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Taking Stock

Fixed-income veteran upbeat on U.S. fortunes Add to ...

The last time I encountered American bond portfolio manager Stephen Smith, he was incensed because a stuffed black bear he tried to ship across the border as a gift for a friend in Montreal had been seized by our diligent customs guardians.

Today, more than a decade later, Mr. Smith, 63, is still rankled about the bear, which was never returned. But these days, he's tackling another ursine issue, this time of the human kind.

At a time when the end-is-nigh Roubinis are still pulling in fat appearance fees for their gloomy visions, the managing director of Brandywine Global Investment Management offers up a remarkably upbeat outlook on U.S. fortunes.

His optimism stems from a conviction that a crucial turning point has been reached on several fronts, including the political, and that a more confident Corporate America is ready to put a vast hoard of cash back into to job-creating work.

The market shifted from abject fear after the collapse of Lehman in 2008 to a conviction that there was no hope for the developed economies, he told a Toronto investment conference on Thursday. "The market believes there is no way out," Mr. Smith said. "People are extraordinarily bearish."

But he argues that the problems bedevilling the U.S. and European economies are being addressed. He even had good things to say about the Federal Reserve's controversial new round of quantitative easing, arguing that its main purpose is to serve as an insurance policy against a double-dip recession and to foster the confidence necessary to get businesses and consumers spending again.

"I'm not trying to be Pollyannish," he tells me later. "I just think we've reached an inflection point."

That's not a typical view in the always skeptical, inflation-fearing bond world. By the very nature of their investing preferences, bond people tend to be both conservative and pessimistic. Their essential view, after all, is that the best they can hope for is to get all their money back. Preservation of capital is paramount. Famed bond investor Bill Gross has argued that the Fed is fuelling a massive bubble.

Yet here we have a fixed-income veteran like Mr. Smith openly telling investors, who have been pulling money out of equity funds everywhere but in emerging markets for months, that stocks are looking more appealing all the time.

Mr. Smith notes that the free cash flow yield in the U.S. stock market, excluding banks, is about 7 per cent and that five of the biggest technology companies alone - Microsoft, Cisco, Apple, Hewlett-Packard and Intel - are sitting with about $130-billion in net cash on their balance sheets.

"Would you rather buy a 10-year Treasury at 2.5 per cent or a basket of those five companies?"

Bond Portfolios

Well, if the goal is a return substantially above inflation, the answer is obvious.

Meanwhile, though, money is still pouring into bond funds, and it has to be invested. "What we've done is cut the duration of our portfolio. We've become more conservative."

Philadelphia-based Brandywine, an arm of Legg Mason, manages about $22-billion (U.S.) worth of bond assets and about $10-billion in equities. Mr. Smith, who grew up in Pennsylvania Amish country, talks in a folksy manner and displays his Reaganesque American values proudly. He cites the mid-term election results as yet another reason for his optimism.

Uncertainty over Obama administration policies and regulatory changes has kept investment in check in two crucial sectors of the economy, financial services and health care, he says. "Now the elections are over. You're not going to have all this negative campaigning. God forbid people should get slightly more optimistic."

All it would take, he insists, is one or two good months of employment growth, say 400,000 net new jobs a month.

He acknowledges this sounds a bit far-fetched, given recent numbers. The U.S. posted a gain of 151,000 jobs last month. The first increase in five months triggered an enthusiastic market response. But economist Paul Krugman put it in perspective, noting that employment is still 7.5 million below what it was before the meltdown. "At this rate we'll return to full employment around 2030 or so," he wrote on his blog.

Needless to say, Mr. Smith does not share the bearish view.

"People now know what they need to do. And the corporate sector has all this cash. Are they going to spend it or are they not? The cash just keeps building up and there are projects that need to be done. There are competitive things that they [industries]need to do. And I'm thinking that we are getting to the point where we're going to get that [resumption of spending]"

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