Transcript:
Caroline Woods
Joining me now is Brent Schutte, chief investment officer of Northwestern Mutual Wealth Management. Brant, great to have you here.
Brent Schutte
Thanks for having me here on.
Caroline Woods
All right. So let’s kick things off by talking about your view on the market. Is this a healthy market or is this a market that’s more fragile than it appears?
Brent Schutte
I think it’s getting a bit fragile. If you look at how many stocks are actually outperforming the index, it’s dramatically shrunk. So over the early part of the year you did have a broadening of we’ve been talking about looking for. So you had more sectors, more parts of the economy doing well or more parts of the market doing well.
Brent Schutte
The past few weeks, as rates has risen, the market has become incredibly narrow, which to me means that there are worries that are out there and it’s really being driven by just a few names in the S&P 500, which I think points to increased fragility, especially as interest rates rise. I think that begs the question of where do we go next?
Caroline Woods
So if I own an S&P 500 index fund, am I too concentrated at this point?
Brent Schutte
Absolutely. So the big message that I’ve had, and this is where you’ll hear me repeat this over and over and over again. Having done this for 33 years, this is the second most concentrated market that I’ve seen in my history. Our guests, it’s probably the most concentrated. There was one of the ones in the late 1990s. And that doesn’t mean it has to follow the path the late 1990s, but I think it informs how you think about risk.
Brent Schutte
And so right now, if you’re on the S&P 500, about ten names that are all kind of concentrated in the same theme, control about 40% of what happens to you going forward. And that’s where I encourage people to look outside of those names, to think about opportunities longer term, and things like small and mid-cap stocks, which certainly are and can be under pressure from rising rates.
Brent Schutte
But I think expectations here are still pretty low. And if you look at valuations, that confirms that, which usually is the set up for people who think more about long term investing to reap those returns. And that’s where I encourage people to kind of continue to think about a broader lens as they think about the market, and not just fixate so much on what’s happening in the S&P 500, because I do think that is where concentration risks are.
Brent Schutte
And I should also add that other parts of the world also have those concentration risk. And so this is where I think rather than just thinking about broader indexes, you need to look beneath the surface and see what actually is driving those indexes. And that’s where things like emerging markets are also concentrated in AI type stocks. And so yes, Caroline, back to your question.
Brent Schutte
The market is pretty concentrated right now. And that’s where I encourage people to think about diversification more holistically than they have in the past.
Caroline Woods
And not just diversifying outside of the US, it sounds like. So what should I be doing about it if I’m too concentrated right now, where should I be adding exposure outside of the biggest stocks in the S&P 500?
Brent Schutte
I mean, there are things you can do. Like you can actually just equate the S&P 500. So there’s an equal weight index that we use that removes some of those concentration risk. I want people to think about the AI risk that is inherent across the board. And so in our portfolios we measure for how much exposure we have to the scene.
Brent Schutte
I want people to have exposure to that, but not so much exposure that if I does, pull back just a bit, which is certainly a risk, that’s where I don’t want their entire financial life to be ruined by that pullback. And I risk kind of like back in the 1990s, if you concentrated just on the Nasdaq or the S&P 500.
Brent Schutte
That is where in the 2000 you had a bad experience. So say for example, you decided to buy all tech stocks in 2000. It took you 17 years to make a new high on the S&P tech sector. This is where I think people need to be cognizant of that, not be fearful of it, but make sure that you add parts of other markets to that exposure.
Brent Schutte
So we like small caps. We like mid caps. We’ve added reach recently because they do have a lower correlation to I and we do believe that if the fed were to let inflation out of the box or continue to let out of the box, those reach now would actually have pricing power. And so this is where we’re paying a lot of attention to what’s happening beneath the surface.
Brent Schutte
And I think diversification today is more important. It’s actually harder to find, just given how much AI is inherent across the economy and in stock markets.
Caroline Woods
So if I’m sitting on some pretty hefty gains and I and the magic seven, I should be taking profits here.
Brent Schutte
I wouldn’t let taxes, drive everything that you think about. So certainly taxes are important. But I think diversification is more important. And this is where I would continue to move out of some of those names into other parts of the market. It is not a common trend that these parts of the market are not great stocks.
Brent Schutte
It’s just that they may not be are not great companies. It’s just not they may not be great stocks and that you are taking excess risk if you actually just concentrate in those parts. Because historically, you know, asset classes don’t die. But some stocks do and some companies do. And that’s where I would make sure that I have that diversification that I’m talking about.
Caroline Woods
But if I’m a believer and I and I want to make sure I don’t miss out on any pieces of that pie, where should I be investing? Are there sectors or beneficiaries of AI that I should be investing in instead of some of those winners?
Brent Schutte
That’s where I have really good news with your fear of missing out. Eventually, AI has to spread throughout the economy and become a benefit to the companies that use it. And so this is what I think about when I think about the late 1990s, where you had the picks and shovels and the people putting the internet into place.
Brent Schutte
That was where you saw the initial benefit over the next 4 or 5, 6 or 7 years into the early 2000. That is where the benefits of the internet reach the companies who used it to increase their, you know, sales, increase their profitability. And that’s where I think you’ll have a very similar type of experience in AI.
Brent Schutte
If I is to become what people expect it to become, it has to benefit the companies that use it. And this is where I think smaller cap companies will benefit a lot from it. This is where I think mid-cap companies will benefit a lot from it. This is where I think the US economy will benefit a lot from it.
Brent Schutte
And so I think you’re continuing to see that value creation spread. We started out in chipmakers and hyperscalers, and then we got to memory, stocks where the bottlenecks were. I think eventually you’ll get up to where, you know, encompassing the entirety or morsel of the economy. And that’s where you’ve seen it move into the financials, sector, where they’re using it to increase their profitability.
Brent Schutte
And I suspect that will continue. So don’t chase. Stay broadly diversified. And the good news is you will pick up the benefits of I just with less risk of trying to concentrate and figure out exactly where it goes next. That’s where I think, a diversified strategy still benefits from I.
Caroline Woods
In a diversified strategy. And I know that this is dependent on the actual person, but what portion of a portfolio should still be allocated to the S&P 500 and some of those big tech winners?
Brent Schutte
It’s still a majority of your, your portfolio, because of the risk return characteristics. But it doesn’t need to be the entirety. And that’s where I suggest having international, us on that. You know, I think one thing we haven’t talked about yet is just the diversification from fixed income, which I think a lot of people are running from.
Brent Schutte
You know, it’s ironic for running from a now we’re really yields on fixed income are back to where they were in 2002, 2003, maybe 2006. This is where if inflation does get put back in the box, this is where bond yields ten year treasuries at 5.1% offer good value for people looking for return going forward. And this is where I would encourage people to think about that side of the distribution, as well as owning something which I know is incredibly unpopular.
Brent Schutte
You know, 4 or 5, six years ago, we have owned commodities throughout this because it does hedge against unexpected inflation. And that has been a big win in our portfolios for the past 4 or 5 years. And I want to continue to own those things also because I do fear and I don’t think we know what happens to inflation going forward.
Brent Schutte
I think the question is still out about what the fed actually does and how does inflation proceed for near.
Caroline Woods
It will get to commodities in just a second. But you’re telling me I should move my tech profits into bonds and if so, where specifically? Or is that money that’s sitting in cash or money market fund.
Brent Schutte
No, I mean, I think it depends upon what your personal situation is. We have a whole army of financial advisors who are tasked with going out and helping clients create a financial plan, which shows how much risk they should be taking to achieve their goals over the next five, ten, 15, 20 years. And this is where I fear a lot of people have deviated from that because they are looking for those stock market gains.
Brent Schutte
And they’re really, heavy on equities right now. And they’re reluctant to trim back because they have, capital gains. So they don’t want to, take. This is where I’m encouraging people to think about that asset allocation and making sure that you’re true to that asset allocation and that it is diversified. So it is not an either or.
Brent Schutte
It’s more of a commentary on what is right for you and your personal situation, which is the most important thing that you could probably focus on from a standpoint of actual investing?
Caroline Woods
Can you be more specific about where you’re seeing opportunities in fixed income now?
Brent Schutte
Higher quality fixed income, particularly investment grade that is higher quality rated. This is where I think going forward it provides some competition for equity markets. If you look at a ten year, you know, a rated or triple B rated, which is investment grade, corporate yields around 6%. Think about that in the context of the S&P 500, which is historically somewhat elevated from a, valuation perspective.
Brent Schutte
And that’s where bonds now offer a competitive return. Obviously, assuming that inflation does pull back, which I can hedge to the side of that through commodities and things. This is where I think, you know, bonds do provide competitive returns going forward to equities. And for all the talk about a balanced portfolio being dead, this is where I think for the first time in some time, fixed income actually offers some sort of return profile going forward.
Brent Schutte
If you think about, you know, from 2008 to 2022, all the lifting in a 6040 portfolio was done by the equity side, and bonds basically provided little, I think going forward is more of a balanced, equation with regards to returns.
Caroline Woods
Okay. So if I’m an everyday retail investor and I say, okay, I want to add high quality fixed income to my portfolio, how do I do it?
Brent Schutte
There are certainly ETFs. The Bloomberg aggregate is an ETF. There’s an ETF for the aggregate index which includes corporates. That includes treasuries. Is basically all the investment grade fixed income in the United States. That is the broadest index that you can add. And I believe it yields somewhere in the fives right now. And so that’s, you know, historically, back to where we were prior to the last 15, 16, 17 years, which were abnormal.
Brent Schutte
This is back to somewhat levels of normality. And if you think about inflation and you believe it to run 2 to 3%, over the next few years, you actually have a 2 to 3% real return, which I think is compelling and attractive in today’s environment.
Caroline Woods
Okay. And let’s go back to commodities, because you said now might be a good time to start adding commodities to your portfolio. How do we do that and where specifically.
Brent Schutte
I would think about phasing in. I mean, this is where the risk are. The cure for higher commodity prices is higher commodity prices. And historically, when commodity prices rise like they have, there is an inflation that goes along with that. And the fed oftentimes acts to pull that inflation back, which is a fancy way of saying commodities have rallied a lot here, just like the cure for higher oil prices, which is a commodity, is higher oil prices, just like the cure for higher interest rates is higher interest rates.
Brent Schutte
This is where I wouldn’t add it all at once. I would certainly phase in, but I think going forward, you need to think about the reality that inflation is a risk to your portfolio. So if you think about portfolio construction and back to my diversification comments, if you were investing from 2007 to 2022, the only risk that you really needed to hedge was the risk of less, which meant that you wanted to own longer bonds even though they didn’t yield much because that was the risk that was out there.
Brent Schutte
The other side of the equation, the inflation risk, wasn’t there. Today, I think as you look forward, that inflation risk is there, which makes commodities more important to longer term portfolio construction. But in this year and now, I would certainly take my time, I think more about real estate investment trust rates being more of an inflation hedge these days.
Brent Schutte
And so certainly I would look at those right now just because we haven’t built a lot of new, supply in the market just because of, cost, because of, of, supply demand imbalances. Now, I think those real estate investment trusts actually have pricing power going forward. And this is where I think about adding those. And last but not least, you can also add tips Treasury inflation protection securities, which there are ETFs that give you that type of exposure to your fixed income.
Caroline Woods
So there’s basically an ETF for all of your recommendations. At this point I do want to ask about other sectors within the US equity markets though, because you obviously mentioned small and mid-cap. But what about financials health care. Obviously you mentioned commodities. So I guess energy and real estate would be with REITs. But materials industrials, utilities. Do you want exposure staples discretionary.
Caroline Woods
Do you want exposure to any of those areas in particular.
Brent Schutte
Yeah I mean I certainly want exposure to those. And I think, you know, right now, being a little bit more defensive is probably not a bad idea. From the standpoint of some of those sectors that you mentioned before, staples, health care, I think so, some of those sectors, I just think the thing that I worry about the most is people chasing a trend, chasing momentum, which has worked until this year, and concentrating on technology stocks and waking up one day and it’s, you know, 2001, and you’re looking forward at a few years of underperformance, just given the fact that you’ve concentrated your portfolio, if your audience
Brent Schutte
is retail investors. This is where my job is to get people from point A to point B to point C. The way that you do that is by not having those large, large drawdowns that can really, hamper your financial future. And so making sure that you don’t wake up concentrated, in the Nasdaq. And not that it has to play out exactly like it did back then, but the Nasdaq fell by 80% from December of 2000, from 2000, 2000 to 2003.
Brent Schutte
And that’s where I want people to remain broadly diversified across the US economy as the benefits of ie spread out, and as the economy continues to broaden in the future.
Caroline Woods
Okay. So it’s time to play defense. What would you need to see to start playing more offense, to start getting more aggressive.
Brent Schutte
So I want to balance that commentary against longer term investing, which keeps me interested in those a more small and mid-cap sectors. Those are areas of the market have not done as well for the past two years. They traded significant discounts to large cap. And that is a very imperfect timing tool. But that does dictate who wins longer term.
Brent Schutte
So this is where I think about having a little bit in each bucket. So on the near term, I think, you know, making sure that you’re a little bit more, diversified, perhaps a little bit more towards your overall equity allocation where you should be, but not ignoring the fact that longer term there are opportunities and that you can’t time that.
Brent Schutte
And so I wanted to have exposure to those small mid-cap areas that I would look to potentially add to, in the future, if you did see rates pulling back, or the economy continuing to kind of broaden out, which we have seen, I think the risk now is that rates, increasing, pulls that back. But this is where, you know, I think, if you see rates coming back down, if you see inflation coming back down, those are good signals going forward.
Brent Schutte
But right now the fed is raising rates with a big question of how many times do they actually have to hike. And this is where we’ve been persistently calling for a reality for the past few years that post-Covid inflation would come down, but the last mile would be a lot harder. The market imagined and at least historically, the only way the fed has gotten inflation back down to target is through some sort of economic slowdown, which could be on the horizon in the future of the fed, has to hike rates much more than what is currently anticipated.
Caroline Woods
Okay. So as you think about this being a fragile market, how do you think that plays out over the next few months, especially as we think about kicking off Q4? Is this a market that you think is ultimately heading lower?
Brent Schutte
I think the market has some headwinds that probably keep it more range bound. It has some tailwinds, too. I mean, I think earnings are still a tailwind. I don’t think rates have been high enough for long enough yet. The new increase that it actually dramatically pulls back, overall economic growth. But I think there are certainly headwinds.
Brent Schutte
We have this discussion about AI safety. What we pull back AI spending. We have this question about whether the fed will actually have to hike more, which I think, unfortunately, they might have to hype more than the 3 or 4 times that markets expect, which do bring, some headwinds in the future. So this is where I think there’s kind of this delicate balance.
Brent Schutte
So I’ve talked about the three B’s in my research. We had a bifurcated economy post the rate hikes of 2022 2023. We didn’t get the overall recession, but we did get that bifurcation. It started to broaden this year because we had cut rates last year and we had fiscal stimulus pile on, and I think we’re still in that delicate balance where there are a lot of questions going forward.
Brent Schutte
And that’s where I’m kind of mentioning these, staying diversified, making sure that you have exposure to different markets because I think it’s incredibly hard to now kind of think about what happens going forward, just giving all the variables that are out there. I’ve never met a certain time period, but this one does feel, a lot more uncertain than other time periods of the past.
Caroline Woods
Okay. I think this is a great time to pivot to our rapid fire round of this or that. Quick questions, quick answers, no hedging if it can help it. Are you ready, Brant?
Brent Schutte
Yeah.
Caroline Woods
Who wins in the near term? Bulls or bears?
Brent Schutte
No hedging. I think bulls still have the upper hand.
Caroline Woods
New money today in stocks or bonds?
Brent Schutte
Both.
Caroline Woods
As a hedge hedging. But we’ll give you one short more long term treasuries.
Brent Schutte
I think longer term treasuries offer value here, especially if you’re looking to hedge an equity portfolio. I think that’s where there’s opportunity to use these as a hedge against the potential that we do. High rates too high and the cure for higher rates as higher rates and an economic contraction.
Caroline Woods
By a 5% pullback in stocks or wait for 10%.
Brent Schutte
I would probably wait for 10%. I just think there’s, a lot more, there’s some downside risk in the near term.
Caroline Woods
U.S. or international stocks.
Brent Schutte
U.S. now, international later.
Caroline Woods
Large caps or small caps?
Brent Schutte
Small caps, longer term.
Caroline Woods
Growth or value?
Brent Schutte
Value.
Caroline Woods
S&P 500 or equal weight?
Brent Schutte
Equal weight. I’ll take the field over the ten.
Caroline Woods
Consumer discretionary or consumer staples.
Brent Schutte
Consumer staples.
Caroline Woods
Financials are health care.
Brent Schutte
Health care.
Caroline Woods
One sector you’d buy on the next pullback.
Brent Schutte
Tough question. One sector I’d buy the next pullback.
Caroline Woods
Reads one sector you’d avoid completely right now.
Brent Schutte
Completely I’d avoid energy right now.
Caroline Woods
Brent Schutte
That’s it. I’d avoid technology right now. Technology? Yes.
Caroline Woods
Best place to put $10,000 today.
Brent Schutte
U.S. small caps.
Caroline Woods
Going back to technology, I trade. Still room to run or to crowded?
Brent Schutte
Too crowded.
Caroline Woods
Next big opportunity. Inside or outside tech?
Brent Schutte
Outside tech.
Caroline Woods
All bigger risks to the market. Rates are oil.
Brent Schutte
They’re connected. But I would say interest rates.
Caroline Woods
Economy resilient are running out of steam.
Brent Schutte
Resilient for now but eventually runs out of steam.
Caroline Woods
True or false? The S&P 500 is no longer diversified enough for the average investor.
Brent Schutte
100%. True. And the biggest risk.
Caroline Woods
Stocks by year end. Higher or lower.
Brent Schutte
I’ll go lower.
Caroline Woods
And finish this sentence. If investors make one portfolio change right now, it should be.
Brent Schutte
I would add US rates.
Caroline Woods
And Brant, just to go back to the initially avoiding energy but adding commodities, can you just make the distinction for us. Because some might hear commodities and think things like oil. So when you say add commodities to your portfolio, you mean what.
Brent Schutte
I mentioned over time with commodities is not doing it right now? That was my initial energy commentary, because I do think, the cure for higher prices is higher prices, both in oil and commodities. And if you look historically right now, commodities are bumping up against a level on a year over year return basis where there hasn’t been good outcomes going after that.
Brent Schutte
And so I do think commodities rising right now is a risk. And that’s where I probably wouldn’t be buying them right now. But I want people to think about them longer term and, start thinking about adding them on some of those pullbacks. And so that was where the energy time was, to that commentary.
Caroline Woods
Okay. So when you say commodities, you still mean oil. It’s just basically buy on the dip.
Brent Schutte
I mean, commodities in general are more of a broad basket. So they’re the commodity basket we use has other things besides oil and it has copper. It has precious metals. It has agriculture. And it commodity prices I think are the rest right now, which I’m comfortable owning some of that because you do want to own the risk.
Brent Schutte
But at the same time, I don’t want people having a full allocation. I want them to use to buy the pullbacks to actually add to it over time.
Caroline Woods
Okay. And just finally, any Bitcoin in your portfolios.
Brent Schutte
There is not we have won gold in the past. We do own it throughout commodity basket. We’ve hedged inflation for the past few years. That’s why we’ve owned commodities. The best hedge for inflation is not gold. It is actually broad commodity exposure. And that’s where we’ve had that in our portfolios for the entirety of my time here. But more so since 2019, till today.
Caroline Woods
When I said Bitcoin not gold unless you’re referring to it as like digital, I.
Brent Schutte
Think that I use I changed over because we don’t know a bit called bitcoin. But I think people equate Bitcoin with gold. I still think gold is cool. And I’d rather that coin we don’t own either now. But we do own gold through that broad commodity basket.
Caroline Woods
Okay. All right. Brent Schutte, chief investment officer, Northwestern Mutual Wealth Management thank you for clarifying all of that. Thank you for playing along. We really appreciate your insights. If you enjoyed this street talk, check out our full interview with Rebecca Walser. She’s still bullish on tech and gives her top tech picks. Check it out.
