Talk Your Book: Diversifying Away From the Magnificent 7

0:00Today's Animal Spirits Talker book is brought to you by Direction. Go to Direction.com. That's Direction with an X and check out their equal weighted NASDAQ 100 ETF. A lot of people are worried about market concentration. Equal weighted fund, especially in tech, equal weighted fund is a decent way to diversify that. Check that out. Go to direction.com. I'm not that worried, but I still am a big fan of diversification if you are worried. So go to direction.com if you want to learn more. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing, and watching.

0:36All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

0:57Welcome to Animal Spirits with Michael and Ben. Michael, we've gotten a lot of questions over the years in our inbox, and I think we like to keep kind of a running tally. I wish I had one of those whiteboards, you know, like in the sales organizations, they'll like stand up and do a little tally when they make a sale, you know? Yeah, sure. Tally, tally, tally. We could have like a tally list for the amount of questions we get on certain items. Paying off your mortgage is a big one. What are some other ones? How do you guys find so much time to podcast and blog? Yeah. That's a big one. I've got a 30-year time horizon.

1:32Why not just use leverage? Yep. Leverage ETFs is a big one. Where does Michael get all of his Knicks shirts from? answer is always Instagram but yeah the leverage one is a big one and people say listen I know all the stuff you guys have said about leverage before if I want to use a two or three times levered S &P 500 or NASDAQ 100 fund I'm willing to sit through the 70 or 80 % crashes when these things fall and I'm going to be just fine just give me the green light to do it and I don't think we've ever really given anyone the green light because that's I think it's a risky proposition and we get into that today with Ed Egelinsky from Direction And he kind of gives his thoughts about the difference between holding one of these two to three times levered funds for a day and holding them for the long term, what that difference is.

2:17Anyway, so I think hopefully we try to put this one to bed and we talk about a bunch of other stuff with Ed too, where the flows are going and some interesting stuff about flows in terms of bonds, the difference between people hedging and people putting their foot on a gas pedal. So here's our talk with Ed Agolinsky from Direction.

2:37We're joined today by Ed Egelinsky. Ed is a managing director. He's the head of sales and distribution and the head of alternative investments from Direction. Ed, welcome back. Thanks for having me. Great to be back. I've mentioned this on the show several times. I don't know if I ever mentioned it to you, but when I started my, let me use air quotes, trading career, this was about, this is as we're coming out of the financial crisis. So I was late to the – I was late to like the – the word that I'm thinking of is party, but I was late to the doom party, let's say. Let's put it that way. And I was trading the three-time levered bear financials after they bought them, right?

3:17You were fighting the last war. Yeah, no. After a sector falls 90%, then you want to go short, right? Obviously. So it was FAS. That's still around, right? FAS is the bull, yes. FAS. Okay, my bad. I was FAS. I was F-A-Z all the way. And I thought that you guys were called Direction. Not sure where I thought you guys hailed from, but it wasn't until much later that I realized, no, dumbass, it's Direction. You know, French is good if you want. So we're definitely equal opportunity in terms of what you want to call us, but it is Direction. It's just a play on words. So I'm curious, thinking through all the different and various ways that you have to, through direction funds to go super long a market or hedge and go short.

4:05If you had to net things out, are more people this year hedging or are they putting their foot on the gas pedal if you had to give a general direction of flows? Yeah, it's interesting. It's a mix. Our top 10 inflows this year, coincidentally, one of them is FAZ. Financials have done well this year. People a bit contrarian with the triple leverage bear. Same thing with the Russell 2000 TZA, which is our triple leverage bear. But we're seeing some inflows into some of the bulls, particularly the single stock, Tesla two times, TSLL and Nvidia two times as well. So it's been a mix, a little more of a bias when you look at the broader US indices to the inverse or bear product.

4:54So I'm curious on the Tesla one, since that stock has been getting hammered lately, are people being bearish on it? Are they stepping in to try to catch the other way? I think they're stepping in. We've seen flows in both, but the bigger preponderance has been on the leverage long side, buying on the dip here. I should say trading on the dip because these are trading vehicles and should be monitored on a day-to-day basis. But you're also seeing some strong inflows in Nvidia. and, you know, up until recently, it was at all time highs, probably in the beginning to middle of March. So I'm looking, I've got wide charts pulled open.

5:30What's the tick on your NVIDIA one? NVDU. NVDU. What does the U stand for? Where's, where's that from? Oh God, I'm a dope NVIDIA. Okay. Of course. Of course. So that's interesting to hear that people are going into the short products in a bull market. Some of them, like gold miners too. We have Dust and Nugget. A lot of your - Of course. Reviewers might be familiar with that. You've had a rip in gold miners recently, the stocks on the stocks. Forget gold, the physical. There's, of course, a difference there. These are vehicles, the ones I mentioned, bear vehicles 2X on gold miners and junior gold miners.

6:12So we're seeing some activity there. And what's interesting also is our triple leveraged China, FTSE's China 50, yin and yang. We're seeing net inflows. They've been some of the top inflows in both year to date because there's been such volatility, both opportunity to trade short term on the bull side and bear side. This is unbelievable. So yin, I'm looking, has, give or take, it fluctuates, but around a billion dollars in assets. And as you mentioned, Ed, it's not exactly like China's on fire, although it does seem to be perhaps. perhaps. I want to say, I'm going to use the word bottoming, but I should say more accurately, it stopped going down.

6:47I don't know if this is the bottom, but Chinese stocks have stopped going down, which is about as nice as a thing you could say about China stocks. Yeah. I mean, listen, of course, relative to the US from a longer term perspective, it's been in a downward trend. For short term traders like what we have, January was a good month for the bears. February was a very good month for the bulls. So these are timing vehicles and should be monitored day to day. And I think Jersey Yin and Yang this year, both are down for the year. So when you get a lot of volatility up and down, that's where some of the compounding could come in, in terms of negative compounding, as a result of the underlying index that you're trading, if it doesn't stay a step up or down, and is more volatile and choppy in both directions.

7:33I got to imagine that's the case with, especially the single stock ETFs that you have, that That volatility decay, or whatever you call it, can be even greater since those individual stocks are so much more volatile than the market. Well, there's more concentration risk. But let's look at the single stocks we have are on the MAG-7 excluding Meta. So you have some of the most widely traded stocks on a daily basis. Some of those might have a higher beta. Some of them might have a lower beta. For example, like Microsoft, for example, Amazon, Google may not be as, or Apple may not be as volatile as a Tesla or, for example, an NVIDIA.

8:11So it really depends. They are 2x bull products, so you should monitor them day to day. But it is interesting if you have a bullish or short-term bearish view, the single stocks are starting to pick up interest in a number of different ways that you could trade them, whether it's the fact that you want to have a short-term bullish view on the long side or on the bear side, we have non-leveraged inverse. So there are a number of ways people are using that to take an outright short position without as much decay because it's a non-leveraged inverse. You still need to monitor them day to day or hedge gains, especially in taxable accounts.

8:53A lot of these Magnificent Seven have had some outsized gains for sure. And then we see financial professionals use it to maybe reduce beta, especially in the case of a broad index like the S &P 500. We have a non-leveraged inverse bear there. Or recently, we launched the concentrated Qs on the MAG-7, a non-leveraged inverse in that regard as well. So we're seeing it used in a number of different ways, especially the non-leveraged inverse, where it's not a 2x or 3x, where you really have to monitor those intraday or daily. the non-leveraged inverse at least gives you a little more runway, but you're still surmounted them day to day.

9:35Sorry, that's a one-to-one then on those non-leveraged ones you're talking about. That's just the opposite on a daily basis of what the underlying stock or in this case index in some case. Okay, so you mentioned that one of your newer products is the MAG-7. So you can get exposure to betting against the MAG-7. So let's say you were really worried about concentration. you could go into some sort of equal weight or small cap or mid cap or whatever it is and hedge with the MAG-7 one times bear. And that would be your way of sort of playing a long short that way, correct? Yeah, you could. It's QQQD.

10:11It's a concentrated Qs. It is the MAG-7 equal weight. It would reduce beta. Don't forget, the NASDAQ 100 is roughly 40 % right now, the MAG-7. The S &P 500, it's about 30%. Most of the people listening have exposure to maybe the Qs or SPY or some derivation of that. And they're very concentrated in the MAG-7. So here's a way to hedge out some of that risk. And or maybe you look at an equal weight approach. We have a, this is more non-leveraged strategic allocation, an equal weight NASDAQ 100. We're seeing tremendous interest there, where, of course, Apple have the same weighting as serious holdings, which is the 100 stock in the NASDAQ 100.

11:01So that broadens out your exposure instead of the concentration risk that you have, for example, in the NASDAQ 100. And it's also less reliant on tech, because when you look at the market cap weight of the NASDAQ 100, of course, tech is about 60%. So this broadens out the sector exposure and equal weights the impact of the MAG-7 along with the other 93 stocks within the NASDAQ 100. And that's been a top 10 inflow the whole year for us. And we're seeing a lot of financial professionals diversify their large cap equity exposure by adding that equal weight. So if you've written the mega cap tech bull market and it's a taxable account and you don't necessarily want to sell and pay taxes, maybe you would look to something like this, where if the market goes south, you could sort of hedge it a little bit.

11:59Is that the thinking behind it? Yeah, I think that's one way that you could look at it. or don't forget the MAG-7. I think five of the seven have earnings this month. And we see a lot of volume pre and post earnings in both directions. So if somebody wants to take an outright short position, thinks maybe the valuations are a little lofty, here's a way to trade that pre or post earnings with a non-leveraged inverse approach to the MAG-7 or the broader S &P, SPDN that we have as well. And I was looking at your equal weight NASDAQ fund today. And I know some people think that it's all the big stocks that are carrying today, and they certainly have done better.

12:42But if you look last year, it was up almost 34%. The NASDAQ 100 was up 54, so it trailed. But it's not like it wasn't going up at all. And I think that is an interesting way to play if you're saying, listen, I want to stay long tech, but I'm just worried about the concentration risk. I do think that's an interesting way to play it, especially if you're having trouble picking who are the winners are going to be in AI or something like that. It makes a lot of sense. And this actually, from a total return basis, hit a new all-time high this year, right? So it's not like it's still lagging. No, it definitely, I mean, it's lagged the market cap weighted version the last couple of years.

13:21But when you look at it relative to the S &P 500 equal weight of the S &P, it's outperformed, the QQQE. I look at this as diversification to spread out the risk and to also spread out your sector exposure within the NASDAQ 100. Anything that you guys are doing product-wise in the AI trade, or is it just too narrow in terms of the number of potential options? Well, all the single stocks, of course, are tied to AI in some way, all the Magnificent Seven. and we got exposure to the six of the seven, excluding meta. That's the only pair that we don't have at present. You can make the case that the semis, triple-leverage semis or tech, they do have some of that exposure there to AI.

14:10We also have a Moonshots ETF that's non-leveraged, that's more early-stage growth companies, more smaller-cap-oriented stocks that could give you that innovative themes that include AI as some of those sub-themes within it. But that's more of a satellite holding. It's going to have high risk reward. It is a non-leveraged vehicle, but it's aptly named Moonshots. And that's a way people can participate. And especially if they own some of the other well-known innovative theme ETFs, including ARK. There's very little overlap with our moon strategy because, as you know, ARK's more actively managed and could have some concentration risk.

14:59And it's a lot of the larger cap names where moon is not. And it seems like that's like the one space in tech for the past, I don't know, call it 18 to 24 months that hasn't really kept pace, that innovation bucket. Is that the same thing with moon as it is for ARK? Yeah, definitely. and especially even more the case of us because it's more small cap oriented. And with interest rates rising, I don't have to tell either of you that that has definitely hampered some of the small cap stocks in general, nevertheless, in the innovative space or the AI space. It's interesting. We act as if interest rates might not be having as large of an impact just because they're not really slowing down the mega cap names.

15:39But to your point, Ed, it's taken a baseball bat to the kneecaps of these non-profitable smaller tech names. There is just very little appetite out there for these stocks. Yeah. I mean, and maybe that narrative is changing. I mean, it's interesting. And you two discussed this all day. Everybody has an opinion on what the Fed's going to do. And at the beginning of the year, it was probably seven cuts. Now there's some people saying they may not cut at all based on the data that's been coming out. And inflation really has been persistent. So that might continue to curtail the small cap space. And that's why I think there's so much of an inflow continuously, particularly in the MAG-7.

16:21Cash rich, R &D, they can continue to spend. And if they don't have the intellectual capital themselves, they could go out there and buy it. Do you see a lot of interest in that new fund for people wanting to? Because I'm curious to see if there are people who are playing the contrarian way or if people are still just on that train and thinking that's the only game in town I'm going to stick with it. Well, if you're referring to QQQU and QQQD, which is the 2x bull and non-leverage inverse bear of the concentrated Qs or the MAG7 equal weight, it's really too early yet. It's been out basically a month.

16:57So we've seen some flows, but the jury's still out. I do think there'll be some interest there because a lot of people are trading leverage queues. And the majority of the return stream in 2023, particularly in the NASDAQ 100, was really concentrated in those seven stocks. And even if you look at the sectors that had performed the best last year, communication services, tech, consumer discretionary, those seven stocks made up a portion of those individual sectors, some of those stocks within each of those three sectors. So a lot of people want that volatility or at least what's controlling the return stream.

17:40And that's why we wanted to launch the concentrated Qs, the leveraged 2x and non-leveraged inverse because of where the return stream also is being generated within that index. Ed, you mentioned the word tool a few times. And that's the way that I personally view these vehicles is they are trading tools, at least, I mean, certainly the ones with leverage, I guess, to be specific. When you think about, you say these are trading vehicles, these are not buy and hold because of the time decay and all those sort of things and volatility being a drag on returns. So what is the appropriate time period?

18:18Is it less than 30 days? Is it a week? How should people think about this before they dare press the buy order? Well, first of all, they'll track for any given single day. But after one day, then there's going to be compounding what you're referencing. So tell me what the trend's going to be of that underlying index or single stock over the period of time you want to look at. And if it's stair stepping in your direction, that leverage could be a tailwind for you. But vice versa, if it's a choppy market or it's going against you, the leverage could definitely work against you. So that's why I say you need to look at this day-to-day, monitor it on a daily basis, because of the fact these are very path-dependent and the timing matters.

19:06So that's why there is no clear-cut answer. But I'd say this, that they're short-term trading vehicles. They're not designed as buy and hold vehicles or holding for any indefinite period of time. You need to see what's going on with that underlying index or individual stock and what's happening right then and there. And is that trend going to continue, whether that's the next day or the day after? And that's why you really have to look at it on a day-by-day basis. The only area where you probably could at least look at it maybe a little bit with a longer viewpoint is the non-leverage inverse. But you still need to look at them day to day because there'll be some level of decay if you're wrong, albeit not like a two or three X.

19:52And if you're using it to hedge out risk, you're going to need to rebalance every so often. So you need to know what's going on. so you can have that proper hedge in place of whatever percentage you're looking for, or if you're looking for it to reduce beta, to keep that beta exposure at the level you're looking for. So that is why we say you should monitor these on a day-to-day basis because they're path dependent and the timing matters. A simple two-day example, most people feel that if an underlying index was up strongly one day, down strongly the next, and you're in a 3x product, Let's say you're a 3x bull product.

20:32Simplicity purposes, you have$100. And the underlying index is up 5 % the first day. So that means you made 15%. So your 100 goes to$115. But unfortunately, on day two, that underlying index is down 5%. So you lost 15 % day two. And you're losing it on$115. So you're below$100 after two days. That's a simple two-day example of compounding in terms of something up and down the same amount on a 3x product. You're right the first day, wrong equally the second day on a percentage basis. But because of compounding, you're below your initial investment. That's just a simple example. So people have to understand the mechanisms of how these work.

21:13I'm glad you gave that example because one of the questions that Michael and I have got from listeners, almost more than any other one over the past five years or so, is, listen, I get the decay thing, but I'm young, I have time, I can sit through, I can sit in my hands through a 80 % crash in one of these, these products, because I've invested in crypto or whatever, I'm just going to put 10 or 20 % of my portfolio in a two or three times S &P or NASDAQ. And I'm going to hold it for the long term, I think it's going to work in my favor. What do you say to people who, who look at it in that way?

21:45And they are kind of looking at it in the more buy and hold kind of framework. What do you what do you say to them, someone who wants to use these products in that way? I wouldn't recommend it because you just can't times over time whatever leverage point you're using by two or three relative to the underlying index and think that's going to be your return. That is a false narrative. Odds are the longer you hold these, there's going to be some level of decay. there will be periods of time where if something stair steps up, maybe you get more the magnitude of that leverage point when you times it by whatever the case may be.

22:22But more often than not, the longer you hold these, unless something goes straight up or down for an infinite period of time, most markets don't work like that. So at some point, you're going to have some reversals. And as a result of that, that compounding could be adverse to you. So that's why I don't recommend these and shouldn't be looked at from a long-term basis. They got to be viewed day to day. Market trends change. And if you're not a trader or you're not an active trader, these are not the appropriate vehicles for you. But it's worse than that. So I'm looking at over the last five years, SPXL, which is the three-time bull versus SPY.

23:05So SPY is up 94 % or 95 % total return. So times two, so that's 190%. SPXL is up 170%. So it's not even up twice as much as - Well, that's where the compounding comes in. And so you're taking the risk of a 3X product. You're holding it, which I wouldn't recommend for that type of timeframe. And you're even fortunate in that case to get almost 2X. You're just not going to get the leverage point of what you're looking for beyond the short-term way it should be used when you're holding these things or considering them longer term. My point, Ed, is that not only are you not getting 3X upside, whatever, 2X upside is still, I guess, good.

23:50However, you are getting 3X downside or maybe not exactly one for one, but these things are just too volatile. I don't care if you're young and whatever. If you want leverage for the long-term, there's probably better ways to do it. Well, listen, I'm not going to pass merit on it. You want to buy options. They expire. You know what you lost. You have a limited risk. Yeah, do what you want. There's time decay. You want to do those type of things. But when you look at this, these are, for short-term active trading tools, bottom line, should never be used as something set and forget it, as I like to say.

24:26Use SPY or IWM or semiconductors or whatever the case may be. that'll give you enough volatility in its own right. It won't have the leverage to it, but you won't have the level of compounding. You'll still have compounding, but not to the extent of a 2 or 3x product, for example. Most people don't realize you're down 50 % on something, and that could happen quickly in a 2 and 3x product. If you're wrong, you got to make back 100%. So that numbers game is going to be against you when you're holding something like this for any length of time. You just can't do it. So I'm curious because a lot of your different funds, not all of them, but a lot of them, you have a bull and a bear option, right?

25:07It could be a two times or three times upside and then a one times downside. And I'm curious of the psychology behind having those offsetting, right? A hedge versus, like I said, gas pedal earlier. Is there a general direction if you had to look at the bulls versus bears on those same products? And again, you have lot of different options. You have single stocks, you have sectors, then you have total market indexes and that sort of thing. So there's a lot of different ways to play it. But is there a lean one way or another where just most of these will be more bullish than bearish? Or is it really dependent on the product?

25:42It depends on the product and what's going on with the underlying index or stock. But I will say this, on average, our flows, or at least our asset base, is more biased to the bull side. People tend to trade more with a bullish slant than a bearish slant. And that's the way our asset base tends to be. Are there time periods where that shifts? Yes. But for the most part, I think there's a bias to the bullish side of our products on average. Which makes sense. Historically, stocks go up. Ed, last year, maybe not last year, could have been 2022, starting into 2023, there was this unusual dynamic at play with an ETF that was the TLT, which is 20-year-plus bond exposure.

26:37And there was a ton of flows coming into that vehicle, even as returns were getting decimated, which is not usually don't see investors running into the fire. What have flows been like on the fixed income side with the direction suite? Yeah, I mean, I can't speak for TLT. I mean, that's a non-leveraged 20 plus year treasury. We have the triple leverage on the TLT, the 20-plus-year Treasury, basically, and what's called the swap on that to get the leverage on the ETF. The flows have been overwhelmingly to TMF, which is our triple leverage bull fund, which is interesting. But we've seen massive flows in there.