The Case for a Continued Rally with Warren Pies

Episode Summary

Executive Summary: Warren Pies argued that the post-2020 macro regime is different from the 2009-2020 era: inflation remains structurally higher, bond yields are less reliable as portfolio ballast, and the classic 60/40 portfolio faces more volatility. He expects measured inflation to ease enough for Fed cuts in H2 2024, but not a return to 2% inflation, and sees a slow broadening of the equity rally led by quality before lower-quality or small-cap stocks. He also explained 314’s systematic, quality-focused ETF and its research process.

Main Topics: The changing fate of 60/40 portfolios (Priority: 5/5): Pies argued the classic stock-bond mix worked exceptionally well in the disinflationary 2009-2020 regime, but that higher inflation and rising-yield shocks now reduce bonds’ ability to cushion equity drawdowns. Inflation regime and fiscal deficits (Priority: 5/5): He framed current inflation as largely driven by persistent, pro-cyclical fiscal deficits rather than just supply shocks, implying inflation is unlikely to revert fully to pre-COVID norms without fiscal adjustment. Shelter inflation and the Fed’s timing (Priority: 5/5): Pies said shelter remains sticky because new rents and existing rents converge slowly; he expects this to keep inflation elevated even as measured inflation softens enough to allow Fed cuts later in 2024. Labor market weakness in construction (Priority: 4/5): He sees early slack emerging in residential construction employment, but believes it will be gradual and insufficient on its own to trigger a recession in the near term. Second-half 2024 market outlook and breadth (Priority: 5/5): Pies expects a continued bull market with rotation from mega caps into the rest of the S&P 500, especially quality stocks, driven by Fed cuts and lower inflation pressure; he remains skeptical that small caps lead first. Sentiment, seasonality, and market tops (Priority: 4/5): He highlighted proprietary indicators such as inverse ETF volume and seasonality patterns that suggest the market is not yet at an overbought extreme, though breadth confirmation remains important within a 90-day window. 314’s quality-driven ETF and systematic process (Priority: 4/5): He described the ETF as a concentrated, monthly-rebalanced strategy that starts with quality screening, then overlays trend analysis to own the top 20 names in the S&P 500 universe.

Key Arguments: The 60/40 portfolio worked in a low-inflation, falling-rate regime because equity drawdowns were typically met with bond rallies; that cushion is weaker now because inflation and yields are part of the problem rather than the solution. Inflation is more likely to settle around a 3%-4% type regime than revert to the old 2% target absent meaningful fiscal tightening. Shelter inflation will not normalize quickly because existing rents lag new-rent trends by a long period; even a modest pickup in new rents can push convergence into mid-2025. The labor market is softening first in residential construction, which is important because construction jobs are a major source of recessionary job losses, but the weakness is gradual and not yet recessionary. The market rally is likely to broaden from mega caps to the next tier of quality names before it reaches small caps or low-quality stocks. Inverse ETF volume and equal-weight confirmation are useful contrarian/breadth signals; the rally is not yet showing the kind of euphoric sentiment that typically marks a top. Earnings estimates look ambitious, but the company-guided path has not broken down after Q1, suggesting the back half may deliver the expected inflection unless a macro shock intervenes. AI is already producing real productivity gains in research, coding, and document drafting, suggesting broad corporate efficiency benefits even if the timing and magnitude are uncertain. 314’s ETF is designed to exploit quality plus trend within a concentrated S&P 500 subset, using monthly rebalancing to take advantage of tax efficiency and market path dependence. Energy is a useful diversifier, but it is intentionally underrepresented in the quality model; Pies believes investors should manage energy exposure separately rather than force it into a quality sleeve.

Data Points: 60-40 portfolio assessment: “dead” as a phrase is overused; not literally dead - Pies used this to emphasize that the classic portfolio is less effective in the current regime, though not unusable. 5% dip buy rate, 2009-2020: about 75% of 5% dips were buying opportunities - He described this as the “golden age of dip buying” during the disinflationary era. 5% dip buy rate, 1950-2008: about 55% of 5% dips were buying opportunities - Used as the historical baseline before the 2009-2020 regime. Fiscal deficit: 6%-7% of GDP - He said deficits at these levels during full employment are a defining feature of the post-COVID economy. Inflation outlook: 3%-4% - He framed this as a plausible intermediate-term base case, not a return to 2%. Shelter convergence timing: unlikely before mid-next year - He said the gap between new rents and existing rents makes rapid shelter disinflation unlikely. New rent rise: 2%-3.5% in some markets - Recent pickup in new rents that pushes out shelter normalization. Residential construction payrolls: 3%-3.5% overstated - His models suggest current payrolls may be above sustainable levels given construction activity. Residential construction employment decline in recessions: 8% peak-to-trough - Rule of thumb he uses for typical recessionary labor deterioration. Fed cut timing: September 2024 most likely - His base case for the start of Fed easing. First-half 2024 equity performance: about 16% rally - He referenced the strong first-half move in stocks. 10-year Treasury outlook: average 4.2% in 2024 - One of their original year-ahead predictions he said he still stands by. Gold target: $2,500/oz - A prior 2024 forecast he cited as part of their outlook. Oil target: $90+ in Q1 2024 - He said oil was expected to spike early and then soften later. Equal-weight S&P performance: up only 27% - He used this to illustrate how narrow the rally has been relative to cap-weighted indices. Inverse ETF volume: about 30% of speculative ETF volume - Current reading; he said 20% is more euphoric and 60% more pessimistic. Market top signal: inverse ETFs at about 20% - He said this was seen around the 2021-2022 top. Buy signal signal: inverse ETFs at about 60% - He said this level marked a strong buy signal in June 2022. Breadth confirmation window: 90 days - He said equal-weight confirmation of new highs needs to occur within roughly 90 days. Date of S&P new high after sell-off: May 15 - He said this starts the 90-day breadth clock in his framework. AI productivity example: 1 week vs. years - He said a client charting/project that previously took years and millions was solved in about a week with AI assistance. ETF portfolio size: 20 stocks - The ETF owns the top 20 stocks from a quality-and-trend screen within the S&P 500. Initial quality screen: top 100 of 500 S&P stocks - Universe is narrowed to the top 100 by quality before trend ranking. Portfolio turnover: 3-4 times per year - Despite monthly rebalancing, the concentrated portfolio turns over several times annually. Strategy return: about 40% on a 3-year rolling basis - He cited the model’s recent performance versus major benchmarks. Outperformance vs S&P 500: +12% - He said the strategy beat the S&P 500 by roughly this amount over the cited period. Outperformance vs QUAL ETF: +12% - He said the strategy also beat the quality ETF by about this amount. Outperformance vs equal-weight S&P: +32% - He said the strategy beat the equal-weighted S&P by a wide margin.

Pivotal Quotes: "I would say that the 60-40 portfolio is dead." — Warren Pies: His opening framing on why the traditional balanced portfolio is less effective in a higher-inflation, rising-yield regime. "This has been a fiscal fuel cycle." — Warren Pies: His explanation for why deficits, not just supply shocks, have powered the economy and inflation since COVID. "The easiest edge to obtain for most investors is a behavioral edge." — Warren Pies: He was explaining why systematic, rules-based investing can help remove emotional mistakes.

Implications: Investors should expect a less forgiving macro regime than 2009-2020: inflation may stay above target, bonds may cushion less, and leadership should broaden slowly from mega caps to quality names. Tactical, systematic approaches and explicit inflation/yield awareness matter more.