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Matthew Tuttle and Rob Isbitts dissect the S&P, Nasdaq, and Dow’s poor index construction (1:00), T-Bill rates and yield curve creep (8:00). This is an abridged conversation from Seeking Alpha’s Investing Experts podcast.
Transcript
Rob Isbitts: I’m Rob Isbitts. I’m a Seeking Alpha contributor. And you can find my work under the profile name, Modern Income Investor. Today, I’m joined by my friend and fellow investment industry and ETF industry veteran, Matthew Tuttle, who is now also a Seeking Alpha Contributor.
And in this episode, we are going to span the globe. We’re going to look at what’s real in today’s markets and what is mythology. Especially in today’s markets, and we can talk about what the reason is for that, but the Nasdaq and the Dow, which for a long time, much of history were at least moving somewhat in sync with each other, even if one was moving a little higher than the other. They’ve completely divorced from each other.
So, what does this mean for the current market environment?
Matthew Tuttle: So, not a whole heck of a lot, and here’s why. To me, the Nasdaq, the Dow, the S&P, probably the Russell, are just stupid indexes, the way they’re constructed. So, right now if you look at the Nasdaq, how much of that is in Seven stocks? I think it’s — well, I mean, Nasdaq-100, I think it’s like almost half now, maybe even more than that.
You look at the Dow, how much is (UNH) because that’s the highest priced stock.
RI: Right.
MT: So they’re just not real good representations except from the standpoint of we know the Magnificent 7 stocks have been doing really, really well and nothing else has been.
What that also tells us is that probably can’t keep going on forever, but what I would want to guard against and, you know, I play around on Twitter I think a lot more than you do. I think there are a massive amount of permabears who made a lot of money last year and have just gotten crushed this year because they’re looking at this and saying, all of these stocks keep going up, keep going up, I’m going to short them, I’m going to short them, and they’re getting crushed.
At some point, does this relationship have to come back to some sort of normalcy? I mean, it probably does, but — and I get worried, I mean, I see people keep focusing on, are we in a bull market, are we in a bear market? Somebody today pulled out, well we’re in a bull market because look at the S&P, and I said, well, but look at the equal weighted S&P.
I mean, the equal weighted S&P is up like 3.5% this year. I mean, not awful, but certainly nothing to be pounding the table on. So, just I think you need to be very careful. And also, I think the comparisons between now and the dot-com bubble are somewhat problematic because a lot of those companies in the dot-com bubble were zeros. I mean, they put a dot-com at the end of their name and all of a sudden, everyone is buying, I mean now they are gone.
RI: Yes.
MT: Whereas you look at these Magnificent 7 companies, yeah are they overvalued? They probably are. But absent AI, are they real companies? Yes, they’re real companies. So, could we have a crash like we had during the dot-com bubble? Yes, we could.
Could these AI companies keep going up and the Dow, kind of industrial types of companies keep going down? Yes, they could. So, I mean, one of the things we always tell people is, trade based on what you see, not based on what you think.
RI: Yes. Now that’s really good insight. The thing I would say is, wow, you and I both managed money through the dot-com era. Okay. We’ve been in the trenches, so to speak. And, you remember when the markets were down three years in a row, 2000, 2001, 2002, and into 2003 before it’s over.
I think you’re absolutely right that there are a lot of differences from that time, but to me, the one thing that never really changes from era to era is human nature and human emotions when it comes to investing.
MT: Right, which also then means the one rule that is always there in the markets, you just don’t know when it’s going to happen is, reversion to the mean?
RI: Yes. That’s right. That’s right. And so, again, before we get a little bit more micro, finish the sort of macro portion of the program here, we can draw any historical parallels we want. Okay? I mean, I personally believe that you can almost throw out, maybe not throw out, but you have to discount almost any performance of any investment or index before the beginning of 2022 last year.
You have to discount it. And the reason is, it is like when people say, well, now what’s your track record? Well, what’s anybody’s track record when you have a combination of rapid rate hikes. We don’t yet know the full impact because it hasn’t worked through the economy yet.
Yes, people are rediscovering income yield in a, let’s call it relatively safe form treasuries, short-term, et cetera. And now the curve is starting to bleed out a little bit more.
So, a two-year or three-year is starting to have palatable yields for a chunk of people’s portfolio. I mean, we’ve never had an environment like this or have we?
MT: No. Because AI makes things very different. And I suspect we have no idea how different it makes it. Look at all the different things that AI theoretically could replace. Will it? I don’t know, but it could.
And you brought up a really good point, what’s your track record? To me, that’s a term that’s probably caused people more money than anything else. We teach something here called forward-looking due diligence. And it’s always amazed me, the industry makes us put in big bold letters on everything, past performance doesn’t predict future results. But then everyone uses past performance to predict future results.
And so, we talk about forward-looking due diligence, which is, alright, I want to look at past performance, but not from the standpoint of, alright, you were up 20% last year, you’re going to be up 20% this year, but you’re up 20% last year, how’d you do it? Is that repeatable? And what could go horribly wrong? And it’s that what could go horribly wrong question that I would suggest people ask before they buy anything. That will save your butt at some point in your life. Trust me on that one.
RI: You are so spot on. And literally, just like two days ago, I was responding to a comment on one of my recent articles, and I was talking about helping them understand what performance attribution means.
Perfect example. Okay. Well, the S&P 500 is up double-digits this year. Why is it up double-digits? Well, it’s up largely because of the Nasdaq, and a small number of companies in the Nasdaq. Yes, they’re in the Dow too, two of them, Microsoft (MSFT) and Apple (AAPL), but you can attribute the performance of the S&P this year to the Nasdaq.
There are other years where you can attribute it to certain other things, but if you don’t know why you performed well, poorly, or somewhere in between, then I think what you’re saying is you’re kind of flying blind.
MT: Alright. Yeah, without a doubt. And if you’re looking at any type of index investment, and especially if you’re looking at an active investment, then you want to know, you know, performance attribution from a strategy standpoint. So, like anyone who’s running an inverse strategy should have made money last year. Does that mean they’re a great money manager? No.
It means they were short of the market. And you’ve got to react accordingly. If you’re talking to a money manager and they can’t explain to you why they’re getting the returns they’re getting, and why those returns will or will not be able to persist, that’s a situation where you run away.
I mean, just a very quick aside, I was asked years ago by a client at the time to review a hedge fund-to-funds that had been putting up extraordinary numbers, went met with the guys, really nice guys, seemed smart, could not explain where their returns were coming from and why they would persist. And, really, I mean, it wasn’t like they’re being secretive. They just didn’t know. Hey, we’re making money. We don’t understand this market. We’re making money.
Turns out half the fund was in Madoff, you know, so I could have, you know, ferreted that out before Markopolos did. Unfortunately, I didn’t ask them the other question of, hey, which funds are you invested in? Then I might have been able to figure it out. But certainly you want to do some sort of attribution on anything you’re doing.
RI: By the way, quickly on small caps. You don’t love the Russell 2000, neither do I. What about the…
MT: All of the small cap indexes out there suck. They’re chock-full of regional banks — small regional banks.
RI: Yeah.
MT: And no revenue, hope our drug goes through biotechs. So, it’s really, they’re not a good representation because those stocks are just so much more volatile than the other stuff that’s in there.
I tweeted about this the other day that somebody, and probably not me, should come up with a better small cap index that maybe either takes that stuff out or has it, it’s such a small waiting that you can really get some exposure to some more stuff you want exposure to.
RI: And yes, he asks coyly, what’s the matter with lots of small regional banks in 2023? Just kidding. I think we know. Now just briefly on interest rates. I mean, I do want to get your opinion on this.
So, I mean, I’ve written extensively, in fact, to my shock and surprise and delight. When I first started writing for Seeking Alpha last year, I was covering a lot of the things that both I owned or I thought were getting interesting or that were undercovered because I’m kind of the undercovered or undiscovered ETF guy at Modern Income Investor.
And with T-Bill rates, okay? Every time I wrote about, like, a T-Bill ETF, there was so much interest. And this is when part of the pun. But – because there is a lot more interest in T-Bills, both financially and let’s call it emotionally and people moving their dollars.
And like you said, with what Tom Lee was saying, at this point, I don’t think I’ve ever been a bigger fan of watching the treasury yield curve not only because they have a printing press, and that’s a good friend to have as opposed to credit bonds, corporates, things like that. I think the people that are reaching for high yield are doing so at their peril unless they really, really, really know that.
But the other thing I’m noticing is there is what I would call yield curve creep. The six-month bill, yes, as of maybe 24 hours ago, was at 5.4%, but the two-year is at 4.7% and the three-year is at 4.3%, even the five-year is now just crossing 4%. And I know whether, again, as people have been financial advisors or if you’re a do-it-yourself investor, you kind of look at that and you say, “Well, it’s nice to be able to lock in 5.4% for six months, but you’re only getting it for six months.”
What’s happening now when I think of the story in the bond market, and especially treasury market, is that if you think it’s going to be two, three years of mess, well, the price or I should say the benefit of not having to deal with that with a big chunk of your portfolio, the benefit is starting to go up.
And I wonder if we’re going to get the same type of, let’s call it, deluge of assets into two-year, three-year type treasury, ETFs, direct to the bonds, what have you. What do you think about that maybe evolution? Because I’ve never looked at bonds like I have now.
MT: Yes. So, I would say if you think that the guys on the Fed are the smartest guys in the room directing things, have their finger on the pulse of what’s going on, you’re crazy. They’re making this stuff up as they go along.
RI: Yes.
MT: And in the markets trying to figure out what they’re going to do. And, I mean, it’s like trying to predict what a schizophrenic person is going to do. There’s no rhyme or reason. At the beginning of the year, the market was going up because people thought they were going to pivot. Now they didn’t pivot unless you count a pause as a pivot. Now they’re saying two more hikes and no cuts for a while. Maybe, maybe not.
So, the way I’ve been doing it is I’ve been buying all of them. So I’ve been buying the six-month. I’ve been buying the two-year. I’ve been buying the three-year…
RI: Yes, you ladder it.
MT: …knowing that if we’re sitting here six months from now and rates are at 7%, I’ll be kicking myself for buying a two-year, but also knowing that the Fed could break something and have to substantially decrease interest rates. And I’ll be sitting here cheering that I bought a two-year or a three-year. So I think you’ve got to have all of the above because you just have no idea what these guys are going to do because they have no idea what they’re going to do.
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