Listen to Larry’s November 24th interview on the “Money Life with Chuck Jaffe” podcast to hear his thoughts about where he is finding opportunities in the market and why income is particularly important for many investors.

Transcript

Chuck Jaffe: Welcome back to Money Life where I'm joined right now by Larry Cordisco, Portfolio Manager for Osterweis Capital Management, Co-Chief Investment Officer for Core Equity at Osterweis. If you want to learn more about the firm and what they do, osterweis.com, very worthwhile to go check out their commentaries at that website. Larry Cordisco, thanks for coming back to Money Life.

Larry Cordisco: Thanks for having me, Chuck. It's great to be here.

Chuck Jaffe: Larry joins me on the Game Bridge Hotline. Game Bridge believes that deferred fixed annuities are a steady guaranteed way to grow your savings. Its innovative self-managed platform provides direct access to trusted annuity products without complexity or hidden fees. Learn more at gamebridge.life. Larry, we are dealing with the market that has gotten back within sniffing distance of record highs. It was supposed to be making everybody nervous and scared a couple of months ago, backed away from all those fears. It's starting to make people nervous and scared again, now. I mean, there's been a little talk that maybe Santa Claus isn't coming or that this January won't have the standard January effect. As you're looking at this market, how much does a market back near record-high levels, but with much higher inflation prospects and a bunch of other things, how much does that make you worry, and how much does that look like opportunity to you?

Larry Cordisco: You know, I think that is one of the great questions, Chuck. As we look at the market, there's a lot of turbulence underneath these indices that are near or very close to all-time highs. And there's been a lot of corrections and a lot of turbulence underneath the surface. So if you basically look at the market overall, it's been very narrow, and the average stock has actually undergone a bit of a correction and we think that's an opportunity. We see a lot of very high-quality stocks that have corrected and if you have any sort of patience as an investor, and I think one of the things I'll add is the market feels very near term, very instant gratification oriented to us. So if you have a two, three, four, five-year horizon looking out to, quality companies that can grow their earnings over time, we see a lot of pockets of opportunity.

Chuck Jaffe: Where are those pockets of opportunities, specifically, broadly, what are you looking at?

Larry Cordisco: Well, one place that we really like, and we have a fund called the Growth & Income Fund that really focuses on these kinds of names, are companies that have an opportunity or a business model that they can grow dividends at a pretty decent rate. And so if you look at the inflation backdrop, which is obviously pretty hot right now over a 6% CPI, we don't think that probably continues in the next year, but it probably stays more elevated than what you've seen over the last 10 or 13 years or so since the great financial crisis. We think investors need to start thinking about protecting their portfolios with dividend growth companies. And so we put a lot of emphasis on these companies where you can see eight, 10% consistent dividend growth and we think of names like Visa, Union Pacific and JP Morgan as really good examples that fit this kind of need for investors' portfolios.

Chuck Jaffe: But dividend growth is such a frothy area right now with everyone who's looking to replace fixed income going in that direction. In terms of what you're seeing in those spaces, how much harder is it to find good dividend stocks at reasonable prices right now? Because yeah, show me a reasonable dividend and I'll show you something that will attract investors like crazy until the dividend's no longer so reasonable.

Larry Cordisco: So we are not so focused on the actual payout ratio or the yield, although it's certainly nice to have a higher versus a lower one, higher yield versus a lower yield. But what we're really focused on is an ability for a company to grow its dividend. If you'd compare two companies that one pays a 2% dividend and grows the dividend at 10%, and the other one pays a 2.5% dividend, but it only grows the dividend at 5 or 6%, within about five years, you're actually at about the same income stream between those two companies. And after 10 years the company grows the dividend at a higher rate.

You're at about 20 plus percent higher dividend payout with a faster growing company, and we'd also argue that if a company has faster dividend growth and earnings growth, it's probably going to have a better share price performance over time as well. So when you think about a total return formula, we really emphasize that dividend growth story over absolute yield. And a lot of these names like the three I just mentioned, have either performed in line or below the market for various reasons. So we don't think these are very frothy names in particular.

Chuck Jaffe: In terms of the names that are frothy. You know, it's been the biggest stocks, they have been not only doing well but any sort of cap-weighted index they make up so big a percentage that we've had guests on this show talking about how they may be a stock market to themselves maybe you just kind of want to look at the market without considering them. Well, if that's the case then you have multiple markets, you have the market for meme stocks and things that quite honestly, I would say that Osterweis would say, yeah, we don't invest in that market. If I know you guys correctly, you're not too interested in those things.

You've got the giants that are maybe driving the indexes, but they're not what you're looking for, and you have everybody else. So let's dig in on everybody else because on the one hand you like those dividend plays, on the other hand, where is that growth coming from? Is the growth coming from small caps? Is this is a case where value is overlooked because everybody's focused on other metrics? Where are the opportunities when you dig deep deeper in the market and get past the things that make a lot of surface noise?

Larry Cordisco: Yeah, that's a great question. You know, and you're right. I mean, we don't chase these meme stocks and the like. We think of our process and our philosophy really being driven around this idea of quality at a reasonable price and it's really interesting. You talk about these different types of return profiles we've seen in the market. You know, we did an analysis where we broke the market into five quintiles, and this was the S&P 500, so five buckets of a hundred stocks each, and we did it by price to sales ratio. And the really interesting thing we saw with this year as we're going toward the year end is that the companies with the highest price to sales ratio performed the best, and they far outperform the S&P index.

The second best performing quintile was the lowest price quintile. So the stocks with the cheapest valuation, they also outperformed the S&P 500, but in between those three other buckets all underperformed the market. And so when you look at this idea of quality at a reasonable price, these companies tend to be less exciting, right? Less memeable in some ways, and less volatile with both earnings declines and earnings recoveries. So when you look at the kind of momentum that's been in the market and stock price momentum's really correlated to a lot of earnings momentum and earnings recoveries. There's this big sweet spot in the middle of companies that are really high-quality that have not necessarily performed as well. And we think there's a lot of opportunity in those buckets in between.

Chuck Jaffe: When you look at this market and you're looking at those opportunities, what scares you? Is it the potential for another wave of Covid? Is it misplaying inflation by the Fed or interest rates? What worries you right now?

Larry Cordisco: Yeah, I think interest rates are the area that most people are worried about. Covid is a worry, but if you look at the recent outbreaks we're having, hospitalizations aren't really up in a corresponding way with the case numbers, we're getting further along in vaccinations and hopefully getting to herd immunity to some degree, we are pretty optimistic that the worst of Covid is behind us. It's the interest rate story that we find so fascinating. If you look at these CPI prints and the 6% we just had, and recently we've seen a little bit of an uptick in rates, you know you have the 10-year rate hanging around 165 or whatever it is today. And that's a really significant negative yield. Now, the bond market is telling you that inflation is not going to be persistent, or else, I don't think you would be accepting this much of a negative yield, but certainly, we think rates are going to go higher.

We think there's going to be a lot of reopening activity next year, a lot more travel. We see inventory replenishment on the come for the economy. And of course, some early infrastructure stuff is going to hit the economy. So we're pretty optimistic that the real economy is going to do pretty decently next year, but what that means to the bond market and to interest rates is sort of an unknown. We think rates go higher, but if they go higher in a very steep, fast step function sort of way, I think that will upset the equity markets. So that's kind of where we focus on the potential driver for equity market volatility is what happens in the bond market. That's really our focus.

Chuck Jaffe: And quickly, because we're almost out of time. For you in looking at all of these opportunities, does the U.S. still remain the best market in the world? I mean, it has been for quite some time, but with everything else that is changing, everybody's facing the same sort of pressures, but not everybody's had the same kind of opportunities in the past. Are you finding that your view of the world is changing at all?

Larry Cordisco: No, we still like the U.S. And in fact, we probably like the U.S. a bit more because if you look at the China story, and how that economy is decelerating and I'll put in air quotes, "it's normalizing," a lot of the emerging market and Southeast Asian sort of economy that's been an emerging market focus for the last 20 or 25 years is really tied to China. So as China slows, we think that the U.S. on a relative basis continues to look really good. Europe's got its own issues and those aren't changing either. So again, we keep on coming back to the U.S. as the most vibrant economy and the most flexible economy. And frankly, like I said, we think there's a lot of value underneath the surface. So we like the U.S. market.

Chuck Jaffe: And is the U.S. market as we see infrastructure and all the rest, can we continue without having some sort of massive correction? I mean, if you don't see a correction coming that would be dropping the market down, do you see a correction in time just a big measure of sideways?

Larry Cordisco: So I think the sideways story is intriguing to us. And the reason is, it goes with this idea that we're going to have more real economy activity, we're going to have higher rates. And so if you look at some of these stocks that have nosebleed valuations, and they're great companies with great products, but really expensive valuations, what we think could happen in 2022 is you have a sideways market where you have some of these really expensive stocks that make up a big part of the index, trade sideways to down.

But underneath the surface and we've seen a lot of rotations in the market over the last year and a half, underneath the surface, you see a rotation more towards financials and industrials and cyclicals, and these sort of more sensitive companies in the economy, sensitive to the economy, where valuations are a lot more attractive. So if you just think of where the incremental inflection in business momentum would be, it'll be in these more cyclical companies with more attractive valuations and a rising rate environment. We think that's favorable for them at the expense possibly of some of these really big, expensive companies that have driven the market in 2021.

Chuck Jaffe: Larry, great stuff. Thanks so much for joining me on Money Life to talk about it. Have a great holiday season. We'll talk to you again in 2022.

Larry Cordisco: Thank you very much, Chuck. Great to talk to you. Have a very happy holiday.

Chuck Jaffe: That's Larry Cordisco, Portfolio Manager at Osterweis Capital Management, Co-Chief Investment Officer for the Core Equity team at Osterweis. If you want to learn more, it's osterweis.com, for information on the firm, its funds and their commentary. Well, we've got more to go on today's show. In fact, we just crossed the halfway pole. So settle back and relax. We're living the money life and we're right back at it in just a moment.

The S&P 500 Index is an unmanaged index that is widely regarded as the standard for measuring large-cap U.S. stock market performance. The index does not incur expenses, is not available for investment, and includes the reinvestment of dividends.

Fed refers to Federal Reserve.

Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care.

Yield is the income return on an investment, such as the interest or dividends received from holding a particular security.

Mutual fund investing involves risk. Principal loss is possible.

The Osterweis Growth & Income Fund may invest in small- and mid-capitalization companies, which tend to have limited liquidity and greater price volatility than large-capitalization companies. The Fund may invest in foreign and emerging market securities, which involve greater volatility and political, economic and currency risks and differences in accounting methods. These risks may increase for emerging markets. The Fund may invest in Master Limited Partnerships, which involve risk related to energy prices, demand and changes in tax code. The Fund may invest in debt securities that are un-rated or rated below investment grade. Lower-rated securities may present an increased possibility of default, price volatility or illiquidity compared to higher-rated securities. Investments in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. From time to time, the Fund may have concentrated positions in one or more sectors subjecting the Fund to sector emphasis risk. Investments in preferred securities typically have an inverse relationship with changes in the prevailing interest rate. Investments in asset-backed and mortgage-backed securities include additional risks that investors should be aware of such as credit risk, prepayment risk, possible illiquidity and default, as well as increased susceptibility to adverse economic developments.

Holdings and sector allocations may change at any time due to ongoing portfolio management. References to specific investments should not be construed as a recommendation to buy or sell the securities by the Osterweis Growth & Income Fund or Osterweis Capital Management.

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Osterweis Capital Management is the adviser to the Osterweis Funds, which are distributed by Quasar Distributors, LLC. [ OSTE-20211124-0377]