Value Investing Insights Podcast: Russ Koesterich on Employment Reports, Cash Flow and Gauging the Economic Environment

The BlackRock portfolio manager stresses the importance of cash flow and determining where the economy is going

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Mar 14, 2024
  • The investor shares insight on the latest employment report.
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Sydnee Gatewood: Hello, everyone! Thank you for joining us on the GuruFocus Value Insights podcast! You can subscribe through Spotify or your device's podcast app, so you never miss an episode.

We are pleased to have Russ Koesterich, the portfolio manager of the BlackRock Global Allocation Fund, join us today!

Also acting as a managing director, Russ' service with the firm dates back to 2005, including his years with Barclays Global Investors, which merged with BlackRock in 2009. He joined the BlackRock Global Allocation team in 2016 as Head of Asset Allocation and was named a portfolio manager of the Fund in 2017.

Previously, he was BlackRock's Global Chief Investment Strategist and Chairman of the Investment Committee for the Model Portfolio Solutions business, and formerly served as the Global Head of Investment Strategy for scientific active equities and as senior portfolio manager in the U.S. Market Neutral Group. Prior to joining BGI,Russ was the Chief North American Strategist at State Street Bank and Trust.

He began his investment career at Instinet Research Partners, where he occupied several positions in research, including Director of Investment Strategy for both U.S. and European research and Equity Analyst. He is a frequent contributor to financial news media and the author of two books.

Russ earned a BA in history from Brandeis University, a JD from Boston College and an MBA from Columbia University. He is a CFA Charterholder.

Thank you for joining us today, Russ!

Russ Koesterich: Thank you. It's my pleasure.

SG: All right, just to get started, please tell us a bit about the Global Allocation Fund's investment strategy. What metrics or characteristics are prioritized when analyzing stocks?

RK: Sure. So you know, Global Allocation, and there are a number of funds and model portfolios that extend from that, has a pretty simple mandate, which is we have the flexibility to invest pretty much in any asset class; in stocks and bonds, commodities, cash derivatives. And the goal is to deliver equity-like returns with about a third less volatility. So we're trying to keep people, you know, generally up with the market, but hopefully give them a smoother ride and you know, in doing that, we can deploy all those different asset classes.

We're generally longer-term investors, although we do hedge. We do think about the macro environment we're in and how to navigate that. And in terms of how we select securities, you know, we don't have a huge value or growth bias. We tend to be focused on one thing, which is cash flow. What is the cash flow-generating ability of the companies and is, what I'm sure we'll talk about, that's been really important in this market because one of the things that has distinguished stocks recently is this ability to power higher, you know, based on a few companies that are just doing an absolutely incredible job of generating a lot of free cash flow.

SG: All right, thank you. How, if at all, do economic indicators like the employment report affect this strategy?

RK: Well, you know, getting the economic environment right is really important. It's important because it's gonna affect your asset allocation mix. For example, back in 2022 when inflation, you know, was taking everybody by surprise and the Federal Reserve was racing to raise interest rates, bonds were a terrible place to hide something we have not seen really in decades. So having an informed view about the inflation outlook, the growth outlook, what we think the central bank is gonna do is really critical in first getting the asset allocation right.

In other words, the correct mix of stocks and bonds and cash, but it's also important because, you know, the economy can also have a large impact on the type of names that are being sought out by investors. Is it a market where growth stocks were awarded or cyclical companies or value or more defensive stocks like utilities? So, you know, a lot of our analysis really does come down to trying to quantify the economy and hopefully have an informed view about where it's gonna go.

SG: All right, that's really great. Thank you. I'm glad that you take a unique view. A lot of people I talked to don't really like to guess where the economy is gonna go. So that's kind of a refreshing view compared to other people that I've spoken to recently. Based on your expertise, what are the most important aspects of the employment report to pay attention to?

RK: So there are a bunch. In the first and foremost of the headline numbers and, you know, the market, I was very fixated on the number of jobs being created. And ideally what most investors are looking for is the so-called soft landing, a Goldilocks economy where the labor market is solid, but it's not so strong as to create wage inflation. So the first thing people looked at was the headline number of job creation, which was higher than expected. It might have spooked the market except for the fact that the last few months were revised lower. So when you look at the number of jobs being created, you know, it's coming down slowly, but it's not coming down so fast that you worry about a recession.

The next number people focus on is the unemployment number, which actually ticked up from 3.7% to 3.9%. That's probably OK because one, you know, the unemployment rate is still very low. It's close to a multi-decade low as a matter of fact, but it also ticked up for the right reason, which is that more people are coming back into the labor market. In other words, the supply of job seekers is going up, which is helping to keep wage growth from rising too fast. And you know, the labor market is no different than any other market. If you get more supply, generally, prices go down a little bit.

And that brings us to the third component people were focused on, which is the average hourly earnings number, which basically gives you some feeling for how quickly wages are growing. And the good news is they've slowed quite a bit from where they were in ‘21 and ‘22. And this is really important because this is one of the things the Federal Reserve is gonna need to see in order to start cutting rates probably later this year.

SG: All right. Thank you so much. Yeah, I definitely will take a closer look at those numbers now whenever a new report comes out, and I believe one came out recently. So could you explain a bit what the most recent employment report means for investors and what they should expect going forward?

RK: So, the most recent report, which I referenced a little bit in the last exchange, came out today, today being March 8, and it represents the state of the labor market for February. And generally, you know, again, it was a pretty solid report, but not one that would tell you the economy is overheating.

So job growth is still robust. You know, people don't need to worry about a recession. Unemployment is low, wages are moderating. So I'd say that it was a pretty good report, which helps explain why both the stock market and the bond market were rising after its release.

SG: All right, thank you for that insight. Are there any other economic reports that investors should pay attention to?

RK: So the next one that's gonna come out around the middle of the month is gonna be really two reports: the CPI and the PPI. That stands for the consumer price index and the producer price index. And basically these are the main inflation reports that come out every month. So these are important because this is what the Federal Reserve is looking at to give them an all clear that it's OK to start lowering interest rates.

This has been, obviously, the big challenge in markets over the last two or three years, you know, for the first time, really since the early ‘80s, you know, going back two generations, we've had an inflation problem it's been coming down, but it's been coming down kind of at a slow and bumpy pace.

You know, the last inflation report was higher than expected. And ideally what investors want to see is that inflation, particularly core inflation, which as many of your listeners know, strips out food and energy prices, which tend to be more volatile. They want to see those numbers coming down. And again, if we continue to see that, that deceleration in inflation, that probably will allow the Federal Reserve to start cutting rates in June, which is what the market is sort of looking forward to.

SG: OK, thanks! As mentioned earlier, you've written two books, “The $10 Trillion Opportunity” and “The $10 Trillion Gamble.” Please share with us what investors can learn from them that can be applied in the current market environment.

RK: Sure. I think you referred to the last two books that I wrote. One was called “The $10 Trillion Gamble,” which I wrote back in 2010, which I think it was, it was irrelevant for most of the last 10 years, but maybe it's just a little bit early. It's starting to matter again. It was about the deficit and at the time, $10 trillion sounded like a big number. It no longer is. I think, as your listeners know, that you've got government debt held by the public of about 2.50 times that level. So this is important because it's something that started to be discussed more in financial markets, you know, for a couple of days last year, last fall when the market started to pay attention more to the deficit. They were worried about all of the supply that the government needs to sell to finance a deficit. That is, you know, roughly 6% or 7% of gross domestic product. All of that supply is, again with more supply prices going down, and when prices go down, the bond market, interest rates go up. So there's more concern about where will all this lead us. And I think for investors, particularly those that invest in government bonds, this has become important. We have to start to pay attention to these deficits and realize that they do pose a risk to long-term interest rates.

And my most recent book, which was about portfolio construction, which sounds like a really geeky title and my wife warned me about it when I wrote it and I should have listened to her because I think I sold about nine books. But, that aside, you know, the point of the book is how you put portfolios together. And the way to think about this is investors have goals; you might want to be focusing on long-term returns, keeping up with inflation income. But they also have constraints. You may not want to take too much risk. You may not want to invest in certain types of companies. So that book on portfolio construction was really not how to take stocks, not how to, you know, forecast the economy, but how to put a whole area together in a way that's consistent with your goals and the amount of risk you're willing to take.

SG: All right, thank you. I definitely think several of our listeners will check those out now that you've given a preview of what their goal is. Shifting focus a bit, as you know, Charlie Munger recently passed away, what do you think his most significant contribution to the investment community was throughout his life?

RK: I think Charlie Munger, along with his partner, Warren Buffett (Trades, Portfolio), basically reinforced for generations of investors the benefit of a long-term perspective. And you know, these were investors that really thought in terms of decades, not not years or quarters and, you know, produced some of the best returns we've seen from institutional investors ever.

So, you know, again, both of them are incredible value investors, people that sought out companies that traded below what they viewed as intrinsic value. But I say even more than that because you know, there are value investors that do well, that growth investors that do well. But just the, the important lesson that at the end of the day, you've stayed invested, investing for the long term, not trying to time every month or quarter is really how you accumulate wealth over the long term.

SG: All right. On a related note, what is the most important lesson you have learned over the course of your career?

RK: Well, I think there are a couple. I don't know if it comes down to one, but certainly, you know, the long-term perspective is one of them. Again, it's very easy to feel stupid on any given day in the financial markets. Markets often create as much pain for as many investors as possible. So, you know, getting through that, sticking with an investment plan I think is one of the more important things that I have learned.

The other is really to think about your goals. Again, I wrote this book about five years ago on building portfolios. One of the main things I tried to get across was, you know, for many people, the conversation starts with do you like the stock market or what's your favorite stock or what technology is gonna be hot? Those are all important and clearly, people that have had the ability to pick stocks, you know, with added superior returns.

But there's another part of the investment process that has to come first. What's your goal? You know, what are you trying to accomplish? For a lot of young investors, that's about long-term growth to support retirement. For a lot of older individuals, it's about getting income to basically pay their bills in retirement. These are important differences, you know, thinking about what you're trying to get from your portfolio, how much risk you're willing to take, how much pain you're willing to take. These have as much impact on the type of investment you should be making as whether or not you think the stock market is gonna go up five or 10% in a given year. So again, starting with what you're hoping to accomplish, what your financial goals are, that's always got to be the first step in the process.

SG: All right. Thank you for those. I definitely agree with you. Those are some good things to keep in mind. What advice do you have for individual investors in the current market?

RK: So I think we're actually in a decent place. You know, ‘22 was a very hard year for investors, both because stocks went down, but also because bonds went down and it was a long time since people had seen that. It was a generation of investors that grew up really not experiencing that, at least when the years when stocks were going down, the bonds were at least cushioning them. So I do think that's something tha was sort of a wake-up call.

I think we're in a better spot today. We're in a better spot because I do think the Fed has done a reasonably good job of bringing inflation down, not to where it needs to be, but to a point where it's less of a risk to financial assets. So for investors today, I say a couple of things. Stay invested. Stocks in aggregate are not cheap, but that really reflects a few companies that traded a premium that probably is justified. So I'd stay in the market.

I keep a bias toward the U.S., which I think is doing a phenomenal job, not only of generating economic growth, but of just producing world-class companies. And you think about any of the companies that are in the so-called Magnificent Seven, companies like Apple (AAPL, Financial) or Microsoft (MSFT, Financial), Nvidia (NVDA, Financial), Tesla (TSLA, Financial). These are U.S. companies that all represent tremendous innovation. They're all, as we spoke about in the beginning, incredible generators of cash flow. They've got business models that are very hard to break into and they're mostly in the U.S. So again, I think diversification is a good thing, but we're in an environment and thankfully we've got a lot of companies in the U.S. that are driving the economy, driving the market and I would stick with those.

SG: Yes, I agree that the U.S. is definitely the place to be right now. I know Warren Buffett (Trades, Portfolio) definitely feels that, you know, the U.S. is a great place to stay invested in, as he said in his past letters and at his conference. But just to kind of round out our time today, whether they are investing related or not, please recommend three books and three movies for our readers to check out. And could you also share why you like them?

RK: Sure. I don't know if I've got three of each. I may give you three in total.

I tend to read a lot of research, obviously spend a lot of time in front of my computer looking at financial data. So when I read, I try not to read too many financial books because otherwise it just becomes overwhelming and eventually I need a break. But I will recommend a book that I recently read, I actually wrote a Bloomberg article about it, which I thought reflected how blown away I was by it. The book is called “Outlive” by a very well-known physician Peter Attia. He is, I believe, out of Austin. He's a doctor and he has done really a phenomenal job, one of the leading experts in longevity in the country. And it's a readable book. It's dense. I won't say it's an easy one, but it really talks about managing your health, thinking about, both from a diet, exercise perspective, sleep, what tends to make a big difference when it comes to longevity and, you know, some of them are tried and true sort of advice. You know, exercise, but a lot of them are things that maybe are new to people.

So I found that really eye-opening and, you know, I guess maybe from an investment perspective, one of the areas we love right now in the market is health care. There's so many important innovations going on. And I think, you know, longevity studies, both pharmaceutical products, but also lifestyle interventions that can help longevity are gonna be not just important for all of us in our personal life, but I think also a very good investment over the long term. So I'm gonna put that out there as my book.

SG: All right, any movie recommendations?

RK: So I will throw out two. Again, I haven't gone to the movies in a long time, but I do tend to travel a lot, so I see movies on flights. The two movies I seen most recently, both of which I'd say I really enjoyed and were pretty thought-provoking.

One was “Oppenheimer.” I don't know how it's going to do in the Academy Awards, but certainly one of the best movies I've seen in years.

The other is kind of more of a quiet movie that, I don't know, I found it really interesting. It might be my age, I think it was aimed at me, which was what I would call a romcom by Meg Ryan called “What Comes [Later].” The way I would describe it is a middle-aged “Breakfast Club,” for anyone who remembers “The Breakfast Club.” Basically, two people in a relationship who broke up decades ago are stuck in an airport during a snowstorm. And there are only really two actors in it. It's Meg Ryan and David Duchovny and they just do a phenomenal job of what feels like just a very quiet play,you know, just the dialogue and the interaction was phenomenal. So I'll use that to round out my book and two movies.

SG: All right, sounds interesting. Well, thanks again for joining us today, Russ! It was a pleasure to have you.

RK: All right. Well, thanks for having me. I enjoyed our conversation.


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