Transcript:

Caroline Woods:Stocks are at record highs, but my next guest says investors should be prepared for more risk and volatility ahead. Here to help us prepare our portfolios is Nick Lumpp president of RCN Wealth Advisors. Nick, welcome to the desk.

Nick Lumpp:Thank you very much. It’s a pleasure to be here.

Caroline Woods:All right. So you think there are reasons to start getting a bit more cautious here? What are they.

Nick Lumpp:Yeah. In general I mean, other than the the usual economic earnings related valuation kind of risks, which I do think that we’re, you know, we’ve seen a lot of tightening in financial conditions this year. That from a cyclical perspective is probably going to see a lot of the economic data start to slow into 2027. So that can create headwinds.

Nick Lumpp:Same thing on kind of the EI story as well that, you know, this past summer, the see that the acceleration in that rate of growth has has slowed. You can see again, a cyclical kind of slowdown from that perspective as well. So there are some things that could kind of slow the market and could lead to a pullback as we go in.

Nick Lumpp:Excuse me into 2027. But even beyond that, I think what’s a little bit more interesting is how the the way money is managed has evolved over the last few years, and it’s kind of distorting the movement within the market. The stock market in particular. The biggest driver of this is when you look at how there’s been a big move away from actively managed funds over to passive index funds.

Nick Lumpp:The effect that this is having is that as money comes in, they everyday have to buy all constituents of the index. And so they’re kind of gobbling up shares. And it effectively removes the supply from the market. Because by mandate an index fund can’t sell unless they have redemptions or outflows. So every week, every month that we have constant inflows in, they just keep pulling more shares from the market.

Nick Lumpp:So it leaves everyone else, other investors kind of fighting over a shrinking supply. This is creating a kind of a magnified effect that is exacerbating the volatility. And and that works both ways up and down. So that’s kind of been the big driver. And that’s been ongoing for 20 years now. But then you layer on top of that the rise in popularity of things like CTA trend following strategies, the increased use of stock options, which can create, you know, something called dealer gamma squeezes that magnifies volatility.

Nick Lumpp:And now the rise in popularity of leveraged ETFs, single stock leveraged ETFs. And now they’ve made, single stock futures. All of these are just magnifying that volatility on top of that effect that index funds are having. So it’s great in terms of when it’s working to the upside. It’s a process that builds. But should any of these dynamics reverse.

Nick Lumpp:This is why we’re seeing kind of like a grinding followed by very sharp downturns.

Caroline Woods:And so I think the big question is when do we start to see these very sharp downturns. This is an ETF spotlight will get to the fund in just a second. But first just kind of set the record straight for us. You’re protecting your portfolio for these potential downs. Or are those downturns within an overall bull market still are you still bullish on this market.

Caroline Woods:You’re just preparing for volatility or are you expecting something worse come next year?

Nick Lumpp:Well, I try to gauge things almost week by week. I do see the conditions starting to build that it seems a little late cycle. I’m not saying today right now this is at the top. I think that things could continue actually here in the fourth quarter for a little bit. But as I look into 2027, you know, we’re seeing signs that the process is slowing.

Nick Lumpp:And so I do think that, you know, we’re we’re preparing for a potential move lower here in the first half of 27.

Caroline Woods:And what does preparing your portfolio actually look like? Is it diversifying away from stocks? Is it taking risk off the table. Is it holding more cash.

Nick Lumpp:That’s you know that’s different for every investor in particular. Based on their risk tolerance, how they’re how they’re managing things. You know, you can do it in any number of ways from just simply rebalancing, locking in some of the gains, you know, yes, you can shift to safer assets, cash, other things. You can look to use other forms of strategies or approaches to the market, things that are not correlated or inversely correlated to stocks, ways of hedging.

Nick Lumpp:What we do in particular is and we feel that it works very well in this environment, and increasingly so that as these variables are making the stock market more volatile, we think that the environment works very well to use systematic trend following approaches, because the more volatile an asset or an asset class is, the better it tends to work to use a trend following approach, meaning when things are working and they’re building to the upside, you want to jump on that trend and you want to ride it as long as it goes.

Nick Lumpp:But if and when that starts to reverse, you want to exit and hopefully avoid as much of the downturn in the unwind as you can. So we found that systematic trend following is working very well. And it’s something that as you’re seeing risks start to build, you know, it’s just it’s one approach that, that an investor can use in terms of having a, a set of rules or a system that tells them no questions asked, you know, when to exit, when to get out.

Nick Lumpp:And, you know, as a way of managing that downside.

Caroline Woods:So the fund is auto R-cnn Strategic Allocation ETF. What kind of investor would look to use that?

Nick Lumpp:You know what’s interesting given the and so the fund itself, it’s fully systematic.

Caroline Woods:Meaning it’s not people making these decisions you’re relying on.

Nick Lumpp:Its more than quantitative based approach. So it uses a combination of systematic. But the best way to think about it is trend following approaches on different asset classes. So it’s more of a fund of funds. So you’ll see asset class exposures, large cap small caps, treasury bonds, gold things like that. In terms of the way it’s constructed, though, it’s all about trying to minimize the downside risk exposure.

Nick Lumpp:And so these these strategies are designed to try to cut out. It’s called the left tail risk. The big down year as much as possible to create a smoother path of compounding. So the way that you can use it, it’s almost mirrors kind of a core portfolio holding. It’s classified as a tactical allocation fund. So you can carve out part of your portfolio for a tactical sleeve because it maneuvers around, but also for, for investors, that might be a little bit more risk averse, a little bit more conservative.

Nick Lumpp:It tends to work well as just a pure equity replacement, because it generally has roughly 70% equity exposure. So when the market is trending higher, we’re participating in that. We’re trying to ride the uptrend. So you’re going to participate in the upside of markets. But when things when trends reverse and turn off, we have the ability to pull out of the stock market and go to 0% allocation.

Nick Lumpp:So it’s a way of kind of utilizing that trend following approach. Still participating, but again, managing the downside risk.

Caroline Woods:Here’s my question. I was looking at the holdings. And obviously this is, you know, the algorithms determining where the money’s going. But the two biggest positions are in small cap ETFs right now. If the expectation is that the economy is slowing going into 2027, why would you want that much small cap exposure? Yeah.

Nick Lumpp:So and this is what gets really interesting when you use a trend following approach is it almost flips the normal dynamics of how you would build a portfolio upside down. So generally with standard allocation models, large caps have a larger size or larger weighting in a portfolio than small caps. That’s generally because they’re less volatile. Small caps tend to be a more volatile asset class.

Nick Lumpp:Bigger up years in the bull markets. Bigger they get hit hard, bigger down years and bear markets. When you apply a systematic trend following approach, it it kind of distorts the the return and volatility profile of the asset class. And so the more volatile an asset is, the better it works to use a trend following approach. So because small caps tend to be more volatile, the strategies actually work better on something like small cap index Russell 2000 than it does on large caps.

Nick Lumpp:So the fund is almost backwards and it tends to have a larger weighting to small.

Caroline Woods:So what do you think would have to change in the market for the fun to have less exposure to small caps.

Nick Lumpp:So basically the way that the the strategy is built, it’s a combination of variables. There is some breadth related measure. So as you see kind of a deterioration where the participation in the market is weakening like that. And then ultimately a

Caroline Woods:Which we haven’t been seeing, which.

Nick Lumpp:We’ve been seeing. And so the strategy is getting closer. It could shut off if things continue to move lower. But it it’s still it we’re still long. We’re still in for the time being. To where it could still be just a pullback in the bull market. Continue.

Caroline Woods:So how different is this portfolio look today than it would have six months ago?

Nick Lumpp:It’s relatively pretty similar actually.

Caroline Woods:Really.

Nick Lumpp:Yeah.

Caroline Woods:So so you start in that small cap momentum that we did.

Nick Lumpp:So through the summer. Small caps had had a pretty good, you know, run this year that was you know they follow that cyclical economic upswing that we’ve seen this year. But again yeah if things start to slow and move lower I wouldn’t be surprised if the strategies turned off and we exited small caps in the months ahead.

Caroline Woods:Interesting. I also saw that you have nearly 19% of the portfolio in gold across two gold ETFs. Why that significant of is a fundamental out amount of exposure to gold right now. Because we know gold has sort of been underperforming this year.

Nick Lumpp:Yeah. Gold is always an interesting conversation. If, you know, we step back for a minute on a very long term perspective, you know, many decades, gold tends to, over time, keep pace with purchasing power. So it does act as an inflation hedge over very long periods on more of an intermediate still long term perspective. Gold tends to go in almost decade long wave cyclical waves based on inflationary conditions or disinflationary.

Nick Lumpp:And then in the short term, it really just acts as like a real time measure of financial conditions. So gold had a very strong run in 2024 and 25. Not surprised at all that it has been basically pausing and consolidating this year. Plus we had the fed turned a little bit more of a tightening bias, which is tightening financial conditions.

Nick Lumpp:That weighs on it a little bit. The way to think about gold overall in a portfolio is you almost have to you have to go back to bonds. You start there. The the Bank of England has over 300 years of data. And even in America now we have, you know, 150 years showing that the correlation between stocks and bonds tends to flip back and forth between being negatively correlated where bonds work, as that offsetting factor is something that goes up when stocks go down.

Nick Lumpp:But then there are long periods where there are positively correlated and they’re moving together. When that tends to happen, usually there’s a almost a line in the sand that when core CPI gets over three, 3.5%, bonds tend to flip from being a high level portfolio perspective that diversifying asset class or flight to safety asset class where they’re moving inversely and they hedge risk very well, they become positively correlated when that happens.

Nick Lumpp:And you can think back to 2022. Inflation was running higher. So bond investors are demanding a higher yield. You know the Fed’s raising interest rates aggressively. And bonds and stocks both went down together. So you lose that that diversification component of that the offsetting move in higher inflationary periods. That low tends to be when gold kicks in and does very well.

Nick Lumpp:So if you look at gold versus treasury bonds it’s almost this dynamic that oscillates back and forth about which one you should be using as your hedge within the portfolio based on do we have structurally higher inflation? Do we have rising inflation or periods of, you know, low and falling inflation? So we’ve been in a period of structurally higher inflation for 5 or 6 years now.

Nick Lumpp:So we look at it from a longer term perspective in that and, you know, just looking at the performance of gold relative to long term Treasury bonds over the last six years, it’s, you know, it’s done significantly better. So we do feel that it’s been positioned correctly. That is still I think we’re still in this environment and it’s still the correct portfolio hedge to have, given everything going on, you know, in the world and so on.

Caroline Woods:But if I’m a retail investor and I’ve been sitting in V0 or, you know, an S&P 500 index fund, or have even more exposure to AI and tech right now, I’m doing pretty well. Why do I want to think about 20% of a portfolio in gold and 40% in small caps? Make the case for me. Why? Now is the time to start shifting?

Caroline Woods:Well, my mindset when I’ve gotten pretty used to hefty returns.

Nick Lumpp:Yeah, I would say, the name of the game is Risk management. And so it again, it depends on every investor’s profile. There’s nothing wrong with being more aggressive, being more stock heavy. But in terms of if you look over kind of longer periods of time.

Nick Lumpp:You want to compound at as high of a rate of return as possible. So yes, you can lean more stock heavy when times are good and the market’s going up. That’s fine. It’s at times when you think that it might be slowing risks might be building that you say, you know what, maybe I want to pull some out of stocks.

Nick Lumpp:How do I diversify? What is a better way to kind of approach the market and manage risk. So I’m kind of reducing that downside risk exposure. And we still think that, you know, again in this environment, gold as well as that, as that hedge outside of, you know, beyond stocks.

Caroline Woods:So for someone with new money to invest today, what’s the biggest risk you think they should be preparing for that up?

Nick Lumpp:It all comes down to time frame. You know, the, the time horizon of this investment money. Again, I do I do see cyclical headwinds. I do think that, you know, the stock market has been on a great run. Again, I’m not saying it’s over today. We could have more upside to go, but there are risks that are building that.

Nick Lumpp:I wouldn’t be surprised with a setback as we go into 2027. So it again.

Caroline Woods:It’s a setback means a correction 10%. Are you thinking fair market and trying to pin out so well.

Nick Lumpp:Again, I try to remain very agnostic about making hard predictions on how much it goes back to those dynamics that that all of these variables that are exacerbating movements in the stock market. What I would say is it’s very much possible that if it’s almost like if the snowball starts to build, it could be a lot more than a 10% correction.

Nick Lumpp:I’m not making a prediction. There are a lot of variables that we don’t know yet. How do midterm elections go? How do you know so many variables? But it’s just a.

Caroline Woods:You want to be prepared. If it it is.

Nick Lumpp:A risk that is almost being embedded in the structure of the market, that I think investors need to be cognizant of that things. Things could move more than just, you know, a standard pullback okay.

Caroline Woods:All right I think it’s a good time to pivot to our rapid fire round. Quick questions quick answers no hedging if you can help it. Stocks are record highs. Buy now or wait.

Nick Lumpp:Wait.

Caroline Woods:Cash it 4%. Hold it or put it to work.

Caroline Woods:Hold it stocks or bonds for the next 12 months. Bonds gold by holder avoid by 6040 portfolio still works are outdated outdated. What should it look like.

Nick Lumpp:To.

Caroline Woods:Market volatility opportunity or warning sign?

Nick Lumpp:It depends how you approach it.

Caroline Woods:But opportunity biggest risk to stocks right now. Cyclical headwinds where investors overlooking opportunity right now.

Nick Lumpp:Real assets.

Caroline Woods:Meaning.

Nick Lumpp:Gold infrastructure. You could even throw Bitcoin in. I think that from a trend perspective is kicking on.

Caroline Woods:Interesting one thing investors have too much of.

Nick Lumpp:Probably tech stocks.

Caroline Woods:One thing investors don’t have enough of.

Nick Lumpp:Probably gold.

Caroline Woods:Finish the sentence. The best way to protect your portfolio right now without mentioning your fund is.

Nick Lumpp:Convexity and non correlation. Meaning meaning hedge downside risk.

Caroline Woods:All right. We will leave it there. That’s Nick Lumpp president of RCN Wealth Advisors. Nick thanks so much. Really appreciate.

Nick Lumpp:It. It was a pleasure. Thank you so.

Caroline Woods:Much. If you enjoyed this interview check out our street talk with Sonali Basak. She has some other ideas about how investors should navigate the market near record highs and likes financials. Check it out.