Oil: ‘There’s a higher floor’ under commodities, strategist says

FS Investments Chief Market Strategist Troy Gayeski joins Yahoo Finance Live to discuss the market outlook given expected Fed rate hikes, commodities, and bitcoin.

Video transcript

- Let's take a deeper dive in some of those moves Jared just highlighted. We've got Troy Gayeski, FS Investments Chief Market Strategist. Troy, it's always good to have you on the show. You sort of said this is expecting, that last year was the green light year. This year we're kind of going into a yellow light, thing slowing down. And here we are talking about these big moves to the upside with bond yields. What does that tell you about how cautious investors are now turning, especially with those rate hikes looming?

TROY GAYESKI: Yeah, so it's really interesting to see markets digest this transition from green light go to yellow light caution. And remember, all the Fed's really done so far is slow down the pace of their bond purchases. They've actually yet to hike at all, as you know. And so what you've seen, of course, is fairly mild correction so far.

You've seen some degree of pain and go go growth. But in general, we think it's going to be a rocky year. And that's one of the main reasons why we see clients focused on the challenges, not only for the fixed income portion of their portfolio, which has been a really problematic place to be really since the summer of 2020, but finally again on the equity part of their portfolio, where I think the best you can hope for this year is no multiple compression with reasonable earnings growth.

But more than likely, you'll probably get two to three turns on multiple compression. We'll call it 10% to 15% earnings growth. And so it's just a much different environment than we've been present in or we've been in since the pandemic bottom.

- Of course, one of the rosier areas that many investors had leaned into for many years to this point, especially in the bull market period, has been tech. And so with that in mind and the potential for raising rates as much as some of the bank earnings and the bank CEOs have projected, what does that set up for tech, especially as we go into some of that heavy rate concern and headwind?

TROY GAYESKI: Yeah, so I think from an asset allocation standpoint, obviously you want to fade 60-40 in favor of alternatives, whether it's senior secured commercial real estate, or multi-strategy, or CLBBs, but from a standpoint of tactical asset allocation and sector focus, this is a time where you want to be lean into cyclical and value, where you have less potential for multiple compression

And one at least on the margin fade tech, now, particularly the go go growth stories of 2020, which as you know in many cases are down 30%, 40%, 50% already, those very difficult, if not impossible, to time a bottom, so within the market itself, time to rotate a little bit away from large cap tech, where you would expect more multiple compression into more value cyclical opportunities.

And it's actually interesting you guys were bringing up oil before because oil is obviously benefiting from tremendous supply constraints with burgeoning demand is the real economy continues to pick up. And that's one of the areas that we're cyclically focused on because basically, if you think of the commodity complex, there's been underinvestment in energy production now for the last year and a half. And it's unlikely that changes. So as you continue to get reopening the economy, that's one of the sectors that should, at least modestly, outperform the broader market.

- Yeah, how much more runway do you see on that front, though? If we're talking about oil moves specifically, we've heard some calls for $100 a barrel. Obviously energy names have gone up alongside those expectations. Is this more of a short term play here, or do you think there's a bit more room to run?

TROY GAYESKI: Yeah, so I think the best way to think about it is there's a higher floor under the entire commodity complex because of the lack of investment. In oil it's been more recent. But in commodities in iron ore it's been going for six, seven years.

So you can have confidence that the floors are higher, and in the near term, as long as the dollar doesn't strengthen dramatically, the trend is your friend there. So you'll continue to see modest upside. But no one's talking about $150 barrel oil. But you could certainly make a run at $100 over the next three to six months.

- OK, so we've got to switch gears here. We've got to bring Bitcoin into the chat and some of the thinking around how this all sets up for going forward from here and what particularly you are tracking on how Bitcoin is setting itself up for some supply shock. Break that down for us.

TROY GAYESKI: Yeah, so in the short term, we would certainly favor higher risk reward opportunities, like in senior secured commercial real estate, or liquid multi-strategy, or some of the areas of corporate credit where you have higher yield with some price appreciation potential, like double BCLOs.

But within crypto particularly, you know the thing to remember is just like all growth stocks, it is more challenged in an environment of less money supply growth. That was one of the principal reasons for its meteoric appreciation starting in 2020. And so as that slows, gains would be harder.

Furthermore, we're also fairly late in the halving cycle. This has already been the longest halving cycle bull market period. We peaked out obviously late last year. So our message to investors there is pretty straightforward. It's you really shouldn't be owning Bitcoin or crypto for the next month, three months, or six months.

You should own it because it's one of the principal ways that you're hedging continued government profligacy, meaning over the next three, five, seven, ten years, do you continue to expect large budget deficits? Do you continue to expect more money supply growth than we've had in previous cycles? And if the answer is yes, then you should at least have some portion of your portfolio there. That being said, we do expect continued chop.

It's an uncertain environment. And it's basically a tug of war between continued adoption, not only by institutions, but ultra high net worth individuals, not just in the US, but globally and the natural dynamics of the having cycle and obviously a Fed that's tightening before our eyes.

- So Troy, if it is about a hedge, how should investors be looking at this? Are we talking about 1% exposure, 5%, I mean, what's the risk? I mean, I guess it depends on somebody's risk tolerance. But what are you telling clients?

TROY GAYESKI: No, so and again, remember that the hedge is a hedge against government profligacy, not against negative market price action. That always gets confused by people. Like, whenever you have a big drawdown in broader markets, you should expect crypto to sell off in tandem. Now sometimes it does, sometimes it doesn't.

What we're talking about here is more medium to long term, where if you look at your asset allocation, you threw out numbers like 1%. Maybe it's 50 basis points. If you have a higher risk tolerance, maybe it's as high as five, if you're a younger person, like yourself. But you have to understand that this is a very cyclical volatile asset, and so you could wake up any day and be down 20% to 30%.

If that changes your frame of mind, if that causes you distress, then you should have a smaller allocation. But it's important, just like with gold and real estate and other assets, that you have some assets in your portfolio that will benefit from continued government profligacy, like we've really seen over the last 20 years, plus starting with the Greenspan era.

Most investors are much more aware now of what's going on with monetary policy since the pandemic bottom. But they're less aware that this is a continuation of these megatrends, where it requires more and more money supply to generate less and less GDP and larger and larger deficits. So I think you're in the right zip code.

And it ultimately comes down to people's risk tolerance, where they are in their life, how comfortable are they experiencing large drawdowns in order to have material upside. And then again, if you step back even further, it's one of the few assets that still has the ability to double or triple over a medium to longer term time horizon, whereas if you look at the NASDAQ as an example, everyone expects a choppy year this year, we think.

And if they don't, then obviously they've got a rude surprise. But over the medium to long term, it's going to take a lot for the NASDAQ to double from here, whereas with Bitcoin you could certainly see that happening in 2024, 2025.

- All right, a lot of big price targets out there for Bitcoin. As to where we will hit at the end of this year and even going out to 2025, Troy, we're going to check back in in the future. That's Troy Gayeski, who is the Chief Market Strategist over at FS Investments.