Tag: REITs
CHARLES ROYCE
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James Grant Transcript 09-28-12 #914
WEALTHTRACK Transcript
#914- 9/28/12
CONSUELO MACK: This week on WEALTHTRACK, financial historian and thought leader, James Grant, attacks the Fed’s policies of zero interest rates and massive purchases of treasury and mortgage bonds as dangerous to the economy and damaging to savers. Grant’s Interest Rate Observer’s James Grant is next on Consuelo Mack WEALTHTRACK.
Hello and welcome to this edition of WEALTHTRACK. I’m Consuelo Mack. Federal Reserve Chairman Ben Bernanke has been widely credited with playing a key role in saving the global financial system from spiraling into a deeper recession. As a recent Financial Times headline read, “Central Bank Action Lifts Gloom”; “Bold Fed and ECB Moves Cheer Investors- Confidence Increases in U.S. and Europe.” There is no question that the Fed and to a lesser degree the ECB, the European Central Bank, are pulling out all stops to boost economic growth, investor confidence, and stock returns, going far beyond what their critics maintain is their proper role. As this week’s guest, financial journalist and historian James Grant told me, “Central bankers have morphed into central planners.”
The Fed, unlike other central banks around the world, has a dual mandate. Starting in 1977, Congress stipulated that, similar to other banks, it is supposed to ensure price stability, i.e. keep inflation in check. More recently, the Fed has focused on preventing deflation and has said its targeted inflation rate is 2%. Its second and unique mandate is to “promote effectively the goals of maximum employment.” With unemployment at more than 8% and long term unemployment near 15%, the Fed is a long way from meeting that goal; which is why the Fed recently pledged to keep short term interest rates near zero until mid-2015, an unprecedented seven year stretch, continue buying U.S. treasury bonds to keep interest rates low, and purchase $40 billion dollars a month of mortgage backed securities until the labor market “improves substantially”; in other words, it’s an open ended commitment.
Perhaps the most stunning statement by the Federal Reserve Chairman came in a recent speech in Jackson Hole, Wyoming. We will have the full text on our website, wealthtrack.com. In describing all the unusual policy actions taken he said: “Central bankers in the United States, and those in other advanced economies facing similar problems, have been in the process of learning by doing.”
This week’s guest is appalled by the Fed’s expansionist policies and worried about its known and unknown consequences. He is Financial Thought Leader James Grant, editor of Grant’s Interest Rate Observer, a twice monthly, self-described “independent, value oriented and contrary minded journal of the financial markets.” It also happens to be a must read among top professional investors. Jim is also an historian and author. His most recent book is Mr. Speaker! The Life and Times of Thomas B. Reed. I began the interview by asking Jim if the Fed wasn’t just doing its job: promoting maximum employment and price stability.
JIM GRANT: That is a good legal question. I think the subsequent financial question is whether there is any reason, either in theory or in common sense, to suppose that suppression of interest rates- and really let us call a spade a spade- price control is going to improve the prospects for working Americans. It seems to me that everything argues against that. The Fed, again to use plain talk, is suppressing interest rates. It is muscling around the structure of interest rates known in the trade as the yield curve. It is virtually allocating credit with its exertions, and it’s in the business of price control. Now, that has never worked. Chairman Ben Bernanke in remarks at Jackson Hole, Wyoming now a week or two weeks ago said that… he said, “We are learning by doing.” Learning by doing. Now, we have thousands…
CONSUELO MACK: And he’s a financial historian as well.
JIM GRANT: No, he’s not.
CONSUELO MACK: Well, that’s what he supposedly he is. Supposedly, he’s a student of the Great Depression.
JIM GRANT: He’s the kind of financial historian, if I may say so, who neither reads history nor writes much of it. That’s the kind of financial historian he is.
CONSUELO MACK: All right.
JIM GRANT: There is a record of monetary history going back thousands of years, yet he says we are learning by doing. This, to me, is not the utterance of an historian.
CONSUELO MACK: So when you said what we’re having in this interest rate suppression, which means that basically by buying Treasury securities and mortgage-backed securities, they are sopping up supply and, therefore, they’re keeping interest rates low.
JIM GRANT: And they are planting an idea in the mind of the market that interest rates will remain low and, that if they do move up, the Fed will be there to tamp them down again. So they kind of bring the marketplace into partnership. People are happy to play along with the Fed. It’s an easy way to make some money.
CONSUELO MACK: People being Wall Street, institutional investors.
JIM GRANT: Yes, professional investors. Right, and today the chairman of the Federal Reserve Board talked about how the stock market’s going to go up which is nice for those who deal in common stocks or who own them, but for those about whom he’s supposedly is most worried, namely the victims of this most miserable and protracted of labor market slumps- not most miserable, certainly among the more protracted labor market slumps- to these people, rising stock prices…
CONSUELO MACK: Savers.
JIM GRANT: Yeah, savers and people looking for work.
CONSUELO MACK: But it’s interesting in that when you look at what the Federal Reserve has done, is that we have had a very positive response in the stock market to the expectations and the actuality of the Fed’s actions.
JIM GRANT: Sure, it’s free money. It’s free money, and it’s no competition from the bond market. I don’t mean to say that every single company listed on the New York Stock Exchange or NASDAQ is unworthy as an investment. On the contrary, there are, I think, some things to do in the stock market- there perhaps always are some things to do in the stock market- but the Fed has got it into its head that if it succeeds in levitating the average level of stock prices, that good things happen from that. Now, shouldn’t it be that the stock market goes up because good things are happening to the companies that issue the common stocks? I mean, in his rhetoric, in his language of technical eco terms, in these bouquets of calculus and algebra that fill the footnotes and the technical sections of these papers, they seem not to focus on two and two.
CONSUELO MACK: So let’s talk about the law of intended or unintended consequences in this point. So what are you seeing? I mean, what kind of distortions are you seeing?
JIM GRANT: Well, the distortions are all around us and in his speech in Wyoming, Chairman Bernanke enumerated four there the tritest and perhaps the least interesting and meaningful to Americans of the many that are possible. For example, he neglected to mention the fact that if you save… there must six or eight people in America who do save. Right? Many of them watch you.
CONSUELO MACK: WEALTHTRACK. Absolutely.
JIM GRANT: He neglected to mention … he might have said,” Sorry the absence of interest rates is starving you, but we don’t mean that to happen.” He didn’t even mention that. He might have mentioned that zero percent interest rates makes hash and nonsense out of credit analysis. The money markets are full of instruments like commercial paper, certificates of deposit that yield just about nothing before tax, after tax even worse, worse than nothing, and people spend time still analyzing the credit worthiness of these claims. But why? If they yield nothing, why bother? So the suppression, the manipulation of interest rates distorts and makes a mockery of credit analysis and, furthermore…
CONSUELO MACK: Well, you know, most of us don’t care about credit analysis. You do.
JIM GRANT: Oh, yes you do.
CONSUELO MACK: Do we?
JIM GRANT: We cared about it in 2008 when we discovered no one was doing it, and another thing, Consuelo…
CONSUELO MACK: Put me in my place.
JIM GRANT: No, no. Another thing that the Fed has not thought about apparently is that all of us who invest, either part time or full time, are kind of doing it in this hall of mirrors. Right? We don’t know exactly what values are, because values to a degree derive their value from some calculated stream of discounted future income; but if interest rates are zero, how do you do the arithmetic? Right? So investment values are distorted, and they’re distorted furthermore because they go up because the Fed says they should, not because companies are doing better. The whole thing is kind of nuts when you think about it.
CONSUELO MACK: So isn’t there some method to Ben Bernanke’s madness? If he’s keeping interest low, that means that the people who are loaning us, I should say, who are loaning us money, the Chinese and the Russians, for instance, and the Japanese, then in fact the value of their Treasury holdings will be stable at least.
JIM GRANT: Well, if I were a creditor to this government and running affairs in China or Russia or some place or Japan, I would like some interest income just to make me feel as if they cared. I think that by suppressing interest rates and by creating hundreds of billions of dollars, new dollars a year, the chairman is not, after all, reassuring our creditors, but he ought to be alarming them. He ought to be alarming our thoughtful creditors. Now, some of our creditors don’t care so much about the market value of their obligations, of American obligations. What they care about is manipulating or suppressing or managing their own exchange rate so they can export more to this country. So they’re not so concerned with interest income as they are with keeping the factory’s chimney smoking.
CONSUELO MACK: Well, just one more point, I mean, along these lines is the fact that the Fed has been pretty consistent since 2008 in that they have pulled out all stops. They have done whatever they can do. I mean, they’ve done it kind of incrementally, but now…
JIM GRANT: Yeah, but from time to time you never knew exactly what was going to happen next.
CONSUELO MACK: True. You didn’t know who was going to be bailed out, who was going to be financed, right.
JIM GRANT: And so, again, what this amounts to, Consuelo, in my opinion, is a full-scale federal war on Adam Smith’s invisible hand. This is a campaign against what the economists call the price mechanism. It’s this miraculous human contrivance that allows Wal-Mart to stock its shelves because at a price merchandise moves or it doesn’t move. That’s the way a complex economy is coordinated. It’s so simple, we scarcely pay attention to it, but this miraculous contrivance is exactly what the Federales are trying to stamp out. They put their thumb on the scale. They don’t want prices to be cleared in the marketplace. They want to dictate them in the interest of macro-economic stability. How the heck do they know what’s going to be stable?
You know, there was an episode in our not-so-distant past. There was a depression in 1920, ’21. It’s the depression Chairman Bernanke never mentions. It lasted 18 months peak to trough, and to meet this cataclysm, this disaster… you know, wholesale prices were down 40%. Unemployment went from three percent to twelve percent.
CONSUELO MACK: That’s a depression.
JIM GRANT: Real activity declined by nine or ten percent. To meet this, the Feds: A, balanced the federal budget and, B, raised interest rates. And guess what? The thing ended. Markets cleared. Assets got cheap. People bought them because they were bargains, and it was off to the races. That was a kind of free market depression. What they’re doing in the past five years or whatever it’s been, one loses track, is everything except that; and the consequences in no small part are the 23-year-olds at home in their bedrooms of their childhood wondering when somebody’s going to respond to their e-mail looking for work. In the interest or with the best of motives of making a capitalist system more humane, they have made it hugely inhumane. Let markets work.
CONSUELO MACK: So Jim, one of the things that you do in Grant’s Interest Rate Observer aside from analyzing this kind of behavior and telling us in plain language what’s going on, is that you also give investment advice as well, and so how do we invest in a period like this?
JIM GRANT: Well, with an eye always to a margin of safety, but it seems to me that from time to time Mr. Market does present one with what seems like a bargain. For example, we have recently waxed bullish on, of all companies, General Motors. I spent the last two hours…
CONSUELO MACK: Right. I almost fell off my chair when you told me that.
JIM GRANT: …sermonizing against federal intrusion into our commercial and financial affairs. Government Motors has emerged from bankruptcy with the cleanest of balance sheets, with a new and, I think, rather energized management structure. It means to do better. The American odometer has put on a lot of miles. We have the oldest, I think, oldest car fleet on the road right now.
CONSUELO MACK: So there will be demand for new cars.
JIM GRANT: Yeah, people are going to want that new car smell. GM, I think, is in a good way. Now, no good value story is complete without the object of one’s affections having a lot of hair on it. Right? Something has to be wrong with it to put people off. In the case of GM, it’s the government’s important equity holding. So the bearish case on GM is, why buy this thing? It might be cheap, but it is cheap like six times the estimate for next year of earnings. But why buy it if the government’s going to come out and dump its stock? Well, GM, we think, may very well be the buyer of that stock itself. It has the balance sheet to do it. So for all those reasons, for operational reasons, for financial reasons and for strategic reasons, perhaps we think that GM is a bargain.
CONSUELO MACK: So let me ask you.
JIM GRANT: And we add this. And because it’s well-financed, because the balance sheet is clean, the chances of permanent impairment of one’s capital, which is always a consideration, we think are low. So that’s our story on GM.
CONSUELO MACK: As far as the investment environment and what’s going to do well in the market and what’s not going to do well, given the backdrop of what the Fed has been doing, so what do you… what are the opportunities that are being created? What are the biggest risks that are being created?
JIM GRANT: I think that the biggest risk… and I’ve been so wrong about this. I preface it with my own assurances that my judgment is just as infallible as the chairman’s, although what I don’t do is impose it on others, but in my opinion, the so-called safe assets are the unsafe assets, and the so-called risky assets paradoxically will turn out to be the remunerative assets. Today we live in this land of risk on and risk off. This is what you hear on cable television with Wall Street, this kind of yak-yak you hear on Wall Street, and conveniently the brokers define these categories for us. We have to think safe or risk off… let’s see, risk off. Right. Safe assets.
CONSUELO MACK: Right, treasuries.
JIM GRANT: Right, sovereign. Yes, U.S. Treasuries and, of course, let us not forget European sovereign credit yielding less than zero, so-called, the dramatic on northern European …
CONSUELO MACK: Swiss bonds.
JIM GRANT: Yeah, Swiss and Danish and German yielding less than zero. So you pay them to keep your money. Doesn’t that sound wonderful? Safe, safe. Well, as we learned in the ‘60s, ‘70s and early ‘80s, and have learned subsequently in different settings, safety is a defined term. Bonds are not intrinsically safe, nor are stocks intrinsically risky. There ain’t no intrinsic in investing; it’s all a matter of price and value. If bonds yield nothing, are they really intrinsically anything except risky? No, to answer my question. They are risky. So in my opinion, the years to come will see a great shifting in our perceptions of risk.
So if you have a good company, and there are many good companies that have the capacity to adapt, that can deal with inflation when it comes, that can deal with deflation, that can adapt their products to a changing marketplace and that are priced at, say, 13 or 14 times earnings that are yielding two and a half percent, to me those are, relatively speaking, pretty good investments over time compared to Treasuries and other sovereign emissions yielding zip. So if I had to pick, and I do, between stocks and bonds, I pick stocks, and if I had to pick between risk on, so-called, and risk off, give me risk on. I want what they regard as risky, and I would sell what they regard as safe.
CONSUELO MACK: And as far as the stocks are concerned, are there some stocks that represent the best, again, you know, best investments as far as price, value, yield?
JIM GRANT: I mean, Google, for example, we wrote about. It was a little bit lower, but we wrote about it this summer, and it had a market multiple. It was like 13 or 14 times the estimate, and this is one of the great collections of American and, indeed, of world intellects, and they sit around all day thinking stuff up, and they have a good profitable business, a fabulous balance sheet. They seem to have the future in sight. They have demonstrated that they know something about technology beyond the fax machine.
And I’m thinking that, as compared with a Treasury that yields little or a Treasury inflation-protected security that yields less than nothing, that Google in a market multiple is a pretty good warrant or option on human progress.
CONSUELO MACK: So where do we go for yield?
JIM GRANT: Well, there ain’t none. There is very little natural yield. However, there are what used to be called business man’s risks. We now call them business people’s risks on Wall Street that will deliver you some yield at a reasonable risk. One of these opportunities is called prime rate or floating rate funds, and they are funds of bank loans. Now, the loans are to leveraged or indebted companies, but you as a lender to them in the bank level get a senior claim, and the senior claim is, I think, a safe claim, and these leveraged loan funds as they’re called, or prime rate funds, deliver interest income that will go up if interest rates go up, and over the past 12 months or so, they’ve delivered seven or eight percent over that time in interest income, and I think they will likely continue to do that. They have been much less popular than speculative grade or junk bond funds. Junk bond funds have had huge inflows. These prime rate funds have had very little in way of investment inflow. So we like those. They’re a decent business person’s risk for interest income.
CONSUELO MACK: So are there any particular prime rate funds that… ?
JIM GRANT: Well, Eaton Vance has one that we have spoken well of, for example. All the big mutual fund companies have them. Another set of interest spinning entities in this world of no-interest income are the mortgage real estate investment trusts. Annaly, NLY, is one. American Capital Agency, AGNC, is one. Hatteras, HTS, is another. MFA, same ticker, MFA, is a fourth. We’ve written about them. We followed them for years and years. They are leveraged, meaning they do business with borrowed money. They borrow short and lend long. There are risks, and there are risks that, for example, that the Fed might succeed so well that it crushes all interest spread in our world of mortgages, but these things yield 12 and 13%. They are trading at book value or slightly above or slightly below it. Each of the four I mentioned has some particular merit and, in some cases, some characteristic frailty, but taken as a portfolio, these four, it seems to me, again, in the context of taking some reasonable risk for income, these are not a bad way to proceed.
CONSUELO MACK: And I know that Annaly has been a past one investment recommendation of yours, and we’ve had the CEO, Mike Farrell, on WEALTHTRACK a couple of times in the past. As far as, you know, we’ve got an election coming up, so what do you think the impact of the election is going to be on the markets? Is it going to make a big difference?
JIM GRANT: Well, we can talk about religion next, now that we’re talking about politics, and this is– I’m not sure what my political views are worth, but I’ll give you them. It seems to me that this issue that the election is really about from the financial point of view, the election is about the price mechanism. It’s about the invisible hand. It’s about supply and demand. Do we prefer that to the government? That’s the question. I mean, everything else is being discussed, but the essential financial issue in this, to me, is shall we give, at long last, shall we restore capitalism to Wall Street? Shall we restore the price mechanism to its proper place in our money and capital markets? Shall we get out of the business of suppression and manipulation?
Now, Mitt Romney is a most imperfect champion of these ideas, but he is infinitely better than our incumbent in my opinion. Therefore, I mean, Grant’s Interest Rate Observer has only endorsed one political candidate in all of 30 years in business, and that was Grover Cleveland, and he was dead and we endorsed him. And I’m not going to endorse Mitt Romney, but I am going to vote for him.
CONSUELO MACK: That is great. Jim Grant from Grant’s Interest Rate Observer, thank you so much for joining us on WEALTHTRACK.
JIM GRANT: Well Consuelo, it has been my pleasure. I thank you.
CONSUELO MACK: At the end of every WEALTHTRACK, we try to leave you with one suggestion to help you build and protect your wealth over the long term. This week we are taking the lead from our guest, Jim Grant, who mentioned a portfolio of mortgage backed REITs as one way to feed our widespread yield starvation. This week’s Action Point is: consider investing in REITs through a traditional real estate investment trust index fund. Morningstar’s favorite is the Vanguard REIT ETF, symbol VNQ, the largest in the category with low fees and less volatility than the competition. Incidentally, Morningstar recommends holding REITs in a tax-deferred account, such as a 401k, because their dividends are taxed as regular income.
I hope you can join us next week. We are going to interview Great Investor David Winters of the five-star rated Wintergreen Fund who is going to challenge three big investor misconceptions. Don’t forget, if you are interested in seeing this week’s program again, you can go to our website wealthtrack.com. It will be available as a podcast or streaming video. And while you are there, you can also see additional interviews with WEALTHTRACK guests answering some unusual questions in our new and improved WEALTHTRACK Extra feature. And that concludes this edition of WEALTHTRACK. Thank you for watching! Have a great weekend and make the week ahead a profitable and a productive one.
James Grant: The Federal Reserve’s Most Outspoken Critic
Federal Reserve Chairman Ben Bernanke has been widely credited with playing a key role in saving the global financial system from spiraling into a deeper recession. As a recent Financial Times headline read, “Central Bank Action Lifts Gloom”; “Bold Fed and ECB Moves Cheer Investors- Confidence Increases in U.S. and Europe.” There is no question that the Fed and to a lesser degree the ECB, the European Central Bank, are pulling out all stops to boost economic growth, investor confidence, and stock returns, going far beyond what their critics maintain is their proper role. As this week’s guest, financial journalist and historian James Grant told me, “Central bankers have morphed into central planners.” Continue Reading »
David Darst Transcript 9/14/12 #912
WEALTHTRACK Transcript #912- 9/14/12
CONSUELO MACK: This week on WEALTHTRACK, what will it take to rebuild damaged investor confidence? Financial Thought Leader David Darst, Morgan Stanley’s Chief Investment Strategist, shows us the steps to take to build a stronger and more secure financial house. David Darst is next on Consuelo Mack WEALTHTRACK.
Hello and welcome to this edition of WEALTHTRACK. I’m Consuelo Mack. Is the cult of equity dying, as bond king Bill Gross recently opined in his monthly investment outlook? Gross runs the world’s largest and one of its most successful bond funds, the PIMCO Total Return Fund and is one of the country’s most influential investors and prognosticators. As Gross’ chart, “Stocks For The Really Long Run” shows, stocks, with their 6.6% annualized inflation adjusted returns, have vastly outperformed bonds and cash over the last one hundred years; a fact chronicled by Wharton professor Jeremy Siegel in his investment classic, Stocks For The Long Run. Gross maintains this track record is unsustainable for a number of reasons, not the least of which is PIMCO’s expectation that the economy will grow at a much slower pace for the foreseeable future. Under PIMCO’s now famous “new normal” forecast, real GDP should crawl along at 1-2% a year versus the historical average of 3.5% in the post-war era.
Many investors seem to agree that the cult of equity is dying. Investors have been pulling money out of stock mutual funds for years. As independent research firm Bianco Research reports and its chart of cash flows into U.S. stock mutual funds shows, “investors correctly started selling domestic equity mutual funds on an annual basis in mid-2007… in fact, in the months ending May 2012, net new cash flow out of these funds set a record at $193.93 billion.” You sure wouldn’t think so looking at how the markets have performed this year though. Stock markets across the world have rallied, led by the U.S. Professional investors are much more bullish than individuals are about the ability of the Federal Reserve and the European Central Bank among others to boost growth and stimulate demand.
Put this week’s WEALTHTRACK guest in the optimist’s camp, with some caveats and measured advice for investors. He is Financial Thought Leader, David Darst, Chief Investment Strategist at Morgan Stanley, where he criss-crosses the globe advising clients. He is also an acknowledged expert in asset allocation and a prolific author. Among his most recent books is a best seller, The Little Book That Saves Your Assets, which I highly recommend. I began the interview by asking David, given recent events, why should investors trust the financial markets.
DAVID DARST: Well, I think the basic reason is that we trust America, the United States of America. America is certainly a country that’s had its ups and downs. We’ve been through the Depression, we’ve been through world wars, we’ve been through great conflicts that were not of world war scale, but they’ve been significant for our heroes and heroines. But I have great faith in the people, the deep-keeled strength of this nation to keep this nation in balance. This nation is the destiny, this nation is the hope of this world.
And why should Americans trust in the financial system? We will get it right. No family is perfect. Marriages have problems. Your kids have problems. Everybody has problems. It’s not the problems- it’s how do we deal with problems? I was recently having lunch with someone and she said it’s not what baggage you have, it is how you deal with the baggage you have, and I think this is baggage- these scandals, the trading, the high frequency trading, the flash crashes. These are things, this American ideal, this American history, and it’s 100% correct, we move to basically… we love problems. We go with the problems and we solve them. Do we do it overnight? No.
And I also have faith in the basic people who do the work in this country, and who do the work in this financial system, that they will do the right thing. Do you have bad eggs? Read the Old Testament. There’s thousands of stories in there of people … one guy kills his brother because the smoke goes up to heaven and his doesn’t. But does that mean we have to stop the Bible in Genesis right there, Cain and Abel? No. And we’re going to have people who make mistakes. We’re going to have pilots who… we’re going to have planes that crash, we’re going to have systems that crash, but I think this whole American ideal is that we will work to fix this.
CONSUELO MACK: So what has been fixed that you think that we can feel better about the fact that we are addressing our issues?
DAVID DARST: Consuelo, number one is public awareness. A show like yours educates people. It is not a high frequency trading show. It is the antidote. You and I have talked about this. It is a show of thoughtfulness, of reflection, of appropriateness, of judiciousness. And I believe what has been fixed is there’s much greater public awareness of these things, and they are now on the agenda. They are not hidden. They are not something that we’re blissfully ignorant of. What has been fixed? People, the SEC, the NASDAQ, people are aware of some of the big egregious errors; the word egregious comes from egrex- in Latin, out of the flock. These things that have been outliers, have been recognized as such, and we are going like the good shepherd to bring that thing back like Rin Tin Tin and Lassie, and bring them back into the fold.
CONSUELO MACK: So let’s talk about what’s changed as far as when you’re talking to clients and advising them on their investments, because many people feel that the markets have fundamentally changed. You mentioned the flash crash, for instance. The fact is that we have had, in the last five or six years, or ten years, we’ve had two back-to-back market declines of 50% or more.
DAVID DARST: Well said.
CONSUELO MACK: So there’s tremendous volatility in the markets right now. It feels like the very nature of the markets have changed, that computers are in charge and the humans are not. So, what has changed and how do we adapt to it to get the kinds of returns that we want from the market?
DAVID DARST: What has changed is in 1876 somebody dropped acid on himself in Boston, Massachusetts and said, “Watson, come here, I need you.” And Alexander Graham Bell, Watson came running in, and we had the telephone and we were able to have information travel through the distance and now it’s sped up to almost instantaneous speed of light. What has changed is the speed at which things are being thrown at us, and we have to become a little bit more nimble, we have to pay a little bit more attention. You and I have discussed you had to drive, you have to drive occasionally with both hands on the steering wheel, wear a seat belt and pay attention to the road. This is not autopilot.
CONSUELO MACK: And you said it’s not a cruise control market, but it hasn’t been in quite a while. So if it’s not cruise control, I mean, you know, do I have to be a Grand Prix driver in order to navigate the market, in which case–
DAVID DARST: Stay within your lanes, stay down the middle of the highway, and if it says “Don’t Pass” don’t pass. And what I mean by that is, what’s changed is the speed. What has not changed in 10,000 years since they began drawing images at Lascaux, Spain and Altamira, okay, over there in those caves– what’s not changed is the things that frighten us are still the things that frighten us and the things that get us excited and greedy are still the same things. Human nature has not changed. The world has changed. I tell all of our financial advisors, our clients, the world as we know it is not the world today that we did know it. It is the end of the world as we know it, Consuelo, is not the end of the world. We have three big changes: demographics, technology and globalization. And the technology piece is what you’re putting your finger on, and that has changed, no question about it.
That having been said, the things… Buffett says when people are greedy then you have to basically stand back. When people are fearful, then you’ve got to force yourself. And I think one of the great things of this show is that you give this long-term perspective, and when things get sold down, our philosophy, number one, asset protection is paramount. The key second word of our philosophy is the word protection; secondly is correlations are critical. You want to have asset classes that zig when others zag so that you’re calm and you are like a surgeon operating on your own relative. You have ice water in your veins, and that’s given to you by assets that do well when others aren’t doing well.
CONSUELO MACK: And the non-correlated assets continue to be non-correlated.
DAVID DARST: Those are cash. Those are managed futures. Those are precious metals. Those are inflation index securities which you have been a pioneer on in your show.
CONSUELO MACK: Let’s go back to some of the fundamental changes, and you mentioned demographics. A lot of people don’t pay as much attention to the aging baby boomers, which made such a huge difference in the market rallies of the ’80s and ’90s and so …
DAVID DARST: It was like a religion. They told us to buy stocks and hold them.
CONSUELO MACK: Right. There’s a major reason why stocks went up, because the baby boomers were a huge consumer, huge stimulative factor. They are now aging, so their patterns are going to change. How much of a drag or a headwind is that going to be on market returns for the next 20 years?
DAVID DARST: Consuelo, I think many of the baby boomers are going to want their portfolios to be more stable and they’re going to want them to generate more income. Those are a couple of givens . Professor Siegel and, you know …
CONSUELO MACK: Jeremy Siegel, right, Wharton.
DAVID DARST: Jeremy Siegel at Wharton. Professor Siegel, in his first book, I remember the last chapter said the U.S. companies are going to be so good and so global that many of these rich emerging markets, people in Indonesia, people in Taiwan, people in China, are going to want to buy stocks of these American global gorillas. I thought, how crazy. Now, 15 years later after is first edition, he was brilliant with that statement. I don’t even know if he realized totally that these young people are going to look for companies they trust, going back to your first point, they’re going to look for companies whose accounting they know, they’re going to look for companies that have been around 160, 170, 180 years. You take companies that are in the consumer products area that have global footprints, these people touch these products every day and they’re going to want to own shares of these. And so I think we have another wave of buyers…
CONSUELO MACK: A global wave of buyers buying these multinational…
DAVID DARST: Global wave of buyers of U.S. companies and European and Canadian and U.K. companies that have good accountings, that have good accounting systems, good managements, that have a global mindset and a global… these companies…
CONSUELO MACK: Are you seeing that happening now? Where is the demand coming from? I thought it was coming from…
DAVID DARST: I just got back from Brazil, as you know. You go to Brazil and you see people coming to investor presentations, you see questions that indicate that the middle class is growing all over the world. The 1700s were about the deposition of monarchies. The 1800s were about getting rid of slavery. The 1900s were about the eradication of fascism, totalitarianism and Communism. This century now that we’re entering is going to be about, number one, the emancipation and the no more oppression of women, globally. And they are savers, and they are household maintainers, along with their spouses, along with their partners, and they are going to buy stocks and they’re going to buy things they trust and they’re going to buy the products of the companies they trust, and they’re going to buy stocks of those companies.
CONSUELO MACK: So what are you telling your clients? How are we getting through this transition and do we have to adjust… during these kind of transitions there’s so much displacement in transitional periods, I mean do we have to adjust our investment expectations? Do we have to adjust our portfolios to new asset allocation, use different sectors? Tell us how we adjust to survive.
DAVID DARST: First of all is diversification. You’ve preached this, I have preached this. You want to basically have a bunch of assets that are non-correlated, good quality assets. Take baby steps. I see people that come in and they get disgusted and they want to change the entire décor of their house. Listen, change the house one room at a time. Focus on, are your equities of high quality, global companies that have free cash flow generation, that have dividend-friendly policy, shareholder-friendly policies, and managements that are trustworthy and are doing things to expand the global footprint? That’s one.
CONSUELO MACK: So David, a lot of people say that’s a very crowded trade, they’re expensive now, especially the global gorilla type of stocks that have a total return, they’re paying regular dividends. That’s the … the criticism is that that stuff is really expensive now. What’s your view?
DAVID DARST: Breathing is a crowded trade. Does that mean I have to hold my breath? Running out of a movie theater when the building is on fire is a crowded trade. Does that mean I have to be contrary? There’s a time to be contrarian. I’m going back to Ecclesiastes. You’ve heard me talk about Ecclesiastes. In there, it says there’s a time for being part of the crowd and there’s a time for standing away from the crowd. And right now, if I saw these valuations, the valuation of the U.S. stock market had come down from 33 to around 12. Has it stopped? Could it go down to six or seven? Of course it could. That’s usually the long-term bottom. But in 2000, and you remember it very well, 2000 the stock market PE was 33 times earnings. It’s come down in dribs and drabs, because the market’s done nothing over these 12 years, to a PE of 12. Therefore, you want to basically own some of these companies that have good valuations.
CONSUELO MACK: So let’s talk about some of the positive things that you’re seeing where there are investment opportunities. So one of them is energy.
DAVID DARST: One of them is energy, Consuelo. I think there’s legitimate concern over fracking. Are we going to be protective of the water? And this is something that this generation demands in a way that our generation was only beginning to, but they really draw the line and say we need confirmation that this drilling is so far below that, that it’s impossible to taint the water…
CONSUELO MACK: To pollute the water supply.
DAVID DARST: And we want our water, we want our air to be clean, and I think there are so many countries in the world, including the number two economy in the world after the United States now, China, they would love to have clean air and clean water. And we, I think, set a standard. So one is in the area of energy. Another one is in the area of water. We have water, but we also have, even in this drought condition year that we’ve just finished, we have filtration, we have desalination techniques, and those are two of the areas that folks in your investment mindset need to be look at is water, not just bottled water. Bottled water is a soft drink, what you need is filtration, you need irrigation, and you need desalination.
CONSUELO MACK: What’s on the radar screen of you, an investor, shorter term- the election, what’s at stake?
DAVID DARST: What’s at stake, Consuelo is the United States’ view towards capital, the United States’ view towards regulation, the United States’ view towards the spending and debt limits. Those are the four things: regulation, capital… listen, these big companies, 80 to 90% of their profits are abroad. They can’t bring them back here. It’s simple, your seven year old niece could put this on a postcard and send it to 1600 Pennsylvania Avenue and say give them a break on the taxes if they hire people and build things here. Let me tell you, Airbus is pulling Boeing. What is that? They’re going to build airplanes in the south part of the United States because they have hardworking, disciplined, non-unionized workers, who work in a country where things get crazy, we depreciate the currency a little bit externally to make the thing competitive, and they don’t have that in Europe.
CONSUELO MACK: What are you telling your clients how to deal with the crisis in the Eurozone?
DAVID DARST: Europe, everybody wants to put it down and says it’s nothing but a big Disneyland over there and it’s people having espresso in the piazza all afternoon. No, Europe is German companies, Europe is Danish companies, Europe is Swedish companies, Europe is Italian leather manufacturers that are not even listed in the telephone book. The Economist magazine said the strongest person in Europe was the Italian manufacturer with less than 15 people because they don’t have to register. Ninety percent of women’s leather glove, to date-Vietnam, Philippines, Bangladesh, okay, Sri Lanka, they’re not made in Asia- 90% of women’s leather gloves in the world are made in Naples, Italy, but Consuelo, there’s not one glove manufacturer listed in the telephone book. It’s all done off the books.
CONSUELO MACK: So what are the investment opportunities in Europe?
DAVID DARST: I think you’ve got some of these phenomenal European companies, these healthcare companies, the dividends on these Swiss, giant pharma companies, the dividends on the French giant pharma company, the U.K., the dividends are five, six, seven percent.
CONSUELO MACK: So these are, again, global gorillas.
DAVID DARST: These are global gorillas. You have some of these German powerhouse manufacturing companies, the big multi-industry companies. Buffett bought into these reinsurance companies in Switzerland and in Germany, and they are conservative, and they have tremendous bookkeeping and they have tremendous risk control. Nobody said a word about these great reinsurance companies. So Europe has tremendous opportunities. Am I going to sit here on your show and tell people to buy the European banks? Not now, because people still don’t know what’s inside their balance sheets.
CONSUELO MACK: So David, one of the other questions that a lot of your clients are asking you is- again, these are the baby boomer clients- in a low yield world, where can we go for income? So what are you telling them?
DAVID DARST: We say take a little, have a sprinkling of real estate investment trusts. They’ve done well this year, Consuelo. The domestic ones recently were up as much as 13, 14%. People were looking for yield. The international ones, which don’t get mentioned on your program a lot, but there are indices that follow them, and there are funds that track these international real estate investment trusts, those things are up 24%.
CONSUELO MACK: So everything has a price so…
DAVID DARST: That’s income. Secondly is master limited partnerships. We’ve talked about these on your show. These are energy infrastructure. They’re pipelines, they are oil storage facilities. They are not downstream, which is refining and marketing, where we buy our gasoline. They’re not upstream, which is drilling for oil. They call this midstream, okay, master limited partnerships is… Congress, in 1961, created real estate investment trusts. In 1987, they created master limited partnerships to encourage national investment in this infrastructure, and to build out the midstream aspect of the energy industry. That’s yield oriented. So you say, where do you go for yield? You want to go with the healthcare sector. Those things are yielding four, five, six percent.
CONSUELO MACK: These are big drug companies?
DAVID DARST: Your telephone companies and your Canadian, the big Canadian giants, Consuelo, you want to own some of those. You want to own your big U.S. carriers, and your biggest Canadian carrier. These yield 4.5, five percent. Those are generous yields that can be maintained, so there’s where you want to be looking for yield these days.
CONSUELO MACK: One Investment for a long-term diversified portfolio- what should we all own some of?
DAVID DARST: Johnson & Johnson is a company of 126 years.
CONSUELO MACK: It’s had some problems.
DAVID DARST: It’s had some problems. They’ve had some recalls, some product recalls, they’ve had some manufacturing issues. This is one of the great ethical companies of all time. They’ve just installed a new chairman succeeding Bill Weldon, who did a good job. They’ve installed on April 12th of this year, Alex Gorsky. He’s a U.S. Military Academy grad, he’s a native of Michigan, he’s one of five kids, he was posted in Greece, he was posted in Hawaii. He then went to work as a salesman for J&J, and 28 years later he’s the CEO. What is he doing? In short, they are basically taking their global footprint and now going to expand it. You take companies that are the biggest consumer products companies in the U.S. They are about 34% emerging markets. You take the big beverage companies, okay, your big cola companies, they are about 50% emerging markets; you take the biggest toothpaste companies that we have, they are 50% in emerging markets.
CONSUELO MACK: Johnson & Johnson?
DAVID DARST: Johnson & Johnson is only 20% in emerging markets. They have a gross margin, that’s sales less cost of goods sold, of 70%. Their revenues this past year were $70 billion, their earnings were 20%, after taxes, $14 billion. They have $12 of debt, they have $70 billion of equity.
CONSUELO MACK: And the dividend policy is…
DAVID DARST: Dividend is 3.5% and a tendency to grow the dividend over time. We think this is a classic example, and I am thrilled that it’s cheap. They can earn $5. It sells for 13 times earnings. It’s towards the low end of its historical multiple. That’s the kind of company that’s emblematic of the themes that we’ve been discussing that we think will give you along, a good return to buy in, it’s just cheap valuation.
CONSUELO MACK: David Darst, Morgan Stanley. Thank you so much for joining us on WEALTHTRACK, as always.
DAVID DARST: Thank you for having me. Nice to be with you.
CONSUELO MACK: At the end of every WEALTHTRACK, we try to leave you with one suggestion to help you build and protect your wealth over the long term. This week I am taking some advice from PIMCO’s star bond manager Bill Gross, whom I quoted in the beginning of the program. This week’s Action Point comes right from Bill. It is: balance your asset mix according to your age. Gross advises “own more stocks if you are young, but more bonds if you are in your 60’s or older” as he is. It also fits nicely into a core part of David Darst’s strategy, which is to be broadly diversified with portfolio protection in mind.
I hope you can join us next week. I am going to sit down with a next generation Great Investor, Matthew McLennan, successor to legendary portfolio manager Jean Marie Eveillard, at the First Eagle Funds. If you would like to watch this program again, please go to our website, wealthtrack.com. It will be available as streaming video or a podcast no later than Sunday night. You can also see additional interviews with WEALTHTRACK guests in our new and improved WEALTHTRACK Extra feature. And that concludes this edition of WEALTHTRACK. Thank you for watching. Have a great weekend and make the week ahead a profitable and a productive one.
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