by Bryan Perry

December 7, 2021

The market has entered what I like to term a “work zone” or “construction area,” where everyone is wearing their proverbial yellow vest and hard hat. No one has left the job site, but no one is taking any undue risk of getting hurt, either. We saw last week how investors can get spanked for being overweight in stocks with a lofty Price to Sales (P/S) ratio and virtually no Price to Earnings (P/E) ratio.

There is no way to sugarcoat the damage. It was a blood bath for high-priced growth stocks. While the S&P shed about 5% and the Nasdaq lost about 7% from their recent highs before catching a late Friday bid, stocks of AI, enterprise, cyber security, cloud, and most Software as a Service (SaaS) shed anywhere from 20% to as much as 50% of share value. To say the tech bubble got pricked is an understatement.

The Ark Innovation ETF (ARKK) has been labeled something like a poster child for hyper-growth investing. Clearly, this fund is breaking down on a big spike in trading volume. At its zenith, the Ark ETFs had over $52 billion in Assets Under Management (AUM). The latest data from ETF.com states Ark AUM of around $35 billion, as a firehose of money is leaving these and other hyper-growth funds.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Even though the yield on the 10-year Treasury fell to 1.34% at Friday’s close, the Street is convinced that the Fed is now in inflation-fighting mode, which will result in a higher Fed Funds rate once the taper is complete, leading to higher bond yields as well. How much higher, no one knows, but the perception is that the Fed is behind the inflation curve and the market is responding by way of multiple contractions for stocks that have enjoyed a first-class seat on the QE express train for the past two years.

That ride is about to end, and investors are wasting no time rebalancing their portfolios to de-risk away from stocks with no P/E ratios, no matter how good their underlying story may be. Investors have voted to reprice these hot growth stocks at considerably lower multiples with end-of-quarter portfolio window dressing and year-end tax loss selling making some further stiff headwinds for the balance of December.

Last week ended with only utilities and real estate sectors showing gains, with the other nine sectors closing in the red. That means there were few places to hide. The biggest winner on the week was the iShares 20+ Year Treasury Bond ETF (TLT), which closed up 6.9% on a sharp flight to safety.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Investors are not fully abandoning these hot growth sectors; they are rotating into related big-cap stocks that have reasonable P/S and P/E ratios as well as strong dividend growth and robust stock buy-back programs. This was clearly evident within the semiconductor sector price action late last week, as the Nasdaq was under heavy selling pressure and yet several chip stocks bucked the trend and traded higher.

For investors seeking yield from after taxes and inflation, then bonds are a tough call right now. With the 10-year T-note paying 1.34% and the iShares Investment Grade Corporate Bond ETF (LQD) paying 2.26% with a 9.6-year average maturity, there is clear downside risk in an up-rate market, not to mention income received is taxed at ordinary income rates with inflation running at 2-4 times current yields.

“Barbell” Bond Strategies Backfire

This scenario kind of throws the traditional “barbell investment strategy” out the window, and yet millions of investors need income to stay on top of the rising cost of living. (According to Investopedia, the barbell strategy advocates pairing two distinctly different types of assets. One basket holds only extremely safe investments, while the other holds only highly leveraged and speculative investments.)

The barbell approach famously allowed Nassim Nicholas Taleb, a statistician, essayist, and derivatives trader, to thrive during the 2007-2008 economic downturn while many of his fellow Wall Streeters floundered. Taleb described his barbell strategy principle this way: “If you know that you are vulnerable to prediction errors, and accept that most risk measures are flawed, then your strategy is to be as hyper-conservative and hyper-aggressive as you can be, instead of being mildly aggressive or conservative.”

This was all well and good when the yield on the 10-year was trading between 4% and 5% during the 2007-2009 crisis. Holders of long-dated Treasury zero coupon bonds made out huge during that time.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

In the current environment, however, with bond yields back down to levels not seen since January and hyper-aggressive stocks being revalued lower, blue-chip stocks with strong dividends are an alternative way to capture healthy yields with qualified dividends where income earners pay a top tax rate of 20%.

The Schwab U.S. Dividend Equity ETF (SCHD) pays a pretty attractive 2.9% current dividend yield, and the iShares Core High Dividend ETF (HDV) pays a juicer yield of 3.5%. Granted, neither of these two ETFs (or most blue-chip dividend paying stocks) will trade higher, like Treasuries, in a black swan event such as what occurred in the Great Recession or the pandemic of March 2020. In this case, when rates are already so low, there is probably no substitute for cash when big trouble hits.

When seeking inflation-hedging income with likely stock appreciation, low multiples and a history of growing dividend payouts, blue-chip stocks with defensive characteristics are an option for lowering beta in portfolios while still maintaining exposure to leading industries with bullish growth trends. In addition, the charts of these ETFs are very stable in an otherwise volatile market landscape.

While this is not a perfect substitute for high-quality bonds in a big or sudden economic downturn, one can always quickly make changes with the click of a mouse, or jump on the TLT trade as a safe-haven that may produce a decent short-term return. In the meantime, and until we are more informed about future inflation, the nature of Omicron, and Fed policy, stocks with the underlying properties noted within generally offer the best alternative to long-dated bonds for tax-efficient income and growth.

All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.

Please see important disclosures below.

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Also In This Issue

Global Mail by Ivan Martchev
Analyze This: Treasuries Rally into the Taper

Sector Spotlight by Jason Bodner
When Good Stocks Go Down, Buy Them

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About The Author

Bryan Perry

Bryan Perry
SENIOR DIRECTOR

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry

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