How To Play The Stock Market in 2020 (w/ Jason Trennert & Vincent Catalano)
VINCENT CATALANO: Jason, welcome to Real Vision. JASON TRENNERT: Thank you for having me. VINCENT CATALANO: Tell us a little bit about Strategas, besides the fact of the name, and get into the definition that came from it, Strategas is what? JASON TRENNERT: Yeah, so Strategas. We're a research firm that focuses on macro-economic research, economics, policy, technical analysis, fixed income strategy, and it's also a broker dealer. In addition to research analysts, we also have sales traders, and institutional salesman. Basically what we do is we write reports on these big picture things. We publish them and then we travel around the country and the world to tell institutional investors what we're thinking. VINCENT CATALANO: That's fantastic. You are, your role is? JASON TRENNERT: I'm the chairman of the company and also the chief investment strategist. I mainly focused on the equity markets, but try to also pull everything together. VINCENT CATALANO: One of the founders? JASON TRENNERT: One of the founders, that's right. I started in 2006. I had worked at Heiman for about 15 years at a place called ISI Group from '91 to 2006. Then my partners Nick Bohnsack, and Don Rissmiller, they joined me and we started Strategas in 2006. VINCENT CATALANO: That's fabulous. Want to start off talking about the markets, overall, the equity markets. One of the things that stood out to me and key reason to discuss with you today is earlier in this year on CNBC, one of the hosts there was pressing you and Rich Bernstein. Where's the market going to go? What's the price going to be at? Where are we going to end up? That thing and Rich deferred, demurred. You said, "All right, I'll give you a--", and you gave a number. The number was, I think for the S&P, which was at the time around 2600 or something like that, you said in the neighborhood of like, 3000. In fact, you gave a specific number, 3005. JASON TRENNERT: Yeah. Oh, wow. That implies a certain expertise I don't have but at least I was bullish, at least that was on the right direction. VINCENT CATALANO: No, right direction. Yeah, definitely on the amplitude of the low was pretty close to it. Here we are coming to the end of 2019, where do you see the equity markets today? Valuation was tough before and more so now. JASON TRENNERT: The hard part now is the market is not cheap by any normal standard. I don't also think it's particularly expensive given where interest rates and inflation are. We're using, just to use round numbers, about $175 for S&P 500 operating earnings. If you put an 18 multiple on that, which I think is fair, given where again 10-year Treasury yields and inflation is, it would tell you the market right now is fully valued, but not overvalued. VINCENT CATALANO: Not Cape like overvalued. JASON TRENNERT: Not Cape like overvalued. I'm not sure I'm a big fan of Cape, frankly, especially with interest rates this low to begin with. We were talking this morning in our-- we have morning meeting every morning at 7:30 where we all get together and we discuss the market's direction and what's happening. Our view is largely that if we're going to be wrong on the market, it's likely that the market's going to continue to strengthen more than people think that markets rarely stop at fair value. They tend to get overvalued before bull markets end, and even though-- again, it's pretty fully valued right now, with the Fed on hold for most of next year, it's certainly hard to be short, it would be my view. VINCENT CATALANO: Earning's looking pretty good going into next year, at least the next 12 months. In any event, interest rates being low. That suggests to me that you guys use something along the lines of a discounted cash flow model for value. JASON TRENNERT: Yeah, we do the earnings on a bottom up basis, really from a sector level so that not bottom up all 500 S&P 500 companies, but we do it sector by sector and we build it up from there and come up with an earnings estimate for the year. Then we use a variety of econometric models to forecast the multiple. Frankly, right now, the models spit out what I would say was almost socially unacceptable numbers of 20 or 21, or 22 times earnings just because you have secularly low interest rates and inflation. Probably we don't want to bite on that too much because generally speaking, it's hard to get a multiple more than 19 or 20 on a sustainable basis but by the same token, 18, or 19, is perfectly reasonable. Again, we'd rather be a little cautious and be wrong by market moving up the other way as opposed to being too galosh and have the market call the wrong way. VINCENT CATALANO: At an 18 multiple, that sounds a little bit like the rule of 20. JASON TRENNERT: Yeah, that's a fair-- the rule of 20 was created by my old boss, Jim Maltz and he had found over time, over a long period of time, that if you added up the multiple of the S&P 500 and inflation, that on average, the sum of those two items equal 20, over long periods of time. We have very sophisticated models that look at all sorts of things. Then we have the rule of 20, and I'd have to say that the rule 20 is just as good as some of the very sophisticated econometric models. They're largely getting at the same thing, which is largely the idea that when you're discounted cash flows by lower interest rates, the net present value is quite a bit higher. That's largely what it's getting to. VINCENT CATALANO: Now, you referenced the Fed and low interest rates and all, where do you see rates going into the next year, which is a big factor all the way around economically in the financial market? JASON TRENNERT: Yeah. Well, short rates in my view are going to stay in the current range. The Fed just met last week, second week of December. You're going to between 1.50 and 1.75, the Fed has made it pretty clear, too, they're not going to change until inflation is above 2 and looks like it's going to stay above 2%. Right now, with inflation about 1.50, little more than 1.50, that doesn't seem to be likely anytime soon. I think the Fed is done for next year. Long rates, on the other hand, though, I think should start to drift higher. Frankly, I think it's a good thing if they're drifting higher because it's a reflection of real GDP growth, as opposed to inflation. It's hard to forecast inflation right now, in my opinion. Our expectation is that a stronger global economy next year will allow interest rates to move higher, and that actually winds up being good for S&P 500 operating earnings because a steeper yield curve tends to be good for financials. VINCENT CATALANO: That yield curve being more positively sloped is a reflection of an economy, US and worldwide, that's in better shape? JASON TRENNERT: That's in better shape. Again, you have decent growth with low inflation. It's really a Goldilocks type scenario. I think, again, next year is an election year, too, as if we can't forget, but the Fed probably doesn't want to be too involved, wants to be less involved than it has been over the last few years, probably doesn't want to get the president involved. They don't need to. Again, they're in a position now where inflation is so tamed that I don't think they have to worry too much about inflation getting away from them, running away from them, and they can take their time with the next move. VINCENT CATALANO: Tell us about the political scene because you guys covered that as well. Dan Clifton. JASON TRENNERT: Yep. Daniel Clifton. VINCENT CATALANO: Down there in Washington and what's your firm's perspective on that? Implications economically and implications for the market? JASON TRENNERT: Yeah, we've been in-- and I was saying before, we've had plenty of bad calls, but one of the good calls we've had was on this idea of populism being something that can last. We were pretty early on in taking Donald Trump seriously as a presidential candidate, pretty early on taking Brexit seriously as a potential outcome. We're still very much of the view that populism is an enduring political theme. One thing I feel strongly about is that whoever next president is, it will be a populist. The question is, is it the right of center populace that's in the presidency now, or is it a left of center populist, like a Bernie Sanders or Elizabeth Warren? I think the days of-- for the time being, the days of having an establishment candidate are probably pretty unlikely, in my opinion, and I think that it's largely reflective of concerns that everyday people have that are not largely and they have not really been met by the orthodoxy of the bigger parties. VINCENT CATALANO: That argues against someone like a Joe Biden. JASON TRENNERT: Like a Joe Biden, in my opinion, he may very well win the nomination but I think if he ran against Donald Trump, he might have a decent chance of beating him but I think Donald Trump would win. Listen, incumbents have a hard time losing anyway. Incumbents particularly have a hard time losing when the economy is as strong as it is now. Now, there's 10 months in-- VINCENT CATALANO: In any number of events. JASON TRENNERT: 10 months is an eternity, especially these days in a 24-hour news cycle. Our best guess is that the status quo will prevail, which is to say that Donald Trump will be reelected, that the Democrats will keep hold of the house and the Republicans will keep control of the Senate. In our opinion, that's the most likely outcome. By the same token, it's pretty a 50/50 country, and anything could happen but economy, in my opinion, will be the single most important factor in terms of who gets elected next. VINCENT CATALANO: It'd be interesting to see what the consequences of that would be worldwide. JASON TRENNERT: Donald Trump being reelected? VINCENT CATALANO: That's correct. In other words, 2016 wasn't an aberration, it is what is. JASON TRENNERT: Yeah. My opinion, Brexit, what's happening in Italy, what's happening in a lot of the regional elections in Europe I think give you a pretty strong indication that 2016 wasn't an aberration, that there are a lot of secular pieties on both the left and the right that have been followed by the establishment candidates, by establishment parties, that average people are saying this just doesn't work for us. You could go through whether it's free trade with a country that's not really interested in free trade, like China or open borders or formal Care Act or wars, endless wars and all these sorts of things average people were starting to question and they want something different. VINCENT CATALANO: Do you think that the, in the US, the Democrats basically with their embrace of let's call it the coastal elites, so to speak, and in particular, Wall Street and Silicon Valley, do you think that that is a dynamic that's there that the democrats are missing? JASON TRENNERT: That's my opinion. I grew up in-- both my parents were Democrats and I was a Democrat for a while, but it was very different party at that point, it was largely for working men, working women. It was largely anti-communist, if you had a strong religious faith, you didn't feel that you were necessarily excluded. The party has changed a lot now and we could debate those things, but I could say there's a lot of people who have those opinions now that might not feel that at home in the Democratic Party, and I think that's one of the issues. I think that's part of the why Donald Trump won, he recognized that and recognized that there are certain longing for something. That's why I think Joe Biden would probably have the best chance of beating Donald Trump because I think he has that every man type of feel. I think he would have a better shot at winning than either Sanders or Warren. VINCENT CATALANO: How do you blend longer term trends and themes with shorter term business cycle related issues? How do you mesh the two together? Because I get a sense that you do that you do look at both. How do you develop that into an investment methodology? JASON TRENNERT: Yeah. Well, that's a great question. Because it is a constant struggle, and it's mainly because our clients are professional investors so to be frank, the main thing we're trying to get first is the next six to 12 months, just trying to make sure our clients stay employed. Then in turn, keep us employed, because one of the hard parts about the investment business, particularly when it comes to stocks and stocks are the longest duration assets you can get really, maybe aside from real estate. Yet most people who manage stocks are managed at best, or evaluated on a once a year basis. Then some hedge funds are evaluated on a monthly basis. It's an almost impossible task for the professional investor today, in my opinion, that they again have our trading at very long duration assets and yet, they're held of this very short term standard. We try to give the longer term themes and we publish separate reports on the longer term themes once every quarter, where we try to give people say these are big, long term things to think about whether it might be populism or whether it might be the convergence between the public and private equity markets or very, very long term ideas. We publish those on a quarterly basis to make sure people know what we're thinking about those things but we also publish every day about what's happening every day and what we think is the most likely outcome on a shorter to intermediate timeframe. VINCENT CATALANO: See, I think that that's one of the great value propositions of Strategas, is the fact that you do reconcile the long term framework, so to speak, with the short term practical elements of it. What you said before about professional investors that they're judged on a shorter term basis, they're in long duration assets, for the most part, judged on a short term basis in many cases. Which is a difficult balancing act to do and the thing I've always been struck by is that Strategas, my sense is that you guys have your ear to that ground better than pretty much anybody. JASON TRENNERT: Well, that's a very nice thing to say. It's actually, in my opinion, is one of the great compliments you could give our firm. I think if we do that well, it's largely because we-- for better or worse, we travel all the time meaning I'd say for worse because I have to go through TSA or the airport. For better, once you get to wherever you're going-- which I travel 70, 75 days a year and will be in everywhere from- - being everywhere from Des Moines to London to Singapore and balance. My partners travel more than I do if you can believe it, they're a little younger than I am. The bad thing about that is time away from your family and it's not easy physically. The good thing though is that you meet a lot of different types of investors and not just hedge funds here in New York. You also meet mutual fund managers in Boston and state pension plans and the middle part of the country and then you might deal with a big bank in Europe or big public pension plan in Australia, those types of things. You have a good idea of where people are positioned and how people are thinking and it keeps your mind fresh too, because you're not just talking to each other, which is one of the biggest, let's say one of the biggest risk in the investment businesses, you just spent a lot of time talking to other people that have the same idea as you do, or the same similar backgrounds or similar circumstances. VINCENT CATALANO: How do you factor that into, or do you not factor that into your estimates of where the financial markets will be? That dynamic of what they're thinking etc. JASON TRENNERT: Yeah, I wouldn't say it's not, certainly not. There's no mathematical way we do it, but we do meet every day as a firm. We have a morning meeting, as I said, at 7:30 every morning and we share all the time what we're hearing from the road, and the questions that were being asked by investors and that the questions that were being asked by professional investors inform a lot of our written work because again, if you spend a couple of days on the road, let's say in Texas, you'll find that you'll get the same two or three questions in almost every meeting or something that's on people's minds. That will be the basis for the next report, we say we should look into-- we might not know the answer, well, likely not know the answer. Then we'll do the research and we'll say this is actually what happens. This is how long it takes between the first Fed easing and the next Fed tightening on average, how long does that take? A lot of things along those lines, what happens when the dollar strengthens or when the dollar weakens as it relates to earnings or sector weightings or things along those lines? VINCENT CATALANO: That then gets fed back into the decision process? JASON TRENNERT: Exactly. VINCENT CATALANO: What happens if you had a view, a consensus view, let's call it out there, of professional investors, some of which may carry more weight than others in your mind in terms of their insights and their views? If that is in conflict, let's say, with the fundamental valuation work that you've done with maybe the technical market intelligence that's there, what happens with that? Does that tilt, you say, oh, well, we believe this but this element here is a dynamic? JASON TRENNERT: Well, I have to say as always, as a basis for all the things we do I have to say is, it's long enough to know that you have to be humble in this business because it's a very humbling business. We're never-- I would say the style of the firm is decidedly never to pound the table on anything. We are always thinking about ways when we put on any new call. Before we put it on, we think about how we might be wrong and what would cause us to change our mind before the trade is put on or before the idea is established because it becomes important because you want to be able to recognize when you're wrong quickly as opposed to just trying to paper over it or make other excuses for it. Our clients, mercifully, our clients give us a lot of benefit for showing our work. Like as long as it's well thought out and well-reasoned, our clients cut us wide slack when we're wrong. Again, we try to have this discipline of when we are wrong, admitting it quickly and moving on and getting onto something where we might have an edge. VINCENT CATALANO: That comment reminds me of something that Byron Wien of Morgan Stanley, one said at a CFA market forecast event that I did, when he was asked the question why are we doing this forecast for the year ahead? He said, it's not the specific forecast for the number, it's the process that you put into it in understanding. That sounds like what you just said. JASON TRENNERT: I think that's right. I think Wall Street or in the investment business, it can be sometimes when people are not involved in the business, it can seem rather dry or very uncreative. Yet I think the investment business in many ways is more and more intellectually stimulating businesses there can be because virtually, everything can have an investment implications. It can be very creative business in its own way. If you're a news junkie like I am, you spend a lot of time learning about all sorts of different things, not just political events, but scientific events or social movements, all of those things can go into higher thinking. It's important. I view it that way, something where you're constantly learning and trying to test your thesis and all the rest. VINCENT CATALANO: Social Science with money. JASON TRENNERT: Yeah. I think the problems-- it is a social science, and the problems in the financial markets come when people try to make it a hard science I find. That's when people like long term capital trying to make it a hard science, people that packaged mortgage backed securities and credit default swaps, they try to make it a hard science like you put a little bit of a beaker A and a beaker B and it equals beaker C, all the time. The thing is when you're dealing with human beings, it doesn't work that way. That's one of the things I have to say worries me a little bit about this Fed. I feel more confident in the past Fed, Bernanke Fed and the Yellen Fed, like I worry quite a bit that they viewed their role as really almost as chemists, or hard scientists, where, if you do enough of one thing, it will always turn out the way you expect it and it just doesn't. When you're dealing with human beings, of course, it doesn't work that way. VINCENT CATALANO: I want to get to a couple of actionable items and areas that your friend was looking at. Before we do, I'd like to get your views on private equity. Quite a bit of money is going in that direction. Institutional investors are shifting money more so than at any point in the past into private equity. First, what's your view in general of private equity as an investment vehicle alternative? Then secondly, I'd like to get your thoughts on what you think the motivating factor might be for institutional investors going into private equity that might include the whole issue of required rates of return, and not being able to hit it when you have interest rates at 2% and 3% and you got mark to market with that, and then you have private equity that's [indiscernible] your thoughts on private equity. JASON TRENNERT: Well, I have to say in terms of just being frank about it, we have no private equity clients. Consider the source. All of my clients are public equity or public market clients. I want to be fair, or just tell you where my biases might lie, but I'm very skeptical about private equity, the future returns of private equity being anything like what they were in the past. David Swensen really put private equity on the map in terms of an institutional asset class. What he discovered was that there was a discount for illiquid private companies, or that there was a liquidity premium for publicly traded companies. He said, I can buy these assets, and I can buy them in the private markets at a discount and eventually, they'll either be public and so on, I'll make a lot of money. That made a lot of sense. He made a lot of money doing it, but of course, he was the first person to do it. Now, you're 25 years removed from when David Swensen really started doing that and there are now 7000 private equity funds that have about $3 trillion in assets. In my opinion you're running out of-- and valuations, in my opinion, are not cheap anymore. I would argue that there's actually an illiquidity premium now over the public markets. Part of this and this gets into your second question, which is why are people throwing so much money there? Frankly I think people are chasing performance and I would also say that there's an opacity of the private markets that is very appealing if you don't want to be embarrassed or fired. Not to be overly cynical about it, but your average public pension plan has an investment return assumption of 7.50%. Very hard to do that when 10-year Treasury yields are below 2% and the long term average returns of public equities are 7, pretty hard to get to 7.50. The only way you can really get that is through leverage. That's what private equity provides. It also though, it provides the best leverage because it moves much more slowly, the marks move much more slowly and so you're more unlikely to be embarrassed again or fired by having very outsized allocations to private equity. VINCENT CATALANO: That aspect that, you brought this up several time now, that aspect is I think really underappreciated by many investors. That dynamic of the potential of career suicide, of getting fired, it's almost as though-- okay, I've refrained from saying this or making this connection but it's just such a fun thing I think to do, CFA equal CYA. JASON TRENNERT: Yeah. Well, listen, I think all of us and no matter what line of work we're in, job number one is keeping your job. I think that we're just human beings. We're all part of the same hypocrisies. You have to just recognize that and try to use it to your advantage and it doesn't mean that people were all-- no, it doesn't mean you're bad people or-- VINCENT CATALANO: No nefarious reasons. JASON TRENNERT: There's no nefarious reasons but there is a reality of the institutional investment business which, again, is as career as a central part of it. Just like anyone else in any other profession has the same tensions, that this just happens to be with other people's money that tells they're different. VINCENT CATALANO: That's a great, great point. Last item, actionable ideas. Sector coping style investing, asset allocation. Give us some thoughts on Strategas as you where I might want to be for 2020. We had Rich Bernstein on the program here a couple of months ago and late cycle investing was his thing that he was emphasizing, your thoughts on where we're at and where we ought to be as investors? JASON TRENNERT: Yeah, I would say in that regard, we have a little bit of a different view than Rich and that I'm not convinced where his late cycle as it might seem, I know the business expansion is 10 years old. It might seem late, but I also think that the real Fed Funds Rate is zero. Usually what ends recoveries is the Fed killing it. Inflation rises where the Fed killing it and here because of financial repression, you're pretty far away from that. What we're telling our clients to do is to get more cyclical. We've told them to really get more, we told them to buy financials, we're overweight four sectors, financials, industrials, technology and telecom. We're of the view that actually next year, the global economy will pick up. That's largely because a lot of the trade tensions will largely be behind us, at least as far as it relates to business confidence. In my opinion, the trade war, in some ways, it's sterilized some of the benefits of the tax cut that you got at the end of 2017. That was good for capital spending for a year but then it faded because businesses got scared because of trade. If trade is behind us, there is a chance that business confidence picks up, capital spending picks up and also global economic activity picks up and that should be good for those sectors. VINCENT CATALANO: Anything in terms of the-- any thoughts in terms of the global markets, emerging markets, frontier, Europe? JASON TRENNERT: Europe in my opinion is probably as a trade, as more of a trade or a tactical approach let's say for a year, six months to a year as opposed to secular, I like you're up quite a bit because in some ways, I tend to think it almost got hurt the most between the tensions between China and the US just because it's so trade oriented, it's so geared towards trade, it should benefit the most if global growth starts to pick up. The question will be longer term, whether Europe makes the structural changes it needs to pave the way for long lasting growth, but for next year, at least in my opinion, Europe looks quite good. VINCENT CATALANO: That's terrific. Thanks so much, Jason. JASON TRENNERT: Thank you. I appreciate it. VINCENT CATALANO: All the best in the year ahead. JASON TRENNERT: Thank you. Thanks a lot. Thanks for having me. Appreciate it.