have a lot of clients who feel one way or the other about China, and maybe they see growth potential like Yon. Maybe they see more risks than benefits. And from our perspective, you're not losing that much, diversification if you decide to exclude it. I think that that's why there's been a lot of flows into EMX China funds. Just either because they want a carve out and they want a dedicated China manager or because they don't want it in their portfolios at all. Yeah, it's an ideological problem here with that. John, I want to ask you about JEPI. You had a big hit with JEPI. I don't

know what it is now 38 billion assets under MAD. This is the premium, the equity premium income ETF folks, JEPI here. It's a synthetic income product and you're still getting inflows. Even though it's been underperforming on a price basis this year, the viewers love this product. It just explains simply how it works. What's the basic idea? It was the right product at the right time two years ago. Sure. And I still think it's the right product now for the right type of clients. Wow, spoke it like a fund manager. JEP is a covered call fund. It has, it covers, you have an actively managed underlying portfolio, and then you have an option overlay. And investors really enjoy income.

And once they get income of 7, 8, 9%, they're very much attached to that income. What you're doing here, you've got an S&P and you're selling calls, so you're collecting a premium. That's the idea. You're collecting the premium, and essentially you're selling some of your upside. Right. So if the market... Because if the market... Then you're, you're giving up the upside, right?

Not full upside and somewhat protection on the downside because it cushions the downside. And when I say they're underperforming, I just want to make sure that you're collecting money. So if it's, if the SEP is up 17% and you're only up 7%, there's a premium, there's a dividend you're essentially getting there as well. That's correct. And people don't understand that about JEP. It's a problem because people send me the charge and say, look, it's only up 7%. The SEP is up 17. It's underperforming.

I said, yes, it's supposed to do that in an up market. However, did you add on the dividends? And what is the dividend? What would you get this year? 8% or so? Well, there you go, right? So throw that in. See, people don't do that. They don't do that calculation.

That's correct. So one of the reason that these assets are so sticky is that investors, again, as I mentioned earlier, they enjoy the income. And they are selling much of their upside, not full upside, but much of it. And again, they're somewhat protecting themselves on the downside. And the underlying portfolio is actively managed. And there's kind of a prescription. Yeah, I know you call it actively managed. We get that problem with it.

We believe, you know, it is actively managed. The underlying portfolio is actively managed, and the option overlay is very structured. Yeah. The product made sense. The viewers love this. I got lots of emails asking about how it works because investors who are smart say,

I'm getting older near retirement age. I don't want to pull out of the market because you don't pull out of the market. that's a bad idea. I need a way to stay in the market and still have some protection. And that was the product that made sense in 2022. Remember we were down 18% in October 2020, folks? That's when this product took off. And everyone said, oh, well, there is a way to stay in the market and have some protection. So it makes absolute, it made sense to me and it made sense to people who flocked to it. I think it makes sense in the context of an overall portfolio. What are you

allocating to income? What are you allocating towards growth and value as well as more traditional fixed income. I want to just move on here. John, you've got your fingers in so many things, but SMH, biggest semiconductor ETF out there. It is market cap weighted. And the important thing here about, I want to ask you, what are we up 35% this year?

Something like that, yeah. But it's extremely volatile, obviously. And it's still getting inflows. I looked at the other day, you know. People are, what's this telling us? Investors are not giving up on, on tech at this point at all. They're not giving up on AI, right?

And it's a big topic here at this conference. It's a big topic daily, everyone. How am I using AI to make my work life easier? And Nvidia captures, I think, they say, 120% of the profits of the AI trend. So semiconductors are a great winner. We just launched a sort of sister fund that excludes the integrated. So it's SMHX, so it's just the fast. semi-conductor companies.

So because why spend billions of dollars on building the chips if you don't have to? Like, Nvidia doesn't build its own chips. So that's another kind of investment strategy. But people, it's built in their core, John and I were talking about this before. It's like part of people's model portfolios or core portfolios is to have this tactical overweight to semis. And some of our biggest clients actually bought on the dip over the last week or two. It's kind of amazing.

It doesn't die. And of course, you're old commodities guy. and you run GDS. Yeah, let's talk about the best investments so far this year, right? It's the hedge against, you never pass up a chance to talk about gold. GDX here is the gold miners, ZTF folks. He's about to give a big pitch for its thing. No, I mean, everyone wants, everyone's nervous about the election increasingly.

And more than that, the fiscal spending issues for next year. How do you hedge? It's obvious you buy some gold. No investors are talking about it really, but it is quietly the best performing asset this year. Bitcoin's right behind it. Now, I have to ask you to make the distinction you and I always make between gold and the gold miners. Gold miners being stocks can perform a little bit differently than just gold. Can you make that distinction?

Educate the viewers. Sure. GDX tracks the gold mining companies and like other commodity producers, their valuations are at least multi-decade lows. For some reason, investors are piling into buoyant. I think... But isn't it cleaner just to own like, you know, a gold... ATF that holds gold rather than the gold miners that are subject to the vagaries of stock market

in the whims. It's not illogical, isn't it? It's not logical, but the big money recently has been from foreign governments buying. And what blew gold through its all-time highs last Thursday, a big technical breakout was rumors that Saudi Arabia was buying not only what they reported, but also over-the-counter markets through Switzerland. So foreign governments, yes, they're buying bullion they're not buying the miners. I think you own both because the miners, if they catch up at all, it's going to rip. And they did on Thursday. He still manages to get in a plug for his fund. It's amazing. Your point here, though, I want to make it's making a very important. Central banks have become much larger buyers of gold because why? They want to diversify their foreign

reserves? Yeah. Our world is de-dollarizing. In a word, over the next decade, the dollar will come less and less important. India's economy alone in 10 years will pass the size of continental Europe. So we're seeing the fragmentation of the global economy. Those countries want autonomy over their own money supply and monetary policies, and they're not going to be dollar, you know, they're not going to use the dollar only in their policies. And gold is one of those other large liquid alternatives. Any thoughts on commodities as another, building a portfolio, okay? Commodities have a place in a portfolio? It's an investment class. Does it? Does it have a place?

I'll talk about more just stores of value type of assets like gold, like Bitcoin, things like that. To me, the big question is what's the source of expected returns? When you invest in a company, when you invest in stocks and bonds, you know that you're giving them capital in order to presumably invest in positive NPV projects. So that's the source of the return. It's not really clear what the source of, you know, there's not really an economic rationale for why some of these assets should continue to have, you know, the returns that they've had. Yeah. I never got the gold as an inflation head story because I can't see the correlation

very well. I understand gold is money. Unlike Bitcoin, gold has a very strong use case to me. It's not only jewelry and industrial products, but it is a true store of value historically and always has been. So I think gold is and has been used as money and can be considered a store of value. And so I get it on that basis. But it doesn't throw off any income. It just, it's like a collectable. I also know. I collect rock posters from the 60s. It doesn't pay me anything, but I like, I like having it. And hopefully the value goes up because some guy will pay me more for my Jimmy Hendricks poster. You're killing me. You're comparing rock posters against one of the major assets classes out there. Mr. Gold is over there. The great rock posters. Yeah. But you've seen

them. The problem with gold is that there's no source of income. Yeah. Thank you. So, which makes them great into falling interest rate environment. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is the Markets 102 portion of the podcast. We continue our discussion with Jan Vaneck, CEO of Vaneck. Just a couple of quick thoughts here. You run the SMH, the semiconductor ETF, biggest semiconductor ETF out there up 35% this year. Yet when I was asking you about it, I got the impression you weren't terribly fond of it at the moment.

What's the problem? Well, I love semiconductors and they've gone from being 2% of the S&P to over 10% of the S&P. They're obviously the best expression of the big AI trend and the huge capital investment that's going on. But you can have a great company, but a bad stock. And so coming into this quarter, if you looked at the US S&P market cap, so the biggest index, and the growth component, growth had never been as extended in terms of the performance compared to value stocks since 1999. And that chart, just like, you know, whenever you

have a multi-decade chart that's that extreme, they say they don't ring the bell on Wall Street. I think they do. So I think the, if people look, you have to stay in U.S. equities. Just don't be so overweighted to mega-cap tech. Literally every fund, momentum, you know, growth, almost value funds, they all have the same mag-7 stocks. And so I think people's portfolio has got really, they really need to take a look at that for them to be happy with their returns. You've been involved with gold for so many years. Gold, most people would consider commodities and gold the most important commodity as an asset class. What place does gold have in a portfolio?

A 60-year-old investor have 5% in gold, or what do you think is a reasonable weighting? Listen, I actually are probably more in the camp, not a gold lover, you can be tactical with gold, meaning there's times to own it and times not to own it. When should you own it not? But now, the U.S. government is spending the highest deficit it's ever had with full employment. There's no way that trillion dollar spending plans in my mind are getting approved next year. So government spending is going to come down. The interest rates are going to have to be cut to offset that.

That's a great environment for gold. That's simply it. You've got uncertainty, geopolitical uncertainty. you've got spending uncertainty out of Washington, and you've got falling interest rate environment. That is a setup for gold. And we have gold in a bull market, and it's going to continue. We're in the middle innings of a gold bowl market.

Of course, you have the gold miner's ETF, the GDX. Jan, I'm going to have to let you go. Thank you very much. It's been a great time here at the Huntington Beach. We are on the beach, folks, for the future proof conference. That does it for the ETF Edge, the podcast. Thanks for listening. Join us again next week, or remember, you can see all the shows,

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