The last three years have been loaded with unprecedented events up to and including right now. Massive stimulus packages, corporate bailouts and the most aggressive rate hiking cycle in history have changed the way that investors need to approach and analyze the markets. Michael Green, Portfolio Strategist with Simplify, is among those trying to interpret this environment. He joins the ETF Think Tank to talk about what he’s seeing and where he’s concerned.
Green is bullish on ETFs, in general, because of the ways they can bring complicated, institutional strategies to regular investors. A lot of things that are difficult within mutual funds, such as managed futures or credit strategies, become more accessible within an ETF. Plus, you can be far more tax efficient than you can within a hedge fund. They’ve been a great way to democratize investing.
One of the themes of the discussion was historical anomalies and how we’re seeing events play out that we haven’t before. One of the things that Green is seeing is what he calls active flows vs. passive flows. Broad flows into index funds are simply trying to participate and allocate according to market cap. He’s found that passive buying scales more with volatility than straight market cap allocation. Small-caps have been getting overlooked within this concept and that’s allowed the “magnificent 7” stocks to dominate recently. By passively investing, you’re skewing the flow of capital towards mega-caps because of cap-weighted investing.
Green believes that the MOVE index, the volatility measure for the bond market, has been rising again because people just don’t know what the heck is going to happen. Under more normal conditions, interest rates are absurdly high at the moment. The reality is that what we consider “normal” is often a function of how people look at the recent past. Various markets, including commercial real estate, are being reevaluated based on pandemic related factors and the presence of high interest rates. The bond market is one area where some behaviors are truly unprecedented, but Green suggests we might be near the end of the process.
Green finds covered call strategies to be particularly interesting. Through the sale of calls, you can effectively turn an equity into a fixed income asset. For instance, by writing calls on a stock like Apple, you’re essentially turning it into a high yield bond. You’re simply selling upside for yield and if you feel that downside risk isn’t substantial at the moment, covered call strategies can make a lot of sense.
Bankruptcies are where Green sees some of the biggest market dislocation. Heading into the financial crisis, spreads were widening, bankruptcies were climbing, but prices remained stagnant (i.e. the scene from The Big Short). Bankruptcies today are actually moving higher, surpassing the pace of the financial crisis. According to Green’s models, he believes high yield spreads should be around 800 basis points instead of the 380 level they’re at now. This is an area where things could correct quickly, but investors aren’t treating it as a major risk right now.
Other key takeaways:
- Who is the target market for Simplify ETFs? Some are suitable for a wide range of individuals, including fund managers, financial advisors, and retail investors. Others are perhaps better suited for RIAs and higher net worth investors, particularly those involving commodities and short volatility strategies.
- Green says he’s seeing a lot of unprecedented price behavior that he hasn’t seen in mega-caps before. If you look at NVIDIA’s post-earnings rally of 30%, there’s not enough short interest to cause that kind of move. What you had was small market moves that saw $7 billion in new money result in a $500 billion market cap increase.
- Green highlighted that real interest rates at the 30-year point on the curve have gone from -50bp to +210. All things being equal, equities should be down 65% with that kind of move. Equity risk premiums should be rising, but they’re not.
- Green suggests that COVID may have inadvertently helped hide the fact that the wheels were coming off in 2019. It took what was looking like a risk-off event and turned it into a violent risk-on event with stimulus and liquidity. Fiscal accommodation fundamentally flipped the script.
You can watch a replay of this virtual happy hour on our YouTube channel here. While there, subscribe to our channel to stay up to date on our latest content.
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