Capital Group chairman and chief executive officer Tim Armour discusses the sudden return of volatility to the markets and provides helpful context for advisors and investors.
Chairman and CEO
36 years of investment experience
Will McKenna: Hello. We’re here today with Tim Armour, the chairman and CEO of Capital Group. To hear his perspective on the current market volatility, and where he sees things going from here. Tim, thanks for being with us today. You know you’ve been saying for some time that we should probably be expecting a pull-back here in the markets, and here we are.
Can you talk about this current pullback in the market and volatility and what’s behind it? What’s driving it?
Tim Armour: Sure. Will, as you know the markets have been very strong now for quite some time--really up until 10 days ago — and for good reason. The global economy has been improving and has been improving for quite some time. Interest rates have been at all-time lows. Central banks around the world have been priming the pump, so we can fully recover globally from the financial crisis so there’s been a very strong backdrop. But with that equity markets have appreciated a lot without any real pullback for quite some time. In fact, we’d had the longest period of time, ever recorded before having a 5% pullback until recently in the last couple of days here, so my view is we were overdue for some kind of correction. As you know we’re really focused on the long term and want to pay attention to what the long-term opportunities are, and we still feel pretty good about the economic backdrop for corporate earnings, what that means for earnings growth, and we think there are plenty of opportunities here, so I would categorize as really just the market taking a breather. There’s some unusual things going on that we can get into, but I’m not overly concerned about this pullback at this point.
Will McKenna: So, it’s safe to say you see this as a little bit more of a pause or a healthy correction, not necessarily signs of something bigger as we go forward.
Tim Armour: Yeah, I think that’s right—you know markets do better when they have corrections periodically. You can’t just go up all the time. The thing that we keep a close eye on really is interest rates, because that is the one measure that has been most important to the equity markets I think over the last several years. And there has been a change—interest rates bottomed a few months ago and have been slowly ticking up, and that makes everybody rightfully a bit cautious, so we need to pay attention to that. On top of that we’ve had unemployment levels continue to drop and economic growth is improving, and even most recently we’ve had good wage growth so there are concerns now that inflation could be coming down the pike and if so what does that mean for interest rates? Presumably it means rates will continue to move up. So at some point if interest rates move too rapidly, one would have to question are equity values appropriately reflected in the markets today? That, to my judgment, would require a pretty big move in interest rates, thus far we are not seeing that so we think the backdrop remains pretty positive. But, this is a healthy process to get some of the froth out of the market I would say. And so we think this is pretty natural, and having some greater volatility in the market now probably is healthy for the market. We hadn’t seen much volatility for quite some time.
Will McKenna: That’s great. To the point you made it does seem like some of the, you know ironically, the good news things like better wage growth were the things that ended up being bad news for the markets in the near term we saw those better numbers on Friday. Can you say more about how that leads your thinking about interest rates and where we go from here—on the balance of 2018?
Tim Armour: Yeah, so look some wage growth would be very healthy for the U.S. economy. Its wage growth that really leads to income levels for the average individual and the average individual consumption drives nearly two-thirds of economic growth in the country…personal consumption. So, very, very important. So we’d like to see some wage growth. I think that would be healthy in the United States. Like lots of things, though, you want the right amount. Too much makes people nervous for inflationary concerns and not enough doesn’t give us the personal income rise that would help fuel greater consumption. On top of that, with the tax plan having been passed recently, it now appears that companies are going to start investing more in capital spending which is the other leg that can help drive economic growth and it looks like we are going to get more of that. So the backdrop’s pretty strong in the United States for economic growth and again I think the key issue: Can that growth occur without heating up too much inflation? And my belief is that that can happen but it is something to watch pretty closely.
Will McKenna: Great, well that’s a great segue to that question about what are the things that you’re both worried about, and then you know the things that may provide you some comfort in today’s market?
Tim Armour: If you want to talk about things that worry us, we are long term in our investment horizon, so we are looking for great companies that we can invest in or great bonds that we can invest in and hold for the long run if possible. The key issue for companies obviously is: What can there earnings growth be, and how sustainable is that earnings growth because earnings growth gets reflected in valuation over time. So to my mind, the real question is: Can we see earnings growth pick up as a result of faster economic growth — the kicker of tax rates coming down will help a lot of corporate earnings--and how much of that can really flow through to earnings growth overall?
And so if we get some pretty healthy earnings growth suddenly market valuations do not look as high as they were say six months ago. And sure enough the consensus view is today that that the market’s probably selling at eighteen, nineteen times future earnings. Whereas a couple of months ago it looked like it was selling at twenty-one, twenty-two times. So my belief is certainly that- that earnings growth will come through, and that’s something we really want to pay attention to. Now, it’s interesting to talk about these broad economic views of the U.S. markets and other global markets, but really the issue for us is looking into individual companies. So we’re striving to find those companies that can have good earnings growth and sell at a reasonable valuation if we can buy and hold onto for an extended period of time.
Will McKenna: Say more about that, I mean do continue to see that kind of strength out there in those company visits and by company selection that we do?
Tim Armour: Yeah, one of the great things that been going on here for the last several months is although volatility had not yet showed up yet in the marketplace, there was a big difference in in the profile of types of companies that were doing better than others. So the there are some companies out there that have been doing very well on top-line growth which has been rolling through to bottom-line earnings growth. Those are the kinds of companies if you can identify and don’t have to pay too much for them, you can do very well as a long term investor. Now, you know almost any time in the market you will have a variation of the types of companies and what’s attractive and what isn’t but, obviously, companies in the whole technology area have been quite strong. Internet-related companies have been quite strong, but, again, they are some of the valuations that have gotten a little ahead of themselves, we’ve felt. So it’s a little bit of a tricky issue— so you really do have to look company by company and identify the attractive opportunities with long term time horizon.
Will McKenna: Were you at all surprised by the severity or the sharp nature of this sell-off? And to what extent was that driven by some of the algorithmic things that are happening in capital markets today that may have been behind this?
Tim Armour: I’m never surprised at what the market will do in short order. Frankly, I was pretty surprised at how fast the market was moving up in January. We were up 8%-plus in three weeks, which seemed very fast and a little out of sync with the underlying fundamentals. So having a pullback that sharp — 8% off from the high — doesn’t surprise me in that same vein …
Will McKenna: It only takes us back to, I think, mid-December or something like that.
Tim Armour: Yeah. Basically, we’re about flat for the year at this point. And things are bouncing around a lot, which they’re likely to. I think it’s clear volatility is on the rise and will probably be higher for a period of time, which, again, I think is somewhat healthy. We’ve been through a period of time where market volatility was at all-time lows. It doesn’t make a lot of sense in the long run. And it tends to lead to a bit of apathy on investors’ parts, which is not healthy.
This is a hard business. One has to be disciplined, one has to pay attention and one has to be long-term oriented. And if one is complacent or thinks it’s easy, it doesn’t usually work out very well.
Will McKenna: Let’s broaden our lens to look more globally. We’ve been in what appears to be this synchronized period of global economic growth and recovery. Again, a lot of good news on the economic front. The U.S. was a bit ahead, but now we’re seeing that strength pick up in places like Europe and Japan and elsewhere. Yet, of course, those markets have sold off as well. What’s your view — and perhaps that of some of your colleagues — as we look around the world at those global markets?
Tim Armour: Yeah. As you’ve said, the U.S. really led the world out of the global financial crisis. It was the one place where central banks really started to hit the accelerator by putting a lot of liquity into the system first. Asia followed next, if I can generalize in big terms, and Europe was the slowest. And frankly, Europe had some of the biggest problems in the banking system that were not addressed early on. So it’s no surprise that the U.S. growth rate accelerated first, coming out of the last seven, eight years, and the U.S. was furthest along. Now today, when you look at things in a snapshot, the U.S.’s growth is pretty healthy. Now, Europe is not far behind, and in fact, Europe has been growing at a faster rate off a lower base to catch up here.
So I’m optimistic that all the pieces continue to be in place with relatively low inflation, low interest rates, revenue growth being pretty good — because consumption around the world is improving — and I think corporate earnings on a global basis will continue to be pretty darn strong here. So the backdrop looks pretty good.
Will McKenna: Great. Tim, you’ve been an investor with us for 34 years. Presumably, you’ve been through a good handful of different market cycles. Love to hear your experience and that broader perspective that you can bring to what we’re currently experiencing today, and how your experience through those prior cycles informs your thinking today.
Tim Armour: I’ve seen a lot of market cycles and lived through a lot of very volatile periods of time. And one thing’s common, I think, in all market cycles — particularly the down ones: It’s scary. It’s uncomfortable. You wonder how far it’s going to fall. And one of the advantages of having been at this so long, you understand — or begin to understand over time with experience — that none of us can predict what the market’s going to do, in terms of going up or down. But what we can do is identify good companies that we know are growing companies, that are going to be better and bigger companies in 10 years and have greater earnings. And if we get those companies right through all sorts of market cycles, we’re going to do well for our investors, and that’s what it’s all about.
So I think the most important lesson, Will, I’ve learned over time is you have to contain your emotions. It’s not easy to do. It’s not easy to do on the way up, and it’s not easy to do on the way down. But it is your enemy in terms of creating wealth over time. So sticking with fundamentals in terms of what your beliefs are, having good asset allocation, a balanced portfolio with a long-term horizon is the best thing I can advise for any investor and what we really try and practice here at Capital, day in and day out.
Will McKenna: What advice might you give to our audience of advisors about how they should be thinking about this period, and perhaps more importantly, communicating with their own clients?
Tim Armour: Well, first of all, advice is critically important. What our advisors out there are doing day in and day out is so important for the individual investor. They need ‘em. They need the advice. They need the long-term reminder, and they need to keep their emotions in check. I’m talking about investor, and advisors are critical in making sure that happens. We all know the worst thing one can do in a volatile period is get nervous and get out. That really hurts people.
So my advice would be, make sure that your clients, your investors, have a well-balanced portfolio that’s well-designed for their own particular circumstances and needs. Having good asset allocation is critically important, and a long-term orientation. So discussing that plan very carefully with the investor, making sure they’re on board with it, because they will have to be reminded. We all have to be reminded. So I think those are the most important elements. And I can’t emphasize enough the long-term orientation. Figure out what the plan is, stick to it and execute on it.
Will McKenna: Great place to end. Tim Armour, thanks so much for your time.
Tim Armour: All right, Will. Thank you.
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