The Most Anticipated Recession on Record
It is difficult to be optimistic about the investment outlook for 2023, but as Raoul Pal points out, this is the most anticipated recession on record. The list of risks and unknowns are high. To name a few in no particular order, (1) cost of capital is a function of interest rates and may stay high. (2) Inflation may come down, but to what level? (3) Layoffs may accelerate. (4) Signals like consumer debt rising and confidence declining reflect the probability of a recession, but will it be shallow, long, etc.? All of this highlights that investors and their financial advisors must be prepared for volatility. This is why we continue to believe that portfolio strategies structured to be uncorrelated to equities and bonds are even more important than in recent years. We include a healthy use of cash in that category, allocated to tactical strategies or the active use of ETFs in a tactical manner as a core part of their long-term strategy. Most importantly, while it has been easy over the past 5-10 years for investors to think long-term, present conditions should not change that outlook. This is why thematic investing will also remain essential for investors. If value outperforms growth in 2023, it may be because multiples (PEG, sales or earnings) do not expand in the overall growth factor. However, that does not mean that growth does not continue to disrupt and innovate. As such, by targeting a specific theme, an investor can earn outperformance over the broad growth factor. But don’t be discouraged – this is why we believe that the due diligence platform we offer to the ETF Think Tank community provides so much value.
Alternatives
Why buy an ETF that provides an “alternative to making money in bonds or equities?” Answer: Because conditions in 2023 could follow trends in 2022, and diversification can lower your risk. To learn more about alternatives, financial advisors should walk through this ETF list, but note that top dogs may also have worked because of inflation circumstances. Moreover, what has worked in 2022 should be reviewed closely in the context of potentially re-weighting. Commodities are almost never a straight-line trade. Long-short and equity market neutral trades, where low, single-digit returns can be earned in flat or declining markets, remain constructive recommendations. Almost 4 years ago, we highlighted the AGFiQ US Market Neutral Anti-Beta ETF (BTAL) in Street.com’s retirement website. Heads really turned on that recommendation.
Thematics
According to an article written by Isabelle Lee of Fortune, the $115 billion Thematics ETF category saw only about 1% of outflows in 2022 despite seeing a drawdown of about 30% on average – about twice the S&P 500. Among thematic funds, innovation and emerging markets technology were at the top of these driving inflows YTD, at $2.2 billion and $1.8 billion respectively. The article continues to emphasize that outflows were in tech/communications, cloud, and robotics at about $3.2 billion, 1.2 billion and $941 million, respectively.[i] We think the thematic category will continue to grow, because investors and financial advisors can understand how the potential return goals can be achieved and know when there are headwinds. Examples of mega themes that should offer opportunity for outsized returns in 2023 and beyond include (1) cyber security, (2) various ways to slice up trends involving electric vehicles, renewables, and batteries, and (3) targeted healthcare themes. Of course, we admit to having a bias towards investment in blockchain, which remains very much at an early stage of development. To learn more, please read the latest from McKinsey & Company, which states that by 2027, 10% of Global GDP could be associated with blockchain. As is the case with all thematic trends, we believe near-term sensibilities around earnings and real cash flow projections in 2023 are going to need to be emphasized over hyper growth and capital market access.
We have hosted a number of discussions on Twitters Spaces and on the ETF Think Tank YouTube Channel on specific themes and certain ETFs that work as broad thematic solutions. Feel free to inquire directly by reaching out. For your convenience, here is a link to read the thoughts of Blackrock’s Jay Jacobs. Of course, getting the theme right in terms of alpha over the broad growth index but not over the particular structure can be very frustrating. In many ways, this plays to the overall Structure Matters thesis, in that certain themes require active management while others, which are narrower, may be best fit to a passive strategy. Please do reach out to us when you are reviewing a thematic ETF; our tools offer helpful information around their value proposition in the context of their “active share,” as well as how they compare with the broad indexes and comparable alternatives.
A balance between alternatives which tend to emphasize growth makes sense, because much of the negativity might be built into the price, and a shallow recession could lead to a spring-board-like rebound. Truth is – we just don’t know. Regardless, tracking the progress of themes is easier based upon a narrower set of circumstances and evidence.
[i] https://fortune.com/2022/12/10/thematic-etf-boom-still-going-strong-despite-brutal-year/amp/ and https://www.bloomberg.com/news/articles/2022-12-10/the-115-billion-thematic-etf-boom-lives-on-even-as-losses-mount?leadSource=uverify%20wall
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