“When things change, I change” is a shorter version of the famous quote widely attributed to John Maynard Keynes. “When the facts change, I change my mind. What do you do, sir?” has thousands of attributions to Keynes, but I cannot find one source of the original quote. (See Quote Investigator’s attempt here: https://quoteinvestigator.com/2011/07/22/keynes-change-mind/.)
Anyway, there is a change.
In the US Equity ETF portfolio, we are now fully invested. That means a 98% model weight (all ETFs) and a 2% friction cash-equivalent weight. These are close approximations, as each separately managed account may have a variance. Also note that the balanced portfolio (60% equity–40% fixed) is also fully invested. We call this Active/Passive and use ETFs in 6- and low-7-figure separate account sizes.
In US Equity ETF, we have maintained and continue to maintain an overweight position in the aerospace defense sector. Healthcare is slightly under market weight; emphasis is on biotech. Banks and financials are way under market weight. We continue the position in equal-weighted S&P 500 (RSP) versus cap-weighted SPY. We are overweight small caps (IJR). We have added semiconductors and NASDAQ exposure.
Some of these positions were phased into the fully invested structure over the last few weeks, and they have been rebalanced along the way, over the last few months. Most of this was accomplished before the Powell press conference, and the final transition was completed after the employment report. We also have enjoyed the rally in bond prices, and the longer-duration positions have performed well.
In my opinion, the outlook has changed. My view is that the slowdown (recession?) is arriving. Since the market is usually looking ahead 6–9 months, I want to be positioned as the slowdown begins, not after it is confirmed.
With the revisions in the recent labor report, I believe that the trends in labor statistics are showing a change in direction and diminishing intensity of labor force pressures. That trend suggests a slowing economy and may even bring about some recession estimates in the next 1-2-3 quarters.
It appears to me that futures and derivative prices suggest that most central banks have seen peaking in their policy-setting interest rates and that the implied transition to flat or declining rates is estimated to start next summer. Hat tip to John Authers of Bloomberg for outlining this in his November 3 column (“Not Even Thinking About Thinking About Rate Cuts,” https://www.bloomberg.com/opinion/articles/2023-11-03/fed-hikes-powell-should-get-thoughts-in-order-on-easing-rates). The Bank of Japan is the exception, as it is still unwinding years of yield curve control.
So, this mix is a major change from my outlook in the summer and early fall when we were maintaining a cash reserve. Stock prices seem to be discounting that the recession (if we have one) will be shallow, and the labor force pressures that push inflation higher are subsiding. Meanwhile, the real (inflation-adjusted) interest rate is now a positive number in most of the world. This is a normalizing event and strategically bullish as it stimulates investment decisions based on real results and not inflation-distorted ones.
Whether Keynes said it or not, I am prepared to change quickly if this outlook is derailed by evidence to the contrary.
The times are highly uncertain, and the global outlook is troubling and dangerous. The political dysfunction in the United States persists and, in my opinion, is the single biggest risk we face as investors and as a nation. Some of the derivative markets have not returned to the pricing seen at the beginning of this year because they are capturing the estimated cost of political dysfunction in America. We watch the credit default swap pricing on the creditworthiness of the US closely.
Positions may change at any time.
David R. Kotok
Co-Founder & Chief Investment Officer
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