Can You Predict the Future?

Understanding the commodity value proposition can help investors allocate across the spectrum of attractive liquid assets without feeling as though they are peering into a crystal ball searching for answers.




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Transcript

Can You Predict the Future?
Season 2: Episode 4

 Ryan:  Welcome to The Real Spiel with Ryan and Kurt. Let's get real about the value proposition of commodities. We're looking at commodities up by most benchmarks that are up about 100% since the pandemic lows, that’s commodities broadly. And meanwhile, stocks and bonds are both down simultaneously as of late. It comes up often in our conversations Kurt. Is it too late to think about you know, commodities as an investable asset class? Or are there still some tailwinds for returns? I mean, we all suffer from recency bias. We've seen this big run up in commodities, but really the decade prior commodities largely did have a whole lot of nothing, and a lot of investors were burned by commodities in the 2010s. Can you talk a little bit about the forward-looking return properties for commodities, and is it too late to consider a commodity exposure in diversified portfolios? 

 Kurt: Those are good questions, Ryan. And I think that history can be a good guide or a helpful guide for us. It is true in the 2010s, Stocks went up 300% to 400% and whether you're looking at the S&P 500 or the NASDAQ or other benchmarks. And that was largely a global phenomenon. So, if you're invested in Asia and Europe or elsewhere, you know or emerging markets you did really well during the 2010’s. That was a strange period, though, because we had all of this government intervention in terms of very, very low interest rates accommodative fiscal policy printing of money, quantitative easing where governments in the UK, Europe, US were buying financial assets to create better financial conditions. That is not the norm, right that's not like a level playing field for investable assets. Meanwhile that created a real headwind for commodities, we had very low inflation and generally low returns during the 2010s. If we turn that on its head and go back just another ten years actually, the 2000s were a great decade for commodities and a challenged environment for stocks, because if you recall right after 2000, we had a significant downdraft in equity returns when the Internet bubble broke, going back twenty years and that create a challenging decade of returns for equities. If we're going back further, Ryan, just look at the big picture. If you look at a hundred fifty years of returns, the returns to stocks and the returns to commodities are actually quite similar. Above inflation, what we call risk premium, they tend return about seven percent or so, and they tend to do so, with roughly a mid-teens volatility, something in the fifteen percent range. So over one hundred fifty years when you adjust returns for volatility, something that’s called SHARPE ratio. SHARPE. We find the SHARPE ratio to equities is point three eight and the SHARPE ratio to commodities is point three nine. So basically, statistically identical. And yet, we know coming out of the 2010s, it was a very challenging environment for commodity returns and an extraordinary environment for stocks and for bonds. So, what's happened now? While we've seen in 2022 that by and large stocks are down north of twenty percent through the end of Q3, bonds are down about fifteen per cent and commodities are largely up about fifteen per cent. So, we've seen this role reversal. One of your questions was: Is it too late did I miss the boat? I think to that point I would argue, well number one. There's a number of reasons to be intrigued about supply chain disruptions imbalances to supply and demand and inflation that are very positive for commodities going forward. And I think that those create challenges for the equity in financial markets, including bonds. That said, I would also argue that it's not a great job to have to try to predict where markets will be in three or six or twelve months. And I think a much more valuable engagement of your time is to think about how to diversify and how to take into account different risk and return streams, that will immunize you from unexpected outcomes. We don't know if we're going to be thrown into a global recession or, God help us, a depression. We don't know if interest rates are gonna keep going up. If inflation will keep going up if it will come down. But when I think about financial market allocators, the job is less about trying to forecast with a crystal ball where markets will be in six or twelve months and what’s much more important is to allocate smartly across a spectrum of attractive assets that are liquid and accessible to you that diversify your outcome. That's why investors don't typically invest one hundred percent into the stock market. They invest into stocks and bonds, or the last call it two to three decades we've seen an embrace of something I will call the endowment model whose kind of promoted and popularized by David Swenson at Yale. That said, you know, going beyond the sixty forty stock bond portfolio, you can invest into developed U.S. markets, but you can also do invest into small-cap U.S. Markets or a value markets. You can invest in to developed Europe into developed Asia. You can invest in frontier and emerging markets. And if you're Yale or an institutional investor, you might use something called private equity, which is another form of equity. What all of those things have in common, though. Is that they're all equity of one flavor or another. On the fixed income side, rather than just buying long term government bonds, you might buy a shorter duration instruments. You might buy high yield in the U.S. You might buy a corporate or government debt in Europe or in Asia or in emerging markets. You might buy structured credit or collateralized loan obligations sometimes generated through the issuance of and creation of private equity. All of those, however, are bonds or fixed income of one form or another. And we know, looking at the data that in 2022, all of those collectively have come down, while commodities have gone up and It's true that commodities have done well in this nine-month period Q3 of 2022 while stocks and bonds have been challenged. It's natural to ask oneself. What did I miss the boat? You know. So, there was a good trade to do six nine or twelve months ago, but I missed it. And I would argue that, actually, that's not the task. The task is to identify assets that diversify offer a positive risk premium and can help your portfolio and commodities tend to be in real assets broadly, including MLPs, energy infrastructure, assets, natural resource, equity assets. And I would include liquid commodity futures. And those all tend to be very underrepresented in portfolios today. I'm thinking allocators and investors really have to take a hard look and understand that the future is uncertain. One thing is one of things that's hard about predicting the future. You don't know what's gonna happen. And that's not really your job. And the best thing you can do is try to diversify, identify those value-added portfolio instruments that will diversify your portfolio when bonds and stocks zig, you want to have something that will zag. And commodities have shown that here in ‘22 and I think they'll provide that utility going forward. 

  And am I encouraging of our podcast listeners to reach out directly to you and I Ryan, if there’s something to follow up, question where we can help illuminate something add value. We can do one on one with anyone when convenient for them.

 Ryan: Absolutely. And we'd love to hear your feedback, any questions you have, topics that you like covered. We can be reached at TheRealSpiel@USCFinvestments.com.  

Thank you for listening. I will talk to you next week.