Special Large Cap Value Fund

Cameron Pickoski: What do investors need to know about what happened in the third quarter? I'm here in Menomonee Falls to spend the day with Bryant VanCronkhite, co-head of our Special Global Equity team, to find out. Hey, Bryant. Good to see you.

Bryant VanCronkhite: Hi, Cameron. Good to see you.

Cameron: Thanks for taking some time to talk to us about the third quarter today.

Bryant: Of course.

Cameron: I appreciate it. First, I wanted to talk about China. It seemed like just a few weeks ago, some investors were about ready to give up, but they just introduced their new stimulus package to help support their economy. And I just wanted to hear from you. What do you find interesting about that package and tell us what you think?

Bryant: Yeah, I think first we need to compare and contrast. We all have in our minds the 2008 package that supported the world economy in 2009 through 2011. That package back then was 4 trillion RMB (renminbi). This package is only a little over 1 trillion. So, much smaller package this time, but let's not forget the Chinese economy is much bigger today than it was in 2008, 2009, and 2010. So, we have a smaller package on a bigger economy. The impact is probably a little less. But what's in the package is also important to understand. So, one of the things they're doing is supporting housing. It's been said that 85% of the individual Chinese net worth is tied into housing. So, giving capital to local state-owned organizations to buy excess housing inventory will support home prices, which is a good thing for the balance sheet of the consumer. But interestingly enough, they're also putting capital into the hands of corporations to support stock buybacks and dividends and also into the hands of large equity investors to allow them to buy more stock, very directly and intentionally driving up the Chinese equity markets, which, again, supports balance sheets, given the growth in the brokerage accounts.

Cameron: Yeah, OK. And so, can we talk a little bit about what does that mean for the broader global economy? We know what it means for China. What does it mean for everyone else?

Bryant: I think we have hopes that the second largest economy in the world, which is China, will drive the rest of the world, right? That's kind of what happened in 2008 through 2011. That big package was all about construction and it drove materials and commodities prices, which is a global market, higher and it supported everybody. Copper was good. Aggregates was good. Steel was good. This is different. This looks very China-centric. It's consumer-centric. They want to stimulate the local economy, pushing people into restaurants, local consumption. I don't think we should expect, as U.S. investors, the benefit, the halo benefit of the past packages. We're going to look for it to support the Chinese economy, but I don't think we should extrapolate it in a big way to the U.S. like we did in 2008 through 2011.

Cameron: All right. So, history is not about to repeat itself.

Bryant: Not in my view. Not yet. They might come out with more, but not quite yet.

Cameron: All right. So, a few weeks ago, the Fed (Federal Reserve) just cut rates and I think everyone's really interested in hearing about what's been happening since then. Do you think there will be another cut? Just what do you think happens next?

Bryant: Yeah, the key that allowed the Fed to cut rates was the cooling of inflation coming back towards their target of 2% but also the balancing of the employment market. We saw unemployment rates rising, which gave them confidence that the market was back in balance, allowing them to cut 50 basis points (100 basis points equals 1%). Now, what's happened since then could be a little troubling, actually. The nonfarm payroll number we saw just recently was really high, meaning labor actually looks really strong, pushing unemployment rates down. In the event that continues to happen, it could cause the Fed to have concern around whether they acted too early, which would change the path of interest rates going forward.

Cameron: All right. And so, knowing that, what's at stake for the Fed over these next few meetings and the markets in general?

Bryant: Yeah, I think there's two critical pieces the Fed has to be thinking about right now. One is how do we avoid runaway inflation? If we see the job market begin to reheat and employment come out of balance, the labor will demand higher wages. And if they have higher wages, we're going to see more inflation. It's a self-fulfilling spiral. It's really dangerous for the Fed. They have to be very careful about the balance between labor right now offsetting inflation. But the second thing—maybe a bigger, higher level issue—is the credibility of the Fed is at stake, right? The ability for the Fed to control the economy, control markets only exists because people believe they can do it, because they're almost prescient in their abilities. If they lose that credibility and the market loses faith in them, what I think you'll see is a lot more volatility, both in equities and in interest rates, which ultimately becomes very challenging for investors to navigate over time.

Cameron: All right. So, obviously the Fed a big topic in Q3 and will continue to be so in Q4.

Bryant: All eyes on the Fed.

Cameron: Always. So, Bryant, let's take a second to talk about what you do best: looking for undervalued companies. What's changed pre- and post-COVID when it comes to company analysis? What's different now?

Bryant: Yeah, I think that's a great question because there's a lot of obvious things that have changed from pre-COVID to post-COVID. There's a lot of important subtle things that have changed. And one of the things I see happening at the corporate level is the change in what dominates decisions. And it used to be that technological advances and outsourcing of supply chains really helped companies reduce the need for labor. It helped companies see margin expansion. But post-COVID, the supply and demand of labor has gone in a different direction. And you see labor reasserting their authority, reasserting their muscle. And you see it best in some of the union activity. We're seeing a lot of different companies in the retail space, the quick service space, employees want to join unions. And you're seeing a lot of unions assert their authority through strikes, whether it's in the aerospace industry or in the screenwriters industry. But nonetheless, they’re asserting their authority. And you're seeing massive changes in wages, which ultimately accrue to margins. Companies will have to change whether they invest in labor and cut back on R&D, cut back on advertising. It could impact long-term growth rates. But even the intangibles are changing, right? The desire to have white collar workers working from home, as an example. It has an impact on efficiencies and it has an impact on culture and things you might not see necessarily until the next generation has their turn to drive company cultures forward. And it has an impact on competitive advantages of asset bases. So, it's a subtle change but a meaningful one. And you'll start to see it first in the margins, but long term, you'll probably see it start to impact growth rates and companies’ competitive positionings.

Cameron: Yeah, absolutely. Well, we've covered a lot today. In your opinion, what do investors really need to take away from this?

Bryant: I think there's a lot to worry about right now if you’re an investor. From a macro level, you have the Fed and interest rate policy. You have employment issues to be concerned about, China's stimulus and what will they do, and then, the U.S. election. There's a lot of macro noise that can get in the way of good security selection. But at the corporate level, things are changing, right? The post-COVID world is different than the pre-COVID world, whether it's talking about labor, supply chains, technology advancements. These all matter, too. And so, what we want to do is get through the noise and think about what do companies truly control and how do they control their destiny? And they do it, in my opinion, through one way only, which is how do they use their capital? Measure the balance sheet flexibility, engage companies, and try to figure out what are they going to do? Make acquisitions, grow organically, buy back stock, pay higher dividends? These are the choices they control and they will drive compounding returns over time. And if you do that correctly, you can fight through all the noise. These businesses can fight that noise for you. It allows us as investors to sleep well at night. So, my advice is be balanced, don't be brave, focus on the controllable, and build well-rounded portfolios around that.

Cameron: So, cut through the noise. Focus on the controllable.

Bryant: Well said.

Cameron: All right. Well, that was our Q3 market recap with Bryant VanCronkhite. Thanks so much for joining us.

Bryant: It’s my pleasure.