MASTERCLASS: ClearBridge Global Market Outlook for 2020

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  • 52 mins 50 secs
A ClearBridge panel previews global equity markets and economies in the year ahead, highlighting opportunities and risks in growth, income-oriented and cyclical stocks in the U.S., Europe, China and Japan and the handicapping the likelihood of a U.S. recession.

In this panel discussion, 4 experts from ClearBridge Investments discuss the 2020 outlook:

  • Jeffrey Schulze, CFA, Director, Investment Strategist
  • Scott Glasser, Co-Chief Investment Officer, Portfolio Manager
  • Aram Green, Portfolio Manager
  • Elisa Mazen, Head of Global Growth, Portfolio Manager

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MASTERCLASS

Jeff Schulze: ClearBridge is a global equity manager with $147 billion in assets under management committed to delivering long-term results through authentic active management. ClearBridge tailors strategies to meet three primary client objectives in our areas of proven expertise, high active share, income solutions, and low volatility. We integrate ESG considerations into our fundamental research process across all strategies. If we had any doubt that the secular bull market would continue in 2019, those fears were put to rest as US equities are on pace for 20% plus returns and their best showing since 2013 while global equities are also up double digits. I don't know if climbing a wall of worry is a completely accurate statement, but investors have looked past a number of geopolitical risks and signs of a slowing global economy to bid stocks higher, especially on the growth side.

For assessment risks have risen over the course of the year as we will discuss in more detail, but the US economy overall remains in solid shape. Will growth continue to lead in 2020 or will the recent rotation and the value remain in place. For insight on these questions and other factors that could impact equities, I'm excited to be here today with my colleague Scott Glasser, co-chief investment officer and portfolio manager for the appreciation and dividend strategies. Elisa Mazen, Head of Global Growth and Portfolio Manager for our international growth and global growth strategies, and Aram Green portfolio manager for the select strategy as well as our small and mid-cap growth strategy.

So, let's start with a brief recap of 2019. Coming into 2019, there was a lot of skepticism about the durability of the longest economic cycle in US history. Recession fears were elevated after the swift pronounce 19.8% fourth quarter drawdown as the tone deaf fed continue to raise rates even though investors cumulatively were screaming uncle. However, after the fed got the message and sooth fears, the further rate hikes, the market has ripped higher and has not looked back. As of the end of November, the Russell 1000 index was up over 27% and outperforming small caps by close to 6%. Like this entire cycle, growth has outperformed value across all market caps as well. Now, Scott, I'm going to come to you first. Given the performance profile that we've seen here in 2019, was that surprising to you and do you have any insights on why small caps have lagged large caps?

Scott Glasser: So it was very surprising to us. The S&P as you know is a market cap weighted index and that the S&P is up about 25% this year. That certainly exceeded our forecast. I think we were surprised by the extent to which the market worried about recession, continue to worry about recession throughout the first half of the year. We had, as you know, we had thought that worry was... was that the worry was exaggerated in the minds of investors in the fact it wasn't a real risk to the overall market. You saw the 10 years, start the year at 2.68 and on those fear go... fears go all the way down to 1.47, so there was certainly a disinflationary, a deflationary bias and worry that was in the market and today it stands at about 1.73.

As you said, the fed cut three times and I think that was really the catalyst for investors gaining confidence that in fact the fed was providing, as they said, an insurance policy to extend this cycle. A late cycle, absolutely, but this was meant to extend the cycle beyond I think people's worries, and beyond historical levels. What was surprising also is how resilient the market was during the year. Certainly, there are risk factors that came into the market. Mark was very resilient. You actually saw it play in, those risk factors play into the market on a sector and a sub sector basis. So, if you looked at what did best throughout the year, it was gross stocks where you had good momentum and stocks that were leverage to large addressable markets and those growth numbers, and those earnings numbers were coming through.

And then you also saw a notable kind of defensive bid to the market. Defensive in the sense that the market bid up stocks with very consistent, very predictable earnings like consumer staples and those were the types of stocks that led the market through the first nine months of the year. A dramatic reversal over the last two months, which we'll talk about back into more value stocks, but nonetheless the market continued up. I'd say overall the market from a factor basis was again for the first nine months of the year was characterized by lower volatility stocks, larger cap stocks, higher quality stocks, and more momentum based stocks in the first nine months and then a reversal we've seen over the last two months.

Jeff Schulze: Aram, any thoughts on the small mid cap space?

Aram Green: It was a more choppy environment in the small cap space. It definitely underperformed in that period of time that you were talking about the drawdown in the second half of the year. We saw a really strong performance in the first quarter, but then small caps tended to lag by around two, or 300 basis points in each of Q2 and Q3. And it's hard to know whether that was small cap specific, or there were other areas in the market that were looking more attractive and actually mid-caps was... mid-cap was the best asset class. So, while small trail, large mid-caps did the best year to date as well as over the last decade. So, I think it's been a little bit mixed across the market cap sizes, but we see a really great setup for small caps here really due to three reasons.

One is the relative valuation after the sell off that we had in September, small caps traded at a discount to where they're traded historically versus large. Second is that small caps tend to do well when the fed eases and we're still in a very accommodating environment and the last is that these companies are very domestically focused. So, if there's still a continual concern over the geopolitical environment globally, small caps have that domestic focus, are much more reliant upon the US economy, which seems to be in very good shape.

Jeff Schulze: Elisa, I'll turn to you on the international space. Any views on this year's performance?

Elisa Mazen: Well, when we talk about performance, we're going to talk about the world very, very quickly. So large caps, which are about 75% of the benchmark did very well. Small caps trailed in most markets primarily we think because of trade war concerns, they were less able to sort of deflect and sort of pivot if there were some issues with regard to trade specifically. You also had a lot of liquidity drawdowns in the international marketplace in most markets save actually Japan and believe it or not, Brazil, those were the two markets that were net positive for the year and those really did help performance, but you've had a lot of money come out of those markets largely on political concerns and that did impact small caps I think disproportionately. So large caps were generally a winner.

 In terms of currencies, which are always something that we talk about in international, the good news is that the dollar was not super strong this year. The DXY, which is the index, a weighted index of the dollar versus other currencies was actually not particularly strong. It was almost flat this year, so there was no particularly major negative performance for international stocks relative to the dollar. That was good. Emerging markets are really a mixed bag frankly. You had the more export sensitive manufacturing sensitive countries like Korea really sort of be impacted by trade concerns, but then you also had some very good performance by sort of larger markets like China, which were impacted earlier on and seemed to sort of do quite well throughout the rest of the year as people are just sort of anticipating recovery.

But emerging markets definitely underperformed relative to developed markets perhaps that's a... that's a good setup. We don't like to always just sort of talk about macro when we talk about emerging markets, small caps, et cetera. We actually have some very interesting small cap emerging market stocks that have done really, really well. It's always very difficult to generalize and paint things with a very broad brush. We always believe at the end of the day it's the stock specifics that matter and there's a lot of interesting small cap emerging market ideas as well.

Jeff Schulze: I hate to bring it back to you some of the larger issues that are out there, but trade wars has held the market hostage here over the last year and I think it's going to continue to have an impact in 2020. Do you see a resolution on the horizon and will this be an issue that continues to get kicked down the road. I think the narrative changes day with the new cycle. Elisa, maybe I'll start again with you on your impact you think will have in the international space.

Elisa Mazen: So, we don't think that the administration is going to sort of wrap this up in a nice bow and sort of hand it to the markets as a gift for this year. No. So I don't think it's really in their interest to do that. I think they want to play this through just sort of use the leverage that they have, and they'll use this throughout sort of I think the whole election period. So, to the extent that they can demonstrate that they've sort of won on these issues, until they can actually demonstrate that frankly, I just don't think that they're going to wrap that up. Actually, yesterday and then today we saw some very sort of negative news on trade and tariffs. Yesterday was Argentina and Brazil steel, today it's luxury goods, French wine, handbags with 100% tariffs. So no, we don't think that's going to be at play.

Frankly, it's really not just about trade, it's about trying to maintain your dominance. You have a large superpower, which is China on the rise. There is an interest in the United States really sort of containing that rise through economic means, trades and tariff and so I don't think that this is something that will... that will end today, nor will it end. I think in the sort of years to come. And we've seen other negative impacts as well. We've seen Brexit, which is having continued impact in terms of what does this mean for the UK economy. You have little skirmishes that are arising with Korea and Japan on trade. So, I think to the extent that you have more populous governments in place, you're going to continue to have more trade issues, concerns in the market.

Jeff Schulze: And it's obviously going to be slow burn issue. The average length of time that it takes to resolve the trade war is about four years. And it may seem like it's been four years, but it's only been about a year and a half.

Elisa Mazen: Right. And the bigger issue, frankly with consumer goods is coming next week. So-

Jeff Schulze: Way to go.

Elisa Mazen: Yeah.

Jeff Schulze: Scott, any views on the domestic marketplace.

Scott Glasser: So, I think that the difficulty that you've seen in trying to finalize a phase one trade deal, which is really quite benign in terms of what the ask is and it's not quite meaningful from a trade standpoint to be honest, but the difficulty in trying to get that just phase one agreement signed points to the fact that it's going to be very hard to get a phase two and a phase three. And in fact, there are substantial structural and philosophical issues. There are different between the two countries. And so, I don't have high hopes for anything beyond a ceremonial phase one certainly this year. I have a more negative, or a negative view of the impact of this trade war. I think it has been tremendously harmful to the US economy. I think it's created a crisis of confidence in the minds of CEOs. They don't know where to invest, they don't know when to invest, they don't want to put new capital into capital expenditures or, equipment, or people for that matter because they don't know what the rules are going to be.

And the worst thing for a company is to not know what the rules are going to be from a tax perspective, from a regulatory perspective and everything else and I really feel that you've seen, and you have seen a significant slowdown in the US economy, a significant slowdown in the global economy and it is the result in many ways of both the direct and the indirect effects of this trade war. And I worry that at the end of the day the benefits coming out of this will be far, far less than the cost that we're paying right now. So, I have a negative view and I hope that it is resolved in some positive way and I hope it is resolved for the benefit of both the US growth and US workers, and global as well relatively soon, but I continue to believe that is a risk with the rhetoric itself I think is much greater than the actual benefits we're going to see and that it's... that it's a deterrent to growth both here in the US and globally.

Jeff Schulze: I want to move over to earnings since earnings typically drive markets over longer timeframes. 2019 has proved to be a tough earnings environment and will that continue into the next year, and maybe I'll kick it off in saying that we had expectations for earnings to not to do as well as consensus expectations this year and I think next year expectations need to come down as well due to the lag effects of fed tightening. You know when fed tightens, it usually takes about a year, or 18 months for that to filter through into the economy, and that means today we're really just filling the third rate hike of last year. We have another rate hike to go and then all of the quantitative tightening or found sheet normalization to digest.

If you think about where consensus expectations were for earnings for the fourth quarter of this year, they were at 9% eight months ago and right now they're actually negative. So, with consensus earnings being 9.2% next year for the S&P 500 we do think that's a little bit too rosy and we think that's going to likely come down as forward guidance comes out for companies in December, in January. I think that the most likely area that we're going to see earnings in is probably in that one to 3% range depending if we have a recession, or we have just a slowdown. Again, we're not sure which direction is going to go, but our base case is for single digit, low single digit earnings growth for the S&P 500. Elisa is that something that you're seeing abroad, you think that you're going to continue to see earnings deterioration, or things pick up from there?

Elisa Mazen: Well, earnings growth has not been particularly robust in markets. It was actually quite good in Japan last year, but it hasn't been particularly good in Europe, so even though the markets have done well, it's really been a lot of forward looking and multiple revisions. So, it hasn't been earnings growth that have really pushed things. We're hoping for earnings growth this year. I think the consensus numbers I saw for Euro stocks is somewhere between anywhere between eight to 10% really depending on what happens with PMI's, what happens with the dollar. That's something that's materially important. If the dollar weekends that's much better. We don't think we'll get a lot of multiple revision. I think you could get some intra sector moves, but I think it's really about trying to get some earnings growth coming out of Europe and frankly we think there's a lot of opportunity for that to happen.

 We do see good wage growth happening in Europe, you're having two and a half percent wage growth. You have unemployment, which went from a peak of 13% to now 7.5%. 7.5%, there's still ways to go, so you're employing more people, you're paying them more money. That's very good for consumer led economies, developed economies in Europe. The political issues that we've seen throughout Europe, most of those issues are resolved, or will be resolved this year we hope. So, we think that will be a good thing.

 The potential for fiscal stimulus in Europe is considerable. You know that the current account deficits are very... surpluses are good and you have a lot of ability of a market like Germany to really stimulate and grow either through green initiatives, or other things and so we think that pro-growth economic strategies are something that we really haven't talked about in Europe for a long time and we frankly think there's a fairly good chance that can happen. So, we're pretty constructive about certainly what we see in Europe and I think the UK coming out of Brexit probably just from base effect impacts can probably see some sort of at least a lifting in near term earnings growth.

Jeff Schulze: Let's not forget from a fiscal stimulus perspective, Germany can borrow at negative interest rates.

Elisa Mazen: That's Correct. That's something that's materially important, I think. You will see people borrowing the green bonds that they're issuing right now are at pretty attractive rates and companies are also interested in growing through acquisitions as well. So, when growth slows down, you are seeing companies do acquisitions. We're pretty constructive about M&A especially coming from the Europeans, which are again in very good shape on a balance sheet basis,

Jeff Schulze: Scott, any views from a US perspective.

Scott Glasser: So I think it is critical and it would be very helpful if Europe in particular, but globally growth starts to pick up. I think that would help actually bring the US up. A lot of times we talk about the US bringing other economies up. I think actually we have the possibility that it works in reverse this time. So, I think that'd be a very positive thing. I think that earnings interestingly are the biggest debate right now on wall street because if you're a bull you're saying, I think it's going to be up 10%, if you're a barrier saying I think it's going to be flat to down. I find myself being somewhat in the middle. I know it's kind of a chicken position, but I find myself in the plus four to 5% range and I think that will continue to be driven by the strength of the consumer, which is the side of the economy, which has been the side of the part of the economy that's been driving the overall economy as opposed to industrial.

I think it's a really important debate because the last year, what we didn't say earlier is last year earnings were up 1% let's say, or we'll wind up the year up 1% yet stocks were up using the S&P 25%, which means it all came from the multiple. The multiple expanded, the valuation on the market expanded over the course of the year. If you don't get any earnings growth and you want to get further gains, which I think we will have next year, it's an awful hard burden to ask the discount rate to provide that much more of a boost, or the multiple to give you those gains going forward. Even at a plus four, or plus five, you're roughly at 17, 7, 18 multiple on the overall market, which again is not extreme given the level of interest rates, but it's not cheap either. It's kind of on the upper end of what I would say.

So, I think the earnings debate is important and I think it'll actually come down somewhere in the middle, but it's... but it's an incredibly important... should be an incredibly important contributor overall returns this next year and going forward where it was not this past year. So, let me ask you, Jeff, I know you've done a lot of work on earnings and you've done a lot of work on the overall global economy, and the domestic economy and you are the owner and the author of the ClearBridge recession risk dashboard. So, tell me, what are you seeing in terms of your own indicators. What's your opinion?

Jeff Schulze: Yeah. So, the recession risk dashboard is a group of 12 variables that have done an excellent job before shadowing and upcoming recession. It's a stop light analogy, meaning green is good, yellow is caution and then red is recessionary, and we are in a yellow signal right now, which means rising recession risks. Right now, we think the probability of a recession over the next 12 months is 50%, or a coin flip. The one thing I really want to talk about though is that there's a big difference between a red signal and a yellow signal. In the dashboard's history, we've had eight red signals. Seven out of eight of those were recessionary. We've had several periods where the dashboard went to yellow, economic growth re-accelerated and went back to green. That's 1995, 1998 and then 2016. Now, ultimately, we think all three of those periods would have been a recession, but a key thing happened that re-accelerated economic growth, which was the fed that recognized weakness early.

They cut rates and provided liquidity to the system and economic growth rate accelerated. Now, if you think about the environment that we're in today, the fed has obviously recognized weakness. They've cut rates for a total of 75 basis points, which traditionally has been the level that was needed to get out of these soft patches, which has given us a fighting chance for this to be not a recession, but ultimately a slow patch. Now the one thing I'll mention is that when the recession risk dashboard is turned yellow, it usually takes about six to nine months for the data to inflect higher, or lower, and it turned yellow in July of this year, which means the first quarter of 2020 is ultimately going to hold the keys to the fate of this economic cycle. Now the three variables that we're watching most closely within the dashboard are manufacturing PMI, profit margins, and then also jobless claims.

Now, one of our core views is that the US economy will continue to slow and we're going to have a recession scare sometime in the first, or second quarter. And if you look at manufacturing PMI, which has done a very good job of being able to identify accelerations and decelerations of economic activity, when you've had fed tightening prior to the deceleration of manufacturing PMI, on average it's bottomed out at a 40.5 level and the most recent print that we got a manufacturing PMI disappointed to the downside at 48. So we think that there's going to be more weakness to come on this front. Now there's a prevailing view that manufacturing has decoupled from services in the US economy because manufacturing only makes up 10% of the economy, and I think that's true up until a point when manufacturing PMI bleeds below 46, you usually start to see that contagion effect and you're seeing it in Germany over the last couple of months.

 So that's one of the areas that we're watching really closely. Job claims is usually the last variable to turn to red. You have had no false positives and when job claims have increased year over year by 12%, you had recession three months later. The good news is that job claims ticked down by about 15,000 this last week and it's at the lower end of the trading range that we've seen throughout the course of this year, but if you do start to see a pickup of job claims, that means people are going to start to lose their jobs and consumer spending, which has been obviously the backbone of this entire recovery may start to come to an end. And then the last thing I'll mention is profit margins. Right now, we look at NIPA profit margins rather than the S&P 500, because NIPA profit margins look at micro, small, mid and large cap companies.

It's a much better barometer of what's going on in the US economy. And NIPA profit margins were revised down by $200 billion in July, which is a huge revision outside of a recession and it's disproportionately affected the micro and small cap companies that are out there because of a tight labor market and higher compensation costs, but also the inability of these companies to pass through tariffs to their end users. Now, if you look at the US economy, about 60% of Americans are employed by a company that has less than a thousand employees. Your average Russell 2000 company, which most of us think of as a small cap employs 3,679 people, which is roughly four times the size of where most Americans work. So, in being able to determine the fate of this cycle, I think those three indicators are the ones that I'm watching really closely.

Scott Glasser: So, can I ask based on what you just told us, I would think that your own earnings estimate for this next year, will tend to be at the lower end. Is that correct?

Jeff Schulze: Yes.

Scott Glasser: Okay.

Jeff Schulze: Again, I think that growth scare that we're going to have in the first and second quarter has yet to play out. And I think earnings estimates will continue to come down and potentially just on the downside. One thing that obviously could impact the market valuations and market activity, however, is the political environment. Obviously, risks are rising, and you know people are nervous to be in the markets because of who ultimately might be president in 2020. I'm going to give a couple of my thoughts, but I'd love to hear what you feel are the political risks coming into the next year. The one thing that I'd like to say and trying to handicap who's going to become president for the next term is it may not come down to who wins the democratic nomination, or a particular view on a topic or policy. It may ultimately come down to the economy.

Now, if you look at every first term president in the US in the post-World War II era that was going for reelection, only three of them did not get that second term. That was H.W Bush, Carter and Ford. Now, those three presidents were the only three presidents that had a recession within two years of the actual election, and the only three presidents that saw a material rise in the unemployment rate the year of the election. So, when trying to figure out who's ultimately going to become president, I think it comes down to whether this is a slowdown like 95, or ultimately a recession.

The other thing is that it's important to stay invested throughout this timeframe because since 1944 we've had 19 presidential elections, and the year leading up until that presidential election, the market was positive 17 out of 19 times. So, your hit rate was an 89% and your average return in that period was 8%. So, I can guarantee you that there was a lot of candidates over that timeframe that had market unfriendly policies, but yet the market looked through that and continued to rise higher, focusing more on the economy. But do any of you have any views on the political realm that we live in and whether, or not it could potentially have some market implications.

Aram Green: I think it’s 2020 is going to set up the environment that we're in right now where it's going to swing around based upon every tweet that comes out in the morning and the afternoon, trade concerns and yeah, I mean maybe that's what... why Trump is going to maybe continue to kick the can down the road in terms of negotiating with China because he has someone to blame if unemployment, or some of these macro factors start to turn negative and he wants to shift the blame to someone else, he can say, I'm doing this because this is in the long-term benefit of our country and I'm going to stand the ground. And I think people who voted for Trump and are behind that agenda are going to continue to vote for that. So, I think he does have a master plan, but he plays by a different set of rules and so I think we're going to see just a lot of volatility next year, and hopefully as active managers we can use that to our advantage to reposition and find great opportunities for the long-term.

Jeff Schulze: Yeah, volatility tends to be an active managers best friend.

Elisa Mazen: That's right.

Jeff Schulze: Another thing I mentioned about the political environment is Elizabeth Warren. There's a lot of investors that are concerned that she will get the nomination and ultimately become the democratic nominee. If you think about where we're in the cycle in 2007 it was Rudy Giuliani that was winning the primaries and then also Hillary Clinton. Neither of those candidates went on to get the nomination and 2011 it was Rick Perry who was leading. So, we are a long way from that potential point and I think impeachment could actually impact who the democratic nominee ultimately is. If you do have the impeachment process that moves forward and the Senate does have a two to four week hearing, that's going to take all the senators off of the campaign trail back in for those hearings at a crucial time leading up to the democratic primaries.

That'd be Elizabeth Warren, Bernie Sanders, Kamala Harris, and then also Cory Booker. And that would be a nice tailwind for some of the more centrist candidates like Biden, Bloomberg, and also mayor Pete. But I think it's important to note that even though it was widely recognized from consensus that Trump would have been negative for the markets, and yet when Trump got elected in 2016 the market's moved higher. Even if you have some democratic nominee win the election that's maybe a little bit more viewed as market unfriendly, the market reaction could ultimately be different than what's commonly perceived.

Scott Glasser: So, I would just add that in terms of the democratic candidates who are more aggressive with their healthcare policies, the market is traditionally done a very good job in telling you how they're doing overall. And you've seen recently, you've seen a significant rally in the healthcare sector as a whole and the managed care companies in particular, which would be affected by Medicare for all. In that respect, I would tell you that the market itself is voting that these candidates are not what, you know, they're not likely to succeed and they're not what kind of mainstream America wants. And that's just me reading the tea leaves from how the market is reacting to their standing in the polls. And the market has done a fairly good job over time in predicting what candidates are elected and how they do quite honestly and what policies will be influential. So, I do... I do read into that a little bit and I'm glad to see it actually because I like the healthcare sector.

Elisa Mazen: I think... I think one of the things that we all have to watch very carefully is the Senate race. So, to the extent that right now you have a Republican controlled Senate and how that sort of manifests itself after election. Do we get... do we get a flip to democratic Senate and a democratic Congress and that could... that could have some interesting implications for next year as well.

Jeff Schulze: Yeah. Right. In order to have long lasting types of sweeping changes of regulation, you need to have everybody singing from the same hymn book.

Elisa Mazen: Typically, yes.

Jeff Schulze: And given the political map, I think the Democrats would have to pick up four seats for something like Medicare for all to come back onto the table.

Elisa Mazen: Right.

Jeff Schulze: Okay. So, let's talk about growth leadership. We've had a long period of growth leadership and obviously we saw value come back late in the year. Can value maintain its leadership, or is this a transitory move within a secular growth market? And Aram, maybe I'll start off with you on what your thoughts there are?

Aram Green: Yes. I guess just setting the stage a little bit of recap in terms of what we went through in terms of growth versus value. Growth started to do really well in 2018 when trade Wars first started to rear its ugly head and investors started to shift focus and dollars towards visible growth. And so, growth assets started to get bid up as people were being scared out of cyclical businesses and there was a pretty broad sell off Q4 of last year, but then the growth trade resumed in Q1 and Q2, and both in the public markets as well as the private markets. And that sort of reached a crescendo at the end of summer with we were coming on the road and going public and we also saw some splash evaluations in private land where things were being valued at multiple tens of billions of dollars, and I think that investors to kind of indiscriminate view of growth and didn't really look under the hood to see what was quality growth and really defensible growth and profitable growth.

And so that really started to become more apparent when we work filed a test one and the management team went on the road as well as some corporate governance issues there. And so we had growth really start to sell off in the end of August through September pretty violently, but yet subsequently growth has been doing better and still leading very much on the year. And so, I think as you take a look at where we sit today and for perspective in order for value to do well, I think kind of one of two things has to happen. One is either you have sort of a cyclical rebound where a yield curve becomes more favorable to financials and also global GDP trade improves cyclically influx. The other way that value can do better than growth is the safety trade because within the value side of the house you have utilities and rates and staples where people tend to own, or flock to those kinds of companies where the outlook is more uncertain and they want the stability of those lower growth businesses as well as the higher dividend yield.

In the meantime, though, innovation and the disruption cycle is refusing to seize up. And so, we still see a tremendous amount of innovation and growth. And I think that after the multiple re reset that we had in the end of summer, beginning of fall, that valuations are reasonable but by no means cheap. And so, I think that what's going to drive growth from here is going to be revenue growth and profitability growth. So, we're not expecting much multiple expansion in the upper end of growth. And we touched a lot upon where we are from a global GDP perspective and it looks pretty choppy and mixed, and I think we're just going to have sort of these tradeoffs throughout 2020 of people kind of trying to rebalance. I think the biggest thing that one of the bigger elements that we can do as active management is make sure that we have our exposures appropriately set, and understand where sentiment is, and where people are positioned.

And so that's.... that's the kind of tension that we continue to see is Scott was talking about in terms of this massive rebound in healthcare stocks recently, it was everyone was sort of positioned against healthcare and out of healthcare because the sentiment was so negative and then when there's a little twist where it's not going to be as bad as people expect, people really increase their exposures and you see big improvement. So, I think being very focused in terms of where your balances are within the portfolio and making sure that you have a diversification across those is very important at this point.

Jeff Schulze: Scott, the value leadership that we've seen, is this a genuine snapback?

Scott Glasser: Well, certainly a snapback, but I would argue the snapback is transitory as well. It's taken me the... the extent of it, has taken me by surprise and I think it extends probably longer than I would have guessed a month ago let’s say. And I've been studying the issue a lot and it seems to me very apparent that it's similar to a rubber band that got stretched too much. If growth is up here and values down here and you stretch that rubber band, it got stretched on some really silly growth at any price valuations late summer, culminating with the failure of IPOs and some of these growth companies just not being able to reach the lofty expectations that existed particularly in the small and mid-cap side. And on the value side, this constant fear throughout the year of recession and deflation really caused investors to flee anything that had more of a cyclical component and in both cases,  you really didn't have a chance.

It was price driven, it wasn't fundamental driven, right. Wasn't the extreme on one way and then the snapback, it's more perception and it's not. So, you haven't seen a large uptick for example in industrial earnings revisions, you haven't seen a large uptick in financials. And let me just kind of be clear, we're talking about growth versus value. You actually have to be much more nuanced than that because within value there's a set of groups, a set of stocks that did, or sectors that did very well last year, and it gets to kind of what drove the S&P. Yes, technology drove it. Yes, it was the best sector and by the way, it's almost 25% of the S&P. So, it's incredibly important how that does going forward, but the other sectors like consistent kind of earnings growth, or kind of lower growth companies that were lower risk, there was a defensive trade, which actually falls into the value camp.

So, reach and utilities and consumer staples all did well. Those are value stocks. And the reversal that you saw was really the pause of tech and the reversal of those other value sub-sectors in favor of financials, which had lagged terribly, industrials which had done poorly on trade war and this fear of cyclicals and to a certain extent healthcare where you got kind of bifurcated stock performance. The med tech did well in the stocks that were fearful of either pricing, biotech's, pharmaceuticals, or more regulatory fears, basically distribution and managed care. Those did terribly and you saw a reversal of that. And so, you had a dramatic reversal within value and you had kind of a stagnant... stagnation of growth for a period of time and then they've kind of comeback recently. I would argue it's transitory. A, because it's not fundamentally driven, it was more price driven than fundamentally driven.

And B, you had extended what I'll call real kind of value rotations in 2013, when you had in the end of 2012 kind of the defense of the Euro in 2013 into a significant Chinese China stimulation. And then 2016 when you had also Trump elected the promise of tax cuts, which drove the US market and also then a real effort by China to stimulate the economy in 2016. You don't have that right now. The way China... China stimulated their economy, but they're also de leveraging their economy and you don't have real money growth in China. So it's not the same type of stimulating. It's not the same type of effort and stimulating the economy that you saw in 13, or 16 and so I would argue that it is transitory, it couldn't go longer. One key question, this is really interesting. Every first quarter going back as long as I could remember, which is a while you get a movement into more cyclical, smaller caps, lower quality, they all rally if you look back and you study history first quarter.

I don't know if it's hope springs eternal, I don't know if it's the momentum trade that always carries, or generally carries through in December and then reversal of that. I don't know if it's the willingness to kind of take some risks into a portfolio on things that... and sell some things also that you don't want to sell in the new year and so you get what work gets sold and what hasn't worked gets bought. But every first quarter you genuinely do get a rally in small cap, in more cyclical stocks, in more value oriented stocks and so my question, and I'm kind of throwing it out without an answer is did we pull that first quarter rally into fourth quarter? And do you still have that same effect in the first quarter? I don't know the answer, it may continue into first quarter. It's hard for me to believe it will be as strong as it's traditionally been that rotation, but there is a seasonal rotation in the market, and it may have been pulled forward based on these factors.

Jeff Schulze: Well, I'd agree with you. I think the market's clearly pricing in a cyclical rebound and a soft landing that global central banks largely have been able to do enough to get us out of the slow patch. Out of the 33 major central banks that are out there right now, 52% of them are cutting rates. So usually the biggest upswings in global growth, you do see synchronized global central bank action working together. And I think it's already, to your point, I believe that a lot of that's priced in and you may not see that same phenomenon as you traditionally see.

Scott Glasser: And you may not get the same effect from those. I mean there's a general fear that central banks around the world don't have the same effect that they had two years ago and five years ago, and 10 years ago in terms of reduction in rates. A, because rates will be low when credit is available and so you also run the risk that even with that kind of... even if it's not priced in, even with that reduction in rates globally, it doesn't have the same stimulative effect, which is why the ECB and others are screaming and basically begging for more fiscal initiatives.

Jeff Schulze: Elisa, anything on the international space. So, you think value will continue to lead?

Elisa Mazen: Well, I think the deeper cyclicals is something that we've really just wanted to go in and evaluate whether we think they can continue. I'll echo sort of Aram's comments. For value to really work in any sort of broad way, you do need to have a lot of clear space in terms of economic growth so that you can take earnings, you can have the confidence those earnings will grow and you can put a multiple on top of that. That seems to be very suspect in the environment that we're in where it's really very choppy. You have seen stimulus coming from the ECB, although I think that that is kind of, we're kind of at the end here, we're not going more negative. So, I think that it really... it really, we have to pass that baton to the fiscal side and then start to get some pro-growth policies going.

The cyclicals in our mind, the auto side, we don't really see a lot of interesting things that we find they're very challenged from an earnings perspective. They are dealing with multiple issues around the combustion engine, the new battery engines, the leftover of diesel gate. There's a lot of issues they're still grappling with, but basically highly cyclical operationally geared businesses trying to morph into sort of a new technology while still keeping sort of very big plans going. We think it's going to be very challenging. So, we're not really in favor of that. Energy for us again, disrupted by a lot of the newer initiatives and the regulatory initiatives that are coming from around the world in terms of climate change. Maybe the US is not involved in that, but climate change is something that the Europeans are taking very, very seriously.

So, you're seeing real interesting initiatives there and we think frankly that's not particularly good for energy stocks in general. So, the commentary that we've seen around sort of the deeper cyclicals, the commodities and some of things like the auto sector is really about a fear of missing out. You better buy it because everybody else has missed it and they're going to jump into it too and that's really frankly a lot less compelling to us. We do think that financials and banks in particular in Europe could be... could be interested. We could talk about that maybe at the next question, but there is potentially something interesting going on there in terms of loan growth and higher rates that could actually sort of change the trajectory of earnings. So that for us could be interesting, but some of those deeper cyclicals frankly we think are not of interest.

Scott Glasser: I was... I was going to agree that there is a nuance when you talk about cyclicals there's deeper cyclicals, there's kind of less deep, or I don't know how you term them.

Elisa Mazen: Core.

Scott Glasser: Matter core. Growth is even growth cyclicals,

Elisa Mazen: Yeah. Sure.

Scott Glasser: And so, it is more nuanced than just kind of growth versus value and we'll talk about sectors, but I think that there are certainly value sectors that could do well over the course of next year even on their growth. I think that you've seen the extremes and then you've seen the snap back. And I think that future performance, sector performance will be more nuanced than just saying growth versus value.

Elisa Mazen: Yeah. Agree.

Jeff Schulze: You guys are teaming up perfectly for my next question. Obviously, we've had a meaningful sector rotation here throughout the year. Are there any opportunities, or sectors that you think are going to be a favorite as we head into 2020? Aram, I'll start with you.

Aram Green: Sure. So, within small cap sectors I think matter a little bit less because there's... there's a lot of heterogeneity within sectors and so we kind of look at stocks in a couple of different ways and where we're seeing opportunities today is really those high growth compounding companies where we see very visible growth with expanding of margins as businesses mature and increase in cash flows. That was the group that we talked about earlier. I don't see a lot of multiple expansion there, but I see very high growth of 15, 20, 30% a year. So, you're compounding out at a very high rate, if you can maintain your multiple that's going to be a lot of capital appreciation over the couple of years.

IPOs, the IPO market was wide open earlier this year and we saw a lot of companies come public and now we're seeing the supply from secondaries come and the fact that we're kind of having this we work hangover, a lot of IPOs have broken their issue price and so we're spending a lot of time going back looking at IPOs we didn't originally participate in, as well as we're buying into some of the IPOs that we originally participated in that are trading below where our initial purchase price, where we think there's a good opportunity where the market is using a broad brush to paint all new IPOs negatively. And then the last area that we're designating a lot of time too and a lot of exposure in the portfolio are self-help stories. So, these are companies that have stubbed their toe for one reason, or another.

Maybe they over promised on a product recently they didn't come through. Maybe they made an acquisition and put a little leverage on the balance sheet. There's some sort of self-help improvement of execution, which we think is going to drive fundamentals higher and so you can get a compounding effect of a higher fundamental metrics, whether those be revenues, or some other key performance indicators and when investors start to see that, they'll be willing to pay a higher multiple. So, you have kind of a compounding effect. We've been finding a lot of new opportunities there.

Jeff Schulze: Scott.

Scott Glasser: So when I think about sectors, I think that technology will continue as I mentioned to be a critical sector for the overall economy and I think that where you're actually positioned in technology matters a lot and so we continue, I continue to believe that some of the bigger markets focusing on cloud, focus on digitalization, focusing on, for me it's kind of the big blue chips that will continue to be a good place to be and you will get ... you will basically make your Macon and potentially exceed the earnings estimates that are out there, and I think that market continues to be quite robust despite trade, despite everything else that's going on. When I talked about the value kind of sectors, the two areas where I do think that there's some opportunity in part because they've been controversial over the last year, are healthcare and financials and if you do continue to get, which I would expect more of a normalization of the yield curve, some pickup in global growth and then the US pulling, hopefully being pulled up stabilization, and pull up the consumer.

If the consumer hangs on, I think that both US financials and then selected US healthcare stocks that have lagged because of pharmaceuticals, biotech's, managed care that have lagged because again, pricing concerns, regulatory concerns. It's not to say they won't be volatile and in both cases I think you're going to... they're going to be volatile. You've got a negative tweet on trade and the financials are down 3% as an example. You get a negative comment or press release on healthcare and the stocks are down 3%. I think those are actually the opportunities you use to kind of pick away at stocks in these sectors. And I think there's some upside there. You haven't, again, because they've been controversial, they tend to have a good combination of both valuation support, decent growth, good share repurchases, in many cases good dividends, solid pipelines and so I think those are an area that that appeal to me.

Jeff Schulze: To your point on bio-pharmaceuticals, there's only been three times where bio-pharmaceuticals traded below the markets over the past 30 years. It was in the early 1990s and then also 2009 and today. In the early 1990s it was surrounded around Hilary care and drug price regulations. It was Obamacare in 2009 and obviously the concerns about drug price regulation today and then coming out of each one of those areas bio-pharmaceuticals outperformed by a pretty wide margin. Elisa, what are your thoughts on a sector perspective?

Elisa Mazen: So, typically we take a pretty broadly neutral perspective of sectors that we're invested in. We try to be involved as growth investors in as many sectors as possible. We are overweight technology for obvious reasons, but we are also sort of involved in financials which are not traditionally growth area. So, we do like the stock exchanges. That's been something that's done very well for those as they've sort of morphed into more information technology companies than IPO machines, or trading machines. So, we like those, but we've moved some of our money into areas that have been really underperforming where we think there's a change. So, for us we call it, we have three different groups that we invest around. Emerging growth, secular growth and structural growth. So, the banks would fall into that structural change category where we think earnings are very depressed and there's an opportunity for earnings to grow nicely.

So, we're overweight European banks, which we think there's some very interesting opportunities again, with higher loan growth and we think eventually better yields. And we think those are... those are set up very well for the next few years. Within healthcare, we did get an opportunity to buy into large cap pharma sort of in 2019 at very attractive rates. We'll let that continue to play through. We've also been invested in an emerging growth company that is oriented into the Chinese, the development of the Chinese healthcare system, which is something that's very new. It's not particularly talked about, but we think that's a very interesting long-term emerging growth play. We think emerging growth in general, again with these growth scares, you get the opportunity to buy into a very interesting long-term growth compounders at attractive levels.

So, we've been doing that. Again, participating in IPOs in areas like FinTech, music streaming we think are very interesting. The biggest part of our portfolio is always this secular growth, which we call sort of steady compounders and we think those stocks continue to do very well in basically most type of market environments. Unless you get to the extremes, we find that the secular compounders continued to do well in a value market and a growth market, and we'll be sort of the ballast that sort of takes you through to better performance for every year basically.

Jeff Schulze: All right. So, where's your edge heading into 2020. Where do you see the ability to add value? Maybe Scott, I'll start with you.

Scott Glasser: So the edge in 2020 better be the same edge in 2019, 2018 and every year.

Elisa Mazen: Absolutely.

Scott Glasser: Before that it'd be really hard to find a new edge every year. I think that just to reiterate, I mean I think the edge at ClearBridge as a whole, and the edge that we all believe is the right way to invest is I'm going to say obviously deep research about our companies and finding companies that are durable and that can live through the things we're talking about, but also owning these companies and having lower turnover rates and believing that by having lower turnover rates than our peers, we set ourselves up. Investing is all about probabilities and you increase your probabilities of doing better and outperforming and providing real effort to clients over the long term. And so, I'm talking about long-term approach to owning a company. Longer, holding periods, deeper research around it. I mean that's... that's I think the edge that we bring as a firm. We all believe everyone may have something that's a little different in terms of their style and getting there. That's what kind of binds us together, and that's what we uniformly believe.

Jeff Schulze: Aram.

Aram Green: I think that one of the keys to the future, again, it's no different than in the past as well is not getting market vertigo. We've been in a market that's continued to rise. You just keep on hearing more on the news. It seems like we're hitting new highs every day and I think there was a dozen, or so new highs on the down set this year and 15, or so last year. Correct me if I'm wrong Jeff, but it's something around those numbers. And so, I think as people hear that you're hitting new highs as market is perceived to be expensive because we're hitting new highs, but companies grow, economies generally expand. And so, with the growth of those markets and economies should... should continue to expand.

And so I think it's just important to have a very long-term perspective as Scott was just touching upon, and so we bring a very long-term investment framework as we're looking at companies and looking at the markets, really on the small cap side, small, mid cap side, focused on innovative growth in products and services that are thinking very long-term in terms of deploying capital today for future growth and success and using the volatility that we've been touching upon to really build positions and duplicate positions, and just as much as it's important to find the right companies and stocks to invest in, it's equally as important to avoid the companies that are deteriorating situations. And so, with active management, what we bring is a thorough de-risking of these investment ideas with a really strong focus on ESG issues.

Jeff Schulze: Elisa?

Elisa Mazen: Well, I'm going to echo the same things that Scott and Aram have said. One of the things I think, and again, it's not a new edge, it's not an edge, every year we come up with something new, but I think having an investment philosophy that you stick to an investment process in terms of how you build portfolios, how you think about valuation, how you... one of the things we always say is we don't think we can ever predict a recession. We can't tell you which market is going to be better. We can't tell you which currency is going to be better. So, we try to solve that. We do think we're good stock pickers, so we stick to that. We have a proprietary model that helps us identify ideas across the market, so we always have a fresh stable of ideas. There will be things to trim as they get near price targets and then they'll be things to buy when the opportunities present themselves and we have a way to systematically evaluate that. And we think that those will continue to be the edges that we have every year.

Jeff Schulze: Well, that's all the time that we have here for today. I want to thank our panelists for sharing their insights and views with us. I want to thank all of you for joining us to hear our thoughts about the upcoming year. It remains our view that the secular bull market that began in 2009 is alive and well as investors continue to fight yesterday's war. However, if the ClearBridge recession risk dashboard moves to red and a recession ensues, we believe it would be a shallow one economically speaking, due to the lack of access that built up across the economy. Regardless, if the 2020s are anything like what we've experienced this past decade, it should make for a very interesting ride. From all of us here at ClearBridge investments, have a safe, healthy, and happy holiday season and new year. Take care.