Inflation, Valuations and the Benefits of Dividend Growth with Simeon Hyman

[00:00:00] Welcome to Excess Returns, where we focus on what works over the long term in the markets. Join us as we talk about the strategies and tactics that can help you become a better long-term investor. Hey guys, this is Justin. In this episode of Excess Returns,

[00:00:22] Jack and I sit down with Simeon Hyman, Global Investment Strategies at ProShares. We talk with Simeon about inflation, the Fed, interest rates, valuations, the market leadership and concentration, and some of the strategies at ProShares, including dividend growth investing

[00:00:35] and their covered call strategy. This is a wide ranging discussion with Simeon that we hope you enjoy. As always, thank you for listening. Please enjoy this discussion with Simeon Hyman of ProShares. Simeon, good morning. Thank you very much for joining us today.

[00:00:47] Thanks for having me. We're going to have a good sort of wide ranging discussion. We'll talk about the economy. We'll talk about inflation, the Fed that's kind of front and center, I think in investors' minds right now, given where we are this week and just,

[00:01:00] I think what's on investors' minds. Then I think towards the middle and back half of the conversation, we want to talk to you about some of the strategies that you're running over at ProShares and how they fit into investors' portfolios, dividend growth and

[00:01:13] covered call strategies that you guys, and there's a lot of strategies over there, but those are the ones I think that we're going to focus on today. So yeah, thank you.

[00:01:21] We'll aim for about an hour today and see where we go. We wanted to start with inflation. We had the inflation readings yesterday and then the Fed meeting, which was kind of a unique thing

[00:01:33] that those things sort of happened on the same day. It seems like inflation is starting to come down and what the Fed is doing is starting to work, but just generally, where do you fall with where inflation is right now? Look, the soft landing looks pretty well in

[00:01:51] hand. If the Fed was wrong about transitory, perhaps it wasn't as wrong as we thought they might have been. Remember, we were up around 10% for about a year or so there and from our perspective, we weren't even so worked up about near-term inflation hanging out at three

[00:02:09] for a little bit longer. Importantly, because longer-term inflation expectations have been reasonably in check, the 10-year break even has had a two-handle on it for a couple of years now. So that's an important ingredient in thinking about this.

[00:02:27] Are you, you guys are, you're sort of more in the camp of this soft landing. It's funny, coming into this year, everyone was saying there's going to be all these interest rates

[00:02:38] cuts. We're going to be slowing. Now look at where we are today, the economy is hanging in, inflation's coming down. It looked like there might not be any rate cuts this year, but generally, what are your feelings on where the economy is today?

[00:02:54] There are few cracks that you can observe. Obviously, we know that the employment market is very strong and yeah, there was a couple of smidgen fissures in the housing market, which you would assume to be the epicenter of concern with high interest rates, high mortgage

[00:03:11] rates, whether it's in the personal or commercial areas. And yes, that's where you're seeing a few fissures. I live right outside New York. We know that there's some issues in office buildings in Midtown and we also know that some of the numbers on the residential housing

[00:03:32] have been a bunch of weaker, but that's about it from an economic weakness standpoint so far. It's been interesting. Both sides of the extremes have basically gotten it wrong here. You had people calling for recession forever here, which never came and then you've got

[00:03:47] people calling for outrageously high levels of inflation, which hasn't happened either. It's like the middle of the road worked out here and the people on the extremes, at least so far, who knows what happens in the future, but at least so far,

[00:03:57] they've kind of the ones that have gotten it right. I think that's quite fair and very important to keep in mind here is that the bond market, and the bond market will, we can then relate to the equity markets, but the bond market has

[00:04:12] normalized, meaning that the impact of quantitative easing and now the quantitative tightening that is unwinding it is more or less done, which means that, and Chair Powell said this to us, he actually said it back in November because remember we had a spike in 10-year yields.

[00:04:31] We had a selloff on the long end of the curve and there was a press conference where one of the journalists covering said, what do you think about these much higher 10-year yields that you're seeing this month? And Powell said something very interesting.

[00:04:46] Of course, he dodged the explicit question because those of us who are media trained, that's what we do. We want to answer what we want to answer, but he did answer something that was super important. He said, when we at the Fed look

[00:04:59] at the 10-year treasury yield, what we want to see is that it's behaving independently of Fed policy and we are confident now that that is true. That has not been true in almost 20 years since the great financial crisis and the artificial suppression on the end of the curve.

[00:05:18] What do you think about what the Fed might do here? I mean, people, as Justin mentioned, there were a lot of cuts priced in at the beginning of the year. There's a lot less

[00:05:25] cuts priced in now, although we just got a pretty soft inflation plant. What do you think? It seems like they want to cut, but the data hasn't supported that. I think typically they're looking at backward data rather than looking at going forward. What do you think about the

[00:05:37] position they're in and what they might do? Why they need to, I suppose, is as you were alluding to, if inflation is coming down and we got a two-handle this morning. Right. So what's the rush? I think as the way we've been thinking about it,

[00:05:54] we're just not so focused on it. In fact, one of the things that we wrote about at the beginning of the year is it's not really so much all about the Fed because in the world,

[00:06:06] that sounds like a movie trailer, in a world where the 10-year bond yield is liberated from the forces from the overnight lending rate. And this is what, guys like me, we said this all the way up until the great financial crisis. The Fed controls the overnight

[00:06:19] lending rate. Market forces control the rest of the curve. Yes, the Fed sort of heaters out its influence and still kind of drives the two a lot, but not so much the 10. And if that's true, then it doesn't so much matter when the Fed begins to cut,

[00:06:35] particularly from an equity market perspective, but also don't expect the flipside of that is don't expect a hail wind to equity prices whenever the Fed gets around to it. Think about it this way. We now have a quarter for 10-year breakeven inflation.

[00:06:53] Let's say even, and you have two year break even as short as one year out now. So if we have 2% inflation, the Fed's target, you might imagine the kind of normal state

[00:07:03] of the world to be maybe a 3% Fed funds on a 4% 10-year. So one of those we already have, we're at four and a quarter on the 10-year, but we think that end is going to be largely stable.

[00:07:14] And whenever the Fed gets around from going to five to three, whenever that happens, whether it starts slowly six months from now or whenever it does, I think is not so, so critical. But they're certainly not in a hurry to if inflation's coming down without them

[00:07:28] having to cut. Yeah, it's funny. Like all of us want to spend all this time analyzing the Fed. And we just had Bob Elliott on recently and he kind of said the same thing you did,

[00:07:34] which we were asking him, you know, we're all excited to find out what the Fed's going to do. And he's like, what they're going to do is nothing. You know, when they become compelled

[00:07:40] to do something, they'll do it. But I think all of us probably get too trapped in this, like analyzing the Fed is the primary thing we have to look at, you know, in terms of the economy. Now, inflation is still relevant.

[00:07:53] It's a real cheating for me to say that the Fed doesn't matter. And it doesn't have anything to do with 10 year rates, because of course, inflation is the thing that links them.

[00:08:03] So if you were, say, looking at the last eight or ten weeks, the 10 year bond deal came down 50 basis points. 25 of that half of that was a decline in the 10 year break even. So it's not that there's absolutely no linkage because the benign readings on inflation

[00:08:23] that we're seeing did bleed through a little bit. But we're talking about 25 basis points of decline and break evens. It's not that big in the scope of the economy or our securities market. Do you have any thoughts on like

[00:08:37] the inverted yield curve? It's one of those things that has worked every time, but is a very, very small end, a very, very small sample. Like the fact that we had, it's less inverted than it was, but the fact that we had this inverted yield

[00:08:48] curve for a long time, is that something that concerns you in any way? It doesn't bug us. From our perspective, it really is part of the unwind of the suppression of longer term yields. And from that perspective, we don't get worked up about it.

[00:09:04] Plus, whatever this post pandemic thing is, that clearly, all the supply chain disruptions, etc., etc., etc., there's no question that that had something to do certainly with the very high spike in inflation and maybe even some of this residual higher than 2% thing. So

[00:09:23] for both of those reasons, we're not so worked up about the inversion as a recession indicator, which what's the famous quip that the inverted yield curve is predicted like 10 out of the last three recessions or something like that. So we're not so worried about it this time.

[00:09:38] Yeah. Your point about the pandemic in 2020 I think is a really important one because we saw something there we really had never seen before. And I think it's tough for any of us

[00:09:45] to analyze when that's worked through the system and how much of an impact it's still having. When you have one of those outlier events, it can be hard to predict what's happening I think. Sure. And among one of the key issues, and there's two pieces to this,

[00:10:00] the tightness of the labor market. So one is the thing that's in the headlines all the time. Will this AI thing be such a productivity boost that it will alleviate some of the in pressures of employment on inflation and real growth rates improve and all that stuff.

[00:10:20] The other thing that may not have completely unwound, and it's hard to really capture this, but are there still underemployed people out there? Are there still people driving Ubers and lifts that don't count as unemployed, but are there to fill some better jobs that may

[00:10:38] suggest that underemployment is still a little bit of a thing that means there's not quite as much employment pressure as one would think at the current levels of stated headline unemployment. Do you have any thoughts that you mentioned AI? Do you have any thoughts about that?

[00:10:54] Everybody thinks it's going to change our world in a lot of ways. We've had people who think economically it's not that huge of a deal, to people who think it's going to be a huge boost in productivity. It's going to bring inflation down. It's going

[00:11:03] to make everything better on the economic front. Do you have an overall view on that? I'll say one thing about AI because I think there are plenty of people who talk about this and study it 24-7, but here's the one thing that I found that was interesting,

[00:11:19] that is interesting, and that is that this time around in this disruption, the benefits appear to go to the incumbents. Now exactly which pile of incumbents we can debate, but whenever anybody says who are the beneficiaries of AI, the young beneficiaries

[00:11:35] are companies that are 20 years old and the old ones are 50 years old. And that's pretty darn important because whenever you look at disruptions, to me as an investor, that's the first thing I want to think about, or the beneficiary is going to be new entrants or incumbents.

[00:11:50] And this is kind of nutty because those of us who remember the late 90s remember this book called The Innovator's Dilemma, which said that disruptions are really bad because incumbent companies will be devoted to their old cash cows and won't make it into whatever this next disruption

[00:12:09] is. That appears to be not at all what's happening right now. Lots of folks have ideas around it, among them of course is just the high cost of entry. You've got to have a lot of money to

[00:12:20] play in the AI space, but I think that's really important and it's certainly part of the dynamic that we're seeing in the equity market, that it's incumbents, not new entrants that are the beneficiaries of the time around. Yeah, it'll be interesting to see how it plays out.

[00:12:34] On one hand, the technology of AI allows a small group of people to do a lot of stuff, but as you point out, on the other hand, right now it's the companies with all the people

[00:12:43] that have the size that are actually winning. So it'll be interesting to see how that plays out. The incumbents have a huge advantage here so they're going to be tough to catch I think.

[00:12:50] I think that's right. I want to ship to a blog post you wrote because it was an interesting blog post and one of the things all of us talk about all the time and you see

[00:12:58] in the media all the time is this relationship between interest rates and what the stock market does. You argued in that blog post that maybe that impact is not as great as people think. When interest rates go up 1%, what actually happens to the market might be a little

[00:13:12] bit different than what people think happens. Can you just talk about that research and what you found? Yeah, one of the easiest and simplest things to do is to just do a scatter plot of P multiples against a 10-year treasury yield. So first things first,

[00:13:26] I said the 10-year treasury yield. So if you're looking at the relationship between interest rates and valuations, multiples don't have that much to do with the overnight lending rate. They are primarily driven by changes in longer term interest rates. So let's get in the right

[00:13:40] neighborhood. We're in the 10-year space and then if you do that scatter plot, you do indeed see that it's downward sloping. So that's not a surprise to any of us either because if discount rates go up, then future earnings are worth less, the standard thing

[00:13:54] that everybody talks about. So it's downward sloping and it's not as downward sloping or as steep as I think that people would guess. So I go out on the road and I'll say what do you

[00:14:07] to an audience, what do you think the impact on the equity markets would be if interest rates went up 1% today? And most people say 10 or 15%. And historically, it's been more like four or five. So if you actually do this little regression, 100 basis points is 0.8 of a multiple.

[00:14:26] Let's round it to one. If P is a 20, that's 5%. So it's actually a little bit less than that. And I think that surprises some folks. You had an interesting chart and we'll put it in the podcast in that same article where you were looking at the relationship between

[00:14:39] the 10-year and the S&P and kind of looking at where we are valuation wise for stocks. What do you find in terms of how stocks look relative to bonds right now?

[00:14:47] That's the other piece that you can do once you make this scatter plot. Then you plot where we are and absolutely, we're a little high. We're at something like 23 times trailing right now.

[00:14:58] And you'd be around 20 if you were on that line. And 23 as if you plot bands around it to get that kind of one standard deviation die, we're right on the edge of one standard deviation high. So in other words, just around the point where two-thirds of the

[00:15:16] observations would be below this 23 multiple. Not really high, but kind of high. But of course, the problem with averages is as an old mentor, I've heard a lot of riffs on averages. I still go with my old mentor's favorite, which is that you can have one hand

[00:15:31] in boiling water and the other hand in a bucket of ice and declare yourself okay on average. So we certainly know what's going on with regards to the top heaviness of the market. But to answer your question, we're a little high on the S&P 500 for sure.

[00:15:47] Yeah. I don't know if you agree with this, but I think to your point, one of the things I think investors get wrong about valuation all the time is they think it's some sort

[00:15:53] of short-term timing tool. They think because things are a little rich or things are a little cheap, that's going to change in the near term. And often it's a better indicator over the long term of what to expect in terms of expected returns than it is

[00:16:04] in terms of what's going to happen in the next six months. Yeah, it is the old Buffett adage that any short run the market is a voting machine. And in the long run, it's a weighing machine. I can talk to my mentor at Columbia who's happy

[00:16:17] that I gave that quote. But indeed, that's absolutely true. And you need look no further than outside of US large cap stocks to see persistence of relative valuation issues. Mid cap stocks are 50 cents on the dollar and they've been that way for several years.

[00:16:36] By the way, that started at 50 cents at the height of the both tech and mega cap bubble in 2000. Went to parity just before the great financial crisis, which was back to 50 cents on the dollar.

[00:16:49] Small caps are at about 30 cents on the dollar as our international stocks. But to your point, I would have said the same thing a year or two, even three years ago. So valuation issues are important ones, but that doesn't mean tomorrow they will resolve themselves.

[00:17:04] What do you think is driving that relative underperformance of mid, small and international? Is it just that investors want quality in large cap and that's where they're gravitating to, that's where the flows are going? Or is there something else under the surface, do you think?

[00:17:18] I think it is primarily this tilt towards this concentration in the mega caps and the mid and small cap pieces are sort of the tail of that dog. They're just sort of following

[00:17:30] that along. And I know that one of the things that you would read in our writings is how to evaluate that, how to think about what that means. And one of the things that we have been

[00:17:44] talking about is perhaps a misguided notion that quality in those mega cap, mag seven, whatever we want to call it. By the way, don't forget they're not all in the techsecure.com services, you know one of them in some way discretionary. So be careful back where you

[00:18:02] look for them. But it is a little bit of a mistake to be so complacent about that because let's go back to 99 and 2000. It wasn't soft puppets and eyeballs in the S&P 500 tech sector.

[00:18:19] That was a bunch of companies making money hand over fist and then they weren't. So there are both top heaviness today, not just in valuation but also in fundamental. Fundamentally I was just looking this morning at some of the earnings, see the numbers.

[00:18:40] And for a second I comforted myself and I said, well okay let's see what's happening. Right right right tech sector 30% year over year. Got it. Okay. Comm services is the other place 40% a year over year. Wait, consumer discretionary is up

[00:18:53] 30% year over year. Oh click the button. 80% of consumer discretionary is Amazon, which had blowout earnings. Okay so that didn't really tell us there was a broadening app did it? So there are challenges. At least things that one should be aware of with both respect

[00:19:10] to valuation and fundamental. That said, hey we're in the stuff landing camp. We're not freaked out like it's the first quarter of 2000 but the average can certainly mask some things that are going on. I'm curious just on this point of the smaller stocks underperforming

[00:19:28] the bigger stocks, have you thought about the impact of indexing there? It's something we've talked about a lot in the podcast and this idea that through everyone's 401ks you've got this money that just is regularly going into these market cap weight indexes especially

[00:19:40] the S&P 500. Most of it's going in the biggest companies unless their liquidity supports those kind of flows. You could argue there's this constant upward pressure because of indexing on those biggest companies. Have you thought about that at all and if you think that makes sense?

[00:19:53] Well I think there certainly could be a sort of momentum-ish thing there. In other words, because mid and small cap, the more we talk the more I sound like a New Yorker so my

[00:20:03] apology for that. I grew up in Connecticut but after 20 years in New York I start to say coffee sometimes. Because mid and small cap stocks have had such a protracted period of underperformance, even folks who say I am following a kind of buy the book asset allocation

[00:20:25] that should have something like 10% small cap and 50% mid cap, they've gotten away from that. In what will get those folks back in? Are they just, in classic terms, will they wait till the numbers actually show up? And that's back to your point of the fundamentals doesn't mean

[00:20:43] that things will resolve overnight. So I'm not worried about it from, I don't think it's a phenomenon of passive investing at all but I do think there's a little bit of momentum aspect because clients and their advisors have outperformed a classic asset allocation

[00:21:03] that would have mid and small cap representation for so long. A lot of them are reticent to have that buy the book allocation and then small cap stuff. Yeah, I mean people chase performance to

[00:21:14] some degree and it'll be interesting to see like when did they as the value becomes more in those areas like when do people think about all right I want to you know I want to move

[00:21:21] some money over there or do they just keep chasing the momentum? It's an interesting phenomenon and I don't know how it's going to play out. And if you're doing an asset allocation by the book you have what's called your neutral allocation which is typically defined

[00:21:35] in the books as what I used to call a look out the window test which is just the market caps as they are distributed around. Whoa! And you know imagine let's just keep it simple for

[00:21:44] a minute. Let's say that in the U.S. you'd be, the plate as it lies is 60, let's say 70 large, 20 mid, 10 small. Now you might say on the large cap side that my bounds of my tactical asset allocation, how far

[00:22:01] am I going to move that thing if I'll bullish or bearish? If 70 is the middle, I love them, I'll have, I love large cap, I'll have 80, I ate it, I'll have 60. That's kind of prudent

[00:22:11] asset allocation. What people sometimes get wrong but I think they might be getting right is that you don't scale that by the size of the position. In other words if large cap is 60, 70, 80, small cap is 0, 10, 20. That's kind of a risk parry approach to asset allocation which

[00:22:29] sounds a little jarred in me. It just means that you could if you are at prudently is kind of in a prudent sense you could zero out small caps if you were really worried about them. I think the problem is that it has become a self-fulfilling

[00:22:44] prophecy that will take a little bit of time to unwind. You alerted to earnings growth before and I was listening to some of your CNBC appearances to prepare for this and you kind of talked about there's this idea that

[00:22:54] the market is a little bit overvalued but a lot of people think earnings growth supports that and we're going to see really strong earnings growth. We have and we'll continue to see in the future. I'm just wondering if you could talk a little bit about what

[00:23:04] you're seeing especially in the S&P 500 earnings growth wise? Yeah it's the uneven distribution. A year over year last quarter was pretty decent 8%. We could debate if that's enough to support 23 on average but again it's back to the problem with the averages.

[00:23:20] That was so tilted towards technology, comm services and then the one guy stashed in consumer discretionary though I think the earnings challenge is not so much did we have a top line or average number for the S&P 500 that was good enough? It probably wasn't so far

[00:23:40] from good enough but it's the uneven distribution and that will have so this is where I'm kind of cheating a little bit when I was pounding the pay table and saying no 100 basis points

[00:23:57] on the 10 year and that's only a 5% move in the equity markets. Well okay but earnings can move too. That's a P multiple delta in that regression so where it's relevant here in your earnings question is yes I think if inflation gets even more tame that should

[00:24:18] promote some broadening out of fundamentals and some of the P&Ls that have been challenged by inflation even at 3 and 4% forget 10 should be able to improve their profitability a little bit as we get closer to 2 and that should help broaden out the fundamentals and the earnings.

[00:24:36] Yeah that's kind of in the question is when will this broaden out to more companies? I mean this has been you don't want to say unprecedented because this has happened before but the leadership in terms of performance in the stock market of these big companies,

[00:24:47] the leadership in terms of generating earnings it's been a very very high number relative to history and it's just interesting to see it's been two markets and it'll be interesting to see if you can see that broadening out if you can see your average

[00:24:58] company doing better. Yeah that is the key I think most people are focused on the narrowness of price and should familiarize themselves with the with the narrowness of of earnings and fundamentals as well. You had a chart in one of your blog posts where you looked at the

[00:25:16] S&T the return so far in 2024 for the S&T 500 and how narrow the leadership was or how much leadership was from certain sectors. Do you just want to kind of talk to that?

[00:25:29] There's so many ways to examine this but there's absolutely no question that this is about a narrow and driven market as we've seen really since 99 and 2000. So you can do it by sector,

[00:25:42] you could do it by mag seven, by the four however you want to slice it and I do think it is fair to admit that the earnings and fundamentals have supported that narrowness

[00:25:55] to some extent so I'll actually throw it back half full what I was previously suggesting was get nervous about the fact that the fundamentals are as narrow as the price action but hey if you

[00:26:07] want to look at the glass half full well you could say that the narrowness of the leadership has been supported by the fundamentals. It's tough to figure out which is which and again

[00:26:17] I think it should tell us that we can be maybe a little bit more relaxed than we were 24 years ago because the money's here and again the AI benefits seem to be going to the incumbents. It's interesting though because you have communication services and then technology

[00:26:34] and then utilities and energy in the third and fourth spots but if utilities make up 2% of the S&P and energy makes up maybe three and a half percent you know that good performance

[00:26:46] doesn't really move the needle. That's really that's a challenge and you know I will talk about this I'm sure a little bit more but when Oaks are looking to certain segments of the market like energy you know they're often looking there as a place that can outperform

[00:27:05] if interest rates fall. Utilities and energy being classically interest rate sensitive but you talk about a narrow slice of the equity markets back to you know kind of a prudent asset allocation view of the world. Energy is so small you shouldn't have you know more than

[00:27:25] 10% of your portfolio on energy prudently and technology is the opposite. If you put tech and comm services together you got 40%. Back to my earlier math if you're 80 you probably want 30 if you're lovely you have 50 you can't have zero you have to have engaged on the you have

[00:27:40] to engage on the energy front. You really shouldn't have 25% of that in your portfolio betting on either Fed cuts or a rally on the long end which we think would be even more impactful.

[00:27:51] What about the case for equal weighted strategies though and how should investors kind of think about that? I mean like you have with the S&P 500 you have market cap weighted which as we're talking about is very concentrated and then you can buy an equal weighted S&P 500

[00:28:05] which might have more of maybe more a smaller value like bias I guess. Yeah all right we had two sort of calling cards or rifts that we started this uh this year with one was it's

[00:28:22] not so much about the Fed and the other is equal weight's not enough and we still feel actually pretty strongly about both of these. Now what do we mean by equal weight is not enough?

[00:28:33] If you equal weight the S&P 500 which sounds like a very simple and straightforward response to the top heaviness of the market the problem is then you're elevating all of the other 493, 496 however we want to tally it up and do they all deserve to be elevated

[00:28:50] or was some left behind for perhaps valid reasons? One way to to note the perhaps oversimplicity of equating the entire S&P 500 is that it actually degrades quality. So if you look at

[00:29:05] return on assets you have classic fundamental guy there um you cut almost half you cut the ROA almost in half of the S&P 500 by equally weighting it. Again this goes back to the

[00:29:18] notion that yes it's quality the big guys have been making money but there are alternatives out there which you will I'll start to uh point us a little bit in that direction. We're big fans of dividend growers the S&P 500 dividend aristocrats is an equally weighted

[00:29:33] strategy of companies that have grown their dividends for 25 straight years that has an ROA that's almost double the S&P 500 but brings evaluation all the way down the same way that just a simple equal weighting of all 500 does. So equal weighting is valid but not

[00:29:50] all the 493 deserve to be elevated. So let's talk about dividend growth strategies a little bit let's step into that um so now we're getting strategy specific what do you talk about the importance of I guess dividend growth you know a lot of investors dividend investors they

[00:30:06] kind of seek the highest income higher yielding stock so something that you know five percent six percent that's kind of when they think about dividend investing that's where their head is at but dividend growth can be a very powerful uh and perhaps more effective

[00:30:23] approach to dividend investing. So can you just talk about yeah the first place to start in your due diligence around dividend strategies is indeed this first choice. The first choice is high dividend yield or consistent dividend growth and it's a very

[00:30:38] important distinction on the high dividend yield side E E E P they're just inverse of one another so the only way to have a high dividend yield is to be really cheap it's a deep value play you'll find your real estate in there you'll find utilities in there

[00:30:53] you'll find things that are very interest rate sensitive and why are they interest rate sensitive because they don't grow think about this I always find it incredibly maybe comical is too harsh

[00:31:04] but you turn on financial tv and somebody will get on and say ah the s&p is at 20 times earnings that's a five percent yield and the money market is at five and a quarter stock

[00:31:17] stint okay that makes no sense because bonds have fixed coupons and good stocks grow their earnings and dividends now if you buy a stock that's really cheap and it isn't growing its dividends and earnings then guess what you practically bought a bond and that's where you

[00:31:38] are on the high dividend yield side it can work it's a cyclical play and you know if you catch a real rally in long-term yields you might get boosted to argue a little bit of this

[00:31:49] utility benefit over the last couple of months is from fault and from that 50 basis point decline in long-term yield but it's not a real great permanent core holding when we look at dividend growers again the flagship for us is ticker in obl that's our etf that follows

[00:32:05] the s&p 500 dividend aristocrats we see a couple of things it is an incredibly elegant marker of quality and i say elegant because by simply screening for companies that grow their dividends for 25 straight years all this other stuff has to be behind there you could try to

[00:32:22] do this stuff with 25 different measures of fundamental and price and put them into a black litterman model in this thing in the covariance and all that or you could just screen for 25 consistent years of dividend growth and all that good stuff has to be there so the

[00:32:35] quality's there and the other item that's critically there is signaling yeah here's think about this for a minute back in the old days pre i think it's 2003 dividends were taxed always at the marginal tax rate this qualified dividend thing didn't exist and capital gains

[00:32:56] were taxed at the low long term if you held like you had the low rate so back then for for all of the history before 20 years ago dividends were taxed disadvantaged and yet

[00:33:09] they existed in fact the yield on the s&p is kind of what it is today why did they exist quite a bit important signal because here's the bottom line on this when a company does a

[00:33:19] buyback they are telling you they had a good year last year but they increase their dividend they're telling you they're confident about the future because as we know nobody wants to cut a dividend so the combination of quality and management aligned with shareholders

[00:33:36] and telling you they're confident is a powerful combination and yes given the run of the mag-7 they're on sale a very interesting point i was also thinking with the aristocrats like the 25 year piece of it i mean you're getting companies that have been through obviously

[00:33:54] multiple market cycles multiple types of economic regime they've kept their dividend they've kept growing their dividend and to your point it kind of gives you this really great sense of this is a high quality company that has uh that pays attention to sort

[00:34:10] of you know shareholder returning capital to shareholders yeah and you take your cake and eat it too because the dividends are growing significantly faster than the dividends of the s&p 500 so the yield today to unchanged but the yield on your initial investment

[00:34:25] becomes three four five six seven eight much faster than in the s&p 500 so it really does become a powerful source of income because the dividends are growing some yeah that yield on costs uh

[00:34:40] stuff is very powerful for investors what is that portfolio i mean if you were to try to talk about the what the portfolio looks like obviously high quality but what are what's like the sector orientation in there the most obvious thing about the s&p 500 dividend

[00:34:57] aristocrats is that it is dramatically underweight technology everything else is a footnote to that from a sector from a sector standpoint and it's one of the reasons why a number of years ago we actually launched uh following the s&p technology dividend aristocrats index and

[00:35:13] that's our ticker tdv and that can be a very prudent way to engage in technology back to my comments earlier you gotta have some uh and with the technology dividend aristocrats yes you're equal weight you're equal weight tech companies that have grown their dividends for

[00:35:32] seven straight years you can't quite go back 25 years and so importantly that signaling piece in the tech space and and the evil way by the way takes the valuation down from

[00:35:43] 35 times in the end in the s&p 500 tech sector down to uh the down to the low 20 so it resolves the value of each challenge but the signaling thing is hey because let's go back to to that

[00:35:57] concentration of fundamental if i'm worried about who might be in a in a little bit of a bubble of profitability well somebody who did a big buyback but didn't either incept or increase a dividend seems like they might be slightly more nervous about their business cycle than

[00:36:17] the tech company that has increased their dividends and it's super relevant now because you know as we and it i was glad that it got into headlines a little bit with a couple of the big players in sifting dividends this year because indeed the tech sector is now

[00:36:33] the largest contributor of dividends to the s&p 500 probably not a lot of people bought that already happened but it did not quite punching their weight tech sector is north of is is somewhere around three to 33 percent but about a quarter of the dividends of the s&p 500

[00:36:49] come from the tech sector so s&p 500 dividend aristocrats noble its biggest distinction is underweight technology a lot of folks will pair it with tdv the tech dividend aristocrats to get a nice sector neutral approach that has the quality and the equal weight i was surprised i'm

[00:37:08] sure it's not in the portfolio correct me wrong if it is in the tech uh dividend portfolio but navidia even pays a dividend now they don't uh yeah there i never remember when they incepted

[00:37:19] but yield there there are a few years out and by the way this goes all the way back to that we had talked about the definition of technology in tdv the legacy definition

[00:37:31] is in there so you have a slightly broader group of guys in there you have mastercard and visa a censure broadcom and you do have microsoft and apple but remember they're all equal weight with it um we've talked recently about some other covered call strategies on the podcast

[00:37:49] and i think we're seeing more and more of these as investors are looking for you know higher yielding strategies with even some capital appreciation potential and doing it you know using covered calls but can you just talk about i guess what the challenges or risks of

[00:38:06] those types of strategies are and then how you know you've tried to address their pro shares it is astounding the growth of of covered call uh particularly in the etf space over the last several years and investors have needed income and they've needed more income

[00:38:24] than they can get from their fixed income allocation for the quick primer in a covered call strategy you spell or write same thing sell or write a call which is right for somebody and it's called covered because you own the underlying thing they're not rolling the

[00:38:38] dike with unlimited losses you have uh you own something maybe it's the s&p 500 you sell away the upside to it you sell the right for somebody to wall it away from you you paid some money

[00:38:51] and that can generate some very nice income but a lot of people forget about the the other half of that i just sold away the upside to my stocks and that's a tough trade-off

[00:39:02] historically there are a couple of benchmarks in this space there is this cibo buy right index on both the s&p 500 and there's the buy right index on the nasdaq 100 and these indices that capture a classic monthly covered call strategy have generated anywhere from just

[00:39:22] one-third to one-half of the returns of the equity market over time and that is a real tough real tough sacrifice to make in pursuit of that income and so what we've done at pro shares

[00:39:35] we're super excited we've launched innovative two innovative etfs that are driven by a daily covered call strategy writing and selling those calls every day i spy which is the s&p 500 high

[00:39:49] income etf that's a daily covered call strategy the s&p 500 and iq qq is our nasdaq 100 high income etsia here's the magic if you will and it's not magic it's just the way options work if you are running and pursuing and participating in a monthly covered call strategy

[00:40:10] the s&p you write this call the s&p goes up the first couple of days of the month it's your call price you are done you have no participation for the next 27 28 days

[00:40:19] you do it every day you're up at that in the morning so a daily strategy allows you the opportunity to generate that income aims to capture the full returns of those equity markets over time and get those returns that the traditional monthly strategies have left on the

[00:40:36] table the um as we kind of wrap up here i want to ask you sort of step take a step back and ask you um a couple things that are i guess a little bit outside the well they're in the

[00:40:51] investing sphere but the first is you know you've been at pro shares i think for over 10 years now and so obviously you had a front row seat to the you know the rapid growth of

[00:41:04] ets and all the different strategies that are being deployed in ets as you kind of look out over the next five to ten years you know what what has you most excited about sort of the ets

[00:41:17] landscape and let me just make you know say one thing it was like you know i feel like a few years ago it was like the the direct indexing stuff was gonna you know uh was gonna disrupt

[00:41:29] the etf landscape and i think direct indexing is powerful and can be used for investors but i don't think it's i don't think it's on the track of what a lot of people were thinking

[00:41:38] anyways so what what has you excited about um ets what i love about what we do at pro shares and i think there's still a nice runway here is the translation of the implementation of strategies

[00:41:55] that used to be the realm of kind of you know active discretionary portfolio managers into rules-based strategies you know when we talk about the s&p 500 dividend aristocrats noble i'm not picking any stocks in the morning that's an s&p index i spy daily covered

[00:42:12] call that's the s&p 500 daily covered call index and that's powerful because it allows you efficiency tax efficiency all these good things but it takes the discretion out of it and i love that because you're back in in previous lives i'd run due diligence on on platforms

[00:42:31] of classic separately managed account of mutual fund programs and when we used to look at active managers we would just sort of put that process on a continual yeah here the line and you

[00:42:44] know this is 100 what percentage of that process was a screen and what happened around the table after the screen and you want to know what we like best processes that were 90 screen we didn't want somebody waking up who used to rip apart balance sheets

[00:43:02] decide they like gold in the morning and then on the perform for the next 10 years i'm not naming names but you could figure out who that is we like discipline if it's the s&p 500 dividend

[00:43:12] aristocrats don't blink don't blink and you don't blink and look you as an investor you can make your asset allocation decisions very cleanly that way so i think the opportunity to continue to find strategies that heretofore were the domain of discretionary folks in figuring out

[00:43:31] make them discipline rules based etf still has a long way to go i want to go way back to um way back in your career and i didn't realize this i just i've just um loris say this so

[00:43:49] well then here's so here's the question i mean you were at lemann brothers during the financial crisis and when the firm collapsed so i'm just wondering like now that you think back

[00:44:00] to that time i mean bring us into what you were feeling what you guys were going through it must have been just i mean it was a terrible time for almost every everyone in the economy to some

[00:44:14] extent but i think the epicenter was investment bank wall street bailouts and obviously you know you got you and a lot of people you know lost your job you went to another firm almost immediately after that but i mean that must have just been a difficult

[00:44:30] i hope it's okay i'm asking this i'm just curious as to your thoughts on this it was obviously a challenging time for for a lot of us i think there are two things i'll

[00:44:41] comment on one is yeah there was leverage all over the system that we don't see today and by the way if you want one in dish of that um net debt to you adopt the s&p 500 is

[00:44:53] an all-time low so folks are looking for a spoken gun i know we could talk about well it's hiding it's hiding in private debt market maybe but still most most in dishes that you can get your hand

[00:45:05] on show that there really isn't a lever problem and the other thing i'll say is that uh i got a lot of friends from that that time period and uh we're all we're all fine there was a there

[00:45:17] was a lot of there was a lot of intellectual capital there that made it long past the bankruptcy whether it's any of us individually or any of the firms that came out of that so

[00:45:26] man we hated it but we all trusted one another and we're there's still an as you guys know there is a strong network of of leman alums doing lots of important things all over the

[00:45:38] street to this day so our standard closing question is uh based on your experience in the market if you could teach one lesson to your average investor what would that be

[00:45:47] i saw that question when you when you forwarded to me and i kind of got a smile on my face because last year for the first time i taught a class adjunct an mda class adjunct first time i did

[00:45:57] in my life um and it was it was fun and we did one class on securities analysis and um the the case study was uh the students were presented with several uh mutual funds and their

[00:46:14] strategies and they were asked to comment on whether they thought they were sustainable and what they would be and everybody came back and said um joe only picks companies with really smart management so therefore i am confident that their strategy will continue

[00:46:29] to outperform to which i said to the class i have a strategy i'm gonna pick companies with stupid management are you so sure that mine's gonna underperform be a little skeptical

[00:46:42] things that are too i don't want to be a death spiral chicago school guy that you know two economists walk down the road and the hundred dollar bill can't be there because somebody would be somebody should have picked it up already i'm not saying that but a little

[00:46:54] healthy dose of skepticism i think is critical to anybody's due diligence process whether it's professional investor or even as an individual talking to your advisor great simian thank you very much really appreciate you joining us this morning thanks for having me this is

[00:47:10] Justin again thanks so much for tuning into this episode of excess returns you can follow jack on twitter at practical quant and follow me on twitter at jj carbineau if you found this discussion interesting and valuable please subscribe in either itunes or on youtube

[00:47:26] or leave a review or a comment we appreciate justin carbineau and jack forehand are principals at bolivia capital management the opinions expressed in this podcast do not necessarily reflect the opinions of olivia capital no information on this podcast should

[00:47:38] be construed as investment advice securities discussed in the podcast may be holdings of clients of lady