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No Sign of Impending Doom in Market

Greggory Warren, CFA

Gregg Warren: I think the conventional wisdom right now is that this market's being driven by expectations for higher inflation and for an increase in interest rates. I'm not necessarily sure if that's the real reason behind it. When a market tends to go up over time, and we start hitting historic highs, there are people that are always looking for ways to take some profit. This just could be the sign that some people are taking some money off the table overall. When we look at the market as a whole, we see some good, positive signs out there. The tax cuts should boost earnings this year, should also increase the level of share repurchases. You've got a lot of companies out that are already saying that absent the tax cuts they're still going to see solid sales and earnings growth this year. It's not the normal signs that we would see of impending doom for both the economy and the markets overall. This could just be one of those more healthy corrections along the way.

One of the more interesting stats I did see this morning is that in years when the market's up more than 5% in the month of January, it tends to be up even more over the course of the year. 1987 was the one exception. That was the year where the Black Monday hit the markets in the fall. Our expectations for the U.S.-based asset managers is that we'll see somewhat of a high-single-digit to a double-digit gain in equity markets this year, so we're sort of buying into this long-term trend, as far as what the markets do in the course of a year.

We think interest rates will be moving up over time. Our base-case model expectation is a 4.5% yield on the 10-year note at the end of our five-year projection period. Now how we get there from here, it's going to be fits and starts. The Fed's really going to look at where the economy is, what the indicators are, what sort of benchmarks they're looking at. Janet Yellen had done a fantastic job over the past five, six years of navigating the market, not necessarily always adhering to the benchmarks that the Fed may have set for themselves, and we don't expect Powell to be much different.

Our fair value estimate for the market overall did come down from about 111% to about 104% last week. There are still pockets of available value out there, you just have to dig around a little bit. I think in media right now, overall that group is trading at about a 15% discount. I know Walt Disney is a name that's been out there highlighted by some of our analysts. We look at the advertising business, Interpublic Group is also trading at a decent discount overall relative to fair value. We also see some pockets of interest in healthcare REITs, some of the medical distribution businesses, and some other areas overall. I think the notion that because the market's overvalued or fairly valued, there aren't opportunities for investment, is not necessarily true. You just have to dig a little bit deeper, look at firms that have solid economic moats, and where our analysts' expectations are pointing to a good margin of safety.

With the asset managers, it's a little bit more difficult because right now we're trading at about a 95% of our fair value estimates. Our top two picks, long term, have always been T. Rowe Price, BlackRock. Right now they're both trading at big premiums to the rest of the group. They're not really trading at more than, say a 10% discount overall, so not really the kind of margin of safety we're looking for, especially for a group where they're highly tethered to the markets overall. That said, we've always encouraged investors to look a little bit further down, some of the second-tier names: Eaton Vance, Invesco, AMG, Cohen & Steers are always sort of top picks in that group. They tend to trade down a lot harder than the rest of the group overall during market corrections like we're seeing right now, so you tend to get better values overall.

Invesco, right now, is our top pick within the group. It's trading at about a 16% discount overall to our fair value estimate. On a P/E basis, it's trading at about 11 times this year's earnings--meaningful discount to the rest of the group overall for a company that doesn't deserve to be there. From an organic growth profile prospective, which for the asset manager is the market rewards, both organic growth and margins, the company's generating about 2% organic growth for the very, very low standard deviation. That's a stable provider over time, so I think people that step into this name right now will likely see some decent gains over the next 12 to 18 months.