Speaker 1: Bloomberg Audio Studios, podcasts, radio news. Join us now?
Speaker 2: Is David Sowerby and Core portfolio manager here with us
Speaker 2: on this Boxing day. I guess not in the US
Speaker 2: but around the world sales you're celebrating, I know, but
Speaker 2: we're supposed to celebrate.
Speaker 1: With the Dale Canada too. It's Canada as well.
Speaker 3: Well, said CommonWell, my neighbor to the south.
Speaker 2: Yes, right, David, great to speak with you, and I
Speaker 2: want to start just by before we look ahead, looking
Speaker 2: back on this last year. What lessons will you carry
Speaker 2: over from the way the market performed this year? And
Speaker 2: if you kind of think of this as chapters, how
Speaker 2: much is the story of the same here going into
Speaker 2: twenty twenty five for you?
Speaker 3: Enough of the same, But one very good same is
Speaker 3: never underestimate the ability of solid US companies to deliver
Speaker 3: superior capital allocation shareholder value creation in the face of
Speaker 3: higher interest rates, questionable fiscal policy, time and time again,
Speaker 3: bet on US companies. That's been the rule of thumb
Speaker 3: for thirty plus years.
Speaker 4: David, you know, am I gonna be lazy in twenty
Speaker 4: twenty five and just hang on to my mag seven?
Speaker 1: Or should I take a little bit of a roll
Speaker 1: up my sleeves a little bit.
Speaker 4: Maybe take a look at some small caps, some mid caps,
Speaker 4: maybe some sectors or factors that haven't really performed over
Speaker 4: the past two years.
Speaker 3: Well, Paul, I don't root against the MAG seven, but
Speaker 3: I think you have to think broader, more participation in
Speaker 3: the markets. We saw this rotation since July eleventh, where
Speaker 3: small caps outperformed quite well, value outperform growth, the MAG
Speaker 3: seven lied or lagged excuse me, And here we go
Speaker 3: into December Mag seven right back on the treadmill. Small
Speaker 3: caps have still modestly beat large caps since July eleventh,
Speaker 3: ten percent for small caps up seven percent.
Speaker 1: For the S and P five hundred.
Speaker 3: It's that two steps forward, one step back, one step
Speaker 3: back in December, but I think we're back to small
Speaker 3: caps having very good turns in twenty twenty five relative
Speaker 3: to some of the megacaps.
Speaker 2: David count me among those who hears that watchword are
Speaker 2: those watchwords small caps and just sort of wonders what
Speaker 2: to do with it. Where are you looking when we
Speaker 2: talk about small caps? Where is there opportunities you see?
Speaker 2: What's your counsel to your clients about what sectors, what
Speaker 2: types of companies? Are are of interest in that world, A.
Speaker 3: Proven process for twenty plus years. Two buckets to look
Speaker 3: into first spinoffs small company spins out of a larger
Speaker 3: company on lock shareholder value.
Speaker 1: Look at the Bloomberg Spinoff.
Speaker 3: Index in twenty twenty four, it's up better than sixty
Speaker 3: sixty percent.
Speaker 1: That's the first bucket.
Speaker 3: The second bucket is under followed companies where there's only
Speaker 3: two or fewer Wall Street analysts following the company compared
Speaker 3: to the previous story on Apple. So an example is
Speaker 3: National Cinemedia ticker symbol NCMI. Only two analysts follow the company.
Speaker 3: They do that advertising when you go to the movies
Speaker 3: hate it and you get there early, and you see
Speaker 3: that active audience for advertising at National Cinemedia over one
Speaker 3: thousand theaters they're in. There's an idea for an underfollowed
Speaker 3: small cap stock.
Speaker 1: And that stock's just ripped.
Speaker 4: It's up a sixty percent year to day with a
Speaker 4: market cap of about just six hundred and twenty five
Speaker 4: million dollars. So that thing has worked here. David, how
Speaker 4: do you think about valuation here? Because I've got a
Speaker 4: fed that I think maybe they're going to cut a
Speaker 4: couple of times in twenty twenty five.
Speaker 1: But I think that's it.
Speaker 4: It feels like earnings have to be a real driver
Speaker 4: of this market going forward. How do you feel about
Speaker 4: earnings visa the evaluation?
Speaker 1: These days?
Speaker 3: All valuation rich, no other way to describe it. If
Speaker 3: you go on a free cash flow basis and value
Speaker 3: the market that way, not as rich, still opportunities for
Speaker 3: the investor, but you nailed it.
Speaker 1: It's a tug of war.
Speaker 3: In twenty twenty five, earnings, pre cash flow dividends will
Speaker 3: all be up ten percent or better. That's pulling on
Speaker 3: the upside. But valuation is stretched. And I looked back
Speaker 3: to nineteen ninety there have been nine years in a
Speaker 3: calendar year where valuation went lower, and in those nine
Speaker 3: years the market only finished positive four on in nine
Speaker 3: years when valuation slipped a bit. So that's the tug
Speaker 3: of war for twenty twenty five rich valuations. I hope
Speaker 3: they don't go lower. With earnings and free cash flow
Speaker 3: up double digits.
Speaker 2: I could detect what my friend Paul Swiney was saying,
Speaker 2: some disdain or eagerness to stop talking about the Fed
Speaker 2: Reserve as much as we have been over the course
Speaker 2: of this last year. What's the role that it's going
Speaker 2: to play in twenty twenty five as you see it.
Speaker 2: I know you were listening closely to that press conference
Speaker 2: just a couple of days ago. How much is it
Speaker 2: going to be continuing to drive things going forward here
Speaker 2: as you look at valuations, as Paul suggests, other facets
Speaker 2: of investing beyond what the oracles down in the Echos
Speaker 2: building are telling the market.
Speaker 3: Well, you're in New York, so let's borrow from a
Speaker 3: famous New York investor, Reggie Jackson. The FED is a
Speaker 3: straw that stirs the So if the market only gets
Speaker 3: two interest straight cuts next year, I don't think the
Speaker 3: Fed should do anymore. Their number one mission should always
Speaker 3: be price stability, and if the market doesn't like it
Speaker 3: in the near term, you have to grind through it.
Speaker 3: But at the same time, if inflation is not brought
Speaker 3: even a bit lower, just look at what the market
Speaker 3: did from nineteen sixty five to nineteen eighty one. It
Speaker 3: was flat on an inflation adjusted basis, it dropped forty
Speaker 3: to fifty percent. So we have to be encouraging that
Speaker 3: the Fed States committed to inflation, and that's going to
Speaker 3: be a story in twenty twenty five. In that Tuga
Speaker 3: war relative to the I think favorable earnings, free cash flow,
Speaker 3: and free cash flow margins that'll still exist.
Speaker 4: David, I've been doing this Wall Street thing since nineteen
Speaker 4: eighty six. One of the really interesting markets to watch
Speaker 4: develop has been private credit. Talk to us about Ares
Speaker 4: Ares Management Corporation.
Speaker 3: Areas is one of the largest private credit publicly traded companies,
Speaker 3: so bank loans in particular, and that has been an
Speaker 3: insatiable appetite for pension funds. I sit on the City
Speaker 3: of Detroit's Investment Committee. My alma mater, Wayne State, I
Speaker 3: chair the State of Michigan Pension Fund for a number
Speaker 3: of years. The demand for private credit continues to grow
Speaker 3: because the expectations are you can get near like public
Speaker 3: equity returns without the same volatility, and that plays into
Speaker 3: a name like Ares, which is one of the largest
Speaker 3: private credit publicly traded companies.
Speaker 2: You know, let's take advantage of the fact that you're
Speaker 2: there in Michigan. I'd love to get your sense of
Speaker 2: sort of not not the politics of the election per se,
Speaker 2: but what issues were front and center, particularly in your
Speaker 2: home state, and what that tells you about what to
Speaker 2: focus on here in the years to come.
Speaker 3: The economy first and foremost, that cumulative inflation was up
Speaker 3: better than two twenty percent since early two thousand and
Speaker 3: twenty twenty one, and I think that's why Michigan, perennial
Speaker 3: swing state, swung back for incoming President Trump relative to
Speaker 3: twenty twenty twenty sixteen.
Speaker 1: We end up voting with our pocketbook.
Speaker 3: The other matters, the other factors matter, But I think
Speaker 3: that was the key reason for Michigan going back to
Speaker 3: Trump the way they did in twenty sixteen.
Speaker 4: David, when you and your team woke up the day
Speaker 4: after election day, did you change your investment outlook for
Speaker 4: twenty twenty five at all?
Speaker 3: Generally no, because I can't predict politics, Paul, But my
Speaker 3: axiom in predicting politics is never never expect.
Speaker 1: Washington to do the right thing. They do the least
Speaker 1: amount to fix a problem.
Speaker 3: That said, after the election, you saw small cap stocks
Speaker 3: the day after pop three to four percent. That was
Speaker 3: validation at animal spirits, we're going to be resurrected. And
Speaker 3: we saw that November NFIB Optimism index take a decided
Speaker 3: spike higher. That can be a factor that bodes well
Speaker 3: for the market next year and in particular animal spirits
Speaker 3: and small cap cyclically sensitive stocks.
Speaker 1: You can't predict politics.
Speaker 2: Let me just ask you about geopolitics in terms of
Speaker 2: what you're watching and how that maybe colors your appetite for, say,
Speaker 2: assets outside the United States, equities overseas, other opportunities are
Speaker 2: Are you staying pretty closely focused on the US or
Speaker 2: do you see opportunity across the Atlantic.
Speaker 1: Outside the US.
Speaker 3: It's interesting, but the bias is still in US domestic portfolios.
Speaker 3: And since the end of nineteen eighty seven, US stocks
Speaker 3: have compounded five five percentage points better compound analyzed return
Speaker 3: superior than the MSCIEFA. That goes back to the superiority
Speaker 3: of US companies delivering shareholder value. The bar is high
Speaker 3: to have meaningful assets oute of the US. You get
Speaker 3: enough diversification here given our indexes.
Speaker 4: So, David, what's your message to your clients? You have
Speaker 4: a thematic message to your clients for twenty twenty five.
Speaker 3: I'm generally not that creative other than keep your head
Speaker 3: down buying good companies that are generating capital and free
Speaker 3: cash flow to the investor. And at the end of
Speaker 3: the day, I'll have the same five risks that every
Speaker 3: wall street analyst has on the street, but ultimately it's
Speaker 3: always going to be the risk you don't know that
Speaker 3: bites you the hardest.
Speaker 2: David, Do you still have clients who are on the
Speaker 2: more conservative side of things, who are part of that
Speaker 2: six trillion dollars cash pile, who are reluctant to get
Speaker 2: back into this market? And if you do, what's the
Speaker 2: council you're giving them to jump in?
Speaker 3: Generally, no, but if there are some you just want
Speaker 3: to take a look at the potential for the S
Speaker 3: and P five hundred, or the average stock and the
Speaker 3: S and P five hundred to compound seven to eight.
Speaker 1: Percent over the next three years. You're not going to get.
Speaker 3: That in treasury bills or treasury notes, and the probability
Speaker 3: is probably better than eighty percent that the US and
Speaker 3: the S and P five hundred, the average stock will
Speaker 3: compound better than cash.
Speaker 1: I like those odds. The next calendar year flip a coin.
Speaker 3: But the next two or three years you feel like
Speaker 3: equities will still meaningfully outperform cash.
Speaker 4: All right, David, thank you so much for you Always
Speaker 4: appreciate getting a few minutes of your time. David Sowerby
Speaker 4: and Core Portfolio Manager from the Great Midwest,