The BID

A stock picker’s guide to 2020

Esta semana com Tony DeSpirito, gerente de portfólio e diretor de investimento do Grupo de Ações Ativas Fundamentais dos EUA da BlackRock

No final de 2019, os investidores em ações suspiraram com alívio. Este ano não trouxe recessão econômica, o setor de consumo está forte e o desemprego é baixo. Esse é o melhor cenário possível? E o que isso significa para 2020?

Neste episódio do The BID, Tony DeSpirito, gerente de portfólio e diretor de investimento do Grupo de Ações Ativas Fundamentais dos EUA da BlackRock, fala sobre suas perspectivas para as ações em 2020, revela como os dados estão mudando o perfil do investidor ativo e oferece sua opinião sobre como os mercados reagem nos ciclos eleitorais.

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  • Mary-Catherine Lader: 2019 is nearly over and investors can breathe a sigh of relief. Though we’re in the late stages of a bull market cycle, we’ve avoided an economic recession. The consumer sector is strong, and though we went into the year anticipating interest rate hikes from the Federal Reserve, we actually saw a series of rate cuts. The S&P 500 Index of large U.S. stocks is on track to close the year with double-digit gains, unemployment is low and wages are up just a little bit.

    So is this as good as it gets? And what does that mean for investors in 2020?

    On this episode of The BID, we’ll speak with Tony DeSpirito, Portfolio Manager and Chief Investment Officer for BlackRock’s U.S. Fundamental Active Equity Group. We’ll talk about the outlook for markets in 2020, how tech and data are changing what it means to be an active stock picker, and his take on what exactly happens to markets in election cycles. I’m your host Mary-Catherine Lader. We hope you enjoy.

    Tony, thanks so much for joining us today.

    Tony Despirito: Thanks for having me, it’s a pleasure.

    Mary-Catherine Lader: So in your day-to-day professional life, you’re a stock-picker, to use an old fashioned term. But you’re also, of course, a personal investor. You’re managing for your own retirement, for your daughters’ college educations. Is how you operate as a personal investor different than what you do as a professional one?

    Tony Despirito: It’s actually quite well-aligned. I always start with time horizon. Are you investing for the next year or are you investing for three, five, ten years out? I’m a long-term investor, and I think that’s important because the longer your investment horizon, the better off you are in equities. I think academics have done investors a disservice because they talk about risk in terms of monthly volatility. But as an equity investor, you're not investing for next month, you're investing for the next three, five, plus years. And so we’ve done a study looking at volatility over extended periods of time for equities and what you find is the longer your horizon, the lower the volatility of the equity returns. Basically it tells you the longer your horizon is, the more you belong in equities. The other thing I think about is okay, given the market opportunity today, what is better: stocks or bonds? And we are at a really unique point in time where you can actually get more income in some cases from stocks than bonds. So if you look at the 10-year Treasury as we’re recording this, it yields about 1.7, 1.8 percent. The dividend yield on the S&P 500 is 1.9 percent. So a little higher. But if you look at a more dividend-oriented index like the Russell 1000 Value Index, that has a yield of two and a half percent. Now if you think about the income over the next 10 years on the 10-year Treasury, it’s fixed. Whereas in equities, if things go according to plan, the income from equities should roughly double over the next 10 years. That’s a very big difference for investors. And then the last point I think about is alpha. I want my money to work as hard as it can for me without taking undue risk. We’re shooting to perform above average and that’s an important concept. And so when I create my own personal portfolio, that’s what I’m talking about, when I create portfolios for our clients, it’s the same thing.

    Mary-Catherine Lader: So when you say long time horizon, how long is long?

    Tony Despirito: Generally three to five years. When we look at companies CEOs are doing three to five year business plans. And so we look at the investments the same way as a CEO would.

    Mary-Catherine Lader: So speaking of longer time horizons, you’ve been in this business for nearly 25 years. And a lot has changed over that time. Back then passive investing was really just getting started, big data wasn’t a thing. And so as each of these things has come to fruition, how has that changed how you think about investing?

    Tony Despirito: Yes, so a lot has changed, but most of the principles are the same. So one is information. Historically there was a dearth of information and your job, my job as a young analyst was to find information. But increasingly we live in a society of information overload, and the key to good sound investing is knowing which information applies to long-term opportunity and value of a company versus short-term noise. And discarding that and not paying attention to it is actually the challenge. And I think that goes to market efficiency as well. I think the market has become hyper-efficient at the short end. If there is a piece of news out there, the market reacts really quickly. So I think it’s a fool’s game to try to trade around that. On the other hand, the market has become so obsessed with short-termism that that’s left an opportunity at the longer end, and that is where we as fundamental investors play. I like to think of it as time horizon arbitrage by having a longer time horizon than most investors. You can spot opportunities that a lot of them are discarding. That’s actually better today potentially than historically. And then finally you point out data. I think there is a real need to evolve as an investor. If you’re doing the same thing today that you were doing three years ago, you’re falling behind. We’re putting together a mosaic of information, reading SEC filings, we’re talking to company management, we’re doing field research, we’re looking at data. And we've always looked at data, but as a society, we’re collecting more and more data and we have more and more computer processing power.

    Mary-Catherine Lader: So let’s talk a little bit about those new types of data. I'm particularly curious for your view on ESG data. So environmental, social, governance factors basically, evaluating companies based on their performance against certain key performance indicators. It’s really a nascent field. The data to support an ESG score is collected with a pretty blunt instrument today, like questionnaires, voluntary company disclosures. So how do you think about the quality of for example ESG data?

    Tony Despirito: I think we’re in the early innings and that is what is beautiful from an investor point of view. So there’s a lot of data, some of it is inconsistent, there is no regulatory standards around it. There are different data providers that come up with different answers for the same companies. And that gives us a real place as fundamental investors to make judgments about where companies stand today with respect to these ESG factors, but also where they are going in the future and where they can improve on those factors, and therefore improve as companies. It’s become a very big topic and I think what we’ll see is the cost of capital changing. If you’re a good ESG company, the cost of capital will be lower; and if you’re a bad ESG company, the cost of capital will be higher.

    Mary-Catherine Lader: Switching gears to talk about the markets: looking back a year from today, we saw huge volatility in equity markets and a significant dip in December of 2018. So as you look back at 2019, how does it compare?

    Tony Despirito: Yeah, to understand 2019, you have to really go back to what happened at the end of last year. And what we saw was a Fed that was very hawkish, that was raising rates. At the same time, we had global growth slowing. And so that created a near-term panic I’ll say in the markets. And we saw both stock markets and bond markets under performing and that is pretty unusual actually that they both underperformed together. Then at the beginning of this year, the Fed switched to a more dovish stance and has cut rates subsequently and that has provided a real boost to the market. And so what we’ve really seen is just a correction of what happened last year. In terms of 2020, we look at the economy and we are in the later innings of an economic cycle. But we’re not at the end of an economic cycle. So we don’t foresee a recession in 2020, and therefore, we expect markets to continue to grind higher. But given that we’re near the later innings of an economic cycle, we do think prudence is important, right, you really better like what you own in your portfolio. And we have been emphasizing resiliency, which means more quality in the portfolio.

    Mary-Catherine Lader: So in talking about resilience, you mentioned quality, and quality is extremely subjective, so what exactly does it mean to you?

    Tony Despirito: It is. It does involve a lot of judgment. And for us, it means a couple of things. A quality business is one that earns significantly more than its cost to capital over the course of a cycle. A cyclical business can be quality, right, so it doesn’t necessarily correlate 100 percent to stability. We also look a lot at balance sheets. When times are good, no one cares about balance sheets. But when times are bad, a strong balance sheet becomes incredibly critical. That’s what provides resiliency. We also want improving free cash flow and earnings trends, and finally, you don’t want to overpay. You could have all the quality in the world, but if you pay too much for it, your returns are going to suffer, so we want quality at a good price.

    Mary-Catherine Lader: So in what areas of the market do you see opportunity in 2020?

    Tony Despirito: I like to think of the portfolio in two buckets, stable earners on one hand, and cyclical businesses on the other. On the stable earners side, a number of stable earners have been bid up in price. Those high prices create a risk. Think min-vol stocks, think bond proxies. So when you think about minimum volatility stocks, you should think about stocks with low price volatility and bond proxy stocks that people are buying for yields. Good examples of these are utilities and also publicly traded real estate companies. On the flip-side, within the stability bucket, healthcare really sticks out. It’s one of the few stable areas that trades at reasonable prices, and then when you look at the underlying earnings, it’s pretty impressive what you see. The demand for healthcare should only grow; it’s almost a demographic certainty. We are aging as a society; as you get older, you consume more healthcare, so the demand is rock solid. The question is how do we pay for it? It’s tough because healthcare is growing as a percent of GDP. There is a lot of political debate about how we’re going to pay for it. But if you look at history, we’ve been debating this since at least the early-90s if not earlier, and ultimately, every time the government has tried to impose some kind of price controls, gridlock has prevailed. So I think this is a ripe area to continue to grow. On the economically-sensitive side, we really like the money center banks. There’s a real muscle memory in the market, the market remembers what happened to the money center banks in the Global Financial Crisis. But these banks have really changed their stripes quite a bit. Most notably, I’d point to capital ratios; the amount of capital cushion that they retain is roughly 60 to 70 percent higher than it’s ever been. That makes them safer and sounder, and we think that makes them a good investment. And you look at the free cash flow, the free cash flow yields are eight, nine, ten percent, that’s extremely high particularly in a world where bond yields are sub-two percent. And that’s through a combination of dividends and buy-backs, and so we think that is also a very fertile area for investment.

    Mary-Catherine Lader: So healthcare, financial services. These are huge topics for presidential candidates right now. When do you think we’ll see markets start to react to the election?

    Tony Despirito: Well, we’ve started to see some, but the market does tend to focus on only one or two things at a time. I think that will definitely heat up at the beginning of next year. We have our first primaries and then ultimately the presidential election. So I think there will be a lot of talk, there will be some volatility around that, but I think the volatility will create buying opportunities.

    Mary-Catherine Lader: Looking back at previous elections, what’s the conventional wisdom on their impact on markets?

    Tony Despirito: So we’ve looked at the presidential cycle as it relates to stock returns going back to the 1920s. And there is a real pattern, and the pattern is the stock market does well in all years, except for the second year of a president’s term. And that has totally corresponded to what’s happened during the Trump presidency. As we pointed out earlier, 2018 was a tough year for stocks and that’s exactly what the data on the presidential election cycle would show you. The same data would tell you 2020 will be just fine.

    Mary-Catherine Lader: Why do you think that is?

    Tony Despirito: Well, the conspiracy theory would be it behooves all of the politicians, both the president and Congressional members who are up for reelection, to really boost the economy in that final year so they all can get reelected.

    Mary-Catherine Lader: Looking back in terms of headlines creating volatility, a persistent theme in 2019 was U.S./China trade tensions. So as you look back at the last 11 months, to what extent do you think that really did move markets and what was the ultimate response?

    Tony Despirito: Global growth has definitely been slower because of trade tensions. Unfortunately, I see this as a long term issue – the competition both economically and politically between China and the U.S. – and I don’t see it going away. I do think that we will get a deal but it will be a deal with a small D and it won’t resolve all of our problems. That being said, if you look at the history of investing, over the last 10, 20, 30, 50, even 100 years, there’s always been something like this for investors to focus on and worry about. But in general, corporations adjust, profits still grow, the economies still grow, and markets go up. And it really speaks to the importance of staying in the market, being a long term investor, and don’t trade around events like this.

    Mary-Catherine Lader: So one last question, what are the biggest unknowns for you going into 2020 and how does that impact your investment approach?

    Tony Despirito: So I think an interesting unknown is the potential for greater inflation. We’ve been in an environment of low for longer for about a decade now. Fewer and fewer investors remember what it was like to have inflation in the United States. I don’t think it’s a huge risk, but if you look at the number of strikes we’ve had this year, it’s actually the most since I think about 2004, so you’re starting to see that happening. You’re starting to see some wage pressure. Unemployment is sub-4 percent and has been for a while. So I think that could be the unexpected event of 2020.

    Mary-Catherine Lader: Okay. So I’m going to end with a rapid-fire round of more personal questions, are you ready?

    Tony Despirito: Okay.

    Mary-Catherine Lader: So I gather that you’re the youngest of 40 grandchildren, which is incredible, what’s the best lesson you learned from your grandparents?

    Tony Despirito: Yeah. So it’s the importance of history actually. Three out of my four grandparents were born in the 1800s believe it or not. So there is a great Winston Churchill quote that it makes me think about, which is the further back you look in history, the farther forward you can see in the future. That really applies to my investment philosophy and style.

    Mary-Catherine Lader: Okay. So looking forward, what advice do you give to your three daughters about investing?

    Tony Despirito: We talked about data and how that is growing in importance. I think math is an incredible skill, and so I’ve encouraged all three of my daughters to study hard and to excel in math, because I think that with more data over time, math just becomes more and more important.

    Mary-Catherine Lader: What’s your favorite way to spend a day when you’re not in the office?

    Tony Despirito: So I love being outside it’s a great way to rejuvenate. I spend a lot of time walking my dog Pepper. We also as a family spend a lot of time in the Adirondacks and that is both summer and winter. So in the summer, we’re out on the water, on a lake, in a boat, swimming, hiking, and then in the winter, we do a lot of skiing, snow-shoeing, even ice fishing.

    Mary-Catherine Lader: So I’m going to guess that when you take Pepper for a walk, you’re sometimes listening to podcasts.

    Tony Despirito: I do, I do.

    Mary-Catherine Lader: Okay. So what are your favorite podcasts?

    Tony Despirito: So I’m a big podcast fan, also Audible, audio books. So obviously The Bid is at the top of the list –

    Mary-Catherine Lader: Great answer.

    Tony Despirito: I also like Columbia, the MBA program has a pretty good podcast, and then personally I also like Tim Ferriss. I love life hacks and that’s what he is about.

    Mary-Catherine Lader: Totally, I love that one too. Thank you so much for joining us today Tony, it’s been an absolute pleasure having you.

    Tony Despirito: Thank you. The pleasure was all mine.