Stocks vs. 5% Treasurys. Plus, Insurance Optimism

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Valuations are somewhere around fair. What I mean by that is if we have a 17.5 multiple today, that in a year from now we'll probably still have a 17.5 multiple. If you add that all together, that means you could probably do a lot better putting money in a T-bill.

Hello and welcome to the Barron's Streetwise Podcast. I'm Jack Howe, and the voice you just heard is Jonathan Golub. He's the chief U.S. equity strategist at Credit Suisse, and we'll hear from him about what to expect and how to invest from here. We'll also say a few words about the insurance industry and hear from the number 2 duck over at Aflac. Listening in is our audio producer Jackson. Hi Jackson.

Hi Jack.

I don't have to tell you what time of year this is and what happened this past week.

Well, March Madness starts on Sunday, which is in 2 days, but do you mean like the regional conference tournaments?

I mean the Association of Insurance and Financial Analysts. That's right. The AIFA annual conference in Naples, Florida. Sounds exciting down there at the Naples Grand Beach Resort. I'm looking at the agenda. I take it you did not attend?

I did not have the pleasure this year.

A lot of good stuff here. It started on Sunday with— let's see, there was a golf tournament, a tennis— okay, they didn't get any work done on Sunday. Monday. Okay, Monday, right out of the gate, you got a State of P&C Insurance panel. That's property and casualty. And then that's followed by State of Life Insurance. You got a quick break and you're right back to the Insurance Brokers panel.

It's like Coachella.

Yeah, the whole thing wrapped up on Tuesday with an Accounting Changes panel. Now, that's a tough room because people are on their way out, they have to catch flights, and you're here talking about accounting changes. You really got bring the pizzazz to hold the attention of the room. I'm sure they got it done. I noticed Morgan Stanley had a wrap-up for those of us who were not able to attend about kind of the state of the industry. And they say, first of all, the mood was one of cautious optimism. I would have guessed unbridled rapture, but it was cautious optimism at the insurance conference. But they say that Rising interest rates and dissipating COVID, as Morgan Stanley puts it, clear and undisputed positives for the industry. Rising interest rates, I'm guessing because it means better yields in some of the credit portfolios there. Morgan Stanley says you have to watch out for signs of any deterioration in credit portfolios as they're not seeing signs of that yet. But keep an eye on it. And they have top picks. Equitable is their top pick among the more equity-sensitive insurance companies, the ones that are sensitive to gains in the stock market. And they also like MetLife and Aflac. Based on Morgan Stanley's target prices, they see more than 50% upside for Equitable. For Met, it's 30%. And for Aflac, it's about 15%. Not bad at all, assuming they're correct about that. And we did have a chance, Jackson, to chat with a top executive over at Aflac.

Fred Crawford, the CEO, who you called the Second duck, right? I'd counter that he's the third duck because the duck duck's got to be the first one.

You're counting the duck, and then the second duck would be the CEO.

Yeah, right.

And he's the chief operating officer.

Yeah, so that's number three.

That's a fair point. Um, we did talk about, uh, interest rates and about the duck, and I think the duck is— first of all, I'd learned some things about Aflac. I knew that Aflac had these supplemental policies that cover sort of specific diseases and things like that. And I always thought of them as being narrower than your general health coverage. But Fred talked to me about why it's really for somebody who might struggle to come up with the money to pay for all of the incidental costs that might come along with having one of these diseases, the copays, the, you know, and so on., which can be several thousand dollars, and some people don't have that in savings. And we spoke about the duck, which he really says is a big advantage for Aflac, and I believe it. He says the company is able to keep its advertising costs lower for its size just because of the recognizability of that duck. It's hard for me to pick another animal in the insurance space. Look, you can talk all you want about the gecko. Yeah, right. And the emu— I can't even remember who had the emu.

Liberty Mutual, right?

The thing that's special about the duck is this: if a duck walked up to me and said quack, I'd say, you know what, that sounds totally out of character. That's a hard K sound right in the beginning of the word quack, and it just doesn't sound very duck-like. If a duck walked up to me and said Aflac, I'd say, you know what, carry on. You go right on being a duck. You sound just like a duck. Aflac sounds more like a duck noise than quack is my point here. And so I think it is. I think whoever came up with it, it's the perfect animal for that company. And you got to have it if you're selling. I mean, insurance isn't the grabbiest thing. And if you're selling supplemental insurance, I don't know, you really need a strong animal. And I think they've got one. Any reaction to that, Jackson? I put a lot of thought into this.

Yeah, I'm kind of held up by this idea that quack is a bad onomatopoeia. Is there anything better you can pull from other languages?

Hold on, I'm Googling. I've seen before foreign words for animal sounds, and some of them will surprise you. Let's take dogs. Okay, and I don't know if I'm pronouncing this right, but apparently the Dutch say blaf blaf for a dog. That's the last— come on. That can't be. That can't be right. Icelandic, Vaff Vaff. Okay. Indonesian, Guk Guk. What's going on, Indonesia? What kind of dogs are these? Japan is Wan Wan. Korean is Myeong Myeong. And Romanian is Ham Ham or Hom Hom. I don't know. Woof. Woof doesn't sound right.

Does not sound right.

Woof or bark. Listen, I can't devote more than 40 minutes more to this topic.

This is fascinating.

We should—

we could do a whole episode episode about this.

All right, why don't we hear from Fred about Aflac and the duck, and then after that we'll get to Jonathan over at Credit Suisse.

Sounds good.

Give us, give us, uh, you know, for people who only know about the duck, tell us what else we need to know about the business. Give us the quick tour of the business, where you are and, and what you sell and what you do. Sure.

So, you know, Aflac is a name, a brand certainly that folks are very familiar with. And of course the duck is, I think, coming on around 22 years old and, and that's the iconic brand. But what we do in both the US and in Japan is we are a supplemental health insurance company, meaning we provide insurance to cover what your major medical insurance doesn't cover. So what most people realize, particularly those who have gone through either an accident or hospitalization or health event, understand is that even though you may have health insurance and it may even be good health insurance, it doesn't cover certain things such as deductibles and copays and also just other ancillary costs associated with getting ill or having an accident, time away from work, commute, and other expenses that are out of your pocket when you get hurt or ill. And if it's something of a more critical nature, such as cancer, which we're a very large insurer of cancer insurance or other critical illnesses, of course those bills can stack up considerably. And again, outside of what you're covered under normal major medical. Japan, we do the same thing, only the difference being that Japan has a national healthcare system. And so what we are supplementing in Japan is what the national healthcare system doesn't cover. Uh, and in Japan, I'll use US currency to make the example, but, uh, 70 cents of every dollar that you experience in the way of a healthcare issue or healthcare in general is paid for by the national government in Japan. 30 cents of every dollar comes out of your pocket. And so the Japanese have grown up even through generations realizing that they can do the very quick math as to what could be the financial burden of an injury or hospitalization or critical illness when $0.30 of every dollar is out of your pocket. And so our policies close that gap or fill in that gap. In the US, we sell predominantly in the worksite, meaning it's your employer that we work with who offers up our product to their employees. And why do they do that? Why is an employer motivated to buy the product or offer the product in their workplace? It's because over half of their employees and on average over half of working Americans have less than $1,000 saved up for an emergency. And so even something as seemingly minor as out-of-pocket costs, copays, deductibles, a day or two off of work could be significantly disruptive to a family that's living paycheck to paycheck with no safety net of savings.

What about advertising? I think there are a lot of people who work in advertising-related fields, including many of these big software companies, who are wondering about, hey, is this some, some weakness in the ad market? Is it going to get worse? How long is it going to stick around? You're an advertising buyer. What type of spending have you found to be the most productive for you? What do you think of your overall level of advertising spending going forward? And what kind of job security does the duck have? How's the duck doing for you? You're still— everybody's still on board with the duck?

Everyone's on board with the duck. It's iconic. And year in and year out, the involvement of the duck in our ads, whether on its own or with more celebrity-type actors, it performs as well or better than any other ad campaign we can come up with. And interestingly, Jack, negotiations with the duck go pretty well each year. So we're able to negotiate.

I wish I had a better duck voice. I'd be auditioning for commercial work for you.

Exactly. And to answer your question, we are— our branding budget in the US, which I would separate from marketing budget, which includes all kinds of other activities, our branding budget, which is what you sort of see on TV and understand to be the duck, That's around $125 million a year budget. And then in Japan, that's in the US. And then in Japan, a similar number in dollar terms, around $100 million or so. And those are actually quite, for a company our size, those are not big numbers, even though they sound like it on the surface. And the reason they don't have to be larger numbers is the brand equity. So it does come back to the duck. It's such an iconic symbol of the company that that brand equity carries us quite a long ways without having to spend the huge dollars you'll see, for example, in the property casualty industry with the Allstates and State Farms and Liberty Mutuals and Progressives and so forth.

I'm just remembering somebody's got the emu out there and I can't remember who it is, but—

so what was Liberty Mutual?

I think just between everyone listening to this podcast, What do folks in the office say about the emu? Do they say, look, these guys are trying to— these guys are trying to get in on our duck action over here? What do they—

what do they say? You know, we, we wish well, Jack, on all of our competitors and their ads.

All the animals in the zoo.

Just to be clear, we will not be confusing our duck with any emu anytime soon.

Thank you, Fred Jackson. I've got a couple more of those foreign words for animal noises. I've got ducks, and in Danish it's "rap rap." I don't know, I don't know what kind of ducks these are. In Hungarian, "hop hop." Italian, "qua qua." Romanian, "moc moc." Turkish, "vak vak." Turkish I could almost believe. Not bad. But French, French is— and I'm not a guy who knows how to pronounce French words. It's the word coin. It's coin coin. Now, is that not pronounced coin? What's the pronunciation of coin in French, man?

I guess quoi quoi.

If it's coin coin, I feel like I deserve some answers about what's going on in the French duck community. Let's take a quick break. We'll hear from Jonathan when we come back.

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Welcome back, Jackson. How do you feel about the state of the US stock market right now?

What did we say the insurance guys were feeling? Cautiously optimistic. I'm feeling anxiously dogmatic. You know, I have a long time horizon before retirement, unfortunately. So I'm mostly in stocks and I've been blindly plunking my money into index funds. But looking at these treasury bonds, I'm feeling left behind.

Yeah. Like you can get 5% without taking any risk. Yeah. Frantically befuddled because, as you say, you know, I mean, the stock market seems like an okay deal, right? I mean, I'm looking at the S&P 500, 18 times this year's earnings, and it's a little above its long-run average. Fine. But then, as you say, bond yields are really up there now. So if you take the PE of the stock market, you flip it upside down to get an earnings yield so that you can compare it with bonds. I looked at a comparison of the forward earnings yield of the S&P 500 and short-term Treasury yields. And they said that the difference between them was the lowest in more than 20 years. In other words, bonds seem like a good deal relative to stocks. And then you don't know if we're headed for a recession. And we're going to play some of our conversation with Jonathan Golub at Credit Suisse. He had a research piece out this past week that says the yield curve is the best predictor of recessions. We've heard that before. The yield curve is inverted now, meaning you get more on the short-term bonds in terms of yield than you do on the long-term bonds. That's the opposite of how it usually is. And he says that over the past 50 years, not including the pandemic, the curve's inverted 6 times. And it's— recessions have followed on average by 11 months. There've been no false positives and no false negatives. But he says the outcome tends to be different depending on whether it's a period of high inflation or low inflation. Bottom line, he says, We're going to get a recession in late 2025. I wanted to hear more about what that means for stock investors and how they should invest now. So I reached out to Jonathan. You want to play part of that conversation?

Oh yeah.

That was borderline Kool-Aid Man. Let's put it that way. For people who know, they know. All right. Let's hear from Jonathan. Oh yeah. I just need to know about everything that people should do with their money right now and what's going on with the stock market, what the future holds, and that's pretty much it.

If you want, we can add the global warming and the future of Ukraine. We have a lot of time.

If there's time, yes. What do you think the rest of the year holds? How does it look to you? How does the U.S. stock market look to you? Is it a good deal here?

A good deal? No, I mean, I think it's kind of a disappointing mediocre kind of outlook. I mean, what are we looking at right now? If you start with the economic and earnings backdrop, earnings are going to be basically flattish for the next not one, but probably two calendar years. And the reason is, is because inflation is running— it looks like over the next year to two years is going to run not 1970s kind of high, but kind of like annoyingly high, probably 3.5% or 4%. Wages are going to go up more than inflation, than consumer inflation, which is good for a consumer because they go to the store and they get to buy more with their wages, but it's not good for a company because they're paying more for labor and they're not able to pass it on all that well. So, it's kind of a rough environment for earnings. It's not going to collapse, but it's not robust. And we're going to, it looks like, not have the recession that people think, and we're going to avoid it for much longer than expected. That's what the yield curve is actually telling us, that the recession probably doesn't happen until maybe 2025 and that the valuations are somewhere around fair. And when I say fair, What I mean by that is if we have a 17.5 multiple today, that in a year from now, we'll probably still have a 17.5 multiple. Now, if you add that all together, that means you could probably do a lot better putting money in a T-bill. And I'm hearing a lot of really smart equity guys asking that question, which is, you know, help me make the case. Why do I need to be in US equities? And, you know, I say to them, like, it's not my job to make the case. It's my job to reflect on what the world looks like. I will tell you though, non-US equities, which have looked much less attractive than US equities the last 20 years, are less expensive and delivering better growth. And non-US interest rates as an alternative are lower. So, it looks as if you're going to be investing in equities, doing that outside of the US is probably favorable.

I thought I saw somewhere that you weren't particularly keen on defensive stocks right now. What don't you like for defensive stocks and for, you know, providing some more safety in your portfolio? Is that maybe a role for more bond exposure, or what do you think?

Well, so the first thing is, um, you buy defensive stocks if you think we're going to go into recession, and it just doesn't look like that's going to happen. And the reason that we're not going to go into recession is simple. There's there's so many open jobs that the consumer is feeling surprisingly empowered. People are wondering how much longer can they charge on their credit cards? Well, if your job is solid and even if you think it isn't, you know you can get a job across the street making similar or even more money, then you're willing to remodel your kitchen or buy a car or do whatever it is that you do. If you look at the other parts of the economy, because it's important when you think about where do you put your money in the stock market? Capital expenditures are expected to be pretty good this year. That's a consensus view. And housing is expected to be lousy. And so when you add those together, you kind of get a mediocre overall economy. But you can buy industrial stocks. They look reasonably attractive. You can buy consumer stocks that look reasonably attractive. I think energy stocks look reasonably attractive, even though the overall economy is weakish, those areas look like they'll be a little bit stronger.

How about some of these tech darlings that have been bouncing back this year after taking a beating last year? Where do you stand on that? I know they're all different, but anything strike you there?

You have to ask the questions: why did tech do so badly last year and why is it bouncing? I mean, the, the big problem last year with these tech companies is that their earnings were lousy. I mean, if you remember what happened with these companies, they just knocked the lights out both in terms of their earnings and stock price in the early days of the pandemic because we were staying at home and we were buying things online and we were using social media and we were using streaming services. And those companies were doing great and they hired a ton of people and they pulled forward a lot of activity. And their earnings have been pretty lackluster. I mean, if you look at this earnings season, the fourth quarter, the S&P had an earnings contraction of 2%. But if you threw out the tech companies, you had an expansion of 5.5%. I want to buy tech. What I really want to buy is secular growth. And when I say secular growth, I'm saying is growth that happens in a slow-growth economy, that doesn't need a good economy to grow well. But when I look for secular growth, surprisingly, tech doesn't seem to make it on the list particularly well. You find things in healthcare, you find things in staples, you find things in consumer, and normally tech leads that charge, but it just doesn't look like it wants to right now.

How should investors protect themselves against inflation? And, and maybe what I'm asking is, how shouldn't they do it? In other words, is just having exposure to the broad stock market enough? Is there something special that you ought to do for inflation protection? And do you think there's mistakes that people are making there right now?

Well, let's just start with what inflation is likely to be over the next, you know, year or two. Let's just assume that it's going to run 3.5% or 4%. And you can get a 6-month Treasury, you know, T-bill at something in the ballpark of 5.1%. So that immediately gets you, you know, a positive real return. So if you're looking from an equity perspective, you can say which equities are naturally, do they do best when inflation is going up? And that would be things like commodities companies, whether it's energy or mining companies and even industrial companies. But you can look at it differently and say, all right, the first 3.5% or 4% return I'm going to get on anything, stocks, bonds, real estate, whatever it is, that's just going to keep me in the same place because all I'm going to do is offset higher prices. And the only real return I'm going to get, the return after inflation, is anything I can do better than that 3.5% or 4%. And my prediction is that the stock market is going to be flattish this year. So it probably, as an overall, probably doesn't pull it off. And then you just have to pick your spots. Like I said earlier, I think you do it better overseas. I think you do better in short-term bonds.. But if you in general just want to say which things have the highest correlation to rising inflation, there's no question it would be, you know, old economy, energy, materials, and industrial names.

What about this game of fiscal chicken that the, uh, that the Congress might be playing in the months ahead? What do they teach you in stock strategist school about how to model that in your numbers? And what, as an investor, It seems like an outcome that could be either way and could be really severe if it goes in one direction.

Should people be worried about that? Yeah. So when you go to strategist school, the first thing they tell you is don't pay attention to these kind of headlines. Or what they actually tell you is to ignore the world is coming to an end kind of potential outcomes. Because if it happens, you're not around for it anyway. But if you look at this situation in terms of the debt ceiling and all, if we do trip it, it's a really bad thing. And you have to assume that smart folks in Congress, the administration are aware of this thing and no different than any other negotiation. Everybody feels like they have the most leverage when they negotiate up to the last minute. So I would expect that the market's going to continue to feel some tension around this, but the likelihood that it goes over that proverbial cliff, pretty low. And if you look at where the VIX is, the VIX being a measure of how much hedging is being done and the cost of putting on a hedge, the VIX below 20 right now is basically telling you that the market doesn't really think that there's really big macro risks to worry about. On the other hand, if the VIX is low, it also means the cost of hedging is really low. And what you could easily do is buy an out-of-the-money hedge on the stock market. And if this thing does go bad, you can buy that hedge for very, very little today, and you'd end up making a lot of money on it.

Last question, and I'll be happy for any thoughts that you want to add on this or other subjects, but just for that long-term saver out there that takes a very simple approach and they plunk their money into the market week after week and they, they just, you know, they're not worried about the downturn this year, but they want to know, are we in good shape in general for the— for that saver for the next 10 years or the next 20 years? When you look at the very long-term trends, are you optimistic about the future direction of U.S. asset markets or, you know, world asset markets?

If I look at— so I'll give you the short answer, and then I'll kind of back into it. I think that returns are going to be weaker for the next decade or two decades than they have been for the last 30 or 40 years. So let me kind of start with that conclusion. Now, let me give you the setup to that. When Volcker beat up on inflation in 1982, the interest rate didn't immediately drop with with falling inflation, it took about 30 or 40 years where interest rates steadily fell. And that meant that you had this beautiful tailwind behind the market because the value of every cash flow imaginable, the cash flow you got from bonds, the cash flow you got from real estate, a private business, stocks, it didn't matter. They re-rated higher, their multiples went higher, their valuations went up and the best decision you could have made in any asset would have been to borrow more money and buy those assets on leverage because the cost of capital fell for 40 years. Now, we're starting with— and interest rates are a little bit higher, but we're starting with interest rates lower as opposed to where they were, let's say, in the early 1980s. The other thing is we've had this wonderful benefit of increased globalization for the last 25 years as we've been able to buy cheaper parts and cheaper goods abroad, which was just a huge benefit. It kept inflation super low. And I think that that environment is going to be more challenging going forward. Demographics are weaker. The population in the US is aging. The population in China— this was the first year China actually had the population shrink. So they're no longer likely going to be the same growth engine. So a lot of those things that resulted in just extraordinary equity returns or returns for businesses in general are probably going to be a bit harder to come by. If you were to say, would I be a buyer of stocks with a 10-year horizon? Sure. Do I think the US with that kind of horizon is the global winner? Yeah, we're more innovative. But do I think it's going to be as wonderful as the last 20 or 30 years? I think that that's going to be really hard to beat.

Thank you, Jonathan and Fred, and thank all of you for listening. Jackson Cantrell is our producer. Oh yeah, subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts. And if you listen on Apple, please write us a review. If you want to find out about new stories, new podcast episode— not nude podcast, new podcast episodes— you can follow me on Twitter. That's @JackHough, H-O-U-G-H. See you next week.

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