Barron's Streetwise - Stocks vs. 5% Treasurys. Plus, Insurance Optimism

Episode Date: March 10, 2023

A top equity strategist sees lackluster short-term returns. And Jack gets a behind-the-scenes look at the Aflac duck. Learn more about your ad choices. Visit megaphone.fm/adchoices

Hey Spotify, this is Javi. My biggest passion is music, and it's not just sounds and instruments, it's more than that to me. It's a world full of harmonies with chillers. From streaming to shopping, it's on Prime. Valuations are somewhere around fair. What I mean by that is if we have a 17.5 multiple today, that in a year from now we'll probably still have a 17 and a half multiple today, that in a year from now, we'll probably still have a 17 and a half multiple. If you add that all together, that means you could probably do a lot better putting money in a T-bill. Hello and welcome to the Barron Streetwise podcast. I'm Jack Howe, and the voice you just heard is Jonathan Golub. He's the Chief U.S. Equity Strategist at Credit Suisse, and we'll hear from him about what to expect and how to invest from here. We'll also say a few words about the insurance industry and hear from the number two duck

over at Aflac. Listening in is our audio producer, Jackson. Hi, Jackson. Hi, Jack. I don't have to tell you what time of year this is and what happened this past week. Well, March Madness starts on Sunday, which is in two days,

but do you mean like the regional conference tournaments? I mean the Association of Insurance and Financial Analysts. That's right. The AIFA Annual Conference in Naples, Florida. Sounds exciting. Down there at the Naples Grand Beach Resort. I'm looking at the agenda. I take it you did not attend.

I did not have the pleasure this year. A lot of good stuff here. It started on Sunday with, let's see, there was a golf tournament, a tennis. Okay, they didn't get any work done on Sunday. Monday. Okay. Monday, right out of the gate, you got a state of PNC insurance panel. That's property and casualty. And then that's followed by state of life insurance. You got a quick break and you're right back to the insurance brokers panel. It's like Coachella. Yeah. The whole thing wrapped up on Tuesday with an accounting changes panel.

Now, that's a tough room because people are on their way out. They have to catch flights. And you're here talking about accounting changes. You really got to bring the pizzazz to hold the attention of the room. I'm sure they got it done. I noticed Morgan Stanley had a wrap up for those of us who were not able to attend about kind of the state of the industry. They say, first of all, the mood was one of cautious optimism.

I would have guessed unbridled rapture, but all right, it was cautious optimism at the insurance conference. But they say that rising interest rates and dissipating COVID, as Morgan Stanley puts it, clear and undisputed positives for the industry. Rising interest rates, I'm guessing because it means better yields in some of the credit portfolios there. Morgan Stanley says you have to watch out for signs of any deterioration in credit portfolios. They're not seeing signs of that yet,

but keep an eye on it. And they have top picks. Equitable is their top pick among the more equity sensitive insurance companies, the ones that are sensitive to gains in the stock market. And they also like MetLife and Aflac. Based on Morgan Stanley's target prices, they see more than 50% upside for Equitable. For Met, it's 30%. And for Aflac, it's about 15%. Not bad at all, assuming they're correct about that. And we did have a chance, Jackson, to chat with a top executive over at Aflac. Fred Crawford, the CO CEO, who you called the

second duck. Right. I'd counter that he's the third duck because the duck duck's got to be the first one. You're counting the duck. And then the second duck would be the CEO. Yeah. Right. And he's the chief operating officer. Yeah. So that's number three. That's a fair point. We did talk about interest rates and about the duck. And I think the duck is, first of all, I'd learned some things about Aflac. I knew that Aflac had these supplemental policies that cover sort of specific diseases and things like that. I always thought of them as being narrower than your general health coverage. But Fred talked to me about why it's really for somebody who might struggle to come up with the money to pay for all of the incidental costs that might come along with having one

of these diseases, the co-pays and so on, which can be several thousand dollars. And some people don't have that in savings. And we spoke about the duck which he really says is a big advantage for aflac and i believe it he says the company is able to keep its advertising costs lower for its size just because of the recognizability of that duck it's hard for me to pick another animal in the insurance space. Look, you can talk all you want about the gecko. Yeah. Right?

And the emu. I can't even remember who had the emu. Liberty Mutual. Right. The thing that's special about the duck is this. If a duck walked up to me and said quack, I'd say, you know what? That sounds totally out of character. That's a hard K sound right in the beginning of the word quack. And it

just doesn't sound very duck like if a duck walked up to me and said Aflac, I'd say, you know what? Carry on. You go right on being a duck. You sound just like a duck. Aflac sounds more like a duck noise than quack is my point here. And so I think it is. I think whoever came up with it, it's the perfect animal for that company. And you got to have it if you're selling, I mean, insurance isn't the grabbiest thing. And if you're selling supplemental insurance, I don't know, you really need a strong animal. And I think they've got one. Any reaction to that, Jackson? I put a lot of thought into this. Yeah, I'm kind of held up by this idea that quack is a bad onomatopoeia. Is there anything better you can pull from other languages? Hold on.

I'm Googling. I've seen before foreign words for animal sounds, and some of them will surprise you. Let's take dogs. Okay. Now, I don't know if I'm pronouncing this right, but apparently the Dutch say blaf blaf for a dog. That's preposterous. Come on. That can't be, that can't be right.

Icelandic vaf vaf. Okay. Indonesian guk guk. What's going on in Indonesia? What kind of dogs are these? Japan is wan wan. Korean is myong myong. And Romanian is hamham or Hom Hom.

I don't know. Woof doesn't sound quite right either. Woof does not sound right. Woof or bark. Listen, I can't devote more than 40 minutes more to this topic. This is fascinating. We could do a whole episode about this. All right.

Why don't we hear from Fred about Aflac and the duck? And then after that, we'll get to Jonathan over at Credit Suisse. All right. Why don't we hear from Fred about Aflac and the duck? And then after that, we'll get to Jonathan over at Credit Suisse. Sounds good. Give us, you know, for people who only know about the duck, tell us what else we need to know about the business. Give us the quick tour of the business, where you are and what you sell and what you do. Sure. So, you know, Aflac is a name, a brand, certainly that folks are very familiar with. And of course the duck is, I think coming on around 22 years old and that's the iconic brand. But what we do in both the U. and in Japan is we are a supplemental health insurance company, meaning we provide insurance to cover what your major medical insurance doesn't cover.

So what most people realize, particularly those who have gone through either an accident or hospitalization or health event, understand is that even though you may have health insurance, and it may even be good health insurance, it doesn't cover certain things such as deductibles and co-pays, and also just other ancillary costs associated with getting ill or having an accident, time away from work, commute, and other expenses that are out of your pocket when you get hit or ill. And if it's something of a more critical nature, such as cancer, which we're a very large insurer of cancer insurance or other critical illnesses, of course, those bills can stack up considerably. And again, outside of what you're covered under normal major medical.

Japan, we do the same thing, only the difference being that Japan has a national healthcare system. And so what we are supplementing in Japan is what the national healthcare system doesn't cover. And in Japan, I'll use U.S. currency to make the example, but 70 cents of every dollar that you experience in the way of a health care issue or health care in general is paid for by the national government in Japan. 30 cents of every dollar comes out of your pocket. And so the Japanese have grown up even through generations realizing that they can do the very quick math as to what could be the financial burden of an injury or hospitalization or a critical illness when 30 cents of every dollar is out of your pocket. And so our policies close that gap or fill in that gap.

In the U.S., we sell predominantly in the worksite, meaning it's your employer that we work with who offers up our product to their employees. And why do they do that? Why is an employer motivated to buy the product or offer the product in their workplace? It's because over half of their employees and on average, over half of working Americans have less than $1,000 saved up for an emergency. And so even something as seemingly minor as out-of-pocket costs, co-pays, deductibles, a day or two off of work could be significantly disruptive to a family that's living paycheck to paycheck with no safety net of savings. What about advertising? I think there are a lot of people who work in advertising-related fields, including many of these big software companies who are wondering

about, hey, is this some weakness in the ad market? Is it going to get worse? How long is it going to stick around? You're an advertising buyer. What type of spending have you found to be the most productive for you? What do you think of your overall level of advertising spending going forward? And what kind of job security does the duck have? How's the duck doing for you? Everybody's still on board with the duck? Everyone's on board with the duck. It's iconic.

And year in and year out, the involvement of the duck in our ads, whether on its own or with more celebrity type actors, it performs as well or better than any other ad campaign we can come up with. And interestingly, Jack, negotiations with the duck go pretty well each year. So we're able to negotiate. I wish I had a better duck voice. I'd be auditioning for commercial work for you. Exactly.

And to answer your question, our branding budget in the U.S., which I would separate from marketing budget, which includes all kinds of other activities, our branding budget, which is what you sort of see on TV and understand to be the duck, that's around $125 million a year budget. And then in Japan, that's in the U.S. And then in Japan, a similar number in dollar terms, around 100 million or so. And those are actually quite, for a company our size, those are not big numbers, even though they sound like it on the surface. And the reason they don't have to be larger numbers is the brand equity.

So it does come back to the duck. It's such an iconic symbol of the company that that brand equity carries us quite a long ways without having to spend the huge dollars you'll see, for example, in the property casualty industry with the Allstates and State Farms and Liberty Mutuals and Progressives and so forth. I'm just remembering, somebody's got the emu out there and I can't remember who it is. That's Liberty Mut Liberty mutual. I think just between everyone listening to this podcast, what do folks in the office say about the emu? Do they say, look, these guys are trying to, these guys are trying to get in on our duck action over here.

What do they, what do they say? Um, you know, we, we wish well, uh, all of our competitors and their ads, all the animals in the zoo, just to be clear, we will not be confusing our duck with any emu anytime soon. Thank you, Fred Jackson. I've got a couple more of those foreign words for animal noises. I've got ducks. And in Danish, it's rap rap. I don't know. I don't know what kind of ducks he's are in the ask meta Hungarian hop hop Italian

quack quack Romanian mock mock Turkish Vak Vak. I Turkish I could almost believe not bad but French French is and I I'm not a guy who knows how to pronounce French words. It's the word coin. It's coin coin. Now, is that not pronounced coin? What's the pronunciation of C-O-I-N in French? Man, I guess coin.

If it's coin coin, I feel like I deserve some answers about what's going on in the French duck community. Let's take a quick break. We'll hear from Jonathan when we come back. With TD Direct Investing, new and existing clients could get 1% cash back. Great. That's 1% closer to being part of the 1%. Maybe, but definitely 100% closer to getting 1% cash back with TD Direct Investing.

Conditions apply. Offer ends January 31st, 2025. Visit td.com slash dioffer to learn more. Breaking news happens anywhere, anytime. Police have warned the protesters repeatedly, get back. Thank you. has changed very quickly. Helping make sense of the world when it matters most. Stay in the know. Download the free CBC News app or visit cbcnews.ca. Welcome back. Jackson, how do you feel about the state of the U.S. stock market right now?

What did we say the insurance guys were feeling? Cautiously optimistic. I'm feeling anxiously dogmatic. I have a long time horizon before retirement, unfortunately, so I'm mostly in stocks and I've been blindly plunking my money into index funds. But looking at these treasury bonds, I'm feeling left behind. Yeah. Like you can get 5% without taking any risk. Yeah. I'm frantically befuddled because as you say, you know, I mean, the stock market seems like an okay deal, right? I mean, I'm looking at the S&P 500, 18 times this year's earnings. Eh, it's a little above, it long-run average, fine.

But then, as you say, bond yields are really up there now. So if you take the PE of the stock market, you flip it upside down to get an earnings yield so that you can compare it with bonds. I looked at a comparison of the forward earnings yield of the S&P 500 and short-term treasury yields, and they said that the difference between them was the lowest in more than 20 years. In other words, bonds seem like a good deal relative to stocks. And then you don't know if we're headed for a recession. And we're going to play some of our

conversation with Jonathan Golub at Credit Suisse. He had a research piece out this past week that says the yield curve is the best predictor of recessions. We've heard that before. The yield curve is inverted now, meaning you get more on the short-term bonds in terms of yield than you do on the long-term bonds. That's the opposite of how it usually is. And he says that over the past 50 years, not including the pandemic, the curve is inverted six times. And recessions have followed on average by 11 months. There've been no false positives and no false negatives, but he says the outcome tends to

be different depending on whether it's a period of high inflation or low inflation. Bottom line, he says, we're going to get a recession in late 2025. I wanted to hear more about what that means for stock investors and how they should invest now. So I reached out to Jonathan. You want to play part of that conversation? Oh yeah. That was borderline Kool-Aid man. Let's put it that way. For people who know, they know. All right. Let's hear from Jonathan. Oh yeah. I just need to know about everything that people should do with their money right now and what's going on with the stock market, what the future holds.

And that's pretty much it. If you want, we can handle global warming and the future of Ukraine. We have a lot of time. There's time. Yes. What do you think the rest of the year holds? How does it look to you? How does the U.S. stock market look to you? Is it a good deal here?

A good deal? No, I mean, I think it's kind of a disappointing, mediocre kind of outlook. I mean, what are we looking at right now? If you start with the economic and earnings backdrop, earnings are going to be basically flattish for the next, not one, but probably two calendar years. basically flattish for the next not one, but probably two calendar years. And the reason is, is because, you know, inflation is running. It looks like over the again, the next year to two years is going to run not 1970s kind of high,

but kind of like annoyingly high, probably three and a half or four percent. Wages are going to go up more than inflation, than consumer inflation, which is good for a consumer because they go to the store and they get to buy more with their wages. But it's not good for a company because they're paying more for labor and they're not able to pass it on all that well. So it's kind of a rough environment for earnings. It's not going to collapse, but it's not robust. And we're going to, it looks like, not have the recession that people think. And we're going to avoid it for much longer than expected. That's what the yield curve is actually telling us, that the recession probably doesn't happen until maybe 2025.

And that the valuations are somewhere around fair. contributions are somewhere around fair. And when I say fair, what I mean by that is if we have a 17 and a half multiple today, that in a year from now, we'll probably still have a 17 and a half multiple. Now, if you add that all together, that means you could probably do a lot better putting money in a T-bill. And I'm hearing a lot of really smart equity guys asking that question, which is, help me make the case. Why do I need to be in U.S. equities? And I say to them, it's not my job to make the case.

It's my job to reflect on what the world looks like. I will tell you though, non-U.S. equities, which have looked much less attractive than U.S. equities for the last 20 years, are less expensive and delivering better growth. And non-U.S. interest rates as an alternative are lower. So it looks as if if you're going to be investing in equities, doing that outside of the U.S. is probably favorable. I thought I saw somewhere that you weren't particularly keen on defensive stocks right now. What don't you like for defensive stocks and for providing some more safety in your portfolio? Is that maybe a role

for more bond exposure or what do you think? Well, so the first thing is you buy defensive stocks if you think we're going to go into recession. And it just doesn't look like that's going to happen. And the reason that we're not going to go into recession is simple. There's so many, you know, open jobs that the consumer is feeling surprisingly empowered. The people wondering how much longer can they charge on their credit cards? Well, if your job is solid and if you're, you know, and even if you think it isn't, you know, you can get a job across the street making similar or even more money, then you're willing to remodel your kitchen or buy a car or do whatever it is that you do.

If you look at the other parts of the economy, because it's important when you think about where do you put your money in the stock market, capital expenditures are expected to be pretty good this year. That's a consensus view. And housing is expected to be lousy. pretty good this year. That's a consensus view. And housing is expected to be lousy. And so when you add those together, you kind of get a mediocre overall economy. But you can buy industrial stocks, they look reasonably attractive. You can buy consumer stocks that look reasonably attractive. I think energy stocks look reasonably attractive. Even though the overall economy is weakish, those areas look like they'll be a little bit stronger. How about some of these tech darlings that have been bouncing back this year after taking a beating last year? Where do you stand on that?

I know they're all different, but anything strike you there? You have to ask the question, why did tech do so badly last year and why is it bouncing? I mean, the big problem last year with these tech companies is that their earnings were lousy. I mean, if you remember what happened with these companies, they just, you know, knocked the lights out, both in terms of their earnings and stock price in the early days of the pandemic

because we were staying at home and we were buying things online and we were using social media and we were using streaming services. And those companies were doing great and they hired a ton of people and they pulled forward a lot of activity. And their earnings have been pretty lackluster. I mean, if you look at this earnings season, the fourth quarter, the S&P had an earnings contraction of 2%. But if you threw out the tech companies, you had an expansion of 5.5%. I want to buy tech. What I really want to buy is secular growth. When I say secular growth, I'm saying is growth that happens in a slow growth

economy that doesn't need a good economy to grow well. But when I look for secular growth, that doesn't need a good economy to grow well. But when I look for secular growth, surprisingly, tech doesn't seem to make it on the list particularly well. You find things in health care. You find things in staples. You find things in consumer. And normally, tech needs that charge. But it just doesn't look like it wants to right now.

How should investors protect themselves against inflation? And maybe what I'm asking is, how shouldn't they do it? In other words, is just having exposure to the broad stock market enough? Is there something special that you ought to do for inflation protection? And do you think there's mistakes that people are making there right now? Well, let's just start with what inflation is likely to be over the next year or two. Let's just assume that it's going to run three and a half or four. And you can get a six-month T-bill at something in the ballpark of 5.1%.

So that immediately gets you a positive real return. So if you're looking from an equity perspective, you can say which equities are naturally, do they do best when inflation is going up? And that would be things like commodities, companies, whether it's energy or mining companies, and even industrial companies. But you can look at it differently and say, all right, the first three and a half or 4% return I'm going to get on anything, stocks, bonds, real estate, whatever it is, that's just going to keep me in the same place because all I'm going to do is offset higher prices. And the only real return I'm going to get, either return after inflation, is anything I can

do better than that three and a half or 4%. And my prediction is that the stock market is going to be flattish this year. So it probably, as an overall, probably doesn't pull it off. And then you just have to pick your spots. Like I said earlier, I think you do it better overseas. I think you do it better in short-term bonds. But if you, in general, just want to say which things have the highest correlation to rising inflation, there's no question it would be old you know, old economy, energy materials, and industrial names. What about this game of fiscal chicken

that the Congress might be playing in the months ahead? What do they teach you in stock strategist school about how to model that in your numbers and what, as an investor, you know, it seems like an outcome that could be either way and could be really severe if it goes in one direction. Should people be worried about that? Yeah. So when you go to strategy school, the first, the first thing they tell you is don't pay attention to these kinds of

headlines or, or what they actually tell you is, is to, you know, ignore the world is coming to an end kind of potential outcomes. Because if it happens, you've got to route for it anyway. But if you look at this situation in terms of the debt ceiling and all, if we do trip it, it's a really bad thing. And you have to assume that smart folks in Congress, the administration are aware of this thing.

And no different than any other negotiation, everybody feels like they have the most leverage when they negotiate up to the last minute. So I would expect that the market's going to continue to feel some tension around this, but the likelihood that it goes over that proverbial clip pretty low. And if you look at where the VIX is, the VIX being a measure of how much hedging is being done and the cost of putting on a hedge, the VIX below 20 right now is basically telling you that the market doesn't really think that there's really big macro risks to worry about. On the other hand, if the VIX is low, it also means the cost of hedging is really low. And what you could easily do is buy an out-of-the-money hedge on the stock market. And if this thing does go bad, you can buy that hedge for very, very little today, and you'd end up making a lot of money on it.

Last question, and I'll be happy for any thoughts that you want to add on this or other subjects, but just for that long-term saver out there that takes a very simple approach, they plunk their money into the market week after week, and they're not worried about the downturn this year, but they want to know, are we in good shape in general for that saver for the next 10 years or the next 20 years? When you look at the very long-term trends, are you optimistic about the future direction of U.S. asset markets or world asset markets? If I look at, so I'll give you the short answer and then I'll kind of back into it. I think that returns are going to be weaker for the next decade

or two decades than they have been for the last 30 or 40 years. So let me kind of start with that conclusion. Now, let me give you the setup to that. When Volcker beat up on inflation in 1982, 1982, the interest rate didn't immediately drop with a fall in inflation. It took about 30 or 40 years where interest rates steadily fell. And that meant that you had this beautiful tailwind behind the market because the value of every cash flow imaginable, the cash flow you got from bonds, the cash flow you got from real estate, a private business, stocks, it didn't matter. They re-rated higher. Their multiples went higher. Their valuations went up. And the best decision you could have made in any asset would have been to borrow more money and buy those assets on leverage because the cost of capital fell for 40 years. Now, we're starting with, you know, and interest rates are a little bit higher, but we're starting

with interest rates lower as opposed to where they were, let's say, in the early 1980s. The other thing is we've had this wonderful benefit of increased globalization for the last 25 years as we've been able to buy cheaper parts and cheaper goods abroad, which was just a huge benefit. It kept inflation super low. And I think that that environment is going to be more challenging going forward. Demographics are weaker. The population in the U.S. is aging, the population in China, this was the first year that China actually had the population shrink. So they're no longer likely going to be the same growth engine. So a lot of those things that resulted in just extraordinary equity returns or returns for businesses in general are probably going to be a bit harder to come by.

If you were to say, would I be a buyer of stocks with a 10-year horizon? Sure. Do I think the U.S. with that kind of horizon is the global winner? Yeah, we're more innovative. But do I think it's going to be as wonderful as the last 20 or 30 years? I think that that's going to be really hard to beat. Thank you, Jonathan and Fred, and thank all of you for listening. Jackson Cantrell is our producer.

Subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts. And if you listen on Apple, please write us a review. If you want to find out about new stories, new podcast episodes, not nude podcast, new podcast episodes, you can follow me on Twitter. That's at Jack Howe, H-O-U-G-H. See you next week.