Stock rally: Still a lot of money on the sidelines and lots of pent up demand, strategist says

Recession and market valuations are financial advisors' top concerns over the next year, according to a new survey from VettaFi. VettaFi Vice Chairman Tom Lydon explains what investors should do given those concerns. When it comes to valuations, Lydon tells Yahoo Finance Live that "we're starting to see a bit of FOMO" in both the equity and fixed income markets, resulting in money being redeployed back into the markets.

Video Transcript

JARED BLIKRE: Recession fears appear to be easing somewhat for the moment, but most investors are still looking for the best ways to help their clients construct their portfolios, going into 2024. According to a survey from Vettafi, 40% of financial advisors are still concerned about a recession in the next 12 months, and is part of the ETF report brought to you by Invesco QQK. Let's bring in Vettafi Chairman, Tom Lydon, to discuss how to be looking at fixed income ETFs. And this is as there are proxies for long-term investments.

Tom, thank you for being here today always. Nice to get your insights in here. We have an interesting market. The tape is saying something that maybe macro conditions aren't, but we're in a big bull trend. How are you preparing some of your clients for next year and the potentiality of a recession?

TOM LYDON: Well, absolutely. We're going to have, Jared, a meeting coming up next week. Many feel that that's going to be the last rate hike that we're going to see by the Fed, which is going to be very, very welcome. And most advisors, as we survey them regularly, feel that a year from now rates will be lower.

So it's nice that they have money on the sidelines, there's a record $6.2 trillion in money market funds that's paying 4,5% to 5%, but advisors and investors are going to be forced to get that money to work, both on the fixed income side and the equity side. So they're going longer duration, they're going up the credit curve by going into corporates and yields, because if we actually do get a recession the Fed then will be forced to get out the hatchet and start chopping rates.

And it's not going to be an orderly fashion of 25 bips every month, it may be as much as 100 basis points at a whack. So those are things that you don't want to miss out on. You want to get back allocated, especially if prior to two years ago you had a 60/40 allocation.

JARED BLIKRE: Tom I think you raise an important point, so I just want to hammer that home a little bit. The Fed, when it's raising rates, tends to ratchet up slowly and very evenly, quarter point, quarter point, or half point, half point. When it slashes and burns, well it's doing that because of reason a reason, there's problems in the economy.

So if you're getting 5% in a short-term government security today, that can quickly change overnight in six weeks when the Fed potentially cuts may be 200 basis points across two meetings. So how does this fit into your thinking about your preparation for the markets?

TOM LYDON: Well absolutely. You think about it, it's been emotional over the last couple of years, for sure. And the fact that you're getting paid to have money on the sidelines makes you feel good, especially advisors clients are saying, I'm OK avoiding volatility, which is the biggest concern for clients these days.

However, you have to think about where the puck is going. And advisors now are putting that money back to work, not just in fixed income, but also in the equity markets. And when you look at the other side of the balance sheet, for the first time in a long time, in the last month and three months, we're seeing the Russell 2000 actually keep in line with the S&P 500, which is really welcome, as top 10 stocks in the S&P has really dominated and pushed that index forward. Now we're seeing more of a broad-based rally, not only here in the US, but also overseas as well, which is very welcome.

JARED BLIKRE: Yeah, we've seen emerging markets pick up, we've seen industrials pick up, XLI at a record high, along with XLK. I didn't think that would happen a couple of months ago. But here we are, we have a very bullish tape. And according to the survey we've been talking about, and here's one of the questions Vettafi asked financial advisors, so people who are managing money.

What are you most concerned about over the next 12 months? Market valuations comes in second, 24%, so in other words maybe stocks are too high, that's what I'm thinking. And then recession is 40%. We talked about that. But should clients, should financial advisors be thinking defense at this stage when there's a huge amount of catching up it seems the market wants to do to these mega-cap leaders?

TOM LYDON: Well, there's a lot of money on the sidelines, number one, and also there's a lot of pen-up demand. You're starting to see a bit of fomo, both on the equity side and fixed income. And we're seeing that in ETF flows. All of a sudden, this year, we're seeing as much money going into fixed income ETFs as we've seen into equity ETFs, and that really hasn't happened for a long, long time.

So the good thing is, money is being redeployed back into the market on both sides of the balance sheet, that's good. At the same time what you don't want to do is find yourself with a big cash position a year from now, with lower rates and the bond market and the stock market continuing to perform well.

JARED BLIKRE: And I think another concern of investors, if they have this fomo and they start chasing the market right now, well, what happens then if the market rolls over. Of course that thinking would have kept investors out of the market, year to date. But how should investors be thinking about these kinds of defensive questions?

TOM LYDON: Well, a couple of things, look at valuations. With the S&P, the Nasdaq-100 is really expensive right now. But if you go into areas like the Russell 2000, or overseas markets, the PE ratios are 10 to 12, where they're 22 to 23 with the S&P. And a lot more with the Nasdaq-100. So you can basically get stocks half price if you shop around and diversify.

Look, we saw out of the financial crisis, it was really tough to beat the S&P 500. And the areas of the market that we're talking about now, drastically underperformed. Eventually the pendulum will swing. And we're seeing generational opportunities in those areas of the markets where people on Wall Street have been at it for a while are saying, you just can't stay away. And those that have been leaning in, in the last three months have been well rewarded for that.

JARED BLIKRE: And Tom, we've got time for one more here, looking at some of your ETF recommendations. Noticing you like a Vanguard FTSE-developed markets ETF. That's interesting to me. Maybe explain some of the reasoning behind that. And then also we talked about the Russell 2000. But then also the financial sector, you have the spider ETF XLF. So looking at VEA and XLF.

TOM LYDON: Yeah, so with VEA we've had a home country bias. And if advisors and investors look at their portfolio, with 55% of market capitalization being outside the US, we are underweighted. It's been unloved, but now we're actually seeing it come back. And you're able to buy really good companies for good prices.

So this is the biggest international developed market ETF, you're going to get good representation there. And as far as IWM, that's the Russell 2000, the biggest representation in the ETF marketplace where you can get it very, very inexpensively.

And then, finally, there's a lot of news about financials and banks. They're really doing well, they're beating expectations. Even with the unfortunate news on Goldman today. But this also has other companies like Berkshire Hathaway, Visa, Mastercard. And with higher rates, these companies are really benefiting, and will continue to benefit if we have higher rates for longer.

JARED BLIKRE: All right, we're going to end it there. Always appreciate your insights. Thanks for joining us here. Tom Lydon, the Vettafi Vice Chairman.