The Dividend Cafe - TBG INVESTMENT COMMITTEE REUNION EDITION – June 9, 2020

Episode Date: June 9, 2020

Is the market about to go through a period of “rotation?” Growth vs. Value, Large Cap vs. Small-Cap, Cyclicals vs. Defensives - does it even matter? Our investment committee is back together, sheltering in place at our own studio, bringing you our perspective on all these subjects and more. Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, weekly market commentary focused on dividends in your portfolio and dividends in your understanding of economic life. Hello, welcome to the Dividend Cafe Investment Committee podcast, our whole group back together in person. Okay, when is the last time we did it? It has to have been Februaryb february because we didn't do this together in march oh together no we did we did uh one together in march by phone and we did and we did the zoom one in may i think so yeah i think we've done a couple together

remotely but i don't think we've been sitting here together since february it sounds right yeah because early march i don't think we did this i was in new york that one week and so here we are of course we've all been talking every day uh i would guess that our electronic communications uh oh throughout the quarantine period were up about five times from normal on a day-to-day basis of our texting and emailing and our various things but um but you know just sitting down here together doing our podcast i know it's what our listeners desperately want is for us to be back here to share the good news uh so yeah we um we have a lot to get caught up on i actually don't want to spend our time

really just focus on the obvious thing of how the market was way down and then the market went way up. And I've been talking about it every day in our COVIDandMarkets.com. We addressed what was going on in market recovery in our last podcast and some of the particular themes that we had through the period. I think that the subject of why markets would have gone up, despite the fact that economic recovery is still playing out and it's not rosy out there, has been really well addressed. Obviously, there's things that will come up that will be related to that. But particularly, there's a theme going on right now in the markets that I want us to talk about here today. written on the markets that I want us to talk about here today. And it has to do with this so-called rotation story. The idea that yes, markets have gone up, but maybe either what is going up is rotating, changing, like before it was X and now it is Y. And we'll talk about what

these variables could be. And then talk about whether or not that rotation story is something that is actionable going forward. Do we want to look to small cap more than large cap or value more than growth or a certain sector more than the technology sector? Things like that. Are there various things rotating in the markets that represent something actionable to us? And I guess the fact of the matter is there does seem to be some changing of what's leading the market in this rally, but that doesn't necessarily mean that it's actionable. So that's what we're going to kind of unpack and share our own views on and so forth. I'll start with you, Brian. Is there a real rotation going on or is this a sort of technical, transitory,

rotation going on or is this a sort of technical transitory just uh week week or two week change or is this something more uh paradigmatic rotation between uh let's start with that so-called growth and value because i think that's the one that'd be most profound certainly the distinct the delta between growth as a leader and value as a laggard is as significant as it's been going back to before the technology bust when I was entering the business. So that's the one that I think is most media sensitive and perhaps most of interest to clients. But yeah, we should, we'll unpack those other categories as well. Yeah, no, I mean, I think that's a good point to define what we're talking about. So we look at just the index, so like the Russell 1000 growth index versus value. There has been a rotation.

And is it long lasting and durable? Time will tell. You know, that rotation tends to happen because value names tend to be more cyclical. And so if we're actually entering an expansion and some accelerating economic activity, then I would say it is durable and it would be lasting. And the other thing I think you had in Dividend Cafe last week was just the relative outperformance of growth over the last 20 years. It's never been this high since 2000.

And so it's not about, well, is that going to change forever or not? It's more about, is that really sustainable? well, is that going to change forever or not? It's more about is that really sustainable? Is it sustainable to have a 30-year outperformance of a growth index at 6.5% above the value index? It's not normal for that to happen. And so, yeah, I do think that there will be a rotation. I think it will be long-lasting.

Is this the rotation? Is it happening now? Yeah, I think it's starting to happen now, but I'm not going to say it is going to go in a straight line or anything like that. But I think if you look at the yield curve steepening, you look at economic activity tomorrow being a little bit better than it is today because everything's shut down and it's going to reopen. That should bode well for more cyclical type of names, and those tend to reside in that value index. Okay. I guess, Julian, from the vantage point of the dividend growth equity you had up research on is irrelevant to us. I mean, in other words, are we agnostic about growth versus value for any name?

And so does this, to Brian's point, it's the Russell 1000 growth, Russell 1000 value, how we're defining it. Are those definitions kind of impertinent to our worldview anyway? I would say yes and no, I guess, because it depends. I mean, our horizon is pretty long-term, and the more long-term you look at this, the less relevant it is to look at probably at value against growth at performing. So these are kind of big moves in a shorter term

if you look at a year or six months. But if you look over a 10-year investment horizon, I guess at the end of the day, we start from it's a bottom--up approach and we pick the stocks. But is that true that the growth versus value story, if we believed in it, which you were about – you're making the point we're bottom-up, so it's not our approach. But if you were top-down looking at that, I don't think it's been six-month or one-year stories, right? I mean after going into.com, the growth versus value outperformance was at least five years. Coming out of.com, the value outperformance or growth was at least eight years.

And then really ever since, particularly with Fang's ascent to 2013 or so, it's been longer term in that sense, right? Yeah, that's right. It's been longer trends, I guess. So I think we'll be portfolios for even longer term than, you know, more than like the next five years. I would say like we'll be for the next 20 years. And then it's probably... I'm going to have grandkids someday. I got a

70-year timeline for my... So the impact on the longer even horizon is probably less. when I think about, you know, change of value at performing growth, I'm wondering if that's going to be the case when you are still in an environment with money being very cheap and you're able to fund all these new technologies.

People are throwing money at them and they're disturbing the existing businesses and they're able to stay in business 10 years without making any money. So that's a reason why you could think that growth could continue to add value because they could keep funding themselves very cheaply. Yeah, I would just happen to just say we're not index investors ourselves. And so when we're talking about some of these things in these unique changes, we're buying stocks based on they have both growth characteristics

and also they're value-oriented because they tend to be dividend payers and things. But so, you know, I mean, I think it matters and it kind of does. But I want to unpack something, Julian, because I'm not sure if I agree that the reason for gross outperformance has been a result of low rates. I think it's a really acceptable first thought, right? That it makes sense, low cost of funding. You can kind of experiment more and have some bad situations that otherwise you wouldn't be able to get through.

But ultimately, is it true, like with the FANGs, was the low cost of capital really relevant to their violent outperformance? We can't say we're not going to make this simpler for our compliance people. We're not going to get into stock names. But when you look at the largest e-commerce company in world history, for example, when you look at streaming on a VC basis, private equity basis, some of the early funding things, does it maybe allocate capital? Well, we know it does, of course. some of the early funding things? Does it maybe allocate capital? Well, we know it does, of course. But when you get into mature indexing, is the low PE the significant driver? I'm not sure.

No. I mean, I think if the risk-free rate is lower, you can argue for a higher multiple on growth names. But on all names. You're not talking about 20 or 30 times earnings for a lot of the names you're talking about. You're talking about 50, 60, 100 times. So I don't think it's that relevant. What's your take, Dan? Right. So I think the low rates, I think it's two-dimensional the way you look at how it affects growth names. Number one, like Julian said, growth names tend to reinvest more. They tend to be negative free cash flow.

They're focused on top line revenue growth. So it's more a story about them needing to invest large amounts of capital. And if that's cheap, I think that helps them grow that top line that their investors like. And number two, as Brian alluded to, if you're doing a discounted cash flow model, which you project out the cash flows of a company, and you apply a certain discount rate to model, which you project out the cash flows of a company, and you apply a certain discount rate to that and bring those cash flows to present value, growth names tend to be very, very sensitive to the discount rate. So if you're in a secularly declining interest rate environment, just from a cash flow duration perspective, that tends to

disproportionately affect growth names. So that – I mean it's hard to say exactly what the factors are that have contributed to the outperformance of growth names over value. I would argue for the movement down of a discount rate impacting growth, not just the mere existence of a low discount. Yes, exactly. In other words, that benefit would wash out. Right, exactly, exactly. In other words, that benefit would wash out. Right, exactly, exactly. So the trending down of the discount rate has significantly helped growth names just from an arithmetic perspective. And as Brian was talking about, some of the growth, that performance over the last 10 years, it's been over 500, almost 600 basis points. It's been over 500, almost 600 basis points.

And I also think it's really important to talk about the definition, the classification. What's widely quoted out there on the street and in the media as far as what determines growth and value is just a simple factor, and it tends to be price to book. And, I mean, that's an overly simplistic and you can argue a very flawed measurement. But you have to really understand what is being talked about when people throw stocks into a growth bucket or a value bucket. I mean, we consider value as essentially, you know, where the intrinsic value is more than what the price of the company is being traded at. But the marketplace and what's reported out in the media is just essentially a company that has low price to book, and those aren't necessarily the same things. So I think that classification is really important.

And just to follow up on that, I think a big difference as well is that if you look at the balance sheet these days, the companies that are much more technology-driven, they look very different. They are asset-light. A lot of the value is in the IP, in R&D, and these are not necessarily items that go on the balance sheet, but a lot of them go on the P&L directly. So if you look at it from a price-to-book value point of view,

it's very... Tech companies look very different. Yes, right, exactly. Well, Robert, is your take that this distinction in this whole conversation is sort of silly? Or is it that – do you think that there is relevance, not just even for us because, as Julian said, our methodologies bottom up. We're looking at companies that have a long-term story of growing free cash flow and distribution thereof. But should the media even be talking about it? I mean, does it even matter to that kind of mom-and-pop investor at home

who's not a client of bonds? I don't think the media knows any better but to talk about it that way. And for better or worse, the way that we look at the world, the dividend growth investing, it tends to overlap more with value names than it does with growth names. So we sometimes find ourselves talking about both categories a little bit regarding the dividend growth and the rotation. I mean, we started to see a rotation to value, let's say last year, right? When we were talking, you know, treasury yields were getting lower, people were saying, Hey, you know, what are we going to do for yield and income? I mean, that story exists now to a greater degree than it did then, right?

I think a little bit – But as that zero bound has come in in the last few months and as all the extra accommodation monetary policies come in, utilities have been the worst performer, highest yielding sector, right? So it isn't so much a yield grab yet. And I think there's a reason for that too. And this is more anecdotal than anything. I mean, as prices collapsed through this whole crisis, what have you, people were scooping up a lot of different names even within the growth categories as well. So there was a lot of buying across the board. So I think that kind of put a little bit of a pause on what we perhaps saw as a rotation into the value or the dividend growth names.

But I think that will continue. I think a lot of the utility underperformance, relatively speaking, could perhaps be attributable to that. Yeah. No, I agree. I agree. I think that there's a sense in which there's self-fulfilling prophecy. The media talks about this for the same reason it's not relevant to investors. And that is that it's all part and parcel of a sort of, not celebrity, but sensationalistic. It grabs a headline. It has a certain kind of a sex appeal to it. Dot com was very much that way. And meanwhile, during dot com, and particularly in the year 2000, let's go back to calendar year 2000.

I think you guys all know the answer. And you're really going to know now because I wouldn't be asking if it wasn't an obvious trick question. When the NASDAQ dropped 70% in 2000, was the Dow up or down that year, that calendar year, 2000? Down. No. Wow. Yeah. Even.

Dow was up. About a percent or two? No. Pretty significantly. Yeah. And the value, quote, unquote, index was up double digits. Yeah. Well, that was when value at that point started to really outperform. 2000 was basically the bottom of the financial crisis.

But my point was it was a violent reversal, and I don't have any reason to believe we'll have a violent reversal now. I don't have a reason to think we wouldn't. It's financials. But see, that's a very good point, is that you had a higher interest rate environment. Dotcom didn't blow up because rates came up then, right? It was – and yet the financials performed very well in that rate environment.

We had different things going on with housing. That was sort of the beginning of a housing bubble. The mortgage world was totally changing in 2000. And really the economy wasn't bad. You just had a bubble burst. Yeah. And so I think a lot of this subject as to what will happen, it really depends on what the reason for growth coming down is. Right now,

the bubble hasn't burst. As you had an entire systemic COVID moment, if anything, the high valuation thing and high growth tech outperformed. But at some point when 110 PEs go to 50 PEs, does that money go into value? I think it probably would. Yeah, I think so too. I think that this pandemic is very unique. I mean, so was dot com. Like you said, just massive bubble in technology essentially.

But this downturn, it was a health pandemic. And the company, the sector that was sort of insulated from loss of revenues and things happened to be technology as well. So they sort of had kind of a double benefit, I guess, in that growth sector. And as we kind of come through the end of it, again, it's back to where are we in the economic cycle? Are we contracting? Are we expanding? We were contracting, and now we're starting to expand potentially.

That should bode well for companies tied to more cyclical earnings. I wonder, Julian, and you remember 2000. I wonder if there's a distinction with this growth tech. Let's not call it a bubble, but let's just call it a very high valuation period versus 2000 in that even if I think these names are very frothy and expensive and so forth and have a longer expected rate, a lower expected rate of return in the future because of their starting point now they are big names they are profitable names 2000 that was the most indiscriminate nonsense in world history no one was distinguishing between the biggest e-commerce player in the world and their buddies.com that they started in their basement well you know what i mean yeah where i got we talked about this earlier podcast last, retail investors said no to WeWork. They've said no to certain IPOs. You've had a lot of really challenging rejected IPOs about big rideshare companies and things like that.

Are we maybe just a more discriminating retail investor now than we were 20 years ago? It's clearly not the same. The tech sector today can compare to what happened in 2000. You know, valuations were crazy. And I mean, you could compare it to maybe the Bitcoins of like two years ago where anything, you know, like there's some name,

they just start saying, okay, we're going to mine Bitcoin and then the valuation goes up by 300% the next day. So that's like, I remember like anything that has kind of internet related, going public would have crazy valuation right away. So now the difference is some of these tech companies, they make 20% of the S&P profits.

I mean, they make, you know, you see headlines that say, well, the top five companies in S&P make more profits than all of the companies of France and Germany combined. And it's true. And that's the reality. It says a lot about France and Germany combined. And it's true. And that's the reality. It says a lot about France and Germany. Yeah, exactly. I think it's important, too, to break out those big names, too, because they do constitute such a large portion of

the S&P and what have you. And no question, there's some real innovation going on there. There's profitability and what have you. But there's also a market share concern down the road, too. I mean, how big and how successful can you get without people wanting to jump in?'ve seen it on the e-commerce regulatory and regulatory certainly come and that's that's bipartisan too you know um but i i don't know i i see still quite a bit of the the FOMO the fear of missing out going on i mean we saw recently you know a coffee

company that was fraudulent right that it was it was foreign right but people were just jumping into this kind of thing we saw it with it with confused ticker symbols for a couple of different companies leading up to this thing. I think it's still very real, and I think the indexification of the markets has contributed to that largely. But I think the value thing will come into play. It's like the fool me once, fool me twice type of deal. I think people will get sick of losing money eventually. So what would be, when you look at the different categories of potential rotation right now, what would be one that is a bit more of interest to us? Let's switch gears to the large cap, small cap arena. This is an interesting subject. Small cap was pummeled

during the COVID hysteria of March. First of all, you had obviously every market index getting hit. And then within the small cap space, you have something in the range of a third of the Russell 2000 companies that don't generate profit. So if you don't generate profit pre-COVID, you really, really don't generate profit when you have no customers or people allowed to leave their house and things like that. Now, the argument for small cap in bad periods has always been it's less dependent on global circumstances. It does not suffer as much when the dollar rallies, things like that.

But small cap got killed, and now small cap has begun to catch up to large cap. And I remember being taught in the business that out of recessions, small cap always outperforms large cap. That has been true every recession that I've invested through and every recession I've studied. The reason why I'm hesitant on this is that this recession doesn't feel like a regular recession. It was not cyclical. It was event-driven. It was a bottom falling out of the economy and then all of a sudden a quicker move back higher. Regardless of where we end up going in the shape, a big portion of the recovery is clearly going to be very sudden. So I don't know. What do we think here about small cap? Anybody can take the mic. Yeah, I'll go ahead.

As far as small caps, and again, it's hard for us, as Julian mentioned, David mentioned, being bottom-up stock pickers to talk about groups of stocks that have some sort of – we're grouping them together based on one characteristic being that their market cap is below a certain threshold or their PEs within a certain range or whatever it is. But as far as if we can offer some insight as to what a group of stocks is going to do over the medium to short term, I think it's very hard to do. But to offer some opinions about small cap, I think that it does appear that there's less uncertainty if you're investing in a name where the revenues are generated primarily

in the US. It looks like this tension between the US and China and the moving of supply chains is going to be a challenge to capital markets for quite some time. And if you're a purely small cap U.S. investor, you insulate yourself from that. So other than that, I'm not sure I have some particular insight, but I think that that's going to matter to reduce some uncertainty. Yeah, I agree with all that. I mean, I think in your first point, we're fundamental bottom-up stock pickers. And whether there's a company that fits below a certain markup cap that would fit our criteria that we would like to own, I would love to own that company, and we do. The fact that a small cap has now started to outperform a little bit because it's so much underperformed is great. But would we shift portfolios just because of that phenomenon? No. is great, but would we shift portfolios just because of that phenomenon? No. So again,

I mean, it's just back to bottom-up stock picking. And sometimes those things, most of the time, fall in that sort of value category, but sometimes maybe it's more of a GARP, growth at a reasonable price kind of category, sometimes mid-cap, sometimes small-cap. And there's different periods of time when all those different subsectors sort of outperform or underperform, but it's not necessarily driving allocation decisions within the portfolio per se. But it's not necessarily driving allocation decisions within the portfolio per se. Julian, is the reason for small cap outperforming large cap recently because it underperformed large cap before by nature of the regular old overshooting? Overshot on the downside, so it's playing catch up. I was going to say that. if you look at large cap versus small caps the ad performance and the performance theme has to do a lot with fear

and greed and so typically like human nature when you have a crisis like COVID you want to go into what you feel safe owning and you feel like large cap companies the big names you know that are stable are going to do better, they have good credit rating they have good balance sheet, they're huge

and they're more diversified. And you know them well, so it's kind of natural to always go back to these large cap. And so that's what happened. And now that you have the reverse, like back to risk on, all the emerging markets,

small caps, going where you feel a bit more risk and more uncomfortable, that's where you're going to find the alpha or the outperformance. I think it's very human nature driven. Yeah. So, Robert, would you recommend that a high risk tolerance investor consider a larger

weighting to small cap right now in a tactical sense? Or do you think the weighting, the relationship between large and small cap within one's equity portfolio should be reasonably constant regardless of where we are in the recessionary cycle. You know, whether it's the model or the kind of the tactical approach, I think the discussion should be had. I mean, personally, I would favor a little bit more allocated towards the small cap space. I think it's an appropriately, dare I say, undervalued sector. There's a lot of potential headwinds there, and I think it could be a good opportunity

for those that have the right risk tolerance or appetite for it. I think it could be good. I think that's an interesting point, that even though we are bottom-up pickers, it's still helpful to realize what tends to do what in certain cycles. If growth has outperformed value, what that tells us is that maybe there's certain opportunities for selection in value, or maybe there's certain opportunities for selection in small cap. We wouldn't obviously pick a small cap name just because it fits cyclically. That was my point. Right, right, exactly. But if we understand the nature of how things move in relation to each other in different cycles, I think it helps us where to look for certain names. The cycle aspect is really interesting that you brought up about how certain things recover coming in or out of cycles.

But is it a business cycle or was this kind of a mandated? So how do we look at that? It's so very different. How do we look at that? It's so very different. What I suspect, and you guys know that our own strategy in small cap has just outperformed wonderfully, both in the really good year of 2019 and the really bad year of 2020. But see, I suspect what happens is that in a big sell-off that was so event-driven like that,

there's no discrimination. And so the company fundamentals and cash flows become irrelevant. It all sells off together. And then all of a sudden when the kind of dust clears and things start to recover, the reality is that well-run companies with more defensive business models just simply got a chance to come back stronger. But then I think of it, and now I'm switching categories a little, I do wonder, are there some small cap biotech names, healthcare names that are tactically relevant in this particular season, M&A opportunities, things like that? It's hard to make investment policy out of that stuff. But, you know, the pond of opportunity for acquisitions is largely going to be small cap names, right, Julian? Yeah, definitely.

I mean, we haven't seen too much M&A. I guess typically boards don't feel comfortable doing an acquisition and writing a check in this environment, but you're starting to hear people talking, writing a check in this environment, but you're starting to hear people talking. And I wouldn't be surprised if in the next six months, you start seeing much more M&A. Interest rates are staying at zero.

Even now the economy is reopened. Interest rates are staying at zero. There's an awful lot of liquidity sloshing around. And Elizabeth Warren is not going to be your president. I think M&A is... What we've seen, we've seen a lot of refinancing. It's amazing to see how many companies have been able – how much they've been able to raise and secure, expand maturities, lower the rate, and just beef up their liquidity to be able to – Trillion dollars of high-grade corporate debt refinanced more advantageously,

improved balance sheets, and lower cost of capital. So what happens generally next? M&A. Yeah, or buybacks. Well, that's not going to happen. But that's not going to happen. The pressure on buybacks right now is why I'm more bullish on M&A. These guys can't do nothing with their balance sheet.

They have to do something. Well, they can also pay more dividends. No, we'll take that too. But that's a given. But I think that to the extent that our corporate treasurers that are not as dividend-friendly as we want them all to be, they're still deal junkies. And by the way, I don't even say this pejoratively. There is M&A that should be done. M&A that should be done.

There are small cap R&D operators that some of the big cap pharma and biotechs right now can buy on the cheap and be rewarded for buying it. That's my take. I think you'll see M&A pick up for those reasons too.

Like you mentioned about the cycle, I agree. I don't think this has been a regular economic cycle at all. And it's just, as far as market movement, it may, well, it doesn't even look like that because it's been such a short-term reversal. So if you're looking at this type of downturn from an economic cycle perspective, I think you've got to be careful because it'll lead you to pretty inaccurate conclusions. I completely agree, and I think

all of those reasons that we talked about, low interest rates at zero, and all of the money that's been put into the system, both from the Federal Reserve and what they've done, the extraordinary measures they've taken, and on the fiscal side, is why you're seeing the market doing what it's doing, and I wouldn't get in the way

of it you know as they say don't fight the fed and and that liquidity is what's driving some of these asset prices and you're right it wasn't an organic recession from a you know from from those reasons it was self self-imposed now so here's here's that's a really good segue to the third category rotation that i want to bring up which would be the so-called cyclicals versus defensives. And that line of reasoning would lead one to believe you would want less defensives and more cyclicals because it's full steam ahead, Fed, all those types of things. Yet we took a more barbell approach. We wanted really high-quality defensives to anchor a portfolio,

and we wanted opportunistic cyclicals where we thought that they were mispriced um is it either or should it ever be either or and that's to me the mistake i think the media makes in this narrative and a lot of asset allocators too i hear guys on tv and you assume somebody's paying them and it's just the weird this binary approach cyclicals versus defensives strikes me as a really good way to blow somebody up. Julian, why don't you take this first, and we'll go around the circle. Is this binary? And if it isn't, does the both-and nature of it require some tactical consideration?

If you really go one way or another, that means you're making a big call into where you think you are in the business cycle. And I don't think it's something that's really predictable. You think that we've been calling the recession, like people have been calling recession for how many years? And it finally came, but was it even a real recession? It's just a self-inflicted black swan event. You didn't hear a lot of the perma bears four years ago predicting we were going to have a recession because of a self-induced quarantine? Yeah, I must have missed that one. So, you know, it's like it's really hard to predict what the business is going to be like.

I mean, it looks like they're getting longer and longer. In Australia, they haven't had a recession in 20 years. So I think the idea is you want to have something well-balanced with, you know, both cyclicals and defensive, basically. you know, both cyclicals and defensive, basically. And then you can try to, you know, on the margin, decide, okay, maybe this is a time where we think we're, you know, closer to the, you know, end of expansion period, and I want to have more defensive,

but it's really hard to call these things. I think it's all about valuations of those two things, too. I mean, you find more value, and cyclical names are more beaten up, and the intrinsic business is good, and you want to own them. And if those defensive sectors are more expensive, and, you know, maybe you would be trimming them. And if those defensive sectors are more expensive and,

and, you know, maybe you would be trimming them. So like to your point, I think it's about tilting, but I don't think it's necessarily what you're seeing on television, which is, you know,

you're, you're dumb. If you don't have all of your money in these technology companies in this period of time, or you're dumb, if you're not now going all into cyclicals, it doesn't, it doesn't work like that.

Well, like you would say, they would probably about, you know, the analogy to football, you want the defense and the offense, the cyclicals for offense, defensive name for defense. Now, were you meaning football as an American football there?

American football, yeah. Okay, because it works both ways in that sense. That's true, yeah. So, Robert, I'm kind of eating the witness here a little bit, but let me ask you a question. Do we care about, quote, unquote, outperforming an index? Is that a driver of our financial goals for clients? It's not. And so is the cyclicals versus defensives really a byproduct of this, quote-unquote, outperformance cult?

What would make somebody care about over-weighting cyclicals here and under-weighting here if they weren't playing this nonsensical game of outperformance? It's a keeping up with the Joneses type of thing. And just regarding the cyclicals defensive, I mean, some of the more cyclical types of things can be extremely defensive. Look at, I mean, the defense sector, so to speak. I mean, that's dependent upon factors beyond just a market cycle. It's government revenues, things like that. And then even within, you know, specific, that's why we love bottom up.

I mean, look at the financials. I mean, a company could be very dependent upon net interest margin for revenues versus one that's fee dependent so i think it's i i think even more so than growth versus value the cyclical defensive can be very irrelevant in practical applications we ran into a situation too again not going into names that you guys will know some of them where we looked at it said here's a cyclical story that's really strong really well priced oh but there's some china exposure we don't like. So you had to look to an extrinsic factor that may or may not have been relevant. Might I call that real value investing?

I think so. It's certainly fundamentalist, right? So, you know, all that to say, at the end of the day, is a person who is just sort of being organic in the way they approach bottom-up selection, and they're going to end up with a portfolio that has cyclical versus defensive weightings. But is that investor very likely to have a period where they outperform and a period where they underperform? And that's just the way it's going to be. Absolutely. I think that it's very hard to say from period to period what's going to outperform what. But it comes down to something that Robert said, which is extremely important, is that real value investing. And real value investing is trying to get an understanding of the long-term earnings power of a business relative to what the stock is trading at

currently. And understanding why maybe there's a gap in that intrinsic value versus what that stock is trading at. So I think that if you approach value as a philosophy more than value as a factor, I think that is real investing work in our opinion, and it's not investing based on a formula or a measurement or anything like that. And that's investing for the long term. I agree. And I think that when you guys go back to where we were in late March and we kind of reallocated some things in the equity portfolio,

I believe that there were names that would be considered cyclical that we added to at really low prices. There would be names that we considered defensive that we added to. And I don't believe that that was ever done out of a call on, well, cyclicals are going to lead or defensives are going to lead. I think it was done out of total agnosticism about that question, but a high conviction that you needed defensives and low beta and high quality balance sheets.

If the COVID moment had lasted another three months, if markets were going to stay down all the way through the fall, you would have wanted a lot more of those lower beta names. As it turned out, they did reduce high volatility. And by the way, it doesn't like they've performed badly in the recovery. Some are at all-time highs and so forth. It's just that you got a lot more juice in recovery from some of the higher beta names. And I think you look to some of the alternative asset managers that we added, and even the banks.

But that's the interesting thing, banks cyclical or defensive, they're cyclical names. There's been periods where they were considered more defensive, more boring balance sheet value plays. I think all this vocabulary stuff is really messed up, not just in the COVID moment, I think it's been distorted for years. Yeah, decades. I mean, it reminds me of the way things were described when we were first in the business. It was like the late 90s or the 2000s.

Everything was style box. It was value growth, small, mid, large, and you kind of set it all up that way in a matrix. But that's not the way we manage money, nor have we ever. And so it's just not pertinent. But I still think the media, people understand it in some sense or think they do, and so it's something to talk about.

We really have to go to the detail of the subsectors and the company's drivers because within a sector even, you look at the industrials, you have the difference that's part of industrial is very uncyclical

compared to civil aerospace, for instance. And that's in the same sector, so it's considered a cyclical sector, but some parts of that sector are not really cyclical. And at the end of the day, if you pick the stock that's really doing defense, you don't really own a cyclical stock. Exactly. That's an interesting point.

Within some of our technology names and within even some of our financial names, not the asset managers but you think some of the big banks, they have business revenue lines that are cyclical and others that are less so. Or even in consumer discretionary, I think we own some that I don't think are cyclical really. You've seen like in the 2008 depression, there were actually everybody was going to them even though they consider discretionary, they're not. They consider discretionary, they're not. Yeah, I have actually had sometimes our sector allocation reporting changed because the world's largest cheeseburger maker with a strong drive-thru franchise and a clown as their mascot, I don't consider a discretionary name.

I think you have to have it. It's a staple. And certainly the world's largest discount department store, the brick and mortar retail aspect, that can hardly be considered discretionary when the vast majority of products we've bought there are kind of normal, have to have household type items. And coincidentally, those types of names perform very well out of 08, is your point. Yeah, I guess that there is an argument to be made, but it's more anecdotal.

It's not foundational. As dividend growth investors who are fundamentally driven, who are value-oriented, who have to make bottom-up calls, can be right, can be wrong, have to analyze things, you do have a greater tendency to find names that are going to fit your criteria in certain sectors and spaces than others. But ultimately, I don't know why any money manager would ever want to limit themselves to just one particular part of the pool. You want to be able to go swim everywhere. And then those areas where

you do find something that might not normally be a space you're in, you could find a really great opportunity. So it's just this sort of binary approach. Maybe it is media driven. I also think it's largely consultant driven. There were factors in our business, you know, the mutual fund industry, the retirement plan industry, they benefited a lot from creating categories and boxes. And I'm not sure it was really great for investors. Certainly not investors who have financial goals, that think around their financial goals. Yeah.

I mean, from the standpoint of maybe forcing someone that didn't have the wherewithal to really know what they were doing in their 401k and they fit things into a box, I guess the benefit could be that it forced them to diversify a little bit in some way. But large scale over time, I think it was a hindrance, not a help. Yeah, we deal with classification issues constantly. I mean, the way certain things are defined, certain things are classified. I think it helps with communication as far as, you know, with the general public. Everybody knows these terms because they're thrown around a lot. But oftentimes, people define them a little differently, and the nuances are really important. But often, as David said, we have our own way of classifying things that may not reflect what S&P classifications are or what, you know, certain investment banks' classifications are or whatever it is. So I think the nuances matter.

And while classification makes things easy to understand, easy to study, when it comes to actually making decision-making or actually picking securities, the nuances matter, and those selections drive less off classifications than maybe most other style box type investors. That might be a really good summary for things, that we embrace classifications out of simplicity, out of convenience for clients, reporting and labeling, but they're not decision drivers. Perfect. Perfectly said. I like that. You summed that up quick.

Yeah. I try to get right to the point. Well, let's wrap it up, guys. Maybe just go around the horn and then I'll close it up. Any closing thoughts on this subject and just maybe your general market approach right now? Pretty crazy time, crazy three or four months. I don't think any of us would dare claim we expected markets to come back to this level in this timeframe. I do think that we all forecasted some version of a very quick recovery of markets and then a kind of period of grind and choppiness, flattishness. So maybe comment

on where you think we are in that cycle, where you think we're headed, and then I'll wrap us up. Brian, why don't you go and then we'll go around. Sure. I mean, the one thing I would say is you're right. I think it did surprise us a little bit on just the swiftness of the recovery. And I'm obviously grateful for it. But I will say that never at one point in all of our conversations, particularly in March, and all the things we're discussing and all the holdings and all the analysis that we were doing, there was never a point in which my conviction or any of our conviction was faltering on that we will get through it in a reasonable period of time. We don't know exactly when, but those decisions that we made all worked out really well.

I think we added a lot of value to client accounts. I'm very proud of all that work. And to some degree, is there a part of me that feels vindicated on going through that hard period of time and holding hands with clients and the whole thing and kind of coming through it? I guess I'll feel a little of that, but there's just no victory lap with it because markets will keep you, they will humble you. And so we're not completely out of it, but I suspect there's probably more positive in the future than negative.

Very good stuff. Julian. Well, it's kind of amazing to be here, but I guess we shouldn't stay cool because who knows how long markets will stay here. And if you look at the underlying fundamentals, there's like on the one hand, the economy, it's going to be a V-shape, a swoosh-shaped recovery. We're still quite far away from recovering

from the GDP on earnings front. That said, we own some of the best companies that are very well managed, strong balance sheet, and do business all around the world. So when they're exposed to Asia, they're already back to pretty much business as usual there. So I think the companies we own, I'm not worried about them. They're going to do very well.

And weather the storm, they're already weathering the storm. And coming out of this, they're going to be even stronger. It's probably more of an issue if you own for the moment bad businesses, but that's not what we own. So now I guess I'm interested to go back to looking at fundamental earnings and they're going to start guiding again probably next quarter.

They're going to be in a position to guide again and that'll be quite interesting. And then we're going to start people even starting to talk about, they're not talking so much about COVID anymore, but they're not focusing on thinking about the election. Now the biggest worry seems to be, we're going to start people even starting to talk about they're not talking so much about covid anymore but not focusing on thinking about the election now the biggest worry seems to be is it going to be a democratic sweep i don't know why you know that's now back to like other topics which is good as well that we are kind of moving away from the covid thing and back to things that are more traditional yeah yeah my my kind of observation

takeaway is more uh optimistic it's um what this this period gave us as advisors and i think our Yeah, that's true. coming out of it into what we hope becomes a sustained recovery. That's a more consistent way to grade your appetite for risk. And I think those are conversations that we love having now more than ever. And there's nothing that helps you not get caught up in the mood of the moment, I think, than really understanding the names you own. And I think the fundamental work that you do really shines in times when there's extreme amounts of fear because you understand the solvency of the company. You understand how they're going to make money in this market and how they're going to be a going concern and why you should continue to be invested in them. And I think that that work really pays off in this environment. So I'll leave it at that.

All great comments. No, I mean it's really – everyone had a different insight to share that I really agree with and I think is very important. And I'll close it at that. the question I feel about equities within a range of outcomes that are pretty reliable, that equities could come lower a few thousand points, they can go higher, retest new highs. There is risk out later in the year around some political side that was there anyways. If I were a betting man, I'd say companies are still going to be hiding the ball on earnings forecast a bit. And by the time we get ready to say, okay, let's actually look at where Q3 really is, then people are going to say, I'm a little more interested in how they're guiding for Q1

and into the future. So the earnings thing has been kind of punted a bit. But what I don't understand is why there'd be a lot of question marks out of COVID around the employment data, the economic recovery, what it means to corporate profits, and there wouldn't be about what in the hell bond investors are going to do. That, to me, is the biggest question in capital markets. I believe that the answer to what's going to happen to equities is the same as what's always

happened. There's going to be volatility. There's going to be reversals. There's going to be up-down. There's a forward-moving trajectory because corporate profits rule the world. I don't think the same thing about bonds. I think it's a paradigmatic shift as to where we're headed. Interest rates are in a very different predicament than they were a year ago. And the outlook for earnings, excuse me, for interest rates is very different for the next 10 years than it's been for decade upon decade looking backward. So I'm really curious as to how wise and effective capital allocators can approach fixed income in the months ahead, maybe even more so than equities.

Something to think about. Maybe I just teed up a new podcast. I think so. Let's do it. That's a great topic. We might have to do that. A 10-part series. That's all we have today for this, our reunion edition here in our studio in Newport Beach, California, of our investment committee of the Bonson Group.

Thank you, as always, for listening. Please direct any questions you have, any time, to any one of us. We would love to help you guide further on some of these things. We'll look forward to coming back to you again soon. In the meantime, check out covidandmarkets.com every day and dividendcafe.com every Friday. Thanks for listening. All right. Okay, great. Good work. Good work. Welcome back, guys. The Bonson Group is a group of investment professionals registered with Hightower Securities LLC, member FINRA and SIPC, with Hightower Advisors LLC, a registered investment

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