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Inflation? Bring It On, Says Stock-Picking Whiz

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Rising inflation isn’t on top stock picker John Buckingham’s worry list. 

“I would love to see higher inflation, and I would love to see higher interest rates,” the value investor coolly tells ThinkAdvisor in an interview.

Both situations have historically benefited value, argues Buckingham, who has been managing investments for more than three decades and is principal and portfolio manager of Kovitz, based in Aliso Viejo, California.

He is the quintessential long-term, disciplined investor who ignores all noise and looks instead to economic and market history for reality, if not mooring.

“We try to take advantage of what the market gives us,” he says of his strategy, in the interview.

In the first five months of 2021, that has meant trimming a number of holdings in his portfolio, which typically has low turnover.

This year, there’s been “a little more,” he notes.

“We thought it prudent to reduce our exposure so as to initiate positions in other attractively priced stocks or to add to existing holdings to boost our ownership,” he says.

One new holding is Volkswagen. In our interview, he forecasts that ultimately it could very well overcome Tesla to become the world’s largest electric-vehicle manufacturer.

Further, Buckingham discusses why he sold some Nordstrom and Kohl’s stock and bought more AT&T and International Paper. 

About the Federal Reserve’s starting to sell off its corporate bond holdings, announced on June 2, he ponders: Is this the first sign that the Fed is on the road to raising rates?

He then opines on President Joe Biden’s proposed retroactive capital gains tax increase: “It will probably not be as bad — if you will.”

Manager of the Al Frank Fund (VALUX) since its 1998 inception, Buckingham is also the long-time editor of “The Prudent Speculator” newsletter.

Through June 3, 2021, the fund has posted an annualized return of 10.91%, which compares to 7.94% for the benchmark Russell 3000 Value Index and 8.45% for the S&P 500.

Value investing isn’t just about buying “cheap stocks,” he maintains. And in the interview, he reveals the real secret of his investing success.

ThinkAdvisor interviewed Buckingham on June 4. He was speaking from his home in Laguna Beach, Calif. 

Asked why his newsletter is called “The Prudent Speculator,” he said — summing up his M.O. — “All investing is speculating on the future. That can be done prudently by buying and patiently harvesting a broadly diversified portfolio of undervalued stocks.”

Here are highlights of our conversation:

THINKADVISOR: What impact could be expected from higher inflation, which everyone is worried about?

JOHN BUCKINGHAM: I don’t understand why people are worried. Historically, stocks have been a good hedge against inflation. 

I guess the concern is that if we have higher inflation, it will force the Federal Reserve to raise interest rates, which many people think is a bad thing. I do not.

How come?

Rising inflation is good for value stocks. We should be happy because we want to get into a more normal monetary-policy climate for the Fed so they have ammunition when the next bad thing happens.

The inflation we’re seeing is likely to be transitory and a byproduct of the supply-chain issue and pent-up demand. All that will stabilize.

Of course, this idea that everybody is nervous or worried about inflation and higher interest rates hasn’t really been borne out by where stocks are — today, we’re three [points] away from an all-time high on the S&P 500.

Why don’t you worry about higher interest rates?

They’ve been good for value stocks. Since July of last year, value indexes’ performance has been fantastic. 

Historically, value does well when interest rates rise. I would love to see higher inflation, and I would love to see higher interest rates. 

But the only way to get those is if the economy is stronger.

What are your thoughts about the Fed’s starting to sell off its corporate bond holdings?

I don’t think they’ll be much market disruption because they’ll be selling them over the period of now through the end of the year. But the question is: Is this the first tapering of the accommodative monetary policy? 

Are they now starting to “talk about” talking about raising rates? That has some people nervous. 

I would like to see higher interest rates because that will benefit value stocks. And if the Fed’s starting to sell bond holdings leads to higher interest rates, woo-hoo!

In 2013, everyone was worried about the Fed taking away the punch bowl by raising interest rates and stopping bond buying. But when the threat of tapering and the actual tapering occurred, stock prices were significantly higher — the markets rebounded.

Thus far, the 2021 stock market has been quite volatile. Has there been more than usual turnover in your portfolio, in which typically there isn’t very much?

We’ve had a little more because the market has given us opportunity to trim a lot of stocks: There have been huge gains on many of our stocks that have done extraordinarily well [approaching] post-pandemic.

Such as?

When Nordstrom, for which we paid $14, was trading a few months later at $40, we wanted to take a little money off the table.

Nordstrom has made substantial investments in online [shopping], and their e-commerce business has grown rapidly. The pandemic wasn’t a bad thing for them; I think they’ll come out of this smelling like a rose.

What other holdings did you trim?

Kohl’s has done extraordinarily well. That’s why we took some money off on that, too.

When a stock goes from $20 to $60 in a relatively short period, we think it’s time to do that. Kohl’s is higher today than it was before the pandemic.

Kohl’s had been a dog for a while. We were getting a big dividend yield; but then the pandemic hit, and the dividend was eliminated. 

But we didn’t bail out. We kept it. And once the vaccines came on the scene, Kohl’s went from $20 to $60. Also, as we go forward, the dividend is being reinstated.

[On May 20], Kohl’s reported phenomenal earnings, and the stock got crushed. So we were glad we had sold some. Now it’s at 53. That’s why we try to take advantage of what the market gives you.

Value investing isn’t just about buying cheap stocks. It’s also about ensuring that the companies have the ability to make it, grow again and if they’re in short-term difficulty, like Kohl’s and Nordstrom were, that they’re going to survive and won’t end up bankrupt.

What’s another stock in which you reduced your exposure? 

Seagate, a data storage producer. The short squeeze in January was some of the reason for our trimming that one. 

They have cryptocurrency exposure: an investment in Ripple. So Seagate is a crypto play in addition to being an inexpensive stock in an industry that we still think is likely to grow substantially.

Again, when your cost basis is $20 or $30 and the stock is trading at $80, you want to take some money off. But now it’s gone up more, and we wish we wouldn’t have taken that money off.

Any stocks that haven’t had big gains that you bought more of this year?

Lockheed Martin, International Paper and AT&T, among others.

AT&T is up from what we paid when we bought it. We think that some parts of AT&T are worth more than the whole. 

We’re not unhappy with their WarnerMedia-Discovery [spinoff merger deal]: We get a pure play on the telecom business and a pure play on the entertainment streaming business.

Monetizing their entertainment side will provide the cash flow for AT&T to continue to invest in their telecom business.

What about International Paper?

We continue to think that boxes and packaging materials will benefit from long-term e-commerce strength. 

IP Is the largest box-maker in the world. It’s a play on the growth of e-commerce. 

Plus, you’ve got a rebounding economy for the regular paper side of the business. With people returning to [offices], more printing will be done. There’s always a need for paper.

What are some stocks that are brand-new to your portfolio this year?

One is Volkswagen, the second-largest car manufacturer in the world. It’s very far along on the electric-vehicle track. We think that ultimately they may even pass Tesla to become the world’s largest electric-vehicle manufacturer.

In general, most EV companies are startups — without a real viable business. Yet investors are paying exorbitant prices for them. We think Volkswagen is reasonably priced.

You’ve bet on a proven entity, then?

Yes. General Motors is another automaker that we own. It’s a company with a proven track record that has the ability to mass-produce cars with an internal combustion-engine operation. That will continue to generate lots of cash to allow them to invest in EV and autonomous vehicles.

Therefore, they’re positioned to benefit from long-term trends, and they’re going to [be the maker too]; so they don’t need to tap capital markets to raise more equity.

It won’t happen overnight. But why not [invest] in companies that will not only be successful [in the future] but that are successful now?

How is General Motors doing at the moment?

It’s going to make less money this year than they predicted two years ago. They have supply-chain issues — can’t get enough chips. 

So GM Is less profitable; yet the market has decided that it’s worth twice what it was worth a year ago. They were an electric vehicle company then. 

But now people are more excited about electric vehicles, and they think that GM is likely to be a longer survivor, which they should have known a year ago because of the cash-flow [ability] from their legacy internal combustion-engine business.

What’s your forecast for U.S. GDP growth this year?

The Federal Reserve’s forecast was 6.5%. That may be a little rich. I’m no economist, but I think it might be 6% growth this year, which would be phenomenal. 

But remember, we had a big contraction last year, and these are year-over-year changes with inflation included.

So that [rate of growth] will only be temporary because once people spend their “fun money” and get back to normal, we’ll start to stabilize. Economic growth will be good but not as strong. 

We need people to burn through [their] stimulus dollars, and then they’ll have to get back to work. That’s when you’ll see an improvement in the jobs numbers.

You use a proprietary research system, but what’s the real secret to your success as a value stock investor?

Patience. It’s the holding part of the stock game that’s the most important thing, not the buying and selling. Holding is where the money is made. But very few investors have the patience and discipline to stay with stocks that may not be performing.

In picking stocks, what do you focus on most?

The real issue in value investing is that you’re buying things that, generally, don’t have great near-term stories. You’re focusing on the long term. 

The key is to buy undervalued stocks and patiently hold them until they reach their fair value — which is very hard for most people — then sell them when they’re more richly valued and repeat the process over and over again.

What else do you look at when buying?

It’s not just about what’s cheap. It’s what’s going to survive and ultimately thrive whatever the short-term difficulties are.

It seems that you take a wide-angle view, correct?

Yes. we’re trying to ensure that the business is likely to be viable and that earnings will grow over the long term. Our time horizon is three to five years. 

It’s about: Where do we think earnings will be in the long term? Where will revenues be? What is the market going to be willing to pay for the [stock]?

Please discuss this fairly recent example: Both CVS and Walgreens said they would administer the COVID-19 vaccine. You chose to invest in CVS. Why?

Walgreens is primarily a pharmacy operation, whereas CVS is integrated with managed care by owning Aetna and are further along in integrating much of that within their stores’ “MinuteClinics.”

They have the ability to satisfy health care needs across the full spectrum. The greater diversity in their business was our main reason. 

What are your thoughts about investing in bonds?

We’ve had a massive bond bull market of almost 40 years. So I don’t get this idea that somehow bonds are going to be attractive over stocks when interest rates rise.

People are going to lose money on bonds and be unhappy. So they’re likely to move money out of bonds and toward dividend-paying stocks. We’ve seen a lot of that since the Treasury yield started rising last July. 

I’m buying stocks that are reasonably priced even after the big rally, and I generally get dividend yields of 2% to 3% on most of them. Do I want to invest in 10-year Treasury bonds yielding 1.6% and lock in my money at that rate for 10 years? 

Or do I want to invest in a company that’s likely to grow its earnings, keep up with inflation and grow its dividends? To me, it’s a no-brainer.

Are you postponing selling stocks because of President Biden’s proposed retroactive capital gains taxes?

No. I think they’ll try to tax the wealthy. But compared to what has been proposed, it will probably not be as bad — if you will.

This is Washington negotiation. You don’t know what it’s going to ultimately look like. Biden understands how Washington works. No way does he expect what he puts forth in initial proposals to [pass]. You ask for the moon and hope to get the sky.

To avoid the potential retroactive capital gains tax, is it a good idea to buy tax-efficient ETFs rather than individual equities?

It’s still the question of: Are you better off investing in an ETF or an individual stock? I’d rather be in individual stocks because I like the granularity of buying the attractive things and not be stuck with everything else.

Number 2: I don’t want to keep putting more [money] into the Apple-Microsoft-Amazon-Facebook bucket since those are the stocks that dominate most of the index ETFs. I like Microsoft and Apple, but our weighting in those two is about 4%; and we’re comfortable with that exposure.

The other issue is how often do you trade? If you’re going to buy an ETF and leave it alone for the next 20 years, then you have no tax consequences. But very few investors can do that.

So whether it’s an ETF or an individual stock, you still have the temptation to trade — and you have a capital gain, or loss.

Pictured: John Buckingham (Photo: Andrew Collins)

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