Liz Young is the head of investment strategy for digital financial services company SoFi. Fool.com editor/analyst Mary Long caught up with Young to talk about:
- Macro data that's meaningful to stock investors.
- How to build an investment thesis.
- One sector that's been unfairly punished.
- The likelihood of a recession in 2023.
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This video was recorded on Dec. 17, 2022.
Liz Young: You need to know what the other side of the argument is. You need to know why somebody might be doing the opposite of what you're doing. You think that stock's a buy, you need to know why somebody thinks it's a sell and really take that into account because otherwise you end up surprised all the time. Granted as investors, we're frequently surprised that it's just a humbling experience but it's really important to have some of that contradicting argument.
Chris Hill: I'm Chris Hill and that's Liz Young, the head of investment strategy at SoFi and she's right. You and I can have the exact same data about a stock and come to very different conclusions. But that's what makes a market. My colleague Mary Long caught up with Liz Young to talk about macro data that matters to stock investors, why strong Black Friday sales could be less meaningful this time around, and one sector that's been beaten up a little too much.
Mary Long: You focus on the macro picture, we cater to individual investors who invest in companies they love and in which they have high long-term conviction. Why should those individual investors care about the macro?
Liz Young: Well, look, you can do things from what we would call a bottoms-up perspective or a top-down perspective. A lot of individual stock investors tend to err on the side of bottoms-up, meaning they start with the company, they start with the strength of the fundamentals of that company, and then they get to a point where they want to purchase that particular stock. But what we've seen, particularly in 2022, is that no matter how strong the fundamentals of a stock, no matter how strong the fundamentals of that business, the macro-environment in some cases, and this has been one of those years, does really rule the day and stocks will move in tandem with each other based on the macro data that is rolling in, so I usually talk about investing as, no matter what you do as an investor, you can't invest with your head buried in the sand so you have to at some point lift your head up and say, what kind of environment am I operating in, the same way that a CEO would have to do that. Where the CEO might be very ingrained in what's happening in his or her own business but at some point, they still have to lift up their head and say, but what environment I'm I operating in, is it giving me more tailwinds or more headwinds.
Mary Long: When it comes to figuring out what that environment actually looks like. When you're looking at a single company, there is almost like a finite amount of data that you can look at and then, at least in my mind, the metrics and the macro picture are overwhelming and seemingly infinite. What indicators should retail investors pay attention to in general, sure, but especially right now?
Liz Young: Well, so first of all, if you're looking at an individual company and if you really want to get deep on an individual company, you might build a model, and it could be a simple model or a very eccentric model. You could build a model that's based on certain assumptions of what's going to happen in the macro-environment. You could build a model that includes inflation assumptions and maybe that's going to either help or hinder your revenue, that sort of thing. The macro factors actually make modeling a company this huge piece of optionality. If you just change your assumptions, your takeaway from that company may be completely different. What you want to look at though, in an environment like this, is clearly we've been victim to the rate cycle, we've been victim to inflation, what the Fed is saying and where we think inflation may go, how quickly it may cool, when the Fed may stop.
You want to watch things that are going to tell you whether or not we're headed in the right direction and what I mean by right direction is; is inflation cooling month-over-month, is it slowing down for consecutive months at a time? The answer to that right now is yes, it is, but we're not there yet. We're still above 7 percent that is far too high and that is far uncomfortable for the federal reserve so, yes, it's moving in the right direction. Then the second thing you look at it and this goes for any indicators. The first being, what's the trend, what direction is it moving up, down, sideways? Then the second thing is how fast. How fast is it moving in whatever that direction is. I would argue right now, yes, inflation is moving in the right direction, not fast enough. There is a point in time where it may eventually just fall off a cliff but the question remains, is that going to happen because we have a recession or is that going to happen because we tightened monetary conditions enough that it was able to just slowly fizzle out.
That's obviously a big thing you want to watch in the macro environment. The other thing that you really want to watch, this is my opinion right now, is the consumer. You can watch things like disposable income. Is income still rising? Is consumer spending still growing? Are consumers still out there using their spending? Is the savings rate at a healthy level? You want to look at some of these indicators of consumer health because the consumer does make up 65-70 percent of our economy. For a long time this year in 2022, despite all of the headwinds that we've faced, many have continued to say, but the consumer is still strong, the jobs market is strong so the consumer can stay strong. At some point that runs out and at some point we put enough pain on demand or we try to affect demand enough that it actually works.
Mary Long: We'll talk a bit more about that consumer picture and the human element of things down the road but you mentioned changing assumptions, and so I'm curious to hear how you build out an investment thesis and that could be for a company or even like modeling the macro picture and so how you do that and then if any of those investment theses have changed over the course of 2022?
Liz Young: Yeah, that's a good question. I always start with the macro. I'm a macro strategist so that's where I start so I do the litmus test of where are we in the macro environment. Many times that involves a analysis or some decision about where we are in the business cycle as a whole so you've got early cycle, you can have mid-cycle, late cycle, and then usually late cycle is followed by a recession. Recession then ends and early cycle begins again so it's just like this big loop that perpetually we were at some point in that loop at any given time. I start with where are we in the business cycle and there's a number of different indicators you can look at for that. I would argue right now we are almost decidedly late cycle and the things that are telling me that are a couple of different elements and I'm going to get into that in a minute.
But starting with the business cycle, what does the macro-environment look like? Then what does it look like outside the US. We've got the US macro environment, which is always the most important to a US investor but then what's outside the US? The answer to that this year has been that the US remained the best house in a bad neighborhood. Best house on a bad block, and you look around the planet, there are a lot of countries that are in worse shape than we are, both from a consumer demand standpoint, and an inflation standpoint. As painful as it feels here, it's still was better comparatively. You look at the macro environment, decide where we are in the business cycle and then my main job is to take that macro data and link it to what I think might happen in the stock market so where are we in the stock market?
Do that litmus test of where are we in the stock market? You look at things like valuations, you look at year-to-date returns, you look at the peak-to-trough draw-downs, how deep has it gotten? What does it look like compared to history? What we've seen so far this year is the deepest draw-down has been 25 percent. If we believe we're going to have a recession, 25 percent is actually pretty shallow, it would be great if we went through a recession and got out of this with only a 25 percent draw-down. You have to take that historical context and realize that the magnitude is either much bigger or much smaller than it has been in the past.
That's the second thing, whereas the stock market in relation to that and then you look at something like valuations, whether by sector, by broad market or at the stock level itself and say, do we deserve to be paying this much in forward earnings, for example; so a good example of this is this last rally brought us up to about 17.8 times forward earnings on the S&P 500. I think that was too high. I think something about that valuation was misrepresenting the environment. That either means that the price was too high or their earnings were too low. I do not think the earnings were too low so used to take it from that high level, where are we in the business cycle macro? Where are we in the stock market on a broad perspective, and then what are the valuations look like? If they're mismatched, something has to move and you decide which one has to move.
Mary Long: When you see that mismatch, is there any think of a time within your own team when you're looking at the same data, that same kind of mismatch, and you draw totally different conclusions?
Liz Young: Yes. Today.
Mary Long: Can you tell us about it?
Liz Young: Literally it happened today. I talked to my analyst about basically what's been happening where the stock market and I have a note that'll come out about this. Where the stock market has tried to get above what we would call a resistance level. Resistance level can be something like the 200 day moving average that did actually serve as a pretty strong resistance level all year. It can also be just the downward trend line so when you look at what the S&P has done this year, yes we've had some little rallies, some bear market rallies, but we kept making lower highs. That downward-sloping trend lines stayed in place.
What just happened a few days ago is that we had this big rally since October 12th and we started to test it. We started to approach both the 200-day moving average and that downward-sloping trend line. If we fail, which it looks like we've failed. If we fail to break through that to the upside, that would be basically the third failure this year of creating a new rally. I looked at that and said, bottoming is a process. This will be the third time. We're almost done. Then I would get more optimistic if we fail at that resistance level, we come back down, that actually makes me feel comfortable because as I just said before, we'd gotten up to 17.8 times forward earnings on the S&P, that felt too high to me.
If we get back down to where I feel like valuations make more sense, we fail at that resistance level, then I say, you know what; bottoming is a process, we've made it pretty far through the process. It's good to have another one of these failures behind us, we're not going to fail forever. My analyst looked at that and said, this will be the third time that resistance level is stubborn, that resistance level is strong and it's durable, and it's going to be even harder because we've failed three times, it's going to be even harder to break through it to the upside. We're looking at the exact same chart, the exact same data, the exact same trend, nobody's manipulated the data and we had two completely different takeaways about what might happen next.
Mary Long: Do you leave it at that, or who wins out?
Liz Young: Well, I have veto power. The piece will be probably more my takeaway, but it's good to have that on a team. If you're an individual investor, one of the things that I love about having him on the team is that happens frequently and he's a good check for me because if I'm digging my heels in and I feel so sure about my position and I have really strong conviction in it, there are times that he'll say, "Hey Liz, have you considered this?" Sometimes I'm like, "You know what? No, I haven't but I should." It'll give me pause. It also is a good test of what other investors might be doing. This is going to sound a little abstract, but I think every investor needs to think about it this way, the stock market is just an aggregation of what we're all doing every single day. You need to know what the other side of the argument is.
You need to know why somebody might be doing the opposite of what you are doing. You think that stocks to buy, you need to know why somebody thinks it's a sell and really take that into account because otherwise you end up surprised all the time. Granted, as investors, we're frequently surprised. It's just a humbling experience but it's really important to have some of that contradicting argument. I just in a place right now where again, I think we've gotten pretty far through the market process of this and we're actually beginning the economic process of that drawdown. When we look forward into 2023, if we talk about the chance or the likelihood of a recession, I'm in a place where if I make a pros and cons list, the cons far outweigh the pros, meaning I don't see how not. I don't see how we get out of this with a soft landing. I find that very, very difficult, if not impossible to even visualize. Now, just because I can't see it doesn't mean it won't happen. But it is difficult for me to understand how. That's what you constantly are doing. There's always something in the other column.
Mary Long: Let's play with this for a second. You say you still don't see how, but we just saw the most Black Friday sales ever so the consumer strength seems strong. Travel has bounced back really significantly, there's layoffs in the tech sector, but apart from that jobs seemed really strong and Powell seems to be indicating that he's going to slow rate hikes moving forward. I've heard you say before and again, you just said it now that a recession is likely in 2023, sounds like you're still standing by that. What do you have to say to those other indicators that are maybe pointing that a soft landing is possible?
Liz Young: Now, when you say Black Friday sales were the highest ever, here's something that I want people to think about. Sales means revenue. When you start an income statement at the top of it, when we say top line versus bottom line, top line is revenue. As inflation rises and if those costs have been passed through and prices have risen with them, revenue rises too. It's not all because there's been the super strong demand and that suddenly more people are out there spending, or they're spending more. They may be spending more just because the stuff got more expensive. Keep that in mind. Also, there's a difference between what's actually happening in the economy in any given moment and what is happening in the market.
I bet that if we didn't allow people to look at the data for a minute and I said, "How do you think retail stocks perform in December on a seasonal basis?" We've heard a lot about seasonality lately. If I asked just broadly, a room full of people, "How do you think retail stocks perform in December compared to other months of the year?" I'm willing to bet many of them would say they do well in December. Why? Because we have the holidays, because people are spending, because they're going into retail stores or their online spending in retail. It's actually not true. Out of the 24 industry groups, retail is in the bottom three in December. You have to keep that stuff in mind too. It doesn't always line up and it's really important to keep your head about you, especially when you're trying to determine what the consumer is going to do next. The consumer is heavily dependent on the job market.
Now, the job market's still looks great, the data still looks great. Yes, we've heard some announcements of layoffs, but they haven't been broad sweeping yet. They've been pretty concentrated in the tech sector, maybe some communications name. But the names that have been hit pretty hard this year so the growthy stuff. Maybe not a big surprise and it hasn't shown up in the data yet. But if and when the jobs market starts to weaken across industries and more people get worried that they might not have a job or that finding a new job is going to be harder, that's when they stop spending money. Last thing, I think I mentioned this briefly before, but what you can look at for the consumers is the savings rate. The savings rate right now is at its second lowest level in decades. You can look at that one of two ways.
People might look at that and say, oh, then everybody is confident, they don't feel like they need to save, they don't feel like they need to shove their money under the mattress and worry about a rainy day so that's a good thing. You can also look at it and say people aren't saving any money and you can couple that with the idea that people's credit card balances are increasing. If you just look at credit card debt, it's increased a lot this year. That means they're not saving any money and their credit card balance has gone up. There has also been a pretty big personal loan takeout that's happened, meaning people taking out more on, in personal loans. Those are risky debt instruments. If you're a consumer, and if you just look at that very simply, I would look at that and say people are overspending and at some point that cracks. Be careful of looking at things like Black Friday sales or Cyber Monday sales and assuming that it's that straightforward, it is really not that straightforward.
Mary Long: There's a lot of talk, again, just about those things that we were just mentioning, but that get whipped up in the media and then that's all everyone is talking about. Are there any sectors that you think are being unfairly beaten down right now. You mentioned the growthy stuff, is that unfair to be down on that or is that warranted?
Liz Young: It's interesting actually, if you look at the sector performance in this most recent draw-down, when I say recent, as in the last five days but, if you look at the sector performance, it's different. Different sectors are taking it on the chin. For most of 2022, we did see tech taken on the chin. Tech consumer discretionary also looks like a growthy sector communications so I would like that to those draw-downs were very rate-based, they were very fed-funds based or very growth-based. You raise rates, it hurts growth stocks more because you're expecting more growth in the future and then as rates rise, that growth becomes more expensive to create basically. This draw-down, the worst performing sector so far has been energy. Second worst performing has been consumer discretionary, also growth sector, but also a very big consumer sector and if consumer spending goes discretionary goes first.
This feels a little bit more like a cyclical draw-down, I believe as it stands right now, financials would be the third worst. Those are very cyclical sectors, consumer heavy sectors that are getting hit more. I think what will happen is that something like financials probably got unfairly punished. It hadn't really rallied a ton this year as it was, so the valuations looked attractive already and it never was really able to get out of its own way from that perspective in the market so I still think financials probably looks unfairly punished. That doesn't mean it won't continue and investors have still a scar from 2008-2009, financials get hurt. A lot of people, that was the first recession they lived through. You look at that muscle memory and think, oh gosh, if there's recession fear, I don't want to be in banks, banks seem like the enemy. But in reality, the banks are much more prepared for some economic stress than they were back then, so if I had to pick one, I'd say financials.
Mary Long: Then let's flip the question, what aren't people talking about? Do you think?
Liz Young: As an opportunity in the market you mean?
Mary Long: Yeah, what sectors or trends are interesting that aren't getting a lot of coverage?
Liz Young: Healthcare gets a decent amount of coverage, but it's not jazzy, it's not super interesting to talk about, especially in a period of time we were obsessed with rates because healthcare just doesn't really react to that directly but that's something that's probably underappreciated as an opportunity for the next, call it, 2-5 years. Partially because when you look at what's happened and what was forced to happen with healthcare throughout the pandemic is that the marriage of healthcare and technology sped up. It was already underway, but it sped up and it was forced to get even stronger so that bodes well for the sector moving forward as a long-term investor.
Some of the things that will always go under-appreciated are just the strength and the power of sentiment in the market. We can talk about fundamentals all day long, sentiment is really, really powerful. It's not necessarily a FOMO, situation. I think fear is the most powerful driver of all but there's actually a big fear of being wrong right now so people are trying really hard to call peaks and troughs and I think what could happen is if we have another draw-down, people will get scared and usually we don't get optimistic soon enough. What might go under appreciated is that after a year like 2022, where everybody feels like everything went down and we're looking at our portfolios, bruised and battered, and your risk tolerance falls when that's been happening to you. In a draw-down, it's that much more difficult to convince yourself to buy something that's risky when in reality, that's exactly what you should be buying toward the bottom.
Mary Long: I love what you said about sentiment, it's so powerful. On your podcast I've heard you talk about the human element of investing and to me, that's sentiment. Again, I've heard you say they're like oh, I think recently you had an episode where you were talking about being in Portugal and talk to your waiter about the tipping culture there, how do you gather that human element and get that anecdotal evidence by talking to people, what do you ask them? Then once you've gathered that, whether it's just through a chance encounter, how do you actually incorporate that into the data-driven numbers based analysis that you're doing.
Liz Young: Well, excellent question. Much of it ends up being anecdotes. You have to use your entire life and I love this industry, I love my job so I'm thinking about it all the time and actually find it interesting. I don't feel like I'm working if I'm talking to somebody about the market on a Saturday afternoon. You have to use all of your life, and what I mean by that is, I grew up in Wisconsin. I lived in Wisconsin until i was 32 years old, much of my family is still there. I now live in Manhattan and I've been here for almost eight years. The experience and the conversations that I have with people in Manhattan wildly different than what you would have with somebody in Wisconsin.
But I go out of my way to ask them. I go out of my way to ask my family what's going on. I have for example; my cousin's husband who runs a landscaping company in Northern Wisconsin. His biggest concern is can I keep my workers? Do I have enough workers? How many times I have to give them a raise, what are the other jobs in factories around the area looking like? He's also concerned with how much does my equipment cost? How much is it depreciating? For him, inflation is terrible, his equipment costs have gone sky high. The tight jobs market is difficult for him too, because he only has a few employees, so he has to make sure he keeps them so he's to continue telling them why they should stay.
But how do you tell somebody that, you give them more money. The costs are just eating into that. But that's a completely different conversation than what you might have with somebody in Manhattan who's in venture capital, for example. They like that some of the valuations have come down because now you can get a company on the cheap and you want to get in early and the valuations are more reasonable. You put that altogether and ask people, Number 1; what's your biggest concern? What are you worried about? What's hurt you most this year? You would think that that's the same across every walk of life, it's not. The pain is different, and what's your outlook? How do you feel about 2023? Are you feeling optimistic, are you feeling pessimistic? Have you cut back your own spending?
Then I think about even myself, have I cut back my spending? Have I changed my habits because of inflation? You just amalgamate all of that together and every once in a while you have a conversation where it's like, wait a minute, I can look that up as an indicator, maybe that person being worried about it is the canary in the coal mine that we're not talking enough about. Or let's say somebody tells me a story about getting a new credit card because they just want the airline miles and I'm thinking to myself, can you afford that though? Then you start looking at credit card debt. It's constantly happening but you have to use all of those anecdotes as little indicators or little signposts to either look deeper into something or question whether or not you're seeing it properly.
Mary Long: When you hear that fear, when you talk to your family in Wisconsin or whoever it may be, and then you match that with the pessimism that you're feeling going into 2023, how does that inform your mindset? Are you worried about what you're seeing long term? Or is this just the cycle working something out and how do you articulate that to someone who is scared because they're seeing employees potentially walk away, whatever.
Liz Young: Well, although the pain points are different for everybody, everybody has been affected by inflation. The way that I try to square that with someone who might be worried about a recession is that this has to happen. If you're less than 80 years old, chances are this won't be the last one you lived through and it's a natural part of just resetting the cycle and this is my opinion, I think resetting the cycle and just having a recession would be better than to somehow have a soft landing that we're not sure when it happened or how it happened and we live in this constant state of purgatory, like is it bad? Is it good? Is it bad? Is it good? Then growth just stays flat-lined, that's worse because at some point we run out of margin to protect, at some point we run out of cash under the mattress.
Dragging it on in this state of uninspiration is worse. I usually take people through, here's how the business cycle works, this is how you might feel at the beginning of it, this is how you might feel at the end of it. The only way to get from the beginning to the end and get back to the beginning again is to go through a recession. Just to put, you don't get to press go. You have to stop and you have to open the door and then go through. Explaining just the natural evolution of that is really important. But at the end of the day, a recession is a painful thing to go through and it's different to talk to somebody on Main Street who might go through it than to talk to an investor about it. Where if you're an investor, a recession is a great opportunity and if you're a long-term investor, a recession can be the buying opportunity of your next decade.
Chris Hill: As always, people on the program may have interest in the stocks they talk about and the Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.
