Jim Stack Warns About the Fed, Tech Stocks, and Real Estate

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This is Greg Bartlett for Barron's The Way Forward. My guest today is Jim Stack, who founded Stack Financial Management 29 years ago. Jim, welcome.

It's great to be here and talk to you, Greg.

Thank you so much for joining. I want to start this by alluding to an interview that Barron's conducted with you in December in which you offered a decidedly bearish take on the market. And I remember at the time reading it and thinking a little bit to myself, oh no, this seems a little bit doomsday-ish. Well, if you look at what happened since then, so many of your predictions came true in short order. Now, of course, you didn't go so far as to predict what would be the catalyst for this downdraft, what's happened, but the, the risk factors all of these things that you painted, the warnings of inflation, et cetera, are coming home to roost. So first, could you tell me a little more about what you were saying then? And I have some notes you could allude to too. And then fast forward to today and just take it from there and talk about the markets, what might be ahead and what your current thinking is.

Well, when Steve Garmhausen did that interview in December and he titled it "Preparing for a Bear Market," we'd actually been gradually preparing as we went through 2021 because we started seeing some of the late late-cycle warning flags that commonly come up in a mature economic recovery or in a mature bull market. Now, that sounds strange since the recession, pandemic recession was only the year earlier. But the fact is we came out of that recession, and I'd call it more like a pandemic panic. For the most part, we've had 12 years of full-blown bull market carrying asset prices, not just on Wall Street, but also in real estate now, to Levels that are pretty worrisome from a valuation standpoint. Almost any metric you look at in the stock market, we're in the 95th percentile plus in terms of high or overvaluation in the market. And what we were looking at in December and what Steve focused on was what we felt would be an imminent showdown with the Federal Reserve. We'd seen a peak in speculative stocks, some of the Zoom, the Peloton, the DocuSign and Teladoc and stuff. Bellwether early warning speculative stocks were already in a steep freefall. And we were looking at inflation pressures and we said, the Fed is underprepared and they basically are so far behind the curve that they're going to have to move a lot more aggressively. So we looked at 2022, to this year, as being a year of surprises. And I think that's still the case.

Yeah, in that December interview, there was a line that caught my eye. You said it's a monetary showdown that the Fed is going to lose. Looking at where inflation is and looking at how begrudgingly they're slowly trying to pull rates up from near zero.

Yeah, the Fed is caught between a rock and a hard spot. And aside from the money management firm, Stack Financial Management, we also have Investec Research that we started 40 years ago. And in that research firm, we've gone back and we've looked at every economic cycle, every bear market cycle going back over 100 years, back into the 1920s and '29 to '32. Of course, we're not facing that kind of a scenario, but at the same time, when you look at the Fed's battle with inflation, it's not a new battle. We've had a number of battles. They basically started heating up in the '60s and '70s, and it wasn't until Paul Volcker in the 1981-82 recession basically broke the back of inflation, then we went through 20 years of disinflation, that people got very comfortable that the Fed has everything under control, that inflation's not going to go up, that if the Fed saw inflation going up, they'd just ratchet interest rates a few notches and inflation would come down. And unfortunately, what they're seeing today is that that's not the case. The Fed is behind the 8-ball. They're behind the curve. In fact, Jerome Powell recently came out and he said, we should have moved earlier. And I think that's the admission of all admissions in terms of what the Fed's facing right now.

In that December interview, you alluded to this as a monetary-driven bubble with a risk-perceived guarantee that the Fed won't steal the punch bowl. And along with that is TINA, there is no alternative to stocks. And you pointed out the incredibly high allocation of US stocks. I mean, you do have home country bias across the globe, frankly, but it's quite high in the US. After 12, 14 years of stocks going up, right? And rates ever going or staying low, a whole generation of people that pretty much knew nothing else.

Yeah, well, it really changed from a phenomenon of FOMO, fear of missing out, to there is no alternative. When the Fed took interest rates to zero after the pandemic hit in 2020, they did what they had to do and above and beyond in terms of stimulus. And what it did, it pushed, I think, a lot of money out of what you might call risk-averse assets, whether it's savings or CDs, and pushed a lot of money into the market that— and it's perhaps the best way to put it is I think there's a lot of people with money in the market today who aren't prepared for what could be lost if we do go into a major bear market.

Probably the case, and it's tricky to know where they go. I mean, to get, let's say, a 3% yield on a stock, you're often buying a PE stock with a multiple of 20+. And that's the safe investment, right?

That's supposedly the safe investment. And you referred earlier that we talked about the fact that the Federal Reserve's overly accommodative and stimulative policies have created a bubble. And first, I want to dispel the whole notion of a bubble, that a bubble means it's going to pop. The bubble basically reflects both the extreme valuation as well as the psychology. And when you go back and you look at past bubbles on Wall Street or even in Japan in 1990, you know, bubbles tend to unwind over time. That was the case in the tech bubble in 2000. Major indexes peaked in March. They didn't hit bottom until 2.5 years later.

And what's so fascinating about that from a perceptual perspective is that there's an element of— I don't know if it's denial, but on the way down, there's that hope, like, it's just a dip. It's okay. It's going to bounce. It's down further. It's okay. It's okay. And then there's a point— hard to define what that is— where there's a recognition of reality, and it is wholly depressing, just like, oh my goodness. And all that hope's suddenly gone. But to your point, it was not an overnight phenomenon. It just trickles lower, lower, lower. And then it's like, oh boy, here we are.

Well, you end up in a long-term bull market with basically developing, particularly for new investors or younger investors, they learn to buy the dip. If the market pulls back, you buy the dip. And that takes a while to wash out after you go through a major market top. Now, as we headed into the top in January, the market peaked actually on January 3rd, and as it came down, this was one of the faster 12% corrections in the S&P that we've seen in the last 30 or 40 years. And not so ironically, a lot of the other stocks had fallen far more.

Right. And just if I may interject, what I was describing was last year, so much of the breadth underneath, not the big cap indexes, but there was a real deep and wide erosion already happening. And then this year we got hit fast.

What you would call a— it's more of a traditional or the normal flight to quality that you see in a mature bull market. And you were seeing the speculative stocks. These are the ones that were based on hype and no earnings. As we said, some of them are Teladoc and they're great companies. Zoom is a great company. It's going to be around. Perhaps not on some of the others, but a lot of these small-cap companies have fallen 50% to 80%. And in fact, on that first correction this year, as the S&P fell 12%, both the NASDAQ and the Russell 2000 did dip into bear market territory, losing over 20%. So we not only saw that migration to quality stocks last year. But we also saw, you know, basically the same thing in what was the first correction or perhaps the first leg down in a bear market, if we are in a bear market. And I think the odds are well over 60%, 70% that with what we're facing with the Fed, that we have not seen the lows, that this is going to be a more protracted downturn as the Fed takes on the battle to bring inflation down.

The Fed can still raise rates 4, 5, 6, 7 times and likely, or a good chance, to still be beneath inflation, right? I mean, so the year-to-date value, let's say the Dow is a proxy for that, has held up relatively better. Next best has been the S&P, and then worst of those indexes, the NASDAQ. For what you envision in terms of a bear market, do you see it— I mean, can you speak to potential magnitude of loss and also Will it be the same dynamic whereby on a relative basis, even though the value stocks will hold up better, even though they may fall?

Yeah, generally the value stocks always hold up better in a bear market. In fact, if you go back to the tech bubble of 2000 and look at the unweighted S&P, it lost half of what the weighted S&P, which means the value stocks actually, if you were holding the value stocks going into the tech bubble washout, your portfolio lost less than half of what the broader indexes did. Of course, the S&P still lost 50% in that bear market and 58% in the 2007 bear market. So it's one of those things where every bear market started out as a temporary correction and every bigger bear market started out as a small bear market. So what we're handling and what we're telling our clients is basically 2022 is gonna be a year of surprises. And unfortunately, we think most of those surprises are going to be negative ones from interest rate and Fed policy. And this is a time to err on the side of caution. In other words, don't assume that just because the S&P might go down to 20%, that it's going to stop there. In terms of valuation, one could rationalize that if the Fed has trouble bringing inflation under control, and I think they will, and this basically progresses through this year and into 2023, then it's conceivable that the blue-chip indexes could drop 35 to 40%.

So just, so walk me through this just a little more on a granular level. So as the year plays out, um, the Fed continues to raise rates, quarter point here, quarter point there, and inflation stays elevated. I mean, even whether it dips or even goes higher, there's still a big disconnect from the Fed rate. And then, and then, and then Is there anything more than simply just people lose faith and the price momentum just discourages more people and more and more people bail? Is there anything else that, I mean, that corporate earnings might fall or any—

Well, corporate earnings always lag. And that's one of the fallacies on Wall Street. Oh, well, if I just watch corporate earnings, I can tell when the stock market's going to be in trouble. Corporate earnings never look bad at a stock bull market peak. They only look bad in the aftermath after you start seeing the reasons why the market's falling. You know, the sword that the Fed swings in interest rates is a very dull weapon in battling inflation. There is no direct correlation between taking, you know, short-term interest rates a percentage point higher and bringing inflation some fraction of percentage point lower. Basically, what the Fed has to do is raise rates to the point at which it is going to start to unwind some of the speculative excess, some of the hype, and some of the some of the hopes, and it's going to hit certain areas of the economy much harder than others. One in particular is the housing sector today. And I think that's kind of the Achilles heel of the economy, as well as the Achilles heel of the stock market. That is what could turn a normal 25% to 30% bear market into something much bigger. We've already seen, even with a small 1/4-point rate hike by the Fed, we've seen mortgage rates, 30-year mortgage rates—

4%.

Yeah. 3%, up to over 4%. All of a sudden, the affordability factor has dropped by at least a third from a year ago.

Right. Not to mention limited supply and all of that.

Right. And the bad news for the Fed is in terms of the inflation. I think if you get down into the components and what is inflation, you can look at the supply chain dynamics and the bottleneck there and say, well, that should start resolving. And it should. And to some extent it is, not a lot, but it is. And you can also look at commodity prices, which are very cyclical. They can go up fast and come down fast. The problem with today's inflation is that it is stickier than we have seen in decades. In fact, the Atlanta puts out what they call the sticky Consumer Price Index, sticky CPI. And it's those type of prices that don't go up very often, but when they go up, they don't come down. And that sticky price CPI is at the highest level in 30 years.

And can you just define that for the listeners? Sticky CPI, what goes into that?

Well, some of the components are what people have to buy or they're not going to give up buying. Ironically, liquor or alcohol is one of the things in the sticky CPI because people are going going to buy that regardless of what the price does. But the Atlanta Fed basically went into the basket of all the components that go into the CPI and said, okay, what is it that is going to— that people keep buying, that you don't see a drop in the demand? And of course, it's running at over 5% today. Another way of looking at the Consumer Price Index is looking at what's called the median CPI. In other words, this is the median where half are rising faster, half are rising lower. Because it was argued last year by some Fed officials that, oh, inflation's occurring, but it's only occurring in certain segments or certain portions or those affected by the supply chain bottleneck. The median CPI is at 6%, and it's at one of the highest levels in 40 years. So inflation is very ingrained in prices that are likely to continue going up. The other thing to keep in mind is that two of the major components in inflation, what makes inflation stickier like it was back in the '60s and '70s, basically relate to a tight labor market, which we have today. And in fact, it's probably the tightest labor market we've had in 40 years easily. And if you look at the wage-price inflation, it's also running at 6%. And the other component, ironically, is housing. Now, what people don't realize is that in terms of the PCE— this is the Fed's favorite tool for measuring inflation, is the Personal Consumption Expenditure Index— in terms of the PCE, that housing prices make up 30%, almost a third of the PCE. And if for the core PCE, which the Fed really favors because that excludes the volatile food and energy, housing makes up 40%. Well, look at what housing has done over the last 2 years. And it doesn't measure housing prices directly, but it measures 2 components, owner's equivalent rent and rent of primary residence. And both of those are in steep uptrends. In other words, the unfortunate part about inflation numbers that we're going to see over the balance of this year is that the big increase we've seen in housing prices is going to continue to funnel into those two fueling components in inflation gauges.

And the government's not They're not giving out money like they were in the past either. So you don't have that.

So if there's hopes out there that the Fed is going to raise rates a couple times and all of a sudden we'll see the CPI come down, the statistics, basically the raw data does not support that scenario right now. And I think the Fed out of the starting gate wanted to, from the comments leading up to the first quarter point rate hike, they wanted to step very softly because they didn't want to do something to to cause a panic in the financial markets. So they only went a quarter point. And what did the market do? It rallied. It rallied for 4 days. So now you see Fed officials coming out and saying, well, we are going to, you know, we're going to have to get more aggressive and we will raise faster. And this is directly from Powell. We will raise faster and further if we need to. And I think that that's the risk going forward. There's 6 more meetings this year. First, next one is on May 3rd. And it's generally already priced in that they're going to make quarter-point rate hikes at each one. But what happens if they start making half-point rate hikes? And that's where I, in terms of surprises, I think investors have to be careful. They should step softly and carry a bigger cash reserve, be a little more defensive, treat this differently than the last 2 years coming out of the pandemic lows.

So I have a question about the Fed. In the past, when they insisted that inflation was transitory in nature, do you think they honestly believed that, or did they say that so as not to panic the markets? And I mean, it's impossible to know.

One might say it was hopeful thinking. I think more than that, I think it was jawboning. Basically the Fed trying to convince businesses that don't raise rates because the pressures you're feeling are only transitory and they're going to come down.

And so then it'll become a self-fulfilling cycle.

Yeah, you basically try to jawbone the perception. If you step back and study the inflation cycles of the '60s, '70s, and early '80s, What happened then is inflation became ingrained in the psychology. It became, you know, prices were going up, so wage demands went up. As wages went up, then, you know, businesses had to raise prices again. It became a feedback phenomenon to where by the time you got to the late '70s, when Paul Volcker got in as chairman of the Federal Reserve, it took back-to-back recessions and a long recession, deepest recession since the 1930s, to break the back of that psychology. And that's what the Fed is afraid of today, is they don't want that psychology to get ingrained in businesses and consumers where, wow, you know, inflation is going to continue to— it's not just going to go through 2022 and be back down to 2% in 2023. I don't think the Fed is looking at that anymore. They just— at the end of last year, they projected the PCE, you know, their favorite model, would be at 2.7% inflation for 2022. And this month they raised it to 4.1%.

Pretty dramatic increase.

Pretty dramatic increase. And of course, the real number year over year right now is at 5.2%. So the Fed is still trying to jawbone the inflation expectations. And they're talking a very tough rhetoric right now about tightening faster, tightening further.

They're trying, I guess, to get the market to do some of its dirty work for it almost.

Yeah.

Then when they act, they don't have to do as much, and Mr. Market is taking care of some of it.

Well, they don't— the Federal Reserve does not want to get blamed. Yeah. You know, if they— and I think that is one of the reasons why they sat on their hands too long after the pandemic. When we came out of the pandemic and all of a sudden things were stronger and we ended up with supply chain problems because of unexpectedly strong demand, the Fed did not want to do anything like tighten interest rates early, or they would have been blamed if Wall Street went south in a fury.

Exactly.

So they basically avoided to the point at which Now they're being criticized on all fronts, including the political front, including from Washington, that the Fed needs to do more on inflation. So if they do become more aggressive in battling that inflation and it does have a significantly negative impact on the housing market and on stocks, then they're not going to get blamed for it because they're just doing their job.

Yeah, I mean, it seems like now you have politicians, some more than others, jawboning the Fed, you have the investor community throwing a temper tantrum or taper, you know, every time there's— do you think the Fed is too cowed by other powers or not?

No, I, I, I, the Fed knows what it has to do. Yeah. And, and it's not going to be a pleasant job. Right. You know, theoretically they're going to— not more than theoretically, in reality, they're going to bring rates up enough to cool off segments of the economy that ease the inflation pressures. And it takes time to do that.

Do you think they can actually do it without really severely rattling the markets? I mean, could it be seen, I mean, as they're reestablishing their credibility and then markets say, yes, this is the right thing to do? Or is it just like, no, economically it's not going to wash?

They always hope that they can. I mean, and that's what part of what we do in the research firm, going back and looking at history. In fact, we were publishing the research back in 1987 when the crash hit. And ironically, Eventually in the summer of 1987, a young, you know, semi-young economist got appointed chairman of the Federal Reserve. That was Greenspan, Alan Greenspan. And over the course of 90 days, the Fed allowed short-term interest rates to go up 1.5 percentage points. That would be the equivalent of 6 quarter-point rate hikes in 3 months. And guess what? We had Black Monday. In reality, it was a monetary pin that brought the excesses in the market down in 1987 in terms of the 1987 crash. The Fed theoretically has gotten a lot smarter since then. They've gotten far more incremental. And the big difference today over what you saw back in the '80s or '70s is the Fed is much more transparent. Now, that can be good and bad. You know, on the one hand, it's good because they don't pull any surprise moves. Back when they were doing the inflation battles in the '70s, they would hike rates between meetings. You know, they'll never do that today. But they will come out at meetings with a surprise half-point rate hike instead of a quarter. And I think that's what the market's not prepared for.

You mentioned earlier that commodities can change quickly, which is certainly true, but at the same time, commodity bull markets can run a very long time as well. I mean, they could go over a decade, historically.

Oh, they definitely can. And of course, with the Ukraine-Russia conflict today, it's a wild card on energy. You know, if you go back and look at crisis conflicts historically, they generally do not have a lasting impact on Wall Street. Now, you can go back to certain ones and say, yes, they did. Germany's invasion of France in 1940, Basically, that's what— when World War II started spreading beyond, you know, just Europe, and it ended up dragging the US into the war and stuff. And it— but we were already in a bear market at the time, and all that did was add to that bear market. A similar instance would be the '73-'74 bear market. We were already in a bear market in January of 1973 because the Fed had to start bringing interest rates up fighting inflation. But there was the Yom Kippur War in October that created the oil embargo against the US and sent oil prices through the roof. And it exacerbated that bear market and it became the biggest bear market. '73-'74 bear market became the biggest one since the 1930s. So commodity prices can exacerbate a bear market, particularly energy prices because they're so far-reaching. I don't think the price of wheat is going to be an influential factor in determining the economic outlook or Wall Street's scenario.

So when you spoke with Steve in December, I think you said you had a 12% allocation to gold or gold stocks, I believe?

It was actually gold and energy. And part of those are just defensive measures. And they've both done very well in holding up. I mean, energy has been the top-performing sector this year. And part of the reason we did that is we saw the evidence that this is a late-stage bull market. And we've gone back historically and looked at, okay, if you go back and look at bull markets from the '60s, '70s, '80s, and '90s, and which sectors hold up best at the last year of bull market, which ones are the weakest? Energy is historically the strongest, both in batting average, that is the number of times that it's better than the index, but also in the size of the gain. So that's why we were overweighting in energy. In terms of gold, we just felt it was a good inflation hedge against what was coming with the Federal Reserve.

And how do you invest in gold?

Primarily gold stocks. Gold mining stocks like American Barrick.

Okay. And what's your take on gold going forward? I mean, it's—

you know, I'm not a gold bug. I don't— I don't think it's going to go to $3,000. I think it's going to continue to be a good store of value. It's a defensive— it basically adds defensive stability to the portfolio. You know, our managed accounts have held up very, very well this year in the face of double-digit declines in the blue chips and 20% losses or more. And surprisingly, as of last week before the rally, we saw 70% of the NASDAQ stocks were over 20% off their highs, off their 12-month highs. So there's been a lot of damage out there in the market. And the buy-the-dip rallies that we're seeing, you know, can get people enthused back in the market and stuff. And you ask You asked me previously, what washes that out? Well, what washes that out is basically you have to go through several of those very tempting, alluring rallies that pulls people in. Wow, it's buy the dip. I've got to get my money back in there because I've lost quite a bit, but I need to put more money to work. And then when the market goes down, takes out that previous low, then there's a gradual demoralization, a gradual "Wow, that didn't work.

Maybe I shouldn't be buying every dip." And are we, what would you say, we're in the middle innings, let's say, of this demoralization process, or?

I think we're still in the early stages.

Still in the early?

I think you still have a lot of optimism, a lot of enthusiasm. You see it, you know, when you look at the liquidity and what it spilled over into. Real estate is the big example. The Fed took interest rates to zero, it took mortgage rates to ridiculously low levels, created the there is no risk no alternative, so put it in something, buy real estate or something. And we've also seen it spill over into cryptocurrencies and NFTs, non-fungible tokens.

It seems like a lot of the risk assets were really, seemed to peak early 2001. I'm sorry, 2021. Yeah, you see even in a lot of collectibles and alternative assets, there was just a lot of hot money really flowing.

You still see a lot of hot money bouncing around. And we saw that back in the tech bubble peak of 2002. In fact, when you go back to 2000, most indexes, in fact, all indexes had peaked by March. You know, by the time you got out to October, the S&P was rallying back to almost a new high. And yet, those small-cap, the internet index was down 50%, and the NASDAQ was falling like a rock. So you end up with this divergence, this disparity, and people still want to put money in the market, but they tend to lean a little bit more toward more defensiveness, and it's that migration that tends to support the blue-chip indexes better than the other indexes, at least for the first third or half of a protracted bear market.

Right, there's more relative safety there, relative being the keyword. We can't talk on an absolute basis, Speaking about herd behavior and psychology, I remember that in March, I believe it was March 2000, right around the peak, Barron's had a cover story on Cisco and it was a skeptical story, which they were, I think, vindicated on that. But the point, the main point here is that there were, I believe, about 30, 32 analysts at the time covering the stock. And you probably see where I'm going with this. They all, they all to a tee had a buy or strong buy or whatever language you want to—

And the forecast for Cisco's earnings were universally positive, and Cisco lost 80% by the time the market hit bottom in October of 2002. 80%.

And they were like the bluest of the blue chips at that time.

And yet it was a golden stock. It was a stock that was going to be around. And in fact, it probably would have— probably, in fact, it was one of the best potential buys at that bear market bottom. When a bear market does take hold and becomes protracted, then it tends to permeate all facets and even take the good stocks down. It just doesn't take them down as much as the other stocks. And that's why I think this year is going to be a year that risk management stands out.

Bottom line, where you stand, so you like gold, you like cash, you like energy.

Well, yeah, well, we basically at the time did that interview in December, we were close to 80% invested.

Right, I think this is 75 or whatever.

Yeah, 78% is what it was. And he asked, doesn't that seem high? And the reason it wasn't too high for us is because we had part of this allocation, 12%, toward energy and gold stocks. And so we knew our relative risk in the market was smaller. And we're also holding individual equities. Now, some of those, they've been holding up very good. And there are core holdings out there that I think are still good holdings.

What sectors, if you don't want to name them, what sectors do they tend to be in?

Well, they tend to be in healthcare. UnitedHealth Group is one company that we're holding, and the stock's doing remarkably well. Consumer staples, Coca-Cola is a staple, believe it or not, and the company is paying close to 3% dividend yield. We're holding in our clients' accounts and it's holding near highs. We tend to avoid the cyclicals, those that can be higher risk in a bear market, but I think the more important today is you have to look at the individual companies and say, can this company weather rising interest rates and can it weather the volatility in the energy prices? One of the stocks that we have in our portfolio that's holding up very well is UPS. You think, wow, UPS with energy prices? Well, what's unique about UPS is they can pass along those energy costs much better than many of the other companies can. So you have to be selective on a stock-by-stock basis, but on an industry basis, I think the healthcare staples might be boring, but they're still a little bit more stability.

They have defensive attributes.

Yeah, yeah, yeah.

Okay.

And the materials, I still think that, you know, with, with the pressures that we're seeing in the economy, the materials industrials are still okay to be holding in. In terms of the financials, it's very split sector. Those that can benefit from rising interest rates versus those that might have exposure to the real estate. This is one of those areas where I would steer away from any sectors or stocks that have a high exposure to real estate because, as I said, I think that's the Achilles heel, and I think we're going to see a big shock in some of the housing statistics coming out over the next 3 months.

And to what extent— I know REITs can own any number of things. Are you— I guess you probably lean negative on REITs on balance, or?

Yeah, I would lean on balance. And again, it goes back to the housing bubble that peaked in the summer of 2005. At that time, we developed a housing bellwether barometer. And actually, we call it a housing, quote, bubble, quote, bellwether barometer. It monitored leading home building and mortgage companies. And 2 years ago, about 18 months ago, we reintroduced that index because of what was going on in the housing market. We said, okay, this housing bellwether index is going to tell us if housing is heading toward a bust. And it hit a very dynamic peak in the latter half of last year. And right now it's come down, it's broken through its first support level, but we're starting to see We're starting to see a lot of weakness in homebuilding stocks in spite of, you know, strong earnings, good valuations. But what's happening is the market is looking ahead at what's coming down the pipeline in terms of monetary policy and what we've already seen in mortgage rates and saying, you know, housing is going to be one of those high-risk areas as we go through this year.

Right. I mean, I think there was— if you go you look forward longer, let's say perhaps 5, 10 years, there is a larger trend of a lot of millennials/next gen who may be going out and buying homes. So that's true. However, you're right, it's like a scale. You have to weigh that against the headwinds and whatnot.

Yeah, it's interesting because we have a very bright analyst on board in our research, and he brought a chart out. He said, you know, I haven't seen this before, but it's the number of homes and units under construction. And we're at one of the highest levels in, in history. In other words, there's a lot of inventory under construction that's going to be coming on the market over the next 6 to 9 months, possibly at the same time that we're seeing a slowdown. We've already seen a slowdown in existing sales. So all of a sudden that, that whole inventory shortage that has driven the psychology up to this point could change course fairly quickly. Wow.

All right, well, I have two final questions, if I may ask, before we wrap up. So the first is a Barron's tradition for asking for an actionable idea, whatever that might be.

The actionable idea I would have for investors is this: I think a lot of investors in the market, particularly younger or new investors, treat the market as if, you know, it's the last train out of the station. If I have money, I need to put it to work right now. And what I've learned historically, my indoctrination came in '73-'74, biggest bear market since the 1930s. And I learned a big lesson in humility and that bear markets can be very big. So what I would do is treat this year, the next 12 to 18 months, differently than you have the last 12 years. Steer a more defensive course. There's always another train out of the station, meaning there's always another investment opportunity. And I think that as we get into 2023, I think we're going to see perhaps one of the better or best buying opportunities that we've seen in over a decade.

Okay. Now that what you're preaching, the patience, that often makes me think of Warren Buffett talking about waiting for the with waiting for your pitch. There's no one forcing you. I know so many people feel they have to be fully invested, right? It is bothering them seeing cash there. So they're like, put it to work into something. So that definitely is an interesting point. Now, I just want to reconcile this though with what many, if not most advisors will, I think, say. They'll say, look, I plan inflation, disinflation. I have a long-term plan. We don't respond to the vicissitudes of the market. We don't zig, we don't zag, we don't react to headlines. At the same time, they obviously don't want to be caught flat-footed, right? And so, you know, realistically speaking, how could many advisors maybe reconcile that or pivot or do without totally telling a client, hey, we're going to— never mind what I said, we're going to do something drastic. But at the same time where they might say, I really do want to tangibly do something.

Let me split this into advice for younger versus those people who might be 40 or 50 and have an established portfolio. If you're young, dollar cost averaging works. Just realize what you're putting in the market today could be worth less or possibly significantly less 6 or 12 months from now before we hit what might be a great buying opportunity. That's— dollar cost averaging works. Maintain the discipline and do it. The problem is once you have an established portfolio, You know, the whole thing in bear markets is not to time the market, it's not to bail out, it's not to sell the market short, it's to minimize the risk, manage the risk. If you can go through a bear market and the major— that the speculative indexes or the NASDAQ drops 40% and S&P drops 35% and you only lose 20%, you only need 25% gain to get back to even. If you go through a bear market like the last one, 2007 to 2009, where the S&P lost 58%—

You need to more than double your money.

Well, then you have to more than double your money to get back to even. And our objective, and we do this in the money management, and that's what we're noted for on the research end, is, you know, to reduce the risk of the bear markets. You can't eliminate it.

Let's say you're given a choice to sell a value fund or like the NASDAQ growth? Now it would seem you would say NASDAQ, given that it's presumably riskier, more expensive, but NASDAQ's already come, tech stocks already come down so much. Value stocks have held up better. Couldn't one argue that the damage has already, I mean, I'm just wondering, or you would still say, look, tech's gotten throttled already, but you know what, even in a further downdraft, it'll likely suffer more. So just get rid of that.

Well, as we're talking right now, the NASDAQ's had a pretty good bounce over the last 5, 6 days.

Right, well, that's the thing. The market toggles between risk-on and risk-off days and you see You see that when the risk-on days, the Dow and value stocks struggle. They go up, but not nearly as much as the risk-on tech stocks.

Well, when we're managing risk and we do it incrementally, we don't do stampeding, you know, we're under a net 60% invested today. That's not an extreme cash position, but it is very defensive considering the type of stocks we're holding. And if I were to continue to lighten up, I would still lighten up on what I consider the highest-risk stocks. How do you tell the highest-risk stocks? Look at their PE compared to their median PE of the last 10 years. Or if you're looking at ETFs, look at their Morningstar rating in terms of how they perform in down markets and stuff. I would still— the best thing in a bear market, what might turn into a more protracted bear market like what we have today is, you know, reduce the risk. You know, basically all you're trying to do is mitigate the risk in your portfolio. So if the market falls another 20%, your portfolio falls less than 10%. It makes it much easier having that cash on the sidelines when you can bring it to the table when stocks are on truly that bargain sale that Warren Buffett talks about.

Yeah, it's interesting because what you just described is really, in a way, what figuratively speaking the market has been screaming at investors. It's been, it's been repricing risk. That's what it's been doing, right? All this stuff that all these high flyers, even great companies like Twilio, doesn't matter, they're very solid companies, but the valuations got so out of whack with more price-to-sales and whatever, and then the market just said, now we're just gonna reevaluate reprice it. And after a decade, people are— it took a long time for that message to sink in.

Yeah, you might think of it as a normalization. And what we're in is perhaps the great normalization. You know, when the Fed dropped rates to zero, it took valuations where we hadn't seen them before in many factors, and particularly in real estate. Real estate prices today are higher above the long-term, you know, growth trend than they were at the peak of the tech bubble in 2005. And that makes real estate a particularly high-risk investment, particularly in the stocks and the home builders and the mortgage finance companies and stuff. But as the Fed brings up interest rates, we're going to see a normalization of those values. And we're going to see price-to-earnings, price-to-sales ratios come down closer to long-term historic norms.

Do you have any predictions for indexes? Like, are you so bold as to make a call on the Dow or S&P 500? If not, I totally get it.

It's funny. I used to do a lot of media back in the '80s on television and stuff. And they'd always ask, you know, okay, what's the high, low, close for the Dow going to be this year? And, you know, I never got it right. You know, no one did. But I think the Again, I'm going to go back to the year of surprises. And I think that indexes will close this year lower than they started this year and lower than they are today. Because I think this battle the Fed is heading into is going to be— it's going to be a tough one. And it's going to require some half-point rate hikes. And all of a sudden you start getting to where investors can start earning 2.5% or even 3%. On their cash reserves and they're looking at what's happening in their stock portfolio and going, "Wow, this is starting to hurt. I think I want to move a little more to cash." You end up with that kind of a self-fulfilling downward phenomenon in a bear market. But as far as forecasting the downside level, I wouldn't put a number on it, but I would say that we will see the S&P in— it's not going to be probably a small bear market for the NASDAQ. In other words, it's not going to be a 20% loss. So it's one where I would definitely focus on safety first, focus on implementing defenses, and remember that there is going to be another great buying opportunity down the road after the Fed gets through this battle.

Excellent. Well, this was an outstanding conversation. I genuinely appreciated it. Thank you so much for for joining and spending all this time with me.

Thank you. It's my pleasure.

Thank you.

Thank you so much.

My guest has been Jim Stack. For more advisor-specific podcasts, please check out barons.com/podcast. For The Way Forward, I'm Greg Bartolis.

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