The past 12 months featured some relatively grim milestones—including the highest inflation in four decades and the first truly durable bear market since the Great Recession. That concatenation of bad news poses two challenges for investing pros: They need to figure out where to find positive returns, and they need to talk their clients out from under their proverbial beds. Neither of those prospects daunted our experts. Indeed, they were united in the view that a rough 2022 could pave the way for a better 2023—for stocks, society, and our psyches.
Joining us for this year’s panel were Josh Brown, CEO of Ritholtz Wealth Management; Georgia Lee Hussey, founder and CEO of Modernist Financial; and Savita Subramanian, head of U.S. equity and quantitative strategy as well as global ESG research at Bank of America Merrill Lynch. The conversation below has been edited for clarity and brevity.
Fortune: The markets have been in a long downward trend, and none of us, as adult investors, has ever coped with inflation this high. Did the three of you see this coming?
Savita Subramanian: We shifted to a fairly bearish outlook by the end of last year. We were starting to see inflation like we’d never seen in our careers, plus the relationship between the market multiple and the inflation rate was completely out of whack. We had an S&P 500 P/E of somewhere above 20, and a CPI that was around 9%; it just seemed really untenable.
It also smacked of 1999–2000. It was the same feeling of: Growth stocks are gonna go up forever, megacap tech is all you want to buy. These companies didn’t necessarily have strong earnings today, but had these promises of fantastic growth. And that was awesome in an environment of very low interest rates. But as the cost of capital rises, it becomes more problematic to take that bet.
Georgia Lee Hussey: I’ve been telling people that market cycles generally are seven to 10 years. And for a while my Spidey sense has been saying: At some point, we’re going to have some kind of correction. We’ve been working with clients building cash positions, building line-of-credit positions, especially for business owners, so they have a lot of choice when the market does correct or, more importantly, when the recession impacts their business.
Our clients are in a position where they have significant means. So as long as they don't panic in the bottom, they're fine. And so there's a lot of time spent reminding folks of that and preparing them to be able to not only weather but utilize this moment, focus on the things that are going to set them up for the next phase.
Josh Brown: Our tactical model is designed to react quickly when it becomes statistically clear that we’re no longer in a bull market. So by the end of February, we were completely out of the Nasdaq. And by the end of April, we were completely out of the S&P 500.
It’s not the entire portfolio; it’s one specific strategy in a bigger portfolio. But that addresses the clients’ concerns as they see those lower highs and lower lows. And it gives us the option to buy back in later. With the big caveat of: We won’t call the market bottom—we will most likely be significantly off the lows when that buy signal gets triggered. That’s how technical analysis works; it’s backward-looking.
Hussey: Emotional decision-making can work in our favor or work against us. A lot of the work that we do is preemptive: We’ll ask clients, “What do you want me to tell you when the market goes down?” We literally write it down and then pull up the file to remind them what their more grounded, stable self said they wanted to do.
Brown: I think that’s such a great point. You’d have a client say, “Okay, get me out.” “You have a million-dollar portfolio, 70% of it in stocks, sell it right now?” “Yes.” “Okay, let’s visit your financial plan that we created. Tell me which of these things you no longer want to be able to do. Can you throw college out? The boat not happening anymore?” We’ll just start crossing items off the list.
So, what are some useful adjustments for folks as they stay invested?
Subramanian: Equities that pay dividends are one of the best ways to protect against an inflationary environment. If you look at financial companies, they tend to grow earnings during inflationary periods, and earnings are nominal, unlike bond yields. And financial companies are still relatively inexpensive.
The energy sector offers nine percentage points’ higher free cash flow yield than Treasury Inflation-Protected Securities. That’s a huge spread that you’re getting. Energy is a tough sector to own if you have an environment-first sensibility. But these companies got the memo: They realize that they are being disintermediated by green, clean, renewable power, and they have pivoted aggressively to becoming more environmentally friendly.
Are the energy companies that have more fully diversified into alternative energy commanding a premium?
Brown: I want to talk about NextEra, an energy company that owns Florida Power and Light, which is as staid and boring a utility as you could possibly imagine. However, that’s only half the business. The other half is this massive, fast-growing renewables company, where they’re building out renewables infrastructure for other utility companies and large-scale corporations. On a five-year look back: NextEra up 126%; the S&P up 61%. This is a stock that is paying a dividend, acting like a utility, but has that premium return because they’re thinking about, How do we power the next century?
Georgia, you’ve been telling your clients that if they’re bullish, everything’s on sale—but ESG in particular, right?
Hussey: Yeah, we have clients that were in a globally well-diversified, all-the-good-stuff portfolio, but they wanted to move to ESG eventually. And I’ve had pings in my software for years, so when the downturn came, we were ready to move. And we’re taking a 20% discount on that reallocation. So that’s been really satisfying.
Brown: Do you find that your clients are more likely to stick with a portfolio that aligns with their values?
Hussey: What I find is that when they're really grounded in their financial plan, to your point earlier, when they really understand their goals, and when they're very committed to values not only in their investments, but also in their charitable donations, in the way they show up the community, and the way they spend their time, all the areas of wealth really —the investing piece becomes the engine and not the path. Right?
Subramanian: We’ve also been seeing that at Merrill Lynch—we’ve got this growing cohort of not just younger millennials or Gen Zers, but a larger cohort of high-net-worth female investors, or of folks just looking to allocate capital according to their values.
I would say that a few years ago, this manifested itself as an exclusionary template: “I’m not going to invest in fossil fuels,” or “I’m not going to invest in companies that do stem cell research plays.” Now we’ve actually seen a lot of those exclusions being lifted. And we’re starting to see individual investors approach this more holistically and thinking about: This is a company that might not look great right now. But are they on a path to improvement?
-17.2
decline in the Bloomberg U.S. aggregate bond index from August 2020 through October 2022—the steepest decline ever for the U.S. bond market
Brown: I’m gonna be a little bit politically incorrect. The energy sector is up 65% this year; every other sector is negative. And I’ve seen a lot of clients who were only halfheartedly interested in ESG, or became interested because their grandson forced them into it, saying to themselves, “Why don’t I have more exposure to Chevron?”
Which does not mean that ESG is dead. I know a lot of people get clicks for writing headlines like that. But maybe it’s something as simple as: Let’s look at ESG on a spectrum, rather than “This company’s evil, this company’s good.” And then say, “Okay, I do want energy exposure: I won’t buy the company that is lighting a river on fire; I’ll buy the company that is making the biggest R&D investments in not flaring natural gas.” I think that that’s where the puck is going.
Hussey: There’s something quite radical about investing in companies that are not going in the direction you want, and then utilizing shareholder power to say, “You have to move in this direction.” One example I offer clients is the Sisters of St. Francis of Philadelphia: They bought into Goldman Sachs in order to put forward a letter that they would have to read at the next public board meeting, explaining their issues with the social implications of Goldman’s decision-making. And when Goldman Sachs didn’t respond, they put out a press release saying, “You did not respond to Sister Nora Nash’s letter.”
Brown: I would also just point out that with ESG investing, before it had a label, before it had a name, there were corporations that cared a great deal about their impact and the community that they serve and thought about employees as stakeholders. And the best example would be Hershey. When you go to Hershey Park, after the roller coasters, take five minutes go to the museum. And what you’ll see is a century of them sponsoring public works in the town, and higher levels of education than the townspeople would otherwise be able to afford, and sponsoring women’s athletic associations.
And Hershey's has not been less successful as a result of taking care of their stakeholders. In fact, it's one of the few remaining surviving companies of that era that’s still thriving globally. So there's a way to do this and not compromise on upside. It's just it takes more effort.
This is getting into the S side of ESG, the social side.
Subramanian: We’re in the tightest labor market ever. You want to have satisfied, happy employees who stay in their seats. We found in our research that if you look at Glassdoor rankings, and you look at companies with high job satisfaction, they’re not necessarily the companies where the employees are paid the most. They’re not the companies where the employees think they have the best trajectory of career success. These are companies where employees rank culture as a strong suit of their corporation.
Brown: The challenge is, when you find something in the data that disagrees with your own feelings, what do you do? You may be familiar with Dimson, Staunton, and Marsh at the London Business School: They looked at the biggest industry classification returns. And going back to 1900, tobacco is undefeated. American tobacco companies, it’s a six-and-a-half-million percent return, if you can wrap your head around that. So there are times where you have to say, “I believe that this ESG approach to investing is valid. However, I’m also willing to accept that if oil stocks double in a year, and I’m underweight or have no weighting, then I am prepared to explain to my clients why we just had to forgo that rally.”
Hussey: There’s a question that I bring forward to clients and in our own cultural conversation, which is: “What on earth is enough?” Like maybe you don't need to catch all those returns...
Brown: I’m from Long Island. So there’s no such thing as enough.
Hussey: Ha, right. But do you really need that next million?
Brown: We had that conversation in cryptocurrency last year: Is the goal here a Lambo? Is it gambling? Is it recreation?
So for some people who work in crypto it's almost like it ties into their identity. Why do you need to have 30% of your assets in this asset class? And the answer is, "Well, this is my mission on earth right now." So that's a very tough thing as a financial planner to say, “Well, it turns out if we don't do this stuff, you'll be fine. So now to what degree do you really want to do it?”
I wrote a book called How I Invest My Money. And we said to 20 people who actually worked in the industry: "Don't tell me what you think your client should do. What do you do with your money?" And it's amazing how much compromise there was between what people should be doing versus what they want to do. And these are pros. And I opened the book up with a thing about how Jack Bogle, who's the godfather of index investing, invested in his son's hedge fund also. And it's completely incongruous with everything he said about costs about alpha, etc. And so they asked him, Well, why do you do that? And he said, Well, family, I love my son.
Hussey: Yeah, some things transcend our investment philosophy. I think that's a really important element in the conversation.
Brown: But let’s not do 20 minutes on crypto.
Definitely not. But on the subject of assets that aren’t stocks: For a long time, we’ve been invoking the acronym TINA—There Is No Alternative to stocks. When interest rates were so low, there wasn’t really another reliably performing asset for most portfolios. With higher rates, it’s a different conversation.
Brown: There is this misconception on the part of investors that when the markets are going down, they’re not making any progress. And in fact it’s the opposite.
In the first 10 months of this year, arguably, we have done more hard work than at any point in the last 20 years. The 10-year Treasury index is down 18% going into November, which is literally the worst performance for the 10-year in any year going back to 1788, which I don’t remember personally, but I can imagine that was pretty rough. The Barclays aggregate index is in a 17% drawdown over the last 27 months. It’s the longest and largest drawdown in U.S. bond market history.
Again, everyone’s got their wounds to lick from this year. The S&P is down 20%. And when you look at a 60/40 portfolio, it’s very hard to find a time where things were worse. But that is where future returns come from.
The TL;DR is, it’s almost impossible to not succeed if this is your starting point. It’s not going to be the starting point for your whole portfolio, but for new investors, for new money, we have made a lot of progress.
“It’s almost impossible to not succeed if this is your starting point … For new investors, for new money, we have made a lot of progress.”
Josh Brown, CEO, Ritholtz Wealth Management
Subramanian: At the beginning of this year, our long-term valuation framework was telling us that returns would be negative every year over the next 10 years. After the shakeout that we’ve seen, after the work that Powell has done, after we’ve been through a bear market, that same model is telling us that returns over the next 10 years are going to be about five percentage points per annum, give or take; if you add on another 2% to 3%, dividend yield, that’s a fairly healthy return from stocks.
Then when you look at bonds, instead of getting zero in your cash, you might as well move it into a three-month T-bill or a two-year bond. If you’re looking for yield and you can take a little bit of risk, the credit markets are starting to look really attractive.
One of the simplest strategies that we’ve found in our research—and I tell my parents about this, I tell my friends about this, I tell anybody who will listen—is that if you track dividend yields, and you own companies in the Russell 1000, the large-cap index, and bought not the ones with the highest dividend but the second-highest quintile, you would have outperformed the S&P 500 on a total return basis. And you would have outperformed every other cohort of the market: the high-flying, no-dividend-yield, zero-paying stocks, the super-high-dividend yield. And all with this Steady Eddie strategy.
Brown: That’s not going to be as much fun as meme stocks. That’s the problem.
Hussey: We tell clients, investing should be really boring! If you’re too excited, you’re probably doing it wrong.
Rising interest rates are slowing down real estate sales. Thank God, honestly, because there are systemic issues that have been created by this incredible booming real estate market, and it’s creating houselessness issues all up and down the East and West coasts. And so being able to slow folks down, I appreciate this one cycle. This moment is winter. I just keep telling people: Winter’s good.
Brown: When everything’s trending up, you can’t think straight, and everybody’s getting richer around you and you lose your shit. You’re just like, “Oh, my God, why aren’t I doing this? How come I didn’t get anything?” And now it’s the opposite. Every day you wake up thankful: “Oh, thank God I missed out on that.” Because all of these things are blowing up or going in reverse.
Back to valuations, the S&P 500 is now finally below its 25-year average. We’re at about 15 to 16 times earnings. The 25-year average, which is the length of my entire career, is 17. So my question for you, Savita, is: Is that cheap enough? Doesn’t the pendulum have to swing a little bit further?
Subramanian: I hate to be the skunk at the garden party. But I do think there are still areas of overvaluation. I see it in companies that are very labor-intensive, that have a high cost structure. Labor costs have gone up; costs of basically every raw material have gone up. So the idea that earnings are going to be just awesome next year is not a foregone conclusion. In fact, we have negative earnings growth penciled in for next year.
$55,150,000,000
Total Q3 2022 profits for the world's five biggest oil companies—BP, Exxon Mobil, Chevron, Shell, and TotalEnergies
The other problem is that we’re starting to see the layoffs hit. We’re starting to see skilled labor lose some skin, the wealthier consumers. We all talk about the wealth effect—I think the math is, for every dollar of wealth created, that impacts four cents of consumption. The negative wealth effect could be much more profound this time because a lot of people who made a ton of money in stocks, owning homes, or working in tech, working in these really well-paying industries, are now at that inflection point where they’re no longer employed, and they’re sitting on half the asset value they thought they would have.
Brown: To your point: Meta is talking about laying off 13% of its workforce. These are people that make a million dollars a year. Their very existence supports the livelihoods of all manner of personal trainer, hairdresser, auto mechanic.
A scarier economic climate often scares people away from philanthropy. How are you steering people through that?
Hussey: We've been talking a lot about, again, understanding what is enough. Most of the people we’re talking about have significant resources. If they haven’t totally overleveraged their lifestyle, they’re probably going to be fine.
We need to remember that the market is not the economy, and the economy is not the market. And the economy makes me very worried about food banks. Children are hungry, people are hungry. And when kids can’t eat they can’t pay attention in school, and if they can’t pay attention in school they can’t be good students; they can’t move forward in the world. And as a business owner I’m thinking, I need to hire these folks in 20 years. And so there's a way in which we keep saying, “Don't worry about your portfolio. Give some money to a food bank instead."
Brown: Thank you so much for bringing that up. We did an event this weekend, my daughter and I; Long Island Cares is the organization. Their pantries are empty: The effects of inflation are ridiculous right now. So we raised money and we did a food drive on Sunday at the high schoo,l and the CEO of the food bank came just to say hello and see what was going on. And he gave an impromptu talk, and the gist of it was there are 225,000 food insecure families on Long Island, 79,000 children who do not know that they'll have enough meals that week. And it's crazy to go from that, and then on Monday morning, walk in, and we're talking about Jerome Powell, and we're talking about P E ratios.
Georgia make a really good point. There's a point at which we're spending too much time thinking about market returns, and not enough time thinking about how lucky we all are to even have that on our plate at something to worry about.
Hussey: We did some research, because I was curious: What is the ROI on investing in kids? There was a study done that showed that an investment in programs for birth to five years old will have a 13% ROI by reducing costs for our shared systems like prisons and healthcare. And so I would say, move your focus away from your 401(k) or your trust account and instead focus on the thing that will actually benefit your neighbors, which will benefit your local businesses, which will benefit our interconnectedness. But I think this is really the opportunity of this moment.
“Move your focus away from your 401(k) or your trust account and focus on the thing that will benefit your neighbors, your local businesses.”
Georgia Lee Hussey, founder and CEO, Modernist Financial
Brown: Politicians can’t think that way because they have to get reelected in four years. But if we did think that way, the dividends that would come 15 years in the future are crazy.
Subramanian: The corporate sector has really taken the reins in driving this home. What we’ve seen over the last 20 years is that supporting the communities in which you operate—banking the underbanked communities; teaching women skills around financial services and investing; returnship programs for people who left the workforce—is making your brand mean something positive. That translates into talent attraction and retention.
Hussey: One thing to add: What you could do if you want better returns is, you can hire a woman to manage your money. Two finance professors published a study in the ’90s with the best title: “Boys Will Be Boys: Gender, Overconfidence, and Common Stock Investment.” And there are several other studies that show that women outperform their male counterparts from 40, to 100, to 300 basis points a year.
Brown: Was this study done pre– or post–Cathie Wood?
Hussey: What I’m interested in here is: Individual investors have a lot of power to make choices about how they allocate their capital, and that includes who manages their money. There are lots of fabulous female managers out there, or managers of a diverse background, who probably see the world differently. And that’s what we need right now, to navigate a world that is uncertain.
What’s something you’re feeling optimistic about?
Subramanian: What’s both exciting and scary to me is that the world of investments has become more democratized. Investing shouldn’t just be for the elite, the wealthy; investing should be something we all think about, from our first job. It’s important for us to teach our children: Start a savings account, start thinking about long-term investments. Even the whole meme stock phenomenon, it was a fascinating turn of individuals against the so-called smart money. You saw an interesting pivot from the idea that hedge funds are gonna make two-and-20 by being smarter than everybody else, to the idea that we can all build wealth, we can all invest, we can all participate.
Hussey: I think this is an exciting moment, but an uncomfortable moment. There are strong reasons to be nervous right now. SCOTUS’s rulings on reproductive rights are unnerving all of our clients, as well as their signaling about gay rights, trans rights, and the impact that could have on my clients who have nontraditional families and businesses.
I think we have an opportunity to be self-aware, realize that we're freaked out and scared and anxious and not take action, but rather use this as an opportunity to reflect. What are our priorities? What are our values? What do we want to be doing now? And then do the really radical thing, which is to not do a damn thing. I don't think we're ready. We're grieving. We need to take a beat, as investors don't do anything in the down market, but also just chill, hang out with people you love, and figure out who you want to be in this next phase. Because I think it's burgeoning. I think there's a lot of opportunity. And I think that’s where we’ll find a lot of the solutions to what we need next. But we’re not quite ready to take action yet.
Brown: When you look back in history and you look at these major turning points, like the aftermath of a war or the aftermath of an assassination, you can always see that there was a turn that resulted from that. And usually the turn is toward more progress, not less. So I hope you’re right about this moment.
3 things to get excited about, and 3 to worry about
Get excited about:
Large-cap stocks on sale
In November, the S&P 500 traded at 15 to 16 times estimated forward earnings, below its 25-year average. Some pros see that as a sign of better returns in the near future.
Tax breaks in a bear market
Investors who have to sell assets in a down market can use the losses to reduce their taxable income. That fact also makes this a good time for a Roth IRA conversion.
Green keeps going
In a hot market for energy stocks, investors are rewarding companies that are committing to renewable fuels, an encouraging sign of momentum in the climate fight.
Worry about:
Corporate profits under threat
Companies have been able to pass rising costs along to customers, but those days may end soon; Bank of America Merrill Lynch expects earnings to shrink in 2023.
Tech layoffs and their ripple effects
Layoffs of high-paid staff at Amazon, Meta, and other tech giants could have a “negative wealth effect,” hurting the service industries that orbit the tech economy.
Inflation and the most vulnerable
Higher prices have sparked a hunger crisis in the U.S., inflicting suffering today and posing a threat to economic competitiveness and social cohesion down the line.
A version of this article appears in the December 2022/January 2023 issue of Fortune with the headline, "Investor Roundtable: Seeking shelter and seeing silver linings."
