Global trade tension, NAFTA up in the air, Brexit pending and an unprecedented North Korea summit: these are just some of the headwinds that could dampen the global economy. John Tobin, Portfolio Manager and Senior Research Analyst at Epoch Investment Partners talks to Kim Parlee about how diversification and a bottom-up approach is key to managing investments in an uncertain environment.
As unemployment fell, the economy appeared to be on solid footing. Here to digest that, tell us what it means for the markets, plus oh so much more, John Tobin. He is Portfolio Manager and Senior Research Analyst at Epic Investment Partners. John, great to have you with us. And what a week for you to join us, in terms of a few things going on.
There's plenty going on. That's for sure.
There's plenty. You've got G7. We can talk about North Korea. But really, I think what the markets are most focused on was the Fed today. So let's just start there. What was your take on what happened today?
Well, I would say no surprises really. The Fed raised by 25 basis points, which was exactly what everyone was expecting. There was a bit of a knee-jerk reaction to the dot plot, and I would say an overreaction. Chairman Powell has frequently warned against reading too much into the dot plot.
What happened today is that the dot plot suggested that the median projection by the FOMC members ticked up a little bit. And it led market participants to infer that there would be two more increases in the Fed funds target rate this year, rather than just one. And there are a couple of reasons to be a little bit cautious about using the dot plot as a predictive tool.
One is, we don't know which dot goes with which FOMC member. And it's important to remember that, of the 15 members of the FOMC and the Federal Reserve Board of Governors, seven of them are not voters. And so we don't know which dot goes with a voting member or a non-voting member.
It's also important to remember that those voting members change year to year. So there are four regional bank presidents who serve on the FOMC. But they go on and off from year to year. So that's another reason to be careful about using the dot plot and reading too much into it.
And finally, it's worth remembering that the Board of Governors of the Federal Reserve System is supposed to contain seven individuals and currently only holds three. There are four vacancies. So we could have one or two more members of the Board of Governors by the next meeting. And that completely changes the potential layout of the dot plot.
So I think the message to take away today was the Fed will continue to follow the data. The Fed will continue to move gradually towards normalization and away from accommodation. But I didn't really see anything today that led me to believe that the Fed is changing in any significant way the trajectory for interest rates. I think the Fed's policy is going to be follow the data, move gradually as the economy allows normalization.
Fascinating insight into the dots. I enjoyed that. Again, these are blind dots to your point. We don't know who is what and what's coming. So let's pay attention to that.
Let me ask you about some of the other big, I'll say, headline events that we saw this week. And I don't think we saw much market reaction to them. But I think what could come of them could be market worthy. We had the Trump/Kim Jong Un summit in Singapore-- historic, no matter what side you happen to be on. I mean, it hasn't happened in over 70 years. So we have to acknowledge that.
But also, probably a little more troubling is the G7, the falling out we're seeing between Canada and the US, and also just trade in general. At what point do you sit back and say, OK, that actually has me worried, and from a trade perspective, and what that could mean for economies, and then the markets?
Right. So maybe first just briefly on the summit that took place with North Korea, it's certainly positive to have the leaders of these two countries talking rather than hurling insults at each other. The fire and fury does tend to make us a little bit nervous. But I think it's mostly a sentiment driver in the market.
I think the likelihood that we have a really fundamental breakthrough here is really still pretty remote. This is certainly not the first time that we've met with the North Koreans, and come away thinking we've reached a deal, and we're making progress. It goes back literally 25 years-- so really just maybe some positive sentiment. But I think I wouldn't quite be rushing to get the Nobel Peace Prize ready just yet for Donald Trump.
Now on trade, the summit last weekend ended badly. And frankly, it's troubling. It is not what anybody would have expected or hoped for from that meeting. And I think what we really are hoping for now is that the volume comes down and we return to more of a normal, diplomatic discourse among the major allies here.
So this is troubling. The potential for a trade war is perhaps the most worrisome thing on the horizon. And it's because we have, for 70 years at least, been moving in a direction towards open trade, free trade, lower trade barriers. The evidence is conclusive. I think every mainstream economist would agree, the evidence is conclusive that trade is good and there are mutual benefits to trade. That's not to say that that the open-trading system is perfect and it never needs any adjustment or tweaking.
But since World War II, the pattern has been towards removing trade barriers. And to turn 180 degrees away from that is potentially very, very worrisome. The most dramatic example that I can give you of what that might mean for economies is to look back in history to the Tariff Act of 1930, the Smoot-Hawley Tariff Act, which was signed into law by Herbert Hoover, and was a real catalyst for a massive contraction in world trade, and is widely viewed as something that made the Great Depression deeper and longer.
So we really do need to be mindful of what might be happening on the trade front. And I would hope that Donald Trump learned a little bit of this at Wharton. I can't imagine they left it out. But it's something that I'm watching and I'm worried about.
I've only got about 30 seconds here before we go to break, John. But I do want to ask you-- I mean, you've got an interesting background. You've got a PhD in economics.
You are also with Epoch, which is a bottom-up, and a fund manager, in terms of how you look at things. So when do you kind of marry the two for you? You've got major macro events unfolding. How does that affect what you pick?
Well, that's a good question. And the strategy that I help run at Epoch, it's a bottom-up strategy. So we don't intentionally try to overlay macro views, sector views, geographic region views. We look for companies that generate free cash flow, that have the ability to grow free cash flow to pay attractive growing dividends, and to use excess free cash flow to buy back stock or pay down debt.
So how does the macro come into that analysis? Well, frankly, it comes in, if you will, through the back door. As we look at companies, as we consider stocks to add to the portfolio, we have to consider the macro and sector environment as we make projections for the companies that we're looking at to invest in. So we look to see what the ability of the company to generate free cash flow and to continue with its favorable capital allocation practices and policies, how that's affected by the macro backdrop that we see. So it does come into play, for sure.
All right, stay with us. When we come back, we're going to have another bit of a conversation with John. We're going to talk to find out about some specific names and how that macro analysis comes in. And you are watching Money Talk. We will be right back.
We are back with John Tobin, Portfolio Manager and Senior Research Analyst at Epoch Investment Partners. He's just taken us through his interpretation of the dot plot, also how macro affects some of the bottom-up strategies. And you've got some names for us, John. But if I could just briefly, tell me a bit about diversification and just how you do that in this environment when we have a lot of things moving together.
Right. So we like diversification. We run a portfolio with neighborhood of 100 stocks. And we really think that that's a strategy that works for helping us achieve the objectives that we seek.
So we're trying to build a portfolio that delivers an aspirational return objective of 9% over market cycle on average. We're trying to develop a portfolio that has an average portfolio dividend yield of 4.5%. And we're trying to deliver a portfolio with lower volatility than the market. And so, it's our view that holding a diversified portfolio reduces the risk around achieving these portfolio objectives.
Let's get into a few names. And if you could, just tell us why they're interesting to you right now. CME Group, this is a stock that you hold right now. Why do you hold it?
So CME Group, as you probably know, operates futures and options exchanges. And they have a broad portfolio of securities and options that they trade, futures and options that they trade across interest rates, across foreign exchange, equity indexes, commodities. And what they've been experiencing for the past year and a half or so is very strong growth in volumes. And volumes really drive this business. So we see good underlying fundamental business development for CME Group.
Now, what makes it work for us is the capital allocation policy that they follow. They pay an attractive dividend. And they pay a fifth annual variable dividend every year. So on top of the four quarterly dividends at the end of the year in December, they sweep cash flow that is excess cash flow to the shareholders in the form of a fifth dividend.
And this brings the yield on CME Group up to around 4%. So we like that feature. We like the fact that they have good transparent capital allocation practices. And it's been a good stock for us to hold in the portfolio.
And that's interesting with them and the fifth dividend, but what about risks with this one? I mean, if you're just playing devil's advocate in this, what do you watch for on this one?
So it's really a volume game. And one of the things that they benefited from is more volatility, which brings more players into the market, both to hedge and to speculate. So they're seeing increasing volumes in their interest rate products, increasing volumes in their equity index products, increasing volumes in their commodity products.
So for them, it's not really so much a risk feature. It really is, as long as the volume is there, they charge a fee to trade a contract. And that's how it works for them.
Interesting. OK I think we have time for one more in here. Intel, tell me again what you like about it. I'm going to ask you again-- play devil's advocate and ask you, what might be the risk with Intel?
Sure. So tech is typically a difficult sector for us, because we're looking for free cash flow. We're looking for attractive growing dividends. And often, the companies that are in the tech space, they don't have free cash flow or they don't pay dividends.
But there are a few stocks that we have found in that space that have worked well for us. And one of them is Intel. Intel, Cisco, Microsoft, these are all companies that are well-established in the tech space. They generate a lot of free cash flow. They have very attractive capital distribution policies, so they pay attractive growing dividends. They have regular, ongoing share repurchases.
And we see the growth prospects continuing-- Intel, in particular, very well-established market positions, broadly diversified across a variety of parts, whether it's desktop computers or handheld cell phones or tablets or the Internet of Things. So we see the growth trajectory there as one that is sustainable. And it's been a good stock for us. And we think it will continue to be a good stock for us.
And just with the other side of things-- and just briefly-- what would you see to be a concern for Intel?
Well, I think it's a business that we watch like all the businesses in our portfolio. And we would look for technological disruption. We'd look for market share changes. But they're really well-established and quite a strong company. So we're comfortable with them in the portfolio today.
John, it was great talking to you. Will you come back and join us again?
I'd be delighted to. Thanks for having me.
Well, we look forward to it. John Tobin, he's a Portfolio Manager at Epoch Investment Partners, and he joined us from New York.