Bobby Blue: I'm Bobby Blue from Morningstar. It's been a difficult start to the year for many investors as equities and bonds are both down sharply, while inflation and volatility are higher. Joining me now to help make sense of the market is David Giroux of T. Rowe Price. David is the lead manager on the Gold-rated T. Rowe Price Capital Appreciation strategy and is a two-time winner of Morningstar's Fund Manager of the Year award.
David, thanks for being here.
David Giroux: Thank you for the invitation. Looking forward to the discussion.
Blue: David, let's start right there. Multi-asset managers have enjoyed strong returns from both stocks and bonds over the past, let's call it, decade-plus since the great financial crisis. That's changed this year as the S&P 500—now in correction territory—and the Bloomberg Ag is down almost 10%. How are you as a multi-asset manager positioning your portfolio right now through this period—from a stocks and bonds lens to start?
Giroux: First of all, I would say, if you think about the fixed-income sleeve of the CAF, we've never really been Barclays Agg kind of index. I know a lot of our peers are. We historically haven't owned a lot of Treasuries, we haven't owned a lot of mortgage-backed securities, and really—and many investment-grade corporates, we really don't own a lot of that. So, coming to this year, the largest portion of our fixed-income portfolio is floating-rate bank debt that is basically flattish on the year despite the equity carnage and the fixed-income carnage. I've never been a big believer that you have to have that Barclays Agg be your fixed-income allocation. We go where we think the best risk/reward is. We think bank debt is really, really attractive and high quality, high yield is also quite attractive on a long-term basis.
Now, having said that, though, to your point, rates have risen dramatically. So, we have started buying Treasuries. This would be the third time in the last decade we started buying Treasuries. We bought Treasuries in '18; we bought Treasuries in '13; and we started buying Treasuries this year. Treasuries today are about 8% of our portfolio, and our cash level has gone down, both by adding the equities as well as funding those Treasury purchases. We're going to take the other side of the argument. We actually believe rates, if you think about it, a three- to five-year horizon are more likely to be lower than higher. And if you have that view and now you're earning 3% on Treasuries, on five-year Treasuries, it actually makes sense to own a little bit Treasuries, which we do now.
Blue: Great. You mentioned coming into the year optimistic on floating-rate debt. Did you fund any of your Treasury purchases through that allocation? Or do you still have an allocation to floaters in that fixed-income portfolio?
Giroux: Yeah, we haven't sold any of our floating-rate debt at all. Essentially, our cash position, I believe, coming into the year was high single digits, low double digits. And essentially, that's going down to 3% to 4% today. And again, that's funded the Treasury purchases as well as increasing our equity allocation to take advantage of the dislocation we've seen in the equity market year-to-date.
Blue: You mentioned a little bit how you're viewing the rates story, but I'm curious from a credit perspective how you view the fixed-income market.
Giroux: Again, when we underwrite—every bond we purchase or every leverage loan we purchase, we do a very thorough underwriting analysis around that fixed-income instrument. And as a result of that, we basically say, "OK, there's a horrible recession, like a GFC kind of event. Is this security still money-good?" So, we own a lot of high-quality companies, a lot of software, insurance brokerage, things that are reoccurring in nature where the leverage level is a very, very small relative to the enterprise value of the franchise and the business is almost all or not very cyclical. So, there's not really one credit in all of our fixed-income portfolio, even though we own some high yield, we own leveraged loans, that we have any concern at all about their ability to pay back the loan or that it's not money-good. We feel very, very good about our exposure and the kind of credit underwriting we've done. I mean, we are lucky—not maybe lucky, maybe good—but we've never had a traditional fixed-income instrument default where we lost money during my tenure, and we don't expect to going forward.
Blue: Maybe moving on to the equity side now: We just wrapped up big tech earnings week, and with the exception of Meta, the market really didn't react favorably to many of the results last week. What did you learn from the reports last week as well as the subsequent transcripts from those earnings calls?
Giroux: The only exception I would make to that comment—the only exception I'd have to that comment would be Microsoft, which is our largest holding, and they put up a very strong quarter and the stock reacted positively. Microsoft relative to all the other big tech names has done quite well. It's come under pressure, but it's down, I think, down 13% or 14% year-to-date versus a lot of the other names that are down 20%, 25% year-to-date. If you think about all the other tech companies, I think what you'd say is, Amazon has probably been the most disappointing. Their AWS business continues to be very robust, actually better than we would have even modeled a quarter ago or what we thought was going to happen, both from a top line and from a margin perspective. The real disappointing side is not even on the top line, it's just the margin trajectory and absolute losses they're having today in their core retail business. That's really a big disappointment for us in all honesty. That is a business given their advertising business, given the scale advantages they have, they should be able to generate a mid-single-digit margin in that business instead of losing money in that business ex-AWS. I think it's a margin issue with Amazon on one part of the business. I would say that's been disappointing to say the least for us on Amazon.
And Google is a little bit different, right? Google has been probably the best performing since the pandemic of all these socks, maybe with the exception of Microsoft. And so, they just have difficult comps. But the fundamentals at Google, I think, are still very, very strong. It means they have tough comparisons here. Meta, you have more structural issues with the Metaverse investments being very, very large. You have capex becoming very, very large and impinging on cash flow, as well as some concerns around TikTok and what that does to the core Facebook franchise.
Blue: And it sounds like maybe Amazon is really the only one that the results led to a change in thesis. Is that fair to say? Or do you still have a long-term positive view on Amazon in that business?
Giroux: I think there is no structural reason why Amazon's core retail business should not be able to generate margins similar to Walmart. I think the concern that we have is just this may take longer than we thought to get to Walmart kind of margins. Again, Walmart doesn't have a giant multi – tens of billions of dollars of advertising business at high margin, Amazon does. I think part of the issue with Amazon in many respects is one of disclosure. Google tells us what other bets are. Facebook or Meta tells us what the Metaverse investments are, right? We don't know how much money Amazon is spending or wasting on Alexa or the satellites they're putting around the earth to provide broadband, right? We just don't know what those numbers are. We don't know what GMV is for Amazon. So, we think the core retail business should get a lot better, should be more profitable over time, but they're not helping the market, they're not helping us, in their disclosure here or their lack of guidance, if you will.
Blue: Anything else from this quarter's earnings outside of big tech that jumped out to you?
Giroux: I think what's interesting is I think everybody is convinced we're going to have a recession. If you ask 100 investors, 99 would tell you we're going to have a recession, which is kind of interesting because like six months ago, if you'd asked 100 investors, 99% would have said we were not going to have a recession, right? We go to these extremes. You see companies like industrials, semiconductor companies trading at very, very depressed valuations today because everybody is pricing this in. And I think going through all the quarterly earnings so far, there is really no sign in orders, sales, backlog, cancelations that we're seeing that recessionary risk coming into the numbers, and, that's I think, it's just across the board so far. Again, I would have taken the over, but there was a higher odds and zero that we were going to have a recession in the next 12 months. Now, I'll take the under that there's probably a less than 99% odds we're going to have a recession in the next 12 months. The market goes from extremes. We tend to take the other side of those extremes, which we're doing right now.
Blue: When I look at your portfolio, there's no real, let's call it, "obvious" inflation beneficiaries in it, things like energy or resource companies, that others might think of as having a really high beta or sensitivity to inflation. How do you as a PM design a portfolio that's resilient in inflationary periods? How do you think about that inflationary risk in your positions?
Giroux: One of the things I've always talked about is I think sometimes people look at the equity sleeve and a fixed-income sleeve independent, right? This is the fixed-income sleeve; this is the equity sleeve. We always look at them intermixed. We think about a total portfolio. The question is: Where do you want to take duration risk in a portfolio? Again, the vast majority of my peers take a long duration fixed-income portfolio with a lot of Treasuries, a lot of mortgages, a lot of investment-grade bonds with seven-, eight-year duration. We came into this year with a very, very low duration. We always said if inflation came with an issue, that might hurt our equities relative to the S&P 500, but our fixed income, again, much more floating-rate in nature and much shorter-duration high yield would benefit.
And to a certain extent, that's what's happened today. Energy has been a really important part of the market's return, I think up 30%, 40%, 50% depending on what index you look and what group. And so, we don't have a lot of energy. We don't believe in energy as a long-term attractive end market to invest in. Not good from an ESG perspective, not good from a cash flow perspective, very, very high volatility, historically, very, very high downside risk. Very, very low-quality companies. And so, we've chosen not to have big exposures in that area. And that's hurt us on the equity side. But again, we've more than made up for that on the fixed-income side by having a very short duration portfolio and being underweight those traditional fixed-income instruments that again a lot of our peers have.
I think that's the way I would talk about it. But I would also say, when you own a lot of high-quality companies like we do on the equity side, we do have pricing power on those companies. Company after company that used to get 100 bps of price is now getting 200 bps of price. We talked to a company yesterday that used to get 100 bps of price, now getting 300 basis points of price. So, the ability to push through price for high gross margin businesses, companies that don't have a lot of competition, they have really good niche products, we're seeing that benefit. Not every company has that benefit. And again, we have a lot of companies that are not pure beneficiaries like energy might or like a resource company might, but I think there's a lot of high-quality companies we have, whether it'd be industrials, business services, life science tools that do have a lot of pricing power that it will benefit them in the short term but probably also in the long term. But again, we're not big fans of energy long term. And while that may hurt us this year, I think that will help us over the next five and 10 years.
Blue: Great. David, thank you very much for joining us today and sharing some of your insights.
Giroux: Thank you.