Replay and Summary: Client Conference Call on Recent Market TurmoilAugust 2011
On August 11, Fiduciary Trust held a client conference call on the recent market turmoil. Mackin Pulsifer, Chief Investment Officer, provided insights on the key drivers of volatility, and offered answers to questions that have been top of mind for investors. The following is a summary of our call.
A Crisis of Confidence, Not of Fundamentals
The recent extraordinary market volatility does not, in our view, signal an end to economic recovery from the 2007-2009 recession. Jobs, corporate sales and earnings and tax receipts are rising—albeit at a less than satisfactory rate-but rising. The fundamentals that drive markets are intact.
What spooked investors was the palpable lack of political and economic leadership in the U.S. and in Europe. The polarized debate over the debt ceiling revealed that neither the administration nor Congress really had a plan to resolve the country’s big short- and long-term problems. When the current Euro debt crisis focused attention on the structural weaknesses of the Eurozone nations’ political and economic arrangements, investor confidence evaporated. Interbank liquidity dried up, and investors questioned if it was September 15, 2008 (the day Lehman filed for bankruptcy) all over again.
In the real world, apart from the market fears, retail sales are moving up and exports are strong. U.S. corporations are reporting second quarter earnings that are up nearly 17% year-over-year. Major commodities like oil and copper are down in price, making life less expensive. We are therefore reasonably optimistic at this point, and feel that the market volatility will calm when economic leadership is asserted.
Q. I worry about keeping too much cash on hand when market volatility is presumably providing opportunities for long-term investors. Are there areas that you think investors should be focusing on right now?
Our answer is to take advantage of the low prices, but it gets down to an investor’s tolerance for shorter-term volatility. We believe that we are not going into a second recession, or if we do, that it will be very shallow. There are a lot of healthy companies that we are investing in, and today they are being offered to investors, in effect, on sale.
We Favor Multi-National Firms with Exposure to High Growth Areas
We look for global companies that are exposed to the high-growth parts of the world and that are providing products and services to growing numbers of consumers in China, India and Brazil. We also favor companies that are building infrastructure to support the huge move from underdevelopment to development in these countries as well as refurbishing so much of our infrastructure here in the U.S. In our view, investing in such companies whose stocks may have been knocked down by 15-25% in the last few weeks should be rewarding.
Volatility Is the New Norm
We caution that there will always be surprises. Investors should expect volatility as emerging countries go though phases of development and as the policymakers in the U.S. and Europe grapple with solutions to the debt problems. How policymakers deal with these shifting challenges will inevitably influence market sentiment.
Q. Should investors buy into the emerging market weakness, despite the higher risk?
What’s going on in the emerging markets, particularly in China and India, is a classic business cycle phenomenon. High growth has brought on inflation and their central banks are clamping down.
Emerging Markets Will Be Volatile, but Continue to Offer Long-Term Growth
The jury is still out on whether these countries can effectively manage to contain inflation. In our view, the evidence at this point looks as if they can, which would suggest that exposing portfolios to growth of five to six times what is likely in Europe or the U.S. is a rewarding thing to do. In the short-term, however, as the rest of the world adjusts to the impacts of deleveraging, investors may have to put up with some pretty severe volatility in these markets.
Q. It seems many investors ran to gold as a safe haven. What is your view on where risk-adverse investors can go today, without losing ground to inflation?
There’s never any truly safe haven in markets because they are ruled by so many often disparate forces. With respect to gold, lots of people irrationally piled in, driven by fears over the dollar’s falling status or by fears of virulent, incipient inflation. The rising price no doubt validated these fears, and more buyers appeared.
We Do Not Consider Gold to Be a Safe Haven
We have been reluctant to commit client capital to gold in this environment. More importantly, we don’t believe that inflation is going to be a big problem for a considerable period of time, and at today’s high price, gold is really not that safe of a haven in our view.
Companies with Stable Dividends Show Promise
We believe company earnings will be the area where investors gain wealth in the current climate. We also expect many companies will pay out more of their earnings as dividends or through stock buy-backs in order to remain attractive. Investors in these firms will receive a stream of rising income supported by stable earnings and, hopefully, when things get back on track, rising prices. In our view, that’s the closest thing to a save haven.
Q. How do you think all of this turmoil will affect the fixed income world?
Corporate debt in top-quality companies is attractive. Cash flows have been rising and default risk is dropping. While carrying more risk, high-yield debt in particular has been attractive, and we have sought to exploit that selectively within the fixed income exposures of accounts.
The risk we are watching is the market’s expectation for inflation. At some point it will increase from its almost nonexistent level today. When that happens, bonds are going to be vulnerable. We keenly appreciate this risk and will be active in managing it when the time comes.
Careful Selection of Municipal Bonds Has Been Critical in this Environment
Among municipal bonds, we are keeping our focus on issues with fairly short maturities, particularly under seven years. We like bonds with reliable income sources, such as essential services like water or sewer services. We are generally avoiding areas that we perceive have a higher default risk, such as building or economic development authorities.
Q. I am concerned about the global banking sector. What is your view on the risk of a second credit crunch happening outside of the U.S.?
I think the risk is fairly small today. The risk is less of a credit crunch and more of a funding crunch. If banks do not trust each other and refuse to loan money to each other to meet their short-term needs, they would be unable to fund the commercial paper operations of major corporations. We saw this beginning to happen in Europe, and the European Central Bank quickly moved to head off another Lehman-like funding crisis.
Europe Can Benefit from the Experience in the U.S.
It is very important to remember that in the U.S., the Fed and Treasury wrote a playbook to deal with situations like this--and it worked. Their actions in 2008 and early 2009 thawed the markets and revived funding, allowing business operations to get back on their feet, and headed off deflation. That playbook is available to the European Central Bank. I don’t think we are going to have repeat failure because all this experience is front and center for Eurozone policymakers to follow.
Q: With such low bond yields, is Fiduciary Trust using high yielding stocks to supplement income in portfolios?
The short answer is yes. We began this strategy in early 2009 as the equity market began to get legs and some of the big problems triggered by the crisis began to dissipate. We saw the opportunity to purchase companies that had to cut dividends during the worst of the markets’ down phase in anticipation that investors would get an increasing stock price, an earnings increase and a rising stream of dividends; and, indeed, we have seen this with many companies.
This communication is intended to provide general information. The information and opinions stated are as of August 11, 2011 unless otherwise indicated, and do not represent a complete analysis of every material fact concerning any industry, security or investment. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment advice or as a recommendation of any particular security, strategy or investment product.
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