Five investors on investing in the 5% world

Mario Gabelli, Steve Eisman, Aswath Damodaran, Saira Malik, Mike Gitlin. (Illustration: WSJ)
Mario Gabelli, Steve Eisman, Aswath Damodaran, Saira Malik, Mike Gitlin. (Illustration: WSJ)

Summary

The 10-year yield is close to hitting 5% for the first time since 2007. We asked some of Wall Street’s brightest how to play it.

Why invest in U.S. stocks when the safest investment in the world—U. S. government debt—pays the most it has since 2007? That is the new question facing investors now that the yield on the 10-year Treasury note is approaching 5%.

Rock-bottom interest rates and record money-printing from the Federal Reserve shifted the picture of what successful investing looked like since the 2008 financial crisis. Roughly 15 years of nearly free cash spurred a tech boom, exponential gains by venture capitalists, and an investing mania tied to digital tokens and stocks on the brink of bankruptcy.

Bonds were a useful hedge, protecting investors from those odd off-years in the stock market, and a safe haven to park money during times of turmoil. Now, bonds are back, offering the highest yields since 2007. And the Fed is tightening its policy, having raised rates at the fastest pace in four decades. In many ways, higher rates mean a shift away from speculative excess and a return to fundamental investing. Still, Wall Street says this period could be unlike any in the past.

We asked five investors what they are buying and where they see potential pitfalls.

Mario Gabelli

Mario Gabelli has invested through over six decades of economic ups and downs. The billionaire money-manager, who runs Gamco Investors out of Rye, N.Y., says he’s not ready to give up on American stocks quite yet.

Gabelli says most investors are overly focused on the tension between the Federal Reserve’s campaign to rein in inflation with higher interest rates and the government’s effort to revive manufacturing and growth in the U.S.

While these forces will impact markets, he says the federal deficit is a longer-term concern, especially since the country’s burden to make its payments will rise with higher interest rates and increased federal spending will force it to borrow more.

Net interest on federal debt jumped 34% to $572 billion in the latest fiscal year according to the Congressional Budget Office, doubling the budget shortfall to a record $1.6 trillion from last year. That doesn’t mean investors should pull out of the market, though, he says.

Gabelli expects the higher debt to drag on stocks, preventing the 10.2% annualized returns that stock investing provided investors for the past 100 years. But he says that investors should weigh America’s prospects relative to the rest of the world—through that lens, the U.S. still looks better than many other countries in terms of population growth and productivity.

“The world has extreme short-termism. When a company used to report lackluster results, the stock would drop from $20 to $19.50. Now you see a $20 stock drop to $16 immediately—those intraday moves are magnified now."

Shortsightedness and reactionary trading have historically hurt everyday investors, who oftentimes would’ve been better off leaving their portfolios untouched.

“For the next three to four months, what can I say? For the next three to four years, it’s hard to tell how the market will adjust to all the debt," he said. “But for the next 30 years? I see 8% to 9% returns in U.S. stocks."

Gabelli began his career on Wall Street in the 1960s when the “nifty fifty" large-cap U.S. stocks dominated the market, then launched Gamco Investors Inc. in 1977. Investing through multiple bouts of inflation and then-Fed Chair Paul Volcker ratcheting up interest rates to 20%, he rose to become Wall Street’s top-paid man as a long-term stock picker.

Steve Eisman

Ever since Steve Carell played him in “The Big Short," the 2015 movie based on Michael Lewis’ bestelling book of the same name, people ask Steve Eisman what—and when—the next big blowup will be. It is only natural after he successfully bet against the subprime mortgage craze ahead of the 2008-09 financial crisis.

Eisman, who manages money for one of the biggest investment firms in the country, Neuberger Berman, says that even with the highest mortgage rates in two decades, there is no housing crisis to sound the alarms about.

He’s going back to basics for his clients, scooping up bonds for the first time in his career, and buying up old-economy stocks—a play on the U.S. government’s spending spree.

“This is the first industrial policy in the U.S. we’ve seen in several decades," says Eisman. “The money isn’t spent yet—it’s the government, it doesn’t take a week. There has been no revenue impact at this point and I don’t think most of the spending has been embedded in any stocks."

Eisman calls his investment thesis the “revenge of the old school." He’s looking at shares of construction companies, utilities, industrials and materials.

“What does Vulcan Materials do? It makes rocks," he says. “This isn’t the nitty-gritty technical aspects of AI. The fundamentals of these companies are not difficult to understand, and they will tend to have the wind at their backs."

Here’s what Eisman is avoiding: “uninvestable" banks and hypergrowth stocks, an era of investing he says is dead. While banks might look cheap, he said he doesn’t expect their outlook to improve much. Having to pay depositors higher interest rates, prospects of a recession, and increased regulation sap their investability, he says, even if the banking system isn’t under any immediate threat.

Aswath Damodaran

Rising rates were supposed to crush high-flying tech stocks by hurting the value of those companies’ future profits. The companies’ costs would go up, and the thinking was that investors wouldn’t take the flier on tech when they can make good returns from risk-free Treasurys.

Aswath Damodaran, a finance professor at New York University’s Stern School of Business who studies stock valuations, isn’t surprised that big-tech stocks have shined this year. Lumping all tech together is a gross oversimplification, he says.

“Stop using tech as shorthand for growth companies," he says. “That was true in the 1980s, but tech is now 30% of the market, it is in everything. The proverbial cash machines, today they’re big tech companies. No one prints money like Apple, Google, Facebook, and so on."

Tech giants like Microsoft have built up massive war chests of cash and reduced their debtload, so many are now benefiting from higher interest rates. Companies like Amazon.com have expanded their businesses to include cloud-computing, subscription video streaming, grocery shopping and e-commerce, generating massive revenue streams from products that consumers can’t live without.

Last year’s inflationary surge tested companies’ ability to pass on higher costs to customers by raising prices. Many young companies haven’t dealt with a recession or higher inflation, and got used to easily accessible money. Damodaran says companies that started and thrived in the era of near-zero rates could struggle to endure the slowing economy that is likely to result from the Fed’s interest-rate campaign.

“Is your Peloton membership really noncyclical? We will discover how discretionary the spending on some of these products is," he says.

Saira Malik

Saira Malik oversees roughly $1.1 trillion in assets as the chief investment officer of Nuveen. Her clients say they have about a quarter of their portfolios in cash—she says it is a great bet—but that doesn’t mean people should dump stocks.

“The return on short-term debt is at the highest levels we’ve seen in decades," she says. “But equity markets have significantly outperformed cash."

Malik says that some investors have been trying to time the stock market’s decline or rise since the Federal Reserve began changing interest rates, but she says most fail to do so successfully, often getting in and out of the market at precisely the wrong time.

While Malik expects a mild recession sometime next year, she feels that the negativity around the markets and economy is overdone. The banking crisis, which kicked off with the failure of Silicon Valley Bank and dominoed to topple several regional banks, proved contained and ephemeral, rather than a structural issue in the market.

Investing in less-traditional holdings like farmland, timberland, emerging-market stocks and private credit are good ideas at the moment, she says, especially with the prospects for rising government debt to ensure inflation remains high for years to come.

Still, she doesn’t see any impending crisis on the horizon.

“I don’t see a bubble bursting," she says. “I’m more bullish than bearish right now."

Mike Gitlin

Mike Gitlin is set to become the president and chief executive of Capital Group later this month. The firm manages roughly $2.3 trillion, more than $800 billion of which is on behalf of pensions and other institutional retirement funds.

He feels good about the bond market right now. Short-term rates are the highest in years, long-term bonds tend to thrive when the Fed begins cutting rates. Even debt from lower-rated companies is offering returns that are competitive with stocks after years of just offering a few percentage points.

“The window opens when the Fed is done hiking," he says.

Investors shouldn’t have too much cash on the sidelines when it comes to their bond portfolio, he says, as central bank rate cuts boost bond prices. High-quality, short-term bonds are offering near 6% yields in some cases. High yield, which are riskier, especially if a recession comes and causes some companies to default, are offering 9% yields, compensating investors willing to be a bit more speculative.

While investors have piled into short-term and cash-like assets, such as money-market funds, Gitlin says now is the time to extend out into longer-dated bonds, which rise in price more when yields fall.

While the 10-year yield could bounce between 3.5% and 5.5% for the next few years, he doesn’t expect yields to go much higher from here. He also doesn’t see rates dropping dramatically anytime soon, though. Expect the fed-funds rate around 4.5% or so in a year from now, not zero, he said.

Inflation is falling, the economy is slowing, and the labor market is cooling. All those signs points to buying bonds, he says.

Write to Eric Wallerstein at eric.wallerstein@wsj.com

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