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Advisors, Markets in Focus at Confab

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Some 2,000 advisors and other financial professionals gathered recently in Hollywood, Florida (during the East Coast blizzard), to debate what business and investment strategies make most sense in early 2016. The four-day Inside ETFs 2016 conference featured talks from Vanguard Chairman Bill McNabb, DoubleLine Capital CEO Jeffrey Gundlach, Betterment CEO Jon Stein, Wharton professor Jeremy Siegel and Charles Schwab Chief Investment Strategist Liz Ann Sonders.

The Vanguard chairman and CEO described the world of financial advice as a field that “is evolving” and “is driven by changing demographics, technology and a more powerful consumer.” While it is a time of rapid change, today’s market also includes “a tremendous opportunity” for advisors, he said.

The five critical considerations for advisors, which he highlighted, are as follows:

  • We are in a low-cost revolution. Investors now want to pay less for investments, as robo offerings create a new pricing floor. Thus, traditional advisory firms have to provide caring in-person, individualized services that robo-advisors cannot offer clients, he argues.

  • Advisors must adapt to a changing industry. In the past advisors won clients with good stock-picking abilities. Since technology can now do much of the portfolio-building work today, advisors should further automate routine elements of their practice, meaning they should digitize and mobilize some of the client experience, McNabb suggests.

  • In some ways, the world is not as complex. As portfolio construction has become commoditized, advisors cannot use this as a point of differentiation.

  • In other ways, the world is not as simple. Some clients entering retirement are looking for very broad advice on topics such as Social Security and long-term care; the demand for such advice is great. In addition, the questions faced by such clients “are increasingly complex,” he says. “Rules of thumb and single-product solutions rarely provide a complete answer.”

  • Advisors must tell their story. To differentiate themselves, advisors must explain their value proposition, McNabb explains: “Perhaps this will be No. 1 going forward … the advisors who will be most successful will be those who can absolutely tell their story in the most effective ways.”

This builds on Vanguard’s profile of the most successful advisors “who can add significantly to what clients experience; we call it ‘advisor alpha.’” Advisor alpha means that registered reps have to “be a great behavioral coach, help clients at being tax efficient and keep investment costs low, i.e., by thinking of [costs] as a percentage of returns,” McNabb explains.

Robo Advising

Betterment’s Stein tried to warm the audience to the world of robo-advising. “There is a sense of competition between robo and human advisors,” said the New York-based entrepreneur. “I think that is a false competition.”

“By 2020, Betterment Institutional will be ‘the full-service hub’ for a new kind of advisor,” he explained. It plans to bring on advisors who want automated tasks like tax-loss harvesting and rebalancing in a paperless system, at a cost of roughly 25 basis points. “The cost of trading has gone to zero, and the cost of diversification is essentially free,” he added.

This means, for advisors, that the business they need to build is “totally different than that of 10 to15 years ago,” Stein states. “Advice is more important than ever, both robo and human, but the tools are different. We are a great do-it-yourself option.”

Clients who bring assets to Betterment “are coming to us from self-directed [platforms] and almost never from advisors,” he explains.

While many advisors work with clients that have $2 million or more of assets to invest, “We see our core clients as one with a household at under $2 million,” the Betterment executive said.

As for advisors, the platform — which includes ETF-based portfolios for clients to choose from after completing a questionnaire — frees their time up “so you can work more on financial planning, estate planning … and all the things we do not do,” he states.

Fed Policy

DoubleLine’s Gundlach focused on the Federal Reserve and the state of the economy in his talk. “I’ve said earlier that the aftermath of Fed policies [to raise rates] is going to come back to haunt us, and we see this is happening [now].”

Describing the latest GDP data that shows the U.S. growing 2.2% per year and Europe expanding 1.6%, Gundlach asked, “Why is the U.S. raising rates when the European Central Bank is cutting them? The difference is pathetic, almost nonexistent.”

“The bond market says that inflation is falling over the long-term horizon,” the DoubleLine executive said. “The [only] inflation we do have is all in shelter,” he added.

The World Bank’s latest estimates for global GDP growth in 2016 are 2.9%, down from an earlier 3.3%, “and the World Bank is not known for pessimism,” he said. Meanwhile, the Atlanta Fed’s GDP Now indicator “is now at almost zero,” said the fixed-income specialist. “Every year we get an optimistic 3%, but it never happens.”

“I am leery of arguments that say we should ignore the bad stuff. The service economy is also falling, and if it goes down a couple points further, we could be in a recession.” He sees much more weakness in junk bonds. In fact, Gundlach says issuance in this group “is going to collapse … and that means 1% of GDP will disappear.”

Emerging markets are poised to drop another 40%, he argues. “The correlation between commodities and the emerging market ETF is quite high.” He advises investors to short these equities. “It’s horrific, and there is room for them to go down,” Gundlach said.

“The bond market is not expected to tank,” he explained, “but watch the five-year yield. It has been very range-bound since 2013. When it breaks out, there will be massive consolidation.”

Bullish Views

“Am I the last bull standing?” Siegel asked the crowd. “There is no reason to apply the bubble label” to today’s equity market. There is no reason to say the Fed is artificially inflating value. If that was true, we would see a 25-plus PE ratio,” he said.

“Everyone fears the Fed and [multiple] hikes,” he explained. “[But] the market is indicating that only about one-third of the hikes the Fed has described as a possibility are likely to happen.”

Siegel predicted that the Fed “is basically going to be on hold.” Conditions then could become “really normalized,” he says. “That is going to be really good for earnings and for the market.”

Still, he admits that today’s returns are lower. “We will see 5% returns” for a while, Siegel said. “How many investors would love to have that? They’ll take five, they’ll take four, and they’ll take three!”

Siegel stressed, “We are going to see lower returns going forward. We are entering a period of lower returns for stocks, bonds and other asset classes.” Equity returns from 2000 to 2015 were only 2.6%, though globally they were 4.5%, he notes. “Valuation globally is key.”

The median price-to-earnings ratio of the past 60 years is about 16.8; it peaked at 30 during the tech boom in 2000. “Yes, we are a little bit above [this median], but not much. With low interest rates [historically], the average PE has been 19, and we are not there presently.”

Looking at a long-term horizon, “The secular bull market isn’t dead,” said Schwab’s Sonders. “But we have to expect more bouts of volatility. In the bull market from 1982 to 2000, there was the crash of ’97,” she said.

Sonders went on to explain Schwab’s belief that while in the longer term we are in a secular bull market, “If [the current market] correction gets worse, it would be more likely be a non-recession ‘bear’ than a full-blown recession bear.”

There have been seven non-recession bear markets since 1968, and they lasted an average of about 200 days. In the most-recent such market in 2011, the drop was 17%. In addition, she said, “The volatility and correction we are seeing are not so outside the norm when the Federal Reserve moves into a rate-hike cycle.”

Nonetheless, these are not easy times for advisors and their investor clients. “It’s the hardest time since 1937 to make money … with no major double-digit-performing asset class” in sight, Sonders stated. “It’s a time of central bank divergences and heightened correlations.”

While the manufacturing and service sectors of the U.S. economy are weakening, there is bifurcation in the decline. “Will manufacturing weakness pull down services? We say no.”

The trends she tracks point to a stable S&P 500, “with no signs of an imminent risk of recession,” Sonders stated. “The Fed assumption is for four increases this year. I see the chance of that happening as close to nil.”


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