BRIAN ROGERS – NOTHING IS CHEAP – Transcript 12/27/2013 #1027

January 27, 2014

CONSUELO MACK:   This week on WealthTrack while the weather outside is frosty this week’s Great Investor guest says the market is frothy! T. Rowe Price’s Brian Rogers warns the Bitcoin, IPO and social media crazes are possible signs of market storms ahead, next on Consuelo Mack WealthTrack.    


Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack. One of my favorite images of 2013 comes to us courtesy of last week’s guest, Jim Grant of Grant’s Interest Rate Observer and his art director artist, John McCarthy. Instead of Uncle Sam commanding citizens to enlist in the army in World War One and Two this cartoon portrays Uncle Ben Bernanke directing us to invest in the U.S. stock market.  The Fed’s unprecedented stimulus policies including buying hundreds of billions of dollars of bonds, even with the start of tapering, and keeping short term interest rates near zero for five years  have certainly helped boost the appeal of stocks compared to bonds and other interest bearing investments.


All financial things considered, the year has been a good one for most investors. The U.S. stock market has been strong, small company stocks in particular have been outstanding performers. The economy is recovering, resuming its leadership role as an engine of world growth. As the independent research firm, Cornerstone Macro, told clients recently: The energy and manufacturing renaissance is continuing.  U.S. industrial production is at record highs. Unemployment has dropped to a five-year low and inflation remains contained. Even Washington has gotten its act together in a couple of  areas- for the first time in years Congress and the Senate reached and passed a budget deal, avoiding a shutdown and scaling back mandated sequester cuts. And the budget deficit is shrinking to 4%. All proving once again that miracles can happen!


This week’s guest wears many hats that give him both a global macro view and a micro one. He is Great Investor Brian Rogers, Chairman of the highly respected investment and asset management firm T. Rowe Price as well as its Chief Investment Officer and the longtime manager of the T. Rowe Price Equity Income Fund which he has shepherded since its 1985 launch.. A Morningstar favorite, the fund has delivered consistent category beating returns over the years with less volatility than the market. I began the interview by asking Rogers why he is more confident about the state of the world than he has been since the financial crisis.

BRIAN ROGERS:  I think it’s primarily because the world is a safer place financially today than it was four or five years ago. When you think of what’s transpired over the last four or five years, how global economies have slowly recovered from the ’08, ’09 downturn, how the global financial system is in such stronger position today than it was, markets have rebounded strongly since 2009 obviously. That can be a good or a bad thing for investors, by the way. It’s been a good thing.  It begs the question what it will be prospectively, but I think economic growth, I think the whole financial crisis is well behind us, and I think investors and the global financial system are both in better places.


CONSUELO MACK:   So let’s talk about what you said. It could be a good thing and a bad thing. It certainly has been a great thing that the markets have rebounded as much as they have since the lows of 2009. However, looking at what you’ve been telling clients, I’m going to quote T. Rowe Price. “Risk reward is more balanced, and we should be risk aware.” What do you mean by risk aware? What are the risks that we should be aware of?


BRIAN ROGERS:   Well, Consuelo, I think what that all means is that prices are up a lot since the bottom, and so it’s not uncommon to find stock market indices up 150, 160 percent since 2009, ditto on the bond market. So if you’re a high-yield bond investor, you’ve made almost as much money as you have in equities, and what risk aware really means is be sensitive to risk after prices have appreciated. Be aware of the risk you’re taking when you make a new investment, because valuations are higher. The global financial backdrop is much better as we briefly mentioned, but with higher prices come higher risk, and so that’s what we’re saying when we say be a little bit more risk aware than you’ve been over the last five years.


CONSUELO MACK:   Okay, because I think certainly most of us have been, you know, frightened over the last five years, because there seemed to be so many risks. So there’s kind of a more complacency now in the market, and that’s a risk in and of itself. Right?


BRIAN ROGERS: Oh, without doubt.  I think you always make more money when you’re terrified, and to the extent we were all terrified back in 2008 and 2009, we had a great subsequent five-year period. Now the backdrop is better. Financial conditions are more appealing. Investors, I think without doubt, are a little bit more complacent today, and I think that’s something that you have to be wary of.


CONSUELO MACK:  So another thing that T. Rowe Price has said in a recent presentation to clients was that investors are finally, U.S. investors especially, are finally rotating back into stocks after fleeing them, but they may too late is what T. Rowe Price said.


BRIAN ROGERS: Well, yeah.


CONSUELO MACK: Is it too late to get into the market?


BRIAN ROGERS: No, I don’t think so. I think it depends on what you invest in and what you buy. I think the great rotation has been a mild rotation. To me it hasn’t been a great rotation thus far, so the money moving from fixed income funds to equity funds has been a slow but steady pattern, and I think that’s probably a good thing for the long term. I think when you think about prices being higher, it just puts a burden on the investor to make better decisions. So a company that in 2009 might have been selling at 10 times earnings, in today’s world might be selling at 15 times earnings.  Now, that doesn’t mean buying a company at 15 times earnings or, for that matter, 18 or 20 times earnings will be a bad investment, but it simply means that your return expectations have to be tempered, and you might not be making 15 or 20% a year in an investment prospectively. You might be making five to ten percent a year, and so you have to really temper your expectations and have more realistic assessment when you’re buying stocks at higher valuation levels.


CONSUELO MACK:  One of the themes that you’ve been talking to clients about is… And I love this. This title is what if nothing is cheap. So my first question to you, is nothing cheap right now, kind of looking at all of your investment choices and the different asset classes that you oversee as a Chief Investment Officer at T. Rowe Price. Is nothing cheap?

BRIAN ROGERS: Well, very few things are cheap. Consuelo, when you look around the world, I always start with the fixed income markets, because there is a predictability of returns in fixed income. If you buy…


CONSUELO MACK: From the income.


BRIAN ROGERS: If you buy the 10-year Treasury, you know over 10 years you will make today 2.8 percent a year.


CONSUELO MACK: Right, and you’ll get your money back if you hold to maturity.


BRIAN ROGERS: And you get your money back. We won’t talk about reinvestment risk and all that, but you know your return will basically be 2.8%a year. When you think about equities, again equities at 15 or 16 times earnings in the U.S., after the type of rebound we’ve had since 2009, many studies would suggest that you might earn between five and ten percent, maybe six, seven, eight percent a year over the next few years.


CONSUELO MACK: Right, versus what you’ve been making which is definitely double-digits over last five years.


BRIAN ROGERS: Over the last five years, yeah, compared to the long-term average of nine or ten percent. When you look around the world, there are different markets, so lots going on at different parts of the world. The global fixed income markets, I would say the prospective returns are similar to those of the U.S. which means modest, and I think in different equity markets, I think there’s all sorts of exciting stuff going on in Japan. A big question about Europe’s recovery, how sustainable it is, and then you have investing in emerging markets which has been a tricky place for the last couple years and an area where I think there’s pretty good opportunity over the next few. So if you think about that 2.8% starting fixed income return, as an investor you have to ask yourself, are you willing to take the risk of investing in equities to try to earn that five to ten percent?  And if you take the midpoint of that five to ten and say your expected return from the equity market might be seven, seven and a half, is that enough to compensate you for the risk of volatility relative to that 2.8%?




BRIAN ROGERS: I think the answer’s yes, but I think again you just have to be a little bit more careful. You can’t indiscriminately throw money into the equity market and hope to make 15 or 20 percent a year. You just have to be more careful.


CONSUELO MACK: I don’t want to leave the fixed income market right away, because I guess 21 percent of T. Rowe Price’s assets under management are in U.S. bonds, I think fixed income. So how risky are bonds? I mean, what’s your advice to investors who want that certain return, and it’s kind of a non-correlated asset. It’s a balance in your portfolio. It gives you income. How risky are bonds?


BRIAN ROGERS:   I think bonds are fairly risky now, Consuelo, and you don’t think of bonds as being risky, but most people don’t anyway, but it feels as though from the starting yield levels and given how at some point the Fed is going to cut back on its asset purchases… And I don’t even worrying about tapering anymore. I mean, if I were the chair of the Fed, I would have begun to taper a long time ago, because I think we’re in a good economic recovery now, and the Fed doesn’t have to be acting quite the way it is, but when you get into duration math which is something I’m reluctant to do on your show, and you think of the risk in fixed income investment if rates increase, you could easily have very low single-digit returns or negative returns in the fixed income market over the next couple years.


CONSUELO MACK: So your advice there for a strategy, again, from the Chief Investment Officer of T. Rowe Price as far as bonds are is to what?  Shorten your maturities.


BRIAN ROGERS: Shorten your maturities, shorten your duration.


CONSUELO MACK: You’ve got about $30 billion in assets under management now at the T. Rowe Price Equity Income Fund. The yield is under two percent. You’ve had a really good year in 2013. Historically you look for undervalued dividend payers, so is there any such animal now as an undervalued dividend payer?


BRIAN ROGERS:  No, I think there are, but I think it’s so much harder. Every day when I look at my portfolio, I think there are so many more things to sell than to buy, and I think that often takes place at times after markets have appreciated. So I think there are interesting things to do, but I think they are much fewer in number. We’ve raised our cash a little bit over the last couple of quarters.




BRIAN ROGERS: To almost seven percent which isn’t too high, but it’s the direction of the movement that’s important. There are very few signs of equity market stress where you can really capitalize on uncertainty and be a contrarian today, and so I think that’s the value investor’s challenge in today’s world.


CONSUELO MACK: So what’s your overall strategy? What kind of companies are you holding?  What kind of returns are you expecting?


BRIAN ROGERS: Consuelo, what we’re focused on right now are companies that have lagged the market over the last couple of years and consequently are inexpensive because of that.  So there aren’t many of those, by the way, so in today’s world, if a company is flat in 2013 and has a P/E of 10 or 11 or 12 and a dividend yield of three percent or something, you know, that’s a pretty interesting investment opportunity to us, and we can talked about some specifics if you’d like, but there aren’t many. There really aren’t many and, again, I come to work every day, and I look at some of the holdings we’ve had that have been really successful investments, and they’re great companies, but their valuations are less appealing, and their dividend yields have declined as prices have increased, and so these are really like benchmark blue chip American companies.




BRIAN ROGERS: Such as like 3M, American Express, you know, fine companies, and we’re not selling because we don’t like the company. It’s because we’re less attracted to the stock price, and we always try to make that distinction between company quality, management performance, long-term return potential and today’s valuation, and we try to balance those couple of things out.


CONSUELO MACK: Is dividend growth a big part of the strategy? So you’re talking about total returns as opposed to what’s going on in the market, per se, or…?


BRIAN ROGERS: I think the perfect company for us, Consuelo, is a company that has a decent dividend yield today and can continue to grow that dividend over the long term.


CONSUELO MACK: Right, so give us some examples of companies that, if I were to look at the Equity Income Fund, you know, these are the kind of companies that you have always had for the last 18 years in the portfolio that represent the kind of companies that you want in the fund.


BRIAN ROGERS: Well, you know, over the last since ’85, we actually have a couple of the same companies in the portfolio for that whole period. One would be J. P. Morgan Chase and its predecessor companies. Another would be Exxon Mobil which way back when was just Exxon.   We’ve had an investment in Johnson & Johnson for many years. Those would be three that I would point to which have had a great track record of creating value for investors, have had really good dividend performance over the long term, and the stocks have done very well over the long term admittedly with big ups and downs in the short term.


CONSUELO MACK: Right. Talk about J. P. Morgan Chase, with what’s going on now with Dodd-Frank, with the Volcker Rule, the various governments around the world are arrayed against the banks. They want to rein them in, and J. P. Morgan Chase, Jamie Dimon seems to have a huge target on his chest. So what do you do in a situation like that where a company is really under tremendous regulatory pressure, and they’re being fined billions of dollars it seems like every other day?


BRIAN ROGERS:  Well, I think it’s probably a testimony to J. P. Morgan Chase’s strength that with all the fines and all the controversy, how well the stock’s done and how well the company’s done from an earnings and growth standpoint over the last one, three, five and ten years, and it’s done a fine job navigating its way through the crisis. I view what’s happened regulatoraly and politically as being grossly unfair to some of these companies and not just to J. P. Morgan Chase but to Bank of America and a number of financial services companies.


CONSUELO MACK:  So why?  Because the other side of… The critics of the banks would say, “Look, they got us into the mess of the financial crisis, and they made a ton of money and basically we can’t let them get in a situation where the taxpayers have to bail them out again.” That’s what the other side is saying.  So what’s your response to that?


BRIAN ROGERS:  Well, I think the blame for the financial crisis, Consuelo, can really be spread around to a number of people. I mean, there was bad lender behavior, appraiser behavior, mortgage originator behavior, Wall Street financial engineer behavior. There was a lot of bad behavior. There was bad political behavior, back to some of the incentives designed to spread home ownership to everybody and, in some cases, folks couldn’t afford it.  So I think there’s plenty of blame for the financial crisis. When I think specifically of J. P. Morgan Chase, and I view the role that they played in helping us get through the financial crisis in terms of the Bear Stearns transaction, the Washington Mutual transaction, those were major institutions that almost took us over the brink.


CONSUELO MACK: Right, and the government basically said you’ve got to take these things over.


BRIAN ROGERS: That’s why I view unjust as an applicable term here.


CONSUELO MACK: All right. So looking at the changes in the regulatory environment for a J. P. Morgan Chase, for instance, I mean, how different is the business model going to be, and how profitable is it going to be in the future?


BRIAN ROGERS:  Well, I think profitability will be impaired by some of the regulatory change. I think the basic business will not really be affected. I think all of these companies will have to hold more capital which is probably a good thing, and one of the reasons I think the global financial system is in much better condition today is because the leading financial institutions have much more liquidity and much more capital.  So if there is another market crisis in the next couple years, it probably won’t be because the residential mortgage sector took us over the brink. It will be something else, and so I think the companies have been healing. I mean, they’re good corporate actors. They care about their investors, and I think that’s an important thing to keep in mind.


CONSUELO MACK:  So a company that might surprise one if you’re looking at an equity income and the kind of track record that you have is Apple, and it was noted by Morningstar in a report I think that while the growth managers at T. Rowe Price were selling Apple, that the more value-oriented managers such as yourself were buying Apple. So talk to us a little bit about Apple.


BRIAN ROGERS:  Well, Apple was a company about a year ago under a lot of pressure, and Apple had been a great performer for many years, and really towards the end of 2012 into early 2013 the bloom really began to fall of the rose, and the stock weakened sharply over the course of the first half of 2013, and we looked at it in the springtime and thought, okay, the stock has gone from 700 to 400 roughly. The P/E multiple is now 10. They’re buying back stock at a frantic pace. They have a nice three percent dividend yield, and there’s a lot of investor controversy, and we love trying to identify controversy and to ascertain whether or not we can benefit  from really what’s a short-term panic, and so we looked at Apple in the springtime. I thought, you know, the stock’s way down. The valuation appeal is pretty high. It’s a yield stock which Apple had never really been, and so we made an investment in the springtime in Apple, and it’s rebounded since. So we’re always looking for companies like that that have struggled, where there’s uncertainty, where the investor concern creates a valuation opportunity, and there are a lot of things going on like that today. I think mean, even simple electric utilities now are very much out of favor.


CONSUELO MACK:  They are. I mean, it’s so funny because you had mentioned to me earlier that telecom and utilities were where you’re looking, and if I look at just about every major brokerage firm, they’re saying, you know, sell, underweight telecom and utilities, and you’re looking at them.


BRIAN ROGERS:  Well, the stocks are basically up a little bit to down over the last year, and because of that and because of the fact everything else is up 20 or 30%, all of a sudden in a relative sense they look pretty inexpensive. So whether it’s Entergy which is kind of an electric utility in the Gulf Coast region or even plain old-fashioned Ma Bell, AT&T with a five plus percent dividend yield, having lagged everything for the last 18 months price-wise. Both those look as relatively safe, risk-aware investments for the investor who wants exposure, who’s looking for dividend income but who does not want to take on too much risk.


CONSUELO MACK: You mentioned emerging markets earlier in the interview, so talk to us about what you’re seeing as opportunities in the emerging markets,


BRIAN ROGERS:  Well, as a sector, the emerging markets sell about 10 times earnings, so when you look at European valuations or U.S valuations, that’s probably a five multiple point difference.  The cash flows coming out of the sector have been large, so investors are moving in the opposite direction, perhaps not unlike investors selling Apple, and sentiment is pretty negative, and the fundamentals are, over the long term, ought to continue to be pretty good, and so many of the emerging market country governments are in better shape than some of the developed market governments.


CONSUELO MACK: Oh, absolutely. Their investment grade


BRIAN ROGERS:  Their investment grade, and population growth is high. The demographics are good, and I think over a five or ten-year period from here, they’ll present very interesting opportunities. So valuation is attractive. Sentiment is bad. Institutions have been moving out, and I think over a long-term period, I think it’s a very interesting area to explore.


CONSUELO MACK: So you’re talking about both stocks and bonds.


BRIAN ROGERS:  Oh, I think primarily equities.

CONSUELO MACK: Primarily equities.


BRIAN ROGERS:  Because from equities you will benefit from that long-term demographic growth case.


CONSUELO MACK: You also mentioned Japan.


BRIAN ROGERS:   Well, Japan is one of those markets and economies.Had I been a global strategist, I would have called for the turn in Japan 10 years ago. That would have been, what, 10 or 12 years into the big Japanese bear market.


CONSUELO MACK:  Right, exactly.


BRIAN ROGERS:  And so it took 20 years, not 10 years for Japan to really turn. And I just think there’s a lot of pent-up potential in Japan. It’s been a great market this year, and I think you can’t correct 20 years of underperformance and a 20-year bear market generally with one year of rebound, and I suspect over the next couple of years the Japanese market will be a very interesting and continuously rewarding place, and I think we’re probably in the second or third inning there, so I think it’s an area investors should focus on or pay attention to and try to capitalize on it if possible.


CONSUELO MACK: Talk about constant surprises in the financial markets. Who would have thunk that Japan would be a very interesting place, exciting place to invest.


CONSUELO MACK: One Investment for a long-term diversified portfolio, what would your choice be?


BRIAN ROGERS:  Consuelo, there are so many great ones.


CONSUELO MACK: I was going to say, how many companies do you have in your portfolio as it is?


BRIAN ROGERS:  Right now we have investments in roughly 115 companies.


CONSUELO MACK:  Right, and I’m asking you to choose your… Right.


BRIAN ROGERS:  I think one really interesting idea for the long-term is Deere.




BRIAN ROGERS:  And Deere is a stock that, not unlike some of the utility stocks or telecommunication companies, is down this year. In response to that price weakness, they announced a buyback of about 25 percent of the company. Great dividend history, two and a half percent, maybe a little bit less than a two and a half percent dividend yield right now, and when you say long term, buy and hold, don’t worry about, I think in 10, 20, 30, 40, 50 years, Deere will still be making the equipment that feeds the world. And when you say one for the long term, I think the company will be… It’s been around for a long time. It’s going to be around for a long time. It’s under performed.  It’s inexpensive. It’s a really high-quality company, great source of income, great source of benefiting from capital allocation and a unique franchise globally.


CONSUELO MACK:   And I have one final question for you. You and I had talked earlier about that one of the things you’re watching are the pockets of craziness in the market and what’s that telling you. So talk about a couple of the pockets of craziness. Bitcoins, for instance, I know are one.


BRIAN ROGERS:   Yeah, Bitcoin is absolutely crazy, absolutely crazy. I think there is a little bit of froth in the IPO market.


CONSUELO MACK: Initial public offerings

BRIAN ROGERS:  A lot of things coming to market. I think the way certain what I will call new age or social network companies are being valued is I’d call it a yellow flashing warning as opposed to a red stoplight like we saw in 2000 at the height of the dot com bubble. I think there are warning signs there, and I think investors would be prudent to pay attention to. The whole Bitcoin thing, I mean, you have to have a currency that is geared to or based on something and not simply a Greater Fool, Tulip Mania kind of concept here, because the last time I checked there was no real economy or series of gold bars or central bank supporting a virtual electronic currency, and so if I were an investor, I would steer clear of that.  If I were a regulator, I would pay an awful lot of attention to what’s going on there.


CONSUELO MACK: And again, it’s telling you that those are flashing lights of frothiness that…

BRIAN ROGERS:  Yeah, I think the whole Bitcoin market is like a 10 or 12 billion dollar market I think, so it’s very small, but I think that type of behavior, that type of very aggressive investor behavior, speculative behavior never happens at the bottom.


CONSUELO MACK: So Brian Rogers, it’s such a treat to have you here on WealthTrack. We appreciate it so much, chairman, CIO and portfolio manager of T. Rowe Price. Thanks very much for being here.


BRIAN ROGERS:  Consuelo, great to be with you.

CONSUELO MACK:   At the close of every WealthTrack we try to give you one suggestion to help you build and protect your wealth over the long term. This week’s Action Point is: Consider rebalancing your portfolio.  The vast majority of the great investors we talk to, Brian Rogers included, periodically trim their winners when they become overvalued by their metrics and add to their laggards when undervalued. The practice applies to individual securities, as well as asset classes, mutual funds and ETFs. Since the market bottom in 2009 and more recently as well, U.S. stocks have been the global winners, small company stocks in particular, so consider trimming there.  Whereas emerging market stocks have lagged, time to potentially add there. In the bond universe consider trimming some top performing high yield bonds and shifting to some much shorter maturity treasury notes and T-bills for safety and stability, and tip toeing into high quality emerging market government and corporate bonds for long term appreciation and diversification.


I hope you can join us next week for a WealthTrack television first:  Two top value investors Wally Weitz and Tom Russo sit down together to talk about their very different portfolios and their mutual hero Warren Buffet. Also on our website Extra feature we will continue our conversation with Brian Rogers and ask him what worries him most in the markets. For those of you connecting with us on Facebook and Twitter keep communicating with us. In the meantime, have a great weekend and a very happy New Year celebration. We look forward to helping you make it a profitable and a productive 2014!

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