Remembering 2019

in advance, so no craziest thing of the week unfortunately. However, I do believe our guests came prepared with the craziest thing he saw in markets all year, So I already gave my craziest thing in markets for the year last week, so we will focus on our guests. Then. His name is Matt Perrone. He's the chief investment officer for City National Bank. Matt, welcome to the show. Thanks, thanks for

having me. All Right, Matt, we'd like to tease the audience with what the craziest thing of the year is, so we'll get to that at the end, but talk us through how you saw the year progressing. I mean, boy, it looked like things were dangerous there for a while in the middle of the year everybody was worried about a recession. How does as a as a strategist investor, how do you handle a year like this? I mean,

was it a tough year to navigate? You know, it was in the sense that, well, we started the year with really a scare. Late December two eighteen was pretty tough on the markets, almost down. So for for us it was a kind of a head scratcher because the fundamental outlook just wasn't that bad. And yet the fear in the market was just and the fear in our clients and everyone felt that this was finally the end

of this cycle. For us, you know, we had to do our job of hand holding clients, of telling them, really, the fundamental outlook isn't that bad. We do think the markets overreacting talk and there was a lot of that um but and and and we published a note called there will be Growth in the Spring borrowing from the Peter Sellers. Uh has some good and bad connotations, but the point to it was that, you know, we we did think there would be growth, and finally that came out.

And then of course we had that mid year dip that you spoke about, So talk us through how your client sentiment has changed from then until now. You mentioned, as Mike mentioned, having to talk him off a cliff, things did get scary in the middle of the year. There was a lot of talk of potential recession, either at the end of this year or heading into Where do they stand now? Have they really come a long way? Yeah? They have. I think you've seen a lot of people

now more comfortable. There are a lot of cash on the sidelines that have that in clients who have come and said, okay, I see now that this expansion still has some legs to it. Maybe taking some more risk does make sense. You know, with rates being lower, it's pressured a lot of people who have been in cash to say, how do I put my cash to work? And don't put me fully into equities, but put me into you know, higher yielding securities. So that's been a

dynamic for sure for our typical client. Are you know, we've stayed invested and we've said that from the beginning. It's don't you know, it's time to be cautious and be up in quality, but stay invested. You know. Uh. Some notes you sent over you made a really good point about the multiple expansion in the equity market, the share I mean, that's basically all. We got very lackluster year for earnings. Um, so now we're looking at on something like twenty times trailing earnings for the smp UH

forward earnings something a little less than seventeen. I think the last time I check, does that make you nervous at all? I mean, are we really pricing in a rosy situation for with that that aggressive multiple expansion? Well, the multiple expansion was certainly farther than we anticipated it would be. I think we've had a you know, just about all of the appreciation in the markets this year

came from multiple expansion. The way we frame that out is, you know, it's somewhat textbook if you look at the impact of rates on the multiple, Well, it actually did what it was supposed to do with rates coming down to where they were, and you flow that through to either a regression model or a discounted cash flow model with low rates and an equity risk premium of four percent. With four percent growth, you get to about today's price.

So it's not completely disconnected from reality, but it's an optimistic view that this will continue now for a long time. So one of the stories of two thousand nineteen. Back to your earlier question, we went from real pessimism and fear to now all things are gonna be okay for the foreseeable future. I want to get your thoughts on this talking about multiple expansion and then compared to the e of the PE ratio and how earnings fit into valuations.

I was looking at some research recently from ned Davis Research, and what they found was that in really gang buster earnings is typically you don't have great equity returns, and it's because typically those returns are pulled forwards. And we saw that happen in seventeen where we had a great year of earnings last year, but then we really had a great year of returns for the stock market in seventeen ahead of the tax cut. And then this year we've got a no earnings growth, but at the same

time we've got an unbelievable returns within equities. Do you think it's saying the same thing potentially about earnings for next year that we've had such great returns this year. First of all, I agree with that that view. It is kind of counterintuitive that you would see appreciation ahead of the market gets in front of it does a good job of sniffing out earnings growth ahead of time. So it's what we call it pre trades it if you will, um and but so yes and no. I

think it's seeing a return to earnings growth. But I don't think the market is yet pricing in a big uplift in earnings. Um. You know, by our measure, it's pricing in you know, five or six percent earnings growth next year. Right. As as you said, uh, pas often are a function of the the interest rate environment. You know, low interest rates, you're you're willing to pay up for stocks,

pay a little higher evaluations. Is there a treasury yield that would sort of make you worry that, uh it will start putting a lid on equity gains, you know at three on the tenure or something like that. Yeah, I think you're right. That's where you start to see the union yang of higher yields will mean typically higher growth, so you can start pricing that in. But then when you start raising the interest rate input, if you will, that caps the multiple, so they off set each other.

I think we're we're above four percent, I think is where that starts. To get that math, if you will, gets tough, and so then you would see equities struggle a little bit more. So you say above four percent, I'll say our guest that we had on the show last week, she said she could see a tenure in the range of two to three, but likely staying towards the low end of that range. Do you see it as at all possible to get close to three on the tenure and maybe even close to that four percent range.

I think four percent is going to be tough. Three percent possible, And is you know anything you know cyclical could happen. Our base case is more aligned with your guest from last week, that will be somewhat kept in that low two percent range. We should get some uplift from a recovery UM in the manufacturing sector in the non US economies, which, by the way, is another big story of two thou nineteen, the tale of two economies, And that's another story that that I think is Who's

going to change in two thousand twenty? Oh yeah, you think the rest of the world will sort of play a little catch up? I think so. So if you look at UM this year, and you look at either in the macro and the micro right the macro data manufacturing was soft. We saw that in the p M I S, etcetera global p M I S in the in the micro data in the sp F, companies with domestic exposure generally had flat slightly up earnings and companies with more than the revenues outside the US had earnings

down on average. And that probably has moved through the cycle. That that was driven by an inventory cycle, that was driven by the trade dynamic, and both of those were moving through. Hopefully on the trade moving through the end of that. And if that, even if it doesn't uplift, it will be the removal of a negative and you could see um a reversion there and people will it'll be more balanced in terms of the global outlook. One thing in your notes I found interesting is you say

dividend stocks are cheap now. Um, when I hear dividend stocks, I immediately default to thinking utilities, which part of the year they got very very expensive. Uh less, so now I think they're back below a multiple of the SMP trade netted discount. Consumer staple stocks got pretty expensive. And then on the other end of the risk spectrum, I look at MLPs. You know, the messter limited partnerships which

are cheap ast heck, but very risky obviously. I mean, I think there's several MLPs that not too long ago we're at like double digit dividend yields. So walk us through what dividend stocks you kind of have your eye on right now that look cheap and not just cheap. But but you know, if you're buying a dividend stock, obviously you want that safety. You want to see that dividend keep rising or at least stabilized. So where are

you seeing good opportunities there? First of all, the the dividend stocks are relatively attractive, they are um versus the rest of the market, but it's in Wharton to look at them on a sector cross sectional basis, and what I mean by that is balanced across the sectors. You're right, if you look at it, where are the high dividend yielders, the utilities and the reats those and the staples those have typically been more expensive if you don't balance around

the sectors. But if you take a balanced view of every sector technology, energy, as you mentioned, then in general the dividend stocks bisector um are there's there's lots of opportunity in there. So we can find opportunities within every sector and create a balanced portfolio around that. But yeah, and then you bring up you know, some of the energy patch is getting very interesting. You see some uh good yields there. We've been very selective, adding very selectively

in that sector as well of late. Even financials for a while this year had some really surprisingly strong dividend yields. You know. You you figure, you know, with the sort of less of a focus on regulation and and fed stressed to it's maybe those those will even be sort of stronger growing dividend stocks than than you would have

guessed a few years ago. Well, they just trade with the yield curve and with the yeld curve flat, you know, the al goes kick in, and you know, and I think, on um, you know, on an unwarranted basis, the algales really I don't want to blame them too much, but I think they don't listen to the shows. It was tick by tick, you know, they were, you know, rates rates down, financials down. It was kind of too much

lockstep to be anything. But but I think and then and that misses the dividend story, which is quite strong, and the earnings yield on those is quite impressive. So the capital return story at the banks has been tremendous, buying back a ton of their own stock. So it really is a total return, total shareholder return story there that I think was missed for a while when the curve was laddening. So do you think it's a miscommunication or at least a mistake for people to generalize when

they think of dividend yielding stocks. A lot of people will just think of your classic bond proxy is the ones that Mike mentioned real estate for example. But the idea that you can actually find companies with higher dividends across any sector, you just have to do the work. Absolutely, I think that's right. I think I think what happened

was yet um both of phenomenon. I want yield and I want safe yield because the world is ending, right, so utilities and reads hit that low volatility high dividend cross section, if you will, and so people gravitated towards that, and I think they're missing the the shareholder yield and the dividend yield available in other sectors um. More broadly, that's so that's something we focus on, is a more broadly diversified high dividend strategy. Alright, MA, I gotta say

this is my favorite line in the notes you provided us. Uh. Tons of our ultra high net worth clients are calling and saying, I missed this. How do you get me back in with low risk? Now, me being not exactly an ultra high network. Uh, but let's pretend I am. How do you get us back in? Is it is? Do you have to talk these people sort of uh down from the fomo effect here? Um? Yeah, And I don't know if I had used the word back If I did, that was a typo. But I meant to say,

how do I get in? Because many people have been sitting out and for years and they're finally saying, you know, at least I want more yield. Maybe don't don't put me into the equity markets, but get get me some more yield. So we are seeing a lot of of calls from clients who really want to participate in at least yield instruments and get out of cash. Basically, So, is this on the equity side, more so on the

fixed income side and credit? How would that be? It's more on the fixed income side and credit people, it's too far to go from pure cash to equities, especially at this point in time. So move me up the credit spectrum, uh, in terms of you know, more yield and in the credit dimension. Um. But but safe yield is really the question. It's an interesting thing because when the world seemed like it was, you know, barreling towards a recession earlier in the year, those cash shields were

pretty attractive. I think the money market funds were at about two in a quarter around there for a while, so, um, a lot of people really parked out there. It sounds like among your clients they did, you know, two and a half was okay? And then the fit took took that away, right, And so that's really what's driving that dynamic. So in and I'm curious about the psychology here here because you said it's been years, so I imagine they've been waiting this out, waiting for a good opportunity to

get in. And I think back to and you would have thought you had the SMP down nine percent almost the end of the bull market. You would have thought that would have been a good opportunity. Was there just too much fear surrounding as well that we didn't actually see investors who have been out sitting in cash take that opportunity to get back in, and that means they've

then missed as well. I think that's right. I think putting aside a different client basis, I think when you look at the flow data, a lot of people were continuing to outflow, for they have been for a number of years into bonds, and they continued that even at the bottom of of two tho um and uh so yes, I think a lot of people have missed out on this rally um And now you know, you're starting to see the flow data reverse a little bit, so they're

coming back in. So if you had to boil it down to sort of a asset allocation uh decision right now, what would you tell clients overweight certain assets underweight? I mean, are you uh it sounds like you're you're still bullish on equities, but maybe not hyperbullish. We think it'll be a coupon your inequities, just like you call it in fixed income, when you just collect your coupon, the spread doesn't change. That will probably be the same thing in

in equities. You'll collect your earnings growth and your dividend yield. But don't expect another rerating of the multiple higher for sure. UM. What we're counseling to clients right now is stay with high quality. It's laid in the cycle to really you know, take risks. So large cap dividend pairs. As I mentioned UM, and there are cheaper parts of the global markets. We like Asia for example, especially e M. Asia is much

cheaper and you have growth. They should be at the bottom of their cycle and you can see some growth. So we like that UM area on a relative basis growth versus that the value that you're getting there. So there are parts of the equity markets. In the fixed income markets we like, UH. Certain areas of emerging markets credit you get nice spreads with pretty tight covenants there. You don't have as much covenant light as you do in the US bank loans were we've got spots and

bank loans that are UH that are good. There are some frothy spots and in the corporate credit markets, but certainly areas and in the bank loans that we'm kind of chuckling inside because it sounds like the covenant situation is are an emerging markets Well, if you're an emerging markets issue, where and you have to issue in the US, right you have to have a pretty tight covenant to Yeah. Yeah,

that's interesting. So built up the hype Mike did at the beginning of the show your craziest thing all year long? So I figured, why don't we get to it, and then we can also talk a little bit more about it as well. What would you say twenty nineteen craziest thing that happened? Well, so I'm going to keep my comments confined to the markets, right because if I go into the sphere or anything like that, exactly, it was

the crazy year all around. I'd say there was a lot to choose from in that dimension, but we'll stay with the markets. I think the craziest part was just the panic that of the recession that never came right, and we really had. I mean, just there was if you looked at the market, if you were on Mars, you would say, oh my god, there's a major recession or depression coming. We had two eight pricing in certain cases you'll curve coming, you know, flat, etcetera. That was

kind of crazy because it was really disconnected from reality. Sure, there were soft patches in the manufacturing sector, just like in two thousand and sixteen, there was a soft patch in the energy sector um just like in two thousand eleven. You know, it was like ad it was a mini cycle, there's no question, as you will see, but a financial

crisis almost was being priced in. That was odd to us, and I think as a representation of how far we've come, I think it is unbelievable you had an inversion of the yield curve these recession fears, and now as we do close out, you now have the steepest yield curve since all the way back in. So it's really come full circle. Ye. Absolutely, So what what kind of risks would you sort of put at the top of your list for the corporate market? Corporate credit markets are something

that we're really watching. It's there's some frothy areas there. We're not seeing big uptick in defaults, but it's a bit of a coiled spring. When it goes, it's gonna go fast. So we we we really want to watch that. We're watching the corporate debt market and we're looking at every uh, every different lens of of credit levels, etcetera. For stress. But sorry, it's not just the end of the year. I can't believe it. It's the end of

another decade, another Uh. I was born near the beginning of the nineteen seventies decades, so I don't like to see these go go buy so quickly. They keep going too quickly. But Matt, what what was the highlight for you of the whole decade? Uh? You know, it clearly was the longest. I forget all the stats. There's a million stats for it. But best decades since the fifties or something like that. In equities, so best decades since

the fifties. If you look at the sharp ratio of the SMP, so steadiest gains to the upside risk adjusted returns. But I know, Matt, you also have some other statistics as well. Well, it was steady. I could see that sharp ratio making a lot of sense when the volatility level was unbelievably low there for a while, making the sharp ray show high. But I think it was the first decade with no recession. And but in terms of total return, so up two this decade the fourth best decade,

nineteen fifties being the best at up four. So it's a way to go. Yeah, you could put it that way, but yeah, it's it's it's interesting when you know, when when you look through history that actually it's only the fourth best decade out there. That's pretty interesting. Yeah, I guess so as we start, we're already going to start keeping tabs on the next decade and see how we start off. We'll have a recession this decade, for sure. I think that we'll hold you to that. You remember

you said that. Happy holidays, guys, Matt Round, Thanks so much for coming on the show What Goes Up. We'll be back next week. Until you can find us on the Bloomberg Terminal website and app, or wherever you get your podcasts. We'd love it if you took the time to rate interview the show on Apple Podcasts so more listeners can find us. And you can find us on Twitter, follow me at Sarah Pontzack Mike is at re Gutonomous, and you can also follow Bloomberg Podcasts at Podcasts. What

Goes Up is produced by tober Forehead. The head of Bloomberg podcast is Francesco Levie. Thanks for listening, See you next time.