ETF Edge - Stocks vs. Bonds: 60/40 Model Back in Vogue 2/27/23

Episode Date: February 27, 2023

CNBC’s Bob Pisani spoke with Alex Morris, President and CIO of F/m Investments, and Dave Nadig, Financial Futurist at VettaFi. They took a good, long look at stocks versus bonds and the core asset allocation debate. With yields on the rise, bonds are looking more and more attractive by the day – particularly as the 2-year Treasury note yield hovers around 5%. The gang broke down various ways in which ETF investors could gain exposure to the roster of single-bond Treasury ETFs that are sporting those juicy yields. 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, supporting the innovators changing the world. Investco Distributors, Inc. Welcome to EATF Edge, the podcast. If you're looking to learn the latest insights on all things, exchanged, 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 Pisani. Today on the show, we're delving into stocks versus bonds with yields on the rise. bonds are looking more and more attractive.

Turns out there are many ways to get exposure to the roster of single bond treasury ETF sporting those juicy yields. We'll break them all down with our guests today. Here's my conversation with Alex Morris. He's the president and CIO of FM Investments, along with Dave Nodick, Financial Futurist, at VETA-Fi. Alex, everybody wants to buy two-year treasuries. I was at a party over the weekend at my family's house. My mother asked me about two-year treasury yields. My brother-in-law asked me.

Now you know it's really seeping into the zeitgeist. Six months ago, you launched a series of single bond treasury ETFs, three months, two-year, ten-year treasuries. You've now got a one-year treasury. Tell us how these work. What do you get when you get, just pick a two-year treasury bond? Sure. What do you get? So you get just that, the two-year treasury, and you'll get the on-the-run treasury.

And that's an important distinction because every month the Treasury Department issues a new two-year bond. So eventually, 24 months later, you get your money back. We stay on the run. That's the most liquid of those issuances that happen, and it's the one that you see quoted on TV. And every on the run simply means that every month there's an auction, a new auction for a two-year treasury, and you roll over the old one into the new one. Correct. Dave, last year at the ETF conference, I mean in 2022, the 60-40 stock bond portfolio was declared dead by everyone. This year there was a very lively debate.

You were there about whether it was back and to what extent people should roll into bonds again. In addition to my brother, I mentioned my brother-in-law asked me this weekend about putting all his money into treasury bonds this weekend. Something is seeping into the zeitgeist here when your mother asks you about two-year treasury bonds. Are bonds really becoming serious competition for stocks? And if so, what's this mean for stock market rallies this year? I think they absolutely are becoming a significant competitor to stock, frankly, to any risk asset. I mean, you talk about the two-year, look at the six-month right now, the highest yielding part of the curve. is buying six-month treasury bills.

That's nuts, right? That kind of inversion, first of all, is something we haven't seen in a long time, and a lot of folks are concerned about the recessionary impact of that. But that inversion speaks to this belief that we're going to have continued increases in the rack rate by the Fed

that puts us in this position of having to really evaluate the risks of bonds coming down because of increased rates or looking at what's going on in the stock market where we're seeing some potential from margin compression. I think there's plenty of concern to be had in the equity side.

I've actually talked to a lot of advisors who are a little concerned that the short-term story here may be actually both the principal value of your bonds and your equities coming down as we saw last year for most of the year. That's a recipe for pain. But on the short end of the curve, you get paid very quickly, right? I mean, if you put in money in a six-month treasury, you're getting almost a five and a quarter percent yield on that. You're going to collect two and a half percent of that in just six months. That's incredible. Yeah, that will ease the pain a lot, Alex, right? I mean, stocks down bonds down two years in a row. That would be a really bad news story. And yet it is ameliorated a bit by the fact that you're getting almost 5 percent on a two-year yield.

Where does this all lead to? I'm asking a 30,000 foot question here, but what is the right stock bond allocation now? Is the 60, 40 dead? Suppose you're 40 years old. People message me all the time. They're 40 years old and I have a moderate risk tolerance. Should I own any bonds? I don't know. The market seems to be voting saying yes, clearly. So I don't know the exact right split, whether it's 60, 40 or 70, 30, but there should be a healthy allocation to bonds. It shouldn't be just treasuries.

There should be corporates. There should be a well-diversified basket of it. But for today, it seems that a healthier dose of treasuries makes a lot of sense. Why would you not take a 5% coupon in 6 to 12 months? It just seems to me if you were looking to get long, say 8% out of that 60 equity percentage. And you can get that today out of a bond portfolio with no risk.

Seems like it's a good trade to make. It seems like a no-brainer for a lot of people. You know, Dave, I see very large inflows into short maturity treasury ETFs like Alex's and to others, including the spider ones and some of the I-share ones. But not as much interest in longer maturity bonds, like the 10-year-earned.

10-year ETF, or even I don't see as big inflows into corporate treasuries. Maybe you do. But why is there so much interest in these very short maturity treasuries right now? Well, very simply because we know interest rates are going to keep going up, right? I mean, currently the market is pricing in three more 25-bip increases. You know, there's plenty of folks out there thinking that may even be late. We may be looking at a percentage. You don't want to be in TLT or the 20-year-long bond if you know that you've got a 1% interest rate hike coming because that's going to come right. against your duration. And that's what duration means. So it's not surprising at all to see folks really allocating towards the short end of the curve. But the interesting point here is if

everybody was doing this, we wouldn't see the rates that are as available as they are. So this is a rare opportunity. I don't think we're going to be looking at an inverted yield curve where you get paid more to own the short end than the long-dated end for a significant amount of time. I think that lasts for maybe six, 12 months tops when we get paid more. get to a terminal rate. Well, that's a good observation for either one of you. Why are yields this high? I mean, if the demand is really that high, why wouldn't yields be lower, Doug? Or Dave, excuse me, why wouldn't yields be lower at this point? I don't, you brought up a good point. Where is, if the demand is so strong and my mother is talking about it, why aren't yields lower? Well, I mean,

some of it is really, I think, the long-term asset allocation problem, right? So, Most folks who are sitting on cash don't think about getting into the two years what they're doing with cash. They look at something that is extraordinarily short-term focused. And in fact, you'll see that that part of the curve, you know, the one month is actually a little bit lower than, say, the six months right now. And that's that hunger for cash. This belly of the curve sort of from the six month to about five years is where there seems to be a real opportunity for investors, real investors to capture some value without taking some of that duration risk of looking at the long bond. It is worth pointing out that the long-term bonds did pull in good assets so far this year, about $15 billion so far and things dated over 10 years. But that's pulled way back in the last few months, last few weeks we've seen in February.

And to your point, everything is about the short term as we're heading into March here. And I was hoping you can comment on this. I mean, the fact that we're still seeing the interest is in the very shorter term maturity, not in the 10 years and not even in corporate so much. I'm even seeing outflows from the high-yield stuff, like the spider. high-yield, J&K, there were outflows recently. So this is not some like, let's go buy bonds across the board. It's a very specific type of inflows, at least in bond ETFs that we're seeing. Sure, I mean, I think it makes a lot of sense from a bond buyer, particularly first-time bond buyers, who probably some of the folks we see today, to want to have no credit risk,

which is what Treasury's offer, and to have the maximum yield they can get. And so everyone is piled in. Plus, the government has been very willing to issue bonds. in that category with reasonably high coupons because that's what the auctions have required them to do. Now, I wouldn't abandon long bonds in the long run, right? Once we do hit a terminal rate, there will be some capital appreciation abilities there. And the U.S. 10-year treasury still remains one of the most liquid securities ever. It is what sets mortgage rates to car loan rates to all of other long-term liabilities. So you will see a resurgence in that eventually. But for right now, If you can get a free lunch at 5% in six months, investors have voted with their dollars and they're taking it.

Can you explain why we need an ETF to do this? I mean, one of the points people bring up to me all the time when I talk about these inflows is, well, I can go buy Treasury direct. I can buy government bonds online directly. What do you get when you get an ETF? Is that a structure that's desirable to own short maturity treasury? Sure. So we think so. It's also why we're launching six more to help people do this.

At root, what you get is the bond that you expect to get. But I encourage others who want to buy it on Treasury Director, who want to buy it through the brokerage firm, simply to try it. It's hard. There's no ticker. You need an eight-digit Q-SIP. Dave's laughing because I made this pitch to him six months ago, and I think he had the same response,

but I'll be curious to hear if he changes thinking. Well, the obvious point here to fill in your thought process, ETF's trade intraday, too, as well. There's an advantage of it, and it is confusing. Dave, I wonder if you agree with this. I actually did this. I went on a big brokerate site and tried to buy it a two year a little while ago. And it is confusing. There's 24 different Cusips, I think, just for the two years. It's every month. It's not impossible. It's just complicated. It's confusing. If you go right now to your swab or your Fido account and you say, I want to buy the two year, they'll quote you a maximum yield to maturity right now of something hovering around 5%. When you go to click buy, you're going to see is a dozen Q-Syps. And those are going to be everything from the last on-the-run zero that they published last month to some piece of paper that was a 15-year note a long time ago and is now expiring, you know,

in that window that is a two-year treasury. So they all end up getting repriced the same. So from a notional perspective, you're going to end up pretty much in the same bucket. But it's not the case that you can just simply click a button, get the exposure of the headline rate that you're reading in the Wall Street Journal or seeing on CNBC. It doesn't work that way. It is much more complicated. And if you're an advisor, you're actually probably paying more than an individual investor for the privilege of doing that.

And heaven forbid you want to do something like rebalance on the 15th of the month. Now you've got a whole other world of pain. So, but I want to get back to the point. Do you agree with the idea? Can you make a case why we need an ETF structure? Like, why do we need a two-year ETF? Yeah, because the bond market is. Yeah, because the bond market is effectively a buy appointment market to start.

start with. In this case, you can make that appointment with Treasury Direct, right? You can go directly to the source and maintain a separate account over at Treasury Direct, which is probably where you've got your inflation bonds and those things, too. It is a terrible process that is rife with opportunity for user error and miscommunication. It's very gross in the sense that you're working with large chunks. You're not being able to do precise rebalances or precise allocations of individual dollar amounts. You're at least buying $250 blocks, if not $1,000 or more. All of those things make it just frankly inconvenient and often more expensive than just buying a 15-20 basis-point ETF that's going to do it for you. Well, there's a good point. Alex, you charge 15 basis points.

And can you make an argument, Dave, as an impartial observer, that it might be worth it to pay those 15 basis points? I would go so far as to say that while I am not personally invested in either of these funds or directly in bonds, if I was trying to get an allocation for the two-year, I would not be going to Treasury Direct. I'd be looking at a product like this or at competitors that are starting to come out offering similar kinds of exposure. But if you're an advisor, again, it may actually be monetarily cheaper to get your exposure this way than to be trying to manage the individual costs of your platform. Now, I'm trying to think of the play devil's advocate here. Is it the issue, if I were to buy your two-year ETF, I'm getting it on the run. So right now this year might this month might be 4.8%, but you're buying on the run.

So the yield will change depending upon the demand, right? So a year from now, I might not still be collecting a 4.8% coupon. I might have a different coupon, whereas if I bought it directly, I'd be still having that 4.8% or roughly that. That's right. So the on-the-run nature will force us to rebalance every month, which is good because we stay liquid, but has the downside of you get the current reset rate. But when rates do reset and say go down, the price of the bond will go up. so you're holding and the amount of bonds we can buy for you will go up.

So you'll still have some total return impact of doing this versus buying and holding a bond. Yeah, that's a good point. You're about to launch some new ones, right? You have six new single bond ETFs. Tell us about that? Yeah, so similar to the ones we have today, which look after the three month, the one year, the two year, and the ten year, we're going to fill out the rest of the yield curve. So you'll see the six month, the three year, the five year, the seven year, the 20 year, and the 30 year come out.

And it's really been just an answer to market demand. Folks have asked us to give them a full rates tool set. So when the yield curve shifts, they can shift along with it. And we're going to give the people what they've asked for. Dave, does this story have legs? I mean, the problem with bonds is they don't sort of have the narrative power of equities necessarily. We have stories behind equities and, you know, personalities. Bonds don't have that kind of narrative power.

But should, does this story have legs? I mean, for example, people have called them, ask me about preferred bonds. Ford's paying, I know, six and a half percent for their preferred bonds. That's been a terrible performer this year. I don't know. I'm trying to figure out what the right narrative is to construct around the bond story. I think the narrative is, I really would come back to the issue of diversification, right? The reason that you own something more than a single ticker in your portfolio is because you don't want that exposure to single issue blow up risk,

whether that's a treasury bond that gets reprised because we have a 1% surprise increase, whether that's the global economy tanking or whether that's an earnings recession, you don't want to have all your eggs in one basket. So bonds have always traditionally been that zagging diversifier when equity Zieg. I would actually say this is an fantastic opportunity for folks, not just to assess their stock bond ratio, but consider the role of other counter-correlated assets they may have, whether that's the equity in their home or a managed futures product.

I would agree with that. Would you, Alex? He just made a simple point. Diversification is key. So you want to have a diversified group of assets, real estate, stocks, bonds, commodities. I collect rock posters. I always say to my wife, she says, you bought another stupid rock poster? I said, it's not a stupid rock poster.

It's a diversified asset. And I get away with that. With that line, I get away with a lot. Honey, it's not a stupid Jimmy Hendricks poster. It's a retirement place. That's right. Actually, I show her that as part of the portfolio. That's smart. She says, oh, yeah, that's good. You're talking to Dave too much.

I don't think you can get that into an IRA, though. That may be a problem. I'm working on a separate, you know, classic rock portfolio ETF. But I think the answer is yes. I mean, look, we do this for a living. We trade bonds, but we own other assets as well, and we encourage everyone to seek financial advice, because what's right for one person isn't right for everyone else. Good advice. And this has been a fascinating conversation, folks. Remember, when your mother asks about a two-year bond. There's something going on here. 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'll be continuing the conversation with Dave Nautic from Vettify. Dave, a great conversation about how surprising the interest level is in short maturity treasury bonds these days. But I wonder what your thoughts are on the current paradigm, the current stock bond paradigm, seem to have been in a sort of correction in the last few weeks. Traders wanted to believe in the first part of the year that there was going to be lower inflation and moderating rates, and that was going to help stabilize the market. In the last couple of weeks, though, these inflation reports have not been particularly great, particularly on Friday with that PCE report.

So now over the weekend, there's all this hand-wringing about, oh, my gosh, we might not have lower inflation and moderating rates. We might have higher inflation and still higher rates, and that's a problem, for earnings. How is the VETify people explaining this to everybody? Well, look, the data is the data, and we live in the real world. And the real world right now is that we have corporate earnings, which had been predicted to be quite high for 2023 coming into the year. Those margins are going to end up getting compressed. We know that a lot of the inflation we have seen has been price over volume, meaning that the major retailers and major manufacturers

have had pricing pressure, pricing capability, they've used it. Volumes have not been what have generated earnings. It's been pricing ability. That's going to get pressure down. There's going to be political pressure to do it. There's going to be investor pressure to do it because it's going to be competitive issues. So I think that there are going to be some headwinds for the stock portion of your split, if you will.

And the bond side, as we were just going through, is really well understood. We know we're going to get more rate hikes. We know what that does. like the math of bonds is inexorable. It means your principal value comes down every time they hike one of these things. So that's just what's the setup isn't great is I guess how I would put it. The setup is a little bit negative for equities, a little bit negative for bonds, not catastrophic for either. Nobody I believe or trust or whose opinion I care about is calling for a 30% drawdown or anything like, you know, or yields spiking to 8%. Like nobody's talking about anything like that.

I think what we're looking at is a slow burn. recession. And to me, the answer is diversify, diversify, diversify. Yeah, it's amazing how people can kind of levitate themselves into believing things are better than they really are. So on this 4.8% two-year yield, you know, my brother always saying 5%. I mean, this is going to be great. Why bother with the stock market? Let's just do all our money into treasury, two-year treasury yields. And I said, you know, what if inflation is still at 7%. You're still actually... Exactly.

You've got a negative real return, and they don't want to think about that. To them, they look at things in nominal, not in real terms. So it's a problem because it's sort of like, you know, you're raining on my parade here, Bob. I got a great idea to buy, you know, two years at 5%. And you'd give me an argument why I shouldn't be doing it. I don't think there's anything wrong with putting some money into two-year treasuries. But you get my point. People were sort of, the interest level is so high in this that nobody's pointing out the obvious thing.

to the average people, only nerds like you and me point out real return versus nominal return on these bonds. And that's the only problem I have. We only get called nerds that way because for the last 20 years it hasn't mattered. Well, guess what? Now it matters. We're not going to get called nerds anymore. Nobody's going to shove us into a locker for pointing out that 5% on the two year is not that great if we spike 8% inflation prints for the next two years. That would be terrible. I think the other missing piece of this is that there's this idea that somehow the short term equals the long term. So if I can get 5% on the two-year treasury versus the long-term return of stocks, well, but now that's on apples to oranges comparison, right? You're getting 5% on the

two-year treasury. The implication is that if the economy was relatively healthy at those rates, you'd be looking at more like a 12% return on the equity market, right? Because the nominal applies, the nominal real discussion applies to equities as much as it applies to bonds, as much as it applies to anything else. Interest rates exist. They're out there. They are in inflation exists. It is going to decrement your spending power.

That just happens. So I think it's a bit disingenuous to say, well, I only ever expect 7% or 8% out of stocks, but boy, look at bonds. It doesn't work that way. Yeah. The one thing I do feel strongly about is it's shocking to me the number of viewers

who stop me on the street or will say something to me about how much cash they have. It's really surprising to me how high cash positions are. I mean, it's the only thing that I say to them is, do you do understand at 5, 6, 7% insurance, or inflation, holding money in cash is a 100% money loser. We have no idea if stocks or bonds are going to be up this year. We know 100% cash is a loser. And people look at you kind of funny, like thinking of cash is a protection.

and it's not. I know a person of $3 million in cash, head of a law school, a man who knows. And yet you think like, do you understand that at 5%, $300,000 is $150,000 a year and you're sitting in cash going down

whatever, 6 or 7% when you can be making 5%. Well, or you could be holding even. It's shocking people don't understand that. Well, it's shocking people don't understand that. Well, it's because, I mean, to your point, to what we were saying earlier, for the last 20 years, it hasn't actually matter, right? Because interest rates and inflation have been low enough that nobody cared. Now, all of the sudden, interest rates and inflation are live and they're interactive and they're important numbers that have meaningful impact on your wealth. So you're absolutely right. I think the game people are playing right now is, well, if I'm sitting on cash, what should I do with it? The short answer is, max out your eye bonds by the six-month treasury, because that's where you're going to protect. cash. You're not going to protect it by leaving it in a bank account. Yeah. I think the key story here is the Tina game that we played for so many years is now over.

There is an alternative. Tina being there is no alternative, as you know, but there is now an alternative. And I find that wonderful and a little worrisome at the same time because being a stocks guy, I see this as very serious competition for the stock market. Like I said, when your brother-in-law and your mother, both start asking you about putting all their money into treasuries. That's serious competition for the stock market. There's something's going on there. The thing that we have to, the thing that we have to remember is that, you know, 90% of the equity ownership in this country happens in the top 10% of the households. And those folks aren't the ones who are necessary, I mean, anecdata aside, we know from a big picture perspective, that's not all getting

sold. Like, that 90% isn't going to get sold down to 80% and show up in cash. Yeah, yeah. We're just talking at the margins. You're absolutely right. And I appreciate you pointing that out. All right, Dave Nodding is the financial futurist for Vettibai. Dave, thank you very much for joining us. And thank you, everyone, for listening to the ETF Edge podcast.

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