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David Giroux: For Income, Look at Leveraged Loans and Utilities Stocks

The accomplished T. Rowe Price Capital Appreciation Fund manager on making good macro calls, finding quality income, and more.

Value stocks have taken their lumps in recent years, badly lagging those of faster-growing, pricier firms.

In a recent conversation on The Long View podcast, we asked T. Rowe Price Capital Appreciation PRWCX manager David Giroux how to make the right macroeconomic call and, just as important, translate that into a profitable investment thesis.

We also discussed the quandary that retirement-income investors are facing with bond yields plumbing lows and stock valuations looking elevated. Giroux offers his perspective on where T. Rowe is finding reasonably priced sources of income.

The complete podcast recording and transcript also cover a number of other topics, including how Giroux broke into the investment business, generalizing versus specializing, T. Rowe's recent organizational change, a chief investment officer's most essential tasks, portfolio construction, why growth-at-a-reasonable-price stocks go unloved, circle of competence, working with analysts, and more.

Benz: You've previously written about the linkage between economic forecasting and investing. People often struggle to predict things like GDP, inflation, and interest rates. But even when they get those things right, they may make the wrong investing call. And we saw a lot of that coming out of the global financial crisis where macro forecasters were correct that growth would be slow, but wrong in favoring bonds over stocks. So, is there a way to get both calls right and profit as an investor?

Giroux: Christine, I think it's a really good question. And it really goes to market inefficiency. We look at everything through a market inefficiency lens. And I think your point is a really good point. The market at times will take a view on a macro outcome, you know, we're going into recession, rates are going to go up, rates are going to go down. What you often find happen in these situations is that that macro environment, that macro view, it becomes the only outcome. It's 100 to zero--in 2008 in Q1, everybody thought the 10-year was going to go to 4 and went to 2, right? Every thought going into '18, we'd have a great stock market. End of '18, the market was basically pricing in a 25% decline, maybe pricing in a recession, if you will. So, that macroeconomic consensus is often wrong. And really what we try to do is when you get to the extreme where the market says this is the only outcome and it's already priced in, we tend to take the other side of that argument.

Again, in Q2 of 2018, when everybody hated utilities, we were buying utilities, because the risk-adjusted return looked so good. They were already at the lowest valuation in a decade--if rates went higher, you can have a lot of downside. But rates went lower, you made a lot of money. In the same way, in Q4 of '18, the markets were: We're going into a recession, we're going to price in a 25% decline in earnings. We went overweight equities to get aside of that, ended up being right. So, it's almost like when the market gets to these extreme views, you almost want to take the other side of it. Even today we find ourselves in an environment where the market is--we're going to have bigger inflows this year--that may play out. That maybe the exactly--but the market forgets about valuation. All those cyclicals that the market wants to buy today, they're already up. The thing is very high valuations not only in '21 earnings, but '22 earnings. So, really, what you want to be doing is usually from a macro perspective, doing the opposite of what the market wants. That's where the best risk-adjusted returns are, historically speaking.

Ptak: Many retirees are wrestling with the question of how to meet their goals when stocks and bonds both look rich, something we talked about earlier. In addition, safe sources of income are hard to come by and they can't necessarily afford a big drawdown. As an allocator of capital and someone involved in forging T. Rowe's market outlook, how would you advise someone in that situation?

Giroux: Well, the first thing I would do, and this is maybe a little bit of a plug, I mean, I would advise them to buy the Capital Appreciation strategy, because that's exactly what we're trying to do. We're trying to give you the best return possible with the lowest risk and the lowest drawdown risk. That's what we're trying to do for our clients on a long-term basis. But maybe more specifically to your question--stocks are expensive, bonds are expensive, where do you see value? And I would say the two areas we see value today would be like leveraged loans. Leveraged loans are floating-rate instruments. They have yields that are twice that of investment-grade bonds, 3.5 times the yield of Treasury bonds. You don't take any kind of interest-rate risk because they're floating in nature as we talked about, and they're exposed. They don't have a lot of energy in them, there's not a lot of energy-leveraged loans, there's not a lot of retail-leveraged loans. So, they get a pretty good index of companies, if you will. So, again, a 3.8%, 3.9% kind of yield isn't great, but relative to the alternatives I think leveraged loans makes a lot of sense. And T. Rowe has an amazing leveraged loans strategy run by Paul Massaro here.

I would also say--and again, I made a comment earlier--that if people are looking for income, not only income, but appreciation over a long period of time is, utilities today, where you can get 3.5%, 3.4% kind of dividend yield, where the underlying earnings for these companies are growing at 6%, maybe 7%, and the valuations are at 40-year lows versus investment-grade bonds. Those are two areas where somebody's looking for either income or looking for income and appreciation and not looking for a lot of downside risk, can probably do quite well.

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