Leo Acheson: I'm Leo Acheson from Morningstar. We're joined here today by David Giroux, manager of T. Rowe Price Capital Appreciation and winner of Morningstar's 2017 Fund Manager of the Year award for Allocation and Alternatives. David also co-chairs the asset allocation committee at T. Rowe Price, which is responsible for setting the tactical tilts within the allocation portfolios.
David, thank you for being here.
David Giroux: My pleasure to be here.
Acheson: Can you tell us a little bit about your outlook for the economy during 2018?
Giroux: I would say right now the economy looks pretty strong right now. We're seeing good job growth. In 2017, we had a very strong global economic environment. Most expectations are that it will continue into 2018, probably benefiting a little bit in the U.S. from tax reform and the incremental GDP benefits from tax reform as well. The outlook at least in the short term looks pretty good for the economy.
Acheson: In your portfolio you have a wide latitude in terms of what you can invest in. You can own stocks, investment-grade and high-yield bonds, bank loans, convertibles, to name a few. Can you talk a little bit about how you're positioned for 2018?
Giroux: I would say while the economy feels good, historically speaking when the economy feels good it's actually probably not the time to be really aggressively positioned in equities. Typically what you want to be buying is you want to be buying stocks during a downturn, in a recession, and not when PMIs are high and everybody's euphoric about the economy. What I would say is, we are pretty conservatively positioned today. We're underweight equities. Our three biggest overweights are defensive sectors.
For the first time, really for the third time in my career, we've started making a big bet on Treasuries. We put about 8%, 9% of the portfolio in Treasuries recently in 2018 as yields have risen. Our high-yield exposure and bank debt exposure, which was once over 20% of the portfolio, is down into the low teens today as we've seen spreads compress and terms on bank debt become less attractive. I would say adding to Treasuries, taking down our high-yield exposure, and being relatively conservatively positioned in both the sectors within equities as well as the absolute equity amount in the portfolio.
Acheson: Can you elaborate a little bit more on your sector positioning within equities?
Giroux: Our three largest overweights in equities are healthcare, staples, and utilities. Utilities is probably the one that a little bit of a change. We've been overweight healthcare almost on a thematic basis for a long period of time. Utilities just two to three months ago we were underweight utilities. I think we see really good value in utilities today. 20 years ago, utilities didn't grow earnings almost at all. Your total return all came from the dividend yield and that dividend yield relative to Treasuries or corporates is really what drove utilities. But back then earnings in the market were growing 10% a year. Today, last five years, the market's only been growing 5% per year. We have a number of utilities in the portfolio today that we think can grow earnings in the mid single digits with a higher than average dividend yield than the market, with materially lower downside risk, which I think is important given where we are in the economic cycle.
In addition, you're actually buying these high quality utilities today for a discount to the market after most of things have actually underperformed the market by 15% to 20% over the last two to three months. It's a little bit contrarian, but I think we feel really good about the risk-adjusted returns in utilities today.
Acheson: Also within your stock portfolio, if we were to dive a little bit deeper, are there any specific holdings that you're especially bullish on?
Giroux: Sure. I would say generally speaking we're not nearly as bullish as we were on any individual name that were two, three, four, five years ago. But I would say a couple names that just stand out to me as, probably three names--like Marsh Mac, an insurance brokerage company, normally trades at a 10% premium to the market, today trading in line with the market, little bit boring. But Marsh Mac is really well-run company, grows organically 3% to 4% every year. Just some really smart acquisitions. Buys back stock. Just year in and year out generates double-digit earnings growth with very little volatility. Pays a nice dividend yield, and again, the low end of its historical valuation range. I think we think that's a really good risk-adjusted opportunity in the marketplace.
Danaher is also a name that we've really added to more recently in the portfolio. That company is on a nice journey. We always like these companies that are growing 2% to 3% organically, and then you look out two to three years, that organic growth rate can accelerate. Also, they have a significant excess capital, they could deploy in acquisitions. Danaher is a name that we think its relative valuation looks attractive, we think earnings growth could surprise to the upside. Organic growth could be surprise to the upside on a multiyear basis.
The last name that I think is a little more of a traditional value name would be a company called Adient. Adient, they make seats for automotive companies. They've had some challenges, their metals business. But if you take out that metals business, this is a company's that going to earn probably about $11 per share this year. Trading at $71. While they're going to lose money in the metals business there's no structural reason why they should be a money-losing business over a long period of time. If you X out those losses, which should not be sustainable, you basically have a company trading for 6 times earnings at a time where the market's trading in 19 times earnings. With a pretty good outlook for margins and ability to improve that metals business. With also a very good CFO. I think we feel very, very good about Adient as well. Again, more of a traditional value name in the portfolio.
Acheson: And from a regional perspective, would say that you've a preference for markets overseas versus in the U.S?
Giroux: I would say again--this is actually a difficult question, I would say. If you look at it from a macro perspective, you just look at European valuation, Europe's probably a little bit earlier in their cycle. Probably Europe looks a little bit more attractive than the U.S. just from a macro perspective. The challenge we have is we have a very concentrated portfolio with 60 names on the equity side. The threshold to get into our portfolio is very, very high. We've done a lot of work on Europe, and while Europe looks very attractive on a macro basis, we haven't really been able to find many names that really fit our criteria to get into cap appreciation. We've added a couple. We've a company called Essity which can be thought of like Kimberley Clark in the U.S. We've added RELX, which is a really good company, again generates high-single-digit kind of growth year in and year out with very good management team and not a very cyclical business. but I thought I'd be able to find some more good ideas in Europe and we actually struggled to find good ideas in Europe.
Acheson: David, thank you again for joining us today. It was great to hear your insights on the markets for 2018.
Giroux: My pleasure. Thank you.