11-23-19 Best Stock and Investing Advice for 2020 From the Experts | Fortune
A
Roundtable of Investing Experts Share Their Best Advice for 2020
Fortune's panelists see great opportunities
for 2020. But they also see a changing of the guard among the stock market’s
winners.
By
November
21, 2019
Economists may be fretting about a 2020
recession; not so the panelists on our annual roundtable of investors. (Even
the self-described “bear in the room” was fairly upbeat.) But our experts also
characterized 2019—a year in which virtually every asset class registered big
gains—as a weirdo anomaly. Next year, they say, investors will need to be
pickier. Our panel was wary about the future of Big Tech stocks, and bullish
about smaller tech, as well as health care—with or without Medicare for
All.
This year’s panel included Savita
Subramanian, head of U.S. equity and quantitative strategy and head of global
ESG research at Bank of America Merrill Lynch; Josh Brown, CEO of Ritholtz
Wealth Management; Karina Funk, comanager with David Powell of the
top-performing Brown Advisory Large-Cap Sustainable Growth investment strategy;
Rob Sharps, head of investments and group chief investment officer at T. Rowe
Price; and Angela Strange, general partner at Andreessen Horowitz. Here are
edited excerpts from their discussion.
Fortune: We’re going on 11
years of a bull market in the U.S., but many investors have spent the past
couple of years wondering when the other shoe is going to drop. We’ve had
slowing GDP growth, we’ve had declining corporate earnings. Are we staring at
something worse, like a recession?
Josh Brown: I’m going to start by
correcting you. We’re in a secular bull market that began in 2013. That’s the
first time we made a new high since the 2007 crash, and that’s important
because we don’t measure the 1982 to 2000 bull run from the lows of 1974.
There’s also the cyclical bull that’s
making new highs as we speak. In December 2018, we were down 20% in the S&P
500. So this is not quite as long of a bull as you might suspect if you just
look at the starting point and the end point. [Pause] I’ll leave now, if you
want.
No, please stay for the remaining 40
minutes! [Laughter] But you raise a good point: Is anybody here feeling
defensive right now for reasons other than the age of the bull?
Savita Subramanian: Not to be the
bear in the room, but there is this risk that a lot of the earnings we’ve seen
over the last 10 years have been manufactured, by companies either buying back
shares to pump up their EPS growth, or cost cutting. The next leg of this bull
market has to be driven by a real economic recovery.
Karina Funk: I don’t foresee
playing defense in a potential recession scenario. Some of the most compelling
investment opportunities today are the companies that are solving customer
problems, and frankly solving some of our thorniest social problems as well. In
terms of access to better health care, whether it’s access to data in
computation or whether it’s access to clean water, we’re not going to need any
less of those things anytime soon.
Angela Strange: A lot of
companies I’m investing in have got a seven- to 10-year view before they’ll
even hit the public markets. But some of the best companies launch when the
market dips. People start to look to save more money, they look for better
services, and they’re apt to switch from incumbents. And so sometimes it is a better
time to get started as a company.
Rob Sharps: Because we’ve had a
record-long expansion, does it imply that we’re headed into a recession or that
the bull market needs to be over? I would say no. We could have the global
manufacturing sector begin to pick up. And could be in a period of time where
we do resume earnings growth.
There are some sectors where
price-to-earnings ratios have become very, very high, out of line with
historical averages, and that’s another thing that makes some investors
nervous.
Sharps: Yeah, I think
the returns this year have been powered by technology, and you can say the same
thing of really the entirety of this bull market. If you look this year at the
performance of Apple, of Microsoft, that’s unlikely to be sustained. The
valuations are more attractive for some of the big Internet companies. But
there are risks around those right now from a policy and a potential regulatory
perspective.
Brown: The elephant in
the room is that every single asset class is up double digits this year. If we
had had this meeting a year ago, when we were in that 20% decline, and if you
had been asked, “What’s the outlook for 2019?,” would your answer have been,
Yes, every asset class from gold to Treasuries, high-grade corporate bonds,
high-yield, U.S. large-cap stocks, European stocks, Japanese stocks, emerging
markets—all up? I think we’ll get dispersion of asset classes next year. It
would be very unlikely to have two back-to-back years where literally every
asset class works.
Subramanian: We’re starting to see
some of these beaten-down, deep-value names outperform or come back to life.
And what worries me about the S&P 500 in particular is that if we do
see this value rotation, the companies that are going to outperform the market aren’t
big enough to offset some of the companies that are going to underperform the
market.
Aspen Technology (AZPN)
Autodesk (ADSK)
Danaher (DHR)
Disney (DIS)
General Electric (GE)
Intuit (INTU)
MercadoLibre (MELI)
So it’s more of a stock picker’s market
than an indexer’s market?
Funk: We’ve had a rising tide with
many, many boats. I’m less concerned about valuation expansion when it’s
coincident with business models actually getting stronger. And there’s a lot
more to tech than the FAANGs. There’s the whole area of digital transformation
and the move to the cloud. There are also industries that have underinvested in
tech for decades.
Construction. Manufacturing.
Infrastructure. So a company like Autodesk, with its building information
management system, can help both in the design phase and the management phase,
when the total cost of construction reveals itself. Or Aspen Technology: It
helps really old industries—process industries, refineries, chemicals, some
manufacturing—to optimize their unit operations.
Strange: I actually think the
concept of a tech sector is somewhat outdated. Airbnb, is it a tech company?
No, it’s a hospitality company.
Brown: Sure, and Amazon is a
grocery store.
Strange: And other sectors are
upgrading their tech. If we look at insurance, one in 10 companies in the Fortune 500 is an insurance company. Every single
one of these was started before World War II. And they’re asking you 40
questions on a piece of paper to insure your house. That doesn’t make any
sense.
Brown: Do you think
the incumbents will digitize, or do you think they’ll be disrupted?
Strange: Both ways, both ways.
Look at finance. Robinhood, they offer free stock trading, right? They’re up to
7 million users, which is a small piece of the pie. But then just recently
Charles Schwab and TD Ameritrade cut their commissions down to zero.
Brown: Do investors
prosper, though? There was a massive market loss for publicly traded brokers.
Robinhood does not trade publicly. I doubt very highly the stock would have
been up on the news that Charles Schwab was
not only cutting commissions to zero but also getting into fractional share
ownership, which is something that Robinhood has done really, really
well.
Strange: There’s a
tension between short-term and long-term. It’s this innovator’s dilemma.
The goodwill that low commissions would
build with a customer feels like a long-term investment. This is going to hurt
my bottom line this year, but five years from now…
Sharps: The market’s letting
companies get away with that to some extent. Look at what happened with Disney when they went
public with their streaming service investment. The earnings estimates over the
course of the next several years went down, but the stock broke upwards. The
market said, okay, they’re taking a much longer time horizon, and they’re
trying to capitalize on it now.
Brown: We saw the same thing
with Walmart. They announced the
acquisition of Jet. It was such a ludicrous multiple. When that news came out,
everyone said Walmart was crazy. The stock exploded higher and has not looked
back. I don’t think they’re making any money on that. It’s not the point. The
point is they are demonstrating to the Street and their investors that they
want to be in the game this century.
Funk: Another company that had a race
to zero is Intuit. Zero dollars for filing your taxes. You think that’s a race
to the bottom. But it enabled QuickBooks Live, the ability to connect in real
time with a live person to finish your taxes.
Brown: Savita tracks
investment strategy based on R&D …
Subramanian: We do. And what
we found is the strongest driver of longer-term [performance] is R&D. That
suggests that long-term growth is rewarded by investors and companies focused
on not just how to navigate the next recession but how to navigate the next
five to 10 years.
Strange: Some incumbents are
realizing that they should pay up to get there faster. And sometimes the public
markets are rewarding them. Prudential Financial just bought
Assurance, a digital insurance broker that started three years ago, for
$3 billion. Their stock went up.
One sector that has had a rough year is
health care. Investors seem to really be terrified of the words Medicare for
All.
Brown: Health care is
the second cheapest sector in the market. But here’s what’s interesting. In
this quarter, health care is, I think, the only sector that’s growing earnings
year over year. So what a puzzle that is. It’s got to be politics keeping
people out of these stocks.
To me this is the fattest pitch that
exists right now: 74 million boomers in the United States, even more overseas.
They will now spend the next 20 years trying to replace every body part they
have [laughter] and living their
best life literally until the last day, and that’s admirable, and I’ll be there
soon—.
Subramanian: We’ll be there
with you!
Brown: I feel like
they will weather whatever Elizabeth Warren or Bernie Sanders throws at them
rhetorically.
Sharps: There’s a tremendous
amount of value there. It might be difficult for it to be realized next year,
given all the political rhetoric that’s going to come out of the presidential
campaign next year. But if you’re willing to look beyond that, there’s just
tremendous returns to be had.
Subramanian: Again, I’m
going to be the bear in the room, but the other issue with health care is that
we’ve seen leverage ratios reach the highest levels in history. It’s an
M&A-intensive sector. But recently, they’ve been using debt rather than
equity to finance deals.
Brown: Yeah, but isn’t
it rational to use that cheap debt financing?
Funk: And consolidation
makes some businesses stronger. Research labs, clinical labs, industrial labs,
they want to buy from fewer vendors. The ones that are consolidating, like
a Thermo
Fisher Scientific or
a Danaher, are grabbing more
share of wallet.
Subramanian: It’s good to lock in
the low cost of capital, but if your debt is floating, and you’re going to pay
that increase in the cost of debt over the next couple of years, that’s
where you worry a little.
I have to bring up the elephant in the
room. As investors, does the unfolding of the impeachment story affect your
outlook?
Sharps: No. I think
it’s political theater. Unless there’s something that we’re not aware of that
comes out as evidence in the proceedings, I wouldn’t change my perspective.
Brown: The Nixon impeachment
was a buying opportunity. Its denouement—did I pronounce that right?—denouement
coincided with the bottom of the ’74 bear market. And of course Clinton in
1998, if you sold that, you missed 18 of the best months of all time. So I
would not play that game with my portfolio. Is that the denouement of that
question?
The denouement was an anticlimax, and
now I’m moving on. Our conversation has been very domestically focused. But are
people seeing opportunities outside the States?
Brown: Well, it’s been
a 50% outperformance for U.S. stocks versus international stocks in this cycle.
So for the people who said you don’t need international, they look really
smart. When are people going to get excited about European stocks trading at 12
times earnings? I don’t know when that will be because you would have thought
it would happen at 14 times earnings. And it hasn’t.
Sharps: The problem with
looking at international broadly is that there are such deep structural
problems in places like Europe and Japan. There are some good things going on
in the Japanese market in terms of better corporate governance, better capital
management, et cetera. But the underperforming sectors, financials and energy,
are very dominant in European indexes. So I do think emerging markets is a good
place to look.
Strange: Structural challenges
in emerging markets actually present opportunities. Look at Latin America.
Credit card penetration, it’s like 14% or 15%. But smartphone penetration is up
to 80%.
So structurally, yes, we could wait for
bank branches and credit cards to be established everywhere. But if everybody
has got their smartphones, that’s how financial services are going to be
provided. So clever companies are starting with small-dollar lending. They’re
judging creditworthiness using data like, How up-to-date is your Android
operating system? Do you charge your phone at night?
Brown: If you bought a
Brazilian ETF 10 years ago, you have no return to show for it. But if you
bought MercadoLibre, which is the payment processor slash e-commerce play of
Brazil, you’re up, like, 1,000% and change.
Funk: It turns out it’s a
really good business proposition to get 1.5, 1.8 billion under-banked
people as customers.
As an ESG investor, I think in terms of
companies playing offense rather than defense in markets like these. Some
typical environmental, social, and governance analysis is defensive: Do you
have a handle on labor relations? Do you have environmental liabilities? Are
your physical operations insulated against the effects of climate change, and
are you doing the same thing within your supply chain?
But you know what? Risk management
isn’t enough to catapult a company into long-term sustainable growth. So the
best companies are playing offense. They’re taking market share because they’re
helping their customers become more efficient and more productive. They’re
helping their customers save money. Saving money never goes out of style no
matter where we are, in a peak or a trough.
Subramanian: We’ve been
doing a lot of work on ESG. If you look at the balance sheet of the average
S&P company, over 70% of assets are intangible. These are assets that you
can’t analyze using traditional measures, and they are more tied to reputation,
intellectual property, and metrics that aren’t necessarily what we learned
about in business school.
So for example, think about a tech
company: How happy its talent is is critical to the success of that
corporation, because the biggest risk is brain drain and losing your smart
people to a competitor. We found that the companies with the best employee
satisfaction scores tend to have higher returns on equity than their peers with
disgruntled staff.
Brown: I would be careful with that because
a lot of the happiness is based on what the stock price is doing, and that
could turn on a dime and almost be a coincident indicator. I’m sure there was a
lot of Champagne being popped all summer long with WeWork.
Subramanian: But one of the
things we found is that employee satisfaction is actually a leading indicator
of market performance.
Strange: And this
workforce is very mission-driven. The answer to the question “Do I work for a
company whose mission I really believe in?” is a very good sign of retention.
A final question for everyone: Where do
you see the greatest risks and greatest opportunities in 2020?
Brown: I genuinely
believe that most of the market is expecting some extreme move out of interest
rates. They either think this whole thing is a fake-out and there’s going to be
a bout of inflation, or that rates are headed to zero. But what if there’s just
more of this as far as the eye can see? There have been 100-year spans where
there wasn’t much volatility in interest rates. So it’s entirely possible that
people with extreme opinions will lose and people that are doing asset
allocation will win.
The biggest risk is you. You are your
own biggest risk. Last year, we had a 16% drawdown in winter. We followed it up
with a 20% rebound. How did you act? What did you do? Did you call your broker,
“Get me out”? If you did, then recognize that you are the one doing the things
that will have the bigger effect on your portfolio. It’s not the Fed, it’s not
Trump, it’s you. The minute you get that through your head, you start becoming
a better investor.
Funk: There are a lot of risks, whether
it’s interest rates, geopolitical, trade wars, and there’s a whole lot out
there that we can’t predict and we can’t control. Frankly, I worry about what I
can control, which is going out there, doing the research, and finding great
companies.
Health care has been a poor performer
in the past 12 months. But some companies there are very, very strong. So
tools, diagnostics companies that are helping with drug discovery, and the move
to this trend from small molecule chemistry-based drugs to large molecule.
There’s a lot more legs in digital transformation whether it’s transforming
business-as-usual processes, moving that to the cloud, and just modernization.
And then finally I’ll mention this trend of resource constraints. That’s not
going away.
Sharps: There was a
sentiment poll cited recently that had the fewest number of bulls in the
history of the poll. But the opportunity for me is to lean away from safety and
lean into cyclicality and unexpected earnings growth.
I like industrials in the U.S., names
like Union
Pacific or UPS where you can
get double-digit returns. If you want to take on a little more risk, you could
buy United
Airlines or
even GE. GE is messy right
now. But they’re stabilizing the balance sheet, and you have a new CEO, with a
proven track record, who can build on some strong underlying franchises.
In terms of risks I do think that there
is an outcome from the election where political leadership implements some
antibusiness policy that raises cost, that increases the regulatory burden, and
ultimately will lead to a negative productivity shock. It could be particularly
acute in sectors like financial services or energy.
Angela, what’s the greatest—
Strange: Not risk! [Laughter] I’m too positive.
Venture capital! I think the biggest opportunity is to create companies that
will serve the 50% of the U.S. and the more than 2 billion people
worldwide that are under-banked or unbanked. I often state that the Amazon Web
Services era is coming to financial services. What that means is, there are
several different infrastructure companies that will partner with banks and
package up the licensing process and some regulatory work, and all the different
payment-type networks that you need. So if you want to start a financial
company, instead of spending two years and millions of dollars in forming tons
of partnerships, you can get all of that as a service and get going.
So what does that do? It will unleash
all of these experiments, some of which will become large companies of the
future.
Subramanian: Well, I’ll
start with the risks. It feels like the market is getting more fragile, and
what worries me about the S&P 500 and U.S. large-cap stocks, which are
normally the most liquid stocks in the world, is that a larger percentage of
these companies are owned by passive investors or by quant funds. So I worry
that if there is some sort of mass exodus out of equities, the liquidity
profile of the S&P 500 could look very different from what it has
looked like in prior bear markets.
For an opportunity, my favorite sector
is U.S. financials. Financials to me looks like the new high-quality dividend
yield sector. Little known fact: The share buybacks plus dividend yield of
financials is the highest of all 11 sectors. These companies are putting cash
back in the hands of investors. And leverage ratios are a shadow of what they
were in 2007. The sector has transformed into a better hedge against a downturn
than it was 10 years ago.
Thank you, Savita. And thanks to the
whole panel.
Prudential Financial (PRU)
Thermo Fisher Scientific (TMO)
Union Pacific (UNP)
United Airlines (UAL)
United Parcel Service (UPS)
Walmart (WMT)
Three
Things to Feel Excited About, and Three to Worry About, for 2020
Get
excited about:
1. Health care: An aging global
population means more demand for medical devices and tests, and opportunities
for companies such as Thermo Fisher and Danaher.
2. Financials: Their balance
sheets are in far better shape than before the last recession, and their stocks
are cheap.
3. Doing more with less: Autodesk and Aspen
Technology are
among the tech companies helping industrial companies conserve resources.
Worry
about:
1. Corporate debt: A spate of mergers
and stock buybacks have saddled many companies with high debt—and their costs
could rise if interest rates climb.
2. A regulation revival: Democratic
candidates are promising tighter rules on finance and energy, which could mean
a rough election year for those sectors.
3. Indexes gone wild: The dominance of
index funds could exacerbate market dips by causing liquidity problems for
smaller companies.
A version of this article appears in
the November 2019 issue of Fortune as part of the 2020 Investor's Guide with the headline
"Investor Roundtable."
No comments:
Post a Comment