Bob Doll: What Advisors Should Say to Clients in 'Crazy Volatility Season'

“So that means advisors need to calm their clients down. They need to be calm themselves,” the CIO said. If somebody calls and said, ‘The market's down, should we sell everything?’ The question should be, ‘Where were you a few weeks ago when the market was much higher than it is today?’ That's the time to sell. Now you're going to do your shopping list to say, ‘Do we have cash on the sidelines earmarked for the stock market? And if so, what are we going to buy?’”

Doll noted the role psychology plays in the market. “The fundamentals are important, the valuation and the earnings … but big tops are made when everybody's rushing in and big bottoms are made when everybody's plowing out exactly at the wrong time. And if you can lean against the wind a little bit, you can make a couple of bucks.”

Doll answered questions about the advice that advisors should be providing their clients now. This Q&A has been edited for clarity.

THINKADVISOR: Are there changes that “stay the course” advisors and clients should make in these rocky markets?

BOB DOLL: If we had this conversation two months ago, before the big downdraft, I would've probably said the same thing. And that is, I see way too many portfolios of Americans, individuals and institutions — I'm going to exaggerate to make the point — they're all in large-cap growth stocks. They have very little value in their portfolio and certainly have very little international.

So if you read our predictions this year, if you looked at some of our commentary, we've been arguing, get a little more balance in your portfolio, have some value, have some international … At the edge, if you're 2% international, think about going to four, maybe six. You don't have to be a hero. …

Value is down 4% so far this year and growth's down 12. So if you're way overweight growth, buy a few value stocks to complement, and the international thing fits as well.

Second thing I would say, and I'm trying to do this as a large-cap U.S. portfolio manager, because the future is more uncertain than usual … I want to take a lot of care in the companies that I own, meaning I want to focus on companies that have strong free cash flow profiles, preferably growing, and also companies with high profitability.

So when I look at my portfolio, the first place I look is, what is that price-to-free cash flow compared to my benchmark, which is the Russell 1000? And what is the return on equity as a measure of profitability relative to that benchmark? Now, if I can own cheaper stocks on cash flow with a higher rate of profitability, that doesn’t guarantee I'm going to outperform, but it does create some wind [at] my back.

Do you have preferences in international stocks? Emerging markets? Europe?

I am more emphatic about having some international than I am, ‘You've gotta own this area and not that area,’ but I'll make a few comments.

The U.S. was priced for perfection. Europe is priced for not many things going right. It's much cheaper. ... The U.S. has so underperformed Europe now for six months, I'd wait for a little movement in the other direction, but that's fine tuning it. If you have nothing, you still should have something, so some Europe makes sense.

Japan's slowly getting its act together. I'm still nervous about China's problems. The Pacific Rim countries that serve India, and secondarily China I think is an interesting place to be. And then there are parts of Latin America — Brazil, for example. So I suggest to most people just pick an international or global fund and think about owning it as opposed to spending a lot of time trying to cherry pick which stocks.

What should advisors say to their clients about rebalancing?

Rebalancing should take place on a regular basis. A little commercial for Crossmark, where we have balanced portfolios: We don't balance them on a time basis, we balance them on a return basis. So for example, if you're in one of our balanced products — let's say it’s 50 stocks, 50 bonds — when it gets 10% outta whack, which a lot of our products have because bonds have done so well and equity so poorly, it's forced to rebalance.

So I prefer rebalancing on that kind of period rather than just the calendar. But the calendar can work too. Anybody who's had a target asset allocation, if they haven't rebalanced in the last couple of months, they're going to, by definition, have more bonds than they want and fewer stocks than they want, calling for some rebalancing.

What recommendations are you making with regard to bonds?

One of our predictions is that the benchmark 10-year Treasury would trade this year between four and 5% yield. So a few days ago we got down briefly to 380 (3.8%) and we said, ‘Lighten up on your bonds. Bonds are expensive. Now, you know, fast forward, I'm looking at my screen, we're at 4.39, we're more indifferent at this price.

You get another big rally and yields go back down, we'll trim some more. Conversely, we were 450-something not that long ago. We start getting over 450 (4.5%) and we're a little more interested in buying some bonds. So we're very more reactive to what the yield is.

In terms of quality, we prefer higher quality, believing the economy is going to slow noticeably, and credit spreads, which until the last week or 10 days have been pretty tight, they're starting to spread out a bit. So we've preferred quality. So generally Treasurys over corporates and corporates over high yield.

What’s your position on equal-weight versus cap-weight stock indexes?

If you look at the Magnificent Seven versus the 493 (other S&P 500 companies), earnings for the mega-cap stocks are expected to slow from a very fast pace. And earnings for the average company are projected to do a little bit better on a relative basis.

That's, I think, the reason why equal has outperformed cap and I suspect we're going to see more of it, probably not to the degree we saw in the fourth and first quarters, but nevertheless, I think we're in a period here where equal weight's going to beat cap weight.

Most active managers tend to approximate equal weight more than the cap-weighted benchmarks. So it's no surprise that in the first quarter of this year, more than 60% of managers beat their benchmark because benchmarks are a little easier to beat when equal beats cap. … Because index funds have done so well over the last decade, if (clients are) heavy in index funds, I would trim some of that and find some active product.

What would you recommend advisors say to their clients about gold? Alternatives?

We are concerned that inflation's going to remain sticky. That's an environment where gold tends to do reasonably well. So I would have a little gold in my portfolio. You almost hope that if gold doesn't do well, the rest of your portfolio does. It tends over the long term to have negative correlations. Having a little gold makes sense.

Alternatives, I say in general, yes, although, as you know, alternatives are a bunch of products. There's not an asset class, so there's no target percentage. Some alternative products increase your potential returns. Some just mitigate risk. And so you have to know in particular what you're owning.

I think many advisors five years from now, will be kicking themselves that they didn't have more alternatives in their client's portfolios. Because I think the traditional asset class returns are going to be pretty mediocre compared to what we've enjoyed. So whether it's long-short equity funds or other vehicles that fit the alternative bill, I think that makes sense.

I'm a bit cautious about private credit because a lot of the lending that took place this business cycle has happened outside the banking system, i.e. in private credit. I'm not saying don't own private credit, but I am saying if you do, know your credit, know your credit, know your credit.

What about private equity?

Private equity, somewhere in between. There's so much money that's gone into private equity. … A lot of private equity managers are struggling to figure out where to put the money because it's been picked over. So you can have some private equity, but I like public equity.

ALM: Illustration: Chris Nicholls/ALM; Photo: Bloomberg