Assessing Risk During All-Time High Markets with Brad Kasper
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Assessing Risk During All-Time High Markets Show Notes
Our markets are at or near all-time highs. There are threats of inflation. People seem convinced that risk isn’t really present, even though it certainly is. What’s going on here, exactly?
To help make sense of market risks and how they apply to you, I’m thrilled to be talking with Brad Kasper, President of LSA Portfolio Analytics. He has extensive experience working with independent financial advisors all across the United States, giving them the tools and resources to make better investment decisions on their clients’ behalf. He aims not just to achieve better returns, but superior risk-adjusted returns for any fund, ETF, or portfolio he helps to build.
In today’s conversation, we talk about Brad’s risk analysis processes, why not all independent advisors are truly independent, the history of extreme overvaluation and market crashes, and how to stress-test a portfolio to survive inflation and uncertainty.
In this podcast interview, you’ll learn:
- Why so many so-called independent advisors are incentivized or paid by sponsors–and how to find truly independent financial advice.
- Why valuations are higher now than in any previous market–and why this doesn’t guarantee that a crash is coming within the next year.
- What made 2000-2002 such a unique period of wealth erosion.
- How the global shutdown of 2020 created artificial markets and led to rampant inflation–and what makes stagflation such a powerful market killer.
- “There’s a number of firms out there that have relationships with fund companies or ETF companies where there’s a soft dollar revenue share that’s taking place.” – Brad Kasper
- “Risk is just as important as it’s ever been.” – Brad Kasper
- LSA Portfolio Analytics
- Episodes with Brad Kasper:
- Schedule a Complimentary Consultation with a Modern Wealth Management CFP® Professional
[00:00:08] Dean Barber: Hello, everybody, I’m Dean Barber, Managing Director at Modern Wealth Management, your host of The Guided Retirement Show. Back again, Brad Kasper, President, founder of LSA Portfolio Analytics. He comes to us multiple times here on The Guided Retirement Show. And today’s episode is going to be super, super interesting. We’ve got market valuations at all-time highs or near all-time highs. We’ve got threats of inflation and we’ve got this whole idea that risk isn’t really present, but risk is ever present. Brad and I are going to break it all down for you today. Enjoy the show.
[00:00:46] Dean Barber: Brad Kasper, founder and President of LSA Portfolio Analytics. Thanks for taking time to join me here on The Guided Retirement Show again.
[00:00:51] Brad Kasper: Thanks for the invitation again, Dean.
[00:00:53] Dean Barber: Hey, Brad. So, let’s go back, though, for those listeners that have not listened to the previous episodes and explain what LSA Portfolio Analytics is and what your overall objective as an organization is.
[00:01:08] Brad Kasper: Sure. So, LSA Portfolio Analytics, we’re a research firm based at the Lee’s Summit. We work with independent advisors all across the country. So, today, we serve a little over 450 advisory firms. And really what we do is we provide a level of research that allows advisors to tie in and try to make good decisions, investment decisions, and portfolio development on behalf of the clients that they’re working with.
[00:01:34] Dean Barber: Okay. And one of the big things that I think is unique about your approach is you’re looking for superior risk adjusted returns, not just a superior return, but you want to make sure that you’re paying attention to the level of risk that is involved in any investment or any fund or ETF or portfolio construction as a whole.
[00:01:59] Brad Kasper: Right. So, we have a defined process. Any time we’re screening for managers or constructing portfolios, we have a defined process of how we search for managers. We use quantitative methods and qualitative methods. We have a defined process of how we try to allocate portfolios and most importantly, how we monitor it all as we move forward because as you know, these markets aren’t static. They’re ever changing. And you’ve got to make sure that your portfolio, the risk stays in line with the market situations that you’re dealing with. So, that’s a full-time job.
And a lot of times we come across advisors that want to pretend that they have the time to do all of this, as well as the financial planning efforts, as well as meet with clients, as well as try to be business owners. And it’s really hard to be efficient at all of those. So, the old saying, you can be a jack of all trades, but are you a master of any of them? And so, what we try to do is provide that research so advisors can lean on it to be the masters of the investment side of things.
The other thing that I like to talk about because I find this a little bit more relevant, especially in today’s markets, as business models have changed in this industry over the years unless they were a truly independent firm. So, there’s a number of shops out there that have relationships with investment companies. And a lot of times, you’ll see these names that pop up in allocations or strategies because of relationships.
For us, we’re truly independent that says the only way that an investment finds its way into our research platform is because they’ve passed through the barrier of screens, that we’ve checked off that the risk characteristics, the return characteristics, the profile of the managers are appropriate for a model series that we might put together. So, I always challenge people. At the end of the day, when you look under the hood, are you really getting a true independent approach to the way that investments are being brought to the table?
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[00:04:02] Dean Barber: So when you say truly independent and the people that are maybe not truly independent, are you saying that maybe there is some soft dollars or something coming in kind of behind the scenes, there’s more of an incentive for somebody to recommend something over another?
[00:04:18] Brad Kasper: That’s right. And I’m not going to name names on the program, but there’s a number of firms out there that have relationships with fund companies or ETF companies where there’s soft dollar revenue share that’s taking place. And the problem is if you’re really an independent advisor on an open architecture custodial platform, you do that because you want to gain access to the full list or the full universe of investments that are available to you and identify the best, but if you are coming in a firm that has these relationships, I question if you’re making the best decision because of those relationships, and the industry is set as much as well.
They’ve penalized a number of these firms for some of those soft dollar shares that have taken place. And I bring that up because, one, it’s the hallmark of the way that we constructed our business model that says if you’re going to find your way into our research, our models, it’s because it’s warranted off of merit. And I think that that should hold true for true independent advisors, especially when you’re operating on real open architecture, custodial platform.
[00:05:26] Dean Barber: Well, that’s the whole hallmark of what the independent RIA community, which is what we are here at Modern Wealth Management is was built on. That you should not be incentivized or paid by any company or product sponsor to represent their product. You shouldn’t be. What you should be is totally independent. You should work for your client. So, you’re taking what we do on the front end as working for our clients. We get paid nothing from anybody except for our clients.
They pay us a fee for the money that we manage in the financial planning work and tax planning work and all of that that we do, but we never receive a dollar from any fund company or product sponsor ever. So, you’re taking that to the next level then, behind the scenes, and saying, look, we’re not going to recommend somebody’s product or investment vehicle go with inside of one of our models because we’re getting a kickback if they get more assets under management.
[00:06:22] Brad Kasper: Exactly right. And that’s the fair way of doing it. And again, if you’re going to use some of these direct products, then go directly to the platform. Don’t step on an open architecture custodial platform. So, let me tell everyone what I mean by that. So, take TD Ameritrade as an example. They are a custodial platform. There are over 30,000 mutual funds that are out there.
What we say is that the universe of 30,000 mutual funds is what we need to be able to screen through to identify best ideas across asset classes. And so, with that framework, the process to do that is where LSA steps in to try to relieve that time on the advisor’s desk, and I always just like to make it aware that our process is again, not tied to a relationship or revenue share, it’s tied to did that fund warrant a place within the model portfolios that we might be reviewing.
[00:07:23] Dean Barber: Right. That’s perfect. And that’s why we love the relationship with you. And because we know that whatever you’re telling us on the research that you’ve done, hey, this isn’t something that somebody is giving Brad an extra few bucks to recommend that their fund or ETF or whatever get into one of your models.
[00:07:39] Brad Kasper: That’s right. You nailed it.
[00:07:41] Dean Barber: Right. So, what we’re talking about right now, I think is critical. As you and I recorded this podcast, market valuations are really at all-time highs. Okay, so I want to take a step back in history and just kind of set the stage for what I think is something that is critical. You and I were talking before we started the podcast here that what we’re going to share right now should keep people up at night. Then you said, Dean, there’s a lot of things that should be keeping people up at night right now.
We can talk about some of those things, but we go back to the 1929 market crash and what caused it. There was also extreme overvaluation. We had the Roaring Twenties, which sent valuations into the stratosphere from what was a normal valuation of the market. And we had a lot of leverage. In other words, there was a lot of buying on margin. And for people that don’t understand what happens when you buy on margin, you can lose more than you have invested. So, when people say they lost the shirt off their back and their house and everything else, they did because they margin, they could borrow at that point in time against virtually anything and invest that money in the market. That was what exacerbated the Great Depression.
We fast forward to 1997 and we were in the heat of the Dot-Com Bubble and in 1997, I believe, was the year that Alan Greenspan uttered the term irrational exuberance. And what he was talking about and referring to was that valuations for the first time since the 1929 market crash had eclipsed that same level of valuation.
You know the story, but valuations kept going up and going up and going up and going up until it almost doubled what the valuations were before the 1929 market crash. Then the Dot-Com Bubble burst. And then we had three years of gut-wrenching bear markets that saw the markets down over 50%, unless you were in the Nasdaq, it was over 70%. It took over a decade as somebody invested in January of 2000. And you were, I think, 12 to 13 years later before you actually got back to even if you just did a buy and hold in the index. Horrific.
[00:09:58] Brad Kasper: Right.
[00:09:59] Dean Barber: Now we find ourselves, in 2021, just outside the COVID era, with valuations higher than they were during the Dot-Com Bubble. We have talked about inflation, we have talked about a second variant that may become even more strong in the winter. And what happens when we get inflation? So, first of all, valuations are out of sight, but that doesn’t mean that a crash is coming tomorrow or the next day or even next month or even next year.
Valuations can stay elevated for a very long period of time, but why bring this up is because I think it’s relevant that people actually understand what they own and what are the real risk so that if this does happen and this thing unwinds like a Dot-Com Bubble or like a Great Depression or a Great Recession, understand what is at risk. The dollars that are at risk because you can’t spend average annual returns, you can only spend real money.
And when this thing comes apart and it’s down and down and down, people need to understand. And I think that was one of the things that happened in 2000 in the Dot-Com Bubble and that it repeated itself in ‘08, is that people that weren’t our clients would come in to say, “I don’t understand. I don’t understand how I lost this much. I had one of these lifestyle funds that was supposed to– I was going to retire in 2010 and I knew it. This is a retirement 2010 fund, this thing down 35%.
I can’t retire in 2010 now,” because they didn’t understand what they owned. And I think, today, we’re so far away from the people that really got hurt then that we have a setup for another scenario where people just don’t understand what they want and they just see their statements keep going up, and so they’re getting greedy. And we’re not going to make a change.
[00:12:00] Brad Kasper: Yeah, so let’s back up a little bit because, through everything that you said, there are similarities between today and what we saw in the 90s. You already mentioned one, valuations, right? If you looked across the nine-style box, which represents large-cap stocks, small-cap stocks, mid-cap stocks, growth versus value, everything is showing that it’s overvalued at this point in time, but guess what? It’s showed overvalued for about eight, nine years now. And so, the question that is out there is how much longer can this go?
And the problem is investors often get in these types of cycles and their expectations start to change. If you go back to the 80s and 90s, and especially in the 90s, man, it seemed like year after year, 20% returns out of equities, the expectation was the gravy train was here, I need to be on it. And so, what happened while everybody started chasing those returns? And guess what? The biggest pocket of growth during that time frame was what? Large-cap growth, the Nasdaq, the technology.
[00:13:08] Dean Barber: Telecommunications.
[00:13:09] Brad Kasper: And so, you started seeing even managers leave their mandates and saying, “I need some of that to be competitive and relative to help manage my value fund over on this side.”
[00:13:18] Dean Barber: Right, because I’m going to get a two-star rating from Morningstar versus a four-star rating, and then people aren’t going to put their money in there. They’re going to pull their money out. And so, yes, they play the game.
[00:13:27] Brad Kasper: And the expectations of the investors is that they need to participate in a portion of that. And I will tell you, it led to one of the greatest periods of wealth erosion that we’ve ever seen, 2000 through 2002. And it’s because we saw this expectation, this greed that was chasing the returns, they got overheated and eventually, markets are efficient. Everybody wants to ignore that statement, but markets are efficient.
And when everything, when the stars don’t all align, then markets are going to price that out appropriately. We saw it in 2000, 2001, 2002, and in 2008. We saw it through the scare of the global financial shutdown with COVID and last year. So, I think this expectation that investors have is a dangerous notion for this go around because what we’re seeing is, again, investors are chasing returns and not just inequities. Let’s use bonds as an example here as well.
[00:14:31] Dean Barber: Real estate as well.
[00:14:33] Brad Kasper: Real estate. So, let’s use bonds for just a second, though, right? A good stable core bond, like the Barclays US Bond AGG, seven- to ten-year duration, very conservative, all of a sudden, you’re seeing everybody kind of ditched that core bond exposure. Why? Because they want more return. The expectation is there. I need to participate in this. So, what do they go get invested in?
Well, they’re looking at credit opportunities, things like junk bonds, high yields, things like bank loans that have a better credit structure than junk bonds, but nonetheless, a credit exposure. And here’s the problem with that, is you start to chase an asset class that is starting to become more correlated to your equity, your stock portion of the portfolio. We saw this in the late 1990s.
[00:15:22] Dean Barber: Well, it happened in 2020.
[00:15:24] Brad Kasper: We saw it in 2020 again, yeah. And you get overextended. And all of a sudden when equities start to crash, your balance the protection in the portfolio is no longer as strong as it was before. So, I think that this is a critical moment for people to at least be exploring and understanding the differences in an expectation, that long-term market cycle versus what we’ve seen in the last 10 years. Similar thing could be said in the 80s and 90s. By the way, if you looked at 120-year history of the Dow Jones, this massive movement, wave of returns that happened in the 80s and 90s, that’s not the normal.
[00:16:05] Dean Barber: No.
[00:16:06] Brad Kasper: That’s not the norm at all. You had a huge economic expansion that took place that lifted everything up. And I challenge if you just started investing, thinking that’s the norm and that’s the expectation similar to people that just started in the last 10 years. Guess what? You could have a very rude awakening unless you’re having conversations around risk to portfolios.
[00:16:27] Dean Barber: Well, I mean, so to think about this, 75% of the money that poured into the Nasdaq in the Dot-Com Bubble poured it in the last quarter of 1999. Okay, so that’s the gravy train, right? That’s I got missing out, I got to get in on this. And they got in. And then the Nasdaq was then off over 70% in the next three years. So, we’re seeing the same thing. All of this Reddit, the social media-frenzied buying of individual stocks. And I call really stock manipulation. If you had hedge fund managers doing that, they’d be fined and out of the business, right?
[00:17:07] Brad Kasper: That’s right.
[00:17:08] Dean Barber: But since it’s all on a social media platform, I know the SEC is looking into how do we keep that from happening, but that’s the same thing, right? And you’re seeing people speculate on mergers and acquisitions. You’ve got all of these. There’s so much money out there right now, and it’s causing this frenzy and this mania. And so, this party, this train we’re on, it could go on for another two or three years. There’s nobody saying that a bear market is imminent at this point. What we’re saying is simply that when valuations are where they are today, you better understand what you own and you better understand what your strategy is going to be when that tide turns, because it will.
[00:17:54] Brad Kasper: That’s right. And on previous episodes that we have done here, we’ve talked about the importance and the relevance of understanding– using the best math that you have access to. What’s the risk of my overall portfolio? How do I pair positions appropriately? So, when one ebbs, the other one flows. Here’s my favorite conversation in the last six months. So, if you were to take a snapshot of the first quarter of 2020.
This is through the COVID movement. Equities were off, S&P roughly around 20% in the first quarter. Your bonds were up about three and a half percent. So, you have one piece in green, your protective component when everything else is getting clobbered over on the equity side.
Now, fast forward that to the first quarter of 2021. And what did we see? We saw that equity markets are up around 10%, 12%, and bonds were down about 3% in that first-quarter market movement. And every investor right now seems to say, well, my bonds are down 3%. Bonds should not be down. Well, isn’t that the relationship that you want with investments? If you’re truly going to have a diversified portfolio, not everything can be in green all the time. And this is a phenomenon that we saw in the late 90s. Everybody wanted what was in green, and guess what? It was in green until it wasn’t. And when one piece wasn’t, it was like, the dominoes fell. Every asset class dropped in a similar fashion. Where’s the protection and risk control in that?
[00:19:29] Dean Barber: The only thing that didn’t lose money in the Dot-Com Bubble were financials.
[00:19:34] Brad Kasper: And bonds. Bonds just…
[00:19:35] Dean Barber: And bonds, right?
[00:19:36] Brad Kasper: Bonds did fantastic.
[00:19:37] Dean Barber: And real estate did okay.
[00:19:38] Brad Kasper: The real estate did all right.
[00:19:39] Dean Barber: Okay, so you’re making me chuckle here because I remember a conversation with a client of mine that had retired back in the mid-90s, and all this mania was going on and he’d call me up and he’s like, Dean, this thing hasn’t made any money for two weeks. Why are we in it? Why don’t we have more money over here? I mean, I’m like two weeks, dude, you just retire. You’re going to be retired hopefully for 30 or 35 years. We need a diversified portfolio.
He’s like, I’m tired of the diversification because these are the things we’re making money. I want more money in that. I’m like, look, not my suggestion. You’re going to have to write me a letter that says that you’re making these decisions, not me because I think it’s the wrong thing to do. Or by the end of 1999, he was 97% technology and telecommunication. And he thought he was the smartest dude ever. I called him, I’m like, good. I’m like, you got to get diversified. He’s like, I got this figured out man. Don’t worry about it. Alright, okay. Three years later, 70% of his money was gone.
[00:20:37] Brad Kasper: And it’s even more challenging today because think about the investors that started post 2010, after the last decade. You have a 10-year window where markets have just been incredibly resilient.
[00:20:55] Dean Barber: And great, yeah.
[00:20:56] Brad Kasper: And not only that but any time you had a correction…
[00:20:59] Dean Barber: It was short.
[00:21:00] Brad Kasper: It was short, and you had a quick recovery. And so, when you take a step back, you do have to ask the question, what’s so different today than in the 80s and 90s, right? Because this bubble keeps getting bigger and bigger. And I think one of the big catalysts that has allowed it to get this far is the quantitative easing programs.
[00:21:21] Dean Barber: The reserve.
[00:21:22] Brad Kasper: It’s the cash, the capital that gets pumped into the markets and bailouts. And what was interesting is in 2008, the great financial crisis, I define it as we were in it, they were in there, writing the playbook as to how do we survive this massive catastrophe, and what did they do? They threw a ton of money at it. So, when COVID hit, and we do this great experiment of the global shutdown, never been done before. Global shutdown. And what did they do? They went back and they grabbed that playbook from 2008.
[00:22:00] Dean Barber: And they said, “Let’s implement this now.”
[00:22:02] Brad Kasper: They blew the dust off of it and they said, we can make this five times bigger and pumped endless amounts of money into the system.
[00:22:09] Dean Barber: And do it now.
[00:22:10] Brad Kasper: And do it now. It happened almost overnight. And here’s my problem with that, if we are truly going to be a capitalistic free market, you have to allow free markets to operate appropriately. Japan found themselves in a very similar situation. They tried to stimulate their way out of it. The issue is they’ve never had the growth to support the getting off of this steroid that keeps getting pumped into their economy and eventually, it starts to stall out. So, 2008 could have been a whole lot worse than what it was. And who knows? History will tell us if it was the right move to pump money into the system. I’m not here to say one way or the other.
[00:22:50] Dean Barber: We still don’t know what the exit strategy is.
[00:22:52] Brad Kasper: We don’t know the exit strategy, but I do know that any time you’re running high deficits, any time you’re leaning on the Federal Reserve to bail your bond markets out like they did last year in 2020. And I want to be very clear on that, between March 7th and March 9th, bond markets behind the scenes just were frozen, frozen and a mess. I mean, liquidity was an issue. Federal Reserve appropriately stepped in and kept cash flow going.
Bond markets kind of settled in, but at what point, Dean, do you have to take a step back and say when are free markets going to operate again? Because this is artificially driving, I think, prices up, valuations up, and the big hope in this great experiment is, can we grow our way into the success that we’ve seen? And when you look at global shutdown and coming back online, I don’t know that it has the legs. And all of this is just speculation to it.
[00:23:52] Dean Barber: Sure. Absolutely.
[00:23:53] Brad Kasper: Just speculation. And so, I want to bring this entire conversation of concerns that we have back to what is something that we can try to control within our environment. And that is when you review the investments that are available to you, can you try to control the risk to the best of your ability? That is what you have the most probability of being successful with not chasing these returns.
[00:24:14] Dean Barber: Right. Well, then that’s when we talk about stress testing that portfolio. Let’s take it back through and see what that portfolio would do through the Great Recession. Let’s take that portfolio back through and see what it would do during the Dot-Com Bubble so that you can have some frame of reference. And obviously, it’s not going to be exactly the same thing, but like you said earlier, Brad, when the markets start to drop, they all go down and they go down pretty darn similar. There’s some eerie charts that you can put together that’ll show, okay, here it goes. And then all the asset classes, they follow each other.
Now, some are a little more deep, some not quite as deep, but it’s a huge deal. So, if you don’t have the right diversification within your portfolio, that’s kind of your first starting point for protection is the diversification, but then it is the mix of those asset classes. And then even at that point in time, it becomes something more actively managed funds, those guys that focus on more protection. That can be a big help at that point in time too.
[00:25:14] Brad Kasper: Yeah, and the word diversification is somewhat of a cuss word in the last 10 years because you could go be in the S&P 500, which has posted incredible numbers and a really solid equity market run-up. And one of the phrases that we have always used with BFG as well, it’s not what you make, it’s what you’re able to keep through full market cycles.
And I think that that is a relevant statement, especially in today’s market, but the problem is the expectations are so out of whack of what investors expect to receive versus the reality of developing the patients within a diversified strategy because diversification isn’t dead, it hasn’t gone away. The relevance of it’s still there. We’re in a pocket where there are certain asset classes that are outperforming it. And we’re going to find a pocket where, guess what? Diversity helps provide that balance the protection of what is there in the first place.
[00:26:16] Dean Barber: So, let’s switch gears a little bit from valuations to inflation.
[00:26:20] Brad Kasper: Okay.
[00:26:22] Dean Barber: There’s no secret that inflations here today. The question is, is Jerome Powell correct? Is this a transitory situation, which means this is a short-term phenomenon for inflation? Or are we really going to have inflation come back in a meaningful way? I think a lot of people think that because of how much money is in the system today because of all of the programs that have been put out there that that’s going to cause inflation. That doesn’t cause inflation, right? Inflation is caused by a velocity of money. And so, I just want to get your take on where you think inflation is transitory, non-transitory?
[00:27:01] Brad Kasper: So, I agree with Powell that I do think it’s transitory. I disagree with this overall notion that inflation is running rampant because here’s an example that I did the other day. We took 25 commodities that are out there. Okay, and we just looked at the last 10 years of prices on those 10 commodities. And the question is, has inflation come in? Yes, we’re definitely off of the lows of what we saw during COVID, but everything was pretty low going into COVID, right?
Inflation was extremely under control and contained. Gasoline prices were down. Cattle, lean hogs, you can go across any major asset class, commodity. So, we came off of really low levels. The question is where we started to see inflation rise, did we supersede where we were pre-2020 with COVID? And of the 25 commodities, there’s only three that are really showing signs of crazy inflation. You can probably name some of them. One, lumber, right?
[00:28:08] Dean Barber: Which is coming back the other direction.
[00:28:09] Brad Kasper: So, this goes to prove that it supports the thought that this is transitory because it wasn’t a shortage of logging. The loggers were out there working the entire time through COVID. This was a supply chain issue. So, there are four primary sawmills across the U.S. And guess what? Every one of those sawmills shut down during the global shutdown. So, the logs are coming here piling up. I don’t know how they get into their shop with all the inventory that they have, but it couldn’t be processed in the sawmills.
So, think about your big box shops, your Home Depots, your Lowe’s. Well, they do what’s called future ordering, so they order lumber six months in advance. Well, guess what? All of the inventory at those sawmills dried up. So, the price of lumber shot through the roof. I’ve never seen it jump like this in my lifetime. And to your point, we’ve already started to see it come back down. So, that would suggest that this one commodity that’s really superseding those levels of 2020 pre-COVID, it looks to be a little bit more transitory.
What’s another one? Palladium. Well, every car manufacturer now is trying to make an electric car. Guess what? Electric cars utilize batteries. Batteries are powered predominantly by palladium. There’s a demand issue that is driving that one up. I don’t believe it’s transitory. I believe that’s just a natural supply demand that’s showing within that commodity. And the third one is canola. I don’t even know how to describe why canola would ever be inflated. So, I don’t have a great story as to why that one’s high, but three out of…
[00:29:42] Dean Barber: Maybe more people are cooking at home.
[00:29:44] Brad Kasper: Yeah. So, three out of 25 that are superseding levels that we saw pre-COVID.
[00:29:50] Dean Barber: That’s interesting. I hadn’t really thought about that until– but I’ve seen some charts where they’re showing a long-term average trendline of these commodities, and we’re right on it. We were just so far below it last year, during COVID.
[00:30:03] Brad Kasper: Yeah. And by the way, inflation isn’t necessarily a bad thing. The issue that keeps me up at night, we talked about what keeps us up, is there’s a dirty little secret within the Fed that if this stimulus that they’re pumping into the system, if it does not generate consistent market growth, GDP growth, and inflation continues to run, you have a massive issue because all of a sudden now, the supply of money, the supply of capital is not supporting, it’s not starting that economy with enough capacity to keep up with inflation. And if inflation runs rampant, you get into a really nasty market environment and situation very, very quickly.
[00:30:48] Dean Barber: So, wouldn’t that be similar to a stagflation? You’ve got a stagnating economy, but you still got inflating prices.
[00:30:54] Brad Kasper: That’s right.
[00:30:55] Dean Barber: That’s killer. That would blow the markets up.
[00:30:57] Brad Kasper: So, the question is, does the Fed have enough tools in their toolbox to combat that? And there seems to be a lot of conviction that they do. And I don’t know.
[00:31:08] Dean Barber: Well, they are saying is don’t fight the Fed, right?
[00:31:11] Brad Kasper: The old saying and it still holds just as true today as it ever has.
[00:31:15] Dean Barber: At some point. I mean, I wonder how are you going to pay all this money back? That’s the question. Or do you ever have to?
[00:31:20] Brad Kasper: That’s a whole nother podcast show because you get down, yes. At what point did we stop caring about what the deficit looked like? Because at some point, that money is real, it has to be paid back. And if you think about the short-term Fed funds rate that the Federal Reserve controls, if we start seeing those interest rates move up and move up and move up, guess what? Just paying servicing the debt or the interest on the amount of debt that we have is going to chew up more and more of that GDP growth every year. And it’s going to stifle real growth that’s happening in the economy. And so, they’re kind of stuck. How do you raise rates knowing that it’s going to potentially clobber GDP growth?
[00:32:06] Dean Barber: And you look at the rates here on our treasuries and then look around the globe at the rates on their treasury equivalents, and we got the prettiest house on the block.
[00:32:17] Brad Kasper: Yeah, negative yields in Europe, I mean, you’re right. And that always comes back to the question. When things really get difficult, where is the real safe money going in? It’s still finding its way into US Treasuries. And I think that point, Dean, brings us back kind of full circle, talking about the importance of protection within a portfolio because historically, what we know from math is that certain asset classes behave in a low or negatively correlated fashion to other asset classes.
And if we can use the understanding of how those positions operate collectively, now you can start to control risk, but here’s the thing that I think investors need to get their minds wrapped around is it’s not always a rosy situation. If you had trouble with your bonds being down 3% when your equities are up in that first quarter of 2021 and you’re saying, “Gosh, I need more out of this,” that’s not necessarily a bad thing because when just the opposite was happening the previous year, we said exactly. This is why we have diversity. Our bonds are providing protection, our equities are down, but when it rolls reversed, it’s not necessarily a bad thing.
[00:33:24] Dean Barber: Well, and the research that you’ve done through LSA Portfolio Analytics has allowed us to utilize some portfolios that we call them our intelligent portfolios because you’re so smart, but essentially, they’re built to limit risk or allow risk, whichever the person wants. So, you’ve got your, we call them an intelligent portfolio, five intelligent portfolios, 10, 15, 20, 25, 30, etc., and that number is what we are targeting as a maximum drawdown, in other words, a maximum drop from a peak to a trough.
So, if somebody is saying, “Look, I want to be a little bit more conservative where we go, then that intelligent portfolio five and we know that the way that math works, 99% of the time, we shouldn’t ever exceed a 5% drop. Now, that leaves that small fraction of a percent that could be out there and maybe it will go, but it’s not going to exceed it by much. And so, you can have that, okay, here’s the money we’re going to spend in the next four or five years, but what about the money that we’re going to spend 15 to 20 years from now?
We don’t need to be that safe with that if we know we’ve got a pocket of money that we’re going to be able to spend, but being smart about the entire process and not looking at your portfolio as one thing and just go put it all in the S&P 500 and everybody’s happy.
[00:34:47] Brad Kasper: Yeah. And so, creating that framework of understanding of drawdown allows us to again curb some of the expectation, this inflated expectation, back down to real math that supports in reality, how have these actual positions operated collectively through these different types of market cycles? And what it tries to do is piece these investments together in a meaningful fashion where risk is under control and your drawdown is understood to the best of your ability, doesn’t mean that things don’t change and you don’t have to monitor it, but when you piece that together, what it can do from a financial planning perspective is set an expectation that’s more appropriate for what’s really meaningful to that investor over a 30, 35-year timeframe. Not in a first quarter, right? This drives me crazy.
[00:35:41] Dean Barber: It gets you short-sighted.
[00:35:43] Brad Kasper: Long term used to be 30 plus years in this business. That’s how we define long-term market cycles. Now, long term, if you can last two to three years. So, our perception has just changed so dramatically in this. I need to go win it now. The Wild West of the cryptos and other asset classes that keep popping up just keep adding fuel to this fire. And we’ve seen this story before.
[00:36:07] Dean Barber: Well, it happened in ’08.
[00:36:08] Brad Kasper: We’ve seen this story before. We saw it in the 1990s. We saw it in ’08.
[00:36:12] Dean Barber: Yeah.
[00:36:13] Brad Kasper: So, I think risk is just as important as it’s ever been, especially at these valuations.
[00:36:18] Dean Barber: It’s ever present and it’s got to be addressed.
[00:36:20] Brad Kasper: And expectations need to be addressed as well because that’s going to be a problem that drives people to overextension.
[00:36:26] Dean Barber: Yep. Hey, listen, this was fun. Appreciate you being here, and it’s fantastic. We’ll have you back again because it’s always insightful. And you and I could sit and talk for hours, so.
[00:36:34] Brad Kasper: I love it. It’s always fun. Thanks for having me.
[00:36:36] Dean Barber: Alright. Fascinating stuff. I could talk to Brad for hours and hours. We’re going to have him back on again. If you’ve missed any of the episodes where Brad Kasper was present, just search the episodes for Brad Kasper. You’ll find him, I don’t know, three, four, or five times. He’s been on with us here on The Guided Retirement Show. Great stuff. If you haven’t subscribed go ahead and do that right now.
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The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.