On the Money


We Remain Optimistic on the Economy

April 8, 2021

David Fingold, Vice President & Senior Portfolio Manager discusses his market outlook, interest rates, small caps outperforming large caps, international markets vs. U.S. markets, and where he is finding opportunities.


Mark Brisley
Managing Director and Head of Dynamic Funds

David Fingold
Vice President and Senior Portfolio Manager


Mark Brisley: You are tuning in to On The Money with Dynamic Funds, a podcast series that delivers access to some of the industry's most experienced active managers and thought leaders. We're sitting down to ask them the pertinent questions to find out their insights on the market environment and navigating the investment landscape.

Welcome to another edition of On The Money with Dynamic Funds. I'm your host, Mark Brisley. I'm once again, joined by David Fingold lead portfolio manager here at Dynamic where he is managing over $13 billion in assets across mutual funds and ETFs that span global and US strategies and a recent rounding out of his suite of mandates with two international offerings.

David last joined us here in November of 2020, right on the heels of the US election and a lot of optimism on the pandemic, economic, and market fronts. With tongue firmly planted in cheek, that seems like an entire stimulus package you go. David, welcome back.

David Fingold: Thank you.

Mark Brisley: Let's start with the big picture then and talk about what your thoughts are on where equity markets are today, and do you see any new leadership emerging for 2021?

David Fingold: I think it's important that we should just back up a little bit and look at what has gone on over the last several years. There was an industrial recession that started at the beginning of 2018 and proceeded through 2019 and coincided with the onset of the trade war between China and the United States.

That industrial recession became a real recession at the end of February, 2020. The National Bureau of Economic Research declared that at that time a recession started, and markets have been recovering since the intervention by central banks that took place in late March and April of last year. We are still in the early stages of an economic recovery.

In fact, the National Bureau of Economic Research has not even announced that the recession has ended. The stock markets are trading the way how they normally trade when we're coming out of recession, cyclicals beating defensive, copper beating gold, the yield curve is steepening, interest rates are rising, small caps are beating large caps. The international markets are showing signs of life after they were outperformed by the American market until the low in the bear market in the month of March.

The market is acting the way that it normally acts in the early stages of an economic cycle. Very little has changed other than if you go a little bit under the hood, you'll see that the recent increases in interest rates have been more rapid.

I think that the election, vaccines, the improvement in the economy have caused interest rates to rise to what are becoming more normal levels relative to the activity level in the economy. I would say that interest rates remain perhaps about a third and maybe even 50% below where they normally should be. That is, the steepness of the yield curve is now about half of what it should be, or at the most two-thirds of what it would normally be given the level of economic activity.

We saw that as the yield curve steepened with the announcement of further stimulus packages, progress with vaccinations, that it caused some rotation within the cyclicals that were working. For instance, financial services had done very poorly in the low-interest rate environments, that we saw and interest rates, as I just mentioned, started to rapidly improve during October, November, and December and into this year.

Interest rates became high enough that financials became investible again. They were something I felt I had to drop like a bad habit in January and February of last year. Thank goodness, we got out of the way. They went down a lot. As the interest rate environment made them investible again, we were able to go back. We've also seen within other areas of cyclicality that a lot of the technology companies that were able to perform last year have gone and taken a break.

Technology is one of the cyclical industries, but there's been a rotation within technology from the very resilient businesses within software and services towards semiconductors, which are a much more cyclical place. With the automobile build increasing, with industrial production increasing and more demand for chips that go into machine tools, we have seen semiconductors do better.

I won't get into granular detail with each industry, but I will say that if you look under the hood of what has done best since September or October of last year, it is the most hyper-cyclical parts of any particular industry and they have been reacting to the higher levels of activity as lockdowns ceased taking place, at least, severe lockdowns ceased taking place. Interest rates have risen and also we have seen vaccinations increase.

Mark Brisley: That's interesting, and you mentioned rotations and we're hearing a lot about that lately, and we've seen this before, these periods where you see things in equity markets where the beat-up names get bought, leadership gets sold. You're talking a little bit about that in your couple of examples, but is this a potential sign of things to come as we see economies open and the recovery become more robust?

David Fingold: It's going to really depend upon the industry. There are some circumstances where there were really dramatic increases in the share prices of businesses that were truly challenged. My suspicion is that if there's any short interest left to cover, it's possible they can go higher, but I will ask the rhetorical question, which is if people were decreasing their utilization of shopping malls in the past, and we saw footfall decreasing in 2017, '18, and '19. There's no question that we can restore the activity within shopping malls, but it was in a declining trend over the long term.

What we are trying to do is we are trying to find the businesses that are on sale because of the current circumstances that ultimately are going to reassert themselves in terms of their growth. This is the toughest challenge we face today in building a portfolio, which is how much we should be exposed to the burden hand and let's call that the business that had a disaster second quarter last year, let's say all their stores were closed or all their movie theaters were closed. They're going to have a huge increase in the second quarter of this year, simply because of the mathematics, just that mechanically they have some business open and previously it was closed.

Those businesses are facing tough comparisons in the second half because they began opening up in the second half of last year and they could be facing impossible comparisons when they move through the first half of next year. What we are trying to do is trying to find the true long-term opportunity. That is to try to find investments, which aren't just trades, things that can be purchased today or perhaps should have been purchased in November, and then you have to sell them before June 30th because they're going to guide to some deceleration. Those are the things we're not really interested in.

What's important today is defined businesses that can do well in the second half and do well in 2022 and do well in 2023. I think that's really where the challenge lies. You asked if there's more to come for the reopening trade? The answer is, it's really up to the shorts if they're forced to cover on highly disadvantaged businesses, businesses that were in long-term decline, they could get pushed higher, but if they continue their long-term decline, they're not sound investments. If you're asking, does it continue with the businesses that will benefit from reopening and have been growing in the long-term, then I would say, yes, it will continue there.

I think that that amount of selectivity is really important because if we look at some of the market action, particularly in the month of November, the stocks that did the best were the most challenged business models and I don't believe there's a lot of legs there. Now, this is not a reason to be bearish. They didn't collectively have a huge amount of market cap and I would say that the long-term prospects are really tremendous and that's where we are focused.

In the short term if somebody wants to get excited about a movie theater chain, let them get excited, but theater attendance has been falling in the long term. I'm sure that if we reopen it'll be up during the time period we reopen, I just don't know what's going to cause people to rush back to movie theaters when they were in a three-year secular decline before the pandemic started.

Mark Brisley: While all that's playing out, we've also got just this unprecedented amount of stimulus that's been put into the market with the US. I was watching the show this morning and they were actually pondering the question, "How could equity markets possibly stumble with this much liquidity?" How do you think this all plays out long-term?

David Fingold: Well, I think, first of all, the sentiment that the stimulus and then the liquidity is positive for equities, I think is a correct sentiment. I think though, that people have to be careful though at analyzing the difference between what they hear on the news and what ends up happening in reality. In reality, a lot of money from the prior stimulus programs has gone unspent.

Now, that's not to say that there hasn't been a massive amount of stimulus, there has, but the headline numbers were not spent. Then there's a lot that's being announced recently. Again, we're hearing headline numbers. We do not have approved legislation in the United States. When we have approved legislation, then we have a headline number, but it's important to understand that when you look, for instance, at infrastructure, the infrastructure is under the authority of the states and not the federal government.

The federal government really only has freedom to provide matching funds. Most of the states have balanced budget laws or have balanced budget amendments within their state constitutions. Now the economy is improving, so that means the states will have more tax revenue and federal matching funds will help. The idea that there's just a tremendous amount of money that's going to flow into infrastructure in the short term, really doesn't make any sense.

Now, again, I'm positive on infrastructure, but I don't see this massive amount of money getting spent soon. To be blunt, a lot of what they're talking about is money that's going to take years to spend just given some of the legal and organizational parameters around doing it. The other thing about it is that you can authorize monies, but you still need to approve projects.

For instance, we hear there's bipartisan support for infrastructure yet, apparently, that didn't include a bridge to Canada and it didn't include a San Francisco subway. Apparently, pipelines are not infrastructure. The first thing the president did when he got into office was cancel the pipeline.

We're hearing headline numbers. I'm certain government spending is rising. I don't know if it's rising as fast as everybody says. I think that before people get concerned about the size of the stimulus, they should think about whether the money is really going to get spent. We still have a very, very high savings rate. It's near-record levels. One of the ways to get some final demand into the economy would be for the government to issue bonds to borrow those savings and then spend it, but spending money is not easy to do.

Mark Brisley: Hearing you mention infrastructure and just thinking about President Biden's announcement last week, but then thinking a little bit about your portfolios as well.

You've been zero weight in places like energy, real estate, and utilities over the years. Does last week's rollout of that package change your view in any of the areas that might impact the infrastructure stimulus and spending? Are there any other sectors that have become unattractive for you as you've watched things unfold over the course of the pandemic?

David Fingold: Our position on utilities is relatively unchanged. The problem with owning utility assets is that you're at the mercy of regulators. When you make an investment in a utility, let's say to improve the quality of the grid, to improve the use of green energy, to improve storage, because you need ways of storing power or installing peakers because solar and wind do not provide power continuously. You have to then go to a regulator and to recover a return on the capital even fast, they have to increase rates and utility regulators are typically elected officials, or they were appointed by elected officials who want to be reelected, so they don't want to let you spend the money.

My take on this is I don't want to be in the position where I'm directly leading to taxpayers getting charged more money. Ideally, one wants to avoid the utility. Will get involved in businesses that are making investments that are a high priority to their regulators. An example of that would be Berkshire Hathaway. A lot of people forget that they own Berkshire Hathaway Energy, which is one of the largest utilities in the world. They claim to be the largest operator in the world of wind and solar.

They will not install capacity unless they're guaranteed their required rate of return in the long term. When they get their price, they're prepared to be involved. They also do not pay a dividend to Berkshire Hathaway, they retain all the cash that's generated because Mr. Buffett believes that the required rate of return he is charging these utility regulators is high enough that he really wants to invest all the cash he possibly can on that basis.

It's a growth utility opportunity. I like that. It just happens that Berkshire Hathaway Energy is private company and part of Berkshire Hathaway. If that helps you understand how we're looking at it, we're not against the idea of utilities, we just want to make sure that we're getting involved, where we have certainty that we're going to earn the right return. Also that we're investing in the energy of the future.

The other thing that I'd point out about utilities and real estate is they tend to be very interest-rate sensitive. I mentioned earlier that interest rates could increase 30 to 50% just to go to normal levels relative to where industrial production is, GDP growth, the purchasing managers indices, and history has shown us that utilities and real estate perform poorly in rising interest rate environments. I just don't think that they're the place to be.

You ask about energy and I just have some things to say about wind and solar, which I rather like. I will also say that I do like fossil fuels, but again, what I'd say about really anything is we always prefer the picks and shovels. The fossil fuel discussion is interesting because business was really terrible 12 months ago. I mean, we had a negative oil price, and for companies who supply the picks and shovels, they're coming from a business level of zero. Anything is pretty rapid growth if they're getting orders for the picks and shovels.

There are some areas there that excite us. I mean, we don't just invest in the equipment for making solar panels and we do, or the equipment for making wind turbines, and we do do that. We also have invested in the equipment for oil and gas production and to support oil and gas production. That can include compressors. Natural gas does not come out of the ground at pipeline pressure, it needs to be compressed.

It can include generators. We just saw in Texas that the cold snap shut down the power grid. I suspect that every oil well is going to need a generator or run the risk of shutting down in a weather event in the future. We have a company that makes heating equipment, electric heating equipment that's used by utilities and chemical plants, refineries, it's used in oil and gas, midstream and upstream assets. We just saw all of those assets freeze in Texas.

I expect that in past weather events, there's been very high order inquiry activity and subsequently, order intake activity, as people begin winterizing their kit. We liked the picks and shovels. I think in a growing economy where the price of oil's already 60 bucks and we're barely driving our cars and we're barely flying around in airplanes, the oil price can be higher. I don't know how much higher, but I know that there's the demand for the picks and shovels. We can really see this in the performance of the pick and shovel companies

Mark Brisley: You talk about a rising rate environment as well. Of course, there's a lot of, I won't say concern, but a lot of interest on the inflation front. I thought Chairman Powell came out with some fairly pointed guidance recently, and it seems like they're going to look to inflation in the whites of its size before they make any policy changes. Here we are sitting, talking about 1.6, 1.7% on the 10 year being high. What do you make right now of rates and inflation expectations and how's it impacting your view on equities?

David Fingold: First of all, we always invest in businesses that have pricing power. If there's inflation, if our companies need to take a price increase, they can, but to be blunt, if there's disinflation, if there's deflation, they get to hold their prices. Pricing power is great. Mr. Buffet was asked by the financial crisis inquiry committee what the most important attribute was that he looked for in a business that he invested in and he said it was pricing power. I agree with him wholeheartedly on that.

I mean, he said that he's invested in businesses where they had to hold a prayer meeting in order to raise prices and he didn't think that that was a very pleasant experience. As you know, I've worked in operations and we were in a commodity business and I had to be a price taker and I understand exactly what that prayer meeting is like. I don't want to be there again.

I don't spend a lot of time thinking about inflation. I think that if there is inflation, good businesses with pricing power will benefit from it. As you pointed out, interest rate should be higher as a result. I think that the other thing that we keep on forgetting about this is that as recently as 12 months ago, 24 months ago, we were worried about deflation. We were worried about secular stagnation.

If Chairman Powell says that he's going to let inflation expectations run hot, I think that makes perfect sense because he was trying to calm people down not so long ago and his predecessor not so long before that to calm them down about deflation.

I think that Governor Kashkari has actually been very clear about this, that in prior economic expansions, the Fed tightened too early and tightened before it was possible to bring discouraged workers back into the workforce. In fact, I think that Governor Kashkari went so far as to actually say that Black and Hispanic discouraged workers, literally would only just be getting hired when the Fed would tighten too much.

I think this current Fed really wants to bring discouraged workers back into the workforce. You can see that in the difference between the U3 unemployment rate and U6, which is the broader measure. I think that they would like to see U6 a lot lower, and I think they'd like to see the participation rate a lot higher before they choke this off.

Look, that's my read of it. I know that for people who are on fixed incomes, they don't want to hear that their spending power could get undermined by inflation. I think that all of us are concerned about the long-term unemployed and that several Fed governors are talking very seriously about it as is current secretary and former Fed director, Yellen. I would expect it to form part of the policy framework. By the way, again, it's aspirational. They've been trying to get to the 2% target for a really, really long time.

Mark Brisley: David, let's talk about the credit side of the equation. It's a big part of your process doing credit work on equities that you want to own. What are you seeing today and are credit markets behaving like you would expect?

David Fingold: Credit markets are currently behaving exactly as would be expected. As I mentioned earlier, I think we're in the early stages of an economic rebound. As a generalization, credit markets tend to improve almost into the later innings of the economic expansion. In fact, let's think back to the cycle in the 2000s, credit spreads were improving until late 2006. We were more than three years into the expansion and credit spreads were still improving.

Also, the cycle ended two years after that. It was two years of deterioration in credit before the cycle ended. I feel like we're in early innings, mid-game at the absolute latest. That is the read that I take off of credit. That also means the growth can be higher and should be higher because businesses and households have plenty of access to credit.

In fact, recently I was looking at consumer credit statistics and the growth in consumer credit. You hear it on television, in the newspaper, big numbers for consumer credit, but people forget about the base effect. They forget that there's $10 or $12 trillion worth of mortgages outstanding and just given where the population is, there should be more like 15 trillion outstanding.

There's plenty of room for consumer credit and business credit to expand. From a security selection point of view, It's very straightforward. I am an investor in the equity of a company and let's all think back to basic finance. The equity holder has to sustain the first loss. It's only when we get wiped out that bondholders and banks and trade creditors can lose any money.

We do credit work on all the companies we invest in. We have a perfect record of avoiding companies that have gone bankrupt. It's almost the most important part of the definition of a high-quality company. Quality is a composite of credit quality, profitability, and consistency of profitability. Quality is what we do. I can tell you that recently, certainly during the month of November and also during the month of May last year, the lowest quality companies did really well.

They had been given death sentences and those death sentences are being commuted. We're in an environment with really abundant credit. That's a reason to be bullish. In fact, I know I've been talking and I hear myself talking about concerns, concerns about long-term unemployment, concerns about getting stimulus passed. I'd want to make it completely clear, I'm bullish. We don't see any red flags for the economy.

Mark Brisley: Yes, because of that bullishness and your optimism, we did recently just launch the Dynamic International Discovery Fund with you and as well an ETF that's going to go alongside with our Dynamic Active International ETF that you're managing alongside Peter Rosenberg. There's been a lot of attention on markets outside of North America, specifically the US. Where are you finding some of the good opportunities right now outside of North America, and are you tilting to more international names in your global mandates like Global Dividend and the Global Asset Allocation Fund?

David Fingold: Look, we just came through a pretty long period of US outperformance. I recall getting questions throughout 2016, through 2020, "This US outperformance, how long can it continue?" I remember saying to people, US outperformance ends when you get a bear market, and then the US outperforms by going down less during the bear market, and then the baton is handed International. We think that's what happened last year.

The reason why this happens is because the international markets contain more cyclical industries as an overall percentage of their market cap than the US markets do. They simply have more industrials, more energy, more financials, more materials. As a result, it's just a more cyclical space in the international markets. It's a good place to be just given what is going on in the economy. I think there are prospects for international markets to outperform, at least until we get to the middle of the cycle.

I think that also almost every investor I talk to has very overweighted the United States, and they're looking to get some diversification. I think that makes sense, nobody wants all their eggs in one basket.

You asked what we were doing in the global funds. The answer is, while the US was working, we had strong weights in the United States. At the start of 2020, I think that the Global Dividend Fund was around 75% US content. By the end of 2020, it was significantly below that. I'd say that it would have been perhaps closer to 40%, 45%.

We have rotated money in the global funds towards International, but it's important to understand that the US is the largest stock market in the world. It's the least volatile stock market in the world. It needs to be the anchor of our global equity funds, especially the ones that are low to moderate risk or moderate risk. Starting an international fund at this juncture as the international markets are picking up the baton is really good timing.

In fact, Mark, I think back on our own conversations that we wanted to time the launch of the fund when we would have the wind at our back. I think we've made that judgment in terms of when we started it. In terms of where we're finding value, it's obviously in the cyclical industries. There's a very strong representation of financial services and industrials in that portfolio and also consumer durables. We're getting to invest in some of the best financial institutions in the world.

There are things you can invest in internationally that you really can't invest in North America. Private banking is a good example. This is a business that the Swiss invented. The other thing is that some of the finest luxury companies in the world are in Europe. This could be in things like leather and handbags. It could be in fine fragrance. Some of the best distillers in the world are in Europe. Again, Cognac, well, Cognac comes from one place, and that's France, and we own a Cognac producer.

Some of the finest cosmetics companies in the world are international. Those are opening up plays because as much as some makeup is getting used for Zoom calls, a lot more makeup will get used when people go out shopping or to restaurants or go back to the office. I'm just giving you a taste of some of the things that we've invested in.

One area that is emerging for us is actually commercial insurance. The commercial lines have benefited from the claims in business interruption last year, and also some of the natural disasters we might say, benefited. When you get that environment where everybody has to pay a lot of claims, everybody has to raise prices. It's actually a lot easier in Europe, for instance, to get exposed to the commercial lines without being exposed to personal lines.

Personal lines in insurance hasn't been a good space because it's hard to raise prices when nobody's driving their cars and there's very few accidents. Europe actually has given us access to some granularity on the part of the insurance market that's improving.

Then there is our investments in Israel, where we have some of the finest technology companies in the world. Also, interestingly, I'm back in the fertilizer business with an Israeli company. The Dead Sea is the world's longest reserve life source of potash. It is the low-cost producer of potash at the Dead Sea Works. That's something we've had the scope to invest in.

It's exciting. It's always fun to have a new fund and a lot of opportunities. If you look at the portfolio, you'll see some greatest hits. Some of the companies we've owned for a long time and the other global funds and also some new ideas as we're building out our first dedicated international portfolios.

Mark Brisley: Definitely the optimism you can certainly hear it in your comments through this entire podcast. One of my favorite sound bites from you, and I know it's a quote has always been that you are an optimist because you've never met a rich pessimist, but here's my actual question to close things off today. Is there anything that's keeping you from closing your eyes tightly at night right now?

David Fingold: They always say, in boxing, you don't see the punch that gets you, it hits you in the back of the head. There's lots of things that I'm worried about, but they really aren't the thing we should be worried about. It's very difficult to accurately predict what the problem is going to be. I don't know anybody who predicted 9/11 or the first or second Gulf War or predicted COVID.

I know people sometimes predict things repeatedly and then finally get them right. I did go to Babson College and Roger Babson did predict the Great Depression. It was the fourth or fifth time he predicted it that he was right. I think that's the reason why we're conservative. Most of the money I manage is in low to moderate risk funds and there's a definition for that. We're supposed to stay between 6% and 12% standard deviation of returns.

We have to be conservative. We have to be willing to raise cash. We have to invest in high-quality businesses, but I think that if we put our conservatism together with some optimism, then I think we should continue to see encouraging results into the future.

Look, I wish that I could name what we should be worried about. I always used to tell people that I was worried about a killer asteroid coming to destroy the earth. I actually just read in a scientific journal that NASA is experimenting with nudging an asteroid because they need to be prepared if something like that happens in the future. Perhaps we can take that one off the table.

Mark Brisley: Who saw a murder ordinance coming? David, it is always a pleasure, I appreciate your perspective and your insights. We definitely love the optimism, but also with that dose of reality in terms of what you're looking for and how you're putting that across your mandates. Thanks very much for joining us today.

David Fingold: Thank you for having me on.

Mark Brisley: Thank you to all of our listeners for joining us for another edition of On the Money. As always, if you'd like more information about anything you heard today or anything pertaining to Dynamic Funds, please feel free to visit us at dynamic.ca. Of course, for any information beyond that, please seek the services of a qualified financial advisor. On behalf of all of us here at Dynamic, we wish you continued good health and safety. Thanks again for joining us.

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