Transcript:
Caroline Woods: What do you do with your tech stocks when this volatility hits? Jon Molchan is head of ETFs and senior portfolio manager at Shelton Capital, joins us now. Jon, great to have you here.
Jonathan Molchan: Thanks for having me Caroline. It’s great to be here.
Caroline Woods: All right. So tell us tech stocks have been on this roller coaster for investors who don’t want to sell but are nervous about volatility. What options do they have.
Jonathan Molchan: So I think what’s been on the mind of everyone is is AI overdone. And then last week we obviously did not price and the outcome. And there’s more questions about AI. But there’s also questions about inflation and interest rates, which continue to be persistently a challenge, where investors can look, for growth in cash flow or an options based strategies which have become increasingly popular.
Caroline Woods: Okay, so on that note, this is an ETF spotlight your ETF SEPQ, the STF Tactical Growth and Income ETF owns names like Nvidia Apple Microsoft while also targeting that monthly income. So tell us how that actually works.
Jonathan Molchan: Sure. So it’s a basket of growth stocks. And it’s very similar to the top ten holdings in the Nasdaq 100 to the S&P 500. But it’s about 100 companies. And then what it can do is in periods of continued trend change. So either up or down it can try to determine the optimal, allocation to a risk asset, which is the growth stocks or can back into treasuries or T-bills.
Jonathan Molchan: You know, largely since Covid when inflation hit, people could find safety and long duration bonds, ten, 20 year, 30 year treasuries. Now that correlation is picked up, everybody saw it in 2022 when you lost more in long duration bonds and you did in the Nasdaq 100. So it also offers the adaptability to go into T-bills, which is very similar to kind of raising a cash balance in your portfolio when it can do that within the tax efficiency of an ETF wrapper.
Jonathan Molchan: P you know, common denominator here is the cash flow mechanism. So regardless of what the underlying holdings look like it supports a monthly distribution. And it’s really meant to supplement, investors cash flow requirements in periods of interest rate volatility. And you know, prior to Covid, it was, declining interest rates. So people were always looking for ways to generate cash flow without necessarily taking on the risks tied to traditional bonds.
Caroline Woods: So tell me we’re in a period of interest rate volatility. We’re also in a period of tech volatility. What does that allocation look like right now. How much is in cash. How much is in equities. How much is in bonds.
Jonathan Molchan: So the key to this strategy is to help investors remove emotion. Attempt to remove the capitulation risk and then the fear of market timing on the way back in. So the outsized moves in these sharp V-shaped moves we do not respond to, if there is a move that is sustained, then yes, the strategy will augment. Right now, it’s still in stocks.
Jonathan Molchan: You know, we shouldn’t forget that rule of ten. So going back to 1990, if you missed the ten largest updates in the S&P 500, you’re underwater. And the largest updates tend to be around the largest down days. So we’ve seen this in recent times. If you think about what’s just happened in the last week or so, if we think about what happened in March, and if we think about last year with Liberation Day, you know, gap lowers were followed by a ferocious move higher.
Jonathan Molchan: And so then it’s a matter of thinking back even farther in time, back to oh nine, when people didn’t know, is it time to get back in or not? Whereas this rules based strategy tends to wipe out those outsized moves, normalized it, and then say, is this a true change? Or is this just a shock to the system?
Caroline Woods: But if this is largely just invested in the Nasdaq 100, why would I be invested in SEPQ here versus just invested in the Nasdaq trading?
Jonathan Molchan: What is it? So the benefit of SEPQ is that we can support the cash flow needs and the growth profile that many investors require. You know, when people look at options based strategies, I think it’s important that they look at the underlying benchmark that they track and how closely they are tracking that on absolute return basis while supporting those cash flow needs.
Jonathan Molchan: If you are giving up five, 10% of that total return for that cash flow, then you’ve got to start asking, why are you even in it? Because to many investors, the total return is the cash flow. For at the end of the day, the idea of SEPQ is that we employ a call spread, not a covered call.
Jonathan Molchan: The idea is that along the way, you’re going to get enhanced upside participation, and that we will have drawdowns from time to time. Statistically, you should see about one month out of every calendar year with the 10% drawdown. And we are trying to collect enough along the way and an active approach so that when we do have a drawdown, it’s not the end of the world and that we just continue to compound over time.
Caroline Woods: So if tech drops 10% from here, another 10%, how much downside protection to SEPQ actually provide? And then if tech stocks rally sharply again, how much of that upside can investors capture?
Jonathan Molchan: Sure. So there’s three compositions to the fund. It can be 100% stocks. It can be 50% stocks or it can be 10% stocks. If we were 10% of lower Caroline, we would be fully risk off. And then it’s a multi-day confirmation to get reinvested into stocks from there. I think what people need to focus on with this is that over the long term, the growth profile will be intact.
Jonathan Molchan: And that this is an a income solution that offers better growth than traditional fixed income.
Caroline Woods: Yeah. I saw an advertised distribution yield around 10 or 11%. So I guess what’s the trade off for investors. What could they potentially be giving up for a 10 to 11% yield?
Jonathan Molchan: Right now on a three year basis, the fund is lagging the Nasdaq by about 3%. Year to date, it’s outperforming the Nasdaq. The the real focus is not to overreact. It’s the from a quantitative perspective, reaction is very dangerous. It brings emotion into the equation. And that’s what this rules based model is trying to eliminate.
Jonathan Molchan: So 90% of this is quantitative 10% is qualitative with market structure. These types of shocks definitely do cause concern at times. But they also did in Liberation Day. And then in March of this year when the Iranian headlines started to cross, I think it’s, you know, the age old saying, over the long term, you make money by sitting on your hands.
Jonathan Molchan:
Caroline Woods: So this is sort of a set it and forget it and let you do the work or let your models do the work.
Jonathan Molchan: It removes it removes the market timing aspect from the end investor, while producing that cash flow for them. But over time, if we have a sustained drawdown, it has the ability, unlike an index fund, to do risk. Okay. Obviously we haven’t necessarily had that in the last few years as the market is basically, had quick shocks to the system and then rallied quickly.
Jonathan Molchan: But this, this really goes on full display. If we were to enter a real bear market or a recession.
Caroline Woods: Okay. And let’s talk about your market outlook then. Is this a market that you think we should be kind of wary of? You talked about maybe some of the AI outcome not being priced in last week. Do you expect there to be more volatility and potentially more downside ahead.
Jonathan Molchan: Well it’s funny because just this morning and last night, the Anthropic headlines cross. So no slowdown in the IPO pipeline makes you think that possibly this is just noise. If we were looking at volatility benchmarks, you know, typically when the VXN retreats from 35, which is the VIX for the Nasdaq, we see, you know, single to mid 18 digit returns over the next 12 months.
Jonathan Molchan: The VIX is still hovering around 20 which doesn’t scream panic. Earnings season is going fine I mean Q3 is tracking at a 4% beat it’s lower than Q2 and 8% beat, but more than half of the company’s guidance has topped estimates. And you know, when we typically see these types of freak out reactions, the market is higher and 6 to 12 months.
Jonathan Molchan: That being said, inflation is a real problem. We have another hot CPI print today, a slight uptick, but it’s still the same issue, which is that energy and transportation is a big headwind for the economy. And food is next. These are three things that we all need. And, you know, as we take like more of a macro level, Caroline, it’s a little concerning because when we came into Covid, US savings as a percentage of disposable income was at the highest levels since the reading started in 1940s.
Jonathan Molchan: And since then with like we’ve had a resilient consumer. But we we’ve now hit revolving a non revolving debt on the consumer. All time highs. Credit cards are almost at 1.4 trillion. Student and auto loans are almost at 4 trillion. The US national debt has doubled in ten years. And we’re now on the heels of today’s CPI print.
Jonathan Molchan: And, some Fed speak this morning looking at a 50 basis point hike in December. So the concern around inflation and the the their foggy visibility on interest rates is, is only going to add to the noise and potentially add to the chart going forward. But with that being said, at what point does earnings growth in the seesaw with the the resiliency of a consumer start to go the other way?
Jonathan Molchan: And I think that’s the biggest question mark going forward.
Caroline Woods: So do you think that the biggest risk to the bull market is inflation here?
Jonathan Molchan: I think inflation is a very big problem.
Caroline Woods: And and the AI trade remains strong. If the consumer is weak.
Jonathan Molchan: I think the AI trade is very interesting and that it could lead to efficiency within companies. That keeps the broader economy strong. Those efficiencies could benefit the consumer. But I think that inflation certainly it’s led by energy. So if energy starts to come in, the geopolitical risks start to calm down, then I don’t think that we are looking at anything that should thwart, you know, further positive outcomes in the stock market.
Jonathan Molchan: Breadth and the S&P 500 is hitting 32 week highs. So you know unlike dot-com AI is benefiting other sectors. Whereas dot-com was really only benefiting tech.
Caroline Woods: So I think that you know as we look at year two titles obviously ahead of ETFs we talked a lot about one of your your many funds. But when you put on your senior portfolio manager cap, what is your best advice to the retail investor who sees all of these different potential outcomes and wonder wonders, well, what does that mean for where I should put my money right now?
Jonathan Molchan: Well, I saw an interesting fact that, of the top 15, or 11 of the top 15 best performing S&P constituents in the first half are now the 15 worst and the second half.
Jonathan Molchan: So that is a move.
Jonathan Molchan: And, you know, looking at the moves that have happened in Intel and SanDisk and I think you have to sit back and say, are these companies going out of business or is this a overreaction to, short term shock that was not priced in? You know, I think the way that.
Jonathan Molchan: I think it’s a short term shock.
Jonathan Molchan: So these are quality companies that everybody requires every day to do their daily duties. I think if you were concerned about froth in the AI trade two weeks ago, it’s out. The forward projected earnings on a 12 month basis for the Nasdaq has now retreated to Covid levels. Forward P/E on the equal weight S&P 500 is 16.
Jonathan Molchan: The S&P is at 18. That valuation gap it’s narrowed so considerably in the last few weeks, months that if it was a valuation concern that’s now been eliminated, from the conversation. And now it’s a matter of single stock picking and saying, okay, well, how are we going to invest in the future? And I still believe that technology and growth companies are going to lead us into the future, supported by cyclicals.
Jonathan Molchan: And some of, let’s just say, the other 450 names in the S&P 500.
Caroline Woods: You know, I do also want to ask about Nvidia because you talked about some of that. Not that Nvidia. Was that the standout out performer at the start of the year. But when a name like Nvidia, which is trading below 170 now drops this much, does your model look at that as a buying opportunity or as a warning sign.
Jonathan Molchan: That I think there’s more going on with that name right now. That is not necessarily modeled out in most instances for anyone. The fact that Nvidia was down yesterday in the Nasdaq was up as much as it was, I think kind of tells you where investor sentiment lays. You know, within the ETF, for SEPQ, the idea is to give investors more of that broader base growth exposure while supporting their income or cash flow needs.
Jonathan Molchan: So headlines from day to day that are very contained for the time being on one name, although it has been the leader, but there are a handful of names behind it that have also led, to the performance year to date of PAC.
Caroline Woods: Okay, so just to try to get the clear takeaway that and bring it back to the fund, because this is an ETF spotlight, it seems to me like you think that tech on the whole is pretty cheap right now. You see a case for it to continue to to maybe rally from here now that the froth is out.
Caroline Woods: So if I already own the S&P 500, why should I add CPU.
Jonathan Molchan: So we have two products. We have SEPQ and we have CP, and CP has more of a value tilt. Think of a starting universe of the S&P 500 holds about 40 or 50 names, and it does single stock cover calls. And then if you have SEPQ you’ve got more of a Nasdaq tech feel, more growth oriented with the index option overlay.
Jonathan Molchan: And so if you own the S&P 500, largely your top ten between the Nasdaq and the S&P are identical. The only difference is what is your next 90 or your next or nine you look like. But if you were to combine a 6040 blend of CP and SEPQ, what you’re getting is a kind of an augmented 2.0 version of a 6040 portfolio, which we all learned was inherently flawed in 2022 when stock and bond correlations went to one.
Jonathan Molchan: And they’re starting to feel like that again. And what this will ultimately give you is, as of the end of Q3, roughly a 21% one year return versus, say, a 9% return on a 6040, but it’s generating 9 to 10% cash flow. The S&P does not generate that kind of a dividend profile. So you’re getting that kind of stock exposure, upside appreciation cash flow on a monthly basis.
Jonathan Molchan: But you’re getting it within two ETF center giving you the tax efficiency, the ability to not worry about capitulating or market timing on the way back in, supposedly.
Caroline Woods: Okay. All right. I think this is a great time to pivot to our rapid fire round. Quick questions, quick answers. Are you ready Jon?
Jonathan Molchan: All right I’m ready.
Caroline Woods: All right. Here we go. Stocks by year end higher or lower from here. Higher growth or value from here.
Jonathan Molchan: Value.
Caroline Woods: Even though did you say SEPQ should be 60 and CP should be 40 or was it the other way.
Jonathan Molchan: It was the other way around.
Caroline Woods: Okay. Tech volatility opportunity or warning.
Jonathan Molchan: Huge opportunity for people trying to harvest premiums and call options while still participating in the AI trade.
Caroline Woods: Higher distributions or higher total returns.
Jonathan Molchan: Higher returns on.
Caroline Woods: Stocks or bonds for income.
Jonathan Molchan: It depends how you use the options on the stocks.
Caroline Woods: Monthly income or maximum upside.
Jonathan Molchan: Depends on the investor, but I am in the monthly income business.
Caroline Woods: Bigger risk missing the rally or chasing yields. See the type.
Jonathan Molchan: Of go chasing yield.
Caroline Woods: Next 12 months higher volatility or calmer markets.
Jonathan Molchan: I think you could see the VIX level between 20 and 30 for some time. But I don’t think that’s going to impact a total return that’s positive. And I don’t think that that’s anything but a positive. There are options writing premiums and the distributions they can pay investors the.
Caroline Woods: Best opportunity from here tech stocks or the broader market.
Jonathan Molchan: Depends what tech stocks SanDisk has been pummeled. But I think, you probably will see the market cap weighted tech stocks again kind of regain that momentum.
Caroline Woods: So mag seven or the rest of tech.
Jonathan Molchan: I think the rest of tech.
Caroline Woods: Semis are software gift.
Jonathan Molchan: Moves I overnight semis.
Caroline Woods: And finish this sentence. The biggest misconception about options income ETFs is.
Jonathan Molchan: That the yield is safe.
Caroline Woods: And the biggest risk investors overlook with SEPQ and CP is.
Jonathan Molchan: Both funds. Those smaller in AUM are led by seasoned investment teams that have been doing this for decades.
Caroline Woods: We that’s a risk.
Jonathan Molchan: Now we take it we take a very active, indifferent approach that, you know, we we are trying to solve for the risk of people that pile into index based option overlay strategies where you’re at the mercy of the index.
Caroline Woods: Okay. We’ll leave it there. Jonathan Molchan head of ETFs and senior portfolio manager at Shelton Capital. Really appreciate it. Thanks so much, Jon.
Jonathan Molchan: Thank you Caroline.
Caroline Woods: If you enjoyed this street talk check out our full interview with James Demmert And he also thinks tech is cheap and reveals the exact tech stocks to buy now.