Insights from an Industry Expert Kevin Caron.

Have you ever wondered how Federal Reserve's interest rate changes can affect the market? Well, Kevin Caron, a seasoned Portfolio Manager from Washington Crossing Advisors, drops by to decode the world of finance. With his in-depth knowledge and expertise, we explore current cash, bond, and stock environments, and discuss the impact that interest changes have on the market. Moreover, Kevin also unravels the potential benefits that can be reaped by savers due to these increases.

As we delve deeper into the complexities of the financial world, we discuss the challenges that young investors might encounter in today's market. The soaring prices of stocks, the looming prospect of the stock market taking a pause, and the impact of the top seven stocks on the S&P 500 are all examined. Guiding us through this labyrinth, Kevin shares advice on how to kick-start the investment journey and navigate the potential obstacles. We also scrutinize the lucrative potential of treasury bonds as a retirement investment strategy and contemplate the effects of inflation and interest rates on bonds.

In the final part of our enlightening discussion, we question the conventional growth and value investing paradigm. Could the mentality of a bond investor unlock a more effective way to make investment decisions? Kevin offers a unique perspective on this, suggesting that looking at companies as being high quality or low quality, much like a bond investor would, could simplify investment decisions. Wrapping up, we also touch upon the importance of portfolio diversification and the invaluable role of professional money managers. So, tune in to gain insights and tips on navigating the financial markets, and equip yourself with tools for a secure financial future.

Transcript

Announcer:

Welcome to Financial Matters with Richard Oring and Josh Levitus with New Century Financial Group.

Josh:

Welcome back to Financial Matters with Richard Oring and Josh Levitus. This is season two, episode three. On this episode, we have a special guest, Kevin Caron, senior portfolio manager from Washington Crossing Advisors. Kevin, thank you so much for joining us.

Kevin:

Good to be here. Thank you for having me.

Josh:

Yeah, so Kevin, tell us a little bit about yourself and your experience in the investment industry.

Kevin:

Well, I've been doing this for round about 30 years, and I started my career on Wall Street. It was a different time back then, but it was a fun time. I mean, I remember going down to start my job, first day of work, and it was summertime and it was hot, and there was a lot of action, a lot of things going on. We were right across from the New York Stock Exchange, but it was a very vibrant place. And on the floor of the New York Stock Exchange, if you visited it at that time, what you would've seen is a large crowd of people. You would've been, by the end of the day, up to your ankles and ripped up little pieces of paper, and very little was done by computers back in those days, that was before the internet. And we've certainly seen a lot of changes in the last 30 years, and a lot of that has changed, much more digital.

But the business is nonetheless as exciting as it ever has been. And for anybody who has an interest in finance, this is an industry that you can be in and you can work through your entire life and never see it all. It's a vast industry and gets into just about everything. But helping people amass, create, preserve wealth throughout their life is something that I've always been interested in. And of course, seeing history from the view of finance has been very interesting too, because we've certainly been through a lot over the last 30 years

Josh:

For sure. So then now you're the senior portfolio manager at WCA. Tell us a little bit about your role there.

Kevin:

So I have a partner, his name is Chad Morganlander, the two of us started Washington Crossing with a gentleman by the name of Joe Battipaglia from Washington Crossing, Pennsylvania. He was our mentor, he passed away several years ago, a great man, and he really instilled some very important things in us. So the idea of always being professional, always treating people with respect, that all came from him. And we carry on today, we have two of his sons working for us, Jeff Battipaglia and Matthew Battipaglia, along with a team beyond them including a risk manager who's had 40 years in the business, a securities analyst who's had 40 years in the business, and a number of other people. But it's a great team and I'm very proud to be part of it.

Josh:

Very cool. So Rich, you were really eager to get Kevin here on the podcast. What were some of the topics you wanted to get into?

Richard:

I think you already listened in the beginning, I wanted to get Kevin on the podcast because I heard that he was a great speaker when he did another podcast for an advisor we know down in Louisiana.

Josh:

Oh, okay. You were on-

Richard:

Kevin's looking at me like, wonder who it is? Do you remember Kevin?

Kevin:

I've done a few of them and I love the format too, so hopefully this one is going to be as good as the ones in the past.

Richard:

Yeah, you did one for Eric Garcia and Xavier Angel.

Kevin:

Oh yeah, I remember that one.

Richard:

We're really good friends.

Josh:

I didn't realize you're a regular on podcasts, Kevin. I guess that's why you're so natural.

Kevin:

It's always a lot of fun.

Josh:

Cool. So to start off, Kevin, we really like our podcast to aim and relate to everyone, not just people that are in the industry, so I want to do a little bit of a market overview on some of the different investment areas right now. So I want to differentiate cash, bonds, and stocks for our viewers. Let's start with cash. What's the current cash environment like?

Kevin:

Well, we're in a very interesting time for cash because the Federal Reserve has raised interest rates in order to snuff out inflation, essentially taking their foot off of the accelerator, which is where it's been for most of the last dozen years, and then applying it firmly to the brake in order to essentially reign in the economy, slow down the rate of inflation. And that has been a very good thing for anybody holding cash. I think that these days you can earn about 5% just holding cash.

Richard:

Kevin?

Kevin:

Yes?

Richard:

I don't mean to interrupt. I just want to clarify for some people that CDs and money markets are considered cash in our industry.

Kevin:

Yes, yes. There's cash in your pocket where you can think of the dollar bills, that's not what we're talking about. What I'm talking about is things like it would be a T-bill or a CD, those kind of things. But that is a big change because for the last 12 years it's been a very unusual thing to be able to earn any interest whatsoever. So the fact that suddenly a saver can earn money essentially just by saving, by putting off an expenditure and instead saving the money, that's a very significant change. And change is the incentives that people have to spend and save. And it's consistent with what the Fed is looking to do, really just to tamp down the economy, slow things down a little bit by creating a little bit of a disincentive against spending and instead favoring savings. So this has been a good thing for people who have some money to put aside. Bonds, essentially, those are going a little bit further in terms of how long you would have to hold the investment in order to earn your return.

And there are bonds of all sorts of different varieties, some that come due in a relatively short period of time, others that go out for years and years and years. And those have become very interesting as well because, no pun intended, because as the last couple of years have played out along with the Fed raising short-term interest rates, helping investors that would be holding CDs or bank deposits or money funds, those kind of cash-like instruments, it has also happened that the longer term bonds have risen. So today, for example, you could buy a 25 year, let's say US treasury, that you would buy today and 25 years from now that bond will come due. So those investments are going to be more volatile typically than holding cash. But one of the good things about bonds is that they allow you to lock in a rate of return for more than a year.

So if you're going to be holding, let's say a CD or a money market fund, what you don't know is... great, you may be able to get a 5% rate of return today, but there's no saying that that's going to be available to you six months from now or 12 months from now. What a bond does is it allows you to lock in a return. So for example, I just happened to be looking at a 23-year zero coupon treasury bond, so these are bonds that pay no interest but you can buy them at a steep discount, you can buy them around $30, and they will come do at 23 years from now. So the rate of return there, you can lock in today, and it's roundabout 5% or a little more than 5%. So the important thing to know is that for these boring fixed income kind of investments, either CDs or money market funds or even longer term bonds, these are very exciting potential returns for investors who haven't seen an interest rate like this in many, many years.

Richard:

I just want to mention, I want to put a timestamp on the podcast just in case someone's listening to this a few months from now, we're recording this on November 13th of 2023, so that's the date where we're using the numbers from.

Josh:

Yes, thanks for pointing that out because we're hoping to get some viewers down the road too. So Rich, the cash and bond market is very different than it has been maybe let's say the past 20 years, how has that affected you as a personal financial advisor and the portfolios you make for clients?

Richard:

Sure. Well, over the last couple of years, anything which was in fixed income was in short duration knowing that interest rates were going to go up. So we wanted to protect client's assets in the fixed income market from rising interest rates. We're not really predicting an increase in interest rates over the next couple months. Hopefully we'll see a decrease maybe in June, we're hoping. So lately we've been utilizing a lot of the CDs, broker CDs compared to a client going to the bank and just getting one. So they've been paying in the mid-fives right now. We've been using T-bills also looking for after tax yields, depending on their state taxes... federal taxes, I'm sorry... but it's beginning to change. The yield curve is beginning to flatten. So we're beginning to look at some corporate bonds and we're waiting. I know a lot of our portfolios, end of September, early October, we started going back into intermediate bonds trying to be in the pregame for it. We don't want to be late for it. So those are the changes we've done recently.

Josh:

Right. Adding cash as a real allocation class into people's portfolios is a huge change versus in the past when cash was yielding 0.2% or something crazy.

Richard:

Right. I mean, I'm really hoping that there's a lot of cash on the sidelines right now when people are getting more confident with the markets or intermediate bonds or longer term bonds, that money's going to come from the CDs and keep feeding back into the stock market or intermediate bonds.

Josh:

Right, and that brings us on to the last allocation class, equities. So Kevin, what's the current equity market look like?

Kevin:

Well, we've had a good year. So here's the thing with equities. Equities, they're going to love when the economy grows and that has been a huge advantage for stocks this year. So coming into the year there was a tremendous amount of depression around the outlook. I've never seen a bunch of professionals as a despondent as they were coming into 2023, and that's because the financial professionals, they tend to look at the bond yields. And when the fed's raising interest rates, the golden rule is don't buy stocks, don't fight the Fed, and there were all sorts of signals that suggested to forecasters that this was going to be a horrible year. Well, it's turned out to be not quite so bad. In fact, the stocks that really got hurt the worst last year, so think like the mega cap tech stocks, those have actually had a fairly good performance this year coming up off of a drubbing they took last year.

So the market actually turned in a pretty good return, the stock market turned in a good return because the economy was good. Looking ahead, there are some challenges though because as I mentioned earlier, if you can earn 5% by either owning a CD or a bond of some kind and you're paying high prices for stocks, I think the typical way that you would look at the price paid for stock is you compare the price of the stock to underlying earnings, and when you do that for the market as a whole, the stock market as a whole, you find that the stock market is now at a bit of a premium.

So you could come into a period where you say, okay, well, we escaped recession that was good for the stock market in 2023, but the prices are now fairly full and they're competing against cash and bond yields which are offering some very nice returns, and it might be that we go into a period where the market kind of churns sideways for a while as it all works itself out. Now in the long run, I think that stocks are going to do far better than cash or bonds, but in the here and now, it might be that the stock market takes a bit of a pause.

Richard:

Kevin, just curious, August and September and part of October weren't great months for us in the stock market. November came, we had one of the best weeks of the year. In history, you used to always tell us the fourth quarter of the market's usually good, third quarter is not so good. Can you see the fourth quarter having a little run to the end of the year after what you just said?

Kevin:

Yeah, well, it certainly could. We don't trade very much, so we're not kind of geared up for week to week, month to month guessing around that. I would just say that in general, the economy seems and the data seems to be flowing reasonably well. We're not seeing stress in terms of jobs. We see earnings that are ratcheting up for the S&P 500 corporate bond spreads, which would be another measure like the difference in yield between a risky corporate bond and a US treasury bond. Those differences in yields are pretty tight, which would be a clue to us that there's some liquidity and expectations that the economy will function at least reasonably well. So there's enough data there that suggests that things are kind of okay as far as the underlying dynamics are concerned.

The only thing that would give me pause is that we've now had a big recovery in many of the more popular stock names, and the markets are going to compare what the expected return on those stocks from these elevated levels are going to be against what could be earned by simply parking your money in cash or bonds, and we're at an inflection point where that could start to become a bit of a challenge for stocks, that there are these other returns that are available.

Richard:

So year to day, a lot of the gains we've seen in the growth sectors in general or the S&P 500 is coming from seven major stocks. So there's still 493 that would need to shine still.

Kevin:

Yeah, yeah, depending upon which day you look at it. The reality is that the average stock is effectively flat for the year. It may be up slightly, but the basic message, you're exactly right. If you'd stripped out the top seven stocks, it would just deduct something like 12% from the return on the S&P this year, which would put it relatively close to a flattish kind of return for the year. So the idea is, especially for a younger investor that might have a longer term time horizon, the best way to do this is to think out about not just about the here and now, but think out over the next five years or so and try to position a portfolio that's diversified, that's going to be able to withstand when something doesn't go well. Because 2023, the recession never came, but it will come eventually and you want to make sure that especially if you're saving for the future and trying to build wealth, that the companies, the holdings in your portfolio, are going to be able to withstand difficult times.

Richard:

Sure. That's how we kind of build our portfolio is we build a portfolio based on the timeframe of the goals and the risk. We've learned in the past that trying to time the market, you have to make two right decisions, when to get out and when to get in, and it's too hard. So I always say this, time could reduce risk.

Kevin:

Yeah, the old adage is it's time in the market not timing the market that yields the best results. And that's as true today as it's ever been.

Josh:

So Kevin, I'm glad you brought out that outlook as a younger investor because just to be frank, it's tough right now. Rents are the highest they've ever been. The ratio between the average salary to the average rent is the worst that it's ever been, worse than during the Great Depression. What advice would you have to someone my age that wants to get into investing for the first time?

Kevin:

That's a really good question. I have have two adult children in their early twenties who are starting out on this journey and the world is different today for them, and they do face challenges. So they're looking at home prices, for example, very expensive. They're looking at a job market, very competitive. So there are jobs available now, but in general it's a very competitive situation. Just inflation in general. Debts outstanding for many young people are an issue. So the idea of getting some income and being able to afford rent, pay down debt, those kinds of things, student loans are a big issue for a lot of people, the idea of having to do all that and then save on the side for the future is a daunting task. In fact, I think the oldest millennial, if I have my math right, the oldest millennials, they'll be turning 65 in just 23 years. Think about that. So in that time period there's a lot that needs to be done.

And effectively, there are three things that you want to be thinking about. You want to be thinking about the compounding, of course, the power of compounding. It's not about living paycheck to paycheck. If you can find a way to put away a couple dollars out of each paycheck to fund your future obligations, maybe it's retirement, maybe it's saving for a child's education, maybe it's just looking to have something put away for even the next generation, all of those kind of things are best done over long periods of time. And time really is on your side. So open your IRAs early, open your 529s early if you're saving for kids' education. Ultimately dripping into those on a regular basis, it's really going to mean a heck of a lot more in the long run than whatever buying today's fashionable stock means.

The other part of it is diversification. I remember my first investment, I invested my first holiday bonus all in one very speculative stock. I lost all my money in two days. It was the least diversified, most rapid loss of wealth ever. But it was actually a very valuable lesson for me. I like to think about diversification as being analogous to if you took a boat out on a lake and it was smooth as glass, and you took the same boat out on the lake the next day, the wind's blowing and it's very choppy. The more diversified a portfolio is, the more you're going to be able to sail across that lake with less volatility, which is akin to having that smooth lake versus something that's very choppy. So diversification across asset classes, stocks, bonds, cash, that's very, very helpful and it allows you to maintain a sense of calm through what can be very volatile markets. Because the biggest mistake that people make is they buy in at the top when there's all the hype and they sell out at the bottom when they're scared.

Richard:

Emotional investing.

Kevin:

Yeah, emotional investing, it's a killer. So one way to help with that is to be diversified and stay diversified. And then lastly, what we just said, it's time in the market not timing the market. So staying invested and being consistent in what you do over long periods of time, that's really what's going to get you where you need to be.

Richard:

Josh, I'd like to add something to what Kevin's saying. First off, what Kevin said about saving, consider yourself a bill. You pay your utility bill, you pay your cell phone bill, pay yourself every month. This way, what Kevin was saying, sometimes it's going to be high, sometimes it's going to be low, dollar cost average, average out your purchase prices of your investments. The second thing is really big. With everything going up, the rent, the food costs, just in general inflation, a budget, write down your expenses. And in that budget put down savings. I don't know if anyone noticed recently, but mint.com, which is one of the largest aggregators that does budgeting is closing the doors.

So if anyone who's used to using mint.com, there are other programs out there. If you're interested in some financial planning, call our office, our planning program does budgeting where you can do it just like mint.com. You can structure a budget, see where you are. It aggregates your checking, your mortgage, your card payments, credit cards, everything, plus you get to work with an advisor to make it work for you and help you contribute enough for your savings, for your short-term goals, your intermediate goals, and your long-term goals also. Hopefully we can help you try to move out of your parents' house.

Josh:

I'm still working on that one, but it is essential. I like that you added that in there, Rich, you're never going to have money to invest if you have no idea how much money you're making a month and then spending a month. You don't know what's going to be left over for investing. So you've got to do that first and then you'll have that money to invest. So let's say making a few thousand a month, spending hopefully a thousand less than that a month let's say, I see my friends, they bought Bitcoin, they made a bunch of money. They bought GameStop and made a bunch of money. I want to shoot the moon, right? Is that the best way to invest, look for the next big thing, Kevin, or is there something I could ask myself to look for a quality investment?

Kevin:

Well, okay, so take for example, let's start with something boring. So let's take a look at a US treasury bond. Earlier in the podcast I talked about a zero coupon, very basically the longest term treasury bond. And let's say you're one of these millennials, let's say you're thinking to yourself, "Okay, I'm going to be 65 in 2046," so that's 23 years from now, "and what can I buy?" Because you just talked about it, Josh, you said everything's very expensive, rent's expensive, everything's expensive, you've got inflation, all these kinds of things. Is there anything out there that is of better value today than it was a couple years ago? I know when you look at housing, it's shocking what you have to pay for a house these days versus two or three years ago, or rent, food, forget it.

But if you look at that treasury bond I just talked about, today you can buy a 30-year treasury bond for half the price that you would've had to pay for it just two or three years ago. So there is something that's right in front of us. It's not complicated. It's backed by the full faith and credit of the US government, and it forms the basis of many, many retirement plans for professional investors in pensions. And for 15 years people walked around despondent. They said, "I can't get any interest. I can't buy a bond because there's no interest rate. Why would I buy a bond if the interest rate was 1%?" And remember, the price of a bond and an interest rate is like a teeter totter. It goes in opposite directions. So what has happened is the higher interest rates means the prices of those bonds today are, in this case a long-term treasury bond, they've been cut in half from where they were two years ago.

And so if you're saying to yourself, okay, I'm going to be looking to retire in 20, 25 years from now, I want to make sure that I'm funding my own retirement, I don't want the vicissitudes of the stock market or having to get in and out of Bitcoin at the right price or in and out of something else at the right price, you don't want any of that kind of speculation, but you want to be able to plan for something that's going to be there for you in the future. Take a look at very high grade corporate bonds, because for the first time in 15 years, 20 years really, you actually have the opportunity to own bonds that are going to compound for you without taking on a lot of risk. So it would be something I would be looking at if I was young and I was looking to plan for retirement in 20 or 25 years.

Richard:

So Josh, we just talked about this in front of our group, the one thing we always have to consider is you can make a lot of money but what's your after tax yields? It's great that you made money, but how much did you get to keep of it? So if you have friends making money on Bitcoin and they're churning it really quick, you're paying a higher tax rate than something you're going to be holding for a longer period of time. Kevin, recommending the strips, you have to pick up OID interest every year but it's spread out over the 23 years, I think, you use as an example.

Kevin:

Yeah, I mean, it doesn't have to be. I'm just using the simplest example. So it could be a coupon paying treasury bond. I'm just pointing to it. I'm just pointing to this, I've been hearing for such a long time, for almost 20 years now, how bond investors or savers have had no ability to save and earn a rate of return. And so we've had a huge change in the last year and a half or so where suddenly there is a very, very respectable yield to be earned on cash or bonds, basically your savings. So the idea of being able to save now and be rewarded for that as opposed to chasing a speculative investment which may go boom or bust, to basically build the base of a financial plan. If you picture your finances as a pyramid, at the base that needs to be all the stuff that you're very confident in.

So that's where you put things like savings accounts or CDs or bonds. And then on top of that, you would want to layer on maybe something like a blue chip stock or something, a diversified portfolio of very high quality, maybe dividend paying stocks. And then after you've covered all of that, then maybe if you want to speculate for the tip of the pyramid, if you will, okay, fine, now you've covered your bases for all of the important things with assets that are matched to the liabilities that you have in the future so that you've got those covered, well, once you've got those covered and you are saving and you have built out that diversified portfolio, then okay, if you feel like you really need to scratch that itch and try something more speculative with a reasonable amount of money, then by all means go ahead and do that. But make sure you have your other bases covered first.

Josh:

Okay, yeah. So let's say I've got... I don't want to give the exact percentages because it's really different at any age... but as a 22-year-old, I've got a third of my money in treasuries, 60% of my money in index funds or blue chip stocks, and now I'm ready to be a little bit more speculative with that small amount of my portfolio. What are some questions I should ask myself when I'm looking for an individual stock to decide is this a good investment or am I going to lose all of my money?

Kevin:

That's a great question. So there would be three things that I would be looking for as an equity investor. You're looking for a company who is fundamentally durable, flexible, and predictable. Those are three things that come in very handy, especially when the markets go upside down, which they tend to do. We did that in the early 2000s. You had a 50% plus drop in the market in the early 2000s. You had a 60% drop in the market in 2007 and 2008. So every once in a while, the market does get upside down, and it's during those periods of times that you want to make sure that you have companies that are durable and flexible and predictable. So basically the way I would say to go about doing that, become familiar with a basic balance sheet. How much debt does the company have? We don't like to have a company have more than about a third of its balance sheet, or a third of the total value of the company, let's say, in debt.

If they do, then all of a sudden you can find yourself invested in levered companies. So Lehman Brothers, Bear Stearns, AIG, all those companies that went to zero during the financial crisis, those were all companies that were expected to be very, very good that turned out not to be. You don't need to be involved in that kind of thing in our view and expose yourself to that kind of risk. So one way that you go is you focus on companies that have very little debt on their balance sheet. If you look at the company's assets, you want to make sure that the company's generating cashflow and you want to make sure that the assets are profitable. So go look at an income statement and see did it generate profits? Did it generate profits for several years? When you look at those profits and you compare them to the assets that are on the balance sheet, are the profits divided by the assets, let's say, is that a reasonably significant number or is it a very, very small number with lots of times where those profits can be negative?

And then lastly, if you're looking at a business, just ask yourself how predictable is it? How many years has the company generated positive earnings? Does it pay a dividend? Are those dividends increasing regularly? And if you can answer to your satisfaction that the company after all that is durable and flexible and predictable, you've got a really good starting place to begin to build a portfolio. And all you would need is maybe 20 or 30 of those stocks. Try to make sure that they're not all, let's say, in the same industry. But if you can build a portfolio around that kind of thought process, I would argue that over time you should have a very good performance, especially on a risk adjusted basis, in comparison with a speculative portfolio that's concentrated in just one or two or a handful of very speculative stocks. I think the ride will be much smoother if you do it focusing on durable, flexible, predictable companies.

Richard:

Can I answer that one in a different way?

Josh:

Of course.

Richard:

If you're 22 years old and you have time to do that, that's great, but your time is going to be limited as you go forward. That's why it's great to use professional money managers because you can have great ideas, you can put a lot of time into it, but before you know it you're going to be distracted with other things and you're not going to be watching your own money. And that could be even more dangerous than picking what's great today and maybe not tomorrow. There's more to it. Like Kevin said, it's the beginning point of looking for a stock. I look at it more as a financial planner knowing that a young person out of college is going to be focusing on their career. They're going to work long hours. They're going to get engaged. They're going to get married. They're going to have kids. And time is just going to not be there to continue doing this.

Josh:

Right, it can almost become a full-time job if you're tracking 30 different earnings reports. It's a very large commitment. That is a lot of people's full-time job if you're a financial analyst. So Kevin, you'd mentioned something before about capital structure and the importance of not investing in companies with too much debt and how that's one of your main theses at Washington Crossing. So I really wanted to get into that. In college and corporate finance they taught us this idea that debt is always cheaper than equity, and you're always going to lower your cost of capital if you finance through debt to an extent. What is that breaking point when you have too much debt? Where'd you get that 30, 33% number from?

Kevin:

So the reason that your finance professor told you that debt is always cheaper than equity would be because there's a tax advantage for a corporation to issue debt, where that is not the same for when they issue equity. But the flip side of that is that when you add debt to a company's capital structure, you also increase the potential that the company's not going to meet those liabilities, it's going to default. And if you're an equity holder, you're sitting at the lowest portion of a company's capital structure, which means if a business does not make its debt payment then that business is in default to its creditors which effectively will mean that your equity investment is in jeopardy of being wiped out. So the idea is that there's no harm in a company having some debt, if a company can borrow at let's say 5% and invest that money at 10%, then that makes sense.

But at some point if the company continues to borrow money and adds more and more debt, what's going to happen is the probability of the company defaulting is going to begin to increase, and there becomes a tripping point. It's kind of an invisible tripping point. Nobody knows exactly where this is, but that company can get to a point where, especially if the economy sours and the assets no longer can generate the returns that they once did, you can get to a tripping point where suddenly that company risks going into default. And that's where you end up with the Bear Stearns or the Lehman Brothers or that kind of situation, and as we all know it turned out not to be a very good thing for the equity investors to be involved in.

So for us, we have found that by limiting the debt to about 30% of the capital structure, in general you find a place where the company can still borrow, they can still responsibly use debt and hopefully earn a positive return on that money, but it stops short of the spot where the risk of default starts to significantly increase for many companies. So we've just found that 30% of the capital structure seems to be an approximately good place to be if you want to limit the amount of risk that comes from ending up with companies that have too much debt on their balance sheet.

Josh:

Rich, any thoughts on that?

Richard:

Actually, I was going to ask a question. I was going to go on a new topic. So right now we have a few wars going on. We have the Russia-Ukraine War, we have the Gaza and Israel conflict, and we get calls from clients concerned about the wars and so forth and what's going to happen with the markets. Do you have any thoughts on that?

Kevin:

Yeah, it's a very tricky question for markets. We have been through similar, well, we've been through wars in the past, we've been through many different conflicts in the past, and in my experience it has not been an easy one for investors to trade around. So for example, if you think back, it was just a few years ago, it was in the first part of the 2000s, there was a different conflict in Israel. And I remember that very vividly, and it was very dramatic what was happening at that time, and we thought through the same issue. We got to a point where we issued a research note or something and we basically said this is something we investors should be cautious, we said this would imply that there should be a heightened risk premium placed on the market, and we cut our expectations for the market.

And that was easy. It was easy to sell. But as that conflict receded into the background, there was no offsetting moment where it was obvious to us to say, okay, well, now this has passed so that risk premium that we priced in has to now be taken out and we need to now go back into the market. And you could say the same thing for 9/11. 9/11 there was an initial knee-jerk sell off in markets that was pretty furious, but within a number of months it turned around and it ended up being a very good buying opportunity for investors who had a longer term point of view. So my main point in all of that is that investing around war and that kind of thing, it's just a very treacherous thing to do, and it's easy to sell but it's not as easy to know at what point should you then change that and go buy.

Josh:

So don't panic is what I'm hearing.

Kevin:

Yeah, so don't panic, or more importantly go back to what I said before. If you own companies that are flexible and durable and predictable, then maybe you can go in and buy things at a better price. So when Covid, for example, hit what we did at Washington Crossing was we asked ourselves, okay, the market's down hard and we asked ourselves whether we thought whether or not this pandemic was going to be here in five years, and we thought it should at least be better, we think. And that allowed us to say, okay, we have our shopping list of companies that we know are solid, that we think are going to be able to get through whatever the world throws at it, and so it became a buying opportunity for us. So it's very important, and it's those times when things get scary and you have to anticipate that that's going to happen, it's during those times when that idea of quality, durability, flexibility, predictability, that's when that pays off in spades. And so that's why you want to build those ideas into your portfolio.

Josh:

So it can be scary investing in uncertainty but sometimes that's the best time to get in. It's hard to say when that time is though. So dollar cost average.

Kevin:

Right, but you've got to know that the things that you're owning and the companies that you're investing in, that they are designed in such a way that they're profitable enough that they're not exposed to sudden death that can come from defaulting on too much debt. And if you have companies that are reasonably predictable and profitable and not going to default, then you can have some confidence in stepping in when the rest of the market is getting scared.

Josh:

Awesome. So Rich, Kevin, I know you guys are both very busy guys. I want to be respectful of your time. Do we have time for one more topic or do you guys have a stop coming up soon?

Kevin:

I'm fine.

Richard:

I'm good.

Josh:

Okay, cool, because when we had talked planning out this podcast, Kevin, you mentioned one topic I thought was super interesting and I wanted to bring to the attention of our viewers. So I was kind of asking you, so Morningstar in the early 2000s or late 90s invented this tic-tac-toe board of large-cap, mid-cap, small-cap based on the company size, and then value, blend, and growth. And I was kind of asking you, what do you think about the difference between value and growth in today's market? You had a really interesting take that I wanted you to talk about on today's show.

Kevin:

Okay, so if I were to give you some examples... We're going to play a game, if you don't mind.

Josh:

Yeah, I love games.

Kevin:

We're going to play the opposite game. If I were to say tall, the opposite is?

Josh:

Short.

Kevin:

If I were to say hot, the opposite is?

Josh:

Rich. No, I'm just kidding.

Kevin:

It's cold.

Richard:

When's your employee review, Josh? Hey Kevin, are you hiring? Josh might be looking for a job.

Kevin:

So the point is, whenever you're measuring something on a continuum, the nature of the thing you're measuring has to be the same thing. You're measuring height or temperature, that's what you're measuring. Now, if I were to say cheap, what is the opposite of cheap?

Josh:

Expensive.

Richard:

Expensive.

Kevin:

But not according to Morningstar. If you look at their continuum, they would say there's value, let's say cheap, the opposite there is growth. And it's not and I can prove it. You may have something that's very, very, very expensive that is not growing. Normally, for example, if you took the price of a treasury bond today and you divided it by the coupon of a treasury, you would find that those treasuries, well, they're a little less expensive than they were were a couple years ago, but treasury bonds, for example, those coupons stay constant. They do not grow. But treasury bonds are very expensive because there's something else about a treasury, they're very dependable. So the opposite of value or cheap is not growth. And this idea has been enshrined all across the financial landscape, so we must have, at this point, tens of trillions if not hundreds of trillions of dollars either directed to index funds that think in terms of growth and value, or they're going to be managed by a manager who is going to be benchmarked to a growth or value index.

But at the core of it, I think we've just proven that there's something logically wrong at the core of growth and value investing. And I think that if you look at what a bond investor does, they are so much better geared for investing than somebody who's following this growth and value idea. Because what a bond investor does is they ask one simple question that's logically consistent, they ask whether or not the bond is high quality or low quality, which to you and me, we all understand what that means. It means can I depend on this thing? If I have a quality car in the driveway it means that when I go out on a cold winter's day it's going to start. It's going to be there for me. So the essence of quality, that can be ranked from high quality to low quality, logically and consistently.

So at Washington Crossing we've thrown away this idea of growth and value, which makes no sense at its root, and instead we've replaced it with a bond investor's mentality by looking at every company we invest in and just ask is this high quality or is it low quality for all the reasons we discussed before. Consistency, durability, flexibility. If you're able to conclude that this company is high quality, then that's the most important question we can ask. And then the other question that a bond investor, the secondary question a bond investor would ask would be, well, what price am I paying? Is it a reasonable price when we evaluate what the company's likely worth in a few years? Are we buying it at a reasonable price or not? And I can't think of an easier way or simpler way to clear up your head and make investment decisions. You do it with bonds, why don't you do it with stocks? So forget growth and value.

Richard:

So Kevin, what's funny is if we're doing overlaps, prospects coming in, looking at their portfolios, I can't tell you how many times we've seen a value manager and a growth manager having the same stock.

Josh:

Exactly. Microsoft, both of them, yeah.

Richard:

It's like the manager's afraid not to own it, so they'll just find a reason to make it a value stock or a growth stock. It happens all the time.

Kevin:

I don't blame the managers because it was a concept that was never really intended to grow in popularity to what it is. It was made popular by, well, there are a lot of parties that got involved in creating this growth value obsession, but it doesn't make any sense. And so when you look around at other companies, I believe JP Morgan for example, does a very good job of, they put out capital market assumptions, for example.

Richard:

They're the largest ones doing it.

Kevin:

Yeah, and they've been doing it for a long, long time. And I noticed that for them, they don't even talk about growth and value anymore, or all this what's called smart beta products that are floating around out there, or factor investing. All of this is a giant admission to the idea that this growth value framework, which has been foisted upon so many people for such a long time, it really sits at the heart of so many investing choices, is really a fallacious choice to begin with. I feel that the industry is just beginning to move away from it and the quicker that we as an industry can get to a point where we stop reinforcing this bad idea and continually ask people if they're growth and value, I think investors will be better served. So focus on quality, focus on price, just like bond investors do, and I think you can do just fine as an equity investor.

Richard:

I just want to clarify something because we used a term where our listeners may not know what it is, a capital market assumption. JP Morgan comes out with them. This is a 10-year looking forward projection of rate of return and risk. We use those a lot when we're doing financial planning or hypotheticals looking at forward projection numbers. Whereas Morningstar or other reporting companies is using past performance to report. So when we use the term market capital assumptions we're looking for forward projection numbers.

Josh:

Yeah, I'm glad you pointed that out, Rich, because I'm sure a lot of viewers are not familiar with that higher level topic.

Kevin:

In essence, I think we do a greater service for our clients if we can keep it simple and not make things unnecessarily complex. So Washington Crossing's contribution to keeping it simple would be to focus simply on quality and price and we'll get you to exactly where you want to be without all the complexities and logical problems of growth and value investing.

Richard:

Well, the reason why we found you is it comes up on our radar. So low turnover, good downside risk, we're looking at Sortino ratios and fun stuff like that. So you're always right on the top. So keep doing what you guys are doing. You guys are doing a great job. We really appreciate it here.

Josh:

Yeah, and thank you again, Kevin, for coming on the show. I know your time's really valuable, so I appreciate you giving us a good 45 minutes of it. Thanks a lot.

Richard:

So Josh, can you tell everyone how they can contact us and you know how to end it.

Josh:

For sure. So if you want to get in contact with us directly, call us up. (609) 924-2049. I'm extension 105. You can go on our website, www.ncfg.com. Book some time with us directly. What else? Hopefully I'm still here next episode after that joke and this is not our last episode.

Richard:

The most important part, get ready for the disclosures.

Josh:

Yes, and now onto disclosures.

Announcer:

Richard Oring's and Josh Levitus's branch office is One Airport Place, Princeton, New Jersey, 08540. The branch phone number is (609) 924-2049. Securities are offered through Osaic Wealth Incorporated, member FINRA, SIPC. Advisory services are offered through New Century Financial Group LLC, a registered Investment advisor, not affiliated with Osaic Wealth Incorporated. New Century Financial Group LLC and Osaic Wealth Incorporated do not offer tax advice or tax services. Please consult your tax specialist for individual advice. We make no specific comments or recommendations on any tax related details.