Seven Questions for Scott Glasser
Co-CIO, ClearBridge Investments and Portfolio Manager
What do you tell investors who ask about your outlook?
I do not have a lot of concerns about 2018. It will probably be a positive single-digit year. The caveat is there are lots of political and global question marks out there, if something happens with Mueller or with Iran, Syria, Russia. They will create volatility. They are not fundamental concerns. They will create shorter-term corrections but not a bear market.
I worry more about 2019, if the economy starts to run at four percent GDP. In terms of interest rates and inflation, liquidity could become a much bigger factor. A tightening of liquidity would make me worry. It would be the classic things getting too hot and the U.S. Federal Reserve may have to put on the brakes. Every significant bear market has been accompanied by negative liquidity. I don’t think we are in that situation, but that’s a situation I always worry about.
My advice at this point is stay the course.
What is the effect of the tax cuts?
The market will benefit from the fiscal stimulus in the tax package. In terms of S&P profits, you will see a bump in the range of probably 12-13-14 percent on overall earnings. The market knows that. That expectation was a good part of the rally at the end of 2017 into the beginning of this year.
What do you think the prospects are for “trade wars” with Europe and China?
What’s interesting about all the trade talk is, in a very perverse way, it is probably helping sustain the bull market. If we get a little bit of a slowdown in global growth because of worries about trade, that could sustain us in “the Goldilocks zone” to three percent. That takes pressure off interest rates. I’m more worried about rates than earnings. Rates are a bigger factor. So if growth slows a little bit, and sustains itself, then we are in an okay environment.
How are you approaching the current climate from a portfolio management standpoint?
Financial weightings are up a little bit, consumer weightings are down a little bit. Energy is in the process of turning around, and we have good representation both on the traditional large-cap side and some of the pipeline companies. We are not overexposed towards the high-yielding parts of the market like utilities and REITs.
While the gut reaction is to sell any kind of dividend stock in the face of rising rates, and all the academic literature says that, the way to offset higher inflation and compensate for what really happens in the market over a longer period is to invest in stocks with higher dividend growth rates. They tend to do very well in those environments.
We are in the tenth year of a bull market. While this year should be positive, risks are higher than last year, and clearly higher than two and three years ago. If late 2018 or 2019 become problematic, dividend strategies can provide some downside support and capital preservation. There is a lot to play out before that, but they can give peace of mind and provide elements of risk reduction.
What do rising interest rates and potential liquidity challenges mean to U.S. markets?
Clearly interest rates are going up. The biggest issue for interest rates or for any market in terms of a bull market or a bear market is liquidity. Liquidity is more than just interest rates: it’s what spreads are doing, what the dollar is doing, what energy is doing, what are flows doing in and out of the U.S.
A lot of things affect liquidity. When you get a severe curtailment of liquidity, at the end of the day you basically force the economy into a recession. When liquidity is ample, if things continue to go as they are and are self-sustaining, they don’t just kind of fall off a cliff for no reason.
We are in an environment that is a little tighter than it was a year ago, but not dangerously tighter. Spreads have more recently started to expand out a little, but very little from all-time tight spreads. All the things I look at, and certainly the initial stages of interest rate increases, do not really impact liquidity. The Fed is also buying back some of the liquidating securities they have on their balance sheet; that has a small effect on liquidity, measured in tens of basis points in terms of overall impact.
Therefore, I see the liquidity picture as being a little less favorable than it was a year ago. It is still favorable for the overall market, but probably the thing I am watching most.
What impact is increasing volatility having?
Earnings expectations get pretty quickly assimilated into the market. Checking the earnings every quarter, that’s why you see the extreme movement in stocks, sometimes up or down. People talk about how the earnings are going to be up or down and that’s pretty well digested.
Volatility is going to be much more present over the course of this year. Earnings per share are discounted, interest rates are going out, liquidity is tightening. That means we are more sensitive to any type of surprise or external stimulus. That could be market-related, and external: Syria, Mueller, North Korea, pick a factor de jour. There are probably more this year as we start the second quarter than there have been in a while. Volatility is going to be ramped up.
In a very perverse way, we love volatility. It gives us the ability – hopefully – to do smart things. Stocks get sold down for no good reason, because when money comes in and out of the market these days, the first five percent is liquidity-driven. High quality, low quality, large versus small, it does not matter: it is liquidity, money coming in and out.
That’s a secular change. The proliferation of ETFs which can make up of that first five percent, up to 40 or 50 percent of average daily volumes. Liquidity coming out of the market creates opportunities in certain stocks.
How have increases in dividends and share buybacks influenced your thinking?
I don’t think there is any doubt that the market backdrop is positive. The biggest question on earnings as we go through the year is how much of that money is going to wind up “extra money.” It’s really extra cash flows, and it is going to wind up reinvested in Capex spending.
How much is going to come back in terms of dividends and buybacks? Now they are both good. Dividends and buybacks tend to be more one-off, in the sense that you get that benefit, and the cash is used where the reinvestment in the market should help to stimulate future growth.
One thing this market continually underestimated has been the power of share repurchase and corporate America buying back shares over the course of the last year. That creates a big support under the market and will continue to do so over the course of this year.
How do you gauge investor sentiment at this juncture?
Sentiment is an indicator that’s most helpful at extremes, and we are not at an extreme.
An extreme was 2008, on the downside by end of 2008 and into 2009. We may have gotten a short-term extreme in January with that huge rally. We had a 12 or 13 percent rally over the course of 12 weeks from December into January and a shorter-term extreme. From looking at sentiment that has backed off a bit, so I do not think we are in an extreme.
There is overwhelming positive sentiment towards equities. What is unusual about this bull market is that retail investor sentiment has not been as ebullient as in the past. We don’t really see it talking to some advisers. But if you look at cash flows, average cash holdings at cost, net exposure and other factors, more on the institutional side and hedge funds: sentiment is high, not extreme. It probably got extreme in January and sold off and created some opportunities.
Over the course of the next two years we should see a slightly rising GDP number. We have had GDP from the 1 to 3 percent range forever, and we’ve kind of bumped that up towards a more sustainable 2.5 to 3.5 percent range. We are trending at the upper end of that range, which is a positive. So earnings are positive, and we’ll see how that plays out over the course of the year.
Scott Glasser is the Co-CIO at ClearBridge Investments, a subsidiary of Legg Mason. His opinions are not meant to be viewed as investment advice or a solicitation for investment.
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