Discover: Most indexes of U.S. stocks are capitalization weighted, meaning the biggest companies have the most outsize effect on the indexes. But there are alternative investments methods that you can take advantage of to mitigate the risk that one or more of the big companies will default: Equal weighting, factor-based weighting or geographical-based exposure.
Inspire: The goal of net zero carbon by 2050 is ambitious. If reached, it would have profound impacts across most industries and markets, not to mention on the health of the planet,
Invest: Yes, but, consumer and investor embrace of everything green is fickle. Consumers overwhelmingly favor less carbon emissions. But they are not necessarily willing to pay more for EVs. Investors may jump into first-mover green companies, but lose enthusiasm when returns fail to match traditional strategies.
Equities’ view: An increasingly complicated investing landscape has more consumers turning to financial planners for advice. But who is helping the financial planners keep up?
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Corin Frost is the managing director at Helios Quantitative Research, a firm that works with financial advisers to help develop new and relevant tools to improve their client’s asset management experience. I spoke with him about the outlook for stocks, the rise of AI in investment advising, and the benefits and drawbacks of ESG investing strategies.
Chuck Jaffe: Let’s start broadly with the market. I mean, we had a market that had this great pickup at the end of last year. It entered this year on a hot streak and it immediately cooled off. It is a presidential election year. Can we pick this rally back up?
Corin Frost: I don’t see any reason why the U.S. equity market can’t continue to push ahead. All the economic indicators that we would look at are broadly positive. When we look at momentum, volatility and the future economic outlook, all of those factors are on the buy side of the equation.
But when we look at U.S. equities more broadly, what do we mean by U.S. equities? I mean, last year’s market rally was hugely affected by the Magnificent Seven. And just to remind ourselves what they are — Google GOOG , Meta META , Nvidia NVDA , Tesla TSLA , Apple AAPL , Microsoft MSFT , Amazon AMZN — technology companies, forward-looking intellectual property companies, they drove a tremendous proportion of the market return. In fact, they basically doubled, whereas the S&P was up by about 25%.
So I think when we think about the U.S. equity market, a lot will depend on how well those companies can continue to drive relative performance.
CJ: The Magnificent Seven, I’m kind of tired of talking about them, but they drove so much of what we’ve seen. If we wind up seeing one, two, three or four lose steam or have a bad earnings surprise or something along those lines, are they so important now that you could literally watch the market tank? Will the tide go out on everybody else if it starts to go out on them?
CF: Well, that is the reality that the significant weight they have in a typical index, a capitalization weight index such as S&P 500, does mean that we do have to pay very close attention to the movements of the largest companies. Of course, over time, investors have embraced other forms of market exposure, equal weighted, perhaps. They’ve looked at factor-based weightings. They’ve looked at geographical-based exposures instead of just market capitalization weighted exposures. Here’s a look at the alternatives.
There are other ways to think about the market. But the reality is that those seven names are incredibly important to the U.S. equity market. Now, they might not be important to the U.S. economy, but they’re important to the U.S. investor.
CJ: A pretty big distinction there, right?
CF: Just because the Magnificent Seven have doubled in the last 12 months or so, it doesn’t mean to say that the U.S. economy is boiling along at a tremendous rate. I mean, we saw U.S. GDP growth last year peak at just over 5% in the third quarter. No one’s expecting that to continue as the government stimulus spending and inflation reduction act spending begins to sort of taper off. So we would tend to think that the U.S. economy GDP growth would probably be more in the 1.5 to 2.5% range. And that’s a good thing for when we think about inflation coming down.
CJ: Separate from the momentum of those few stocks, what in a slower growth economy is going to be driving equity returns and what should someone look at?
CF: Well, we look at ourselves as an in-source CIO. So we help advisers really provide the highest quality investment research market outlook to really influence … their clients’ decisions in terms of investing in equities or fixed income or other asset classes. But we tend to focus on momentum, volatility and, crucially, future economic outlook. We look at over 200 economic indicators.
Now, of course, that’s not us as individuals. We’re using machine learning tools, AI tools to really tease out the true relationships that exist to enable our forecasts to be, we certainly believe, superior to the average research house. So those are the key drivers of returns and we need to look at the broader economy rather than just individual data points.
CJ: I want to talk about one data point that I know is important to you because it’s an area where you think we’re going to see a pretty big theme, which is the net zero agenda, the idea that we’re going to try to have much less carbon footprint by 2050. And especially how that plays out in autos and in energy, you know, whether it’s wind and solar and infrastructure products, projects or it’s companies like Tesla.
CF: Well, the Net Zero 2050 goal is incredibly ambitious. And if governments can stick to their targets, we’ll have significant implications for most industries. That’s the reality. I think Europe offers some salutary lessons in terms of how the end consumer, who after all will be paying for any net zero ambition and how the efforts there, I believe are really beginning to stall.
For example, the UK, similar to California, has a 2035 electric vehicle 100% target. The reality is that new car sales in the UK, in particular, are way below current targets and it’s difficult to see how governments can continue to mandate consumers being forced into buying electric vehicles, being forced into buying heat pumps. These are incredibly expensive decisions on the consumer and they perhaps will begin to see a political backlash.
When consumers are asked, would you like to see less carbon, they say yes. When they’re presented with a cost, it’s wildly prohibitive. In fact, the conservative government actually won a by-election against all the odds, really because of the ultra-low emission zones in London, which aimed at reducing diesel cars and polluting vehicles. So the consumer is beginning to wake up: the sort of carbon footprint reduction strategy of governments is going to be prohibitively expensive.
CJ: How much do you wind up thinking that the good has been priced in and the real result will be these companies that we’re counting on to be solid ESG investments may be in for more volatility or trouble moving forward?
CF: I mean, that’s right. I mean, certainly the early mover investor enthusiasm. We didn’t just see that with Tesla. We’ve seen that for electric vehicle charging points. We’ve seen that for all types of green IPOs where the first blush of interest really caused prices to increase dramatically.
But over the last two years, the average investor in green securities, certainly on the charge point side, which are EV cars, you’ve lost 80% to 90% of your investment. So it’s incredibly difficult to pick winners in the ESG space, particularly when government largesse may determine those winners, as opposed to pure competition.
CJ: What does that mean in terms of what you’re telling clients, especially with ESG?
CF: I think one of the things with ESG is it means different things to different people. So how do you define it to even to begin to build an investment strategy? And we have clients that would definitely want to have an ESG strategy and we will implement a portfolio that meets those needs. I think that’s the role of the CIO, to represent clients is to provide investment strategies that meet needs. What is impact investing and what is ESG investing?
The reality is broadly, in terms of academic research, there’s not a whole of evidence that ESG adds value over and above a typical capitalization equity benchmark such as the S&P 500. So it’s an area where certainly there is the emotional appeal, but does it drive investment results? So it’s certainly not something that we at Helios would be promoting to clients directly, but we can certainly implement ESG type strategies.
CJ: Is there evidence that it detracts from returns? I mean, if it doesn’t add, there would be plenty of people would say ‘Yes, as long as it’s not killing me, it’s still what I’m going to favor.’
CF: I think the evidence is mixed. In terms of ESG, the investor experience has been incredibly mixed. And I say picking winners in that space is a risky strategy. When we look more broadly at index versus active investing, the long-run experience of investing in active portfolios has been very disappointing. When we look at 15 years of data from the S&P index versus active report, for example, over 90% of active managers underperform.
And when we think about ESG, it’s a form of active stock picking. So we may have a good experience with Tesla and the initial burst of enthusiasm. But as you say, there can be headwinds with Tesla. Certainly the Hertz cancellation of 20,000 orders. That’s a sobering wake-up call … that there isn’t the demand for electric vehicles, etc. that perhaps we thought at the outset.
CJ: Last question. Here we talked about what’s happening and we talked about the domestic market, but where are you on domestic versus international as we move forward in 2024?
CF: Certainly, I think international does play a role in investor portfolios. And again, it depends on the investors’ risk appetite, their comfort with investing in not just developed markets, perhaps emerging markets as well.
So I would argue that the U.S. is well positioned from an equity market perspective. But again, so is international. There’s no reason why investors should not be looking at the UK, Germany, the G7 economies to diversify their portfolio.
Chuck Jaffe is a contributor at Equities and the host of “Money Life.”
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