Tom Plumb talks about the market and Plumb Funds with Chuck Jaffe. He expects a return of volatility this year and thinks that companies with “secular tail wing” have the potential to do well.

Transcript from original audio interview:

Chuck:                         And joining me now on The Big Interview, it’s Tom Plumb. He is the president and chief investment officer of the Plumb Funds. He manages the Plumb Balance Fund, and if you want to learn more about the firm and its funds, you’re going to go to plumbfunds.com. But the Plumb Fund’s based in Wisconsin. And again, plumbfunds.com for more information. Tom Plumb, welcome to Money Life.

Tom Plumb:                Thanks, Chuck. It’s a pleasure to be here.

Chuck:                         We are living in sort of pretty interesting times. And I have to say we got a message this week. We’ve had some great interviews this week. Jack Bogle’s been on the show. And – and then we had Sam Stovall on the show from CFRA, formerly S&P. And Sam made a point that was pretty interesting. He said as – as I put it out there, people’s expectations for this year are somewhat muted and they’re not expecting great returns. He basically kinda came back and said yep, we’re kinda thinking the market should gain five percent or so this year. Guess what? We’ve done that in the first week.

Now we think we’re going to probably be flat for the rest of the year. Okay, that was a bit of a bombshell to me. I hadn’t thought about that. But when you look out at the market right now, what are you seeing? Because we have had this great run. We’ve had what amounts to a Santa Claus rally that lasted from Christmas of 2016 all the way through 2017. But what do you see as coming down the pike?

Tom Plumb:                Chuck, I’d even go back to the 2009. I mean, we’ve had a bull market with modest corrections so far. And I think that it – people may be making a mistake by selling it short. The these things tend to last longer than anyone had thought and as long as we have this earnings momentum in the United States and this virtuous cycle, which is causing the rest of the world’s GDP’s to rise, I don’t think we’re going to be in a stagnant stock market environment.

Chuck:                         So, what kind of environment are we going to have? If we’re not in a stagnant environment but we have a little bit less room to grow, does this mean we’re going to be in an environment where, hello, here’s volatility coming into the picture?

Tom Plumb:                I think it wouldn’t be surprising to see volatility come back this year and certainly the lack of volatility last year was one of the big stories. I think that that doesn’t continue forever. As we see interest rates are going to be a little more gyrating and I think there’s going to be a lot more questions about who’s going to win and who’s going to lose, so I think there’s going to be some selectivity in the stock market. And I think that those companies are going to show that there still have what I’d call secular tailwind.

And I’d call that secular tailwind when you see companies that are grabbing a greater percentage of the GDP and that ends up companies certainly people talk about the FANG companies. But I think also you – you can look at anybody who is involved in transactions, financial processing. Um, there’s such an incredible amount of new technology coming to play worldwide that I think that you’re going to see those companies continue to do well long – long beyond what people expect.

Chuck:                         You mentioned the FANG stocks and what I know about the Plumb Funds is that you are looking for what amounts to market leaders. That’s the words that I see used repeatedly in your literature and your – and on your website. You are looking for market leaders and of course nothing has led the market like the FANGs. From the perspective of the broad market and okay, we’re going to see that increase in volatility and – and maybe a little bit tougher sledding, but the kinds of things that – that is your take on and layering on the things we’ve heard from others, are the market leaders going to have the ability to out-pace the rest of the market at this point when they have been so strong for so long?

Tom Plumb:                I mean that is a good question because I think we’re going to be in a little broader market where I mean that the average stocks might do better than last year because last year there was a huge spread between growth stocks and value stocks. And I think that we’re in this segment where the wealth effect, the – the environment on the GDP, those things may cause companies that were different from last year to perform this year.

especially probably in the financial area. But even some of the depressed consumer discretionary companies should probably do better because they’re treated pretty well by the tax law changes. But at the same time, I don’t see anything that’s going to stop a company like Visa or these companies that are participating in all aspects of financial transactions from them contained to be leaders for this year.

Chuck:                         I want to turn this for a moment at least to the other side, the other part of – of your mission. Running Plumb Balance, and I should point out to my audience it’s P-L-B-B-X for Plumb Balanced. P-L-B-E-X for Plumb Equity. But Plumb Balance, P-L-B-B-X. Running Plumb Balance to all, you have a mandate that you have to keep a bunch of your money in bonds. We are in a situation right now where we’re expecting, if we believe the Fed, at least three interest rate hikes this year. And while we’ve seen the market absorb rate hikes without really blinking, are we going to get to the point where we see the usual impact of rate hikes if we get that many this year? Or how – how are you positioning to absorb what we think is on the horizon?

Tom Plumb:                I – I think you lose – you really raised a good point. the short-term interest rates are set to rise and they’re going to continue to rise as long as the fed approaches that. They also have indicated that they want to be neutral and not historically when they start to try to slow down the economy with interest rates, that’s when you have these major corrections. Well, we’ve had so far this year and last year was as they raised the short-term rates we saw flattening of yield curve.

And I think if you just think back a year and a half ago most people thought the ten-year was going to rise with the short-term rates and in fact rates came down. And and even now there’s people who are a little bit anxious because the ten-year’s over two and a half percent. But it – those don’t seem to put a damper on the economy. What they do do is make it very difficult for our dual mission to balance the total return and principle preservation with our growth mandate.

So what we’ve done is we’ve used somewhat of a barbell approach. There’s variable rate bonds that we have that should participate if – if rates move up because they will have higher coupons reset. And we do have some pretty short-term bonds and then we have a few seven to ten-year bonds. But our primary expectation is that we don’t want to bet against interest rates right now, so we’re taking what I’d call credit risk, get paid for that credit risk, but keep it short. Our duration on effective basis is about two right now.

Chuck:                         Okay. And – and is that regardless of what you’re holding? Because you’ve got a mix of corporates and – and treasuries I believe. So – so it – duration for you is duration regardless of the bond that you’re using?

Tom Plumb:                Um, yes – we, well, actually what we’ve done is because of the treasuries are really just waiting for rates to rise on the short-term basis, they’re – they’re very short-term treasuries, it’s the corporates that we’re using the variable rate and capturing that incremental return.

Chuck:                         Let’s get back to the – the stock market and – and how you run money, where again, as I pointed out, you’re looking for those – those types of market leaders at – and the ability to kind of drive things going forward. What in your opinion are the industries that there’s not much future in? I mean we all talk about sectors and everything else and what looks good, etcetera. But if you’re looking for market leadership, I mean, do you ever go back and say I have to consider energy? Or that’s a – a mature developed whatever and it’s just going to be a supporting player and never be a market leader.

Tom Plumb:                Well, again going back I think that the energy could come back. But for when you look at it, how we’ve perceive and the market and what we’re looking for, one of the key things is we want to know that companies can be self-supporting in their cash flow. So when we take – look at the energy industry it’s really we don’t want to own companies where they are dependent a lot on outside capital. I do think that some selective energy service companies will do well and I think some alternative energy companies might do well.

But – but as a whole, we’re – we’re avoiding those companies because of the incredible capital deeds that they have every year just to function. If you take companies like Visa for example, we talked about earlier they – they generate about two to three dollars of earnings for every dollar they have to reinvest in the business. Um, it’s one of the reasons why they don’t need [music playing] debt and they’re not beholding to anybody. But I think that the cyclical companies you – who have benefited from low interest rates, I think there’s going to be a challenge in the next couple of years.

Chuck:                         Tom, this has been great and I love the fact that you’re willing to talk individual stocks. We’re going to have you back on the show in the not-too-distant future. Have you in the morning call – in – in the market call so that we can talk about your methodology and get more of your takes on stocks. But thank you so much for joining me on the show.

Tom Plumb:                Well thank you. It’s been a pleasure. I’ve enjoyed it.

Chuck:                         Tom Plumb is the president and chief investment officer at the Plumb Funds. That’s Plumb Balanced Fund, P-L-B-B-X and Plumb Equity as well. Plumbfunds.com. By the way, fabulous five-year track record on Plumb Balance. You’ve had a really good ten-year track – road track record as well. You can go to plumbfunds.com for more information. All right, we just hit the half-way poll on the Friday edition of Money Life, but we’ve got lots more to go. Up next, we’ll be talking with Dan Zanger from Sharp Pattern. After that, we’ll have the Market Call with Dave Harden from Summit Global Investments. Stay tuned.

 

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Definitions:

FANG is the acronym for four high performing technology stocks in the market as of 2017 – Facebook, Amazon, Netflix, and Google (now Alphabet, Inc.)

Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country’s borders in a specific time period, usually calculated on an annual basis.

Effective duration is a calculation used to approximate the actual, modified duration of a callable bond. It takes into account that future interest rate changes will affect the expected cash flows for a callable bond.