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The Artisan Podcast - The Search for Yield: Where to Find Income Now?

Updated: Apr 23, 2022

Welcome to Northland’s The ARTISAN Podcast - a behind the scenes look where we share insights and views from some of the world’s top investors. The objective is to provide a deeper understanding of the complex challenges investors face today and the risks and opportunities we see for tomorrow.

In this episode, our guest speaker is Alpine Macro's Chief U.S. Strategist & Director of Research David Abramson along with Northland's Co-CIO Joseph Abramson and our moderator, Arthur Salzer, CEO.

Key issues to be discussed in this podcast include:

  • The best income opportunities available at present?

  • How will the economic re-opening impact bond markets?

  • What is the interest rate outlook at the Fed and Bank of Canada?

  • How to survive a blow-up in the bond market?

David Abramson is a Partner and Chief U.S. Strategist & Director of Research with Alpine Macro. For 28 years, David was a Macro Strategist holding a variety of senior roles at BCA Research. Most recently, he was Chief U.S. Strategist and also Director of Research for the firm.

During his tenure at BCA Research, David launched and managed the European Strategy and Commodity & Energy Strategy services. In addition, he was the Managing Editor for the Foreign Exchange Strategy and the China Investment Strategy services. He has taught international finance to MBAs at McGill University for 20 years, and is on the Client Committee of the Kenneth Woods Portfolio Management Program at Concordia University. Transcript


David Abramson, Joseph Abramson, Arthur Salzer

Arthur Salzer 00:01

So welcome to Northland's The ARTISAN Podcast where we share insights into the markets by hosting some of the world's top investors. Our next guest is someone whose research and insights are the go to for the world's largest and most sophisticated pension funds, global banks and fund managers for the past three decades. David Abramson he's a Partner and Chief US Strategist, and Director of Research with Alpine Macro. For 28 years, David was a macro strategist holding a variety of senior roles at Bank Credit Analyst Research. Most recently, he was Chief US Strategist and also Director of Research for the firm. During his tenure at BCA, David launched and manage the European strategy and Commodity and Energy Services strategy. In addition, he was Managing Editor for the Foreign Exchange Strategy and the China Investment Strategy services. He has taught International Finance to MBAs at McGill University for 20 years, on his on the Client Committee of the Kenneth Woods Portfolio Management Program at Concordia University as well. Now, I got an email this morning, probably just after midnight, and David, I can see that you have a new research report on the search for yield hot off the presses. Maybe you can give us a few insights into that.

David Abramson 01:19

Sure. Well, thank you very much for having me. That's a very long bio. So I hope I can answer some of your questions. Really, what the question comes down to initially is, are we in an environment where it's going to be like before the pandemic where the risk free interest rate is very, very low, and you can just stretch and stretch and stretch for yield till everything gets compressed, and people start to take on irresponsible leverage. The other possibility that I look at in the report is, are we into a time where inflation is going to rise? And the stretch for yield gonna look completely different, more like the 1970s, where you think you're getting a good nominal yield? You end up getting a terrible after the fact real yield? That's what happened to Treasury bond investors in the 1970s. And so, what the report looks at Arthur is, it says, well, these dividend growers, these Dividend Aristocrats, public equities, are they really attractive, they have this long term record of increasing their dividends year after year, they're offered in Canada and the US and the UK, their small cap version, large cap version, you name it, and are they attractive? Should you look at high yield, which is riskier yield high yield corporate bonds? Should you look at leverage lending. And so I'm just going to give you the bottom line, these dividend growers, which performed quite poorly for mid 2019 till the end of last year, we think they're going to be really good performers in the next couple of years. And especially if you want to hold those big tech companies, the risk associated with those big tech companies, those dividend growers are going to help you with that, too.

Arthur Salzer 03:07

That's fantastic. No, no, Joe, what do you think about this? That these thoughts from your brother, our Dividend Aristocrats the way to go? Or is there something else we should be looking at?

Joseph Abramson 03:18

Well, I completely agree with the view in favor of dividend aristocrats if you're limited to public markets, but why should you be limited to public markets when private markets are much more attractive? So if we look at the Dividend Aristocrats, we have something like a two and a half percent yield. But the PE is 25. If we look at public markets, enterprise value to EBIT DA is something like 15 times. Meanwhile, in private markets, you can buy smaller companies at three to six times EBIT da, and generate much more attractive returns. So if you look at our private equity funds, we've been getting 18 to 20% returns, as opposed to public markets, where you've been getting eight to 10%. And the reason for that is a they can buy much cheaper companies and smaller ones that they can bundle together to get the higher valuation and be in public markets. It's illegal to do insider trading, where it's in private markets, not only is it not illegal, it's advantageous. And it allows the best managers to continue to outperform. It's called serial correlation. So the past managers continue to outperform. It's very different in public markets, and much harder to choose a fun. So yes, for public markets. I agree with Dave. However, I strongly prefer private markets as to our clients.

Arthur Salzer 04:51

I think I think maybe even a combination would would work really well you know, given the liquidity of public markets and the longer term longer term ration of some of the funds in the private equity side, and to be able to mix them correctly for a family. I think that's really something that, that that's a personal decision and needs to be discussed. Now, just before we jumped on the podcast today, David and I and Joe, we were all talking about earlier on in David's career when when he was at the Bank of Canada, and maybe you can go into the project that you were working on, because it's it seems sort of monotonous and boring. And it had a lot to do with the Accounting I took in the 80s. But But things changed.

David Abramson 05:39

Oh, that's fascinating. What we were talking about, before we came on air was my first job, which was kind of the only non global top down macro was a very formative period, 1983 to 1986, at the Bank of Canada, like a lot of my colleagues, including Tony Beck, who was there in the early 1960s. And one of the key things that you got from that period was anyone that was a central banker in the 1970s. And especially in the late 1960s, when inflation was bubbling under the surface. They were they were really affected for life by that even if they were central bankers, 30 years later, because inflation came up slowly. It was a big surprise, it even surprised, as I said before the bond market, but it also surprised a lot of central bankers, they felt that the Phillips Curve really worked, and that if you had high unemployment, you couldn't have high inflation, which was a big mistake. And so the whole time that I was at the Bank of Canada, those three years just as a research assistant right out of school, a lot of the discussion was about one question, which is, what is price stability? How do we get there at the lowest cost possible? And so I think that really informs on the questions that are being asked right now, after the pandemic, is it getting ingrained? As the change in Central Bank attitudes? Is that going to create inflation, all these huge questions that kind of have elements of similarity with the late 60s?

Arthur Salzer 07:15

Now speaking of that, I mean, we've heard a lot about technology over the past decade or past two decades after, after the tech bubble burst, and that technology through cheaper new goods and and more, because there's more of them and production rates went up has, you know, added to to deflation. And obviously, we've seen a lowering of interest rates over time. Now, now that's really been a tailwind. This next decade going forward, is that still going to continue? Or is that going to face some headwinds from what we're seeing from the Federal Reserve and other central banks around the world?

David Abramson 08:02

This is a huge question. And I guess first of all, what I want to say which, which you guys, obviously understand, but it's the difference between forecast and strategy. So an Alpine we call ourselves, strategist, but really we are forecasters. We are trying to add alpha, get the markets, right, get overweight and underweight. Right? I think your job is actually much tougher, because you really do need to do strategy, which is risk management. What if I'm wrong? What if there's a black swan event? And so I'll answer the question very, very simply happy to go deeper. But no, we do not think things have changed. On the surface. Of course, they've changed, deficits are really big. You know, if I was a government, the lesson I would have learned last year is when I blow up my budget deficit bond yields fall, isn't that great? Maybe I'll just double up and triple up. If I'm the Federal Reserve Bank of Canada's a bit different, but the fund the Federal Reserve, I'm saying, well, we've made these mistakes on the side of deflation for 11 years in a row, we are going to commit to overshooting 2%. So I'm not saying at all that inflation won't happen. But our view is very strong. And that is, if you take a look before the pandemic, after the global financial crisis, kind of what that was like, that's what we're going to go back to for a while, not forever, but for three years, five years, maybe even 10 years. And an inflation won't be a problem. There's a lot of reasons I'm happy to go into. But the one that you pointed out Arthur is a really critical one where I've done a lot of work, which is technology, capital spending, whenever there's been a technology capital spending boom, the part of inflation that the central bank really can't control very much. That tends to be extremely subdued. And there has been a massive technology capital spending boom since about 2013, artificial intelligence cloud computing, and of course, they went into a bit of overdrive last year. We're Well,

Arthur Salzer 10:01

exactly I can I can see that. And look, I mean, most of our meetings that we did probably up until two years ago, they were always face to face, right? I mean, you, your team would come to Toronto, you would meet with institutional managers, pensions as well as as private investors. And today we're doing this all online, which means no travel, no hotels, more time safe to do other things. And that's really I think, been, you know, huge, a huge advantage and time saver. Now, I've read some work show that some of the monies have, although they've not shown up in inflation, they are showing up in asset prices. And have you seen that as well, and in public markets, or even private has is capital flowing there instead, I mean, real estate's at an all time high in the GTA region. Montreal, I think, is really picked up on a real estate side. What's what's going on? Do you see that show?

Joseph Abramson 11:04

Well, I think just before getting into that, yeah, I have a bit of an issue with technology, you know, resulting in disinflation, because you a you don't see it, in terms of the productivity. B. Yes, that was true. Up until about eight years ago, because we had Moore's law, everyone knew that, that leads to everything becoming more productive. Moore's Law ended quite some time ago. And it's very clear. Most of what we're seeing in terms of new technology now, is in terms of social media. So I mean, does Facebook really improve productivity? I think it decreases productivity, because especially with people working from home, they're doing something that really isn't improving production. Second, you had a global supply chain. So most of the cheap semiconductors came from Asia, as well as other tech products, leading to deflation within technology itself. Global trade peaked now, quite some time ago. And we're seeing shorter term, some additional issues in terms of technology. So I think just because technology should improve productivity and create disinflation, it doesn't mean that it has, and the facts really stand in the face of that. In terms of your direct question, Arthur. I think, David, and I would both agree that that is exactly what we've seen, for quite some time, we've seen substantial money printing, and low interest rates, and that was really necessary to get any type of growth whatsoever out of the economy. But most of it went into financial markets. And in particular, you know, the wealthiest 20% did very well, and they could increase their consumption. So I would very much agree that it really supported asset markets, which was beneficial for the economy, and, and beneficial for our clients as well. David?

David Abramson 13:20

Yeah, I think there's, I think there's a number of reasons why we feel inflation is not going to be concerned the next couple of years. But as I said, I think the main reason is simply that the expectation of inflation, it's really pretty high profile. Right now, there's been a big shift in long term inflation expectations in the markets in the 10 year bond yield in the 30 year bond yield this, this is a number that you can that you can calculate, but also, more anecdotally, just every conversation, particularly with our hedge fund clients, really concerned about inflation, the cost of I tried to build a deck, I built a deck called cost double what it cost last year. And so I'm just going to very quickly Listen, listen reasons, I don't have a direct problem with what Joe with what Joe said. Again, I've done a lot of work on the tech side of things. I'm happy to talk more about that. But there's five reasons. The first is if you compare to the 1970s, which was I was, you know, it's I wasn't working then. But I worked with people who had just gone through that kind of what I call PTSD of inflation. That was my 83 to 86 experience. And the basic idea is that, as you mentioned, globalization, unionization and currency markets, those are the three things and if you take a look at just for example, exports plus imports, us divided by US GDP are the same thing for the world or whatever. As you said it, it peaked like I don't know eight years ago, if you compare that to the 1970s I mean, you You know, that declined in the last eight years you don't even see it on a chart, the world was the US was just not very open. Again, I don't want to go into like great length. But if you think of the price setting behavior and the wage setting behavior, the 1970s in the key industries, steel chemical autos, there was virtually no foreign competition. It was all oligopolies. It was all unionized. And so the central bank attitude was extremely important because these workers, they all had what they called cola clauses, cost of living adjustment, if there is inflation was 4%. They got 4% plus something automatically was fine, because DuPont could just pass it through because it was an oligopoly. Maybe there's that kind of market concentration right now. Certainly, it's increasing, but probably not. And in places like big tech, where there's market concentration, there's, there's deflation. They're, they're pushing their prices down. They're crushing competition. Maybe it's not competitive, but it's definitely not pushing up prices. The last thing that I'll mention, I have all kinds of other reasons happy to talk about inflation. But currency markets were critical in the 1970s, you had a situation where in the late 1970s, the Bretton Woods system was intact, it fell apart from 1971 to 73. It was held up the dollar was fixed versus gold until 1971. But the underlying equilibrium value of the dollar that made sense because of these unbelievably irresponsible policies by the US, which was the key central currency, that was linked to gold, that got way out of whack, and it took 10 to 12 years of the dollar, adjusting down quite sharply until the late 1970s, when under President Carter, they actually had to issue bonds denominated in yen, the US had to issue bonds denominated in yen, can you believe it? You know, picture that now? How embarrassing that was before Ronald Reagan came in and, you know, changed everything around along with Paul Volcker. I'm just mentioning all of this because the analogies with the 1970s are extremely Ropey and my colleague Tony Beck, who again use central banker in the 1960s. And he got inflation, right in the 70s, when he was the owner of VCA. And he's our, he's our partner now. And he's written a piece called not like the 1970s. So he always looks for inflation. And right now, he just sees too many differences.

Arthur Salzer 17:29

As a counter. As a counterpoint though, I have been talking to some Northwind families that are in the manufacturing side, and they're talking about two to 300% increases in commodities. They are passing that through to the end customer. And and there's no complaints. But is your analogy that manufacturing is smaller now than it was in the 70s. So it may be localized, but it probably won't translate through to society is that?

David Abramson 17:58

No, there's a couple of things in there, Arthur, that's a very important point that you're raising. So one of the points is, what will commodity prices look like 18 months from now 24 months from now. So that's the difference between a one time price adjustment, which clearly at least is happening right now. No question. Prices are going up input prices, output prices, you've had two months in a row where there's just been massive upside surprises in PPI CPI, you name it, whatever. That's not really the debate, the debate is, is it a one time? Or is it inflation, because inflation is not one time movements, bond yields are not really affected by one time movements in prices, income generating the you know, vehicles are not really affected by this. And so there's a couple of things that you can unpack there. The first is commodity prices themselves. So are higher prices, causing some kind of adjustment? What's happening with the price of semiconductor chips, lumber, ironore, aluminum, all of these things have had really massive downward corrections from incredibly high levels. So I'm not going to answer your question is very tough to answer. But in three months, I think we're going to know way more. What I've written is, and I wrote this a while ago, so this is not a surprise to me or our company at all. And that is the fog of inflation. When you come out of the pandemic, the manufacturing sector has been on fire through the pandemic and that's what your your clients are seeing. It's been on fire, they have pricing power, is that going to continue for 12 months, as the demand shifts to services? Maybe services will be on fire for six months, and manufacturing won't have pricing power by next January? That's the question. I don't I don't have the answer to that question but

Arthur Salzer 19:53

like a rolling inflationary correction through different several rolling

David Abramson 19:57

upward adjustment in prices that result In 2%, inflation 18 months from now, that's what we expect. Of course, like I said, we're forecasters, not risk managers. Of course, you need to be protected against that scenario. But what I'm saying is, I can see that inflation right now, the five year five year for this is long term inflation expectations that are in the bond market are like two, two and a half percent. They're above 2%. So that might happen. But we don't expect it to be above that. And probably, you know, in our view, at least, there's a reasonable chance that we'll be below that. So we think 10 year bond yields will be 1% or 1.2%. A year from now. That's how strongly we have this view, but it's a forecast.

Arthur Salzer 20:41

So So Joseph, I mean, being co CIO of Northland, you know, how are we positioning our family's portfolios? What, how do we take this information and translate it into a workable solution to improve returns and, and manage wrestle

Joseph Abramson 20:59

things there. The first impulse important comes from the title, the search for yield. As I made clear in my opening comments, the private markets just look so much more attractive than the public markets. If you're limited to the public markets, and a two to 4% yield, yeah, maybe inflation's 2%, maybe it's 3%, you're really not getting paid to take that risk. However, in private markets, the most direct comparison, the best vehicle for your search for yield is private debt. So you can still today get private loans. And these are in the funds that our clients own, where the underlying yield is 11, or 12%. But these aren't ropey loans, they're senior secured, first lien loans, where on average, when the loan is made, the loan to value is under 70%. So if something goes wrong, the odds of you losing your capital are fairly low. But there's more than that. If you look at the private loans, the default rate, and the loss, if they do default, is less than public loans, it's actually less than investment grade loans were in public markets, you're getting all of 3%, thank you very much, I'll take the 12 or 13%. With a lower default rate and a higher recovery rate. The key is finding the right manager. And that takes a lot of due diligence and a lot of work. Hopefully, we've done our job. For clients. There's other areas as part of a total portfolio where you'd want to be involved things like real estate, where you're getting a cash yield of four or 5%. But it's nearly all tax deferred, because you get the umbrella of depreciation, and a lot of it is return on capital. So on an after tax basis, that's equivalent to eight or 9%. You might say, Okay, fine. Why don't I just own public REITs public REITs only have a two or three or 4% yield. But more importantly, they are forced to distribute all of their cash flow. Whereas on the private side, you're finding the high quality manager that is creating value by investing that capital. One example would be, you know, an apartment REIT that we own a private one, where the manager is finding undervalued assets where the rents are less than half of the comparables in a very high quality building in a good location. They're not doing anything to the building overall. But they're doing cap that's on the individual units. And on average, they'll do $25,000 capex on the unit, they're able to double rent, which if you look at the valuation of that, they're creating value of $200,000. So an eight times return within one year, doesn't matter what the market does, the valuations could fold in half, you're still gonna make money. That's the sort of thing that we want to do. We don't want to be reliant upon a market where interest rates are staying low, and they've made everything expensive. We want to invest in good quality managers in a diversified portfolio so that our clients can do well, or at least in a bad environment, not that badly, regardless of the environment.

Arthur Salzer 24:49

Now, no, Joe, you brought up you brought up private debt, private credit, and this is non rated, so it's non investment. grade, although it's it's senior secured, when when public markets have have non rated debt or or when they have non rated debt, I mean, we've been using the term junk bonds for a long time. Now, David, like junk bonds are liquid. They're obviously trading higher rates of return than than sovereigns are. But but is this something that an investor should look at? Or is this this? Is this a hand grenade? Is this something you want to throw away really quickly? before it blows up?

David Abramson 25:35

It's a great question, because this is a huge market in the US. And I think the rumors of its death have been greatly exaggerated for a number of years right now, because of the potential for lack of liquidity after the GFC all kinds of risks associated with it. And yet, this has been a great market in terms of its outperformance of treasuries. So the question is great, the distinction that I would make is with those dividend growers, which are equities, not bonds, but maybe you could think investment grade to that safe yield. Now, dividend grower that's growth yield, it's public, like Joe was saying. So I bought I buy this private equity argument sounds really exciting. But with the high yield, that's risky yield. And what happened last year was, and this really upset, the vulture funds that are really good at picking the wheat from the chaff was the governor of the government, and especially the Federal Reserve said, we have this huge an unexpected shock, we cannot allow the credit markets to stop functioning, we can't let the corporate bond market just stop trading, and have these really weak credits that need to borrow constantly go bad. So what happened instead was they elect they had this essentially a put option for these high yield corporate bonds, corporate bonds, a number of which should have gone bust. But instead, it not only didn't go bust, but they had record issuance during the pandemic. And so what instead has happened is you created a number of zombie companies with extremely tight spreads, that it won't even take a recession for the for those spreads to blow out, just some kind of an economic slowdown. Now, if you believe there's going to be an economic boom for the next two years, they're going to be fine. But we don't believe there's going to be an economic boom, we think it's going to be hard to grow, it's just going to be kind of like, like I said, 2008 to 2019. So those so called Junk bonds are going to be very unattractive in the next two years. They offer no value right now, during an economic boom.

Arthur Salzer 27:51

Now, now, one of the theories that that that Joe's had was that there's going to be a rotation from growth to value stocks over over the next decade, and in general value will outperform. Now, financials are part of that value group. And I know recently, I saw some news that they were passing the Fed stress tests. So is this an area that, you know, people should be rotating money into US banks? Or is there something else going on there, David?

David Abramson 28:22

Sure. So I'll say I'm interested in what Joe has to say. But financials are an important part of some of the Dividend Aristocrat indexes, not the US one, not the European one. So it's critical. There's overlap with this yield question, but it's important on its own, and I think there's a longer term thesis for these financials that's interested, interesting, especially if they can take advantage of the FinTech revolution and lower their costs and not get beat note by these little FinTech companies. That's a technology question. But the question for the next 12 to 18 months is a little bit different. And that is what's going to happen with net interest margins. So if, if there's a big bounce in these bank stocks, which are cyclicals and which tend to benefit from higher bond yields, that we would use as as as a reason to reduce exposure for the next 12 to 18 months. It's different than a 10 year thesis, for sure. Maybe they'll just be kind of boring income creation vehicles like they were before the property bubble of the 2000s. But if net interest margins are going to get squeezed, as we suspect, then we want to downgrade we've been very excited about financials as cyclical plays, and now we're looking to downgrade sometime in the next few months.

Arthur Salzer 29:44

Already, Joe, we're gonna give you the last word I would agree today. So what are your thoughts

Joseph Abramson 29:48

on this cyclical view? However, um, I've done a lot of work on financials, actually. When I was working with Dave at DCA So I think it's a little bit more complex, my thesis and very unique. So the argument that I made back in 2016 is that banks had become much less risky than in the past. And therefore in the next recession and bear market, they would sail through. And it's not until after that event that that they would be revalued upward because we would say, Oh, these are these things are gonna blow up like they did in 2008. They're safe. And I actually argued at the time, that banks should no longer be acting cyclically, that they'll act the way they did for the 60 years, up until 1970, when they actually acted like utilities, and the outperformance and underperformance was the same as utilities safe and kind of interest sensitive. So a completely different view of the world that's actually played out, in the sense that they did get revalued because they're no longer risky. We'll see if the second part plays out as well, to me, it's just common sense. If they're no longer risky, we should treat them differently, and they'll act differently. And so if my view does, in fact, turn out to be the case, and Dave's macro view of low interest rates is is valid, then they should outperform on the sort of time horizon that's appropriate for our clients. So luckily, we don't need to focus as much on the wiggles the day to day movement, because our clients tend to have longer time horizon of three to five years. And I think over that period, given the starting valuation and my view that they should outperform, you know, in the next three, six months, as as the economy slows, and people have made a lot of money, they may take some some profits. So intermediate term, I remain positive.

Arthur Salzer 32:09

Well, thank you very much, Joe. I want to thank our listeners and viewers, and David Joseph, thank you again and hope to have you on soon. Thank you very much.


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