Which Investment Themes Matter Most for 2019?

 In Market and Investment Insights

Co-Head of Strategic Fixed Income John Pattullo, Director of European Equities John Bennett and Head of Global Equity Income Ben Lofthouse discuss lessons learned from 2018 and what they expect from the coming year in our latest podcast. In this roundtable discussion, they explore where we go from here and what it means from their varying investment perspectives.

Key Topics

  • How late cycle are we?
  • Is it time to sell tech?
  • What are the prospects for Europe?
  • What have we learned from market moves in 2018?

Which Investment Themes Matter Most for 2019?
John Pattullo, John Bennett and Ben Lofthouse

John Pattullo: So today, I’m kindly joined by John Bennett, Director of European Equities, and Ben Lofthouse, who is head of Global Equity Income. Gents, thanks for making the time. What I thought I’d do is I’ll give my rather miserable bond outlook. It’s all macro context, and then feel free to ping that back at me. And then, we’ll talk a little bit about growth and inflation, and then we’ll come onto you, Ben, global equity income, the traps, the opportunities, what’s gone on this year, what’s going to happen next year. And then similar with you, John, and European investing, if that’s okay.

So I suppose from the bond desk, the last two years have been a little bit tricky because as you know, we work with a secular stagnationist, Larry Summers. We generally think the world’s turning quite Japanese. Amazon is drawing many businesses, causing a lot of disruption, quite deflationary. There’s too much debt in the world, not enough growth. We’re all getting older; all of those sorts of things have got to be put into context in the last two years. Because all those secular drivers have been going down and making bond investing, I guess, quite attractive.

But the last two years have challenged us because you’ve had quite a nice cyclical reflationary period, which has been good for growth equity investing and risk in general, really driven by the Chinese reflate in the world in ’15, ’16, which helped the Trump reflation trade. And obviously, you had Trump with his fiscal expansion, which frankly, was exactly the wrong time. I don’t think anyone would disagree with that. And it’s spurred a fiscal expansion at exactly the wrong time and really drove risk assets. And then, of course, the Fed got a bit worried about alleged inflation coming on, the economy’s overheating and then really this year, you’ve had a classic late-cycle development. So you had a lot of early signs this year. You had the melt up of equities in January, obviously, but there was almost a rolling bear market developing because I think U.S. house builders have been pretty bad all year relative. Regional financials have been pretty bad. You had flat yield curves, you had real yields, some pulling up risk and making the environment harder for all of us. Then you had this kind of rolling set of mini allegedly idiosyncratic things going on such as bitcoin and VIX and EM and Turkey and Brazil. And then more recently, what gave us some confirmation, I think, was the oil price coming off remarkably heavily just when equities were meant to kind of spur out to growth and inflation was going, bond yields went up, but to us, it seemed like a false breakout. And as we’ll come on, there seemed to be quite a lot of rotation back to defense of equities away from cyclicals, and you had this contradiction in the bond world between that and what was going on in equities. And as you know, as of the last couple of weeks, bonds have rallied quite hard.

The economic data has been tough in Europe, and Chinese data’s been rough. Simon Ward’s actually called this really well, and you guys both follow Simon Ward on moneymovesmarkets.com, because basically, he’s saying there’s not enough money supply, not enough money supply in the world to purchase global output, and hence, it’s quite hard to get inflation. And there seems to be some of the data we’re seeing, and I think you guys can tell me if I’m wrong, seems to suggest there’s a bit of a slowdown going on and that’s really, and the bond market’s gotten wind of this, so you know, a couple of weeks ago, the bond market was saying, “Well, there will be three or four more rate rises next calendar year.” And now they’re saying there’s probably one. So I don’t know, Ben, is that kind of a fair representation or I’m just miserable?

Ben Lofthouse: I think it’s a fair representation maybe of what we’ve been through. Yeah, I think the reality is like those big questions that you talk about, I just don’t think we’re going to settle them. Like we could have been talking about Italian and French debt and deficits 15 years ago. You know, until, you know, only at times when the bond market really stops financing sovereigns, you know, do we necessarily know whether it matters. And I think actually, you know, for me at the start of the year, it was more worrying to see so many people so bullish within equity markets in certain areas like industrials. You know actually from a, you know, value point of view, you tend to make more money when people aren’t as positive, and I think this year we’ve seen a big rotation. I know we’ve seen a lot of confidence ebbing out of parts of the market. Technology, semiconductors, you know, they probably just were never as good as people thought. It doesn’t mean they’re all broken. So actually within there, you will get some opportunities now that are available in good companies that will be really good investments in different parts of the world.

I think that the real threats are disruption, particularly, you know, from an income investor’s point of view, we have been able to feel we are quite safe investing in some very high-margin businesses with high barriers to entry. I think what we’re seeing in various ways, whether it be TV, you know, free tower TV in different countries, whether it be some parts of the auto manufacturing area, and numerous different things. We’re seeing, you know, people are attracted those high margins, and they don’t have the same profit motive, and they didn’t used to be able to get in there. You didn’t used to be able to, you know, get social media to be able to sell new soft drinks and things and to get something like Fever-Tree off the ground and to move that quickly and to take share was harder. I think, you know, that’s an area.

The other area for me, specifically, is income investors, is this movement towards populism. A lot of the traditional high-income-paying areas are regulated, and in the UK is a classic example where it used to be considered a good regulator environment for the investor to be able to invest in that safely, you know, in a 10-year view. And actually, with the movement of politics, both parties now have moved to be, you know, more aggressive on the regulation and the ability to make money on investments. We’ve seen the same thing in parts of Europe and the same thing in it for utilities in somewhere like Brazil. Telecommunications is similar; you have to be very careful which telecom operator you invest in based on the regulator environment. So I think those things, at a stock-specific level from an income point of view, mean that you just have to be more careful. And it doesn’t mean there aren’t great opportunities. And maybe just the final thing I’ll say is that if you are right, and this is the top of the rate cycle, what are investors meant to do for the next decade? And I would say from, you know, if you’ve got bonds, sovereign bonds yielding across Europe, across Japan, across the UK, sub-2%, in some cases sub-1%, I still think people will come back to equities as a source of income, you know, on a repeated basis. It may not be this month, it may not be next month, but the other rates have not moved up far enough for you to have the option to park yourself in cash. The U.S. can. I think we’re seeing some liquidity moving out there, but the rest of the world has got no chance.

Pattullo: Okay, Ben, that’s interesting. But I suppose there’s been a bit shakeout recently. I mean, what’s going on in sectors and then, you know, often the cheap stuff seems cheap for a reason, and the expensive stuff has gotten expensive for a reason. How did you kind of look at value using the dividend yield as a proxy for risk? Can you expand on that sort of stuff?

Lofthouse: I think value, you know, there are a lot of measures of, you know, traditional value. And some of them can be, you know, illusory. You know, for business underlying, it doesn’t have the ability to sustain its dividend and balance sheet is, you know, too stressed for that. Then you’re not going to be paid to wait. You know, one of the things as an investor, as an income investor, you’re doing is partly being paid to wait.

But I think what I would say, you know, something like, you know, tobacco as an example, you know in the years ’98, 2000, you know, that was going through some incredible pressures there, how they diversified into some pretty weird and wacky areas like financial services to try to not be there. They were getting sued in that period of maximum pain when they underperformed in the market most, you know, they for the next 10 years were a great investment. I’m not saying tobacco’s necessarily that investment, but what I’m saying is that quite often in those periods of maximum pain, the beauty of our equities, if you don’t mind me saying, versus bonds, is they do get to change. You do get to bring in management teams, you get to sell them off, and so things can sometimes happen to them. They don’t have to stay the same as forever. And sometimes, it’s in those periods of change that the most happens, so I think they ought to sector the moment, I don’t know a lot there, but it’s going through a massive period change. It’s hard for investors to analyze. Within there, there’s probably some great buying opportunities that weren’t there two years ago when you just didn’t know this was going to happen.

Pattullo: And you showed me the other day some really quality stocks, which actually almost hit new highs, like Eli Lilly and Pfizer and all those sorts of stuff.

Lofthouse: Yeah.

Pattullo: Is there enough yield in that stock or no? Are they growing enough or…?

Lofthouse: I think some of those are starting to… I think some of those are starting to price in. You know, what you’re seeing, I think maybe what we’ve learned in this last couple of years is the movement towards passive and to also ETFs, and factor investing means that you can get sectors very quickly overpricing and losing too much value very quickly because people are indiscriminately selling and buying sectors, not necessarily the stocks. I think over time, the fundamentals of stocks come out, and if there’s a problem there, it will still a problem, you just might go through a period where you get a chance to sell at a better price. So I think one thing I’ve found this year and the last two years is we’ve seen a lot of big movements in sectors without necessarily the whole market moving. I feel it throws up opportunities, but maybe other times, you’ve just got to be realistic. If it’s taking a stock that you own too far, you just have to be realistic about that.

Pattullo: Okay. And what about the dividend traps? I mean, it’s always quite, all those dividends quite sexy. Now you know it’s something.

Lofthouse: Yeah.

Pattullo: I mean, but I think part of the strategy is do you look globally and the global comparisons? You don’t have, you’re not forced to buy globally, are you?

Lofthouse: No.

Pattullo: You can buy other…

Lofthouse: I think that’s right. I think, as I say, that what you’re finding is there is a lot of change going on. And I would say, you know, if I look at my funds, we’re not the highest-yielding funds partly because I feel the highest-yielding areas, some of them have got serious threats to them. Now, I think, you know, if you look to buying some of the oil stocks two years ago when people were massively bearish, they’ve been a great investment for you, and they’ve kept their dividends. So not all of these stocks with high yields are going to be value traps, but I think you have to be quite selective.

Pattullo: Just on the side, I mean, one thing we’ve seen in the bond world when in the days of QE, I mean, money was just free and easy, and things got financed, which frankly, shouldn’t have gotten financed because the return of capital, people just threw money at shale gas and other industries, and it’s the old adage, “When the tide goes out, you see, you know, who’s not wearing their swimming trunks and so on.” And certainly, a lot of our clients seem to have gone into slight off piste activities like peer-to-peer lending infrastructure, PFI, aviation finance, small business lending, I could go on. So it’s the old story, you’ve got that dollars spend, you’ve got to get that return. And the best return as ever is in a coupon or in your world, the dividend, I suppose you would tell me. And yet, the dividend growth on your dividend index, I think most of the growth is actually in technology, is that right, and not in utilities?

Lofthouse: Since we started tracking in 2009, and technology and financials have had the best dividend growth because maybe financials, they’re coming off a low base, so, and both of them were coming off a low base, and, you know, and that sometimes, you know, not just looking at the history and is important, you know, to look forward and to look at things improving. Sometimes, they can be a best returns risk, some of those utilities have seen a lot more competition. I would say the biggest thing, probably again, just is quite simple, you know, increased competition in an area or decreased competition in an area. It’s still working. You know, amongst all this stuff that we talk about in technology, you know, you still find imbalances within old-fashioned industries where, because no one’s made money for a decade, nobody stops investing. And then because of that, no one’s allowed to invest. That’s quite often a great industry to invest in. What I would say is, you know, I think we have tried in our portfolio to reduce the leveraged companies because I do feel… and maybe technology will be the place where we find, not in the listed ones, not in the big listed ones, but there’s a lot of people financing things that are a bit more like 2000. You know, that could be that that’s just not in the world that we operate in. That could be where the bubble is happening. These companies staying unlisted for a lot longer. You know, but the problem with it is they’re competing with my companies. So until it goes, that’s partly the problem.

Pattullo: Yeah, because certainly on our side, we’re very wary of the disrupted space because, you know, bonds that can just be horrendous, and Amazon moves into a sector and, you know, the equity crashes and the bonds just go. And it’s extraordinary, so you’ve got to be up with events, but there is a space for the cash cow. Cash cow as long as you can grow sales a little bit is what you’re saying, rather than structural decline. Is that…

Lofthouse: I think things just change. I think, like, you know, you can find actually your aim of sometimes income investing is not just to find the cash cow, it’s to find the cash cow that’s cheap, that people currently hate that they could like. And maybe that’s just that it’s got one business in there that people underappreciate. Maybe it’s got some of the parts case that there’s, you know, a good business and a bad business. So I think for me, some of the things that people were doing a few years ago, just buying income for the sake of the income, actually equities aren’t the best thing for that. If you want to do that, go and buy a Treasury or something. You know, I think what the income for me allows you to do is getting paid to wait for that value realization at some point in the future and to compound. You know, so that area of compounding, we were talking the other day, you know, five years at 5%, you know, into a stock, and then you get 20% move at the end, it can be a big, powerful compounding.

Pattullo: And I find the world earnings are strong, but multiples have contracted roughly offsetting.

Lofthouse: Yes.

Pattullo: Is that fair?

Lofthouse: Yeah.

Pattullo: Because I, as a bond guy, equity guys don’t always speak enough about multiples as well as earnings growth.

Lofthouse: Yeah.

Pattullo: You know, you rarely see it in the popular press, how earnings went up or equities must go up and but of course, if you multiple… and multiples tend to go with the cycle, is that fair, or the shape of the yield curve?

Lofthouse: They tend to be slightly sentiment-led and also, you know, they’re taking a view of where they think profitability is. So quite often, the high PE can be interesting if you’re at trough earnings, but when you move to a point where the market starts to think the earnings have peaked, some of the sectors, they’ll move them to a low multiple and wait and see. They may be wrong, but they’ll wait and see. So more of a kind of voting machine than a weighing machine.

Pattullo: As always, the purchased multiple, the purchased dividend yield really determines the future performance, where the value you buy on. That’s pretty important, isn’t it?

Lofthouse: For those types of stocks, I think, you know, I think I’m very clear there. There are lots of different ways to invest, and for some people, you know, investing in things that don’t yield, they’ll be perfectly good. You know, I’m not, I don’t think income investing is the only way by any means.

Pattullo: No, not at all.

Lofthouse: But I just think, you know, it’s something within a portfolio at the moment that can offer some of the attractive returns, and it suits certain types of companies much better than others.

Pattullo: Of course, but it’s nothing quite like dividend stream, just to see.

Lofthouse: You get a bit…

Pattullo: It brings us on to banks. Of course, you’re on your way to banks? I think John is as well. We’ll go onto it in a second.

Lofthouse: Yes, they’re tricky. You know… you’d say on a kind of valuation basis versus history, you know, there’s often what you look for as an investor is asymmetry. You don’t, you can’t necessarily pick the market when you’re looking for, if things don’t go how you think, you don’t lose that much. And if things go different to how everyone thinks, so if you’re wrong, and there is inflation, you know, it’s a sector that will, you know, is not pricing that in, you could make a lot of money in it, and you can make your dividends while you wait. So, you know, I think they’re tricky because there’s a lot of them. There are a lot of them.

Pattullo: Too many.

Lofthouse: Arguably too many, and maybe they’re prime for disruption. So yeah, they’re a tricky sector. They’re very cheap, but if we’re coming into, if we are coming into a slowdown, then that won’t help you necessarily.

Pattullo: Okay, thanks, Ben. John, you’ve always got a view on rates for bank stocks, if I’m not mistaken.

John Bennett: Yes, I’m always, I guess, after sort of 31 years, if you haven’t learned that bank stocks are, you rent them, you don’t own then. And we have had periods where we’ve rented them and actually, the last time we owned them or rented them was for about 18 months.

And then in January of this year, we took the opposite side of the consensus macro view, which is synchronize, was synchronize, and as you said earlier, John, you know, classic late-cycle things seemed to be ignored for a while, but of course, they’re not being ignored, and we’ve been reminded. I think we’re getting recession in many parts of the world spreading from Asia. And so I took the opposite side of the prevailing macro view with that in mind. Reading Simon Ward’s work, I thought, “No, we’re going through a slowdown here,” and I thought, and I’m not a huge macro guy, but when you’re going to buy, own or rent bank stocks, you need a macro view because what’s their life blood, their… and so you have to have a macro view on banks. I think they’re, in most cases, really very per businesses. I mean, they’re very low margin.

Pattullo: Yeah, they’re very low margins, and they’re massively levered.

Bennett: We’re over-banked, over-branched in just about everywhere in Europe, they’re now prone to disruption. From businesses that, so long as, and I think you made a really interesting point earlier, and I think we should sort of maybe touch on it, which was I’ll dwell on it, which was how many things are being financed out there off public market.

Pattullo: Yeah.

Bennett: Because I think that’s a tide that’s going to go out.

Pattullo: There’s been a lot of warnings on that. You’re going to see some beached whales.

Lofthouse: Definitely, definitely.

Bennett: So fintech, you know, meanwhile coming to a bank that you own is fintech. So how long can the fintech staff tap the unicorn or whatever, keep that money, that private equity money? That’s a big question. But so long as that fintech and that group of fintech keeps that money, it’s going to disrupt your bank stocks and, in my experience, most bank companies, most bank managements, are legacy management, legacy-type people running a legacy-type assets, legacy-type IT, too many IT platforms.

Pattullo: Yeah.

Bennett: They’re just ripe for disruption. Nevertheless, we did rent them, but I thought the U.S. Treasury’s going to struggle to get above 3% and hold it unless we get true inflation, and I don’t think there’s a true inflation.

Pattullo: No, I think if it was going to come, it would have come this year. This was the year of inflation and reflation and growth, and you haven’t seen any. What about capex? Have you guys seen, so it’s a big capex plans because…

Lofthouse: Yeah, I mean, there is some, you know, some companies, people prefer to focus on where there isn’t capex. But actually, when you look at something like, you know, one of the reasons that German auto is, you know, people don’t want to invest in it is their capex is going through the roof, isn’t it? It’s forced, but what I mean is there’s…

Pattullo: So there are no regulations?

Lofthouse: No, no, no, electric cars.

Pattullo: Changing.

Lofthouse: Changing. But someone on the other side of that is the recipient of it so, like, if you’re holding the stock, like the amounts that are being spent by companies in the technology space, not necessarily just technology companies, it’s Siemens, it’s LG Chemicals, it’s around the world, the capex that’s going on is in sectors that we don’t really talk about is enormous. But the bits that we don’t want to talk about, you know, is it happening in Europe or the UK or in, you know, in certain parts of industries? Probably not. But if you are on the receiving end of it, and you’re in Silicon Valley right now, you feel absolutely brilliant.

Bennett: You feel good. I worry about the ROCE on that because…

Pattullo: I’ve got no idea.

Bennett: Because if it’s forced, you know… every business model is being disrupted.

Pattullo: But capital was cheap, too. They could suck up off the bond market and buy each hour and consolidate and all that sort of stuff, couldn’t they?

Bennett: Are you going to, if you have to redesign the power train, are you really going to make the return commensurate with the investment, and that’s a question to be answered. One of the things, you know, we try to, but I’m not good at it. This is a “Were we beneficiary of a new tech?” I’m just not good at that kind of thing. But you can get some old tech that’s going to do just fine, so manufacturers of air bags, seat belts, tires, I don’t think the tire’s about to get disrupted. So you can actually play certain themes in an old-fashioned way…

Lofthouse: I think that’s why I’d say, like, as you know, I heard you talk a lot about Amazon. And I know you like Amazon. But, like, you can’t Amazon a lump of enhanced plastic material for a plain, like, do you know what I mean? There’s a lot of industries where there’s just old-fashioned supply and demand, like they’re a new… We need lighter cars, we need new glass for new cars for it to be lighter to get the CO2 down. We’ve got new plastics being developed. We’ve got new battery technologies being developed. There will be people who make the cathodes for it, and that stuff, I think, you know, the high Street might be facing troubles with Amazon, but that stuff’s nothing to do with Amazon. So actually, the disruption there is this trade war with China.

Pattullo: Sure.

Lofthouse: And the actually, the real issue for me looking at some of our portfolios is the biggest battery, electric battery companies in the world are all Asian.

Pattullo: And Australia, is that right?

Lofthouse: The mining might be there, but like, so again, are we developing, like, we had the industrial capacity in Europe, are we going to have it in the future owned by our same companies? It doesn’t, I agree with you, that the ROCE might not be good, but quite often in these industries that we’ve been though, you go through a period where you’ve got too many competitors, and they slim down, and it’s survival of the fittest. What we’ve seen is, like, Asia now is the main place for the cutting-edge semiconductors. The U.S. has become the place for cutting-edge software. I think that probably the question on a longer-term view is, like, where is the capex going? And is it being incentivized to come into some of these countries that we need it to come into in Europe and become the next industry leaders? I just don’t know if that’s, I don’t know how we get there in the current environment. But that’s, it’s a much longer-term thought.

Bennett: And we don’t know how much, we just don’t know how much capital’s being, it’s hard to measure just how much capital is being sunk into that.

Pattullo: Well, from my side, it seems like quite a lot. And quite lazy, complacent, thrown easy money.

Bennett: Yeah, and commitment on the lazy, complacent bit, John, I know there’s another sort of… one of the things I find, you know, really quite confusing, perplexing as an active manager, active management being under enormous pressure. But as an active manager in liquid securities running a liquid fund that our clients can buy or sell any day of the week, and we know the basis points fees that we’re charging, and they’re not 100 and, you know, they’re going down across the industry. And yet, the backers of many of these ventures called private equity, I still see 2 and 20, and I see 2 and 20 being paid by clients for funds that are locked up for let’s start the bidding at seven years.

Pattullo: It is a bit bizarre, isn’t it?

Bennett: So no liquidity, and they’re paying a huge price to take the liquidity away and very probably over-invest in what are going to be found to be some really dumb projects. I’m kind of looking forward to that.

Pattullo: Yeah, fair enough. And then, John, just on your funds and your style, U.S. view of European valuations compared to the American markets? How are you feeling there?

Bennett: It’s always…

Pattullo: Europe gets a bit of the bad press, doesn’t it?

Bennett: Yeah, much of it deserved, but some of it not deserved. You know, I think every client must be sort of “Oh, don’t give me another European fund manager coming around saying, “But look at the discount Europe’s fund to America,” because it just, that hasn’t worked. That hasn’t done you any favors to date. But I personally think the elastic has gotten stretched way too far. Now I know price-to-book is discredited because, well, the last time it was discredited was the last peak. So that’s all right.

But it’s not only discredited because Ben’s talked about it hollowing out of the physical book, the physical assets, it’s all IP now and it’s all intangibles. But if you did just take a look at the relic called price-to-book, and we all know below two standard deviations, below the median in European equities versus U.S. equities, that doesn’t make Europe a buy. But what it to me confirms is that the world knows that 30% of the S&P got into, became tech. An interesting number because that’s actually where other sectors have peaked historically before it collapsed.

And I personally believe U.S. tech stocks are going to collapse. We haven’t, the bear has only just shown up there. So I think, yes, you’ve got a big valuation discount. That hasn’t worked in the past. I actually think we’re on the verge of something that the asset allocation world is just not prepared for: Europe outperforming the U.S., probably not by going up, but going down a lot less.

Pattullo: Yeah, okay. And against your peer group, I think you were saying the small-cap growth guys had a pretty good run, but what was happened there this year and how is it looking, how your portfolio is constructed relative to, you know, the peer group, which is what we’re kind of measured against?

Bennett: Yeah, you know, it’s been so interesting because everybody, you know, you meet so many people who are all-cap managers, no, they weren’t. They’re small and mid. I interviewed lots of them when we were building the… in the last year.

Pattullo: Because I as a bond guy and some equity guys who were, “That’s my style, and that’s that.”

Bennett: Yeah.

Pattullo: And it doesn’t suit the market, but you try and blend across…

Bennett: I do. I make it, I make sure, and I’ve said this, and you stop saying it to consultants, “I’m very happy to have absolutely no style.” And there’s, “Oh, you must be growth, you must be volume or you’re growth at the right price.” Well, who wants to buy decline and pay their own price? It doesn’t make any sense to me. I believe in cash flow. I believe in paying the right multiple for that cash flow. How quickly can the company pay down its debt and/or market cap? That’s old-fashioned value investing, in my view. It’s not so much some inner ratio. What was fascinating, and I’ve struggled for two years, partly, our own stock picking, in my view, was lousy, and we fixed that. But also, I’m watching these league tables, and you’re sinking in the league tables, and it’s just silly, league table business. But you can hang on. “Why are we sinking that far?” I know we’ve had a bad run, and then the light goes on and you go, “Wow, after a 10-year rampant bull market by small-, mid-cap versus large cap, you can just see small-, mid-cap really kind of go into a crescendo. I think especially, small-, mid-growth. And I went, “Ah, here it comes…”

Pattullo: What’s the names of those ones?

Bennett: Well, they’re sort of the Amadeuses, the Geberit … great businesses, but everybody knew it – it was in the price. Great businesses. Amadeus, we still own a bit of Amadeus, Geberit, Wirecard, I’m less convinced about that as a great business. So, you know, people were bunching… Europe is home to a whole bunch of listed Mittelstand-type business. You know, not just Germany, but Italy as well. You know, maybe family owned, great businesses, but they just got too expensive. And you could see it was dead easy, dead easy for fund managers to say, “I don’t need to bother with pharma.” I was getting that chat. “I don’t need to bother with insurance. I don’t need to bother with big oil. I don’t…” and then one day, you need to bother, because everything, the positioning matters, and that stuff that carried people for so long and then almost went vertical. Certainly went vertical relative to large-cap dull. From September/October 2018, it just went into reverse. Large cap, though, didn’t go up, it just went down a lot less. And you have seen convulsions in league tables. Bring it on.

Pattullo: And your relative numbers are now looking…?

Bennett: Well, it’s nice to be back in the top quartile. It’ll be a wee bit of a fatter goose this Christmas in the Bennett household than it has been the prior two.

Pattullo: Well, that’s encouraging. But Jenna and I are finding we’ve underperformed most of the year, but in the last month and a half, it’s completely come good, and now we’re looking pretty respectable. And, frankly, we’re amazed and almost appalled by the amount of risk some of our leading competitors are holding in credit, and we’re quite long sovereign bonds. Obviously, the turn in the cycle suits us. But you don’t want to be holding too much credit. And we’re not even that bearish on the fundamentals. It’s more the technicals, which you guys don’t see quite so much in equities; you do a bit in small cap. But it’s more like the liquidity goes and then it reinforces itself. And that tightens financial conditions, and then that’s self-reinforcing, and then, you know, the spreads blow out and you think, “Oh, that’s nuts,” because you’re discounting a massive implied probability of default, which means it’s cheap, but it’s all about liquidity and where things trade.

Bennett: Yep, yep.

Pattullo: It’s quite important.

Bennett: And that is germane to our world, because I think there has been in the second half of 2018 forced selling in small-, mid-cap.

Pattullo: Yeah, okay. And that throws up some opportunities, yeah.

Bennett: And by the way…

Pattullo: And that’s exciting for a stock picker, stock pickers like you guys.

Bennett: Yeah, I went…

Pattullo: There’s less macro now.

Bennett: That’s right.

Pattullo: Stock picking, yeah.

Bennett: I think the macro becomes very, very clear. Recession. So 2019, recessions bring bargains.

Pattullo: And that’s exciting, yeah.

Bennett: That is exciting.

Pattullo: But you’ve got to be in the position. You’ve got to be pre-positioned.

Bennett: You’ve got to be ready for it, because, exactly, if you go in and got 4% per position in those things, you’re mentally offside, financially offside. You’re not going to be the guy ready to go, “This is now a buy.” And that could be a bestseller. That could be Trelleborg, that could be all sorts of, UPM-Kymmene in Europe, you know, industrials. At some stage in 2019 in European industrials, there’s going to be a big, fat buy.

Pattullo: And big learning lessons of this year for you? Each of you? What do you think is the big lesson? Because for me, it’s actually patience and belief. And think a bit differently. And Simon Ward, as we said, has been massively helpful because not only does he look at money super, he looks at the industrial cycle regarding capex and inventory, and he’s got them both bottoming next year, not housing bottom next year, which is nice. Because if you get all three bottoming, it’s got a serious downside, he’s got industrial. But sometimes, you can be a bit patient and just accept. You’ve just got to sit there and be patient and let other people throw money around and then just let it come good. Which it sounds like that’s happened.

Bennett: Well, you know, as you know, one thing about this business is that it can be bloody lonely. You know, when you’re not performing and people are crossing the street to avoid you because of one or two bad years. You know, funds, we’ve talked about this, John, funds are being bought and sold at three-year numbers. This is so value destructive. But when you’re going through it, and you come from a similar part of the world, John, we’re prone to bitter misery, and as an equity guy, I’ve been asked, “Why do you do it? You should be in bonds, you’re so miserable.” I don’t mean JP.

And you know, but yet, when you’re going through it, you go, and people are saying things like mean reversion is for the birds. And that’s kind of been going on and I thought, “Maybe they’re right. Maybe it’s dinosaur time, I’m a relic, mean reversion doesn’t work, but it might just has again.” Positioning matters, valuation matters, and that’s what’s going on. We’re having a down year, everybody’s having a down year, but there’s some real pain out there, and so much of this business, as you know, is you’re going to fall into holes. You’re going to fall into holes. Most of them you’re hoping are relatively shallow, but you’ve got a choice. Climb out or dig and, you know, our job is to avoid the really big holes. And this has been a year where some of the potholes have really opened up. And it’s just lovely to have avoided many of them.

Pattullo: Sure, okay. Ben, similar?

Lofthouse: I think for me, it’s that I don’t know if it’s new, and John can give a better perspective on that, but I definitely feel, and I’ve been doing this well over a decade…

Pattullo: You’ve not got much white hair, though.

Lofthouse: I’ve got a lot more this year than I had. I think for me, it’s, like, just don’t underestimate the structural, and perhaps with the structure, it has to be really, really cheap. And what you’re finding is that when things, it’s been quiet momentum, and again, it’s this, I’m still learning it. I don’t know if it’s this factor investing and people trying to do it.

Maybe, John, we would like say lazily, wouldn’t we, “Well, I want to buy biotech. Let’s buy this ETF.” And then, and if your stock isn’t in it, it doesn’t go up, and you think, “I’ve missed. What have I got wrong about this stock?” And then you’ve got something else that goes, that’s going up that shouldn’t be going up. But on the same side, when it goes, when this momentum goes on you, and maybe this links into what John’s saying about some of these mid-cap areas, when it goes, it is absolutely brutal and the falling knife. The value investor almost wears a badge of being proud of catching the falling knife because you know in the long term, you’ll make the money when people are coming out. And what I’ve found is that you’ve got to have a lot of fingers to catch that knife at the moment because for whatever it is in the market, it can go so far, but you mustn’t stop, but you just must wait. So maybe it’s the old patience point.

Bennett: Sizing, sizing, sizing.

Pattullo: Yeah.

Lofthouse: Just sizing.

Pattullo: It’s tricky.

Lofthouse: But this is an extreme.

Bennett: Well, yeah, and I do think and again, this is sort of a more intuitive, because people used to say about hedge funds, “What do hedge funds do? They speed up the movie.” The movie’s being sped up. We’re all getting older, so we maybe feel that way, but the movie’s been sped up. So here it comes, and this quarterly earnings madness. And you know, the stock doesn’t fall 3%, it falls 9%, and factor investing and all that and algos, etc. It’s going on, and it speeds up the movie, but your insurance policy and mine, fundamentals will out. What we have to do, in my view, as an industry, as fund individuals, we have to try to marry our time horizon with the clients’. That’s still a hell of a challenge.

Pattullo: Take your clients with you. Always.

Bennett: Take your clients with you, but, because you get a lot of nodding, don’t you, from clients, you get a lot of nodding in the room, saying, “Oh yeah, yeah, yeah, five year plus, absolutely.” Nod, nod, and two years’ bad numbers, “I’m off.” We’ve got to, that’s not the client’s fault, that’s our fault. We’ve got to talk the client through. We’ve got to take the client with us, and we have to ignore that noise and that sped-up noisier noise of quarterly earnings, factor investing, algos – ETFs and passives are about to be tested.

Pattullo: Yep, definitely.

Bennett: They’re about to be tested.

Pattullo: Very interesting, isn’t it?

Bennett: Broad entrance, let’s see how broad the exit is because there’s going to be forced selling, and that should be the moment for active.

Pattullo: Great. Well, thank you very much for your time, Ben and John. It was fun. Hopefully, we’ll do it again. I’d like to thank you for watching. Hopefully, you found it interesting. Any feedback reviews, much appreciated if you’re a salesperson. With that, I’ll wish you happy holidays. Thank you.

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