International Growth Strategy Update 4Q20
January 25, 2021
Jenna Dagenhart: Hello, you're watching ClearBridge Investments, Exclusive 2021 Outlook Masterclass. We'll cover what the new administration could mean for markets, the rally and growth stocks, and where to find opportunities in the new year. Joining us now are three portfolio managers from ClearBridge Investments, Margaret Vitrano, who focuses on large-cap growth, Michael Testorf, who focuses on international and global growth, and Mike Clarfeld, who focuses on dividend strategies. Everyone, thank you for joining us. Let's start with the U.S. election which is finally in the rear-view mirror with a Biden White House likely working with a divided Congress. Given this outcome, Margaret, what do you see as the most notable impact on growth stocks?
Margaret Vitrano: Yeah. Well, I think for growth stocks, one of the areas that had been talked about a lot during the election for potential change was tax reform, and I think with a divided Washington, the chances for broad tax reform are probably lower. So, what that means is, higher capital gains tax rates, higher corporate tax rates, higher national income, all of those are probably a little bit less likely for technology companies, many of which are multinational companies that have a big portion of their revenue coming from offshore. That means that their tax rates are probably not going up.
Margaret Vitrano: The other area that I think is talked about a lot as it relates to big growth companies is regulation, and on that front, I would say that, a divided Congress and a divided Washington probably doesn't make that much of a difference because regulation of the biggest technology companies is really a bipartisan issue. It's been an area that's been under a lot of scrutiny under the prior administration, and I would anticipate is probably a concern over the next couple of years as well. So, no real change there.
Jenna Dagenhart: Mike, what about dividend paying equities?
Mike Clarfeld: Yeah. I think I'd broadly probably echo what Margaret said, which is, there are some modest changes in the change in administration and the new Congress, but we actually don't see big changes. I think, from an investor and market perspective, what would have been most meaningful in terms of leading to a real change in the markets would have been if you had a significant blue wave. So, you had a unified president with Congress behind him, with a strong majority that could have passed through a lot of legislation. That would have had a whole host of implications, we'd be having a different conversation now. But I think with the outcome that we have; we don't see many significant changes.
Mike Clarfeld: I'd also talk about the tax point. One of the concerns we would have had would have been, in terms of how dividends are taxed, and capital gains are taxed, for a long time up until 2003 dividends were taxed at the same rate as ordinary income. In 2003 tax laws have changed since dividends became favorably tax equivalent to long-term capital gains. That really drove a Renaissance dividend investing. So, we have been watching that would have been a concern if dividend taxes will change, but they weren't. So again, long-winded way of saying that there were scenarios where there could have been a lot of changes out of Washington, but broadly speaking, we don't see many.
Jenna Dagenhart: Michael, how does a new U.S. President influence trade tensions and other geopolitical risks that you follow?
Michael Testorf: Yes, I think the international market takes it as a big relief, Biden is seen as more consistent and rational with his international policies. I think that would be a lot of parallels with the Obama administration where foreign policies are concerned. Step number one will be repairing the damage with the U.S. allies. I mean, Europe and Japan in particular, which helps trade with both regions. In terms of Russia, I think that Biden would be expected to be tougher than Trump, but Russia is less of an importance for overall equity markets. The other part which will make a difference internationally it could be human rights, where Biden is clearly pushing for that, and most pronounced would that be in some of the emerging markets where we have dictatorships and most important is actually to see what it means for China.
Michael Testorf: China is number two economy in the world, and getting more important year by year, but what is important to see the Chinese are very pragmatic, the way they deal with policies, they are also very interested to deescalate the situation with the United States, their long-term minded politicians, they want to be at one point independent from the West as much as possible, and de-escalation would buy them time, but Biden will not be dovish. I don't see that, but he will look through it and he would pick his fights case by case, and he'll consult with the business leaders and see what hurts and what will work.
Michael Testorf: I mean, to sum it up, China, U.S. I think there would be an improvement, but only a little improvement. I think where we see a big change is in terms of climate change, as you mentioned already before, because the U.S. will align with the international players, they will rejoin the Paris Accord, although as Mike and Margaret, you said, there was not a blue wave and therefore he will not have all the funds available which he had before, but I think that will be enough playroom for him to make a change in terms of climate change.
Jenna Dagenhart: We'll certainly talk more about ESG and the environment later in the program, but before we get there, let's spend a little bit of time on growth and tech stocks. Michael, U.S. growth stocks have seen a big lift since the pandemic, while the rest of the U.S. market, as well as international shares have lagged. How does recent performance set up global markets heading into 2021?
Michael Testorf: So, yes. It appears that international markets have not done well in particular not compared to the S&P 500. I think the good part of that is the composition of the respective indices. If you look at S&P 500, it has 27% in tech, which was of course, a major winner in the pandemic and only 10% of financials, which were clear losers.
Michael Testorf: So, if you look at the international side, so MSCI EAFE which is everything outside of the U.S., there we have only 8% in tech and 16% in financials, and if you look at the tech part of international markets, that did also relatively well. Secondly, the countries which have done, or which have been in the corona lockdown earlier and came out earlier therefore, have done also relatively well. So, China was up the local market, 27% and the tech heavy transcend market was around 39%, but you're right, in general the international markets in particularly Europe, Japan, and most emerging markets are more cyclical in nature and have lagged S&P 500, and that's where the opportunity is.
Michael Testorf: So, first of all, if you believe like I do that vaccines are successfully rolled out, the economy should recover nicely in '21 and '22. Markets have perhaps taken some of that already in account, but I think there's more to go and the international market should do relatively well as they are more exposed to this cyclical upswing of the economy. So, secondly, I do think that there is quite some money still sitting on the sideline, and they're looking for an opportunity to get involved, and there are not that many liquid asset classes which are available and earning you a decent return besides equities. That means people will likely buy the dips. Asia and Japan have seen inflows already, but Europe and the rest of emerging markets have not.
Michael Testorf: Compared to the heydays of international investing, which was quite some years ago, I have to say, we are still far away from the highs. So, I see interest rates being low, because central banks have learned their lessons from the financial crisis, which means taking a way the foot from the gas pedal too early can hurt the economy is more than expected. So, loose money policy will continue, and that is definitely positive for equity markets and even Japan, which has been out of favor for ages is undergoing some circular changes. Japan has a new prime minister which will lead these changes, but even more important is a change in companies thinking about being more profitable, which is good for valuations and good for share prices.
Michael Testorf: Then the icing on the cake could be currency gains, with cyclical upswing in the international markets normally comes a dollar weakness. We have seen that in the early to mid 2000s, which is now supported by an interest rate differential between the U.S. dollar and most international currencies which has narrowed somewhat. U.S. dollar weakness could help the international markets as well. So, the big picture is not that bad for international.
Jenna Dagenhart: The tides could be turning for international markets?
Michael Testorf: I hope so. Okay, I'm talking about my book here. Right? But I think the setup is pretty good.
Margaret Vitrano: Well, but to that point, it's interesting because so much of what you think about the U.S. stock market, it's really tech, right? Especially as the growth investor for the Russell 1000 Growth Index, we're 50 or 55% tech. So of course, we look brilliant this year because the tech markets have been so strong. If tech rallies 10% of our index, our appreciation this year would be vastly different and much more like some of the other markets globally.
Jenna Dagenhart: Yeah, that's a great point, Margaret. It's also worth pointing out that technology and internet stocks have led the market for the last several years, not just in 2020, although the advantage definitely grew more pronounced as work from home became the norm due to COVID-19. Mike, is valuation and market concentration a concern, or do these areas still hold promise?
Mike Clarfeld: I think the answer is yes to both in the sense that, absolutely these areas do hold promise. So, I mean, I think if we look at a lot of the largest U.S. growth companies and tech companies, and it's not hyperbole to say that they're some of the best companies the world's ever seen. They are phenomenally profitable; they have terrific returns on invested capital. They have big moats, and these are companies like whether it's Amazon or Microsoft or Google or Facebook are putting them really terrific growth rates even off a huge basis. Right? So, they're pretty scattered with wonderful companies.
Mike Clarfeld: From a fundamental perspective, if we set aside the regulatory risks, which are real and hard to quantify, but also renewable aside from those, it's hard to see how you really would have a meaningful, demeaning issue in their relevance in strength and growth. So, they're terrific companies that absolutely merit enthusiasm that they have. At the same time, the valuations are full. They're not crazy, this isn't like 1999 at all, where things were valued based on eyeballs or Super Bowl ad. These are the most profitable companies in the world, but it's also true to say that, if interest rates were ever to change meaningfully, that would have big ramifications for all asset classes and gross docs, I wouldn't say necessarily more than others, they would be in a category with some others, because they're very long duration investments where the value is based a lot on the growth in the future.
Mike Clarfeld: So, it could present a real risk. I think echoing something Margaret said earlier, there is also a concentration consideration, where these companies have become very large components of the markets. Again, in one respect that makes sense given their size and profitability and at the other usually have certain sectors that become like energy, for example, which has become effectively negligible in the S&P 500, even though it's obviously incredibly relevant in the global economy. We'll talk about that more, I think, later. But, it's a mixed bag and is the answer that these companies continue to have their attractive prospects and merit and much evaluations they have, and yet there are concerns around concentration and evaluations, particularly if interest rates ever change.
Jenna Dagenhart: Yeah, Margaret, I see you nodding your head.
Margaret Vitrano: Yeah, I absolutely agree. I mean, it's very pronounced within growth spread of the hyper-growth companies, many of which are up 75% or so this year. I mean, just momentum companies overall within the Russell 1000 Growth Index are up 30%, but the value part of my index is down 47%. That spread is enormous. So, what you're seeing is that a small segment of companies that are really benefiting from work from home, have pulled forward several years of growth and they're trading at very high valuation. So, the question is, where do you go from here? Just getting back to something Michael said before, I do think that as we move through the recovery, whenever that happens, but on the other side of the pandemic, we are going to see more of a broadening out of the market, that group is down 47% is going to start to recover, you'll see a broadening out of participation.
Margaret Vitrano: So, I think that when I think about technology, I think that the work from home trend has certainly pulled forward a lot of demand. That demand, we're still very nascent in terms of cloud computing, in terms of shift of consumption offline to online, cloud security, collaboration. There's a decade of growth still to come, it may not be linear from here, so I just think we have to be careful that there is still a long runway for growth, but we've pulled forward a lot of it into 2020 as a result of this exhaustion.
Jenna Dagenhart: So some of these trends could be here to stay, even if life does start to return to normal?
Margaret Vitrano: Absolutely. Absolutely. I mean, I think it's interesting because one of the areas that you see a lot of growth in is, cloud security. That's because we're doing so much more of value online. We've been watching videos online for a while, but now that we're transacting all of our online, or now that we're having business meetings online, now that we're putting payroll and human resources records online, that needs a whole different level of security. So, things like that ... and by the way, the attacks are getting more sophisticated. So, things like that are important and will be increasingly important for decades to come, collaboration now that we can all work in different places and still communicate, we need more and more tools to help us do this effectively.
Margaret Vitrano So I think all of those have a lot of runway for growth. It's just a matter of what you pay for it. So, it's trying to balance the long-term growth with where you think you can find value in the stock market.
Michael Testorf: Perhaps I chime in on that one as well. So, I mean, COVID 19, as you said, Margaret, I mean, has accelerated the adoption of technology online penetration and digitization. I mean, in 2020 growth rates, I fully agree that cannot be extrapolated into the next year's, because of the rollout in 2021 of the vaccine, which I'm a believer, and as I said, there would be some reversal. I mean, there would be a rotation happening because of the discrepancy which you just described between growth and value. But there are certain things which we have learned during the pandemic, and we behave differently and some of them will be sticky. You mentioned one which is the payment space, right? I mean, you use digital payment, which is a credit card or any kind of other means for internet shopping, already long-time. Right?
Michael Testorf: But didn't you actually like to use Apple Pay, Google pay, or just tapping your credit card on the terminal when you go grocery shopping and forget about these kinds of dirty filthy notes and coins? I think this would be one which would be definitely sticky. If you see what other countries where they are already in terms of penetration. So, if you look at South Korea and China, we're already north of 80%. Tech savvy countries like Sweden, 80%, the United States is around 32% where the world averages, and my whatever country, my birth country is Germany, I feel very bad about it, but they have only 20%. If you go further South to Italy, Spain, Greece, they love their cash, it's 15%. So, there's a long way to go to 80%.
Michael Testorf: You mentioned working from home. I think the genie is out of the bottle. I mean, what was looked at with suspicion, because people might not work from home and so on. I think this has done this argument and we have shown with a lot of success that we can do it. Also, this kind here remotely, we have Asset TV, which is phenomenal. So, when it comes to food and grocery shopping, I mean, we have become professional, how to order, how do we get it delivered and so on. So, I think this convenience factor will continue probably not be as gross as it was before, but it will continue. To be very honest, in my lifetime I have never seen so many disruptive forces working all at the same time.
Michael Testorf: I do believe that the Cloud AI, internet, renewables, EV is offering really good long-term growth stories, and we have to be careful with some of the value sectors because they get disrupted and they could face stranded assets, which have to be written off and weigh on profits of companies. So, I think there is quite some interesting stuff in the growth segment, and I do believe there could be a rotation, but the question is for how long will it last?
Jenna Dagenhart: Yeah, fascinating point there too about digital payments and some of these trends that were already underway. I love the book, Curse of Cash by Ken Rogoff, and I know they talk a lot about India as well.
Michael Testorf: Yes. I mean, India is definitely one of them. I think this is true for all the emerging markets. We have more exposure to Brazil on the payment space, because their regulator is clearly in favor of pushing for opening up the banking market, and the banks in Brazil has super high margins which is not necessarily good for the consumer and the regulators on the side of the consumer and would like to open up monopolies, and that's why some of these payment companies have been so incredibly successful. We have a company which is called Stone, which is making further progress coming from the small and medium-sized enterprises and going to the larger ones as well.
Jenna Dagenhart: Now going back to the vaccine, and I know Margaret mentioned the recovery with positive news on the COVID vaccine front, we've seen bond yields begin to rise and stocks rally. In fact, the S&P 500 in doubt, both hit new record highs the same day the news broke that Moderna's vaccine was 95% effective. There's a lot of optimism too surrounding Pfizer's vaccine. Michael, are we discounting the rosy scenario, or will we see a commercially available vaccine soon? If so, can that act as a catalyst for healthcare stocks?
Michael Testorf: So, from my side, I mean, I'm a believer in vaccines, I do see of course, certain risks with this because the world is baking in already some normalization because of the vaccine. Now, the risks which are there is that potentially that the rollout will be too slow. I think the developed markets have done a pretty good job already in terms of preparation. I think the risk is more on the countries which are a little bit poorer, because they don't get the vaccine later. They do not have the infrastructure to deal with the extreme refrigeration requirements, and that could slow down herd immunity globally. I hope that WHO and the pharma industry and the developed nations would chip in a little bit to make sure that also the laggards, meaning the poor countries, have a chance to get vaccinated.
Michael Testorf: Now, the good news is that there are other vaccines in the make which will not require these extreme conditions. The other risk of course, could be that there is a slow uptake of vaccines. So far around, only 50% would like to be vaccinated, and for herd immunity we need at least that uptake. I personally, as I said before, I'm more positive thinking about these vaccines, and I will like to be vaccinated earlier than later, I could see that people will ... this number of 50% will increase over the next month. We, unfortunately, will see more cases in the Northern hemisphere, and therefore some people might see the benefits of vaccinations.
Margaret Vitrano: I also think that in a low interest rate environment, the market is just very simplistically kind of looking through how we roll out the vaccine and how long it takes, because in a zero-rate environment, the market's looking at 2022 and 2023 for valuation. So, very simplistically, it doesn't matter whether it's six months earlier or later than what you and I might guess, and I think that gets back to what the market is just counting. Low interest rate environment and all the stimulus we've seen has really enabled the market to look through how long it takes, and which countries go first, but look through to the recovery and value stocks on those recovered earnings.
Margaret Vitrano: The other thing is, it's interesting because as a large growth investor, healthcare has really just had a target on his back for, I don't know, five years. I do think that while drug pricing is still going to be a topic in Washington, I'm sure, but I think that if there's one thing that we've seen out of the pandemic, it is that, it's important for our country globally to have a vibrant healthcare ecosystem, to have drug delivery, to have drug R&D, to have an infrastructure in order to facilitate testing and care. My hope is that all of that will maybe mean that governments around the world will allow healthcare companies to be profitable enough to invest in their business and continue to grow. So, my hope is that some of the negativity around healthcare companies in that sector in general will abate a little bit on the other side of this.
Jenna Dagenhart: Mike, what do you make evaluations on the heels of the vaccine news?
Mike Clarfeld: Yeah. I think, kind of echoing what Margaret and Michael have said. I mean, the vaccine news was as good as it could be. I think the reality that we have a vaccine, two vaccines that are 95% effective, which is comparable, all of us have turned into armchair epidemiologists, but I'm not an expert here, but it is as effective or more effective than all the childhood vaccines we get. So, this is an incredibly effective vaccine, and I think it provides a definitive marker that there will be an end to the pandemic. I think the world is currently operating on two timeframes, the short to intermediate term is that it's going to be a very brutal winter in the Northern hemisphere and the human suffering is going to be awful, and we're all going to have to continue to social distance and not have a lot of fun.
Mike Clarfeld: But the market mostly appropriately is looking through three or four months and realizing that in April or May, it's going to be a very powerful recovery. I think it sets up, I think, Michael Testorf, points about the global role are correct, there will definitely be differences in how it gets rolled out in emerging markets versus developed markets, and that's unfortunate absolutely, but there also will be a globally synchronized recovery that has a lot of potential momentum and power behind it. So, from an evaluation perspective, I come back to what I think I said earlier in the conversation, which is, from a fundamental perspective, I think the enthusiasm back to vaccines is absolutely right. The key question remains, does this do anything to interest rates? So far, the answer has been no.
Mike Clarfeld: But we've been in this observably low interest rate environment. We don't even talk about the fact that interest rates are negative in most of the world these days, we just accept it, but we've been into this absurdly low interest rate environment for a decade, which has underpinned all sorts of things in markets across the world. As long as that doesn't change, I think the current valuations all make sense. The question is, does the vaccine somehow catalyze the global economic recovery? It leads to a change in the yield curve and rising rates in which case the valuations would prove challenging.
Jenna Dagenhart: So, looking forward to when we can gather in big groups, again, go to concerts, have lots of fun, have a babysitter as I know you're looking forward to, what impactful will this move toward normalcy have on both U.S. and international equity markets? Mike.
Mike Clarfeld: Yeah. I think it's going to have a tremendous impact, and I'm glad you framed the question in terms of comparing the U.S. and global markets, because I think that's something the U.S. investors need to do right now. I think we're very lucky in the United States, our economy and our markets are so big and diversified that they provide really sort of most U.S. investors probably are mostly focused on U.S. investments, which works because we have exposure to all these different sectors. We're lucky like that.
Mike Clarfeld: If you lived in different areas, for example, my wife is Canadian. So, if you're a Canadian, you have huge potential investments in the Canadian market in resources and banks and stuff like that, but not a lot in some other areas, like nothing like the technology investment potentially United States. As U.S. investors, we tend to be U.S. focused. The U.S. markets have outperformed whole markets, and my colleague, Michael, talked about this more knowledgeable than I have, but have outperformed markets tremendously over a very long period of time. We saw that pick up even more momentum this year as the work from home trades took effect and the technology companies, many of which happened to be U.S. based. So, their fundamental performance improved in the valuations and stock takeoff.
Mike Clarfeld: So, I think there's a real potential that you have a global rotation in the year ahead as the vaccine normalizes economic activity around the world, as people pull out some of the monies they put into these work from home winners where they've been hiding out, not just hiding out but hiding out in what is perceived as a safer area, it starts to reposition. So, I think within the United States, the potential is similar, it's that microcosm of I think you'll have a big sector rotation or potentially meaningful sector rotation as people come out of certain areas into others. I think that's a microcosm of what you're going to see on a global basis and is something that U.S. investors need to be mindful of.
Michael Testorf: Right. On the international side, I think that would be a two-tier market because there have been economies which were in the pandemic earlier and successfully contained the pandemic, and they will be, of course, back to normal earlier and they actually have been. So, if you look at China, for example, I mean, China overall I mean, it's mind boggling, has less than 5,000 deaths. South Korea was little bit more than 500, and Taiwan it's below 10. I mean, it's like, we cannot even believe it that this happened when you see all these numbers in the Western world. If you look at these countries in particular, the manufacturing output is already back where it was and actually growing.
Michael Testorf: So the only one which is not necessarily back where it has been is the service sector. I think these countries on a relatively scale, I'm talking about Asia or Northern Asia, China, Taiwan, North Korea, they will have less upside potential because of this rotation versus the ones which were really hit hard. These are the ones which particularly are located in the Southern part of Europe, which is like Italy and Greece and Spain and potentially France, because I didn't have the tourism, but also many of the emerging markets, so I'm just highlighting the big ones like Brazil and India, which should be doing relatively well in this kind of normalization trade. So, I asked the question a little bit earlier, so how long does this kind of rotation actually lasts?
Michael Testorf: So, we have looked into the past and these rotation trades are normally somewhere between two and five months and with an average of three. If I look at it, I think we have already done it ... whatever, third or half, if I should guess, done with a rotation which we have seen. I'm asking myself, what are the actually the ingredients which have to go in to make this an out-sized very long rotation where particularly the value part of the markets would do very well? For me, the critical part of that is what will happen actually to inflation? Inflation means then also rise of long-term or long-term rates.
Michael Testorf: As I said before, I mean the short-term rates, I think they will stay low for quite some time. If you look at market rates and the international markets, they look flat like a pancake. There's no upswing whatsoever. Then we have a little bit of another kind of uptick in long-term rates. I think you might see a little bit more in the U.S. than internationally, but I don't believe that it's longer fundamental because the central banks are still accommodative. I think there's still quite some slack in the economy and we talked so much about technology, but technology will lead to efficiency gains, and that in the long-term will be deflationary.
Michael Testorf: So, I see there is also an end to a rotation trade, we don't know how violent it will be, but at the end of the day, I mean, there might be the pause or a decline in the winners because they are other source of money in this rotation traits, but we own the international sites, we're looking actually also plus how food ... looking at the opportunity, which it offers for us to increase our exposure to these quality growth names. These are the ones with the strong management, the good casual generation. Then hopefully developing a discount or bigger discount to their intrinsic value. So, we're happy to pick up some of the great franchises on this weakness.
Margaret Vitrano: I think there are so many of these, there's been so much retail money that's flowed into the market. There are a lot of ETFs that have really driven up technology growth companies. So, once you see some kind of reversal, even if it's just a month long or three months long, you may get some good entry points, and that dovetails nicely with what we were just talking about before, which is those circular long-term trends are still intact. So, I think all of us are trying to be valuation sensitive and pick points where we can still own things for the next five and 10 years but hopefully buy them in a smart way.
Jenna Dagenhart: Turning to ESG, interest in sustainable investing continues to accelerate with ambitious economic recovery policies on the environmental and to lesser extent, social front. Margaret, what types of opportunities can this create in 2021 for active equity strategies?
Margaret Vitrano: Well, one of the themes that we really like is electric vehicles, not only because it fits well on an ESG basis with less use of fossil fuels, but the consumption of autos and purchasing of autos is also at a cyclical low. So, the global auto sales has been cyclical depressed for the last several years. So, we think that there's a potential for cyclical uplift there. There are also globally governments also providing incentives for automakers to produce more electric vehicles and for consumers to buy more of these vehicles with less of a carbon footprint. So, for several different reasons, we think that electric vehicles have ... that's a great, not just a short cyclical trend, but one that we think fit well with an ESG basis, but also has a nice cyclical component to it. So, we've been looking at a couple of companies in that space.
Michael Testorf: I agree, Margaret, I mean, the electric vehicle is also one of our favorite subjects to talk about without any doubt. Let's look at ESG because ESG in Europe has been already a big, big, big winner, and a lot of money has focused on ESG. But there is in the U.S. we are just catching up on these kinds of trends towards ESG focus funds, and that's where most of the active money is actually going. I agree, random environmental changes will see the largest impact in the years to come now. It's not only the Biden administration here in the U.S. who is looking at climate change in particular. Actually, there are so many countries in the world which have set already challenging targets. So, early in the year we had the EU talking about ambitious goals, by 2050 they want to be carbon free, by 2030, they want to reach at least 50% reduction, and the current goal was 40.
Michael Testorf: Japan wants to be carbon free in 2050, and in September, even China talked about being carbon neutral by 2060. So, China, as you might know, I mean, it's the biggest emitter of CO2 globally. We're talking about 28% of all CO2 comes out of China. So that's what is the recipe for healing. I think it's the renewable part. I think there will be a massive filled out of wind onshore, offshore and solar projects. If you want to put that a little bit of perspective, today's 60% of the electricity production comes still from fossil fuel and only 10% from renewables and the rest is from nuclear and hydro. If you look at the forecast for 2050, that will be 60% coming from renewable and 30% from fossil.
Michael Testorf: So that means the sector has to grow at least six times by 2050, and that would increase that we don't need more electricity. If Margaret is so excited about electric vehicles, as we are, electricity demands will even rise, and that will lead to the sector by gross rates between probably just shy of 10% panel, which is huge for such a long period of time. If I were doing even the exercise, looking at all the kind of pipeline of all these kinds of renewable players, this is only a fraction of what has happened to meet these long-term goals. Therefore, I do believe in the renewable space, there are a lot of investment opportunities. We have done, of course, quite some multiple because we are so convinced about it.
Michael Testorf: We have Vestas, which is a Danish company, is the largest windmill producer. We have EDP, a Portuguese company, which is the largest wind developer in the world, and we have Solar Edge, which is producing, I think, the best inverters and solar systems. The inverter is actually the brain of a solar installation.
Margaret Vitrano: I'm a huge believer in renewables as well broadly, but many of those companies are small, it's just such a nascent space that hopefully in the next five years, many of these other renewable companies, whether it's hydrogen or wind or solar will graduate up into my space.
Michael Testorf: Yeah. That's the good thing, we are all cap, can do some mid-sized companies as well, and you're right, there are many of them in the 10, 20, 30, 40 billion market cap.
Jenna Dagenhart: And Mike, I know you manage some dividend ESG strategies. So, taking a closer look at the E the S and the G, what do you see as the most important issues in the year ahead?
Mike Clarfeld: Yeah. I think 2020 was a watershed year for ESG investing in the United States. As my colleague, Michael has mentioned, ESG has been a dominant theme in Europe for quite some time, in the United States it's way behind. I think there had been a lot of, I wouldn't say, lip service, but a lot of rumblings about ESG but we didn't really see either investors or corporate managements embracing it. I think in the last 18 to 24 months, we really saw it on the environmental side, and I'll come back to that in a second. I think in 2020, we also saw it on the social side. So obviously, over the summer with the killing of George Floyd and the blossoming of the Black Lives Movement, I think it brought systemic racism in the United States to the forefront. I think companies have stepped up and realized that they need to do a better job and really work to be part of a solution in that regard.
Mike Clarfeld: So, there's obviously a long way to go, but we've seen companies actually address that in ways we haven't seen before. So, I think from a social perspective, that was a big change. On the environmental side, I'm probably going to sound like a broken record with my colleagues where we just think electrification is a massive deal. Energy is at the core of the modern economy, and the amount of investment that will be required as we move towards less fossil fuels and more renewables is in the tens of trillions of dollars, and this is not a one-year or two-year thing, this is a decades thing. I think one of the things people will talk about is, what's the importance of a Biden administration in this regard?
Mike Clarfeld: Obviously, a Biden administration is more supportive of it than the Trump administration has been. But it's really one that now, climate change is far less of a partisan issue than it used to be, is more broadly embraced by Democrats and Republicans across the country, and it's not just the federal level, it's at the state level. So many states in the United States have embraced very aggressive renewable portfolio standards, which are driving investments. From our perspective in dividend investing, one of the best ways that we believe you can play this theme is through electric utilities, and utilities for something that, they're not always the sexiest companies, and in many times in the last 20 years, I've looked at them and we've looked at them and thought that they didn't know [inaudible 00:40:08] attractive investment opportunities.
Mike Clarfeld: This year however, we think they do, because of the way stock markets play out this year where growth companies have done so well, you have an interesting phenomenon where during the pandemic, utilities, which fundamentally did exactly what they should, which is, deliver stable steady earnings like they expected in the beginning of the year, it actually underperformed. So it set up a situation where you haven't attracted venture valuation, an attractive current dividend yield, and we think really pretty nice, dividend growth for as far as I can see now, it's not the kind of dividend growth rate you might see with some of our risk stocks that are growing 20, 30, 40% a year, but we think that electric utilities can grow their dividends in the high single digits as far as I can see, which when you combine that with a 3-4% upfront yield a very low risk business model, we think that sets up for a very attractive investment opportunity.
Jenna Dagenhart: Michael, going back to what you said about Europe and other parts of the world, getting a head start on ESG compared to the U.S., where do you think ESG is most advanced? And building on your comments earlier, what does the future of ESG look like on a global scale?
Michael Testorf: Well, let's start with the second part of your question. I mean, the ESG side will be very, very, very powerful. As I said before, there's so much money right now in Europe, active money going into ESG, and I do expect the same thing will happen globally. So, there will therefore also be a focus of all asset managers, and fortunately ClearBridge, we have a long history of ESG investing already, but asset managers which will not embrace the ESG principles will have long-term, I think, will have a problem or less inflows in terms of money.
Michael Testorf: On the other hand, I look at the companies, right? The companies which are not embracing ESG will have a problem too, because the force of investors and investors shareholders, and to potentially governments to look at not only at whatever the climate change aspect, but it's also the supply change, it's about governance and so on and so on, that it's very, very important for companies to think about it, how the ESG will look like in the short to medium term. Countries which have done already a very good job on that are the Northern part of Europe without any doubt. I have seen some of that also in Australia and then the other parts which are clearly behind. So, I wish that we are getting all on higher levels going forward, and I think the pressure is high and therefore I'm also half full glass thinker on ESG here.
Mike Clarfeld: Just to chime in, this isn't just happening within investors and shareholders. You're seeing this more broadly in financial services and the financial system. So interestingly, just this morning I noticed that Bank of America came out and said they will not finance drilling in the Arctic, which I think the administration is offering some drilling permits there that had been held back for a long time, and now being offered. So, Bank of America, one of the largest banks obviously in the world is saying we won't finance it. I think there are others like that as well.
Mike Clarfeld: So it's not just the shareholder thing where you're seeing this, you're also seeing banks which finance their clients saying, "There are certain parts in oil and gas, of course, where we're going to continue to participate in, but there are certain areas that are worsening we're] saying that it's not right in the long-term interest of the world, but when you take the totality of profits and social interests and society."
Jenna Dagenhart: Yeah. And Mike spending a little bit more time on your 2021 outlook here, it's no surprise that many sectors have struggled due to restrictions on activity like travel, eating out and shopping and stores, energy demand has also fallen sharply, which areas do you think are best positioned for a comeback in the year ahead?
Mike Clarfeld: Yeah. I think fundamentally there are many areas that are right for a comeback. When I say fundamentals, I mean, I think restaurants or theme parks, theme parks are entirely shut in many cases, you're going to see a huge resurgence in people who have been dying to take their kids to Disneyland and finally can, and you're going to see business really skyrocket recover, I think in many of those situations though, not all, but much of that has been priced in. The area that we continue to believe is potentially most interesting is energy, in the sense that, this is a cyclical business for sure, and what we saw in 2020 was a drop-off where has never happened before, oil demand globally fell by meaningfully into the double digits.
Mike Clarfeld: These are depleting resources, each year production declines because the existing asset base is not as robust as the year before, and if you don't invest, ultimately that's going to have ramifications. So, even while we believe that longer term, we hope that fossil fuels go away to mitigate climate change, for better or worse, that's going to be a multi-decade process. So, we believe that the combination of a resurgence in energy demand and the impact of the massive reduction in energy investment could set up some cyclical rallies. The area from a dividend perspective and from our perspective, we've been most interested is actually in pipeline corporations. We own a couple of those, and the interesting thing about that is that, they have proved from a fundamental perspective, pretty defensive this year, where [inaudible 00:45:48]
Mike Clarfeld: Many of the companies, the top companies there have actually hit their initial guidance for the year, which they delivered before the pandemic happened, and they're not exposed to the commodity price, and yet they've sold off in many cases, not quite as much as the producers, but meaningfully. So, we do think that's a piece, and then the last piece I'd thrown about energy that makes it unique is just that, generalist investors are not interested in energy, it's become so small in the S&P 500 that you can, in some ways, almost ignore it. It's 2 or 3% of the S&P, it's half the size of either Microsoft or Apple and as a sector, it's become tiny. While ultimately, hopefully it does go away, that will be a multi-decade process and there will be some pretty big and violent and volatile up moves and down along the way. So, we think the fact that people are ignoring it to a degree they have also ultimately may sell the seeds of people having to chase it to get in.
Jenna Dagenhart: Margaret, I see you nodding your head a little bit there.
Margaret Vitrano: I thought it was funny because in some ways when no one's paying attention, that's when the inefficiencies are, and then the Russell 1000 Growth energy is less than 1%. So, Mike is right, I'm ignoring it right now. We're more focused on things like retail. We've been thinking about it that instead of looking for the V recovery, or instead of looking for the U recovery, look for the square root recovery, where on the other side, you're actually coming out better. You're a better positioned business. So, within retail, I think the story is that, because things have been so bad with traditional retailers and especially mall-based retailers, you're going to have something like 2000 stores closed between 2020 and 2021. That's an enormous part of our retail store base.
Margaret Vitrano: So the companies that have the balance sheets to survive that are not in the mall that have either an online presence or an omni-channel presence, they're positioned to be the square root, they're positioned to gain share coming out of it. So, we've been looking for businesses like that, where yes, we'll get the cyclical recovery, but hopefully we'll get something more, we'll get some market share growth and some real appreciation potential from there.
Michael Testorf: I mean, we on the international side, we tried to pair our typical investment approach with this kind of cyclical upswing. So, it's still these companies which we want to look for. Do they have long-term growth? Do they trade at a discount to their intrinsic value? And does the company have a strong mode, and would that deliver the long-term free cash flows? We talked about travel, travel, for sure, will normalize because I want to get out of my house and want to do something different. That most likely will happen towards the end of '21. But we prefer to invest in companies which are not only beaten up but have the long-term growth agent there. Company I want to mention it would be like Amadeus, which is a booking agent for airline tickets.
Michael Testorf: They are already the world market leader, and what happened in this pandemic is, they actually got even stronger because their competitors, on a relative scale, got weaker because their balance sheets are not that strong. So, we would expect a company like that to do fairly well, and we have still the long-term growth agent behind us, because at the end of the day, the overall growth in passengers is still, of course, 2020 being the exception, is still growing 5-6% on the long-term. In a similar order, when we talk about travel, there's an airline manufacturer or plane manufacturer, which is called Airbus, and the duopoly was Boeing, of course, and they have the short-term headwind, but once the deliveries are starting up again, and most likely '22, and airline travel is coming back, that could be also a good high free cash flow returning company.
Michael Testorf: Then of course, indirect ways to play, we played more luxury, we don't have that much of restaurants and theme parks in the international arena, it's more the luxury sector, which is interesting, which is winning out of increased travel. The other one where I would spend a little bit more time on is on the business service sector, because as I said before, manufacturing has done already fairly well. Now, the question is what is lacking most? I see that in the business service sector, which is the last one to recover. So, there could be another little search ground which will do well and fit in our investment approach.
Jenna Dagenhart: [inaudible 00:50:21] today, Mike, from a dividend perspective, is this enough to attract investors back to dividend stocks, or are you looking for other catalysts?
Mike Clarfeld: Yeah. So, we absolutely believe that dividends are very attractive right now and that investors should be focused on them. I think high growth dividend companies have done very well this year. So many of the names we run on our portfolio is like Microsoft, like Apple, like MasterCard, like Visa, have done terrifically well. Throughout this, some of the value-oriented companies, even ones that aren't cyclical have lagged a bit. Again, this is part of a theme that we've seen this year, where growth has done very well and other things not so much. We do think there's tremendous opportunity right now, and high-quality dividend payers that we own, you can get two and a half to 4% yield from a company that's very robust with us, solid growth outlook.
Mike Clarfeld: I think investors have been so whipsawed this year, the year started out one way, then you had COVID and everybody ran for the bankers and then everybody wanted to get back in and catch the rally, and the reopening trade. I think a lot of people maybe aren't having the normal conversations they would have with their financial advisor like where is it, I want to be in five years and how I'm going to get there, and how much should be allocated to different things to auction bonds. It's much more been like, "Get me out, get me back in." So, I think people sit down and have those conversations to reappraise their portfolios for the years ahead, I think to the extent they're underrepresented there, we absolutely expect them to get back. It's a terrific time.
Jenna Dagenhart: Finally, as we wrap up this panel discussion, Margaret, what's your outlook for volatility, and what risks are you paying the most attention to heading into the new year?
Margaret Vitrano: Well, in terms of risks and things we've been thinking, I guess, just to get back to something we said at the outset, which is, what does a divided Congress mean for the markets? If there's one thing we know it's that the markets do not like uncertainty. So, the good news is that, a divided Congress probably means less change, less uncertainty, and that should be less of a risk going forward. The thing that I've been spending a lot of time thinking about is inflation. Exactly what Mike was talking about before, the inflation and the slope of the yield curve is really one of the key determinants in my view, in terms of whether growth really outperforms in 2021. So, we've been thinking a lot about how we know that historically, GDP growth and inflation tend to be correlated since 1985, that's clearly been the case.
Margaret Vitrano: We know we've had a lot of stimulus in the U.S., we know that GDP growth is accelerating, and so one would think that inflation would be starting to pick up. We're not really seeing it yet, but when inflation picks up and the yield curve steepens, that's going to cause that broadening out in the market, it's going to be more cyclical, we're going to see less of a premium on the very narrow universe of growth stocks that have really performed so well for the last couple of years. So that's the key risk and opportunity that we see for 2021.
Michael Testorf: So perhaps on the international side, of course, besides of the vaccines, which we have gone through in all details by now, it's a tightening of monetary conditions, which I personally, as we have talked about, is less likely, but also more specific on Europe, we have a European budget which needs approval, and that is for the next five years. In part of this budget is a 750 billion package, which has to be released for corona purposes, and that's currently held up by countries like Poland and Hungary. But both of them are net beneficiary and both of them are actually hit by the pandemic. I hope that rational thinking would prevail, and these funds would be released.
Michael Testorf: The second part is, this more Europe specific, as you want to believe it, I mean, we're still talking about Brexit and this is how many years in the make, I think, what is it? Close to four by now? That would be negative for the UK, but to a lesser extent to Europe, we will get more details on that relatively soon. I could see that that will be mild compromise. So, that's, I think, which is more region specific as a kind of risk.
Jenna Dagenhart: Mike, final word over to you, what about risks and volatility in the new year?
Mike Clarfeld: Yeah, I think it seems likely the volatility will persist and the volatility itself may be more volatile than it has been in the past. I think 2020 has been such a remarkable year in so many ways. I think for many investors and certainly for us, it's been very humble. Last year, if you asked me what I might've thought would be the risks of going into 2020, I'd say, "Oh, the election, growth in inflation rates." Pandemic was not on my mind. So, I think we're all more aware than ever that there are things we can't forecast that may be relevant. I think on the very positive side, the vaccine is so much better, or as good as it could be hoped for. It really does provide real certainty that this is going to end indecisively, whether that's on the earlier side in the March, April, May or on the longer side towards the back half of next year, it's going to end.
Mike Clarfeld: Our discounting mechanisms, they look forward. So, the markets have the confidence they need to start to project forward, that's very positive. Of the things that I'm aware of, the normal stuff we talk about, the politics, the geopolitical, those are all obviously highly relevant. The one that has the most potential in our view and I'm really broken record here to actually upset the Apple cart and really change the dynamic on the markets will be if interest rates ever changed. That's been the million-dollar question for the last 10 years, and it hasn't happened yet. In all current points would seem to indicate not happening in the near term, but to the extent, that would be a spoiler for the market or a real change for the markets that would result in all sorts of changes. That's the biggest thing we're watching, but again, nothing near term points to that.
Jenna Dagenhart: Well, here's to hoping that 2021 is a little bit less remarkable or unprecedented for the sake of the world. Everyone, thank you so much for joining us and great to have you.
Michael Testorf: Thank you so much for having us.
Margaret Vitrano: Thank you, great to be here.
Mike Clarfeld: Really enjoyed it. Appreciate the opportunity to speak to you today.
Jenna Dagenhart: Thank you for watching this ClearBridge Investments, Exclusive 2021 Outlook Masterclass. I was joined by portfolio managers, Margaret Vitrano, Mike Clarfeld and Michael Testorf. I'm Jenna Dagenhart with Asset TV. Please note the following: Past performance is no guarantee of future results. The opinions and views expressed in today's video are of the individual speakers as of December 1st, 2020, and may differ from other managers, or the firm as a whole, and are not intended to be a forecast of future events, a guarantee of future results, or investment advice. Any statistics referenced have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed. Neither ClearBridge Investments nor its information providers are responsible for any damages or losses arising from any use of this information.