Tag: episode 1106


August 1, 2014

Jason Trennert is Managing Partner and Chief Investment Strategist of Strategas Research Partners, an independent investment strategy and macroeconomic research firm. Trennert is widely followed by institutional investors in the money management and hedge fund world, and is identified as one of “Wall Street’s Best Minds” by Barron’s.

CONSUELO MACK: This week on WealthTrack, a financial thought leader who is full of creative investment ideas. Jason Trennert and his independent research firm Strategas are known for identifying pithy investment themes like “There Is No Alternative”, or TINA and the New Sovereigns. Find out what they are next on Consuelo Mack WealthTrack.

Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack. How worried are you about the stock market? Is the near tripling of stock prices since the 2009 market bottom a cause for concern? A recent Bloomberg poll of financial professionals found that 47% of them feel the market is close to unsustainable levels, while 14% saw a bubble. And most were expecting stock volatility to increase within six months. All of these expectations might indeed turn out to be prescient. As financier J.P. Morgan once commented about the stock market: “it will fluctuate.” But there are other aspects of the market which provide a different and more positive perspective that are provided by this week’s WealthTrack guest, a financial thought leader whose work is widely followed by institutional investors in the money management and hedge fund world.

He is Jason Trennert, Managing Partner and Chief Investment Strategist of Strategas Research Partners, an independent investment strategy and macroeconomic research firm he co-founded in 2006. Barron’s has identified Trennert as one of “Wall Street’s best minds”.

Prior to Strategas Trennert was the chief investment strategist at ISI group the firm run by WealthTrack guest Ed Hyman. Trennert’s team was voted one of the best investment strategists by institutional investor for three years. Trennert and his Strategas team are known for their in-depth economic and market analysis and identification of investment themes.

One fascinating trend they have uncovered is how much the supply of publically traded stocks is shrinking. As you can see from this graph, the number of companies on American exchanges has shrunk from a high of nearly 9,000 in the late nineteen nineties to 5,000 today, a decline of 43%. On the flipside, as you can see from this chart, private equity assets under management have soared over the last decade, as more companies are choosing to go private. Trennert notes that simple supply and demand dynamics could contribute to the continuation of the stock market rally.

One of trennert’s most widely quoted stock market themes is one he wrote about in The Wall Street Journal. It’s called TINA, which stands for “There Is No Alternative.” I asked him to explain his theory that “there is no alternative to stocks.”

JASON TRENNERT: It really has a lot to do with the idea of financial repression, and financial repression is the idea that central banks try to keep interest rates extraordinarily low, lower than the rate of inflation, and you’re seeing that, certainly a Bernanke doctrine. You’re seeing that play out all over the world, and really the point is that in a world like that it’s very, very difficult for individual investors to get yield. It’s very difficult for institutional investors to meet their actuarial assumptions by just buying fixed income. You have to buy stocks. You have to buy riskier assets. In many cases some of these riskier assets have very high dividend yields, have other yields, but really the central banks are giving you almost no other choice but to seek riskier assets to invest.

CONSUELO MACK: How much longer do you think that the central banks will continue to provide us with the kind of environment where there is no alternative to get higher returns or better alternative than stocks?

JASON TRENNERT: Well, it certainly seems like the Fed is towards the tail end of their bond buying program. That seems pretty obvious. Having said that, the Fed has greatly expanded its balance sheet. It’s very accommodative, and what the Fed might take us away, the Bank of Japan and the European Central Bank might give us because they’re still in a mode where they’re very worried about deflation in many cases. So global central banks are still, again, very wedded to this idea of the Bernanke doctrine which is the idea that if you have a risk between inflation and deflation, you always want to make the mistake on perhaps creating too much inflation, and the irony is that winds up being a very, very good period for stocks as long as inflation doesn’t become much of a problem. So right now you’re in a relatively slow growth economy. There’s not much inflation but there’s ample liquidity, so stocks continue to rise.

CONSUELO MACK: You’re calling this an old-fashioned bull market. We’re five years in. How much longer do you think that’s going to last?

JASON TRENNERT: Yeah, they’re very much one and the same thing I believe, which is to say that a lot of this really comes down to when inflation becomes an issue. Our own best guess at our shop is that we have probably at least another year, perhaps even two more years where inflation is going to remain very restrained at least in the United States. Wage inflation, sadly for workers, is really not coming back. There are a variety of reasons for that. It’s technology. It’s immigration, trade, all of those sorts of things. I’d also say that globally there’s really not a lot of pressure on commodity prices. So that’s likely to keep inflation lower. Banks also are not particularly interested in increasing their loan portfolio, so the velocity of money hasn’t picked up. All those things should conspire to keep inflation relatively low but also will probably keep the central banks still very accommodative. So again, that should last another year or two. Generally speaking, though, it’s hard to have an inflation problem without the participation of labor. In our view, it’s really when you start to see broad-based wage inflation that you might have more serious long-lasting, endemic inflation.

CONSUELO MACK: One of the things that you told me in a conversation you and I had earlier was that investors are more worried about the potential risks in the market than they are about the opportunities. So my comment about that is, having suffered through the financial crisis, many investors are justifiably scared and scarred by that experience. So we can’t really blame them for thinking about the risks but, the markets having almost tripled since the lows of 2009, shouldn’t we in fact be worried about the risks of a much higher value in the market?

JASON TRENNERT: Yeah, I think you have to look at it in terms of valuation and, again, what the alternatives are. Let’s say if you look at Treasury bonds where a lot of people are hiding, they’re yielding let’s say about two, two and a half percent. Let’s just use round numbers.

CONSUELO MACK: Right, the 10-year.

JASON TRENNERT: Two and a half percent. That means that they’re trading, if you were going to look at it as a stock, it’s trading at 37 and a half times earnings whereas you can buy Apple at 14 times earnings or you can buy the S&P 500 at 16 or 17 times earnings. So it’s all relative. Everything has to be priced off of something else, and the true north of what long-term risk-free assets are, yields on risk-free assets are such that you can support a much, much higher valuation, and that’s why inflation again becomes very important because that will give you an indication of how long you can expect interest rates to last, but it’s true. Everyone is sleeping with one eye open, both institutional investors, and they’ve really gravitated towards alternative investments like hedge funds and individuals who have gravitated towards bond funds. The only thing that worries me is that I think that there’s a sense that they’re perhaps less risky and that …

CONSUELO MACK: That bonds are viewed as being less risky.

JASON TRENNERT: Bonds are less risky, less risky, and I think that they’re not as riskless as I think some people saw last year when the Fed first started talking about tapering. They’re not as riskless as people thought.

CONSUELO MACK: How risky are bonds? Because we’ve had guests on WealthTrack who have said the most risky investment now are Treasury bonds, for instance.

JASON TRENNERT: I think if you have a long-term investment, if you’re a long-term horizon, let’s say five years, they’re quite risky because the nominal GDP growth let’s say in the United States might be three and a half, four percent. That’s usually a pretty good indication of what 10-year Treasury yield should be.

CONSUELO MACK: That’s underlying GDP growth plus inflation.

JASON TRENNERT: Plus inflation, and that’s a pretty good rule of thumb as to where 10-year Treasury yields are. Now they’re at 250, so bonds are very, very expensive relative to where they normally should trade. Having said that, the deficit’s coming down. There are supply/demand issues that are keeping interest rates very low which I think will persist really for a while. Again, it really comes back down to when inflation, when wage inflation, when loan growth picks up, all those things that will really start to give you a hard time. But for the time being, I’m not so sure that’s really going to be a problem.

CONSUELO MACK: Therefore, at Strategas, what are you watching as far as an inflation indicator? What should we be watching as investors?

JASON TRENNERT: It’s a great question. I think there’s two things and one is a little more esoteric than the other, but one is simply just wage inflation, and you can take a look at average hourly earnings. You can see that on a monthly basis from the payroll employment report. That’ll give you a pretty good indication of where wages are. Those are still well below. They’re around two percent, a little more than two percent right now, so it’s still very modest I think by historical standards. The other thing that the Fed watches is something called five-year, five-year forwards, and those are expectations about what inflation will be five years hence, and those have blown out a little bit, but they’re still very, very modest by historical standards. So those are two things that we’re watching. That’ll be a little bit harder to find for the average person, but you can find it on the Internet, and those will give you good indications of what inflationary expectations are.

CONSUELO MACK: To go back to what you had told me, investors are more worried about the potential risks in the market than the opportunities. What are the opportunities in the market that you are focusing on at Strategas?

JASON TRENNERT: The opportunities really lie with the fact that the cost of capital is still very, very low for corporations, and one of the ways it’s being evidenced is a big increase in mergers and acquisitions, or M&A, and one of the interesting things that’s happening is that companies that are announcing acquisitions are actually going up on the news. Usually for a little while they go down.

CONSUELO MACK: Absolutely.

JASON TRENNERT: Right, so now, though, the cost of capital is so low that the market is essentially saying anything companies do with cash is going to be accretive to earnings, and so in particularly I would say the one sector that probably has the greatest opportunities would be technology. Large cap technology has a lot of cash. They’re the activist movement among our friends out there. Mr. Icahn and others are targeting companies that are probably overcapitalized, have too much cash. I don’t think that trend is really close to being over. I think we’re in the middle innings of that trend towards activism which is prompting some M&A.

CONSUELO MACK: Therefore, as investors, and I know of one your five investment themes for 2014 is that shareholder activism will pick up, and the use it or lose it year for corporate cash is the way to describe 2014. So shareholder activism, you expect it to continue, and how as investors, though, do we take advantage of that?

JASON TRENNERT: I think the best way, if you look at the targets of the activists, they generally tend to be companies that are very cash rich, and one of the very simple ways to look at would be the amount of cash companies have as a percentage of their total assets. About 25 percent of all activist targets this year have been in the technology space which tend to …

CONSUELO MACK: Because they have tons of cash.

JASON TRENNERT: They have tons of cash. So I can’t say that the activists necessarily have better ways of managing the companies, but they’re saying, listen, there are ways that we can use through financial engineering of increasing shareholder value, and that might be share repurchases, or it might be … it’s not going to be cap ex, but it might be a number of other things that they can do. Financial engineering in terms of debt restructuring, and I think that’s one way to look at it.

CONSUELO MACK: So Jason, any other opportunities out there in the market?

JASON TRENNERT: Actually I would also say … it’s a somewhat non consensus idea, but I also think Japanese stocks are very interesting. Again, it seems somewhat controversial because Japan has been in a funk as we know for the better part of really almost now three decades since 1989, but I do think that the Bank of Japan is going to continue to ease very, very aggressively, and I also think the prime minister, Prime Minister Abe is really making great strides to try to restructure the economy, and I’m not sure that’s being fully appreciated, and so now you have a situation where the Nikkei is trading at 12 or 13 times earnings and has a dividend yield well in excess of what you can get from 10-year Treasuries in Japan. So that’s another if you want to take a little bit more risk. That could be another way to play another opportunity for investors.

CONSUELO MACK: And why should his restructuring and why should his easing in Japan be beneficial to Japanese companies?

JASON TRENNERT: The real question I think that you’re asking is why should we take it seriously this time? Right?

CONSUELO MACK: Yes. There have been many false starts.

JASON TRENNERT: Because there have been many false starts in Japan. The main issue I would say is that Japan in my view has really no choice. They have an aging population. They have no natural resources. They’re not particularly open to immigration, and so they’re really running out of other options, and so it seems to me that generally speaking when you run out of other options you finally kind of try to do the right thing, and I think the restructuring might actually hold this time.

CONSUELO MACK: Jason, Strategas is known for coming up with these really fun investment themes, and one of the investment themes I really appreciated over the last couple of years is what you call the new sovereigns. What are the new sovereigns?

JASON TRENNERT: The new sovereigns are made up of companies that the market believes are better credit risks than sovereign debt.

CONSUELO MACK: And sovereign debt being government debt.

JASON TRENNERT: Sovereign being government debt, and it’s also supposed to be the most risk-free asset, and it’s ironic because after our debt was downgraded in the U.S. for a while, there were about 55 companies in the U.S. that had lower credit default swap spreads, had lower credit risk it was perceived than Uncle Sam. Now there’s only about seven, but there’s still 100 companies that are seen as having lower credit default swap spreads than, let’s say, French sovereign debt. So French sovereign debt, one would think, would be close to risk free, but there’s 100 companies in the U.S. that have better or seen as having better risk than Japanese government debt, and so these are the types of companies. They tend to be large fortress-style, blue chip.

CONSUELO MACK: Such as, a couple of examples.

JASON TRENNERT: So it would be Johnson & Johnson, Exxon, Microsoft, all kind of your standard really big ticket …


JASON TRENNERT: Big cap names, but they also have dividend yields. They have obviously very little debt, generally speaking well capitalized, and dividend yields in many ways that are very, very competitive with what you would get from what was previously seen to be on a saleable sovereign debt.

CONSUELO MACK: And growing dividend yields as well.

JASON TRENNERT: And growing dividend yields, and I think especially as the bull market matures, our view, the reason why we call it the new nifty fifty or the new sovereigns is because we think increasingly as the bull market matures, more and more investors are going to be forced to buy stocks that kind of look like bonds, and they’re going to still have to buy equities, but they might not necessarily want to play in the small cap area or other places, emerging markets for instance, that are somewhat riskier. So they’re going to still buy equities, but they’re going to buy secure or safe equities.

CONSUELO MACK: Another interesting statistic that you have been looking at Strategas is actually in two areas, is the supply/demand situation for stocks and for Treasury bonds. You are saying that the supply of stocks is actually shrinking. How dramatic has the shrinkage been, and what does that do to share prices?

JASON TRENNERT: It’s pretty remarkable, because in 1997 there were 8,800 publicly traded companies in the United States. At the end of 2013 there were 5,003. So we essentially lost 3,800 publicly traded companies. There are …

CONSUELO MACK: They went private. Got acquired.

JASON TRENNERT: They either went private or they went out of business.

CONSUELO MACK: Acquired, whatever.

JASON TRENNERT: Or acquired, but I think what’s happening really, Consuelo, is because of the growth of the private equity business and the cost associated with being a public company have gone up very dramatically, a lot of companies that would normally go public are not going public. The problem is that those private companies are not particularly liquid. So you have, for investors that need liquidity that want to have equity investments but want to have liquidity, you’re essentially being forced to buy a smaller pool of publicly traded equities, it’s part of the reason why the stock market’s moving higher.

CONSUELO MACK: Supply/demand situation in Treasury bonds. They’re shrinking, too. Right?

JASON TRENNERT: The budget deficit is improving so dramatically right now. It’s hard to believe given how much we’re spending, but it’s improving very dramatically, and there’s almost a sense in which the Fed, in my view, had to start lowering its purchases of Treasuries simply because the deficit wasn’t large enough. The Treasury wasn’t issuing enough Treasuries. The deficit this year could be something like $400 billion. Last year the Fed purchased about $540 billion worth of Treasuries. So there was a real reason why the Fed actually had to slow down its purchases. They’ll probably be done by this October according to the best estimates, but that shouldn’t scare people in terms of being worried about bonds it seems to me because the U.S. is still a reserve currency. You still have a lot of people around the world that would rather own U.S. dollar-based assets, secure U.S. dollar-based assets than any other place in the world.

CONSUELO MACK: And the U.S. Treasury debt still represents …

JASON TRENNERT: It still represents probably …

CONSUELO MACK: … the gold standard as far as liquidity and …


CONSUELO MACK: … safety.

JASON TRENNERT: Again, it’s all relative. It’s hard to take a victory lap on $400 billion budget deficit, but it’s certainly a lot better than it was five years ago.

CONSUELO MACK: One of the things that has intrigued me is for many years now institutional investors … and it’s trickled down to individuals … have adopted what’s called the endowment model, the Yale endowment model, and it’s run by David Swensen who is a very successful manager of the Yale endowment pre financial crisis. We had him on WealthTrack just before the financial crisis, and what the endowment model did was it emphasized alternative investments and diversified away from stocks and went into things like private equity and hedge funds and timber and farmland, all of them being illiquid assets.

It worked great up until the financial crisis. It imploded during the financial crisis, and since then the endowments have had pretty awful results. I mean, the Harvard endowment was 1.7 percent annualized returns according to your research over the last five years. Yale’s five-year total returns 3.3 present. Columbia did a lot better at seven percent. What should we make of what happened with the endowment model, and what place should alternatives have in individuals’ portfolios?

JASON TRENNERT: I would be careful in terms of what you’re getting for the fees, and I think when David Swensen focused on alternative investments, of course the reason why it worked so well for so long is he was the first person to do it. It was seen as somewhat I wouldn’t say heretical, but it was really seen as a very non consensus idea, and the idea was that people were over paying for liquidity. So you wanted to be in more illiquid investments because you weren’t paying up for them. Now, again, that makes a lot of sense when no one else is doing it.

What happened, though, is all the endowments, a lot of foundations, a lot of pension funds did the same, and so what you’re finding now is that there is a tendency to try to go towards illiquid investments that supposedly have lower volatility, and they may have lower price volatility, but I think what’s happening is people are conflating the idea of volatility and risk and, again, just because you’re not pricing something regularly doesn’t mean it’s less volatile necessarily, and I think that’s what a lot of people found out in the financial crisis. So it has a place in individual investors. Wealthy individual investors in particular I think it has a place, but I think you want to be careful about trying to replicate what the big endowments have done in terms of making it really the majority of the assets that they hold, and in many ways I would argue that publicly traded equities in some cases might be more attractive than private equity or other illiquid investments.

CONSUELO MACK: One investment, Jason, for a long-term diversified portfolio. We ask every guest at the end of WealthTrack. What would you have us own some of?

JASON TRENNERT: Yeah, listen. I think one of the biggest opportunities for the United States, and I think the administration also is embracing this, too, little by little, is the idea of U.S. energy independence. It may sound somewhat cliché, but the U.S. is now the largest producer of crude oil in the world.

CONSUELO MACK: It’s amazing.

JASON TRENNERT: And it is something where it could really bring manufacturing back to the United States. I think it’s an inevitability. One of the companies as an example would be Cheniere. I own it personally. It’s a very good play on liquefied natural gas and the potential export of liquefied natural gas at some point. So to me that’s again one that I own. There are many others that investors could find, but that’s probably a pretty safe one.

CONSUELO MACK: Super. Another great theme from Strategas as well, energy independence. Jason Trennert, thank you so much for joining us, chief investment strategist and one of the founders of Strategas. So thank you for being on WealthTrack once again.

JASON TRENNERT: Thank you very much. Thank 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 follows up on Trennert’s new sovereigns theme of companies with fortress like balance sheets with growing dividends that offer an income alternative to bonds. Over the years we have mentioned funds that specialize in companies with a history of growing dividends and we will do so again. So this week’s action point is:

Own at least one fund or ETF with growing dividends.

In a recent appearance on WealthTrack great investor Charlie Dreifus of the Royce Funds mentioned two ETFs that he owns personally. They are SPDR S&P Dividend ETF which holds all the stocks in the S&P 1500 that have raised their dividends every year for the past 20 years. There are about 80 of them. And the Vanguard Dividend Appreciation Index ETF which focuses on U.S. firms that have raised annual dividends for at least 10 years.

To paraphrase an old accounting saying, “profits are an opinion, dividends are a fact!” Next week while public television stations hold their summer fund raising drive we will discuss the greatest investment challenges investors face with two outstanding personal finance journalists, The Wall Street Journal’s Jonathan Clements and Jason Zweig.

To see more of my interview with Jason Trennert go to our website wealthtrack.com and click on our extra feature. And while you are there take a look at our WealthTrack Women series which is currently focusing on what to do when your financial plan goes off course. Thank you for watching! Have a great weekend and make the week ahead a profitable and a productive one.

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