Navigating Uncertainty – A Conversation with Chuck Bath
Q: Uncertainty seems high right now. How does today’s market compare with other periods of uncertainty?
A: Uncertainty is high right now, but there are always periods of uncertainty. Once uncertainty around the coronavirus passes, there will be something else clouding the future. As investors, we need to ask, “Does this particular uncertainty impact our ability to understand a company’s earnings power five years from now?” With coronavirus, we can be relatively confident there will be a therapy or a vaccine sometime in the next 12 months—maybe a bit longer. It’s almost unusual because you can see a finite ending to this particular uncertainty. So we are asking whether this nearer term disruption is impacting longer term demand patterns, and it obviously varies from industry to industry and company to company.
In some ways, there was more uncertainty in 2008-2009 and 1982-1983 than we have today. When I first started in the business in 1982, inflation was a real problem for investors—this was during a time of significant economic weakness. It was unclear if and how that would be resolved. It ended up taking very high interest rates, of course, but that issue was eventually put behind us.
Q: Does the market today remind you of 1999-2000?
A: In some ways. In both periods, the market was incredibly narrow and a few mega-cap companies drove a big portion of market returns. One key difference is that in the late 1990s, earnings growth for growth and value names was largely in line, yet growth stocks hugely outperformed because their multiples expanded so dramatically. That market was much more speculative. In today’s market—while similarly narrow with growth names hugely outperforming—earnings growth for growth companies has been meaningfully outperforming that of value companies, so it doesn’t appear to be as speculative.
Q: What do you think about the Federal Reserve cutting interest rates to zero and expanding its balance sheet to buy things like corporate bonds?
A: The Fed buying corporate bonds is a big deal. Accommodative monetary policy has been a big driver of this rally, as it has been over my career. In 1982, what started the bull market? Fed easing. In 1990, Fed easing got us out of a smaller financial crisis. It was the same in 2002 and in 2009—Fed easing fueled the coming bull markets. Today’s Fed easing has brought down interest rates making bonds less competitive with stocks, and the discount rate on future cash flows we use to value companies is also lower, supporting higher valuations. The belief that the Fed will do what it takes to provide needed liquidity is, in my mind, the biggest contributor to the equity market rally since March.
Q: There aren’t many signs of inflation … yet. Is that something we should be concerned about?
A: There aren’t real signs of inflation yet, but the dollar has weakened and commodity prices—gold, silver and copper—are rising. Those are often early warning signs of rising inflation. The Fed has indicated it is on hold with no desire to tighten for the foreseeable future, but I have seen periods when the Fed has no choice but to respond to rising inflation. I don’t think we are there yet, but that is a risk I’m particularly mindful of.
Q: How are you thinking about the upcoming election?
A: When I think about some of the presidents that overlapped with very successful markets—Reagan, Clinton, Obama—all served eight years and had very strong equity markets, yet their politics were very different. That should tell you the underlying opportunities available in the marketplace are much more important than who is president. I think corporate America will be able to manage either outcome successfully, particularly when you take a longer term view as we do.
Q: Any closing thoughts?
A: We are asking, “Where’s the reward, and where’s the risk?” In an environment where the 10-year Treasury is at 50 basis points, equities are still inexpensive compared to other asset classes. And if investors need income, there are all sorts of opportunities to earn income in equities. I think therein lies the opportunity. Where’s the risk? I think it’s inflation and how that plays out over time. Those are the things I’m monitoring—low interest rates providing the opportunity for equities, and rising inflation being a potential risk.
The views expressed are those of Diamond Hill as of September 2020 and are subject to change. These opinions are not intended to be a forecast of future events, a guarantee of results, or investment advice.