Secular stagnation, Brexit and the U.S. election have investors treading carefully. Bill Booth, Portfolio Manager & Senior Research Analyst, Epoch Investment Partners, shares his views with Kim Parlee on stock valuations and attractive investment opportunities.
Let's continue our look at the global economy and our world tour.
And we're going to turn our attention now to Europe and the United States.
And joining us in studio-- which is great, because he's normally not in Toronto, he's usually in New York-- Bill Booth, Portfolio Manager and Senior Research Analyst at Epoch Investment Partners.
Nice to have you here in person.
It's great to be here.
Because last time, I know we were talking to you in New York.
We want to, if we can-- so the first part of our talk with you is talk about the United States.
We just heard from Paul Danes in terms of what he sees in Asia.
Then we'll move things on to Europe.
But let's start with the States and some of the big, I'll say, things that are going on.
The Fed, so it's going to be next week.
Nobody thinks anything is going to happen.
I mean, I don't know.
But we'll see.
But when the Fed does decide to move, what is the impact on that?
Or what are we going to see happen in the US in terms of equities?
I think the key question is, what's the pace of future increases by the Fed?
So if we're sitting here six months or nine months or 12 months after the next rate increase, I think that's a benign scenario for the markets.
I think what the market's fearful of is a very aggressive rate hiking stance, which would be bad for, potentially, the economy and certainly equity markets.
My own view is that the Fed is going to raise by the end of the year.
But it's going to prove to be short-term volatility related to the market reaction, because the Fed is going to be, I think, on pause for a while after that.
Now, in terms of the reason why the Fed is on pause is if you take a look at what's happening in the US economy, you guys have a paper that came out recently called "Secular Stagnation." That says it all right now in terms of what's going on.
There's not a lot of growth out there.
No, and that's, I think, the issue the Fed's grappling with is that there are some signs of inflation picking up.
I don't think it's broad-based or strong enough to warrant aggressive action because growth is really disappointing.
And in our paper, we point out that 2% is the new 4%, that those 4%-type growth rates that the US economy enjoyed for many years pre-crisis, those days are long gone.
It could be because of demographics and other issues that are facing the economy.
But with a 2% new normal growth rate, I think the Fed has the luxury of waiting and seeing how the market and how the economy reacts to this next increase.
Layer into that, of course, the US elections 55 days from now.
What does that do to the whole US growth picture?
I think is going to, like the Fed, create a lot of short-term volatility.
But the market's going to move past it.
I think Hillary Clinton would be an extension of the Obama administration.
The market would probably react more favorably.
We know it.
Donald Trump's a wild card.
We don't know what he's going to do.
And so I think the markets don't like uncertainty.
And so that would be bad for the markets in the short term.
But one of the brilliant things our founding fathers in the US did was create a system of government that makes it very difficult to enact dramatic change overnight.
And so I think once the markets digest whoever's president, that it's like life goes on, and we're back to normal.
I think more importantly it's a sign, having Donald Trump as a candidate.
And then if you think about the runner-up, Bernie Sanders, on the Democratic side, of what we were just talking about-- this low-growth world, that many people just feel left behind.
They're no better off today than they were pre-financial crisis.
And that's really feeding into this anti-establishment, anti-globalism movement.
In this paper you do-- and we're going to go through all of it.
But you take a look at the Gini index, where you talk about the income inequality and what's happening there.
I mean, I don't have an investment question.
It's more of a sociological question.
But how long can that Gini index-- higher is bad.
It means there's more income inequality.
It keeps moving up.
I mean, how long does that start to disrupt economic growth?
Because I mean, it has.
But hasn't disrupted the markets.
It hasn't disrupted the markets.
And part of that is because of the policy response to the situation where we had these very low interest rates, which benefits the financial markets.
But that's one of the big issues in that it does not translate to economic growth, because the top 1% in the US save 40% of their income, whereas the bottom 99% save basically nothing.
And so that's an issue that we're facing, this growing inequality.
And it can't sustain itself forever, because we've seen many civilizations implode because inequality becomes such a social issue that the country essentially breaks apart.
Implode is not a good word.
But we'll come back to that.
In terms of valuations in the States right now, I know that basically-- and you've talked with us many times, and other folks at Epoch, about returns have been driven by valuation increases, PE expansion over the past little while.
So what happens from here?
I think valuations can sustain themselves as long as the Fed does not go on this aggressive hiking stance.
But it's hard to see further meaningful valuation expansion.
As we've discussed, valuation has driven most of the market return over the last several years.
And that's really a function of these very low interest rates.
You have low short-term interest rates that propagates through other maturities in asset classes.
And an equity is nothing more than the present value of all future free cash flow.
And when you bring down the discount rate, you increase the value of that future free cash flow.
Which has been brought down so much.
I want to just finish off, if I could here, in terms some of your holdings, what you like right now.
We've got about a minute here.
Cypress Semiconductor is one that you think is interesting.
We like Cypress a lot, because in a low-growth world, Cypress has growth avenue.
So they design and develop semiconductor solutions for the automotive market.
So if you think about infotainment systems, instrument clusters, and all of the autonomous driving systems, Cypress has content.
And the story there is this content's being adopted.
And they have more content per car going forward.
So if you think about a high-end car, it has about $1,000 per car of semiconductor content.
A normal car has about $300.
And we know that the leading edge technology in cars today becomes standard technology three, four, five years down the road.
So they have a very nice growth story related to their end markets.
And they also have a significant supply chain and manufacturing initiative to reduce their cost base and improve their margins.
So we like the self-help element as well.
CVS Health is another one you like.
So healthcare has been a tricky sector, given all the rhetoric from our presidential candidates.
CVS Health is well-positioned because they're the leading drugstore chain in the US, about 8,000 stores.
So they're a play on aging baby boomers who consume more than two times the average person's prescriptions.
We have generic drugs increasing because of the cost issue.
We have a bunch of especialty pharmaceuticals coming to market.
And then they're also playing into convenience and access because they have about 1,000 Minute Clinics where you can go and get vaccinations, or if you have pink eye or strep throat, because in the US, we have a shortage of primary care physicians.
And that's only going to grow stronger in the future.
So this really plays into a need as well as consumer convenience.
It's a lot easier to go to the corner CVS store than to try to make an appointment with your primary care doctor.
Which is always tough.
All right, fantastic information.
Let's talk about Europe now.
Before we get into holdings, big picture, Brexit.
And straight up, a lot of people did not see that coming, because if you look at polls and even the bettors, so to speak, were saying not.
What's going to be the impact of Brexit longer term on Europe, in terms of anti-trade, anti-globalization?
Is this just a drop in the bucket?
Or is there something more to come?
I think it's a good question.
I don't know the answer.
I think you can look at Brexit as the canary in the coal mine that is potentially predicting more issues in the Eurozone with other countries like Italy, Spain, and even France, where there is a growing movement against the euro.
Or is it the wake-up call that gets the political elite in Europe to address the structural issues, because Brexit was partly was due to immigration?
But I also think it's a sign of a bigger frustration, much like I talked about the US and the citizens being left behind.
I think it's even worse in Europe.
And so there is this growing disenfranchisement with the Eurozone, the current structure of the political apparatus.
And so I'm hopeful.
I'm cautiously optimistic that the political elite are going to use this as an opportunity to start addressing the issues that underline things like Brexit happening.
I guess in the question with all this, too, is even if they address them, can they address it fast enough, because policy is not fast.
I mean, it takes its time.
What about valuations in Europe?
I mean, what is the state of Europe?
I mean, I know that's a broad question, but generally speaking.
In general, I think valuations are relatively attractive.
Much like the US and the rest of the world, we have seen valuation expansion, largely driven by this low rate environment and the impact of QE and negative interest rates.
And then when you get into sectors where there's controversies, of course, you can use that as an opportunity to pick up stocks attractively valued because the market is mispricing them over some concerns that may not be permanent.
I mean, there's a whole series of elections coming out.
And again, how disruptive will that be?
It potentially could be very disruptive.
We have an important Italian referendum later this year.
And then we have French and German elections next year.
And the way some of these local elections have been going, it's not been good news for the people in power where we've seen these anti-euro and more extreme parties gathering a decent amount of the vote, in some cases, actually winning elections.
So definitely have to mark your calendars with these dates, because they could be potentially as meaningful, if not more meaningful, than what we saw back in June with the UK.
So much political turmoil going on everywhere.
It's an interesting time.
OK, let's talk about some of the picks and again, holdings that you have right now, what you like.
Safran, not a household name, I don't think, to a lot of the North American investors.
No, Safran is a name I really like a lot.
It's an aerospace company that makes engines for airplanes, so single aisle, narrow body Boeing and Airbus airplanes.
And it's a great business.
Aerospace is enjoying good demand because of the emerging market consumer wanting to travel more.
So that's a real demand growth.
In the developed world, in the US and other places, we have a very old and fuel-inefficient fleet of aircraft that need to be upgraded.
And the engine business is really attractive, because it's what I call a razor-and-razorblade model where you sell an engine today for essentially no profit, but then that engine is in service for 25 years.
And the airline goes back to Safran and pays them an annuity like revenue and cash-flow stream to do the aftermarket parts and service.
So that provides great visibility.
They also have a new product that's being introduced into the market now, which is going to be, I think, very successful and gives us for further visibility into their business because they have an order backlog that's greater than five years.
So they could stop receiving orders today and keep their factories running at full capacity for five-plus years, which, again, in a very low-growth world with a lot of uncertainty we find extremely attractive.
A little more expensive than a razor.
But yes, I get the metaphor.
Let's talk what about AXA.
This is one that is of interest too.
So AXA is a French insurance company.
And financials are very controversial right now because of negative interest rates, low rates, flat yield curves.
But we think if you can buy financials that have attractive cash dividend yields that you have confidence in that you can be paid to wait for the market to turn around in terms of sentiment.
So if you think about AXA, it's almost a 6% cash dividend yield, which I'm more than happy to take and wait out as a patient investor until the market realizes that their business is much more durable and robust to the current rate environment.
And I think investors have been trained to just think low rates, flat yield curves, death for financials, avoid them at all costs.
And I think companies are starting to show that that doesn't have to be the case.
Well, it was great to have you here.
Please come back again in person.
Really good to have you here in the studio.
Bill Booth, Portfolio Manager and Senior Research Analyst at Epoch Investment Partners with a overview of the US, Europe, and some interesting holdings.