Dennis Stattman: Stocks are the Best Game in Town - "Invest in Real Businesses"

DENNIS STATTMAN: I don’t think there is a good substitute. We simply have to face the fact that the returns on Treasuries are likely to be unattractive. And if we want that risk reduction role, without risk of loss in a higher interest rate environment, we’ll have to have very short maturities or very limited duration. And the yields on those instruments are vanishingly low. Which means if you want that safety, then you’re going to have to accept a very low return for it, unfortunately.

CONSUELO MACK: The dollar, another statement of yours. The dollar is not a reliable store of value. Just explain why the dollar is not. And again, what’s the substitute for the dollar, which is of course, the world’s reserve currency, still?

DENNIS STATTMAN: I don’t think there is a great substitute for the dollar. And every day we ask ourselves what can we use as a substitute for the dollar. The euro has its issues. The yen is an expensive currency. The pound has its issues. And those are the only really big currencies that there are, that are freely traded. Now, at some point, the Chinese Yuan is going to be more freely traded, but it’s not functional as a reserve currency today. That’s one of the reasons that gold has become more popular, is simply many investors are seeking an alternative to the big currencies, and they can’t find one they like a lot, so they put some money in gold.

CONSUELO MACK: But some money in gold. I mean, you’re really limited because gold, it’s a hard asset and you can’t use it as a paper currency. So that’s really one thing to have as an investment, but again, a liquid means of trade and commerce, just it’s not. So what do you do at the Global Allocation Fund? I mean, what are you using as a substitute for the dollar, what do you use as a substitute for Treasuries?

DENNIS STATTMAN: We have a very broadly diversified portfolio. And ultimately, we think that’s the answer when it comes to a store of value for investors. And with respect to Treasuries, what we’ve done is to keep our duration in maturities very short.

CONSUELO MACK: So very short being three months, or?

DENNIS STATTMAN: A lot of them are three months or less, and then as we go out the maturity spectrum, still we’re in one, two, three-year sorts of durations and maturities, in a lot of cases. Also, our currency exposure is across a portfolio of over 30 currencies. We’re underweight the biggest currencies, the dollar, the euro and the yen. We’re overweight some smaller currencies that have good fundamentals. Anything from a basket of Asian currencies, including for example, the Singapore dollar, to some emerging market currencies such as the Brazilian real, which, despite having appreciated a lot, has good fundamentals, in our view.

CONSUELO MACK: You were quoted recently saying stocks are the best game in town, but not necessarily a good game, which is not a ringing endorsement of stocks. So why aren’t they necessarily a good game?

DENNIS STATTMAN: What we mean by stocks being the best game in town is that relative to other securities, stocks are the most attractive. What we mean about stocks not necessarily being a good game is that, while we think there’s a strong relative valuation argument for stocks, especially compared to bonds, as I’ve said, we’re pretty negative on the return outlook for bonds. And so that might be the bigger statement there, when it comes to relative pricing. Also, while valuations on stocks appear to be very attractive, and very undemanding, for example, if you look at the 50 biggest stocks in the S&P 500, there are only eight of them that trade with a PE ratio of 15 or above. Only eight out of the biggest 50. And 15 is not a demanding PE, historically.

There are 16 stocks on 2012 consensus earnings estimates. Sixteen out of those 50 biggest stocks trade with single-digit PE ratios. Those are valuations that get our attention. Having said that, we believe profit margins are already very high, and are unlikely to expand cyclically in a normal fashion from here. In other words, the big ramp-up in profit margins has probably already happened. So we have to worry a little bit about the outlook for margins and profitability from here, and that may attenuate, to some degree, the attractiveness of stocks. But they’re still the best game in town.

CONSUELO MACK: So let’s talk about one of your themes has been that, again, we’ve been talking about preserving purchasing power and finding real stores of value. So one of the places that you could find real stores of value, of course, are commodities. I mean, hard assets.

DENNIS STATTMAN: About the only commodity that we can invest in directly is precious metals. It’s pretty much directly.

CONSUELO MACK: Oh, you can directly, but you don’t have to do it through ETF?

DENNIS STATTMAN: We can effectively do it through an ETF, but the ETFs there are relatively pure plays. In terms of other commodities, we’d be in the position of buying a commodity producer, for example. And as I mentioned, energy is an area that we think is very favorably positioned secularly, because in the developing economies, in particular China and India, per capita energy is still very low. But it is growing rapidly. And as those economies develop, that per capita energy use is going to go much higher than it is today. And at the same time, in order to replace or add an incremental barrel of new oil reserves is very expensive today. So owners of existing reserves are in a very good position. And companies that help other companies find and exploit new reserves of oil are in a very good position, in our view.

CONSUELO MACK: So speaking of kind of real assets and real stories of value, another theme of yours has been to invest in what you call real businesses. So tell us what real businesses are, what do you mean by a real business?

DENNIS STATTMAN: That’s the typical company. And I say a real business, to differentiate from a financial business. A financial business is generally one in which the company is borrowing money at one rate, and lending it at a higher rate and earning a spread and paying expenses beyond that. But while that is a real activity, it is not the same thing in general, as inventing something new, producing something, distributing something. It’s a different kind of business. And we think the businesses that are involved in invention, production, distribution, and so forth, are more real in terms of stores of value than are financial businesses.

CONSUELO MACK: And so for instance, what kinds of companies are you talking about, when you’re talking about real businesses?

DENNIS STATTMAN: A wide variety of companies. Anything from a technology company to a healthcare company to an energy producer.

CONSUELO MACK: So IBM, Johnson & Johnson, Exxon Mobil, whatever.

DENNIS STATTMAN: Union Pacific, you name it. A wide variety of them.

CONSUELO MACK: Now it’s so interesting that here you are, in a financial services business, and you’re saying that financial companies aren’t real businesses. I mean, what about, are asset managers real businesses? I mean, you know, this is where you work.

DENNIS STATTMAN: They’re very much real businesses.

CONSUELO MACK: Okay, distinction.

DENNIS STATTMAN: They exist. But their value tends to be a function of the level of financial markets, and the value of paper assets, to a much greater degree than say, the value of the Union Pacific Railroad doesn’t depend so much on the level of the stock market.
I would hasten to add that there are going to be times that the financial sector is very attractive. And we think one of those times may be ahead. But we still have to work through a lot of assets that are housing-related, that are not necessarily fully marked down, and the losses are not necessarily fully realized. There’s still a big problem in the existing housing stock, and there are surplus houses on the market. There’s still pressure on their prices, and we haven’t worked all the way through that yet. Some day we’ll be more bullish on the financial sector.

CONSUELO MACK: So you know, looking ahead, Dennis, and the way that you’re operating the Global Allocation Fund, again, do you see any other trend that you’re going to end up following? Are you doing things differently now than you would have done, let’s say, three or four years ago?

DENNIS STATTMAN: We’re a little bit more cautious on the developing markets than we were, say, four or five years ago. Where we had, at that time, a combination of superior growth and valuations where you didn’t really have to pay for that growth. And we actually think that we may be getting to the that point again, but in the meantime, there was a run-up in the level of a number of those markets, and they became a bit more expensive than they’d been, so you had to pay for the growth. There had been some selloffs in some of the markets, and at the same time, earnings have come up, so valuations have gotten a little bit better. When we get to the point where we have less concern about inflation and less concern about tighter monetary policies, there may be some good entry points again, in a number of the developing markets.

CONSUELO MACK: Final question is the investment, the One Investment for a long-term diversified portfolio, what all of us should own something of? And obviously you cannot recommend your own fund, but you have a great track record. I looked at the past like ten recommendations that you made, and just about, well there may be one or two exceptions, they’ve all made money for our viewers, so we are appreciative of that. So what do you have for us today?

DENNIS STATTMAN: As I mentioned, big cap high quality stocks, we think, are very attractive. And in particular, big cap high quality stock that’s not getting a lot of respect right now, but which we think is very well-positioned, and could present a good return versus risk opportunity, for the viewers, is simply Microsoft. Microsoft trades at less than ten times 2012 consensus estimate. It has a significant cash position, between four and five dollars a share, in net cash. If you took that cash out of the price, Microsoft trades at under eight times earnings. And it has a new product cycle coming, with Windows 8. So we think Microsoft is strongly-positioned, has a catalyst for earnings growth, has a great balance sheet, and is very modestly valued.  That seems like a good risk/reward tradeoff to us.

CONSUELO MACK: All right, well, the Gates Foundation thanks you for that recommendation, at any rate. Dennis Stattman, it’s such a pleasure always to have you on WealthTrack, and thank you very much for joining us.

DENNIS STATTMAN: It’s a pleasure. Thanks for having me.

CONSUELO MACK: Next week we will be hearing the views of Financial Thought Leader, best selling author, historian, teacher and commentator Niall Ferguson on America’s economic, educational and debt challenges and how we might overcome them. To see this program again, please go to our website, wealthtrack.com, to watch it as a podcast or streaming video. And while you are there, check out WealthTrack Extra, where you can find complete, extended interviews with other recent Great Investor and Financial Thought Leader guests. Thank you for taking the time to visit with us. Make the week ahead a profitable and a productive one.

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