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Welcome to Merrin Talks Money, the podcast in which people who know the markets explain the markets.
I'm merrin'sums at Web. Now.
Things aren't quite as they were in the US. The spell of exceptionalism is broken, and everyone's looking around the little if not the US web does that there is value all over the place for those that care to look for it, perhaps in Japan, perhaps in Korea, and perhaps in Europe, which is picking up the fiscal stimulus bat and the US looks to be dropping. So to unpack all of this, I am joined by Sarah Catter, a chief executive officer of Causeway Capital Management. That's fifty
five point two billion dollars in assets under management. She also serves as a portfolio manager for the firm's fundamental strategies. Sarah co found of Causeway Capital Management in two thousand and one and has decades of experience managing international and global value portfolios.
Sarah, it is great to have you on. Thank you for having me, Maren.
Now, we've got quite a lot to get through. Things seem to change every minute these days. It's hard to keep a handle on what's important and what's not important and where.
Things might or might not go.
So why don't we start by looking at the US equity market. John, my colleague here at Blmberg and I. We look at this all the time, and we keep going. This is absolutely extraordinary. Everything that's happened since the election, everything that's happened with the tariff conversations, with the mutterings, bet recession, no recession, et cetera, et cetera, all the kaos, all the difficulties, the insanely high valuations, what look like insanely high valuations to us, and yet in the end
the market is pretty much backward it was. Does that make sense to you, because it doesn't make.
Sense to us.
It does make sense, Maren, because there is still quite a bit of money looking for a home. If you look at the Chicago Fed Conditions Index, something that we at Causeway watch, they appear reasonably loose. In other words, credit is still reasonably abundant. People have money to put to work, an aging population that developed world, they need to continue to invest. So none of this surprises me.
If we did have persistently higher tariffs and there was a trade embargoed with China, markets certainly in my view, would not have recovered the way they did.
Okay, so there are circumstances under which this extraordinary performance of the US market might come to an end. I mean, you tend to be quite valuation orientated, right, That's something that you talk about a lot and think about. So it must be extraordinary for you to be operating inside a market that consistently, consistently destroys any sense of value investing.
Well, that's a that's pretty harsh indictment. We at causeway we invest both quantity and fundamentally. In the fundamental side, we have much greater emphasis outside the US. They may do within the US, but in our global equity portfolios where underweight the US market versus the indices.
And that's from the bottom up.
That's from finding more non US companies that meet our value criteria. I have gone so far with clients, and our clients are predominantly institutions, mostly in North America, and I say to them, non US, particularly non US developed equities are value relative to the US. However, that doesn't
make them necessarily superior. Underneath that value umbrella, it's really important for us to look for companies that are well positioned competitively that have financial strength or are moving toward much improved balance sheet leverage.
And they are they.
Have the ability or soon we'll have the ability to return capital to shareholders. I couldn't say this without being booed out of the room during the long period of zero or negative interest rates post the Global Financial Crisis and post COVID. But we're in a normal rate environment and that makes value really interesting because these stocks where the market is underestimated their earning potential and where there can be returns of capital in the form of buybacks
or dividends, that's extremely valuable. So we're more excited about the value part of our business in fundamental research and portfolio management than we've ever been.
Okay, that's interesting.
Let's just go back a bit and maybe you could explain, to explain to our listeners why this is all about interest rates. It's something we've talked about a lot on the podcast, but I'd love to hear your take on that. Why the interest rates that change the environment from growth to value being interesting.
Think about a stock. What is a stock? What's it worth?
It's worth the present value of all the cash that can generate into perpetuity. So that's forever hard to imagine discounted to present, and the discount rate on that long stream of cash flow when it's near zero, that means investors are willing to pay anything for that stream of cash. In fact, investors at a zero rate are indifferent between
cash today or cash tomorrow. That a specuative company that is promising huge returns sometime in the future is worth taking a gamble on because there's no cost of money. When rates rise, especially real interest rates are firmly positive, then there is a significant cost of money. In other words, you could put your money in a government deposit, you
could be in a money market fund. You could get a risk free rate that is just above inflation, so even after tax, maybe you're above even, but your money's not shrinking. Or you could own equities, and in our view that that higher discount rate means there is there
are only certain valuation multiples that make sense. And if the and if the valuation multiples like a price to earnings multiple or price to cash flow, if it gets too high, you have overpaid, and so you paid too much for that stream of cash, and therefore you're very unlikely to get your money back.
Okay, so if you live at it like that, an overload of the American market is overvalued. Yeah, expense to the market that you wouldn't necessarily want to invest in. Yes, there are there are expensive parts of the US market, and there are more growth stocks, there's more technology exposure, much more from a sector basis in the US than outside the US, to the tune of like two and
a half times. Okay, So when you take the idea to your clients that maybe it is time to move a significant amounts of money out of the US into more value orientated markets.
What's the reaction.
You're getting a different reaction to now than you might have gone three four years ago, two years ago, one year ago.
We are getting a different reaction. A part of that is the spell is broken. The long period of dollar ascendency has turned. The US dollars lost some of its strength, so investors aren't as concerned they'll be this constant if they're dollar based currency headwind. They're looking for a tailwind now. But also they recognize they need to be diversified. This is a watchword of investing, whether it be for individuals
or institutions. And becoming over index to the US market having too large an exposure just due to the letting it ride having maybe not rebalanced back to the anacid allocation that includes non US equities. I think they're nervous about that now and investors are attempting now to get more non US So it's not a stampede, but we definitely see this trend.
It's interesting, this idea, this bell is broken, isn't it That even though the US marketer is really still performing remarkably well, there is a sense that it's no longer in absolutely longer given. It's no longer entirely reasonable to have the majority of your money tied up in the US.
I mean, we've been looking at the passive investors and retail investors all around the world are just buying into global index funds, or even worse, just US index funds, and even if they're in global, they'll have six seventy percent of their money in one market. And it's hard for people to turn from saying that that isn't really the type of diversification that we've meant historically.
And there are catalysts for Europe in particular that we haven't seen in a long time. And some of this is a byproduct of the political, diplomatic and terror related stresses put on Europe, but needing to spend on defense several percentage points more in terms of GDP. That's hundreds of billions of euros of additional spending infrastructure. Having a
need now urgently for a harmonized EU capital market. All of this speaks to the potential for Europe to become a more attractive place for capital and even if it isn't all realized, just some of it at the margin that will help close that valuation gap, not close it completely, but just narrow it from this extremely expensive US market versus rest of world, in particular Europe in the UK.
Yeah, so a big part of this is really about the fiscal shift. So if in the US stimulus has really reached something a limited at this point and that's much discussed, whereas in Europe the space for fiscal stimulus and that's going to drive this coming together evaluations.
Yeah, fiscal rope in the US.
My colleagues and I Cosway looked at to breakdown of what created such a massive performance increase premium US versus Let's just take Europe over the last decade and yes, much greater sales growth in the US was a large contributor, but the second largest contributor was multiple appreciation. In other words,
multiples just rose in the US. And we think a good part of this is a function of a lot of fiscal stimulus, and that stimulus now has to be curtailed because of the US bond market is going to constrain the politician's ability to keep spending with abandon.
And let's stick with America for a moment. Do you see that the new tariff regime, Not that we're entirely sure exactly what it's going to be after this little truth in ninety days, but we still don't know what we are obviously, But do you see any sense that that might end up being good for parts of US business? That we may see this manufacturing renaissance which may change the way the enemy works and hence the way the market can be valued.
From a causeway research perspective, we think it's unlikely. At the margin, maybe more auto manufacturing, because that's one area where President Trump is very keen to ensure there's more onshoring, but there are low end products from just about everything in the electronics components, consumer goods. Think about toys, for example, textiles, they don't belong in a US manufacturing context unless fully automated. And who's going to pay that upfront bill for those
automated factories? The returns don't make sense for companies, and without some sort of bizarre government subsidy, we think it's very unlikely. So those maybe some of that will move out of China, as it already has, but it will go to friendly countries and they will and it won't be on you in US soil. We just can't see a mannerfacturing renaissance. What we'd like to see is an education renaissance, but that hasn't been mentioned yet.
All right, well, let's have a look then at Europe.
And in one of the pieces that you wrote recently, you've got a great shot which shows the extent of Germany's fiscal boost and it shows that if it works out as expected at the moment, it would be a bigger physical booth than the Marshall Plan, a bigger physical boots than the reunification of Germany, etc.
I mean as significantly bigger.
Actually, And on your chart you've got that fairly clearly divided between infrastructure and defense. So if you were investing into Europe, you are slee Are those the sectors that you're looking at.
Most of the European listed defense stocks started moving last year and they've had a significant run, so the market's already gotten there. But the defense spending leads to a whole ecosystem of stimulus in Europe. And one of the companies that we like very much is in green transportation. It's Alstam. They're the France listed world's largest manufacturer of
rail a rail equipment and signaling. They make the bulk of their profits from services, in other words, servicing and maintaining and upgrading these rail systems, whether they be rails or subways or subway cars. And this is a company that governments around the world and as well as in Europe, recognizing more urbanization, will be spending on improving public transport,
long term contracts, very long term customers, well positioned. They made some unfortunate acquisitions in the past which created some contracts that were mispriced, and they management team has been upgraded. This is just the sort of stock we like. At Causeway, where investors had lost interests they thought the business wouldn't do well, particularly given inflation and the cost of their contracts, but we saw a management team capable of creating an
earnings turnaround and thus more cashful for shareholders. And it's a it's a stock very emblematic of what I think of as sort of the new Europe, where efficiency is the watchword, corporate managements know they need to deliver for shareholders. And then that's all very synergistic with ensuring the prosperity of Europe and beyond.
Yeah, and when we look at at infrastructure, I was at a defense conference last week and a lot of the discussion was around how infrastructure is effectively defense to a degree, and that if you don't have a national grid that works, you kind of stuffed before you even begin, right, if you can't keep the electricity on in Fain and Buttugal and France, then deciding from a pretty lousy base.
There's this blur between what is defense and what is infrastructures that we would expect an awful lot of money to go into, for example, electricity grids.
Oh yes, across Europe, oh.
Oh, very definitely already has and will continue to do so, and rate bases will reflect that. But one area you haven't mentioned that it's also very I think is very interesting is how will in an aging population that boost in manufacturing and all the stimulus, how will it translate into output? And that's through automation. And although there are interesting there are very well placed automation companies like parts
of Zeman's in Europe. The ones that are the most undervalued and we think the greatest upside are actually in Japan, companies like Panic in robotics or SMC in pneumatic equipment.
This is very I can see how people would be board stiff listening to this, but this these are the building blocks of manufacturing and of and of ensuring that for example, the automotive industry or electronics industry, whatever it is that where Europe or the US needs to onshore for national security reasons that automation is essential for productivity.
It's interesting, isn't it.
There's a big divergence between the levels of robotics in different economies. I mean, the UK were absolutely useless. We have one of the lowest ratios of robotics to workers of any developed countries. But some European countries are much better at than we are.
But the UK will likely catch up and the AI enabled robotics will transform how products are manufactured and for the better. That should ensure that we can, even with a limited labor force, create the output necessary for GDP growth.
So Japan is already responding to this demographic crisis that we're seeing across the cross the rest of the Western world, and they've done that to a large degree with much more in the way of robotics, automation, etc. Than we use elsewhere. And that's been relatively sex that's full in the GDP ahead in particular hasn't follen or come off in the way that many expected.
So we have an example to follow.
Yes, yes, their demographic situation is more dire than that of just about anywhere else, but I would agree with that, and that technology is homegrown for them.
All the good.
Robotics companies outside Japan that you're interested in.
There are good ones that values are really in Japan. And this has part lead to do with the fact that the end had been extremely the en it's been very volatile and now settling around one hundred and forty five yen to the dollar. I think that investors are concerned that the end may con might go on another bout of appreciation which would be somewhat detrimental for these companies. They do slightly better in a weaker yen environment.
Do you have other investments in Japan with terrib qing one, we're always talking about what amazing value it isn't and coblitely being mildly disappointed by it.
Amongst us c of what i'd call maybe mediocre corporate governance type companies, there are some extraordinary world champions companies like Murata in multi layer ceramic capacitors. They are the best in the business, just the way SMC is the
best in pneumatic equipment. Imagine being number one across your different industry verticals and marauder trades is if it's just it's a cyclical aticyclical low so low in price to book terms, low and uh in prospective pe multiple terms, because investors haven't seen the kind of smartphone sales for example,
that would that would propel this stock forward. But what we do know is that edge devices are coming, and that our device is whether it be p seeds or smartphones or any other type of device than wearables well
glasses for example, they'll be AI enabled. This is all inevitable and the key for US at causeway is, find these great companies when they're at sickle lows, be prepared to own them for several quarters while the market digests the disappointing news, and then then have a large position when the cycle turns upward.
Do you have any interest in the UK market? Do you find you're talking about finding innovative companies, interesting companies, best in class companies When you look at the UK you can definitely find.
Value here, yes, But can you find that kind of.
Value companies in the throes of operational restructuring? We can find that, and I consider that to be derivative innovation because it requires tremendous discipline, requires management being able to extract something from the business that no one else has done before. And the best example I can give is the UK aerospace company Rolls Royce at near death in early twenty twenty during covid is wide body aircraft engines that they manufacture. Planes were grounded, no flying hours or
little to know. The cash flow went into the red and the company had to do an enormous rights issue.
It looked very bleak, but a CEO upgrade.
And a transformation of that business into this world class company that's in a duopoly with ge and what we've seen out of that is cash flow generation galore. And that's a testament to the governance to the chairwoman need a freu and a determination to get the right person in the top job. We like to see that, and when we see it, we are backing it.
Are you still backing if you still invested in real road? Yes, we are.
How often does a value investor, which we are in our global equity portfolio, how often do we get access to a duopoly? What does it mean to be in in a monopolist or a duopolist. It means you have either none or one competitor, and that translates into pricing power. Being able to go back to your customers and say we're raising price and have no pushback at all. Rare and in this environment.
We like that.
We like to see and that's why I mentioned Alstam for example, being excellent at what they do in rail cars and rail signaling gives them that pricing power and having very few competitors, but roles having just one major competitor, and wide body aircraft engines they're in a they're in the catbird seat.
If you look at things like that, But you're also a valuation driven What is the signal for you, even with an amazing company like that, to say, Okay, you're producing vast and masive cash, you're a dua believe you have pricing power. We love that, but now you're too expensive.
Where are your parameter?
So we work on a risk adjusted return basis, and what that means is that for every stock that we consider for our global Portfoliolo, we Causeway portfolio managers and
analysts and they're about twenty seven of us. We determine the two year price target for the stock, where should that stock trade two years from now based on the as we discussed its earnings in cash flow, and then we risk adjust that So using our quantitative multi factor risk model, which sounds very complicated and isn't, we're determining the incremental or additional amount of volatility that stock will add to our existing portfolio if we actually bought more
of it. And some stocks add to risks we already have, so they are very high risk and therefore on a risk adjusted return basis, the risk will will make them less attractive. And then there are other stocks that may have very high returns but have very modest amounts of additional risk that they pose to the portfolio, and they will look very attractive. So we rank all these stocks.
We rank about one hundred and fifty stocks globally, the ones we're most interested in on risk adjusted return, and the highest ranking stocks the top fifty are typically well represented in the portfolio, and the higher they rank, the more we generally own. And as they do well, as the price of the stock rises, unless we're raising our to year price target, that means the prospective return is diminishing.
So the stock is descending, it's falling in that ranking, and as it does, I'm finally answering your question, that's when we sell, or would trim the stock at least, if not sell out completely, and then reinvest the proceeds those sell proceeds back into you guessed it, the highest ranking stocks. This discipline process ensures there are no politics in our approach. There's no seniority, there's no committee myopia.
It's all about what the stock can deliver risk adjusted versus all the other candidates we have.
That is a bottom up process. Okay, interesting, he did answer my question. That was a great answer. Really interesting.
Take you, but Listen, all the companies that we've talked about so far have been very big. We've talked about large caps, but I know you also have an interest in smaller companies, which of course as well if you really are a value investor. There's a lot of value knocking around in small caps globally, even in the US. There's a lot of value. That certainly is in the UK where our smaller and midsized companies are on their knees valuation wise.
Tell me what your thoughts are there. Well, if they're very small, we stay away.
We need at least a billion US dollars in market cap, and that would be an all free float.
In other words, there can't be a large insider holding.
There needs to be lots of trading liquidity, and I'd say we're more comfortable in the three billion dollar and higher level, where we have the ease and liquidity of entering the stock and exiting as we see fit. In that what I think of is more MidCap area. There are plenty of stocks, there are no shortage of them. The Smiths Group here in the UK is one we like very much, or also in the UK SSP group, wh Smith another one that when cause we gets excited
about these stocks. We end up owning five six, seven, eight, nine ten percent of the outstanding shares and you can understand our commitment because that means that we're in It's going to be quite difficult to extricate our clients if.
We called it wrong.
So are the lesser liquid stock. The smaller it is, the more we need to be absolutely certain that we are We've made the right decision, and we believe that the management team can affect the operational turnaround, the improvement in earnings and cash that that we suggest that they should.
What's the case for wh Smith wh Smith this morning? Yeah?
Travelings, Well, travel is the case. And of all the areas of consumer discretionary spend, travel is one that seems to be most resilient and with travel comes expenditures. A cousin to that is another stock we like very much, List in the UK and also in the US. But Panamanian Carnival Cruise. This is travel on steroids because this is the world's largest cruise company fourteen million passengers last year and they are now bringing passengers to their own
private islands to keep spending. So travel and spending go hand in hand. And if you have a captive customers you do with WHMI given their franchises and in airports and train stations, or you do with Carnival, you've got this cash flow machine. Carnival hasn't been a debt, but they're able. They've already been announced some significant refinancing and the trends look really good. They're eighty percent booked through
the end of twenty twenty five. That's a high level of confidence even as we started this conversation in a world of tariff uncertainty.
W A. Smith also fits into your monopoly duopoly idea, doesn't it, And that it's pretty much the only place you can buy a newspaper at the app works in the UK.
There are no other options. That's it.
The only place to buy your every thrillers and your overpriced water and your sandwich, et cetera.
It is W A. Smith. Carnival has competition.
Well not really though I would really back on that Carnival. You're on those ships, there is no competition. There is nowhere to go. And when you're on their own private island like Carnival with their launching in July, it's all theirs. So no In fact, they have created. Once you have bought that ticket and step more.
Go on another ship. You can go on another ship. There quite a few crews go not.
Once you've once you've embarked, you have no choice. You're stuck. Where is Carnival Cave? This is fascinating. I did not know celebration. They're all these private islands are in the Bahamas.
So you go there in the cruise ship, you anchor off the private island. You spend, but you don't stay on the private island. You spend more of your money on the private extent. You get back on the ship and off you go again.
Yes, you go and spend money on the private island, enjoying yourself with kayaking and water slides and I think a tremendous amount of alcohol. Then you get back on the ship and spend some more.
And is this all part of the story about I mean, I've been writing a bit about the travel industry and the rise in the amount of money that people are prepared to spend on travel, which is maybe partly about COVID and people thinking, well, now I wan't to e experience as opposed to stuff, but also partly and this brings us back to the conversation we had earlier about the present value of cash, but also the present value of an experience is hugely enhanced by social media because
the experience has more status value out with the actual experience, and you can keep it rolling for a long time, so it has a value that isn't immediate and it's just different and that gives it more value. Is that part of that whole vibe.
Yes, the baby boomers supposedly aren't this experience focused, but we've seen indications to the contrary, and travel dollars leisure, travel dollars to cruises seems to be very heavily skewed toward that demographic.
It's not the young.
I thought that what we were saying was a rise in younger people spending more money than you would expect on vacation experience.
Well, at the margin, there are more than you'd expect, but it's still dominated by the retiree set. To your point, they're very keen on experiences and are willing to spend there in ways they wouldn't spend in any other type of leisure.
What about what about emerging markets.
We've mainly talked about development markets across across this gal a. There emerging markets where you up finding interesting stocks that maybe Asia, maybe Latin America.
We have a separate quantitabily managed emerging market fund that is overweight Asia at present and even overweight China and invests across the whole array of emerging markets. And then within our global fundamental strategy we have some exposure. The one emerging market that actually really should be classified as developed where we have the most is likely South Korea, and that has a lot to do with under evaluation and the star performer there is some such Electronics, the
world's leader in memory semiconductors. They've a big consumer electronics business, displays business, but Samsung trades like a cyclical memory semiconductor stock. So when the memory semiconductor environment is oversupplied and prices are falling faster than usual, the stock price tanks, and it's in that lower level evaluation now. But what we know, and it's Brian Chow who heads up our technology research A Causeway says over and over again to the team,
compute equals memory. In other words, the more compute needed, and every enterprise we talk to is adding compute capability. They're moving their it to the cloud. They need to be able to take all the data they have and be able to extract important signals from that. They're using AI ways they never did before. And that's just the start. So the demand for memory and it'll be come from
s k Heinex, from then from Micron. In the US, these three giants control the bulk of the memory semiconductor market. This to us is just another example of the market saying, oh, short term cycles down, we don't want it, and we causeways say we want as much as we can get because we know when the cycle turns up we will have a very low entry price and therefore tremendous returns.
So you use to see it c polygopoly.
Yes, there's yes, this one in an oligopoly well put, and it doesn't necessarily lead to tremendous pricing power, but it does. There is a moat, and the moat is the incredible cost of building these the fabs in order to manufacture these semiconductors three billion dollars each or something of that magnitude.
The hell of a barrier to entry.
Yes, do you hold any commodities companies any minus anything like that?
We do our sol or matol in steel. Why would anybody buy steel in the Chinese they're dumping it? In their thesis is they can't. And that's one thing that's coming out of this tariff Breujaha, which is steel simply can't be dumped on any The US in Europe are going to be very careful to ensure that that isn't happening. And you can't tranship it through Vietnam. It's still steel. It can't be hidden our salaries to have a terrible
bound sheet now it's absolutely fantastics. They have a lot of financial strength, so they have the ability to weather all sorts of storms. But the need for steel is inexorable. And maybe no big huge housing boom, but it doesn't matter. And the surplus coming out of China, if it's controlled, means that pricing should be better. So there's one. And we also like Smurf at West Rock and Packaging, just
very very well managed business. And the concern about tariffs and less shipments for linerboard container board demand would drop, we consider that to be temporary and that ultimately e commerce is a trend that doesn't stop and there will
be more need for their product. So we'll go for a commodity company, if a very well managed b we think the commodity itself has a reasonably rosy future, and the balance sheet is excellent because commodity stocks can be volatile, and the last thing you want is financial leverage along with operating leverage.
Okay, brilliant, that's a great one. Thank you for that. Listen. I've taken up an overload of the other time.
So I just got a couple of quick questions that I kind of ask everyone at the end, and if you don't have an answer, absolutely fine, Okay, But I wonder if I were to offer you a choice of bitcoin of gold, which you might take.
I own some bitcoin and I don't own any gold, but I own bitcoin because my kids shame me into it.
What can we do to shame you into buying some gold.
I think if the gold price sagged again, I might consider it, But given how strong it's been, and I understand in part the reasons, and we can see that there's central bank buying, there's individual buying. There's a lot of concern about about fiat currency being oversupplied, and that's all very legitimate, and that's in part what drives the demand for cryptocurrencies, especially the leaders like bitcoin. But at least with crypto, there's you get to partake in it,
an exciting future that involves blockchain. Gold is just a lump and I just have very little to say about gold except without earnings and without cash flow, I'm less interested.
Yeah, it's just not an asset for you. And what are you reading at the moment? Financial and non financial?
We don't care we this episode.
I think lately it's been mostly posts that I've enjoyed because I'm trying to get more technologically savvy, listening to Mark Zuckerberg talk about Lama models.
But.
Get my head around what was going on in the US administration. So I jd Vance's book. I read that it helped me understand his background and maybe how the perspective he comes from.
He'll billy elogy.
But since then, I think I've just cooled on books and I'm more podcast focused.
Okay, good, that's what I like to hear. Anyway, I don't know how publishers would like to hear that. I'm very keen to hear that about you and podcasts. Thank you so much for doing us today. That was really interesting and I think incredibly useful.
Thank you, Thank you.
Thanks for listening to this week's maryn Talks Money. If you like us to rate, review and subscribe wherever you listen to podcasts, and keep sending your questions or comments to Merin Money at Bloomberg dot net. You can also follow me and John on Twitter or x. I'm Marinus w and John is John Underscore Stepic. This episode was hosted by Me Maren Sumset Web. It was produced by Samasadi Moses andam and tala Amadi. Sound designed by Blake Maples and special thanks of cost Sarah catter Up