U.S. equity markets are once again moving towards record high levels, but there may still be landmines out there that could derail corporate earnings. Kim Parlee speaks with John Tobin, Portfolio Manager and Senior Research Analyst at Epoch Investment Partners.
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- Well, US markets are once again moving towards record high levels. But my guest says while some risks are less pointed-- decidedly less pointed-- there still are some landmines out there that could derail individual corporate earnings. Joining me now from New York, John Tobin. He is Portfolio Manager and Senior Research Analyst at Epoch Investment Partners.
John, it's great to have you with us. Let's talk a bit about, or continue the conversation I was just having a few minutes ago. We have seen a fairly significant recovery in the markets this year. We're seeing some pretty decent economic data starting to bloom for spring, which is always nice. But there's still some pretty significant risks out there, too.
- Absolutely, there are. Top of mind is Brexit. And it's in the news today. We had Theresa May going to Brussels hoping to get an extension on the Brexit date. She was thinking more along the lines of June 30. But the news reports this afternoon suggests that the leaders of the EU are thinking more in terms of December, or maybe even March of 2020. So it looks like we're going to have a delay in the Brexit decision.
And why does that matter? It matters to us. We might think that we're at a safe distance and we can watch sort of passively from over here in the US. But a no-deal Brexit is a bad thing. And it probably leads, if that were to happen, to a recession in the UK, it probably is negative for economic growth in the EU, and it's likely to spill over, broadly, across the global economy and affect us. So we need to keep an eye on this as well. We certainly do at Epoch, as global equity investors. But even a domestic, US-focused investor should have an eye on this as well.
Let me ask you, though-- I mean, you know, I guess the bad news is good news category, I mean, when you have the central banks watching this unfold, and watching unfold all the trade concerns, quite frankly, right around the world, it looks as though they're kind of cooling their jets in terms of what they're doing with rates. And I guess that's going to be a bit better news. At least we saw the minutes today, and seeing that is the case.
- Well, it absolutely is. And I think this is one of the reasons we think that some of the risks have receded since the fourth quarter. So the minutes today came out from the FOMC meeting in March. No surprises. We saw pretty much what we expected to see, which is to say we see evidence that the Fed is on pause. They're looking at the data, they're seeing evidence of some weakness in the data, and they've decided that it's best to pause and be careful and be cautious.
And as you just indicated, the other central banks around the world are also saying similar things. We heard Mario Draghi today also echo that view. Economic risks seem to be tilting to the downside. And he even described some of the tools that he has at his disposal, should they need to pull them out and use them to combat some economic slowdown in the eurozone.
- What about earnings? I mean, we're getting ready to hear from some pretty big players in the States. We've got some US banks coming out, too. How do you feel that these earnings are positioned in light of all these upheavals that are happening around the world?
- Well, earnings season is about to start. And it's going to be an interesting one, to be sure. I think that there is a consensus view that we're going to see some slower earnings growth or earnings declines. Last year, it was a strong quarter, so the year-over-year compares are going to be difficult.
So we do have that coming at us in the next couple of days. I guess the banks start to report on Friday. There will no doubt be surprises, and there will no doubt be dramatic price reactions in the stock market as we digest the first-quarter earnings report. So it's going to be an interesting ride.
- OK, so what do you-- I mean, I know, obviously, I've been talking to you guys long enough that I know that free cash flow, number one thing you're looking for with companies. So I mean, are there any kind of standouts that you're looking for in this earnings season, or companies that you like in this environment?
- Sure. And you're absolutely right. At Epoch, we're all about cash flow, we're all about capital allocation. We like companies that have a certain profile, if you will. We like companies that generate cash flow that grows over time. We like companies that have a management team that focuses on capital allocation, which means investing where they can earn a return above the cost of capital, and otherwise returning capital to the owners of the business, through dividends, share buybacks, and debt reduction.
So a couple of names that I might suggest that we like in this environment that we own and in fact have owned for a while-- one is a global insurance company, Allianz. So Allianz is a global company with a presence in property casualty insurance, life and health insurance, asset management. In fact, I'd say that if you bought an airplane ticket recently, you've probably bought trip insurance, and you bought it from Allianz.
So what do we like in particular about Allianz? They have a very transparent capital allocation policy. They pay an attractive dividend that yields over 4% today. It's a dividend of been growing at about 5% per year in recent years. They have a share buyback program today, and they've been buying back stock consistently over the past few years. Generate a nice return on equity, very strong regulatory capital position, and it's one that we feel comfortable owning today.
I'm going to ask you the same question I ask everybody, too, when we talk about specific names. Any risks on the other side? I mean, you said airline, I thought Boeing. I'm not sure if that even kind of plays into the world, or if it's material what they do. But what are some of the risks with Allianz?
- Well, typical risks with a company like this. It's a property casualty insurer. So from time to time, there's an elevated experience with natural catastrophe losses. In fact, we've seen that happen in 2018 and in 2017. 2017 was a particularly difficult year in terms of nat cat losses. So that can affect near-term earnings in the property casualty segment. But this is a company that's demonstrated an ability to be resilient in the face of those types of events. So even with that risk, that's something that we think is well factored into the security price. And we're comfortable even with that risk as a possibility for Allianz.
I know another name that you guys like right now too is DowDuPont. And they're in the process of doing something pretty interesting right now, too.
- They are. It's a little bit of a complicated story, if you will. I'm sure you know that in 2017, Dow and DuPont merged. And the idea all along was to put the two companies together, move some of the pieces around on the playing board, and then separate them into three different focused businesses, a company that's focused on commodity chemicals-- the new Dow-- a company focused on specialty chemicals-- the new DuPont-- and from both of those legacy businesses they extracted the agricultural chemicals and seed businesses to form a new company called Corteva.
The new Dow company spun out on April 1. So it's just been trading for a few days now. And the split between DuPont and Corteva is scheduled to take place on June 1.
So what is it that we like about what we've seen here and what we are seeing here? All three of these companies have had Investor Day presentations. And they've laid out, very clearly, their capital allocation practices and policies. And we like what we hear. They have a dividend policy that they've clearly articulated, in terms of the payout ratios that they expect to achieve. And as well, they've already declared the dividends that they expect to pay this year.
So there's clarity about what their dividend policy is and what the dividend amount will be. And the dividend yields as a result, we think, will be attractive. They'll be different among the three of them, reflecting the different types of businesses and the different cash flow characteristics of the businesses. But all three have that in common-- clear articulation of capital allocation policy, and a clear focus on return on invested capital. So we like that transparency, we like that clarity, and in particular, we like the dividend that they've already told us that they're going to be paying us.
And on that, we're going to leave it, John. It's always a pleasure. Thanks so much for joining us.
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