ETF Edge - Underprepared for Uncertainty? 2/3/25

Episode Date: February 3, 2025

From tariff turmoil to concentration risk, the margin for error in portfolios is getting ever smaller… and it seems most investors are perhaps not as prepared as they should be. We’ll look at ways to fix that.  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're in the right place. Every week, we're bringing you compelling interviews, thoughtful market analysis, and breaking down what it all means for investors.

I'm Courtney Reagan in for Bob Pisani. Are investors underprepared for uncertainty? Here's my conversation with John Davy, CIO at a portfolio advisors along with Todd Rosenblu, head of research at Vettify. John, I mean tariffs, the talk of the markets, the talk probably of the globe. Of course, one of the major criticisms is that they can spur inflation, but you believe that's just the tip of the inflation iceberg and it's a bigger risk right now actually than most portfolios are prepared for.

What do you mean? What about more so than beyond what's happening today? Well, you know, the last two years you've had this mega cap concentration, rally and just seven stocks and that's driven like the S&P and the NASDAQ 100 higher. So most advisors that we talk to still want to own growth and they're very apprehensive about owning other sectors and themes, you know, sectors that benefit from higher inflation. You know, core PCE, which is the Fed's preferred measure of inflation is 2.6. The goal is 2%.

So we're still structurally higher. And, you know, tariffs that are announced over the weekend, the tariffs by nature are inflationary. So prices will go up. And I think investors' portfolio should begin to allocate towards these real asset sectors. Yeah, obviously a lot of puts and takes and discussions about what's going on today. And things seem to be moving a little bit with timelines at the very least. But Todd, what's your assessment of inflation risk in the coming year? So beyond this week.

Well, I think advisors aren't really thinking of it. We had VETify recently did a survey of what the key risks for many advisors have top of mind. And geopolitical and downside in the equity markets was more top of mind than inflation. I think inflation moved to the back burner for many investors and advisors. But we do think it is a concern. If there are tariffs and if they stick, and that's a big if, then that's going to be inflationary. Prices are going to rise for many goods. And that's likely not something that advisors, investors, investors are fully aware of and prepared for.

And obviously we're already sitting at pretty high price levels, at least when you compare sort of a core bast of goods at the very least to what we're looking at 2019. So you're talking on top of that. I mean, John, you run an inflation adjusting fund. How exactly does that work? Why might that be a good idea for someone concerned about rising inflation? Sure. So we look at the sectors that historically have benefited from higher inflation. So that would be like energy, industrial material stocks.

And we really pick, you know, the highest quality stocks within those sectors. So we launched the fund in December 2021. And if you were to pull up a chart of PPI or fund versus SMP, I mean, the vast majority of the last three years, you know, we have been beaten the S&P, which is very difficult and very rare to have something that doesn't use leverage or, you know, complicated derivative products. So at the end of the day, these are valueish sectors. And there is some idiosyncraties within these sectors, which is that, you know, there's a buyer's strike. because we have been living in the last three years of structurally higher inflation. And then more recently, we have added data centers, power plays,

which again is another idiosyncratic story that's looking to benefit from like the AI theme. But still at the end of the day, these data centers and power plays are real assets. So the fund has a 13p ratio, still pretty cheap. S&P Mag 7 is, you know, 20. I mean, it's very expensive, right? the S&P, it's 22 and a half on forward earnings, which is 10-year highs. So, you know, we like it as a

portfolio diversifier. So obviously, Todd, there are other inflation fighting funds out there. We let John sort of talk about the one that he offers. How are they looking, sort of the other options for inflation fighting funds? Right. So PPI is distinct versus some of the other products that are out there because it's multi-asset. So Horizon Kinetics has an ETF. The ticker is INFL. Horizon Kinetics, Inflationary Beneficiary ETF, I believe, is the full name. And INFL offers just exposure to the stocks that management believes can outperform in an inflationary environment. They're asset light strategies.

Whereas we have some funds, the Fidelity has the stocks for inflation ETF. The ticker is FCPI, Frank CPI. That ETF is more. multis diversified across the sectors in that space. And you can see how F-CPI, it's a bit more technology-focused than perhaps the PPI product that John's talking about. And that's why its track record has been better in the more recent past. We'll see what happens going forward. And then the third fund that comes to mind is Vanek has a real assets, ETF. R-A-A-A-X is the ticker on that one. And this is Vanek's own ETFs. It's a use of ETFs that can give you exposure.

to some of the industries and sectors that Vanek believes can perform well in an inflationary environment. John, you were talking about the Magnificent Seven earlier. I want to talk about concentration risk. So Invidia, for example, earlier this morning, getting caught in the crossfire right after taking a hit last week on the Deep Seek news. I mean, wow, what a whipsaw we've gone from last Monday to now beginning of this week. Let's talk about that concentration risk in Navidia. What are you seeing there? Well, I mean, the S&P is not a diversity. index anymore that's for sure 10 stocks make up 40% of the index there was a reason why it was good to own the mag 7 which is that they had exceptional earnings

growth but what's happening is that of late the S&P 4903 their earnings on the margin and the rate of chain has the rate change has been incrementally better so for 2025 analysts are expecting the mag 7 earnings growth to be in aggregate 20% whereas the 4983 on aggregate it's 8% So the spread of about 12%, let's say. You know, last year, that spread was more like 32%, and even wide of the year before. So we just think that if the economy is strong, and I know that we're concerned about tariffs, but at the end of the day, we still have a relatively strong U.S. economy.

earnings growth is still relatively strong on aggregate for the S&P. Jobless claims is low. So with that said, as a backdrop, you know, you should rotate your portfolio and rotate into other things besides Mag 7 stock. So when it was time for us to make that decision about a year, year and a half ago, we didn't love the options that were available to us. I think equal weight is an entrance into diversifying. The problem equal weight is that if you equaluate the S&P 500 index or the Russell 1000 index, you know, your marginal contribution to risk and return is going to be a lot smaller. So the average stock and the S&P equal weight index is 20 basis points, you know, which

basically means if you're selling spy to buy that equal 8 S&P index fund, you know, you're going from like, you're making a big sector size and style bed. So we created REO, which is an equally weighted fund of 100 high quality stocks. And, you know, our margin of contribution to risk and return is a lot higher. Each stock is 1% weight. And then we match the S&P sector weight. So, So, you know, as we look forward the next three to five years, you know, earnings growth will shift, and we just think that those Mag 7 socks are very expensive right now. Yeah, obviously, a lot of discussion about those Mag 7, and some people feel like maybe they've missed the boat, but it sounds like you've got other options, too, and not to worry,

especially if the differential gets smaller as the years go on and those earnings growth. I mean, Todd, similarly, you're focusing on quality growth. I mean, not just that growth at any price, which we were okay with for a long time, but maybe not so much anymore. So what funds sort of capture that thesis for you? Yeah, well, you were showing on the screen RSP, that's the Invesco S&P 500 equal weight ETF. So John was talking about Rowe, which is a quality-oriented portfolio. RSP is just those 500 stocks in the S&P 500. If you wanted a more quality growth or quality filter on the S&P 500, Invesco has an S&P 500 quality ETF, SPHQQ.

If you wanted something that was more quality and growth and additional filters, American Century has an ETF. The ticker is Q-G-R-O. This is an ETF that's going to filter based on quality and growth characteristics and a few other ones. And you talked about earlier about diversifying away from Nvidia. If folks want to do that and still have a focus on the artificial intelligence theme, overall, there are ETFs to give you exposure to that. And so we think the Robo Global Artificial Intelligence ETF, the ticker is T HNQ is an example of that.

Global X has an artificial intelligence ETF AIQ. There's a number of ways to get diversified exposure to the artificial intelligence theme. Todd, another important observation from you, I think, the changing of the GAR, so to speak, in tracking the full SMP from the long dominant SPY, We hear that all the time to the VOO. Why is that?

Why are you looking at this shift? Right. So it could happen this week. We could see Vanguard 500 ETF. The ticker is VOO, as you mentioned, have more assets under management than Spy, the Spider-S&P 500 ETF. They're both over $600 billion in overall assets. Spy historically has been used more by institutional investors,

and Vanguard's 500 ETF VU has historically been used by more retail and advisors. That's a great sign to us. First of all, it's success and records being broken are made to be broken. But more retail adoption, more advisor adoption of the ETFs is going to broaden the universe of investors that are buying ETFs. So we're watching that. Even as Spy remains the default product for many institutional investors, it's still the king out there for many institutional-oriented products. Got it. Okay, so let's drill down a little bit beyond tech. Let's talk about other sectors that you both want to highlight and sort of the idea of us broadening out here. So, John, you see that the bank ETF, the KBWB, catching a political tailwind.

Tell us about this. Is this a deregulation? Absolutely. So we just think now with the new administration, you know, I worked at a bank for 18 years and, you know, basically treated like regulated utility. You know, you had to ask the government if you wanted to buy back your shares and increase your dividend. And I do think that regulation, deregulation is the Bidim. So with the idea now that there'll be more IPOs, more MNA activity, you know, the funny thing about the banks is that they were actually from an earning standpoint fundamentally

getting very attractive prior to the Trump administration being, you know, effective. So, you know, over the last one year, it's KBWB is being the S&P 500 by like, you know, 10, 12%. So it's still pretty cheap in an area of the market that's very idiosyncratic. So we like it quite a bit. I see sometimes advisors use XLF, which has a lot of insurance, exposure, a company like Berkshire Hathaway's closer to the top. But we just think like the large cap money centers like Goldman, Jake Morgan, Bank of America, Morgan Stanley, which make up most of the KBWB. We think that's really the area you want to hone in on with this new administration and the headwind and the tailwind, sorry. Very interesting. So then of course, we have to talk about the whole spectrum. So let's go the other way.

Instead of these large cap money center banks, Todd, you're looking at small caps. What's attractive there? We are. So if we have a focus on the U.S. and making America even stronger, then small cap companies stand to benefit from that because they have less multinational exposure. And so smaller companies are in focus for us at VETI. But we think an active or a smarter, index-based approach is a good way of doing that. So Tiro Price has an actively managed small and mid-cap ETF, TMSL. Newberger-Berman has a small and mid-cap ETF NBSM. We're showing that one on the screen. And then Victory shares has S-Flow. So the Newberger-Berman one is actively managed. Great way to tap into the expertise of a money manager who's sorting through the universe looking for attractive valuations and strong funders.

fundamentals, whereas that S-Flow product from Victory shares takes a focus on companies with high quality, strong free cash flow generation, but it has a growth filter to it. So companies have to have been very profitable enough to make it into that screen, and we think S-Flow is going to garner more attention in the year ahead. S-flow, okay. No, John, fixed income, always in play when talking about diversification. But you see it as being a little tricky here. Does that have to do with interest rate policy?

Yeah, I mean, we've had a pretty, you know, big range in the 10 year. I mean, I mean, if you just take a like real like a long step back during COVID, a 10 year reached, you know, 0.6, you know, it got as much as, you know, 4.8 in December. So we think that, you know, the bonds market has been pretty tough the last few years with a rising rate environment. You know, I think you have to be much more tactical, you know, T-bills at, four and a half percent doesn't give you much room when you factor in the high inflation that we live in plus then the you know how bonds are kind of taxed for retail advisors you know credit spreads are very very tight you know we do like the mortgage-backed security space so there's a ticker dmbs from

double line which gives you exposure to mortgage-back securities you know spreads right now are like 130 bips so it's in like the 80th percentile and just to contrast that with us i.i.g which is 88 PIPs and the seven percentile. So we think there's a lot more, you know, value in the mortgage back, you know, space. But that's very, very myopic. It's very idiosyncratic. I think the general idea that we have for investors is that there's a lot of uncertainty with rates. I think the bond market is going to price extra term premium on the back end. So with all the political backdrop, you know, it just feels like bonds is an area that you'd want to be underway. And if you have to have exposure to it, you know, certainly would rather be more active than passive.

All right, we covered a lot of ground here, gentlemen. That is all for now. My thanks to John and Todd. Tune in again next Monday for another ETF Edge. How does InvescoQQQ Rethink Possibility? By rethinking access to innovation and the NASDAQ 100. Let's rethink possibility. Investco Distributors, Inc.