GLOBAL INVESTMENT TRENDS Transcript 8/16/2013 #1008

August 22, 2013

CONSUELO MACK: This week on WealthTrack, Morgan Stanley’s asset allocation king David Darst teams up with Mutual Global Discovery Fund’s Peter Langerman to dig for hidden treasures in world markets. Where are they finding buried bargains? Darst and Langerman on where the global values are, next on Consuelo Mack WealthTrack.

Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack. This has been a great time to be a U.S. investor. Over the last couple of years American stock markets have outperformed the gains in other developed markets, including Europe, and have trounced the losses experienced in many emerging markets. Having a home bias has paid off, but will it continue to do so? If history is any guide the answer is no!

According to a study of the performance of twelve different global asset classes over the last decade by wealth management firm Gerstein Fisher, one year’s winners are rarely next year’s victors. Last year’s winning category, Global Real Estate Investment Trusts has dropped out of the top three this year. Gold, the number one asset class in 2010 and 2011 is near the bottom of the list so far this year. And the move into emerging markets, which was so rewarding in seven out of the last ten years, is now lagging badly.  Gerstein Fisher’s conclusion: It is nearly impossible to pick winning asset classes in advance and in fact broad global diversification is the best long term strategy, it’s beaten U.S. only focused investing pretty consistently over the last 10 and 15 year periods.  We will have a copy of their research report on global investing on our website,

Global investment trends and strategies are our focus on this week’s WealthTrack with two global investment pros.  Peter Langerman is the Chairman, President and CEO of Franklin Mutual Advisers where he oversees the value-oriented mutual series funds. He is co-portfolio manager of several including Mutual Global Discovery and Mutual Shares. Financial Thought Leader David Darst is a WealthTrack regular. He is Chief Investment Strategist of Morgan Stanley Wealth Management with responsibility for asset allocation and investment strategy.  He is also the author of seven books including a wonderful primer on the art and science of asset allocation titled, “The Little Book That Saves Your Assets”. I began the interview by asking Langerman, as a deep value investor, about his view of the U.S. stock market given its strong multi-year performance.


PETER LANGERMAN: Things aren’t as cheap as they were. On the other hand, my view is they’re not so out of control in terms of valuations and what’s really happening at the company level that we feel that the market is overvalued.  There are always pockets in our view that people are not looking at or worried about, and that’s what we tend to focus on, and at the same time there’s some areas that have done very well, and where we had exposure we’ve trimmed and we’re avoiding. So there are things to do, and that’s good for us as bottoms up value investors.


CONSUELO MACK: Right. So David, at Morgan Stanley your view of the U.S. stock market, given the run up that we’ve had in the last couple of years?


DAVID DARST: Well, it looks on a short-term basis to perhaps be a bit overbought right now, Consuelo.  Volatility is very low. Margin debt is very high. Trading volume has been very low of late. That having been said, the four engines of this U.S. market and economic aircraft are all firing very, very flawlessly. Monetary stimulus is still in place. Number two, the housing market, new home sales, existing home sales, pending home sales, builders’ confidence. Number three, the consumer. Retail sales, consumer confidence, these numbers, consumer borrowing. People have been willing to take on some debt to purchase things and, finally, the production side, Philly Fed, the Empire State manufacturing, the Chicago purchasing managers index. So a lot of these. You won’t believe this, but the 55 reading that just came out a couple of weeks ago on the ISM manufacturing. Anything above 50 means expansion.


CONSUELO MACK: So looking at where you could invest in the globe, about half of Global Discovery Fund or the Mutual Series Funds are in the U.S.?  So you’re still finding value in the U.S.  What kinds of situations are you looking at that are kind of emblematic of what you’re doing at Mutual Series?


PETER LANGERMAN: Sure. I mean, some of the things that we’ve looked recently are in the underperforming areas such as energy, for example.  Energy by and large has been an underperformer. There are lots of reasons. Part of them is macro. Part of them is just the nature of those businesses. They’re very capital intensive by and large, and they haven’t really participated in this general market recovery. So there’s some specific companies. Again, it’s not let’s find an industry and invest in a bunch of different companies. It’s much more company-specific, but for example there’s some E&P, exploration and production companies, that have kind of left behind. There have been some names in the news where some large shareholders, activist shareholders have taken the opportunity to say, “Wait a second. These are underperforming companies that have lots of value, good asset value, but they haven’t really demonstrated that in terms of their stock price.”


CONSUELO MACK: So Apache, for instance, one of your holdings.


PETER LANGERMAN: So a name like an Apache where we’re active. We’ve owned it for a while. We engage with management. They’ve actually taken some steps of late to announce sales of assets, rationalization of their business, you know, doing things that we think are moving in the right direction, albeit they have a ways to go, but to highlight the value. So it’s a stock that trades in the 80s that we think is worth well north of 100, and the asset value really is there to demonstrate it, but they’ve got to show the world that they can actually get there. Some of the med tech names is another areas.  Now, those names have done by and large pretty well, but a name like a Medtronic which we still think trades too cheaply. People still have lots of issues with the nature of the business and product liability issues. There’s a medical tax issue, but you cut through all that. They’ve got a CEO who really is focused on delivering value to shareholders, returning cash to shareholders, being more thoughtful about acquisitions, so that’s the kind of name that we look at, and we still think there’s lots of opportunity there for us.


CONSUELO MACK: So patience. I mean, how patient are you as a deep value investor?

PETER LANGERMAN: I think for value investors, there’s a balance. I think most value investors like ourselves want to make sure that you’re right on the values. Right? If you’re right on the values and you’re buying something at 60% of intrinsic value, you’re willing to wait.


CONSUELO MACK: You know, it’s so interesting, because what his view as a professional versus what usually the individual investor’s view is, is very different. Individual investors don’t tend to be that patient. Right? And so I’m looking now at what’s … we’ve had changes in different asset values, and we’re seeing some very marked fund flows, David.  For instance, the last couple months there have been wholesaling selling of bond funds, and individual investors have been moving into U.S. stock funds.


DAVID DARST: Many of your viewers, many of our generation okay, the baby boomers … there are 76 million of us born from 1946 to ’64. We basically want our portfolios to have a little bit more stability and give a little bit more predictability of income. So that was the driver into the bonds. So I find it good. This is early innings for people for this massive great rotation you’ve talked about on your show, we have a lot of cash which is yielding you nothing. However, it’s yielding you 22 percent if you didn’t buy Brazil.  It’s down 22% this year. So you basically have that as dry powder. The market has run up a lot. Should it pull back in the U.S., in Japan, if it even gets further cheap in Europe as Peter’s been talking about, we would basically be adding to U.S. stocks, to Japanese stocks, and then begin to nibble at European stocks. Emerging market …


CONSUELO MACK: So this is incremental you’re talking about. .


DAVID DARST: That’s right. So we think it’s early innings, this great rotation out of bonds, but we would say to all your viewers be very careful. If bond interest rates rise by one and a half percent from this level… right now a two-year bond yields only 30 basis points, 0.30. A ten-year is 2.5 …


CONSUELO MACK: These are the treasuries.


DAVID DARST: Ten-year treasury, 2.58, and a 30-year treasury is 3.58, right about 100 basis points more. If interest rates go up by one and a half percent, 150 basis points, Consuelo, a two-year bond loses one percent. Okay? A 10-year bond …




DAVID DARST: In principal value.  A 10-year bond loses 11 percent, and a 30-year bond loses 25%. So we say to all your viewers be very careful. Analyze the maturity structure of your portfolio, and be looking at short-duration bonds and/or floating rate notes whose capital doesn’t change because the coupon changes if interest rates do rise. We don’t see rates spiking upward, but we think they’ve gone down. Your viewers know they’ve gone down for 32 years since 1981.  Here we are in 2013. So you’ve had a long, long bold market in bonds, so to me it’s a wonderful thing that individuals are starting to shift from bonds into stocks. There was a period earlier this year when they were moving from bonds into cash, and so a year ago we had 30% in stocks. Today we’re 42% in stocks for a moderate high net worth investor.  A year ago, we were 42% in bonds. Today we’re 30% in bonds. Most of the reduction has come in the mid and long maturity corporate and government bonds.


CONSUELO MACK: The problem is no one wants to be the last guy out of their bond fund or whatever, so that’s why it’s such a temptation to make some pretty radical moves. You know, you just talked about Europe. So Morgan Stanley starting to think about investing in Europe. You are there, Peter, in the Mutual Series Fund, so tell us and you’re there in a very contrarian way. So tell us what your European strategy has been.


PETER LANGERMAN: Yeah, it’s interesting that I think our initial view was that Europe would not completely implode.  It semi imploded but didn’t completely go off the rails which was, to some extent, a contrarian view. We had a lot of people talking about the breakup of the euro, et cetera.  It got bad, but it didn’t get that bad. So we were there, but actually what we’ve been focusing on more recently that I think still is a bit unusual is companies that are euro-centric, that are not only headquartered and domiciled in Europe but actually doing most of their business in Europe. There are certainly lots of companies that are headquartered in whether it’s the U.K. or Switzerland, but their business there is minimal.


CONSUELO MACK: Forty percent emerging market. I mean, that’s…


PETER LANGERMAN: Right, they’re Europe in name, and that was a theme. They kind of got tarnished with everybody else that was in Europe, but we’ve in a sense gone beyond that, because there’s some companies that actually do most of their business or a lot of their business in Europe, and we’re seeing some signs even from some of the major brokerage houses saying, “Oh, you know what?  Europe actually is showing a little bit of life here,” and it was always recession, almost catastrophe. Now it’s not great growth. Nobody’s talking about Europe being China. On the other hand, if they’re just stabilized, that’s a big victory, and so there are these companies, Metro is an example of a company that’s basically a European-centered company headquartered in Germany but has lots of operations in Europe.  It’s a consumer-based business going through a restructuring.


CONSUELO MACK: So what is it? Consumer electronics?


PETER LANGERMAN: It’s in electronics. It’s in hyper markets. It’s in cash and carry, a lot of those types of businesses. It’s also going through a restructuring. We like that. It’s got a new CEO. So they’re selling assets. They’re restating their financials to make it more understandable, being a bit more shareholder friendly, but it’s also in the context of an overall situation that is stabilizing and getting a little bit better. So I think, yeah, we’re not in the business of making these kinds of predictions about big picture macro trends, but we are seeing from the ground up, talking to CEOs, talking to companies, that by and large things are okay, not great, and there could be another bump in the road, but they’re not the disaster that most people were anticipating was going to happen.


DAVID DARST: And your European stocks have a nice yield of about 3.8 percent, Consuelo, versus 2 percent in the United States, and they’re a 40-year low. Peter knows this, a 40-year low relative to the United States in terms of the price/earnings relative multiple. In Europe, they sell for 12 to 13 times earnings. In the U.S., it’s 15 to 16.  That’s a 40-year cheapness. All you need is a little catalyst, and we think that catalyst might be September 22nd which is a Sunday, the big elections in Germany. Chancellor Merkel is likely to be reelected for a third term.


CONSUELO MACK: So is that the positive scenario?


DAVID DARST: We think that could be it because…


CONSUELO MACK: Because she’s pro-business or a known quantity?


DAVID DARST: …she, we believe, will open up the purse strings bilaterally, not through the IMF, the European Commission nor the European Central Bank. She would open up the purse strings to companies, mid, small-sized companies in Spain, in Portugal, okay, in Ireland, and we think that is a big opening of the purse strings selectively by Germany, because don’t forget…


CONSUELO MACK: So this is the German government that would be lending money under Merkel to…


DAVID DARST: 75% of Germany’s exports go to the other European countries, and if they’re choking them with austerity, they cannot buy German products. So it’s to help Germany as well. So we think her legacy… you see these newspaper articles and magazine headlines, “Gravedigger of Europe” for Chancellor Merkel. She’s been tremendous by her relative calm, and I think Peter has said it very well. They didn’t explode or implode. They basically have had their problems, and some of the recent data, the U.K. numbers, the Italy numbers for the second quarter have come in surprisingly to the good.  They’ve got issues. Everybody’s got issues, and I think you’ve got to keep that in mind, because when everything looks sunny, then it’s already in the market prices, and so this is the time to go picking around.


CONSUELO MACK: You had mentioned China and I know, David, you’ve got a series of articles coming out or reports coming out of Morgan Stanley on deleveraging in China. So China, the fact is it looks like China is slowing. It’s an economy in transition. It’s got some big problems. Does that factor in to your thinking at all? Is that creating any opportunities as a value investor?


PETER LANGERMAN: Well, it factors into our thinking in the sense that even though we’re bottoms up, we can’t be blind to what’s going on in the macro world, and China is such a driver that almost any company you buy that’s a global company has a significant portion of its business either directly or indirectly dependent upon China. So you can’t ignore that, but again, it’s a matter of how bad is bad, and is seven and a half percent growth projection, is that awful? Is that likely? Is that your base case? And I guess our general base case is that, yes, China’s going through some issues. It’s certainly trying to become more of a consumer-oriented economy as opposed to the export-driven economy that it’s been, and there will be some bumps in the road.  We don’t view it as, again, the catastrophe scenario.

So in fact, getting back to some spots where we found some value, and we’re not really commodity players trying to buy a specific commodity, but with all the concerns about China, a name that’s come onto our radar screen is like a Freeport-McMoRan, which has gone through its own merger and lots of controversy about those transactions and the management of it, but kind of caught up in this China downdraft, and we look at it and say, is it beaten up enough where we’re being compensated for the risk of a China slowdown? In that case, we thought it was. So yes, it’s creating some opportunities, but it has to be an intersection of and of the big picture global with the bottoms up analysis. That’s what we’re looking for.


CONSUELO MACK: Right. I have to ask you each, because I think you each have an interest in Apple. That’s been on your radar screen. So David, what’s the current view of Apple?

DAVID DARST: Well, we like Apple. We think the stock can rise from here. It’s down now about 12 percent-ish from the beginning of this year, Consuelo. Number one, their price/earnings ratio is very low, so basically with the $450 price in that neighborhood, that thing could earn a $40 number. So they’re selling for 11 times earnings. You take the cash out, and it gets down well below 10 times earnings. Number two, we expect Tim Cook, who’s their CEO as you know, succeeding Steve Jobs, he has said he expects in the second half of this year to get a contract to carry the Apple iPhone on the NTT Docomo which is their mobile carrier in Japan and in China Mobile which has six, seven hundred million users, none of whom have an Apple right now. So we see that as a second big driver, catalyst.


Thirdly, we expect some new product flow from them, not only an iWatch or an iTelevision, something like that that dazzles everyone, but also the mid-range smart phone is really… the very low end is dominated by Chinese producers and Taiwanese. The high end is Apple and its big Korean rival. The mid area, if Apple… and we expect them to come with a cheaper iPhone in that mid-range that people want to have that feeling of brand reinforcement. So those reasons and number five. I left this out. Number five, they’re embarking, they’re in the midst of the largest corporate repurchase program in stock market history, $50 billion they’re buying back of their stock.


CONSUELO MACK: Creating enough value for you, too?


DAVID DARST: So these five things indicate to us that it’s a good place to put some money.


PETER LANGERMAN: Yeah, so the reality is we own Apple today. We bought it this year. We watched it for a long time go straight up. It was always, at least in recent memory, a very well-run company, very innovative, but the market was paying for that. The market was paying a premium for that. That’s not our business. So we watch it, and if we never get our chance, so be it, but as the stock came down and got into the 400s, the sentiment almost completely changed where they would never innovate again.  The competition was eating their lunch. They were going to eat their own lunch in the sense of having to introduce low-priced products. Their margin structure was going to collapse. We thought that that became so extreme that the valuation, that’s what gets us. Right? So between the cash and whether they’re going to earn 40 bucks or 45 bucks or 39.50, the stock was trading at a low enough valuation that we thought our down side was very, very limited, and the up side, we’ll let that take care of itself.  You know, we’re not saying that this thing is trading at 450 and worth 1,000, but you know what? It could be trading at 450 worth 700, and that’s a very nice return. So we like it very much as a value investment. If the stock appreciates, it may be… you know, great company, well run. C’est la vie. It’s time to go.


CONSUELO MACK: Right, so activism is another area that, Peter, I know you’re involved in as well, and one of the companies that has been very much in the news is Dell, and at Mutual Series you got involved in that Dell battle.




CONSUELO MACK: Right, so basically what’s your take on Dell, and why would you choose to get involved in a Dell situation?


PETER LANGERMAN: Sure, I mean, Dell, it’s a good example of the kind of thing that we’ll get involved in, and we’ve owned Dell stock from time to time over the past, so we’re familiar with the company. During this latest chapter in the company’s life, again, we look at it on a very specific day-to-day basis.  Obviously there was the going private proposal, transaction. Other investors, Carl Icahn among other, Southeastern, large shareholders were opposed to it. There was a price on the table.  You know, we have to do our work. One, what do we think the company is worth? Two is, what are the dynamics of this deal process?  Might there be other competitors? Are other people coming in, interested parties, et cetera? What do the legal documents say in terms of the ability of somebody else to come in? And we felt in this case that we’re able to buy the stock at a level where we felt our down side was limited in the sense that, one, if the deal didn’t happen we were comfortable that there was a base level, whether it was another recap plan or some other proposal that would protect ourselves and, two is, we felt good enough about the values that we were prepared to buy more stock if the stock came in. There was a lot of talk about if the deal doesn’t happen, the stock goes back to single digits or maybe low double digits, and our judgment would have been that if that had happened, we were prepared to buy more stock, so basically to say yes.


We don’t necessarily like to take the hit of a one-day drop, but as long as we’re comfortable with the values, we can make money doing it that way. So working through those dynamics, and then we’re experienced at sort of being part of that process. So once you’re a large shareholder you, in effect, invite yourself to the table and have a seat and have discussions with both sides, and that was the case in this situation as well.


CONSUELO MACK: And so, so far is it working out for the way you think will be good for you as a shareholder?


PETER LANGERMAN: It is so far. Yes, this will, and we’re comfortable that we’re going to make money for our shareholders which is, at the end of the day, that’s our objective.


CONSUELO MACK: Right, so One Investment for a long-term diversified portfolio, David Darst?  What should we all own some of?


DAVID DARST: Well, I think you want to own Apple. We talked about Apple. Another one that we’ve mentioned in the past which is Johnson & Johnson, and they have only 20% of their sales are to emerging markets. So we see the emerging markets as a great growth area for Johnson & Johnson. Their product suite, they’ve got the drugs. They’ve got the consumer products, and they have the medical devices which Peter mentioned earlier is an area that’s been under a cloud, but we think they’ve done a very good job of managing that business. So gross margin expansion, new CEO, Alex Gorsky, came in a year ago April, so April 2012 he came in, and he’s restructured the company and delivering shareholder value. Made a new 52-week high as you know, but the thing still yields almost three percent, 2.9 percent, so Johnson & Johnson, but Apple and Johnson & Johnson. Put those in your portfolio. That’s what we’d say right now.


CONSUELO MACK: All right, and what would your choice be?


PETER LANGERMAN: Both nice companies, by the way. Well, I’d go back to one of the companies I mentioned which is Metro, which again most people probably haven’t heard of who live here. It trades in Europe, but it’s got this combination of internal restructuring, new CEO in a spot globally that people are negative on, this euro focus that I think they will be able to take advantage of. The stock had a bit of a run because people have started to believe in the story. It’s still got a long way to go, so I think that’s the kind of name, limited down side we think, nice up side, a lot of different dynamics, a lot of different things that they control that will make for a very successful investment here.


CONSUELO MACK: All right, well, let’s see what happens to all of them. Thank you both so much for joining us, Peter Langerman for the first time from Mutual Series.


PETER LANGERMAN: My pleasure. Thanks.


CONSUELO MACK: Appreciate having you on WealthTrack, and David Darst, it’s always a treat to have you back.


DAVID DARST: Good to be with you. Thank you, Consuelo.


CONSUELO MACK: At the conclusion of every WealthTrack we always try to leave you with some suggestions to help you build and protect your wealth over the long term. This week we wanted to share two investment book recommendations from our guests for your end of summer reading. David Darst’s choice is an investment classic first published in 1935 during the Great Depression era. It is The Battle for Investment Survival, written by then influential money manager, financial writer and author Gerald Loeb. Darst describes it as a guide to help investors navigate the market’s twists and turns both tactically and emotionally. As Loeb so presciently put it: “The most important single factor in shaping security markets is public psychology.” How right he continues to be!


Peter Langerman recommends the much more recent biography of a fellow value investor, who was the Canadian equivalent of Warren Buffet, titled, There’s Always Something to Do- The Peter Cundill Investment Approach. It is based on Cundill’s interviews, speeches and the daily journals he kept for 45 years chronicling his successful search for bargains around the world.


Next week we are going to explore real estate investing with Third Avenue Real Estate Value Fund’s Jason Wolf, who works with legendary investor Marty Whitman. He and award-winning wealth manager Gregg Fisher will discuss the opportunities they are finding in global real estate. If you have missed any of our past Great Investor or Financial Thought Leader guests you can find them on our website as well as access exclusive interviews and research in our WealthTrack Extra feature.  In the meantime, have a great weekend and make the week ahead a profitable and a productive one.






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