TRENNERT: UNAPPRECIATED BULL MARKET TRANSCRIPT

October 9, 2015

CONSUELO MACK: This week on WEALTHTRACK, Financial Thought Leader Jason Trennert and his team at Strategas Reserch Partners mix investment formulas to profit by including TINA, the Thrifty Fifty and the New Sovereigns. What he is cooking up now is next on Consuelo Mack WEALTHTRACK.

Hello and welcome to this edition of WEALTHTRACK, I’m Consuelo Mack. Despite the fact that we have had an almost uninterrupted bull market for the last six years investors have remained largely unconvinced, favoring bonds over stocks by an overwhelming margin.
Since the March 2009 market bottom bond mutual funds and ETFs have experienced net inflows of more than a trillion dollars, whereas domestic equity funds have seen less than nine billion dollars in flows.

The one exception to the anti- stock bias is international stock funds which gained nearly $600 billion in net flows. As several WEALTHTRACK guests have put it, including this week’s, this is one of the most disbelieved bull markets in history, despite the fact that stocks have had a fabulous run and have creamed bonds.

Since the 2009 bottom the S&P 500 has appreciated 184%, a 17% annualized return. When you add in dividends, the total return is a 226% advance with annualized returns of nearly 20%. The total return of the benchmark Barclay’s Aggregate Bond index over the same period has been a mere 35% for the entire period, an average annual return of 4.65%. Hindsight of course is 20/20.

A recent front page headline in the Financial Times sums up the current thinking towards stocks. “Equities face worst quarter since 2011 over fears for global economy, including “China slowdown concern”, Fed policy and the “U.S. earnings outlook.”
Those fears have knocked $14 trillion off global markets in the last 4 months, a more than 19% plus decline and by far the largest in several years. Are the best years of the bull market behind us? Are equity markets becoming too volatile and risky to navigate safely?

This week’s guest is a Financial Thought Leader known for his analysis of market patterns, risks and opportunities. He is Jason Trennert, Co-Founder, Managing Partner and Chief Investment Strategist at Strategas Research Partners, an independent investment strategy and macroeconomic research firm catering to institutional clients. Identified by Barron’s as one of “Wall Street’s Best Minds” Trennert and his team are known for their in-depth economic, political and market analysis and identification of investment themes.

I asked Trennert why despite the long bull market he thinks U.S. stocks are still a good place to invest.

JASON TRENNERT: Well I would say the irony is that although the bull market’s seven years old, in many ways it’s the bull market no one’s loved, especially among individual investors. If you look at the flows into mutual funds and into ETFs, there’s actually the net redemptions from U.S. stock funds over the last seven years. I know it’s hard to believe the market’s tripled, but the flows into international equities and into bonds have been much, much greater, and to me that’s where really more of the risk lies, and the reason why common stocks in the U.S. look attractive to me is that they’re still largely under owned especially among individuals.

CONSUELO MACK: Even after the kind of appreciation that we’ve seen, you still think it’s not too late to get in?

JASON TRENNERT: I don’t think so at all. Especially for … CONSUELO MACK: Why?

JASON TRENNERT: Especially for large well-capitalized companies because you’re looking I would say at an S&P 500 that might be trading at about 15 times earnings.

CONSUELO MACK: Not cheap.

JASON TRENNERT: It’s not cheap, but if you look at bonds, the ten-year Treasury bond will give you two percent, and that way it’s trading in some ways at 50 times earnings with no potential for growth and a lot of potential for capital risk. I think one the things that bothers me a little bit about bond funds is that people are assuming that it’s a good proxy for cash. What you’ve seen is a big decline, a big redemption in money market funds and big increase in bond funds. Those two products are not the same. A bond fund is not a good proxy for cash. You can lose principal. On the equity market side, there are many companies. Actually some of the best companies in the U.S. actually have better credit ratings if you look at certain measures than a lot of sovereign countries like …

CONSUELO MACK: And talk about this because at Strategas you come up with these wonderful names and concepts, and you have the Thrifty Fifty. So explain what the Thrifty Fifty is.

JASON TRENNERT: We call it the Thrifty Fifty. It sounds a little complex, but we’re essentially looking at what the insurance rates of default on their bonds are, and we compare them to what the insurance rate of a default on government debt is, and believe it or not there are about 75 companies in the United States that have lower insurance rates than …

CONSUELO MACK: And so therefore deemed better credit.

JASON TRENNERT: Deemed better credits than Japan. There are 54 that have better rates than France. So in many ways they’re new sovereigns that actually could be seen as proxies for sovereign debt which would normally be seen as the risk-free asset. In today’s world actually with governments having so much debt, a lot of companies have something that a lot of governments don’t have. They have money, which is helpful when you’re trying to pay a dividend. So in my view there actually is less risk in some of the largest best capitalized companies.

CONSUELO MACK: And these Thrifty Fifty, I’m just looking at my notes here. So I mean there are names like Apple and Colgate and Chevron and Exxon Mobil and Google, J&J, Merck, Walmart. So there are a whole wide spectrum of companies, of large companies. Should we treat those as a bond equivalent?

JASON TRENNERT: To me absolutely, and I think if you look at the performance of that group of companies in relation to the market as a whole, they’ve outperformed in a relatively big way, and I also think again you’re taking far less risk. All those companies provide dividends. Virtually all of them provide dividends. You’re talking much less risk than you are I think in buying sovereign debt or lending the U.S. government money or other governments money at extraordinarily low interest rates for long periods of time. So in my view again it depends on your comfort level, but I think I always get nervous when people think they’re taking no risk when in fact they’re taking a lot of risk when they’re investing in Treasury or sovereign debt.

CONSUELO MACK: As far as the bond market, I’d like to ask you about how dangerous you think the bond market is because I’ve heard this refrain now for years, and it’s always been in the context of that we expect interest rates to go up and, in fact, interest rates have not gone up. We are endlessly waiting for the Fed, but the global economy is slowing. Interest rates are still in many places near record lows. So why now? I mean why is the bond market still dangerous?

JASON TRENNERT: I think it’s dangerous to the extent to which all of the world’s central banks want inflation as a policy goal, and I can’t tell you when that will occur, but it’s very clear that not only the Fed but the Bank of Japan, the European Central Bank, the Bank of England, Swiss National Bank, they’re all …

CONSUELO MACK: China.

JASON TRENNERT: China. They’re all on the same page. They’re all desperately trying to get inflation higher. Now the Lord only knows when that will happen, but I’ve generally found that it’s not a good idea to bet against central banks; that eventually it’s going to work. I think the other thing that makes me somewhat nervous about the bond market is that there’s less liquidity. Part of that is because of the regulatory framework that’s been created, and when you have an accident … at one point they called it the taper tantrum. That was in 2013. You saw interest rates back up very, very quickly in a very short period of time.

JASON TRENNERT: As we saw during the taper tantrum during 2013, interest rates backed up a lot in a very, very short period of time.

CONSUELO MACK: Backed up meaning they went up.

JASON TRENNERT: They went up. They went from about 190 to 310 which doesn’t sound like a lot, but if you’re looking at it from what that did to the principal of those bonds funds, it was a very, very large hit. So this is why I think people just … it doesn’t mean that you don’t want to have income. It doesn’t mean that you don’t want to have bonds in your portfolio. It’s just I want people to understand the risk that they’re taking. It’s not risk-free. Money markets are risk-free, but bond funds are not.

CONSUELO MACK: At Strategas have you identified areas of the markets that you think are in bubble territory?

JASON TRENNERT: I think high-yield would be one especially in the energy sector. I think it’s very clear that there’s been a lot of issuance of high-yield debt in that area. I would be careful there. I also think, and I’m not sure if the individual investor has as much exposure to this as they might have other investment instruments, but private equity is another place where I think the valuations are really sky high, much, much greater than it is for common stocks, stocks that you can buy in the marketplace, but a lot of these unicorns, if you will, are trading at multiples that really are almost hard to justify in any economic environment.

And that I think has a lot to do with the fact that there’s probably just too much money, too much liquidity chasing too few investments. In a low interest rate world, in a world that they call financial repression where central banks are purposefully pushing down the level of interest rates, people start reaching for yield, and they start paying more and more for what I would call marginal investments. The irony to me is that common stocks could be the Cinderella asset class. People are so scarred by what happened in 2007 and 2008 understandably, and yet they’re ignoring these instruments like common stocks that might be volatile but offer a much better value for a longer-term investor.

CONSUELO MACK: That’s so interesting because the smart money, the big institutions, the endowments for instance, I mean the Yale endowment, private equity has been a big part of their endowment, of their investing strategy. So where individual investors are kind of clamoring to get in and certainly financial service firms are trying to offer private equity alternative investments to individuals, you’re saying it really is too late. They’re overpriced.

JASON TRENNERT: I think so. Yale’s brilliance was not that they invested in private equity per se. It’s that they invested in private equity so early. David Swensen, who’s a genius in the endowment models, started investing in private equity in 1994. He started recognizing the fact that there was a liquidity premium on common stocks, that people were paying too much for common stocks relative to privately held companies. It’s hard to make that claim now, though, because everyone, really all pensions, endowments and foundations I would argue have outsized exposures to private equity, and very, very little exposure to common stocks which are seen as riskier. It really doesn’t make much sense. You’re taking in many ways the same level of risk. It’s just that it depends on how often you’re measuring the risk, but the risk largely is the same. It’s just that for a common stock you’re seeing the price move on a day-to- day basis. With private equity the prices move too. It’s just that you don’t see that as often.

CONSUELO MACK: So that’s really interesting. I mean Strategas and you are known for identifying big investment themes, so one of your investment themes is that private equity is expensive and public equity is a much better deal at a time when big institutions like CalSTRS, for instance, the public pension in California, is saying that they’re going to reduce their stock position. So could we be in one of those situations where the consensus is going against equities and exactly at the time when in fact equities …

JASON TRENNERT: It should be going … CONSUELO MACK: Going forward.

JASON TRENNERT: I would say one of the big themes we have is that in some ways common stocks will be seen as the TINA asset class. There is no alternative …

CONSUELO MACK: There is no alternative.

JASON TRENNERT: … for a lot of pensions, endowments and foundations that have very high actuarial assumptions, and there’s really very little way to get there, in our view, with the traditional asset mix or at least the more recent asset mix which is very heavy on alternative investments, somewhat less on bonds, but they’ve really decreased their exposures to common stocks in a great way to fund their alternative investments. In our view there’s much greater value in public equities than there is in alternatives. So that would be one of our major themes.

CONSUELO MACK: Jason, what’s another big theme that you’ve identified at Strategas?

JASON TRENNERT: Well, another big theme is that yesteryear’s raiders are now activists, and so Carl Icahn would be a perfect example. So when I started in the business, he was known as a raider. Now he’s known as an activist, and he’s largely doing the same thing except that maybe he’s doing it now with the support of a lot of shareholders and even in some cases support of the companies themselves. It’s a good thing I think because a lot of companies in the U.S. are probably over capitalized, have too much cash and are too afraid to use it for a variety of reasons. The financial crisis, regulatory overhang. The way the free market should work is that a guy like Carl might come in and encourage companies to use the cash for the benefit of shareholders, and I think there are some examples of that. I think you’re going to see more of them particularly in the technology industry where companies arguably have much too much cash, and they should either give it back to shareholders in the form of a dividend or a buyback.

CONSUELO MACK: Invest it in capital expenditures and research?

JASON TRENNERT: Or they should do something with it. You can’t have it both ways I think as a company. No one’s buying your company. No one’s buying the stock of your company to act as a bad bank. You either have to give the cash back to shareholders in some way or use it productively to create more money, and I think that’s the role that activists largely now are playing. They’re encouraging sometimes nicely, sometimes not so nicely, companies to use the cash for the benefit of shareholder value.

CONSUELO MACK: Is there a way? Your clients are institutions. Is there a way for individual investors to take advantage of that theme, of activism being something that we’re going to see a lot more of?

JASON TRENNERT: I think the technology sector, buying the technology sector in general is probably the biggest companies. It’s probably one of best ways because they’re the companies with the most cash. So an Apple, a Google, what have you is probably a good way. I think also some of the financial companies really like a Greenhill or a Lazard or Evercore. Those are companies that really do a lot of M&A work, and so those could also be very interesting, another way of playing what I believe will be a very robust period for a lot of deals.

CONSUELO MACK: Another major theme. We talk a lot about market volatility, but one theme that you’ve identified is there’s a lot of political volatility that we’re going to be seeing. Explain what you mean by that.

JASON TRENNERT: There’s certainly a lot of political volatility around the financial crisis and then in President Obama’s first tem. There’s been somewhat less volatility in recent years, but we can see as we’re going into the presidential election cycle we’re going to see more of it. You saw the Democratic frontrunner, Hilary Clinton, tweet about drug prices. You’ve seen Donald Trump talk about changing the tax code. You’re seeing that not only in the U.S. but you’re seeing there’s a very big election coming up in Canada that is a very contentious one, seeing a strong wave of populism in Europe. All these things are going to weigh on investor sentiment. It’s also going to weigh on companies, the way company managements deal with what they perceive to be threats or change in the rules of the game. We’ve had a quiet period if you will, but I think as we enter the silly season of the presidential election cycle, we’re going to see more of it.

CONSUELO MACK: And how much pressure does that put on companies’ management? Especially I’m thinking of the multinationals that have to deal with all sorts of political environments, and is that going to actually possibly make their businesses less attractive because there’s going to be so much uncertainty that they’re dealing with?

JASON TRENNERT: This is a difficult thing to say, but knowing how to navigate the shoals of a lot of political forces is actually … our work has suggested it’s a skill. It’s a management skill.

CONSUELO MACK: It is a management skill.

JASON TRENNERT: It is a management skill, and the companies that are good at it have tended to outperform the companies who aren’t so good at it.

CONSUELO MACK: Jason, one of the quotes that I picked up from some of your research a while back really intrigues me in talking about kind of big themes. This is the quote. “The greatest investment opportunities in a world in which holding periods are less than a year,” which they are now … “lies not in access to information but in an investor’s willingness to arbitrage time horizons.” What do you mean by that?

JASON TRENNERT: Well, it’s ironic in a way because common stocks are among the longest duration assets you can find. In 1960, believe it or not, the average holding period for a common stock in the U.S. was eight years.

CONSUELO MACK: Wow. That’s amazing.

JASON TRENNERT: Now it’s less than a year, and people then wonder why it’s been so difficult to beat the market. You say well these are very large corporations, or they’re corporations that are dealing with a lot of different challenges, and in many ways if you look at the best investors, let’s take Warren Buffett, I always find it odd if he worked at a large mutual fund company, Warren Buffett probably would have been fired a half dozen times, more probably, almost every other year.

CONSUELO MACK: For periods of underperformance.

JASON TRENNERT: For periods of underperformance, and yet he’s playing a different game than the average mutual fund investor, mutual fund manager is playing. He’s playing for the longer term. He’s willing to really stick with a company that might be underperforming in order to realize its long-term value, and that is really the challenge. In many ways investing is a lot like golf in that the chief opponent largely is yourself, is your own psychological makeup, and of course no one likes to be wrong for any period of time, but if you find good companies that you believe in and that other people will give you for sale occasionally, you should theoretically be buying more of them, and that to me is really arbitraging time horizons, being willing to stick with an investment longer than perhaps the crowd would.

CONSUELO MACK: Of course it’s something that individuals can take advantage of because they’re not under the kind of impression that active managers are where we’ve got to have quarterly performance standards set for us. So that’s an advantage that we have as individuals.

JASON TRENNERT: It really is an advantage that individuals have. The competitiveness of the money management business makes it very difficult for portfolio managers to have long- term time horizons. So many of these people who are our clients know that they should be holding stocks longer than they are, but it’s the competitiveness of the industry makes it very difficult for them to do that because they might get fired. As an individual, you’d have to fire yourself, so that’s harder to do. Sometimes you do that, but it’s probably easier to do your homework, pick good companies and stick with them for a long period of time.

CONSUELO MACK: You wrote a book called My Side of the Street, and the kind of introductory phrase was Why Wolves, Flash Boys, Quants and Masters of the Universe Don’t Represent the Real Wall Street, and then you give my side of the street. Do you think that Wall Street is going to be able to recover its reputation after the financial crisis? We do see these wolves of Wall Street type movies, and that’s a common perception.

JASON TRENNERT: Boy I hope so because I feel strongly. I’ve been doing this for 27 years, and I feel so strongly that it’s an honorable profession, and I think that …

CONSUELO MACK: What’s honorable about it?

JASON TRENNERT: What’s honorable about it is that really I feel very strongly that the reason why the U.S. economy has prospered so greatly has been the depth of its capital markets, is the depth of these institutions that raise capital for companies that breathe life into the dreams of entrepreneurs. That is something you don’t see in other parts of the world. It’s not something you see in other parts of the world. It’s not something you see particularly in Europe which is much more dependent upon bank financing, not something you see necessarily in Asia. Of course, like any business you can have bad actors, but I think unfortunately there’s too much of a focus on the bad actors and not enough focus on the people I’ve grown up with who are trying to do the right thing, trying to act as fiduciaries, coming to work and try to do the best thing for their clients every day, and I think again the proof is in the pudding. The U.S. economy has been the strongest economy, will continue to be the strongest economy for the foreseeable future, and I think a lot of that has to do with again the depth of our financial markets.

CONSUELO MACK: Jason, one more question about Wall Street. We are hearing it in the political campaigns, and that is the fact that we have the greatest financial crisis since the Great Depression and yet very few people, especially major executives, have gone to jail. What’s your response to that?

JASON TRENNERT: The response is I think it’s difficult sometimes to criminalize stupidity. I think there are certain activities that are criminal, and there are other activities that are reckless that are ill-advised.

CONSUELO MACK: But they’re not illegal.

JASON TRENNERT: But they’re not illegal, so that’s a very difficult distinction to be made, and I’m not making excuses for some of the bad practices, the practices where executives purposely went out to defraud other people, but in many ways the financial crisis was the result of a mass delusion, not just on the part of unsuspecting investors and home buyers but also a mass delusion on the part of financial professionals.

CONSUELO MACK: Alan Greenspan.

JASON TRENNERT: Alan Greenspan.

CONSUELO MACK: He never expected … the U.S. housing market never had a recession. Chuck Prince at Citi.

JASON TRENNERT: You got to dance while the music’s playing. CONSUELO MACK: Dance. Right.

JASON TRENNERT: I think that’s a distinction, and trust me. As someone who loves Wall Street I’d like to see everyone that didn’t act in the best interest of their clients, I’d like to see them punished because the industry is that important to the country as a whole, and it’s important that we restore investor confidence.

CONSUELO MACK: One investment for a long-term diversified portfolio. What would you have all of us own some of?

JASON TRENNERT: I like Home Depot quite a bit here. It’s not a small cap stock. It’s a big stock but we call it in the thrice blessed category. It’s part of the Thrifty Fifty that we discussed before. It’s a company that has very, very low risk in terms of the strength of its balance sheet. Our technical team likes the stock a lot which means the chart looks very good in a period in which the market’s had some difficulty. The stock has held up very, very well. Lastly we’re very bullish on consumer spending in the U.S. for the next six months to twelve months, and it should benefit. Home Depot should benefit quite greatly by the fact that the unemployment rate is coming down. Home ownership is moving higher. Household formation is strengthening. So all of these things should benefit, should really redound positively on Home Depot. You also have a yield there that is higher or close to higher than the ten-year Treasury yield.

CONSUELO MACK: Jason Trennert from Strategas, thanks so much for being with us on WEALTHTRACK once again.

JASON TRENNERT: It’s my honor. 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 is: Focus on companies with financial strength. We are entering a period of increased volatility in the stock market, which just suffered the worst quarterly performance since 2011. Many companies have taken on large amounts of debt to take advantage of low interest rates. The IMF just warned of rising corporate failures because of the borrowing binge. As many predict, financial strength is going to be increasingly important. Trennert’s theme of the “Thrifty Fifty”, U.S. companies, that by one key measure, 5- year credit default swap spreads, are considered to have better credit than many developed- country governments is one way to judge financial soundness.

Three that recently were deemed as having better credits than U.S. Treasurys are Merck, Chubb and Cambridge Bancorp.

Financial soundness matters especially in times of slower growth and economic stress.

Next week on WEALTHTRACK we will talk with wealth advisor Jewelle Bickford about her professional mission to empower women financially. How she helps clients achieve financial security.

To see this program again and other WEALTHTRACK interviews including our EXTRA feature with Jason Trennert about his defense of Wall Street, the motivation for his new book, My Side of The Street, please go to our website wealthtrack.com.

Also feel free to reach out to us on Facebook and Twitter. Thank you for watching.
Have a great Columbus Day weekend and make the week ahead a profitable and a productive one.


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