article 07-22-2015

Steve Lipper on MoneyLife: Moderate Returns Ahead

At this year's Morningstar Investment Conference, Principal and Portfolio Manager Steve Lipper talked with MoneyLife Host Chuck Jaffe about the current investment landscape in the U.S. and abroad as well as those areas of the market he currently finds most attractive.

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Chuck Jaffe: I'm joined right now by Steve Lipper, portfolio manager for The Royce Funds. Steve, one of the things that I've been getting out of this conference: A year ago, as you talked to people, everybody was sure the Fed was going to raise rates and it was going to have a more dangerous effect on the market. Of course the Fed didn't raise rates and the market kept going. This year, everybody now is not quite as certain even though it appears that a rate increase is more imminent, and they're also a lot less worried about what a Fed increase is going to do. So for you, have we gotten to the point where we can kind of sweep it under the rug and when we get to a rate increase it's going to be a non-event?

Steve Lipper: Yeah, I think the Fed rate increase for us is less important in terms of the overall market. It may be more important in terms of subsections in the market—in terms of REITs or banks; probably negative for REITs when it happens and maybe positive for banks in terms of increasing their net income—but our view overall about the equity market is we probably have moderate returns ahead and that Fed rate rise isn't going to be an impediment to that.

CJ: "Moderate returns ahead" is something everybody has no problems with. What they have problems with is achieving moderate returns with big swings on the downside. They don't mind big swings on the upside, but they certainly mind the downside. So how much event risk do we have? Not necessarily the, "We'll have a little period when we're flat" or what have you but serious, "Hey, we can take the head off this beer we've been enjoying for so long."

Steve: Well any equity investor should be aware that a 10% decline is sort of the price of entry. If you're not comfortable that you're going to be experiencing that then your asset allocation probably should be something else. But if you're talking about a 20-30% decline, that has to be caused by something that's meaningful. Things that are meaningful usually come from one of two things: aggressive Fed rising—I don't think that's on the horizon—or recession, which would collapse, meaningfully, earnings. I don't think that is either. So significant declines in the near term don't seem likely.

CJ: At the same time, psychology says we look at numbers and see how long things have gone on and says they can't go on forever. Right around the time that you look and you say, "Well this time it's different" is when you find out it's not. Is this time different, at least from the standpoint of, "Yeah, we could see a record kind of length of duration of this bull market" but things not be different in terms of "It's still the same old market?"

Steve: Yeah, it's a very key point. One of the things that I characterize what we do as investors is we have to separate signal from noise. There's a lot that's out there and we have to say that's not significant, that's significant. In this rally, this bull market, we think time is noise, and what I mean by that is that historically, length of a bull market correlated to length of a business cycle. But business cycle has been in slow motion, as frankly they often are in recovery for banking prices. We've seen that outside of the U.S. So time won't be a good compass. Price will continue to be a good compass, and price in terms of valuation versus long-term inflation rates are fine. Our outlook is that stocks can advance in line with earnings growth. We've seen P/E multiple expansion—that's probably behind us—but we're going to be ok.

CJ: Do you also look at the political situation and go, "I don't have any worries on the horizon because even if we wind up seeing a party change in Washington, we have an election to get through and nothing too bad happens during an election year?"

Steve: I have a non-traditional view about Washington, and that's that the most important person for your portfolio doesn't sit at the White House or at Capitol Hill, she sits at the Federal Reserve, and she's supportive of you investing.

CJ: From the investor's standpoint right now, you don't see the Fed doing too much. But we got foreign central banks, and they're becoming accommodative at a time when our Fed is looking to change its ways. How much does that make you say, "I want to spread my wings and be investing internationally"?

Steve: I think it's a really good point because where you do well is where things go from pessimism to moderate, then to optimism. Liquidity is meaningful. Both Japan and as you know Europe are increasing their liquidity. Japan did that earlier. We've already seen this year outperformance of international markets, particularly Europe. You could see that continue.

CJ: You talked about Japan and Europe. What about emerging markets, the BRIC nations, and even the frontier markets? 

Steve: I think we are getting to the point where people are going to disaggregate the BRIC because they are so different. Some of them are very commodity led and I think they have a significant headwind. Some of them have major governance issues. That commodity/governance challenge I would put both on Brazil and on Russia. India seems to be doing reforms and as a commodity buyer, so oil price declining gives them a lot of latitude to cut their interest rates because it keeps their inflation down, and they seem to be taking a lot of good steps. Overall I would have people be wary of most emerging markets because they're commodity exporters, and this is a challenging time for them.

CJ: You know you talk about commodities and I know you stay focused on equities, but I would have a hard time believing you don't have an opinion on gold going forward.

Steve: Gold: We don't invest directly, sometimes historically we have, but we don't currently invest meaningfully in gold or in gold mining. I would suggest history tells us around gold is you want to be aware of real interest rates. When real interest rates are high, the carrying cost for gold is high. And given that gold produces no income, that makes it less attractive. In this environment I'm challenged to see how gold gets attractive again.

Jaffe: If you had to pick something that you think is going to be particularly attractive, is there one sector that stands out to you?

Steve: I think housing may begin to surprise on the upside. Housing has been the part of the economy that's been out of sync. Usually what happens in a normal cycle is the Fed cuts interest rates and that's a big boon to the economy because it makes mortgages and housing cheaper. Because what got us into this crisis, that wasn't the response. We've had healing. Actually the consumer balance sheet is very good right now. We're seeing wage growth. We're seeing affordability and availability come up. We think the housing and suppliers to that may surprise on the upside.

CJ: And then who might surprise you on the downside? What's the sector that you're already thinking, "It's time to go?"

Steve: Well we've tended to have underrepresentation in Utilities and REITs. I guess I would summarize it this way: We think you're going want to lean into economically sensitive stocks and lean away from interest-sensitive stocks.

CJ: Well, Steve, great stuff. Thanks so much for taking time out to join me.

Steve: Great, it's good to be here Chuck.

Important Disclosure Information

The thoughts and opinions expressed in the interview is solely that of the person speaking and may differ from those of other Royce investment professionals, or the firm as a whole. There can be no assurance with regard to future market movements.

This material is not authorized for distribution unless preceded or accompanied by a current prospectus. Please read the prospectus carefully before investing or sending money. The Royce Funds, with the exception of Royce Special Equity Multi-Cap Fund, invests in securities of micro-cap, small-cap, and/or mid-cap stocks, which may involve considerably more risk than investments in securities of larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.) Investments in foreign companies may be subject to different risks than investments in securities of U.S. companies, including adverse political, social, economic, or other developments that are unique to a particular country or region. (Please see "Investing in International Securities" in the prospectus.)

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