Co-Heads of Investments Ben Kirby and Jeff Klingelhofer discuss consumer, corporate and government balance sheets, market breadth and ex-US valuations.
Observations: Balance Sheets, Market Breadth & U.S. Leadership
Adam Sparkman: Fixed income really at its core is an exercise in balance sheet investing. Um, I know you and the team really think about the three major balance sheets: government, corporate and consumer. Discuss your broad outlook, if you would maybe for each of those three balance sheets kinda for the rest of 2023.
Jeff Klingelhofer: Sure. I mean, for quite some time, what we’ve talked about has been we’ve really liked the consumer balance sheet, right? That’s on the back of the strength of incredibly strong consumer within the US and, and even abroad, right? What we’re seeing, unfortunately, now is we’re starting to see some of those fundamentals weaken, right? We’re seeing people spend through all of that excess savings they accumulated during COVID, but they continue to be supported by a very, very strong labor market. The, the thorn in the Fed’s side, of course, has been not only a strong labor market but increasing wages that help support that balance sheet. So by and large, we still like that balance sheet the best. It’s incredibly, incredibly strong, but it is weakening at the margins. So within that balance sheet, we’re focusing on the higher quality consumer versus we were much more willing to dip down to the lower quality consumer. Then the corporate balance sheet side, we’ve seen companies do exactly what is expected of them in a very low interest rate environment. They’ve turned out their debt. They’ve taken on additional debt. They’ve, they’ve gone on uh, significant Cap X uh, expenditures and we’ve seen leverage increase. So what corporations have done well is they’ve turned out the, the, the, their balance sheets, right? And ultimately, rising rates haven’t really impacted them yet. We’re watching that closely but overall, net leverage levels being high gives us a bit of a pause and concern, and then, of course, on the corporate, or the government balance sheet side – excuse me – governments have gone in a, on a, on a real spending spree and, and so ultimately, we haven’t liked that balance sheet, um, for, for quite some time. Now, it’s offset with higher rates globally, and so there is a little bit of that offset effect, but I would say our primary focus continues to be on the consumer side, where the, the consumer is incredibly, incredibly resilient at this point.
Adam Sparkman: So, Ben, maybe shifting back to, to equities, um, participation in this year’s recovery has really been limited to growth stocks and really a pretty narrow breadth of US tech-oriented growth stocks, do you see the narrow breadth that we’ve had in markets as a sign of underlying market weakness or do you think that the level of bifurcation at the company level potentially creates an opportunity for active managers?
Ben Kirby: Yeah, mostly a narrow market like we’ve had this year breadth has not been good, just a very very few stocks have really driven the returns in the market, um, but it doesn’t have to be a bad signal for sort of future returns. I was looking earlier, so Nvidia, kinda the leader in the market this year, earnings expectations have grown 70 percent this year. So, you know, they’re gonna earn 70 percent more than we thought they would at start of the year. That’s amazing. That’s phenomenal for a large-cap company. The problem is, the stock price is up almost 200 percent. So we’ve had a lot of multiple expansion. You’re paying a lot more for those earnings even with the, the better expectations than you were at the start of the year, and that’s true for a lot of growth stocks, you know, so we think that especially with inflation still stubborn, the Fed still hiking, eventually that does continue to challenge growth stock valuations, and so we think that the market can broaden even if the overall index level doesn’t change that much, composition under the index can, can favor a, a broader group of stocks. That is a great environment for active managers. Uh, this was a hard year to keep up with the first half of the market. When seven stocks drive everything, if you don’t own those seven stocks, it’s hard to keep up. As we go into the back half, we think it can broaden and we think that that’s a great opportunity for stockbrokers.
Adam Sparkman: Okay. Well, maybe sticking with that, that thread a little bit, um, to your point, you know, the US has, has been the leader. It’s actually recorded one of the strongest first halves of, of the year, um, you know, really for the 21st century. Um, much of that performance, to your point, was driven by PE expansion, rather than that earnings growth, NVidia being one of the exceptions. Do you expect that US leadership will continue through to the rest of the year, um, or does the landscape potentially favor opportunities outside of the US?
Ben Kirby: So international assets are historically cheap versus the US. That doesn’t mean they’re gonna outperform in the second half, but just looking at valuations as an interesting starting place, the S&P 500 is at over 19 times earnings, Europe is close to 12, emerging markets are closer to 12. That’s a 36 percent discount versus the US and that’s a historically wide discount. So at least a starting place for international diversification is even better than it was at the start of the year. At the same time, the US dollar is also pretty strong and has the potential, we think, as the US you know, inflation picture gradually cools, the right cycle gradually slows down for the dollar to peak and international currencies to appreciate. So there are a lot of, a lot of straws in the wind that give us, um, some, some comfort in the international, um, assets performing stronger, um, as we, as we enter the second half of the year.
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