Lead-Lag Live

Cameron Dawson on Wealth Portfolio Management, Market Trends, and Alternative Investments

• Michael A. Gayed, CFA

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Can you anticipate market trends and mitigate risks to protect your wealth? Join us as we engage with Cameron Dawson, the Chief Investment Officer of New Edge Wealth, to unlock the secrets of managing ultra-high-net-worth portfolios. Cameron sheds light on the intricacies of handling substantial assets, emphasizing the critical importance of tax sensitivity and the intriguing potential of alternative investments. She shares her tactical yet long-term investment strategies, offering insights on maintaining quality across asset classes, and provides a thoughtful analysis of the current market cycle, the importance of respecting trends, and the dangers of low-quality rallies.

What drives international and small-cap market performance? Discover the conditions necessary for international and emerging market outperformance with historical insights from Cameron Dawson. Explore the impact of significant dollar devaluation periods and how capital flows facilitated major bull markets internationally. We also dive into the dynamics of earnings growth versus the risks of tech-driven bull runs, and assess the potential regulatory and political challenges that could impact mega-cap tech companies. Cameron's expert perspective provides valuable context for understanding the broader economic environment and the implications of Federal Reserve interest rate cuts.

How do you strategically manage portfolios amid economic uncertainties? This episode is a must-listen for anyone looking to enhance their portfolio allocation strategies. We examine the effects of Federal Reserve policies on financial markets, the nuances of balancing sector overweights and underweights, and the potential of alternative investments like private equity and private credit. Cameron Dawson's insights into managing equity portfolios in anticipation of a recession offer practical advice for navigating turbulent times. Tune in for a comprehensive discussion on balancing balance sheet relief with income statement health and ensuring rigorous due diligence in alternative investments.

The content in this program is for informational purposes only. You should not construe any information or other material as investment, financial, tax, or other advice. The views expressed by the participants are solely their own. A participant may have taken or recommended any investment position discussed, but may close such position or alter its recommendation at any time without notice. Nothing contained in this program constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in any jurisdiction. Please consult your own investment or financial advisor for advice related to all investment decisions.

 Sign up to The Lead-Lag Report on Substack and get 30% off the annual subscription today by visiting http://theleadlag.report/leadlaglive.


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Speaker 1:

My name is Michael Guyatt, publisher of the Lead Lag Report. Joining me for the rough hour is Cameron Dawson, who I know a lot of people have been seeing doing the media rounds quite a bit, actually in the last several months. But, cameron, introduce yourself to the audience. Who are you, what's your background, what have you done throughout your career and what are you doing currently?

Speaker 2:

Definitely Well. First of all, thank you so much, michael, for having me I'm really thrilled and for the flexibility to reschedule. So happy to be here, thrilled to get to chat at what is such an interesting time right now with so many markets in flux and in motion. So I'm the Chief Investment Officer of New Edge Wealth. We are an ultra high net worth private wealth manager focused on families and institutions. I oversee our investment platform. We have an incredible team of investment experts across the asset class spectrum. I come to New Edge after spending a year and a half as a chief market strategist at a smaller RIA and then I was, prior to that, in industrials analysts on the buy side at Bank of America for eight years, so being steeped in bottom up fundamentals analysis of some pretty darn cyclical companies. And so I'm from Florida originally and went to Rollins College. I think that's about it.

Speaker 1:

You talk about ultra high net worth, which, of course, means people that love zero DTE options trade, but I am curious, given that that's the focus of New Edge, from what I'm hearing from you maybe explain some of the concerns that very, very wealthy people have in terms of how to position their portfolio, because they have a different mindset than the much smaller, obviously, retail trader.

Speaker 2:

Yeah, well, I think that in many ways there's a lot of similarities, in the sense that taxes are a big constraint for our clients, just as they are for any trader, and sometimes taxes can be the kind of thing that is the tail that wags the dog. But at the same time, one of the things that we try to do and think about is always being sensitive and aware of that, but structuring portfolios so that way we can make tactical decisions if needed. We are long-term investors, so there are certain things that we try to encourage clients to not be overly tactical about, but that doesn't mean sitting on your hands and watching volatility go and come and not being proactive with portfolios. We are invested across the asset class spectrum and as accounts get larger, it does allow you to do some pretty interesting things, mostly in the alternative space for funds that do have big minimums, but even then we do provide opportunities for smaller account sizes to be able to get into alternatives. We're highly, highly, highly selective there.

Speaker 2:

There's a big push to things like asset gathering and alternatives that where we've seen one of the terms we use is that alphas that used to exist have decayed into betas. So we are certainly in the camp of being highly selective across the spectrums, but what tends to happen is account sizes get more and liquidity needs start to become a less big portion of an overall account. The end result is you can tolerate more liquid types of investments. So everything is done in the context of where we are in the cycle and certainly wanting to take that into account, even when we are in things that typically have less liquidity.

Speaker 1:

So that's actually a good transition to that question of where are we in the cycle? Because you use the word tactical, there are different time frames with which you express a tactical view. Unless you were incredibly quick tactically positioning and over-weighting small caps the last five, six trading days, probably most people didn't really benefit whatsoever unless they were already in it, and you don't know when that tactical moment's going to come. But let's take a step back. Let's talk about your view, the firm's view, of where we are in the cycle late cycle. Are there things that suggest the bull market persists? Are there things that suggest that maybe not so much?

Speaker 2:

So I think that the first standpoint is a phrase that we've been saying a lot over the last year and a half or so, which is respect the trend but don't ignore the risks. Respecting the trend means that we remain fully invested in equities, but knowing that there are certain pockets of risk, whether we're looking at it from a sector perspective or as we're seeing things brewing under the surface of the market and we'll talk about kind of that list of things that we're watching that warrant our attention and really demand from us a focus on things like quality investing. Quality is something that we have as an overlay in all of our equity investing, as well as through our fixed income and even into the alternative space as well. That allows us to say, instead of trying to chase high beta or very low quality rallies very similar to what we saw yesterday, low quality absolutely trounce the market. It certainly was a catch-up trade, but we tend to find that those are very ephemeral rallies. They have big, huge surges upside to the upside and then tend to tend to reverse. So one of the things that we've been then saying is that you do have to respect this uptrend that still is persistent in the market, and that what we've seen is that you've seen sell-offs that are in the order of magnitude of 7% to 10%, but remaining in an uptrend, and that is all perfectly well and good and normal, and why I say good is that it does help shake out weak hands. It does help keep the market in an uptrend longer versus these parabolic moves higher.

Speaker 2:

We think one of the reasons why you're seeing market action like you are today is simply because over the last month and a half you went parabolic in things like the growth versus value ratio. You went parabolic in the outperformance of MAG-7. And so you certainly had the potential for some kind of mean reversion. It was just a matter of when it would happen, and the further you started from the upside above your trend, the more room you just had to come in and correct. So it's something that we try to talk to clients about saying look it's, you know, don't be scared by things of the order of magnitude of 7 to 10%, because they're very normal in a normal bull market. The trend can still very much be up, and then we can assess, as we interact with that trend support, if we really are going into a sea change, something that looks more like the beginning of 2022, where, of course, you saw a breakdown of trend and that really catalyzed what was a remainder of the year. That was a really rough time for markets, or, if it is again yet another, just healthy digestion of where we are. So it's all very well and normal in the bull.

Speaker 2:

One thing that we're watching really closely as a risk, and something that I think we have to keep a laser focus attention to, not necessarily because it tells us anything about timing, but it tells us a lot about the potential eventually for some kind of reset, which is that we call these three things the mood rings valuation, sentiment and positioning and all of these items are rather stretched at this time. Valuations on a two-year forward basis are only 0.2 points per PE points away from the 2021 high. From a one-year forward basis, you're about a turn away, turn the half away from the 2022 2021 high, which just means that valuations are very, very stretched. If you look at it from a from a sentiment standpoint, sentiment is resoundingly bullish. You have a I surveys showing, you know, bulls really outweighing bears.

Speaker 2:

Lastly, on the on the positioning side of things, you people will like to talk a lot about money markets being very fulsome and having so much cash on the sidelines, but if you look at things like institutional positioning or AAII's household allocation, household ownership of equities, fed also publishes a household equity allocation.

Speaker 2:

Household equity allocation all of those are the AI1 is only one percentage point away from the 2018-2021 highs. You have the Deutsche Bank Consolidated Positioning Report, which is a fantastic measure of trying to get all the different pieces of positioning together. That's in the 96th percentile. It's in the 98th percentile for Mag7 growth tech. All of this is just to say that you are on the same side of the boat. Not a great timing tool Doesn't tell you, doesn't ring the bell and say get out of stocks and you could see these even get more extreme. There have been even more extremes readings, like at the beginning of 2018, but we don't know. Eventually, on the other side of that, the unwind is when you typically see more market volatility, and that's something that we will feel very shocking and jarring, simply because we've been in a world of such low volatility over the last really let's call it 12 months.

Speaker 1:

I've used that line before. It's since you said it everybody's on the same side of the boat holding an anvil. Now to your point. It's hard to actually know and time that and I'm sharing on the screen a slide from a deck that you sent me showing that point about overvaluation. And, to your point, can't really do much with it, right, it's just more for context, because you can't time based on valuation.

Speaker 2:

Well, do much with it, right, it's just more for context, because you can't time based on valuation. Well, I do know that valuations are a helpful predictive tool, typically on once you get after the three-year mark. Once you get to the three-year mark, the predictive power goes up pretty significantly. And that's where you would argue and this is building on some great work by people like Barry Bannister over at Stiefel great work not only because he was an industrials analyst as well in his early years, but Barry's work on predicting forward equity returns by looking at a combination of valuations as well as ownership.

Speaker 2:

That, where we are today, given high degrees of ownership and high valuations, suggests that over the next five to 10 years, equity returns would be below average. Now, what do you do with that? Because you can get to below average many different ways. You could have a massive bull market run and then a crash. You could have a crash and then a recovery, or you could have a sideways movement. And that's why knowing that you can get to the same end point on an average basis by taking multiple different paths means that you have to be aware of the tacticals, you have to respect the technicals, you have to respect the trend like we're in today, and I think that that's that balance between the medium long term and seeing what's going on in the short term tactical.

Speaker 1:

Obviously we're talking from a very US-centric perspective, but a lot of things that you mentioned I don't believe necessarily apply to international markets, certainly not on the ownership side of things you can argue. I'm curious to hear your take on if we're going to have sub-average returns in US markets, if that means we could be seeing above-average returns internationally.

Speaker 2:

Not necessarily, but potentially there's other things that you would need to see in order for international to outperform. It's a great question, michael, because if I think about the periods of sub-average US returns, the first one that comes to mind, of course, is the 2000s, where, from the peak in 2000, it took until 2013 to make a new all-time high in the S&P 500 a year later, even for the NASDAQ. And so that, of course, was a period, at least from 2000 to 2007, where international stocks performed far, far better than domestic stocks in the US Value outperformed, small caps outperformed, and a lot of that was a function of just the unwind of the growth trade, of the tech trade, the tech bubble. I do not know. In going back to the 70s, which was the other period of 1969, I believe 1982, was a period of effectively flat equity market performance. I'm not sure if during that time, international outperformed. International had a massive bull market in the late 80s following the Plaza Accord, where the dollar was significantly devalued and you saw, of course, the massive bull run in places like Japan ending in 1989. And, of course, that market only just hit a new all-time high after 35 years.

Speaker 2:

I bring up that period because this is the necessary condition for international outperformance, which is that you have to see a weaker dollar, a sustained major dollar bear market, in order for there to be a major international bull market. You only see sustained runs in international and EM outperformance when the dollar is significantly moving weaker. It's for a few reasons. Some of it's to do with capital flows. There's a bit of a chicken and an egg. You saw massive capital flows out of the US into international EM in the 2000s, for example. The other aspect of it is appreciating that international markets have a lot higher weighting to things like materials and energy, which typically benefit in a weak dollar environment.

Speaker 2:

So there has to be an earning story. The last thing I'll say on this front is that from the peak in 2007 earnings to 2023, us EPS growth is up some 120, 130% from peak to peak. However, EM and international EPS growth is flat to down. So you've truly had a lost decade, not just in the investments and the valuations of EM and international, which have also compressed, but also the fact that they did. They have not been able to grow earnings. So you really have to have a distinctive view on an earnings story for international and EM for that to be an area that can significantly outperform the US equity markets.

Speaker 1:

I think that's spot on. I guess the point about the sector composition is interesting because that does relate also to small caps. The one commonality across international stocks or small cap US stocks is it's less tech. I think it's sort of the main sort of overarching theme. Yeah, the market's being driven based on earnings and based on momentum by primarily the tech sector not fully but primarily, I'd argue, in an outsized way. I guess the question, going back to the cycle, becomes can we be in an environment where tech is no longer the leader, where that rotation into the other sectors, which ultimately should be driven by earnings, is what drives things higher as opposed to what? To your point, we saw from that 2000, 2002 period, where it was the bursting of the bubble, International did well, but it was a lot of relative strength as opposed to absolute.

Speaker 2:

Yeah, but what's interesting is back in that time, we did a series of pieces over the last month or so looking at value, international and small cap stocks. So those are all up on the New Edge Wealth website where we looked at these big cycles, and what you saw in value, for example in 2000, is that value earnings did outperform growth earnings. Quite funnily, value earnings actually outperformed growth earnings going into the last few years of the tech bubble. It was all multiple expansion that growth had it wasn't translating to earnings, which showed you the fragility, the underlying fragility, of what that bull run was and why it collapsed in such an epic way. But if you go back to 2022, which is the last time that we had growth underperform and value have a great year, there was a slight and it was slight but it's enough when you're trading at high valuations there was a slight outperformance of value EPS over growth and part of that was because growth was rationalizing after having two gangbusters years in 2020 and 2021.

Speaker 2:

There was a lot of pull forward from the pandemic spend. There was, of course, a lot of pull forward from the cost perspective and, of course, 2022 being that year of, or 23 being the year of efficiency after 2022 is really weak year. We also have to appreciate that, and this is something I think that's important is that growth, tech, communication services, consumer discretionary stocks, all the Mag7, they breathe the same economic air as we do, and one of the dynamics that happened into 2022 is that you had a slowdown in things like advertising spending, which really hurt. Darling mag seven.

Speaker 2:

Names like Meta, like Google, and names that are still sensitive to the underlying economy, have huge return on invested capital, huge free cash flow generation, a lot less sensitive to the underlying economy than, say, a C, a caterpillar, but that they still have this sensitivity and that their costs did matter in that time.

Speaker 2:

So if you're trying to come up with a sustainable reason as to why value international or small cap will outperform, it's not enough to say that valuations will revert. It is enough in the short term, to say that positioning will revert. I think that's exactly what's going on today, but I think you do have to make a true earnings case as to why you think those areas will be able to deliver better earnings compared to the growth and tech names. And look if we're talking about things like regulation or antitrust or cramping down on the ability to do M&A. All these things end up actually playing into the question of does the earnings power maintain itself for these mega cap names in the same way it has over the last two years, plus the tough comps and the fact that you're seeing decelerating second derivatives?

Speaker 1:

But that's normal decelerating second derivatives, but that's normal. Are there certain policies under a Trump administration that makes that more likely? Versus, if Biden gets reelected, unification regulation? I think that's probably a big one.

Speaker 2:

Yeah, I don't know. I mean, there's been all this debate, with the announcement of JD Vance as the running mate, as to what that could mean for things like antitrust regulation and going after big business versus small business. I don't know. I think a lot remains up in the air. The only thing, and the consistent thing I've been saying, is that typically, once you fully price something in prior to it happening, maybe it's a buy the rumor, sell the news kind of situation. So I think that's all still very much in flux. We don't know how much the bark is versus the bite.

Speaker 2:

One of the things that I think is interesting that you can see is that there is a really big difference. Both potential parties are talking about, of course, extending the tax cuts, the Trump tax cuts. The question is how they get paid for, and that's one where there's been a bit more articulation. Biden has talked about paying for it with tax increases and other areas. Trump has talked about paying for it through the tariffs channel. So you could then play out how that could impact individual investors or businesses, whether you're thinking about higher taxes for some or done through the tariff channel, which, of course, is a tax in a way, on consumption. So it could go either way, but I think that that's probably the most straightforward or most articulated portion of all of this.

Speaker 1:

You mentioned before this idea of respect the trend but be aware of the risks. There is a trend which is a risk, which is the unemployment rate and the Fed cutting cycle, which is a risk in and of itself. So I'm sharing from that slide that you sent me screen that looks at the S&P 500 and the direction the Fed funds targets. Everybody that's watching this has probably seen these charts ad nauseum, but typically when the Fed starts to begin a new trend of cutting rates, it's not as bullish as people initially think it is, because it means that something probably already broke. I want to get your take on the new trend that could be coming on the unemployment rate rising, the Fed responding and what that means for all trends.

Speaker 2:

Yeah, the thing that stands out to us, or the question we're asking, is that it's far less interesting when they start cutting rates and how much they do in 2024. We're far more interested in what they do in 25, because the history going back, is that the Fed has never cut rates in the last 40 years by more than three cuts without being in a recession, meaning that if they did three cuts and stopped, it's because they could cut rates, inflation was moderating or the fact that the economy was recovering just fine. You go back to times like 1995, economy was recovering just fine. You go back to times like 1995. You go back to 2018 or even 1998. And both of those times, by the time that they ended rate cuts, markets were at all-time highs. The equity market sniffed out that maybe, hey, fed, you think that you're cutting because you're worried about a recession, but we know we're not going into a recession and markets soared and you continued to have the bull run.

Speaker 2:

If you do more than three rate cuts, at least over the last 40 years, it's typically been coincident with a much weaker growth environment, a much weaker employment environment and, of course, higher unemployment. And the question would be is that how much further do we move higher in unemployment? Usually, when you've moved up this much, you keep going up. But there's a lot of caveats in the unemployment data. It's based on the household survey, which has been huge print in the establishment survey, and then big job losses. It was almost a 500,000 job difference between the two surveys, which is just wild, but the unemployment rate is based on that household survey, which has been consistently weaker throughout this year. We think it's good to use kind of an to an extent an empirical way of judging which survey is right, which is just to say, if retail sales or overall consumption starts to fall off a cliff, the household survey is probably right. If it holds up, then maybe it's not as good as what the establishment survey is saying, but at least we're not really starting to crest and fall into a much weaker position.

Speaker 2:

I would say, though, it's hard to talk about this without acknowledging the fact that there is a massive bifurcation in consumers right now, where you have lower income consumers getting absolutely pinched whether it's through housing costs, food costs, energy costs that are simply not going down, and then higher income consumers, in a kind of in a strange backwards way, really benefiting actually on net from higher interest rates, given the fact that they tend to have high cash balances. Fuel consumption at the same time is that they're far more likely to have 30-year mortgages at fixed rates that are far below where the current standing rate for a market rate of mortgages. So all of that is to say is that the aggregate numbers are likely very misleading, and you can see that in distinction as well by looking at things like delinquency rates as well as requests for refinancing have spiked up higher. Your delinquency rates and refinancing requests are now consistent with being in a recession, so I would argue that there's probably pockets of the economy and the consumers that are in deep recession. It's just not showing up in the aggregate numbers.

Speaker 2:

So the question would be is that how much higher can that unemployment rate go If it continues to creep higher? That would be supportive of more than three Fed rate cuts, but if it stays in this territory, it's likely that the moderates policy is getting tighter, and so they want to keep the real rate steady. There's historical precedent for them to keep real rates above 2%, 2.5%, almost 3% back during the late 90s, as well as in the 2000s prior to the GFC, meaning that they didn't cut real rates back to zero, to be neutral, but they kept the real rate as a positive and the economy chugged on for a few years. They actually kept real rates near 3% for over four years in the late 90s. So every cycle is different, but it's just something to consider if inflation stays sticky or if unemployment doesn't continue to drift higher.

Speaker 1:

I think it was that old saying three cuts and a stumble, sort of the way that markets usually historically work. I guess if we're talking about you know, typically it's three cuts, right? Is that really enough for small caps, because this initial move right has been driven. I think off of this sort of feeling that, okay, why have small caps been held back? Because of higher for long? All right. So now the implication is they're going to cut rates, so those so-called zombie companies have a chance at surviving. They get the lifeline when they refinance their debt against very razor-thin margins, but one cut's not going to do it. I mean, is three enough? This is where it gets into the taxable discussion.

Speaker 2:

Yeah, I mean if you're refinancing debt from 3% to 13%. Obviously those are extreme numbers, but if you refinanced at a time where you've seen many companies have their interest costs where they would have refinancing interest costs that are significantly higher than they are today. One note on that is that the entirety of the US yield curve, of the treasury yield curve, is above the average coupon of the investment grade, which is obviously not small cap, but the investment grade index, which just says that there's refinancing risk for many if they have maturities that are coming up close. I completely agree with you, Michael, which is that if 75 basis points, if it's three cuts, really doesn't do a lot to ease the pressure on the balance sheets. But then you also have to, I think, appreciate that there's two ways that Fed policy impacts the underlying economy. One is through the real economy, meaning cut interest rates so that way people are paying less on interest on their debt. The other one is through the expectations channel. And how much could you do you enliven animal spirits, Like of course you did in 1998 in response to LTCM? How much do you enliven animal spirits and get M&A going and people going oh, we're going to get more relief on the balance sheet, It'll come. We're in this tightening cycle. It's kind of like the gateway drug One cuts means three, which means six, and look, nine cuts are priced in through the end of 2026. So I don't think we can ignore the potential kind of psychological shift. The reason why we can't ignore it is because that psychological shift was really important in 2022.

Speaker 2:

The housing market, as soon as the Fed started raising rates off of the zero lower bound, slowed materially. Ipos ground to a halt. Speculative areas of the market really started to struggle. You saw venture capital really start to struggle as well. None of this was necessarily because rates were high.

Speaker 2:

It was the expectation that rates would be going higher and continue to be a challenge, and nobody at that time thought that they would go, or only a few people at that time thought that they would go up to over 5%. At that time thought that they would go up to over 5%. So that expectations channel was really powerful in the slowing down of some of that froth that had been in markets. And so if you take the inverse of that in the argument, you'd say, okay, well, if the expectation channel runs ahead of itself and expects a lot of cuts, then it could add some froth. But here's the catch in this all Financial conditions maybe not as of today, given the market moves, but as of the close of yesterday were at their easiest levels since 2021. And so, how much lighter fluid do you want to throw on a market environment or market backdrop that still remains, you know really well, bid and rather liquid from a financial conditions standpoint? Not to say that there wasn't pockets of stress, because there certainly is, but that aggregate measure.

Speaker 1:

Well, to that point, on pockets of stress, and since we're talking about refinancing risk, there's also how interest rates impact consumers from a delinquency perspective. So on that deck I'm sharing on the screen here, look at delinquency rates showing bifurcated consumers I always love that word bifurcated, just not something I hear too often. Showing bifurcated consumers. I always love that word bifurcated, it's just not something I hear too often. You look at credit cards. You look at and I've seen also on the auto loan side, separate from what you've done here, there clearly is a very big pickup seemingly taking place. Hasn't mattered yet for the broader market, but I'll go back to. Can you have a situation where small caps are leading the market higher when they're more sensitive to consumers as the liquidity rates are trending the wrong direction?

Speaker 2:

Yeah, I mean that's that you have to have this perfect combination of falling rates and falling rates for a good reason, with growth holding up, in order for small caps to be more than just a positioning flip and that positioning flip could last a couple of months but for it to sustain you. That's what you typically only see major small cap bull markets that are sustained coming out of market lows because you're in an environment where, in market and economic lows, you're in an environment where you are turning the quarter corner of the economic cycle, you have the bounce back of those that nearly fell into bankruptcy so they rushed with despair and they were able to recover, and that you have a multi-month quarter and even year run in small cap areas because economic growth is recovering, accelerating, and you typically have the backdrop that the policy is still in a supportive territory, meaning that you know Fed has cut rates and they're certainly not raising them yet because things are still too fragile. They might still be actually providing support. So this is a, this is a. We've been using the phrase. You know we're here for a good time, not for a long time, in the sense that if you do start to see more weakness within the economic side of things, we do think that small caps would resume their underperformance simply because they are more economically sensitive and they have higher degrees of unprofitability.

Speaker 2:

Forty percent of small caps are unprofitable today in this economy. 40% of small caps are unprofitable today in this economy and so if you were to see a weaker economy with higher unemployment and lower overall consumption, then you would see even higher rates likely of unprofitability, which just means that small caps would go back to being in a risk-off kind of mode. But right now they're trading as a beta trade on yields. So if yields keep falling, you have the suspension of disbelief about the income statement side. So I think that, to sum it up, you have to think of small caps in balance sheet and income statement.

Speaker 2:

Balance sheet is sensitive to what's going on in the yield space. Falling yields helps the balance sheet. But then you have to ask why are yields falling? And if yields are falling because the economy is slowing rapidly, does that hurt the income statement? And if you see balance sheet relief but income statements hurting, you likely will still see small cap underperformance. The holy grail would be to say interest rates are falling because the fund is cutting because they can, but the income statement is holding up, the economy is holding up, and so you get the best of all worlds. We can't really judge that today with the data that we have. We're seeing enough deterioration in the economic data. That definitely puts our spidey senses up, and so our prudent way of saying it is that, okay, we can own small caps, but we have to do it with a big, huge caveat that we reserve the right to change our mind.

Speaker 1:

Okay. So on that point about the spidey senses coming up, I think a lot of people that might be hearing this or that have watched you aren't of the impression that if you say something you're immediately acting on it that day, or you will very soon, but you're managing money for, to your point, ultra high net worth investors. I'm going to make the assumption that the standard has to be pretty high to shift an asset allocation policy over weighting or under weighting different asset classes. Educate those listening and watching on the process of not just making a call, but how do you actually shift assets to do that?

Speaker 2:

Yeah, it depends on the scenario. We run a lot of money in-house through our own strategies, which does give us a far more direct ability to say we like this, we don't like this. We are, whether it's individual stocks, we're buying the stock, we're selling the stock, and so where sometimes a lot of investment managers and we use third-party managers as well, we'll use third-party managers, so there's a lot less control over what you might be seeing and what shows up, and so we're always aware of that. Then trading is also a major constraint of, you know, trying to do things in a really efficient way to get best execution. We're always thinking about taxes, as I mentioned as well, and knowing that you know a whipsaw is really trying on investor kind of sentiment and it's one of the things we think a lot about is that you know, the most important thing for lot about is that the most important thing for any advisor and the most important thing for any individual investor is to prepare themselves enough mentally for eventual market volatility. So that way when you get to that market low, you're not calling up the advisor saying, sell everything, just get me out.

Speaker 2:

And I've seen it in my own career many times of clients that panic sold and then didn't get back in because they were too scared to get back in. And of course, you know that happened after the great financial crisis, happened after COVID. And so there's a there's this balance between seeing what we're seeing within the market, seeing the potential for volatility, but also seeing the very long term of knowing that the most detrimental thing you can do is sell, take capital gains and not get reinvested. And so we have to think about the long run. We do a lot of work in capital market assumptions, in doing our own forecasting and projections for individual asset classes, feeding it into asset allocations and then overlaying from that strategic allocation different tactical views. And, of course, we're doing everything. When we make a tactical view, We'll be very specific about identifying the length of time that we're making that view and the conditions for what we would do to update it, so that way we can be as transparent with advisors and clients as possible.

Speaker 1:

You've mentioned a few times. A lot of your clients are focused and worried about taxes, and for good reason. When you look at interest payments, those are kind of going in their own melt up and there's no trend reversal in sight on that, given how much there is. Listen, there's a lot of people that are obviously concerned about government debt. Are the ultra high net worth, generally speaking, more concerned about it because they think that they want that to pay for it first and foremost, more concerned about it because they think that they want to have to pay for it first and foremost? Or is it not as much of a consideration because the LDRI now worth certainly can tell politicians don't tax tire.

Speaker 2:

I'm not sure about that, but I do know every conversation it comes up about fiscal largesse and what the potential aftermath is of running such high deficits in a non-recessionary environment.

Speaker 2:

You're running at 5.6% on the deficit to GDP. That's a little bit less than where we were at the beginning of this year, end of last year, but still pretty elevated, given the fact that it's percentage of GDP which is really strong right now, meaning that you typically have not seen such large deficits in healthy economic expansions. And I wouldn't be surprised that in the next recession even if it's a mild recession we actually see the deficit to GDP potentially retest the great financial crisis levels, which was 10% of GDP, only because you would see things like tax revenues fall. You would see counter cyclical spending pick up. But you're starting from such a high base of where the deficit is today that it wouldn't be surprising to see that. The question is how would that impact the overall markets? Does that impact the bond markets?

Speaker 2:

We, of course, saw over the course of the third quarter and into the fourth quarter last year what happened when Yellen increased the issuance of coupon treasuries and de-emphasized bills for just a couple of quarters and, of course, treasury yields went up by 150 basis points Sorry, not a couple of quarters. A couple of months Treasury yields shot up higher and of course, sorry, not a couple quarters a couple months. Treasury yields shot up higher and of course then Yellen came out and said oh no, we're not going to do this anymore, we're going to focus on bills. And treasury yields came right back in down and of course they fell 100 basis points in November and December and that gave the backdrop for that 20 percent rally within the small cap index. So you know, again, it's a great reminder that small caps at least the Russell 2, is a beta play on the 10-year treasury.

Speaker 2:

So the question would be you know, as we move forward, you know Yellen and treasury have been relying on much more bill issuance. It's above 20%, which is the T-back sets a target of 20% maximum for bill issuance, sets a target of 20% maximum for bill issuance. I don't know if that it's likely that T-BAC I've had some conversation will increase that to say, oh okay, you can go up to 25, no big deal. But the question would be as you progress through this, is there a point where Treasury whoever is leading the Treasury will be forced to issue more long-term bonds and the market may not have as much appetite for those long-term bonds, and you see a re-steepening of the yield curve and a bear re-steepening where the long end starts to move much higher because of that higher issuance.

Speaker 2:

The counter to that is that typically, if you have higher, issuance is stepping up, like you had in times like 2020, you're also seeing a flight to safety. You're seeing people hide out what is still the safest asset, backed by the full faith and credit of the US government, and that that flight to safety typically helps stop up some of that incremental supply. But the difference would be this time is that now we've had this inflationary period in our very close rear view mirror and we're running these higher deficits perpetually since the pandemic time. Does that cause people to be less hungry for those bonds? It's a huge, big question. I don't know the answer to it. We'll probably have to judge it as it comes, but there's a lot of push and pull on that front.

Speaker 1:

Yeah, I mean, that's been kind of the bane of my existence. Is this duration bear market, not a credit bear market? But you need to have a recession for spreads to widen for that flight to safety to kick in. Let's talk about other ways of playing defense outside of the pristine asset of treasuries, in case it fails, whenever spreads actually start to widen which is technically almost impossible. But from a sector standpoint, if you've got equity portfolios, equity allocations for your clients and the cycle looks like it's turning might be headed for a recession, where do you overweigh, where do you underweigh? Where do you tilt?

Speaker 2:

Yeah, the one thing, the easy answer, when you're saying, okay, I'm afraid of going into a recession, what people might say is well, buy super defensives, and what you see is that things like utilities and staples which is your classical defensives they typically do well in the very early stages of a recession. So the relative performance charts look a lot like the VIX in some ways, meaning that they have this episodic volatility higher. So staples and utilities do really well for a shorter period of time and then, as you start to round the bottom of the recession, then of course they lag and tend to lag throughout the entirety of the expansion. So you could make the argument that they're really good names to own as you are growing in confidence that you were going into a recession. But you would, if you're owning names in that space, have to be very, very aware that it is a trade and not a buy and hold, simply because it's very likely that once you do round the corner on the economic cycle, you will lag pretty significantly. Our favorite way to prepare portfolios is we'll get defensive in some of the sectors, as I mentioned, knowing, with that caveat, that it has to have a bit of a timeframe on it, but we also are consistently focusing on quality companies through cycles which we have data to show that through very long-term cycles they tend to be much better at protecting capital to the downside but still are able to participate in the upside, the lag in the very initial days of a recovery, because that's typically when you see the most of the junkie junkie rallies. You know again, remember that brush with near bankruptcy that they rebound from. But you can do that throughout sectors.

Speaker 2:

And one of the things that I did a hot take railing against the cyclical versus defensive ratio because I think it's really misleading. The cyclical index, the MSCI index, is filled with mostly tech stocks. I think Microsoft is one of its largest weightings. It's a lot of semiconductors as well, and so that's a little bit misleading in this environment where people have been using tech as a rather defensive kind of positioning and uncertain kind of economic environment. So you have to look a few layers down to the individual drivers of the stocks or the industry groups, which is what we do, and then looking for names that are really good at protecting capital to the downside, not necessarily, like I said, the just saying in the hyper defensives, but looking throughout industry groups. One of our favorite ratios in cyclical defensive is actually machinery versus waste stocks. So machinery stocks being super cyclical, waste stocks being super defensive. It's a great way to take a sector like industrials, which is typically looped into being a cyclical sector, and break it apart. That's that example of looking down one layer deeper into the industry groups.

Speaker 1:

Start of the conversation you mentioned, there's some focus on alternative strategies. I think most people think alternatives are just alternatives to making money. Given how some of these things have not performed that well for the last decade and a lot of alternatives that at least from my own research that seem to be doing well are largely still beta, I'd argue long-short. Yeah, I know it's considered alternative, but it's just. If you look at the aggregate long-short indices, it pretty much tracks consumer staples as a long-only sector correlation. But let's talk about the alternative space, with the caveat that those listening may not have access to interesting alternatives. But are there certain areas which, broadly speaking, look really interesting to you?

Speaker 2:

Yeah, look, the idea behind alternatives exposure is that if you're willing to tolerate illiquidity, then you can get paid for that illiquidity in one way. The other one is that there are market dislocations that exist in some pockets of the alternatives landscape that aren't in the very well-priced and efficient public markets. So we kind of think of it in those two big buckets. But the challenge with alternatives is, of course, the asymmetry of information that you have that's far more pronounced than you have in public markets, meaning that the information that you're getting from alternative managers about the asset classes can be rather sparse. Nothing is necessarily done in public ways in some of these deals.

Speaker 2:

So we rely on due diligence partners and also have a big due diligence team in-house in order to go through these potential opportunities. Because they are long-term commitments, it has to be done with a lot of risk underwriting. So everything from private equity to private credit, to GP stakes, to secondaries, private real estate, across that market we have to be hyper-select, selective, because there's an influx of managers Everybody wants to raise from our channel being the wealth management channel, and so there's a really fine line in distinguishing between asset gatherers and true asset managers, making sure management is aligned. The undertaking is massive and it's something that we think is a good distinguisher and differentiator for what we do, because we've invested heavily in it, seeing that it's an important asset class for our clients, or set of asset classes, very disparate set of asset classes.

Speaker 1:

The catch-all for anything that's not stocks, bonds or if it's in a box is alternatives. The catch-all for anything that's not stocks, bonds or if it's in a box is alternatives. Cameron, for those who want to track more of your thoughts, more of your work and learn more about New Edge, what would you want to do?

Speaker 2:

Yeah, so I'm on Twitter. At Cameron Dawson, I'm also on LinkedIn. I'm trying to be better at posting the reports, but I believe that you can now sign up for my weekly piece on the website at newedgewealthcom we also post that up. I put out a Monday chart deck as well that I typically post Monday afternoon, tuesday morning. That's a collection of chart decks. I just had an outlook that we did come out on Monday, so I'll be posting that as well later this week and it's the chart deck that Michael has a wonderful 90 plus pages of charts for all of your watching and listening pleasure. So lots of deep dive information that we put out. So at Cameron Dawson and on LinkedIn as well.

Speaker 1:

Appreciate those who listen to and watch this interview. Again, this will be an edited podcast under LeadLag Live. Everybody, please make sure you follow Cameron and hopefully I'll see you next time and hopefully I'll get through this fast, which, again, I am resuming. So, thank you, cameron, appreciate it.

Speaker 2:

Thank you so much, Michael. It was a true pleasure.

Speaker 1:

Cheers everybody, Thank you.

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Michael A. Gayed, CFA

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