Sam Huszczo thinks investors are too obsessed with mega caps, and too focused on their home turf. Neither of these facts is surprising, he says, given the market performance in this pandemic year. But Huszczo, founder and head of SGH Wealth Management—a young Detroit-area advisory firm—argues that it’s time to be forward-looking, and rethink some of the heavy allocations to what’s done well so far.
ETF.com: As an advisor, what are some of the biggest conversations you’re having with clients right now?
Sam Huszczo: One of the conversations we're having right now is what's going on with midcap and small cap stocks. And why aren't we putting everything in Apple. There's a huge recency bias right now, in our viewpoint.
Everybody feels what's done well will continue to do well, and maybe because we’re kind of trapped in this COVID year, people's viewpoints are a little shorter term—it's harder for them to think of what's going to happen three to five years from now because we're dealing with what's happening three to six months from now.
ETF.com: Sounds like a common investor mistake right now is time horizon—focusing too much on mega caps in the short term?
Huszczo: I’ll admit when you look at earnings, not only have a lot of those mega cap, especially tech stocks not gotten hurt by coronavirus, but some of them have actually benefited, so there's some justification to how well they've been doing. But I'd also say, yes, to the extent that you’re giving up on some tried and true ways of investing for short-term performance-chasing in a time like this.
And that gets worse when you go down to midcap and small caps. The old Fama-French-type of rules show that if you look at rolling periods of time in history, midcap and small cap stocks do outperform over longer periods of time. What I've been trying to get people focused on right now is, yes, obviously mega caps have done the best. But also, they have the highest P/E ratios, price-to-book ratios, free cash flow ratios, [and are] some of the most overvalued from a more fundamental perspective.
Where are we going from here? I think a lot of people are having a hard time being forward-looking.
I’d argue that there will be likely a whiplash effect after there’s a vaccine. All of us, myself included, miss going out and experiencing things and going to events. There's going to be a huge overcompensation of that once everything does open up again.
When that whiplash takes effect, then the tech companies, the internet-type of providers may see some of the benefits they've gotten from coronavirus subside a little bit, and that's what could potentially put them at risk a little bit.
But being forward-looking, we tend to see some similarities not only to a tech bubble, which I think is a little extreme to say, but more to the downturn we experienced in December 2018.
That was more of a fundamental downturn. And in that time, technology stocks got hit worse than the broad market. What goes up really fast will also go down really fast. If momentum pushes it in that direction, those are the stocks today that might have a little bit of risk.
ETF.com: Say a vaccine shakes up the market. You think mid and small caps would be better able to weather volatility, or a correction?
Huszczo: Yes. It'd be hard for them to go down again as much as they did in March. I don't foresee that.
In March, there weren’t many safe havens out there, but the recovery has been much faster in mega cap, so that certainly could have some downside protection ideals behind it.
I’d say the sector you're in is probably the stronger play in terms of trying to have some downside safety. A vaccine will be good news for the market, and small cap, midcap and nontechnology stocks will go up faster from the good news than mega cap tech.
On the downside, the volatility index is back to the low levels of December 2019, and we were calling for a period of complacency back then. The volatility index is a tool to judge psychological factors of the stock market.
With complacency, if there's a shocking news headline that comes up, that's the environment for people to make knee-jerk reaction-type decisions. With the low volatility index nearing October, we don't know what the catalyst would be, but it feels like a highly charged zone where politics are going to be in full swing, China is still making headlines, COVID is still around—the bubble in mega caps could somewhat deflate.
ETF.com: Let’s talk application. On the equity sleeve of a portfolio, what is a properly diversified mix right now for the world we live in?
Huszczo: We subscribe to traditional asset allocation norms. We’d set parameters on how much to own in large, mid and small caps. And then, we keep those relatively static. But within those areas, we do factor-based investing. Different factors might come in at different times.
One of the best factors from the lows to now has been momentum. That's caused the recovery to be as fast as it has been. One factor that hasn't done as well in an uptick, which is expected, is low volatility.
But in trying to urge people to be forward looking, we’d say maybe it’s time to increase exposure to low volatility—sector overweights in low vol now are health care, consumer staples, communication services, all areas that could probably withstand some negative news a little bit more easily.
Those are the layers we use. You have to have risk parameters in place to stop you from getting too far into one area. You don’t want to be too risky or not risky enough in your asset allocation. And then within those parameters, we can get into different factors through factor-based investing, more of a quant method than anything, which permeates into the sectors.
ETF.com: To round out the equity allocation, what about international stocks? Is there an overlooked opportunity in that space?
Huszczo: We’d focus on emerging markets. Back in the March/April time frame, there was almost a complete stop of capital inflows. Emerging markets require outside capital to continue their progress.
Something similar happened in 2008, when there was a similar capital inflow disruption to the region. But this time, the reserve adequacy of international or emerging markets is better than it was back in, say, 2007. That means they could withstand more of a blow.
If there is further upside in markets, emerging markets should benefit. Again, since they did have that capital shutoff, we can say that not many people are paying attention to emerging markets this year.
That's where we see home bias. It’s the old Peter Lynch ideal: People are comfortable buying what they know. Certainly once you get to emerging markets, there's less comfort. Being forward looking, we’d argue that they're going to be able to propel forward with a vaccine faster than the more stable nations.
ETF.com: Any asset or segment you’re staying away from?
Huszczo: We're really well-diversified investors. We don't really say "stay away." Yes, I’m cautious about mega caps, but we have a big portion of them. It's just that we're underweighted mega caps now.
We also have a very strong position in gold, and have had so for at least a couple of years now. Gold's done phenomenally. But that's another thing where you look at peak prices of gold historically, and how we haven't seen much inflation, so I don't see us adding more into gold.
ETF.com: All of these investment ideas you implement through ETFs?
Huszczo: Yes. We’re 95-98% ETFs. The only area where the market doesn't have enough coverage for us is the Michigan municipal bond market. We’re somewhat regional, so most of our clients are Michigan-based, and we cater to that.
Contact Cinthia Murphy at firstname.lastname@example.org