Archive for July, 2014

WILBY & SARGEN: GLOBAL DANGERS TRANSCRIPT

Two veteran global investors, private investor Bill Wilby, formerly of number one ranked Oppenheimer Global Fund and Fort Washington Investment Advisors’ Chief Economist and Senior Investment Advisor Nick Sargen share their perspective and strategies on today’s market.

CONSUELO MACK: This week on WealthTrack, storm warnings! Two veteran global investors Bill Wilby and Nick Sargen are tracking rising geopolitical conflicts, central banks in uncharted territory and markets at record levels. What are their financial life saving skills telling them about the dangers ahead? Great Investor Bill Wilby and Fort Washington Investment Advisors’ Nick Sargen are next on Consuelo Mack WealthTrack.

Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack. Markets are famously supposed to climb a wall of worry. And there are plenty of worries to go around right now. There are several geopolitical hotspots of strategic significance: Ukraine’s battle with Russian separatists, Israel’s battle with Hamas, Syria’s civil war, the terrorist group ISIS’ campaign in Iraq and Iran’s ongoing efforts to build nuclear bombs.

On the economic front: the uncertainty surrounding the Federal Reserve’s exit plan from its unprecedented monetary expansion of the past five years. The U.S. economy’s subpar growth during this recovery, and the struggling economies of Europe and Japan.

There are serious market concerns. Stock markets, particularly in the U.S. have been trading at record levels and bond prices are elevated. Despite all of these worries the markets have been relatively sanguine, with a few notable exceptions, since the height of the financial crisis five years ago. As you can see from this chart the widely followed Market Volatility Index, the VIX has been subdued for the last couple of years. Has this been the calm before the proverbial storm? We have two investment veterans with us who have kept their heads and portfolios through many market cycles and economic booms and busts.

Great Investor Bill Wilby is with us exclusively on WealthTrack. Now a Private Investor Wilby retired at the market’s peak in 2007- talk about timing- because he was distressed and concerned about the state of the financial markets. Until his retirement, Wilby was the former Portfolio Manager of the award winning Oppenheimer Global Fund which was ranked number one in its category for the 12 years he ran it. He also headed up the entire equity division of OppenheimerFunds. A graduate of West Point, Wilby also has a PhD in International Monetary Economics and has been a global investor for his entire professional life. He has held various international finance and investment positions at several top financial institutions including the Federal Reserve Bank of Chicago.

Nick Sargen is another lifelong global investor and was recently named Chief Economist and Senior Investment Advisor at Fort Washington Investment Advisors, the asset management arm of Western & Southern Financial Group. Sargen wanted to scale back from his previous position as the firm’s Chief Investment Officer. Sargen also has a PhD in economics and has been International Economist, Global Money Manager, Chief Investment Officer for several firms, as well as working at the Federal Reserve Bank of San Francisco.

I began the discussion with a Federal Reserve question: how is the great monetary experiment going to end?

NICK SARGEN: Thanks for such an easy question. I mean, that’s the one every investor wants to know the answer, and I would say, Consuelo, that the Fed is trying to reassure people and say, “Don’t you worry. We have all the tools that we need to handle this exit strategy, but I believe that this is unprecedented, and at the end of the day you have to make a choice as an investors, and it’s will the Fed begin tightening early or will it wait and be late? And my view is with this Fed it will err on the side of being later. So I think that the risk would be not immediately, but there would be a risk that if it waits too long and then inflation does come into the picture, then we might see some spike in bond yields, but that’ll probably be at least a couple of years away.

CONSUELO MACK: Oh, and so beyond 2015?

NICK SARGEN: Yes. Well, I think that the talk is that they could begin tightening in the second half, but what I’m still saying is it’s a process, and I think that the key test in my view is, what happens when they start tightening but then something goes awry? Do they blink or not? And that will be, I think, the tests for the markets.

CONSUELO MACK: Bill? How’s it going to end? Well or poorly?

BILL WILBY: You know, it’s an unprecedented experiment and I think there’s a huge Fed risk premium that’s built into assets right now because of I think some concern about how the Fed’s going to exit the process. The more leverage there is in the system, the more sensitive the system is to interest rate increases and so in a way the Fed has built up an enormous conflict of interest in its own policymaking. To the extent that it tightens, not only is it going to depress the value of its own balance sheet which now owns a lot of long bonds, but it’s also going to have a very powerful influence on the economy, the markets and everything, a much more leveraged, much more highly geared impact than in previous tightenings and, therefore, they run the risk of doing exactly what Nick said, is panicking and backing off, and then they’ve lost all credibility. So the Fed on the one hand runs enormous credibility risk in the next cycle, and on the other hand the longer they stay at this, the more financial tumors are likely to grow through leveraged loans in the credit markets and other places that we won’t know about until they do start to try to raise rates.

CONSUELO MACK: One of the biggest risks in the market that we have talked about in a very brief form that I want to expand upon now is the geopolitical risks that are going on. So what are the geopolitical risks, number one, Bill Wilby, that you’re tracking and how concerned are you about them?

BILL WILBY: Well, I think you can’t talk about geopolitical risk without talking about the Middle East today. I think it’s in a horrendous situation. I think the possibility or even the likelihood of real war, serious war involving more than one or two countries is probably higher than it’s been in a long time. So I think that’s a real concern. With respect to the market, I think what’s happened to the equity market is there’s a geopolitical risk exhaustion because it’s been around for so long that you’re now building in geopolitical complacency, and you can watch even during horrendous events happening overseas, the equity market just totally ignores it and goes on on its merry way, looking at market technicals like the amount of cash on the sideline, the corporate balance sheets, da, da, da, da, da. So there’s a degree of whistling past the graveyard that’s taking place I think in the equity market, but the interesting thing about this is when the market builds a geopolitical risk premium in, that can cut both ways. If the risky event doesn’t happen, the market can go up. If the risky event does happen, the market can go down, and I think what happened if you went back two years ago, the risk premium was there, so there was a stronger likelihood of the market going up if the risks that were priced in like the Iranian nuclear issue and things like that, if they didn’t happen. Now I’m not so sure. Multiples have gone up. There’s a degree of geopolitical risk complacency right now that makes me concerned that if we did have something really serious happen, that it could hit the market pretty hard.

NICK SARGEN: I completely agree with this seeming complacency, but I think at the same time, just listening to Bill, it is so complex that even the sophisticated investor at the end of the day throws up their hands and says …

CONSUELO MACK: I can’t understand.

NICK SARGEN: Yes, so you ignore it, but the one thing I would say, Consuelo, that the market would not ignore is if something were to happen and it led to a spike in oil prices, because always throughout my career I think of five times where we saw major spikes in oil prices, and that always caught the market’s attention. So …

CONSUELO MACK: And catching the market’s attention means that the market declines.

NICK SARGEN: Absolutely. So again, we can have this nice long discussion of the extended business cycle in the United States, but there could be an external event causing oil price to spike and there’s a whole new ballgame.

CONSUELO MACK: Where are we in the market cycle then, Nick? You first.

NICK SARGEN: Yes. You know, I think of four phases of the cycle. I have the recovery phase, and that was clearly up until about 2012, 2013. In my terminology, we’re now in the expansion phase, and what I mean by that is that this is a phase where the economy has now been growing where you have to start thinking about the prospect of Fed tightening, but it doesn’t necessarily occur. And then the later phase is when the Fed actually is raising interest rates. So I think we’re in that in-between zone, and the final phase is recession. I think we’re way off from that.

CONSUELO MACK: And Bill, you sent me a little list. We’ve got three phases of the market. So just quickly tell us where we are, what they are and where we are.

BILL WILBY: I’m looking not at the full complete cycle. I’m looking at the phases of a bull market, and the phases of a bull market in my mind are the recovery phase, the earnings-driven phase and the speculative phase, and the speculative phase is normally driven by P/E expansion. It’s when people start to get optimistic because the market’s been going up for a long time, and that’s when you get the speculative blowup. In my sense, we entered the speculative phase of this market somewhere around the first or second quarter of 2013, and so we’ve been about a year, a little bit over a year into the speculative phase of this market. In my view it’s the most difficult phase for investors.

CONSUELO MACK: Why?

BILL WILBY: Because the next phase is big decline, but the speculative phase can go on for a couple of years, and the upside risk is as great as the downside risk. Both are amplified in the speculative phase of a market. So you can be hurt a lot by being out, and you can be hurt by being in, and it makes it a very uncomfortable time for professional investors. I think for myself I know I hate this phase of the market cycle.

CONSUELO MACK: Even when the market’s going up. You just …

BILL WILBY: Even when the market’s going up and the more uncomfortable it becomes.

CONSUELO MACK: Because Nick actually told me that markets never stop at fair value. Are we at fair value, Nick?

NICK SARGEN: I think we’re in a fair value zone, but we’re in the cheap. I would agree with Bill that up until 2012 you could have the argument, is it cheap? And I think after ’13, when the market’s up 30-some percent and profits haven’t risen nearly as much, then clearly there was multiple expansion. So I think the only difference and nuance that I have is where I’m a little bit more optimistic is I do believe this is an extended economic cycle, because it’s subdued. We don’t see inflation. We don’t see the credit formation that leads to bubbles.

CONSUELO MACK: We’re talking a lot about risks. So as investors what do we do in this transition period? And I’m also thinking about, Nick, as you have an expertise in the bond market. What about the bond market?

NICK SARGEN: The bond market is the market that you shake your head at as Bill says. You face first of all Treasury yields still very low by historic standards, but then when this rush to get yield, the yield pickup for investment grade bonds versus Treasuries now is getting back to where we were in 2007.

CONSUELO MACK: So very narrow.

NICK SARGEN: Very narrow.

CONSUELO MACK: You’re not getting a lot more to going out into the bond market, the corporate bond market than you are just buying a Treasury.

NICK SARGEN: Right, and so in high yield which we actually like from a longer term perspective, but again there’s been this … high-yield bonds today give you five or six percent. Is that high yield? That makes it harder. And very recently two areas that we’ve looking into, one has actually been in preferreds because we think that’s been kind of a sector that now on a relative value basis looks somewhat appealing.

CONSUELO MACK: Preferred stocks.

NICK SARGEN: Yes, and then the other is actually some areas in the municipal bond market are also looking attractive on a spreads basis compared to other alternatives.

CONSUELO MACK: And that’s even if it’s for a tax-deferred account, for instance.

NICK SARGEN: That’s right.

CONSUELO MACK: Even for … munis are attractive. And Bill, what are your view on bonds?

BILL WILBY: Well, I think again it’s high risk. I don’t have a lot of bonds. I usually use cash to shorten the duration of my bond portfolio, but the bonds I do have are munis.

CONSUELO MACK: Are munis.

BILL WILBY: And because it’s a retirement portfolio and I think munis are very appropriate for a retirement portfolio here. I have a little bit of high-yield bonds, but I’m in a selling mode there and duration shortening mode in both high yield and munis. I also own some preferred, so I think that preferreds are attractive, but all of it’s going to get hit.

CONSUELO MACK: And again because of the dividend, the yields on preferreds.

BILL WILBY: Yeah, yields. You can get some very attractive yields on preferreds. On the other hand, with the equity component in preferreds, you’re going to get … if the Fed raises rates, all of these asset classes whether they be munis or whatever, if you’ve got any duration in the portfolio at all, they’re going to get hit. Duration meaning the length of the maturity, average maturity in the portfolio.

CONSUELO MACK: What do we do then?

NICK SARGEN: So first of all I do think that stocks will still continue to outperform in this type of environment before you see the Fed really come into play.

CONSUELO MACK: Outperform bonds.

NICK SARGEN: Yeah, will outperform bonds.

CONSUELO MACK: So you’re slightly overemphasizing in a balanced portfolio stocks.

NICK SARGEN: Yes, we would have what we call an overweight position relative to someone’s strategic norm, but I think the other thing that we’ve been doing is our own tradition is we’re value- based equity investors.

CONSUELO MACK: Anyhow from the get-go.

NICK SARGEN: Yes, but for our parent which is an insurance company, in the low interest rate environment we’ve said, well, we do need additional yield. So we have gone into the dividend arena and created a portfolio of dividend-paying stocks, and what I liked about that strategy … Bill may differ, but what I feel is if we’re still in this environment where you’re not sure are rates going up or not, if rates are going up, those stocks are going to lag, but this year when bond yields came down by about a half a percentage point, the more dividend-oriented portfolios actually slightly outperformed our value portfolio. So what I view it as is a way of diversifying our equity portfolio and recognizing that, depending on the interest rate environment, one may lead and one may lag at different points in time.

CONSUELO MACK: Bill, are you taking profits? Are you starting to pull back from … ?

BILL WILBY: I did. As typical I was early. I started taking profits about a year ago in 2013, and I took some money. Almost my entire portfolio was mainly in stocks, and I’ve taken it down to where it’s now … you know, I’m about 65 or so percent in stocks. So I took some out of the market in here. I’m comfortable with that. I’m not in a buying mode. The bond portion of my portfolio is about half bonds and half cash. Again, I don’t know what’s going to happen. Nobody does, but I’ve got one eye kind of towards reducing risk, and what I’ve tried to do is build convexity into my portfolio.

CONSUELO MACK: Meaning?

BILL WILBY: Meaning it’s a term that comes from the bond market where you have a combination of very short-duration bonds and long-duration bonds. Stocks also have duration, and value stocks are short-duration stocks, and growth stocks are long-duration stocks, and you build a barbell portfolio, and what that does is it gives you very good volatility characteristics. You underperform in the down market but you can still participate in the up markets with a convex portfolio.

CONSUELO MACK: So give me some examples of what’s in either end of the barbell.

BILL WILBY: So what I’ve got is I have some dividend-yielding stocks as an anchor.

CONSUELO MACK: In the value.

BILL WILBY: That are more value, and most dividend-yielding stocks are value stocks if they’ve got any yield at all. So there’s some health care in there. I’ve got a number of kind of blue chip health care.

CONSUELO MACK: For instance.

BILL WILBY: For instance, Roche Holding in Switzerland. Nestlé is another example of that. I’ve owned some Pfizer. I’ve had Verizon in there for a long time. I also own some utilities, and I’ve had a small utility portfolio that I’ve kept in there. That’s kind of an anchor, but then I’ve got some growth stocks where I’ve got some things out there more on the aggressive end, like I’ve got a portfolio of biotech stocks that I own as well.

CONSUELO MACK: And where does Google fit in? I know that’s been one of your holdings.

BILL WILBY: And Google is more on the growthy end. I own Google, Apple.

CONSUELO MACK: Apple, right.

BILL WILBY: I think cheap technology is very attractive in here, and I think a lot of the big technology stocks have great growth characteristics, and they’re selling on very reasonable multiples, particularly if you take the cash on the balance sheet into account and subtract it from the market capitalization. These are cheap stocks.

CONSUELO MACK: And Nick, if you were to describe the portfolios that you’re overseeing or that you’re doing for yourself.

NICK SARGEN: Yes, I would say again I think is it a time to be buying aggressively? No, for the reason that Bill said, but at the same time I have difficulty selling because my problem is if I sell, where do I go? Well, you could say cash. My motto is cash is trash. It’s zero. It’s admitting defeat, and so I think there is this lack of good alternatives, but I think the other thing, Consuelo, within our team it’s interesting that there’s more disparity of views. Some people are saying this is the time to pare back a little bit after the market’s had a huge run, but others have said but hang on. We’re not in overvalued territory. Plus we look at some indicators that signaled market tops in the past. One is if you start to see the market becoming narrower and narrower and narrower …

CONSUELO MACK: The leadership.

NICK SARGEN: Right. Then that’s usually a very late-stage cycle.

CONSUELO MACK: And we’re not there?

NICK SARGEN: We don’t see it there. We see a little bit of that in the small cap space which had had a great run, but when we look at mid cap, large cap, we think it’s been a fairly broad-based rally. So therefore, we’re staying the course for this time.

CONSUELO MACK: Well, it’s kind of time to pick one investment, because we’re almost at the end of our allotted time here. So what would you have us own some of in a long-term diversified portfolio, Bill Wilby?

BILL WILBY: I think, and I’ve said before on this show I like Google a lot, and one of the reasons I like Google in a world where information is the prevailing abundance, the scarcity there is the navigation through that sea of information, and so Google has something of a chokehold on the navigation space, and I really like that as a characteristic for the business, and I’ve owned it for a number of years. I’ve owned it since the IPO, and I still have it. I think I’ve mentioned its name on your show in the past.

CONSUELO MACK: And you’re sticking with it.

BILL WILBY: I still like it.

CONSUELO MACK: Nick?

NICK SARGEN: One of the hallmarks of this bull market has been an incredible surge in dividend growth. We’re at record levels now, and it’s been very strong increases for the last five years. So one of the strategies that I like is looking at dividend growth stocks. So they may not have the highest yield, but just bank on the companies that you think are able to generate sufficient cash flow that they can make future increases in dividend payments.

CONSUELO MACK: And I know you and I have talked about this, but everyone has talked about the S&P dividend aristocrats, and there is an ETF that is based on the dividend aristocrats, and that is the ProShares S&P 500 Aristocrats ETF. So that’s a possible vehicle. There are some others out there.

NICK SARGEN: I like it because it’s a more diversified way of playing the dividend idea and, as I say, it’s emphasizing the growth aspect as opposed to the yield aspect.

CONSUELO MACK: We are going to have to leave it there. So it’s so great to have you both here, Nick Sargen from Fort Washington Investment Advisors and private investor, Bill Wilby who has run a fabulous global fund for many years from Oppenheimer prior to retiring, so thank you both so much for being with us on WealthTrack.

NICK SARGEN: Thank you.

BILL WILBY: Thank you, Consuelo.

CONSUELO MACK: At the close of every WealthTrack we usually make a suggestion to help you build and protect your wealth over the long term. This week’s action point is less work and more play, some books to read on your summer vacation. Bill Gates recently shared his favorite business book with readers of The Wall Street Journal. It is Business Adventures, a collection of New Yorker articles by the late business journalist John Brooks. It was given to Gates by his good friend Warren Buffett in 1991, who told him it was his favorite business book.

It is only available digitally right now, but will be released in paperback in September. The other suggestion comes to us courtesy of one of this week’s well-read guests. Nick Sargen recommends Lords of Finance: The Bankers Who Broke the World by Liaquat Ahamed, winner of the 2010 Pulitzer Prize. Sargen points out that while today’s central bankers are “being criticized for keeping interest rates too low for too long,” the lords of finance, the central bankers of the 20’s and 30’s “committed the opposite mistake of pursuing overly restrictive policies, which many believe was the cause of the great depression.

Lords of Finance is already on WealthTrack’s bookshelf and is worth revisiting. Next week we will talk to financial thought leader Jason Trennert, a top ranked strategist, co-founder and managing partner of institutional research firm Strategas about why he believes this old fashioned bull market still has room to run.

In the meantime, to see more of my interview with Nick Sargen and Bill Wilby go to our website wealthtrack.com and click on our extra feature.

Also in our WealthTrack Women section we will have updated financial advice specifically for women from our panel of women financial advisors about how to prevent your financial plan from going off course. Have a great weekend and make the week ahead a profitable and a productive one.