Why the ripple effect on residential real estate may hit your neighborhood
Ric Edelman: It's Friday, August 18th. We've been talking in past months about the problem with real estate in major cities across the country. There's a 20% vacancy rate, and that's before sublets are considered. Thousands of buildings have mortgages that were obtained when interest rates were near zero. A lot of those buildings now have to be refinanced over the next couple of years. And with interest rates now at 5%, the monthly payments are going to skyrocket at the very moment that tenants are not paying rent. Double whammy. We're already seeing defaults.
This is going to increase and the residential sector homeowners don't want to sell because they refinanced back when rates were 2 or 3%. But if they buy a new house today, they'll have to pay a new mortgage rate of 5 or 6%. So they're sitting on their houses, not moving. That means less inventory for people who want to buy homes. It's also causing the prices of new home construction to rise. And between those prices and higher interest rates, buyers are being priced out of the market. That's hurting the real estate market. And that's the biggest driver of our economy.
And now there's a new report that says it's not just commercial retail and residential real estate that's in trouble. Government real estate's in trouble, too. The GAO, the Government Accountability Office, says many large government buildings are being significantly underused. GAO examined 24 agencies that occupy most of the federal government's buildings in Washington, D.C. We're talking 21,000,000 square feet of office space. 17 of the 24 agencies are at just 25% of their real estate capacity. We're talking the EPA, Department of Justice, Department of Labor, State Department. On average, these two dozen agencies are only collectively using about 45% of their headquarters capacity.
The government is spending $2 billion a year maintaining the buildings they own. They're spending another $5 billion a year on rent at other buildings. But most of that space is empty. GAO found, for example, at the Small Business Administration that even if every employee showed up at the office, at the same time, the building would only be two-thirds occupied. GAO says that's a conservative estimate.
So you can forget about the government adding to its office space needs. That means they're out of the market. They're not going to be a buyer of real estate anytime soon. That's going to put more pressure on the real estate marketplace nationally. And yeah, the worse it is for real estate, the worse it is for the economy.
The Big Investment Story of the Year: Generative AI
You know, of course, the big investment story of the year. Generative AI. It's not like AI's new, but this new development is making what was already a fast growing sector into a rocket ship. By the end of the decade, annual spending on AI computer chips is expected to hit $165 billion. That's a 30% annual rate of return between now and 2030. Spending on graphic processing units, hardware manufacturers, memory and networking gear. All this is going to skyrocket. Everybody's got to upgrade their gear. That means lots of spending. Traditional computer processors were known as CPUs. I'm sure you know that phrase CPU central processing unit. Your old desktop computer had one of those, but now forget about CPU. It's all about GPUs, graphic processing units. They can handle demand for heavy duty processing. Originally designed for video games, but now it's also used for AI as well as crypto. $16 billion worth of GPUs went into AI use cases last year and spending is just getting started.
All told, IT buyers are going to spend $224 billion on data centers every year. We're talking about money being spent on processors, memory storage, networking components and other hardware. If you figure that companies replace their gear every four years, we're talking more than $1 trillion worth of new spending over just the next few years.
It's easy to see why all this is happening. Ai chips are used in everything for autonomous driving edge computing, mobile devices, networking equipment, high speed memory cooling systems, you name it. And that is all before we even talk about ChatGPT that hit 100 million users in just two months, it took Netflix ten years to reach that number of users.
Generative AI has the potential to revolutionize just about every industry, and that means that just about every industry has to invest in it. We're talking content creation for text music, art, video, customer service using chat bots, healthcare because generative AI can help doctors with electronic medical records and imaging data for diagnoses. Generative AI develops new diagnostic tools, predicts disease outcomes, improves patient care In finance, generative AI can predict stock prices, exchange rates and the debt market. It can translate languages faster and more accurately than humans or other existing software. It can be used in gaming to create characters, environments and storylines. And of course you can use it when you search online.
And one of the most important areas of opportunity is how AI will expand the market for robots. The global robotic market is expected to double this decade to more than $100 billion. Not only is the tech getting cheaper, I mean, think about it. In 2010, the average industrial robot cost $46,000. They now cost only 15 grand. Generative AI is not only helping those robots become cheaper, it's helping them do more than ever.
So watch for huge growth in industrial robots and automation, as well as non-industrial robots. That means the bots. You're going to have to help you around the house cooking and cleaning, for example, and eventually babysitting, as well as the impact on autonomous vehicles and self-flying cars. And get this, generative AI is only eight months old. Imagine when it's eight years old. It's all pretty exciting. If you would like to add exposure to generative AI and robotics to your client portfolios. Look at the Global X Robotics and Artificial Intelligence ETF. The symbol is BOTZ. It's the world's largest AI fund launched back in 2016. It's got $2.5 billion in assets. It tracks the Global X Robotics and Artificial Intelligence thematic index, passively managed fund. You can learn about this by going to Global X ETFs.com. And if you're an investor, talk to your financial advisor about investing in AI and robotics.
Exclusive Interview: Invesco’s Nick Kalivas on the Big Problem with Owning the S&P 500 Stock Index
Ric Edelman: It's impossible to talk about the future without talking about investment strategy, because let's face it, this is a personal finance focused podcast and we are spending all of our time and effort trying to figure out how to achieve retirement security, how to ultimately generate income in retirement, how to make sure that we are okay, financially speaking. And you're spending an awful lot of time and effort and energy and focus accumulating assets, saving money for your future. And the real fundamental question that everybody always has is what's the investment strategy? And there is a fundamental issue, a fundamental concern that I have that I fear that you're doing something wrong, that you don't realize you're doing it wrong because you specifically think you're doing it right because of what so many people are telling you and have been telling you for a long time. And I know I'm not making any sense right now, but trust me, this is going to become clear in a minute. And to help make sure that it gets clear, I'm going to bring in an ally to help make sure this conversation makes a whole lot of sense. So I'm really happy to introduce Nick Kalivas. He is the head of ETF Factor and Core Equity product strategy at Invesco. Nick, I've had you on the show before. I'm excited to have you back. Good to be with you.
Nick Kalivas: Yeah, it's great to be here. Thanks for having me.
Ric Edelman: I asked Nick to come back and even though his title is confusing, head of ETF Factor and Core Equity Product Strategy. In fact, what Nick does is incredibly simple in concept, and I want you to understand what it is Nick is focusing on because Nick is getting this right and what they're doing at Invesco is really important and it has a fundamental impact on how you're managing your assets. And Nick, to break this down for everybody to make sure that both investment advisors who are paying attention to us right today as well as investors, I want to make sure we're doing this in baby steps. So I'm going to ask you to talk about this one step at a time. And we're going to begin with the very basic element of investment strategy active versus passive. So let's start there. Begin by defining for us what those two words mean and the difference between active investing and passive investing.
Nick Kalivas: Sure. I think when you're thinking about active investing, there’s a couple trees we can go down. But first of all, you can think about a manager kind of looking at the market, looking at the environment and based on kind of their strategy investing or buying and selling stocks to try to achieve an outperformance. So there's a bit of a human element to it trying to use different tools and theories to gain excess return. When we think about passive, you can think on one extreme, you know, just buying the S&P 500 or the Russell 1000. There's something we would call smart indexing or smart beta that periodically changes what it owns in the portfolio to try to achieve excess return.
Ric Edelman: And that's really what I want to home in on, because what it comes down to, as you noted, in looking at the array of stocks available in the stock market and there are thousands of them, investors are facing a very fundamental decision on a daily basis. What stocks will I own or what basket of stocks will I own? And the question is, do I want to buy all the stocks and call it a day or do I want to own only the stocks that are going to do better than the other stocks?
In other words, do I want to buy the stocks that beat the market? That's the holy grail of investing, isn't it? And these active managers, those who are actively engaged in that effort, are literally trying to do exactly that. They're trying to buy only the stocks that do better than other stocks. And there's a lot of people who try to do this. There's a lot of fun companies. There are a lot of money managers. There are a lot of brokerage firms. There are a lot of hedge funds. That's what their business model is. They claim that they're going to do their best to try to beat the market.
But a lot of people have looked at a lot of data over the last 20-30 years and have reached the conclusion that the active managers really don't do all that very good a job at achieving their goals. They don't really succeed at beating the market. So all they're doing is spending a whole lot of time, a whole lot of effort, a whole lot of money in an effort to accomplish a goal that they end up failing to accomplish. And this is why the notion of passive investing, let's just buy the S&P 500, let's just buy the Wilshire 5000. Let's just buy the Russell 1000. Let's just buy an index and own those stocks which represent the market instead of trying to beat the market. Let's buy the market and call it a day. And this is, I think, most effectively represented by the S&P 500. This is the best-known index. It's the most broadly familiar. And how much money is in this these days, Nick? How much money has been invested in index funds that represent the S&P 500?
Nick Kalivas: Oh, it's trillions of dollars. There is an awful lot of money that is benchmarked to the S&P 500 and specifically into index based products.
Ric Edelman: And so when we look at this, trillions of dollars in the S&P 500, these 500 stocks or the 500 largest companies that are publicly traded in America, these are household names, Ford and IBM and Procter and Gamble and Delta Airlines. And the list goes on and on. So I'm going to bet that you own an index fund, an ETF or a mutual fund that reflects the S&P 500 because it is so incredibly common. And here's the point of this conversation. Nick, tell me if you agree, I believe that most people do not realize that there is a huge problem associated with the S&P 500 as an investment strategy. They don't understand a fundamental fact about this index that if they knew it, they would rethink their ownership of it.
Nick Kalivas: I think that is very true. It's my perception when people invest in the S&P 500 index, you know, they kind of think that they're getting this more equal or spread out allocation to the stocks that make up the 500. They are not in tune to the concept of market cap weighting, which is how the S&P 500 is constructed. In the S&P 500, you tend to get a heavy amount of concentration, meaning that a few names can make up a substantial portion of your investment. And when you allocate a dollar of new money to the S&P 500, you're putting more of that dollar in the stocks that have already risen and less of that dollar in the stocks that have lagged.
Ric Edelman: Now, let's make sure people understand why this is the case. We're talking you used a phrase there called market cap weighting. And I want to make sure everybody understands what we mean by that. In other words, when people buy in the S&P 500, they think that they're investing in 500 stocks. I mean, that's the whole point of it. I want to own a diversified portfolio. There's safety in numbers. I don't want to put my money into a single stock. I'm going to put my money in 500 stocks. And the S&P 500 index is a convenient, easy way for me to accomplish that goal. What people don't realize is that they're not putting their money equally into those 500 stocks. What they're doing instead is putting their money into those 500 stocks based on the size of each of those companies. In other words, more of the money goes into the number one stock than in the number 500 stock. Give us an idea of how significant that is, Nick. In other words, if I were to invest $100 into the S&P 500, how much of my $100 is going into all 500 of those stocks?
Nick Kalivas: Yeah, that's a that's a good question. So the top 50 names make up about 50% of the entire S&P 500.
Ric Edelman: And it's rather astonishing that you have more money in the top 50 stocks than in the other 450 combined. Which raises the question, why are you bothering to invest in the other 450? You have such a small portion of your investment allocated to them. It's kind of pointless. It doesn't matter how well those stocks do. There's so little money invested in them, they're not going to move the needle in terms of your investment performance. And this is something that I think most people don't understand. If you were to say to most folks, why do you own the S&P 500, they would say, because I want to be diversified. They would have no idea that they, in fact, are suffering from something we call concentration risk.
Nick Kalivas: Yeah, that's exactly right. I mean, you know, at the end of the quarter when we measured it, Apple and Microsoft individually had greater value than the entire S&P 500 retail sector and materials sector and the utility sector. And combine, they were actually worth more than the financial sector. And so I think that shows you the concentration that is present now.
Ric Edelman: It sounds like somebody made a horrible mistake in the construction of this index to have it so lopsided in such a way. But let's face it, the folks at Standard and Poor's are not dummies, so they clearly didn't do something wrong. They didn't make a fundamental error. Explain to us what the purpose of the S&P 500 index is, because it was never originally built as an investment strategy. It was built for an entirely different reason. Explain to folks what that reason is.
Nick Kalivas: They're just trying to give you a snapshot on the size of the equity market more generally as opposed to being an investment strategy. When you look at the academic research, they would tell you that strategies such as value or smaller companies or quality or low volatility or yield, those are really the ways to generate stronger, more durable returns over time.
Ric Edelman: Yeah, the S&P 500 index was created as a proxy for what's going on in the economy. At some point somebody said, Well, gee, how about if I just invest in the index and index funds were invented and it was never really designed for that purpose. It just kind of evolved in that way. And here we are. Trillions of dollars are now invested in a strategy that is based on an index that was never designed for that purpose. So that's the problem that we are now facing. We have tens of millions of Americans who have invested trillions of dollars of money into a fund that is investing in a cap weighted way where they are putting most of their money in the top part of that list as opposed to equally in the entire list. This is the problem that you've identified at Invesco, and you've also created a solution to that problem. So I want you to talk, Nick, about the Invesco S&P 500 Equal Weight ETF that Invesco created 20 years ago.
Nick Kalivas: Yeah. So this ETF [Ticker RSP] takes those names in the S&P 500, but equally weights them every quarter. So if you think about the weighting, it's literally every company is 1/500 of the portfolio. Now what happens every quarter to keep the strategy equal weighted, those stocks that have run up above their equal weight are trimmed back. Those stocks that have fallen below equal weight are bought back up to equal weight. So there's this natural buy low, sell high type of process that takes place to maintain the equal weighting. Likewise, when you look at the academic data and you study the markets, what you see happening is that the equal weight is providing you more exposure to the smaller names in the S&P 500.
And historically speaking, those smaller names have tended to generate a higher return. And the spread that you have seen historically between the smallest 50 names and the largest 50 names is about 4.5%. And it's a concept that the academics and the practitioners call the small size effect. And so RSP is actually giving you some exposure to that smaller size effect.
Likewise, it's also providing you a bit of a value tilt because of that quarterly rebalance process. It's tending to buy low, sell high. And if you look again at the literature and study the market on value investing, Warren Buffett maybe being the poster child for value investing. And this isn't a specific value strategy, but the process gives you some. Value exposure being present in RSP. So you get some, what I would say rewarded factor strategies in size and value. You still own the same 500 stocks. It's happening in a very efficient ETF wrapper which is shielding you from capital gains until you actually sell. And it's very low cost for the investor.
Ric Edelman: You referred to it as RSP. That's the ticker symbol of the Invesco S&P 500 Equal Weight ETF. The symbol is RSP. This fund is now over 20 years old. Talk about the performance difference. Somebody who had invested in the S&P 500 versus RSP, which is an equal weight version of the S&P 500. What's been the difference in performance for the past two decades?
Nick Kalivas: Yeah, So if you look at the 20-year period on a cumulative basis, you've had nearly 100% more in terms of return.
Ric Edelman: That's a huge difference considering that you're investing in the same index, in the same stocks, you're just investing in those stocks in a different combination and you're rebalancing the holdings on a more frequent basis than the so-called buy and hold approach of the S&P 500 index itself. What's your suggestion, Nick, for how investors use RSP in their portfolio?
Nick Kalivas: So when we think about RSP in the portfolio, we think about it as kind of a better solution for the core of your portfolio. So you want it to be an anchor to your portfolio and then you can employ other strategies around it. So think about it as a core position. We talked about that concentration in the S&P 500 right now. So when you are owning RSP, you're managing that concentration risk. The other things that you might want to think about is that the S&P 500 itself has become more growthy over time. And I'm not saying that there's anything wrong with growth strategies, but when you own it, you are owning something that's tilted more growth. If you compare the S&P 500 growth index to the S&P itself, there's a 66% overlap. So when you buy the S&P 500, you have a big growth bias. So RSP can really help you cut down on the growth bias. So if I were to sum it up like, how do I see people using it, I tend to see them taking a portion of that cap weighted S&P 500, allocating it to equal weight, and then building around that core to build a portfolio that that helps them meets their goals and objectives.
Ric Edelman: So when you say that the fund can serve as a core holding of the diversified portfolio, what percentage of the portfolio are you seeing people use it as well?
Nick Kalivas: It really kind of varies by our client type. So it really boils down to what the allocator is trying to accomplish and what their goals are.
Ric Edelman: Got it. You had mentioned that the fund was low cost, so...
Nick Kalivas: It's 20 basis points.
Ric Edelman: Which is in fact a low cost fund compared to the industry averages. So do you think that this concept of equal weighting is going to gain in popularity?
Nick Kalivas: Yeah, I do. I think we have seen in recent years it has gained in popularity. I think the conditions in the market are really putting a spotlight on the value of equal weighting. And I think as time evolves, we're seeing investors more willing to embrace these alternative type strategies.
Ric Edelman: So clearly, investing in the S&P 500 is an essential, fundamental element of any diversified long term strategy. You need to make sure, however, that you're investing in it in a smart, effective way. And that's why I wanted to bring this whole issue to your attention and make you aware of RSP, the Invesco S&P 500 Equal Weight ETF. You can learn more about this at Invesco.com or talk with your financial advisor who is very likely familiar with it. It's one of the largest and oldest ETFs in the marketplace for obvious reasons with a track record that is quite enviable. And so I really think you should take a serious look at this. Nick Kalivas, the head of ETF Factor and Core Equity product strategy at Invesco. Nick, pleasure to be with you as always. Thanks for explaining this to us.
Nick Kalivas: Yeah, great to be here. Thank you.
What On Earth Is An Oracle?
Ric Edelman:. You know, if you spend any time at all in the world of crypto, you come up with the notion of an oracle. What on earth is an oracle? Why does it even matter? Well, it's real simple. You know, blockchains are smart, but in a fundamental sense they're pretty dumb because they only exist online. You know, for example, say I program my money to send it to you only if a certain day occurs. Meaning I want you to get my money in two weeks or only if it rains.
Well, it's real simple. You know, blockchains are smart, but in a fundamental sense, they're pretty dumb because they only exist online. For example, if I program my money to send it to you only if a certain event occurs. Meaning, I want you to get my money in two weeks, or only if it rains, or only if a certain sports team wins a game.
That's all well and good, but how does the blockchain know that that event occurred? I mean, how does the computer code know that it was actually raining on Wednesday or that the Mets won the game last night? Well, that's what an oracle does. An oracle takes real world events and provides that information to the blockchain so the blockchain can act on it. Because if you think about it, the coin doesn't know if it's raining. So the weatherman in the real world provides that data onto the blockchain so the blockchain knows what to do. That's what an oracle is.
And as you would imagine, there are also outbound oracles where something happens within the blockchain and that information gets transmitted to us in the real world. So we know what's going on in the virtual world. Oracles. There are fundamental way that the physical world connects with the virtual world.
Ric Edelman: That's all we've got for you this weekend. Coming up Monday, I've got two big announcements for you, one including a free opportunity. I'm going to tell you about my new white paper. You're definitely going to want to read it and I'll tell you all about it on Monday. Have a good weekend.