The CPM Roundtable: Adventures in Global Equity

The CPM Roundtable: Adventures in Global Equity

Josh Rubin: This is the CPM round table, where Thornburg client portfolio managers will discuss topics that are top of mind for investors. My name is Josh Rubin and I’m joined by Phil Gronniger and Ben Keating. And as client portfolio managers, we are engaged daily with both the investment team and clients, which gives us a unique insight into what’s top of mind. In our last discussion, we talked about tariffs, stagflation and the Fed. Today we’ll move to markets and talk more deeply about the equity market and all of its many dimensions.

Josh Rubin: Given some of the dislocations in the market moving macro trends, let’s talk about asset class trends, it’s a broad topic, but we can dive in from any direction.

Phil Gronniger: If you think about the equity side of things, equities have done well. And in spite of, the geopolitical risks, in spite of the ballooning deficit as well, spite of the fact that rates haven’t come down, they’ve actually gone up a little bit. What we’ve seen uniquely in the equity market, it’s lagged for many years, but this, US exceptionalism, has faded away and we’ve seen really strong international markets on the equity side.

And many have said that in the past, we’ve seen some call it head fakes on the international equity side or non-U.S. equity use, global international that we’re viewed as head fakes, short term moves that gave back some of those gains. But this seems to potentially have some legs to it. And this non-U.S. We’ve reset the cost of capital in 2022 when interest rates jumped so dramatically.

We had so many years of zero interest rate policy (ZIRP) that favored the growth-oriented companies, which lent itself much more to US-oriented technology and discretionary companies. But after that rate reset, that cost of capital, normalizing the US dollar weakness now, as opposed to US dollar strength and appreciation of more than 30% over the last five plus years, giving a tailwind to those growth companies that were betting on future cash flows.

Now you’re seeing, I like to call it a little the old economy, those dividend payers, those boring but beautiful businesses that are delivering that are also, by the way, on a much cheaper valuation level too. So, when you look at, say like P/Emultiples, U.S. versus many non-U.S. markets, in the international space, you can find people a much better relative value there.

Not to say that U.S. companies are fading away and the opportunities up there is fading away, but you’re seeing really good potential in companies outside the U.S., that in many cases, aren’t even exposed to the potential U.S tariffs too.

Ben Keating: And that is the biggest, you say, what’s the trend? That is the biggest trend. You know, we’re all blessed to travel in all channels. You know wirehouse, independents, banks, big/small. And that’s been the most glaring observation in most recent years’ travel. We all travel quite a bit is most of the even the most disciplined allocators let their international equity allocation slip understandably right. A lot of it’s just cynicism. They feel like it’s a lost third decade of going overseas. Right. So, I agree with Phil. The backdrop that set up the underperformance perhaps, or the lack of interest international I think is going away. And the next ten years, X many years, it’s going to be something different. And you see there’s definitely a fair amount of performance chasing, no doubt. People have noticed at the start of this year, even from last fall, that international has done well. And they kind of remind himself, we want to maybe close the gap. But whenever their neutral allocation was international equity, they may want to close that in the coming quarters. But yeah, that’s definitely the biggest change. I think more people are open to looking at international equities, s a U.S investor.

Josh Rubin: It feels like an aspect of what both of you were talking about is markets broadening in the current environment. And maybe that’s another reason that we are not seeing as much volatility as we might have expected, in the sense that we had a sort of a decade, maybe 15 years, where it was a very narrow global market in general, and there was a period where it was a very Nasdaq market, but including biotech up through big tech.

And then it sort of narrowed a little further into FANG and a little bit of an extension from there. And then, you know, through Covid, it was in a lot of ways, anything that didn’t make money, but you could put a price to sales multiple on it. And all of those companies were really concentrated in the US and often concentrated on the on the West Coast.

But plenty of companies around the world kept chugging along and blocking and tackling and executing their businesses. They just didn’t keep up with sort of this, this Nasdaq and narrowing rally. And then, you know, today we’ve got the MAG seven. But as the cost of capital has normalized, you know with rates rising really around the world, suddenly a lot of types of companies can sort of make perfectly attractive profits as opposed to the last several years where there were a few that kind of had this extra advantage of ZIRP.

And, you know, we’re really making not super profits, but they appeared very differentiated. And so maybe because of that, we’re not explicitly seeing money flow out of the US, but it is broadening. Or, you know, as money flows into international, we know that investors of all types have this huge cash pile. Once, you know, you mentioned the 2022 interest rate rise.

And that’s when really money started shifting into cash because you could earn 4 or 5%. Great. Now you don’t have to sell the hottest dot in equities to buy something else. You’re just pulling money out of cash to do it. Or if you’re a foreign sovereign or foreign investor, maybe you just let your treasuries run off because you can go buy, you know, local companies that have a 5 or 6% dividend yield you don’t need to buy US treasuries with a 3 or four. But this cost of capital renormalization seems to be contributing to a broader market and a broader market is less volatile in and of itself.

Ben Keating: Yeah, I think that’s a keen observation and just, it seems, early days, right, that there’s more and more people that are becoming a defined contribution. More and more people are equity owners that are really across the globe, not just in the US. And early signs, the demographic that talented millennials, Gen Y, Gen Z, whatever the new generation is, they seem to be fairly stoic with their investors in kind of stay disciplined. They didn’t fly out in April having flown out in the last few weeks. You know, again, they don’t be tested. But it’s a good sign that more people are taking a concerted effort on investing in their own personal portfolios. I think that speaks over to some of the stoicism you see in investing.

Josh Rubin: Phil, maybe or go ahead.

Phil Gronniger: Yeah, I was going to add that, yeah, as we had we’re getting better at market breadth. That’s a really positive for not just markets but the economy overall as opposed to the narrow leadership that we saw whether it was, Nasdaq-led, FANG Mag seven, having good market breadth is a very positive sign overall. And wanted to touch on something you mentioned too, Josh, you mentioned finding a good dividend yield in companies as well. You know, growth and buying a stock thinking or hoping for as an investor into double or triple over time, those, those growth oriented companies, whether it was a, biotech or straight tech company, going back to those boring are beautiful businesses, that cash flow, consistency over time and returning it to shareholders historically has been really critical to driving total return. In fact, if you go back roughly 150, after last 150 years, dividends have actually contributed about half of the total return over that period. Now, the last decade, the two decades, it’s really been driven by growth and dividends haven’t been as important. But during that period also that was the zero rate environment. So, we’ve reset cost to capital. Dividends matter. They’re important to that total return and compounding of capital. And it shows really good discipline from a management team to deliver that consistency.

Ben Keating: Yeah. You know it does feel like income’s going to be a big source of returns. It’s hard to see multiples going dramatically higher. We already got decent cap gains and a lot of equity. But that’s come back and then remind people you know people don’t want to have a prediction. But what do you think U.S rates will look like 12 months out and next July. Next June of 2026. Do you think there will be 1 or 2 cuts in that that because that’s classic reinvestment risk, you probably will not see those types of yields. There’s 50 basis points. It goes away from your cash in your senior year. So, I know we’ve been kind of in a holding pattern in cash, maybe seemingly fine. But it’s not too far off. Perhaps that we see lower rates in the short end. And we certainly see another possible cutting rates as they’re cut bias across the globe. So, a reminder that reinvestment risk is still.

Phil Gronniger: And for that money sitting on the sidelines. This is an old phrase or old saying that I’ve heard kicked around in the investment world. And that is that you can date cash but you can’t marry it. Once the Fed starts cutting, that front end goes away if you’re getting a dividend from a company, and unless you’re going into a recession, which is at our base case, company is going to keep paying that dividend, most likely. There’s no guarantee, but hopefully you’re going to pay that dividend because they’ve done it consistently, throughout history. And they’ve drawn that dividend as well as we’re moving into a period where the fed will eventually start cutting interest rates, not aggressively, like in their last cycles, if you will, that they’re going to start adjusting policy a little bit, and we’re going to get a new fed chair sometime next year as well.

Josh Rubin: Maybe two things that add on to what you just mentioned. One, strong companies, even in recessions generally can maintain that dividend. And so, it’s, you know, especially for patient investors, your income doesn’t change, even if there’s a period of time where the chart goes down. You know, so it’s not just recessions caused dividend cuts, but it’s dividends aren’t guaranteed like bond payments are. But obviously they can be very stable in healthy companies. But the other thing you mentioned, you know, how the last 20 years or so dividends haven’t been to material, that’s really in US markets. And I do think that’s sort of underappreciated that in in the US after the tech bubble, you know, early 2000 dividends actually were essentially all of the total return that investors received in equities.

But then after that, as international has been lagging, dividends have actually been pretty material to the total return investors have received. And in some ways, you know, dividends pay you to wait. And especially if we’re in a better environment for capital appreciation. But you allocate something to international markets where dividend yields are higher, you know, if you’re wrong and those markets tread water for a little while, you’re still being paid to wait sort of at a differentiated level. Then, either cash maybe, or just chasing upside for sure.

Josh Rubin: Ben, you mentioned, you know, valuation. We really haven’t talked about that. But I think when we do think about market breadth, you know, we’ve really been talking about price action and we sort of talked about macro. But then there’s company fundamentals not just macro fundamentals. And you know I think as we’re talking about cost of capital, there’s sort of this mix of fixed income in theory sets the cost of capital and then equities. You need to earn something on top of it. But you know I’d love to hear how you guys view kind of that that relative risk reward outlook, you know, from the different types of fixed income up into different equity opportunities.

Ben Keating: Yeah, it’s just been a remarkable run for corporate America with a lot of naysayers that the higher multiples are unsustainable or is too concentrated in the MAG seven. It’s, it’s a high inflation issue is going to go away. I mean, it’s to be determined. But even in the face of what we saw in the last quarter, right, in tariffs is a massive uncertainty. So it’s not just current reporting of earnings, which are largely in line and fairly good based on perhaps a weaker economy. But the earnings guidance has been more torpedoed. Right. You can’t deny that there’s more uncertainty so that even the well-run companies are not giving us great guidance. But I it’s just a great testament to how well-run companies are, not just in the US, but overseas. That’s a that’s again, that’s a really exciting aspect to be investing in. But it gets back to early conversation. How much more room do you have to run in the US versus overseas?

Just a reminder that the multiples in the EAFE, European companies, in large, are still in the mid-teens, 13, 14, 15 these are very well-run companies that perhaps, in our opinion, have been unfairly dinged. There’s still some bad companies in any market. There’s companies that unfortunately won’t be able to compete in a very competitive market that is now even more tech driven.

So, keep that in mind. That’s the case for active in a nutshell. But I think overall, I think too many people think the multiples need to crater before they start to put new money to work. That’s not the case. You either talked about dividends, but these are just very innovative companies that can probably maintain a fair multiple. And then you’ll just see, like we’ve seen over a brand new companies that are incredibly innovative to come out of angel to small cap to mid to large and mega cap. —- That trend still not going to discontinue either. You’re still missing great innovation there. So it’s just a weird juncture where people are kind of doubting the sustainability of the growth and the multiples. But I would say don’t doubt that us. But take a look at elsewhere, because you’re seeing obvious value in well-run companies that just happen to be domiciled somewhere else inside the U.S.

Josh Rubin: Maybe I’ll, I’ll be a devil’s advocate on and one of the things you said, you know, when we talk about valuation, we tend to talk about P/E multiple. And sometimes we’ll talk about dividend yield which has a relationship but is not the same as the p e multiple. And a great benefit of globalization to American companies has been offshoring.

And with offshoring they’ve really outsourced their capital intensity their business. And so it used to be you weren’t 100, you had 70 of capital expenditures. You could afford to pay 30 of dividends. And then it turned into you earned 100. You had 30 of capital expenditures because a Chinese factory or Malaysian factory was going to take on the rest.

And so, you did buybacks with the extra and then paid out your dividend. But if the US is reshoring or if capital intensity moves back on to US corporate balance sheets, you may still earn 100, but then you actually just go back to, okay, we can pay 30 as a dividend, but we don’t have this extra for buybacks or something. And I don’t know if that changes the valuation construct in the US or maybe stocks traded the same P/E multiple, but they don’t grow earnings as fast just because they’re not able to buyback 2% of their shares every year. So earnings you know EPS grows 2% slower. But you can kind of this balance between rest of world companies and the US.

US companies have been able to grow a few percent faster with buybacks. And you know, European companies in particular, but definitely a lot of global companies have returned that extra 3% from dividends. And so, the optics of earnings growth has favored the US. But maybe reshoring, you know, it’s not necessarily bad for companies or bad for the overall economy, but it changes the optics, and perhaps impacts multiples or just makes the US and Europe and you know, in Asia look, look more uneven ground.

Ben Keating: Yeah, and that was debated in early days of Liberation Day. You kind of get your arms around. What does this mean for each industry, each company. But I think to your point, that would be a more pronounced event if the reshoring took place abruptly and was more permanent. There still is a sense that with the walk back phase and Trump, that maybe this won’t be as biting. And even if you want to have reshoring, some of the industries, the tech in general in Taiwan Semi, it’s going to take you a generation to get that technology back on here. So you can’t change that supply chain and reshoring instantly. So I think time that companies and investors perhaps will have time to digest some of the bigger moves that that may take place.

But again, it’s amazing how any company, any well-run company anywhere in the world can really kind of roll with the changes. And it’s this is a big change in tariffs. But overall, I know no one seems panicked even if the companies directly impacted by this, the Chinese based companies, they are taking it in stride and they’re kind of going to react appropriately.

Phil Gronniger: Yeah. I’m just going to add on to that. The globalization has been a wonderful thing for companies around the world. Being able to deliver better margins, giving that back to shareholders, whether it’s on a dividend or buyback. And when we look at the differences of the U.S. and non-U.S. companies, part of that, that’s a boardroom decision. There are some advantages to, buying back stock in the US as opposed to paying it out in a dividend, from a tax standpoint, it’s a little better from a tax standpoint, for the non-U.S. companies to pay that dividend, versus again, the U.S companies as well. But deglobalization, I would say, make no mistake, is not a good thing in general.

And the offshoring has been said takes decades to, to get back to, you know, bringing things back, manufacturing in at home. But it is going to lead to higher costs. So, companies are finding ways around the potential for increased tariffs and avoiding that, decision that they would potentially have to make to onshore, manufacturing and that. But, you know, deglobalization wouldn’t be good if every company out there and every country was heading down that same path now.

Josh Rubin: And that’s actually a different funny, difference, I think, for the U.S. compared to the rest of the world, which is we’re pursuing a lot of different deglobalization policies today, you know, on the labor front via immigration as well as on the supply chain.

And so one of the things that means is U.S. companies, which if you think about, you know, the major US indices, US companies, generally have sort of maybe 60% or more of their revenue coming from inside the US. Pretty close to 60% of US earnings that have a direct tie to tariffs or labor changes that, etc. But if you look around the rest of the world, you know, EAFE, which is sort of the developed markets index, a little less than 25% of revenue in that index comes from the US.

And so actually there’s a there’s a world where or a future where maybe the US globalize is the rest of the world doesn’t to the same degree. And so the earnings impact is a lot smaller to the rest of world companies than it is to US companies. You know, the margin squeeze or the growth rates or something. And again, all of this falls back into the it’s a highly anticipated but completely unknown, you know, how things will evolve. But it could be something where global companies in the rest of the world sail through a still globalizing world, you know, sort of in a normal way, while the US has to do a lot more adjustment.

Ben Keating: Yeah. And you can’t deny that this whole exercise, maybe, maybe the liberation days kind of last straw in both our friends and our foes across the globe, they’re rethinking their relationship with the US. We’re still the greatest country, we still have the best consumers are still not going to give up. We’re still the safe haven exceptionalism, but they’re rethinking, even our allies are saying, can we trust the economic relationship? And then, more importantly, perhaps militarily, using a commitment from our allies to spend more on defense, and that, there’s a whole other conversation which we can spend probably a whole podcast on. But those are new dynamics. Those are new events that are taking place in recent months. And have yet to play out and will affect investors in some aspect.

Josh Rubin: Ben, Phil, this has been great. Thanks a lot for your time today. In our next discussion, we’ll focus on some of the macro trends and the overall state of the fixed income market.

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