Episode #505: Que Nguyen, Research Affiliates – Walking the Tightrope: High Valuations in an Inflationary Landscape – Meb Faber Research

Episode #505: Que Nguyen, Research Affiliates – Walking the Tightrope: High Valuations in an Inflationary Landscape

Guest: Que Nguyen is the CIO of Equity Strategies at Research Affiliates. She leads the cross-sectional equity research and strategy design that supports the firm’s systematic active portfolios and smart beta indices.

Date Recorded: 10/11/2023 | Run-Time: 42:35

Summary: In this episode, Que Nguyen discusses the potential risks of stretched valuations, rising interest rates, and inflation for investors. She also highlights areas of opportunity in the U.S. market and shares insights on the ‘Magnificent Seven’ stocks, fundamental indexing, and the future direction of the dollar.

Sponsor: Vinovest is a wine and whiskey investing platform that democratizes access to these ‘liquid’ assets. With more than 150,000 registered users, Vinovest makes it easier than ever to buy, sell, and store high-performing wine and whiskey.

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Links from the Episode:
1:09 – Welcome Que to the show
1:29 – The Magnificent Seven stocks in the S&P 500
5:57 – The merits of fundamental indexing as an investment strategy
12:37 – How investors should be thinking about the macro forces prominent today
20:39 – Forecasting the future path of interest rates
21:25 – Integrating the energy sector into the macro world
24:47 – Why sectors are becoming more stable through time, and the dollar gaining strength
27:07 – The Asset Allocation Interactive
28:46 – Contrarian views not commonly held by Que’s colleagues
33:17 – Non-market capitalization, evaluating quality, and the importance of capital discipline
37:56 – Que’s most memorable investment

Learn more about Que: Research Affiliates

Transcript:
Welcome Message:
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Disclaimer:
Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.

Meb: Welcome everybody. We have a special episode today with our guest, Que Nguyen, the CIO of Equity Strategies at Research Affiliates. In this episode, Que discusses the potential risks of stretched valuations, rising interest rates, and inflation for investors. She also highlights areas of opportunity in the U.S. market and shares insights on the ‘Magnificent Seven’ stocks, fundamental indexing, and the future direction of the dollar. Please enjoy this episode with Que Nguyen.

Que, welcome to the show.

Que: Thank you.

Meb: It’s been an interesting year as always. We might have officially crowned Research Affiliates as the number one podcast alum on the show with you joining us today. So welcome. But where do we begin? What do you want to talk about? Should we start with your overall view of the market or discuss the Magnificent Seven? Where should we start this fall, October day?

Que: Sure, we can talk about the Magnificent Seven certainly. I mean, those stocks have been truly magnificent. They’ve accounted for about 50% of the increase in the S&P 500 this year. That’s great returns for our investors, but the problem is that it causes a narrowing of the index. So now, when you own the S&P 500, you’re increasingly getting exposure to those stocks. If you’re looking for diversified exposure, you’re not necessarily getting it in the cap-weighted index anymore. This increases risks for investors going forward. You’re owning more and more expensive stocks and less and less of cheaper stocks, resulting in less effective diversification. So one of the things that we’re seeing is investors looking for alternatives. What’s a better way of owning a more diversified portfolio? I think that’s the opportunity going forward for investors.

Meb: Some commentators would usually say something like, well, isn’t that always the case? Aren’t market cap indices always a little top-heavy? Is this something unique in history? Are there similarities to the late ’90s? Is this totally unique in time?

Que: I would say this is not quite the late ’90s vibe, but it’s definitely getting there. So from that perspective, you have to be careful. There is a lot of room for concentration, but when things get overly concentrated, particularly when valuations are stretched, interest rates are going up, and inflation is on the rise, that creates a tinderbox that could be not good for investors.

Meb: So as you think about this, one solution is certainly to move away. I doubt your takeaway is going to be like, all right, go short these seven stocks, maybe it is and write them down. But what’s the best alternative? Because I think some people may have said this earlier in the year too, where, hey, look, the broad markets are still kind of on the expensive side, top-heavy, and here we are with these seven stocks ripping and roaring. What is the alternative? Where should people be going?

Que: There are two types of alternatives. The first is to go to an alternative index that isn’t as concentrated in the top stocks. For us, the history of the Fundamental Index or RAFI is really hard to beat. It’s very compelling. Rather than selling or shorting these expensive stocks, we recognize that what you want to own is a broadly diversified set of stocks. Even in RAFI, we will own these seven stocks, just not in the weights that you see them in the S&P 500. One of the nice things about that is that you get to participate in their run-up, but as they run up, you rebalance back to their fundamental weight. The discipline of selling high and buying low creates better returns over time.

Meb: Most investors are familiar with the Fundamental Index. We often talk about market cap weighting in this podcast. I imagine if you polled most investors, particularly retail investors, they would think index investing is fundamental investing. The concept you guys talk about. I doubt most individual investors would say market cap weighting is a price-weighted stock time-share. I think they would assume there’s some fundamental real-world component to it, and they would be wrong. Maybe give us an overview of what fundamental indexing actually is and why it’s a better way.

Que: Fundamental indexing started in the aftermath of the tech bubble. Rob Arnott, the founder of Research Affiliates, was talking to a friend at the Commonfund. They recognized that the S&P 500 had all these ridiculously valued stocks like Qualcomm and Yahoo, yet they owned larger quantities of these stocks. It didn’t make sense and created a lot of risk. So they designed an index on a clean sheet…



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