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What is your take on the divergent views of the bond and stock markets?
The stock market is still bullish, thinking the economy will continue to improve to the extent it had previously expected it to, whereas the bond market yields have come down. The bond market thinks the economy will not be as strong as previously envisioned.
And truly, at this point, no one knows. It’s a function of Congress and it’s a function of to the extent we get the fiscal side of the economy to kick in. Timing is uncertain, magnitude is uncertain.
We have this dichotomy going on where, and it happens from time to time. They’re not necessarily in sync but given market valuations, it’s interesting that people haven’t questioned the continuation of the growth in the economy more than they have.
Which fiscal actions would make you more optimistic?
Well, some of them we’ve already seen in a probably less dramatic fashion because they have only required executive orders, which are in regulation, but some of these regulatory ones will also need Congressional support.
Taxes are a big part of this. The infrastructure, while helpful and needed, is not so much the needle mover as taxes would be. Taxes are probably the single most important to make us competitive around the world and, and cause companies not to situate outside of the United States.
I’d be looking closely for action regarding taxation, repatriation, all of those matters, yes.
What is your outlook for small-cap value?
Well, this year has been, so far, a rather strange year. Small-cap value as an asset class did extremely well last year. This year it’s the least attractive or least best performing, and large cap growth is the best performing.
Sort of a mini revisitation of the FANG situation that occurred to my great detriment in 2015. I’m carefully watching that. And, and it’s interesting, while the market has done well, hasn’t retreated, it’s been dominated by more defensive, growthier kinds of names, which again, raises the question, what is our true belief of really getting America rolling again in terms of, you know, output, you know, getting nominal GDP higher, getting inflation. You know, frankly, inflation has been too low. You know, getting everything working.
There are many other things that are still lagging and in order for small-cap value to continue to do well, which historically we’re in a cycle where it should, we need the economy to cooperate.
What are you hearing from company managements?
The messaging from companies has largely been, you know, things are okay. They’re not exceptionally good. Its fits and starts, which is interesting because we have yet to see the translation of the optimism take hold in action.
It seems like the order flow, the business is not consistent. They’ll be fits of good business followed by a lull. It’s particularly in retailing, I must say and it’s to the extent I own a lot of retailers. I’m influenced by that.
But even on the industrials, technology book-to-bills have indeed improved. Now, one of the things that can influence that and cause that to drop again would be the concerns that are being voiced now about order production because what people don’t at first realize or other than investors is that a lot of the strength in the technology companies comes about because the automobiles are much more technological and have many more sensors and everything on them.
So that the strength in the auto business has been one of the reasons, not the only reason, that book-to-bills. But that would probably be the only area where there’s been that catch-up and indeed, technology has done well.
It, in theory, at least, occurs at a time when the economy is strengthening, and earnings growth should be there and rising rates to a point are not that detrimental to PEs and to the extent that earnings evolve because of the strength in the economy, it offsets, and hopefully more than offsets the erosion in PEs. There does come a level, as we all know, where the absolute interest rate becomes harmful to market Pes. We’re a long ways away from that. We’re talking years, you know, three, four, five years for that to occur at the current pace.
So, I don’t see that risk, but where we can fail is in that we don’t get enough of an earnings bump because we’re not getting enough of the fiscal side.
Article by Charlie Dreifus, The Royce Funds