STEPHEN AUTH: My view has been that the market forces are now in place for a new secular bull, where you could have a couple of decades here, a pretty good performance. In secular bull markets, you can have 20% declines. In fact, you need them to fuel the bull. But importantly, you don't get 40% declines.
ED HARRISON: Hi, I'm Ed Harrison for Real Vision. And I'm going to talk to Stephen Auth who is Executive Vice President and Chief Investment Officer at Federated Investors. And this is going to be one of these interviews that we normally have where we go over the typical stuff about the economy and investments and so forth. And I think that's going to be a great part of the interview.
But one of the reason I'm particularly interested in this interview is because we're going to talk about a break that Stephen had in his life, and how that caused him to reassess his faith and what that meant in terms of his giving back to society here, particularly in New York. So, very interested in what he has to say on that, in the book that he's written on that. And I hope that you'll like this interview.
Stephen Auth, thank you for joining us for this interview. I'm really excited about this. I'm excited because even though we're going to talk about the markets for a large percentage of it, we're going to get to some very interesting things about your personal life in particular at the end of the interview. And actually, I wanted to start a little bit with that at the beginning. Because you told me earlier that when you first came on to Wall Street, investment, and so forth, you weren't really thinking of it as this is the end all, be all, it was really more sort of a job is my understanding. Tell me about that.
STEPHEN AUTH: Yeah, as a working class kid- my father was a steam fitter- I just needed a job when I get out of college, and I had bills to pay. So, I came to Wall Street, really, from that perspective. It seemed like a place where I could make some money.
ED HARRISON: Tell me about the environment of Wall Street at that time when you first came on board.
STEPHEN AUTH: Oh, it was 1979, leading into the 1980s, which was the heyday of the LBO era and Michael Milken. And that whole scene. So, it was a pretty wild and crazy day, it was wild days on Wall Street, big commissions. I was on the investment side so I was more paying those commissions. But it was a wild and wily place, very different than the Wall Street of today, I think.
ED HARRISON: And it's interesting, you came in at a very pivotal point in time when we were going from what I would consider a very difficult period in time, '79, through to the apex of that political time and difficult investing time to the run and the bull market. Tell me about that transition and how you felt as a young investor.
STEPHEN AUTH: Yeah, it's funny, because I came in at a time when I was little, don't go to Wall Street, the markets are terrible. And it was just the end of the bear market. But I probably have a somewhat optimistic personality maybe. But yeah, I was very fortunate in that, in my career, it began really at a bottom and enjoyed a long 20-year run, with a few big accidents along the way, including '87, which I still recall, horrifying event, down 25% in a day and that kind of stuff, which doesn't happen today.
But I learned from that that certainly, learned a thing, Bob's back up, and you stick with it, do your homework. But I came from a very conservative investment culture, I was working for Prudential, very, very conservative company, investing for the long haul. And that actually have taught me the importance of looking at balance sheets and cash flows and being pretty, we weren't really winging it too much over there.
ED HARRISON: Tell me about that, being at Prudential, your first job out, that was your first job. And that culture versus the one that we were just talking about, the wheeling and dealing and the Wild West that developed on the sell side in particular.
STEPHEN AUTH: Yeah, we're on the other side of that. And at that time, back in the '80s, I was doing a lot of private investing for Prudential in the LBO business, which was growing rapidly. We're doing a lot of financings. So, it was an interesting juxtaposition. But deals found their way to us. We are careful and cautious. We did very well with the investments we made in that era. And then at some point, the CIO of Prudential, God bless them, asked me one Sunday afternoon, if I would go to Tokyo, that was in 1990, just as the market was peaking at, I don't think we've ever re-achieved those levels- 40,000, 39,000.
And he asked me to go over there to set up a stock investment team for Prudential. And I said, Garnet, I said this, you're an interesting guy to ask, I don't speak Japanese. I've never bought a stock in my life. I'm based here in the US, but he said, you'll be perfect for the job. And that really was my entree into investing in stocks, having come from the private side. So, I just had, as a result, a very conservative focus. I couldn't speak Japanese at the time. So, I didn't understand any of the explanations of why the market was at ridiculous levels. It all seemed overpriced to me. And I just started buying balance sheets, which I understood and I quickly learned the Japanese terms for that.
Well, that ended up working out pretty well for us, as it turned out. The market cracked, we ended up doing pretty well. So, sometimes it's luck. In retrospect, some- I maybe say divine providence, but I seemed to be in the right place at the right time at key moments in my career.
ED HARRISON: I think that's pretty interesting, because we know you as more of a bull in the baron's roundtable. You call the market pretty well during this time. But that was your formative moment, coming in almost at the top and being a conservative investor. How did you ride out- not necessarily the Japanese side but the American side as we went through a troughing in the jobless recovery and then into our own bubble?
STEPHEN AUTH: Yeah. And it's funny, I do have this reputation of being a market bull and some people think I'm forever bullish, because I have been, to be fair, bullish from the '09 lows. In fact, we first got bullish at Federated- go backwards, I switched over to Federated, I've only been in two companies my whole life. So, I've been at both about 20 years now at Federated. But we went bullish on stocks back in late 2008, was a little bit premature, but it worked out for us.
So, people think of me as always bullish. But I've been on other side to this in the Southeast Asian crisis, we traded that from a short position most of the time and I can see bad things coming, it's just that this has been a very nice run. And I looked at the opportunity in 2009. I have a very broad vision of the market. So, I think we had this 20-year bull run in stocks that lasted to '99 that you mentioned, which was the first arc of my career, if you will, and then the first 12 or 13 years there, after we were in a multiyear bear market, really, I would count it from '99 to 2013, when we finally escaped the old '99 highs.
My view has been that the market forces are now in place for a new secular bull that I think just started when we got out of the old highs in 2013. So, I would say starting in 2009 doesn't really matter. But where you could have a couple of decades here, a pretty good performance. In secular bull markets, you can have 20% declines, is in a corrective phase. In fact, you need them to fuel the bull. But importantly, you don't get 40% declines. You don't have a capital in this rating of event.
And what makes the secular bull dangerous in a secular bull market is that we are willing to step up on 20% declines and buy in size, because we see them as massive opportunity. So, as you mentioned, in December of 2018, we were in such a decline. Now, I know everyone believed that a big recession was coming and the world was ending and the Fed was going to hike until it caused a recession, everything else. And I was on national television, I said, I'll tell you what, he's done hiking. Really done hiking. He's told us he's going to keep hiking.
I'm telling you, whatever he's told you, I know that one of the effects of going through a secular bear is that everyone is cautious, including the regulators. And on the regulatory side, the one thing the Fed does not want to do is cause another recession. So, I thought reason would prevail. And even if Powell didn't, and that was the case, very shortly after his hint that he was going to hike until he cause a recession, he came out and read his- I call it the Iranian hostage speech where he pretty much- someone on the staff members must have written it for him, but pretty much retracted everything he said, I promise I'm never going to hike again. I'll never do this. I'm sorry. And it's been all up from there.
So, yeah, I think the psychology of this market is beautifully cautious. It's been the most unloved bull, the more people- I was getting a lot of criticism in December for our call, even for my own sales sourcing, they're like, Steve, do we have to be this far out there? And we were at 2450 for goodness' sakes.
ED HARRISON: And you were talking 3100, is that right?
STEPHEN AUTH: We're talking 3100. And we're the high guys that year, we've been the high guys on the baron's roundtable most years, but I'm just doing the math on this thing. And I keep reminding everyone that the first thing to do is reverse this ridiculous correction, which doesn't make any sense. That gets us to 2950. So, it's not really that heroic to call 3100 if you think the whole correction was nothing more than that. And that's our view.
ED HARRISON: You talk about three components that make up a secular bull when you look at what's going to move you higher, can you tell me a little bit about that?
STEPHEN AUTH: Well, one I would just say is the economy. What you have is the economic players were all terrified for overinvesting. Every time they invested between '99 and 2008, it eventually came back to haunt them. So, the real players have been very cautious about capacity in this uptrend. And that cautiousness continues to pervade their thinking. We talk to a lot of companies every day. And I can assure you, they continue to be very, very cautious about new investments.
Caution's starting to come off a little bit, which is good, confidence is improving. Investors are cautious, because they all got burned, stocks went down 40% twice in that bear market, actually 50 entry year. So, they all know, in fact, most portfolio managers also "know" that the market will decline by 40%, which is exactly why it doesn't declined by 40%. Because all these people have this special knowledge. That's why they're willing to sell when it drops 20%, even though the fundamentals are okay, because they know, they're only halfway to 40%.
That's how you get 20% declines, you got to have sellers at minus 20%. And that's the vast bulk of investors were very, very cautious. And the regulatory authorities, the last thing they want to have is another Great Depression. And the reason that the big recession of the late '20s, early '30s, extended to a great depression was that the Fed prematurely started hiking in 1937, you probably know that. And that led to the extension of the thing for another three or four years until the war bailed us out and then the Fed is study this ad infinitum.
So, they always are going to play this now from the perspective of let's not do any damage. And on top of all that, in terms of say call that altogether sentiment, you've got this third industrial revolution going on, which of course, no one knows it's industrial revolution until afterwards. But look what's going on around us, the economy of the United States is being digitized, everything's being digitized, and whole industries are being destroyed and recreated. And that is a massive deflationary force within the US economy, which is allowing us to have growth without inflation.
Everyone's using stale models to calculate how much growth should translate into how much inflation but it's just never happened. And still hasn't happened, the Fed hasn't hit its 2% inflation target yet. That's part of why I think they are about to cut just because they've realized that they didn't need the December hike. Inflation is not showing up.
So, our view is you've got this digitization of the economy. On top of that, you've got partly related to that, maybe another anti-deflationary force, we'd call it the Amazon effect. They're up there on a hill walk with a Gatling gun, looking for volunteers to raise a price in any industry, just raise your hand and boom, Amazon moves in. So, that keeps things under control, people are forcing on productivity.
And now, we've had this third driver, which is this late cycle investment stimulus effect of President Trump and you can like him or not for his social policies, but economically, he's understood that an economy- the so called late cycle, the way to stimulate it is to stimulate supply. And you do that by cutting corporate tax rates, improving the after-tax return on investments, deregulating, which also improves the future cash flows from investment because it's less costly. And that can bring extra supply to a market that's undersupplied and lengthen non-inflationary growth.
So, you've got those three drivers, I think taking place that should cause earnings to continue to rise higher over the next few years, we've got a longer term target on the market of 3500. And probably be raised net, we're saying another target a couple years out. But I think, not to say there can't be a 10%, even a 20% correction. But we're big buyers on those kinds of pullbacks.
ED HARRISON: Very early on in that, you said something and that I thought was interesting about the technological revolution. My question to you is about productivity. So, what's happening there? If this technological revolution is happening, and it's going to be positive for growth, why are we not seeing it in the productivity stats?
STEPHEN AUTH: Well, first of all, we have started to see it. The productivity numbers are starting to get better finally. And it takes a while. But we're starting to see some improvement there. And I would guess we're going to continue to see that over the next few years. I also think, by the way, that GDP accounting itself doesn't really capture everything.
So, I think there's stuff going on, let's face it, most of your viewers know they're more efficient today, by a factor of three, probably than they were even a decade earlier. We're all working all the time, now. We got our smartphones in our pocket, we can do everything we need to do. I think the world is increasingly a more efficient place. And maybe it's not being all captured, but we're seeing it in growth. And we're seeing it in low inflation. So, by definition, we must be having some kind of productivity improvement here, or else we'd be getting a lot of inflation.
ED HARRISON: Let me go back to your call, which I think is interesting one, because we've had a lot of guests recently who have made the opposite confect, I think we're going to have a recession week, where we're going to be talking to people, we're talking about the recession definitely happening. Walk me through Jerome Powell's 180-degree-turn, and how that how that plays out. Basically, it could be that he's cutting 75 basis point. That's what the market says, this year alone. How do we go from that bottom's falling out to this Jerome Powell's doing 180 and then cutting rates within six months?
STEPHEN AUTH: The tenor to that question that I love because we always assume the bond guys are right, people keep telling me, oh, Steve, the bond guys, the bond market, the bond market, I'm like, well, the bond market was telling me he was doing three more hikes in December. Now, six months later, the bond market is telling me he's doing three cuts. Let me suggest, as an equity guy, that the bond market might be wrong.
In December, he wasn't doing three more hikes. In fact, he was done. And I would say today, there's no way he's doing three cuts, that is not necessary, is not going to happen. The bond market or the market in general is quite self- assured that a recession is coming. I have all the great economists, economists of Wall Street walks into my office regularly. And one thing I love to do is tell them, okay, you're here, I want you to give your presentation without mentioning the word cycle. Can't do it.
Because there's this fundamental belief that everyone just accepts that there is a cycle, and it must end. And there's something called the average cycle, and that we are long in the cycle. And therefore law of physics, it has to end.
ED HARRISON: Right now as we speak, this is the longest cycle, right?
STEPHEN AUTH: Right, the longest cycle. So, how many cycles have we had? We've had 12 cycles, maybe 13, since World War II. Each one has been a different one with a different driver, that's lasted different lengths of time from as short as a year to as long as 10 years. And as you say, now, we're in the longest one. When you average that together, you can get an average cycle and create a notion of a cycle. But it's statistically meaningless.
Most statisticians will tell you 10 data points gets you nowhere in developing a meaningful statistical relationship. So, I'd rather say an economy is a mass of millions of people making individual decisions. And it's usually mistakes that cause the ends to cycles. In fact, all cycles have been ended by the Federal Reserve, either as a mistake or some would say that ensured the longer term growth of the economy.
To unpack that, I'd say, well, the Fed, their view is inflation is a bad thing. And their mandate is don't allow inflation to eat up economic advancement. So, the Fed's constantly on guard for that. And sometimes, it has caused the cycle by mistake by thinking inflation was coming when it wasn't, and accidentally hiking rates to cause everyone to scale back inventory adjustments, et cetera, consumer loans go up, people start- economic slows down, recession gets caused. Sometimes, they've done it legitimately where the economy is just overheated. And the only way to prevent the coming inflation or the