Linda Duessel: Hello, and welcome to the Here & Now podcast from Federated Hermes. I'm Linda Duessel, Senior Equity Strategist. Today, I'm joined by Federated Hermes CIO of Equities, Stephen Auth. Steve oversees all equity and asset allocation products globally, and has more than 35 years of investment experience. Over those years, Steve has gained invaluable insight and wisdom that he has agreed to share with us today. Thank you, Steve, for joining.
Stephen Auth: Thank you for having me, Linda.
Linda: Well, Steve, I know because I sit in on your morning meetings on Mondays that you have a list that you call 40 years, 40 lessons. And I've been very curious about that, about all 40 of those, for quite some time now. Can you tell us, first of all, what is the idea here and are there valuable lessons from past crises? And if so, how do you know which ones are applicable?
Stephen: Well, as you know, Linda, because you've worked with me for a long time, and thank you for having me on your podcast, by the way, because it's a real honor for me to be on the podcast with you. At the end of every year, I ask everyone and ask myself what were the top three lessons you took away from this year? Your biggest mistake, your biggest success, and what you're going to do different going forward because of those two things. And so, yeah, I've got this so-called list of 40 lessons. It's actually 63 lessons. I'm trying to squeeze it. It sounds better, 40 or 63 lessons doesn't sound that good.
Stephen: And a big takeaway is that history rhymes, it doesn't repeat. You wish there was a holy grail that you've somehow picked up in the past that you can absolutely apply in the future. I think that's not the case. The one thing that I think is constant, though, is human psychology is similar. And studying these lessons over years, it's made me as much a student of human psychology and predicting how that might work out as much as a specific analog to previous markets. So there are certain lessons that we'll probably get into here, I'm sure, that are more relevant than others. So history rhymes, it doesn't repeat.
Linda: I've often thought that was very interesting, you telling us that you need to be a psychologist to be successful in this business. And I think about that a lot with the different people that I meet and the things that I read as well. But yeah, okay, so you have 40 lessons or more. And that's a lot of lessons and unfortunately we don't have time to go through all of them. So I wonder if you could tell the group what are the top three lessons from the past that you think might be relevant for the times in which we now live?
Stephen: Well, I can knock off five of them with one lesson. So 1977, 87, 99, 2008, 2020, 2022, Don't Fight the Fed. And what's remarkable to me is like every time I've gone through those periods sometimes fighting the Fed on the way up and other times fighting the Fed on the way down, there's always a group of very smart people who say, 'Oh, this is different.' And they ignore this lesson that's actually the number one lesson in every investment textbook. But it's a simple one. Don't Fight the Fed. I think that's relevant here.
Stephen: The second one is a little bit related, but it's for those who want to get themselves all wound up into a negative framework, which certainly don't fight the Fed right now at the brink of what's likely to be a series of significant rate hikes could get you pretty negative. And usually at times like this, they bring out the bears to work through how the world, once you start pulling the thread, is going to be completely unwound and everything's going to end in tears.
Stephen: This is a very important lesson that goes all the way back to the biggest mistake ever made in central bank history, which was the 37 Fed. People have written books about this, Fed governors have made their careers out of it, including Bernanke. The premature rate hike that extended the Great Depression made it a Great Depression in some way. So since that time, no modern government has ever, or any modern central bank, has allowed its economy to simply melt down and do nothing. And that was sort of the attitude in the thirties, let the economy work itself out.
Stephen: And I think this time around, for those who think this is going to end in complete catastrophe, I would stand back and say, 'Look, any central government will step in.' So, I would just say that, sooner or later people talk about a Fed put. But at some point the Fed is worried about the liquidity in the financial system. And when you hear the bears get on TV and explain to you how the world is about to end in ashes, remember that. Can I give you my third lesson first?
Linda: Yes, please do. Please do.
Stephen: Don't Confuse Chess with Checkers. So this is a really important lesson that kind of repeats again sort of like Don't Fight the Fed. I think what happens with a lot of market professionals and certainly market amateurs is they develop a theory of what the next move is going to be, and they kind of predict it and they move on. And they begin to think they've got this figured out and no one else does. And you got to remember that the stock market is very complex. It's a multidimensional chess game with a lot of smart players at the table. And they're synthesizing the same information you are. And so what's really important to figure out is what's in the prices, what's in the expectations that isn't already been discounted. That's much more difficult.
Stephen: And bears always sound smarter because they tell you everything that everyone knows and that's been discounted. And bulls usually sound a little bit crazy because they're sort of predicting what could happen. Of late, we've become cautious, as you know. Entering the year here been kind of cautious all the way through and getting more cautious as we go. But somewhere out there, keep in mind that a lot of bad news has been discounted. And we do think, in that light, we're getting closer to the end and the beginning of this correction.
Linda: I think that's really an important lesson. And I think our human nature fights against that and wants to just stick with our thoughts. And I would tell the group, I remember in March of 2020, and I was very much afraid, and I was on a call with you and one of our coverages and you were both saying, yeah, we've been around long enough, and basically said that our government and our leadership would not allow the economy to melt down. And you were certainly right. I remember you saying, 'I've been cured of my...' I don't know if you remember when you said that, 'I've been cured of my super bearishness and I think this is going to work out,' and wow, you were right. And went on talking to many of our clients and saying, 'Please, please, please.' I remember you saying, 'Please, please, please don't panic with this.'
Linda: But of course they did respond very dramatically, as I guess they did back in the day, when you learned your lesson. But now, of course, now we are officially in a bear market and with inflation at 40 year highs, many are wondering if we're going to have a repeat of the stagflationary 70s, which has never been experienced by either the massive Millennial or Gen Z generations. So, what do you think, Steve, do you think we're going to have to relive the 70s or is there another period that you think is more similar to now?
Stephen: Well, there are certain similarities with the 70s that I get. And certainly the word stagflation comes to mind because we're entering a period here of slower economic growth with high inflation. You could call that stagflation. I call it a rocky landing. Rocky landing is different from stagflation because it implies a rough period that then ends once the plane comes to a stop on the runway. Stagflation implies a sort of endless problem. So, here's what's common.
Stephen: One is, we have to a certain extent a supply-side driven inflationary impulse here. In the case of the 70s, it was obviously the oil embargo, which put an artificial shortage of oil as the centerpiece of the inflationary impulse. And this time around, we have a self-inflicted wound, to a certain extent, because collectively the investor base and the government basically made the oil companies to stop drilling. There are some big differences, though, with the 70s, to keep in mind.
Stephen: One is the 70s inflation was also driven by, at the same time roughly of the supply-side shortage in oil, was the breakdown of the Bretton Woods System, which had pegged the dollar to everything else. And when the Bretton Woods System was unwound in the early 70s, it resulted in a massive devaluation of the US dollar. So, obviously, a devaluation of the home currency creates a very significant inflationary impulse when you're importing a lot of things. And we had a very high current account deficit at that time.
Stephen: We don't have that today. In fact, we have the opposite. In the midst of all this crisis, and the war in the Ukraine, and China, and all these other problems, we've had a very significant increase in the value of the US dollar, which is a deflationary impulse. So that's a big difference versus the 70s to keep in mind. The other big difference is that we had the 70s. And as a result of that, the Fed knows that playbook and they don't want to go there. So, the key point of the playbook was that once you had these two big inflationary impulses in the 70s, the Fed really didn't do anything about it for almost a decade. So, you had a decade from which inflation could get ingrained in the economy and in the mindset. And everybody sort of got used to getting significant annual pay increases.
Linda: Why did they not do anything about it at that time?
Stephen: Well, they tried to do things. They tried price controls. That worked until they took them off. And then you had another big inflationary impulse. I think they thought other ways of addressing this could affect it. They were trying to avoid, we had a stock market crash in '73 because of the Nifty 50. That's another similarity, by the way, is the FANGS today's Nifty 50. So another similarity to the current situation. But again, I think a key difference is the Fed is more aware of the danger of letting inflation get ingrained. It seems to me very likely that we're going to land and not crash. And I think some of these things are self-correcting as people make adjustments, again, the multiplayer chess came here.
Linda: So, now we are living in an internet and information age that's brought an explosion of data and coverage of the economy and markets from everywhere. From your 40-year career, Steve, can you offer us a lesson on how to deal with the hyper news cycle?
Stephen: Well, I have a couple of thoughts here, Linda. One is that you shouldn't confuse activity with productivity. So, we're tempted, because of hyper news cycle, to try to absorb everything that's going on. And I experience this, and I know you do too, because you're also on the TV shows a lot, the talking heads. And something's going on, and they call you up and you offer an explanation, and they're constantly focused on today's action.
Stephen: And sometimes I can explain today's actions, sometimes I can't. I always try to focus people on what does this mean in the next six to twelve months? So that's kind of the window, six to eighteen months, really, that we're typically looking at is we're analyzing companies and trying to in a way figure out where the future's heading, if you will. And that's the window that's often not discussed. And you can really get caught up in the news cycle and feel you've got to react to all the noise that's flying around and kind of miss the bigger picture. So, try to stay focused on your agenda, where you think this thing is heading, and less focused on their agenda. And certainly at Federated Hermes, that's kind of our whole gig, as you know, with our analysts. I mean, let's stay focused on our agenda. Let's not get caught up in the noise. So, that's one.
Stephen: I mean, there's sort of another interesting lesson here, which I just can't help but discuss, at the risk of insulting any of my lesser experienced colleagues. But that's lesson from late 99 called Beware the Taxi Driver. And that was late 99 when I had all these taxi drivers telling me about their portfolios and inevitably their individual portfolios were doing better than my portfolios. And I'm asking my guys, 'Guys, how come the taxi drivers are doing better than us? I mean, what are we getting wrong here?' And of course, we know how that kind of ended. But my translation of that in the last twelve months has been Beware the 23-year-old Explaining Bitcoin on CNBC. And the whole thing.
Stephen: And I would often get asked, I know you were as well, Linda, I mean, almost any interview on TV in the last 18 months, sooner or later, they want to talk about Bitcoin. And I have to sit there like a dope and go, 'Look.' I mean, honestly, I'm glad people are making money on this. I think it's terrific that they are and they are obviously smarter than I am. But at Federated Hermes, we are very good at analyzing businesses, figuring out what those businesses produce via cash flow, then trying to evaluate what they're worth today. And we can't do that with Bitcoin. So, we just don't swing at that pitch. That was my kind way of saying this is a bubble, full stop. And it's now, of course, as we know, coming undone, unfortunately.
Linda: Now, since I have the chance to ask you, I think it'd be interesting to know, if you were talking to a young investor, or if you were talking to an older investor, a more, what did you say, experienced one...
Linda: Would you offer a separate lesson to each of them based on their life experiences probably to date?
Stephen: Well, I don't know. I mean, I think that my favorite lesson, and I know you've heard me quote this many times in our investment meetings, both at market highs and market lows, but I'll repeat it here because I think it's relevant for people of all levels of experience. And simply this. Humility at the Highs, Confidence at the Lows, Integrity Always. Now the integrity always part, most people get. You start making stuff up, you don't live the outside where the inside is. That doesn't work out well. People get that part. But the humility at the highs.
Stephen: This for me, when I'm hiring someone, is one of the first things I try to ascertain about this individual. Because it's something that's hard to learn. But boy, it's so important for investors to remain humble at all points, but particularly at the highs, when things are going really well and they're particularly right, and they start to think they're smarter than everybody else. So, a little humility at the highs is a really good idea.
Stephen: The other side of that, Linda, though, is confidence at the lows. And as you know, one of my key jobs around here is to keep our analysts and PMs from stepping off a window near the lows. Because at that point you feel like a complete dope, you've gotten everything wrong. You're an idiot. And often that's the double-down moment that you really got to step in and say, 'No, I got this right. People are following the noise. They're not looking at 18 months. This is going to be okay.' So, I would say those are useful lessons for folks of all stripes.
Linda: And integrity.
Stephen: Integrity always. At Federated Hermes, it's the few things that will get you fired in a hurry, but that's one of them.
Linda: Yeah. That's great to live by. I thought I'd also bring this up because within not that many months, we're going to have our midterm elections. But, do you have any election lessons learned that you would like to share before we come upon those days?
Stephen: In general, I try not to buy into too much of the rhetoric from our friendly politicians. I think the less they do the better. I have enormous confidence in the decisions of millions of people, getting back to a little bit of humility here. But the confidence I have in millions of people to get it right collectively. And even in terms of the current situation here, I think the individual decisions of millions of people looking through how they're going to manage their expenses through this inflationary impulse will get us, we can self-adjust out of this. I don't know that we are going to need the Fed to save us this time. I mean, if there is a crisis, I leave that out there that they will, but I don't think we'll need it. I think people get there individually. They stopped buying stuff that they didn't really need. They focus on things they really wanted. The inflation numbers come off the wall, et cetera.
Linda: We have time for just one last question. And I've chosen for that to be, for everyone who's listening today to benefit the most from your 40 years of 40 lessons, what would be the one chart that you think that everybody might want to have on their desk or on their wall and see it every day to keep themselves as grounded as which you have obviously have become over these years with all the lessons you've learned?
Stephen: I have a chart of the Dow Jones Industrial Average going back to 1989. And it goes all the way up to today. And it's full of all sorts of problems, crises, great depressions, great recessions, COVID lockdowns, 40% corrections, 20% corrections, Fed reactions, et cetera. Even periods of malaise called bear markets, of a significant length. What's remarkable about that chart is it always goes higher eventually. Over the long haul, if you own a stock, you own a participation share in a global economy, particularly US economy that's dynamic and ever-evolving and ever-growing. It never happens an economy declines forever or more than a couple of quarters, frankly, particularly in rocky landing scenarios. So, the name of the chart is The Line Moves up and to the Right. And I think it's important in periods of rocky landings, over time, the line moves up into the right. And I think it's important to have that in mind in periods like this.
Linda: That's excellent. I think what I'm going to really remember and take away of all the good information you gave us is that history rhymes but doesn't repeat. Human psychology is often the constant. Do absolutely not fight the Fed. I want to think about this next one a lot more than I have done. Don't confuse chess with checkers. And of course, humility, confidence, integrity, and what's priced in. And then the best one of all, I think, the line moves up into the right. I think that's fantastic.
Linda: So thank you, Steve, for sharing your perspective and wisdom. Steve also has a book coming out in July titled Pilgrimage to the Museum, which analyzes Western art through the lens of history and religion. And of course, thank you to our listeners. We look forward to you joining us again on Federated Hermes Here & Now Podcast. If you enjoyed this podcast, we invite you to subscribe to the Federated Hermes channel to get every Here & Now episode, plus our other series, Amplified and Fundamentals, for a global perspective on the issues, challenges, and trends shaping the investment landscape. I also encourage you to subscribe to our Insights email updates for the latest market commentary from the many great minds at Federated Hermes and follow us on LinkedIn and Twitter.
Disclosures: Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector. Past performance is no guarantee of future results. Investments are subject to risks and fluctuate in value. There is no guarantee that dividend-paying stocks will continue to pay dividends. The Dow Jones Industrial Average, Dow Jones, or simply the Dow, is a stock market index of 30 prominent companies listed on stock exchanges in the U.S. FAANGs is the acronym for Facebook, Amazon, Apple, Netflix and Google aka Alphabet stocks. Nifty Fifty: The moniker given 50 large-cap U.S. stocks that were most favored by institutional investors in the 1960s and 1970s. The Bretton Woods System established that gold was the basis for the U.S. dollar and other currencies were compared to the U.S. dollar's value. It stood from 1944 to 1971. Federated Global Investment Management Corp.