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Investing Roundtable: Where is opportunity lurking?

Mario Gabelli; Gabelli Asset Management, Russ Koesterich; BlackRock, Henry Ellenbogen; T.Rowe Price, Sarah Ketterer; Causeway Capital Management, Rajiv Jain; Vontobel Asset ManagementMario Gabelli; Gabelli Asset Management, Russ Koesterich; BlackRock, Henry Ellenbogen; T.Rowe Price, Sarah Ketterer; Causeway Capital Management, Rajiv Jain; Vontobel Asset Management
Our group of five market veterans gathered to share insights and ideas on Nov. 20, 2014. From left to right: Mario Gabelli; Gabelli Asset Management, Russ Koesterich; BlackRock, Henry Ellenbogen; T.Rowe Price, Sarah Ketterer; Causeway Capital Management, Rajiv Jain; Vontobel Asset ManagementPhotograph by Patrick James Miller for Fortune

The economic recovery that investors were long waiting for—and betting on—finally bloomed in 2014. But prospering in the market is about looking ahead, not behind. In 2015 global growth appears likely to slow. U.S. interest rates seem poised to rise. And profits have a historically tall bar to clear. In short, the outlook is uncertain. Where can you make money now? To answer that question, we turned to five top-tier investing authorities.

Veteran value investor Mario Gabelli is the founder of $47 billion Gabelli Asset Management. Russ Koesterich is the chief investment strategist at BlackRock, which oversees $4.5 trillion. Sarah Ketterer, CEO of $32 billion Causeway Capital Management, is a value investor with a global focus. In his $15 billion T. Rowe Price New Horizons Fund, Henry Ellenbogen specializes in small-cap stocks. And Rajiv Jain is chief investment officer at $49 billion Vontobel Asset Management. Here, edited excerpts from their discussion:

The market had a rough September and October. But stocks have snapped back to record highs. What does that tell us about 2015?
KOESTERICH: It tells you there are still a lot of reasons to own stocks. We do have a slowing global economy. Oil prices are lower, though I’d argue that’s a good thing. But the reality is we still have a lot of reasons to own stocks, the biggest of which is that, on a relative basis, stocks are still cheaper than most of the alternatives.

Are you worried that this is a market built on sand?
JAIN: I don’t really think so. I think there’s clear improvement. However, Europe is still shaky. Japan isn’t growing. Emerging markets are a little more of a mixed bag. And the U.S. is obviously the furthest ahead. Things are better, but you’ve got to be careful to pick your spots.

We came into 2014 worried that Fed tapering would disrupt stocks. It hasn’t. Will we be surprised again by interest rates in 2015?
KOESTERICH: I think so. We have a very different rate environment from the last 30 or 40 years. One, you’ve got lower nominal GDP growth, and long-term rates correlate with nominal GDP. Second, you’ve got a lot of demand from institutional investors at a time when there’s just less supply. Third, demographics. It’s not discussed very much that the population in all developed countries is aging. As you get older populations, the equilibrium for real rates tends to be lower. So I think rates are going to edge up a bit, but I do think for investors you’ve got to get conditioned to the environment in which long-term rates stay much lower than we’ve all gotten used to.

What does that mean for the market, Henry?
ELLENBOGEN: What you’ve seen is there’s a premium for growth. The companies that can grow because of their own structural advantage, because they’re innovative, deserve a premium. The market went overboard on that in 2013. But if you look at what happened this year, small-cap growth stocks have underperformed the market. So a little bit of that financial pressure has come out, and I think it’s now at a point where you really want to go out and understand the changes going on in the economy and buy the right companies.

Russ Koesterich Photograph by Patrick James Miller for Fortune

“There are still a lot of reasons to own stocks. Stocks are still cheaper than most alternatives.”
Russ Koesterich

Sarah, what do you think about small-cap growth companies underperforming?
KETTERER: They have in the U.S. It’s a little different in Europe and Asia. Small-caps tend to do better in the early stages of economic recoveries.

Does it suggest we’re in the later stage of the recovery if people stop buying small-caps?
KETTERER: It says that they’ve just outrun their valuations temporarily, but they’ll catch up. What I find fascinating is that we’re in a prolonged period of low interest rates. That means we have a low cost of capital. That means that stocks can trade at higher valuations for longer. And that helps to add a bit of confidence, because there’s nothing worse than buying at the top.

But interest rates eventually have to go up. Don’t investors have to price that in?
JAIN: I think so. If you look at a 10-year forward basis, lower interest rates lead to lower equity returns. High interest rates lead to higher equity returns 10 years out. Because, as you said, interest rates do eventually go up. If we look at Japan, it’s a perfect example. Interest rates have been low for a long time there. And it hasn’t really been great for investors. The underlying things matter.

Henry, is there enough innovation going on in the U.S. economy?
ELLENBOGEN: I see innovation everywhere. The innovation that started in consumer technology for companies like Google and Facebook is spreading out across the whole economy. It’s changing the way we produce, and white-collar workers work. You see it spilling into health care and financial services. Falling oil prices in the U.S.—that was a technology revolution, fracking. Five years ago my view was that you were going to see technology and innovation spread across the globe. But for the most part we have really continued to maintain our lead. In fact, some would argue we’ve actually widened our lead. And that’s good news for the U.S. economy.

JAIN: I would take the other side. It’s great for certain companies. But from an economic perspective, how many jobs does Amazon ­really add vs. how many jobs it’s actually ­destroying.

GABELLI: It’s creative destruction. You’re going to destroy jobs. And if you don’t destroy jobs, you’re going to get stuck as a society.

JAIN: Right, but you can’t destroy more jobs than you create. Look at the last 18 years—the U.S. has not added a single new full-time job. The jobs they’ve added are great for the tech companies, but it hasn’t added overall. That’s why interest rates are low. That’s why growth is low.

Sarah, if you’re looking for value, how do you not run right into Russia? Stocks there trade for five times earnings.
KETTERER: Gazprom, the giant Russian oil company, trades at three times cash flow. The market is practically giving it to you for free. But you have to be very careful, because we could be in a period—a full year—of low oil and gas prices, and that’s really hard for Russia. I think one should step very lightly in Russia.

Sarah Ketterer Photograph by Patrick James Miller for Fortune

“There’s another area investors don’t like that I think is attractive: the big banks.”
Sarah Ketterer

Are any of you buying in Russia?
JAIN: There are a few interesting Russian companies that we own in our emerging-market portfolio, mostly on the Internet side, that are still growing at double digits. And it’s unlikely that the government is going to do anything to those companies, because Putin would much rather have those companies that he can control or dictate, rather than give Russia’s Internet industry over to Google. So a company like Yandex, which runs the largest search engine in Russia, we own and we like quite a bit.

Sarah, you have been comfortable investing in Europe, despite its problems. What are you buying there?
KETTERER: One of our largest weights is in a Dutch paints and coatings company called AkzoNobel. And what’s interesting is that more than 30% of its revenue is in Latin America. It has done extremely well in decorative paint, which seems to cost more every year. Yet its stock trades at a discount due to the company’s domicile.

Have you been looking at Europe, Mario?
GABELLI: Luxury goods are phenomenally interesting to us. You go to anywhere in the world, and BMWs are still luxury goods. And if you have ever looked at those cars, you see there is a red device on the wheels. There’s a company in Italy called Brembo that makes these brake covers. Those are surrogates for luxury goods.

What trends should investors take note of for 2015?
ELLENBOGEN: The way the millennials consume technology has really changed what they demand out of companies too. And it has huge implications for consumer product companies. A perfect example is GrubHub. It’s a simple thesis. We all walk around with mobile phones. It’s changed the world. People want ease and convenience. And this is a company that allows you to basically bring food to wherever you are instantly. It’s a very big company considering it’s really only four years old, because that’s when the smartphone revolution started. But we think it can be much, much bigger, because it’s a huge addressable market. It’s a terrific free-cash-flow generator.

Rajiv, you’ve been bullish on Brazil. Are you still?
JAIN: Yeah, we’ve been actually loading up on Brazil. The country has had by far the best equity market over the last 20 to 30 years. Specifically, we like a credit card merchant acquirer, Cielo, which is growing 17% to 18% a year. And the stock trades for a 15 multiple, despite the fact that you are getting a 4% dividend yield.

We also like Itau Unibanco. It’s the only bank that I know globally that for the last 25 years, every year, has had at least a 15% real return on equity. It’s a $100 billion family-owned bank still growing, with a 4% dividend yield.

Sarah, falling oil prices have led to falling energy stocks. Could that be a theme for 2015?
KETTERER: There’s a self-correcting mechanism here. A lot of producers, like in U.S. shale or Canadian oil sands and much of Russia, can’t sustain exploration when oil prices are under $80 a barrel. So that could eventually lead to an improvement in prices. Meanwhile, you could go buy CNOOC, an oil company in China, and get a 5% dividend yield and tons of free cash flow.

Rajiv Jain Photograph by Patrick James Miller for Fortune

“We’ve been loading up on Brazil. The country has by far the best equity market over the last 20 years.”
Rajiv Jain

Mario, you own some fracking plays in the U.S.  Do falling oil prices change your opinion of those companies?
GABELLI: No. The U.S. still has a negative balance of payments of $200 billion on our oil bill, and that’s got to change. We’ve got to be able to get rid of Venezuela, the Mideast, and find alternative and renewable energy. So we have to have an energy policy finally that’s focused on that.

I’m buying National Fuel Gas because they own acreage in the Marcellus [shale], under Utica, N.Y. They’re not paying royalties. They don’t have to drill. It’s a long-term play. And they can split the company up. Financial engineering among the utility companies has a good track record. They can create a master limited partnership to attract investors if interest rates stay low. And if oil prices stay low, the companies will react to it.

Henry, what’s got you excited in tech?
ELLENBOGEN: We’ve been buying shares of Shutterstock, a company that is using technology to disrupt the photography industry. So you look at how they go to market vs. the established player Getty Images, and there’s a classic example of disruption.

Another example is Guidewire, which is essentially revolutionizing the way the insurance industry both deals with claims and does underwriting, and it’s an industry that skipped the PC revolution. It’s the only company that’s doing it, and they’re old systems that literally are kind of crumbling. So change in an industry happens slowly. It doesn’t happen overnight. But there’s tremendous opportunity.

If you look at the Alibaba IPO and the valuation it got, are you concerned about the valuations for tech stocks?
ELLENBOGEN: I felt a lot worse about it last year. The Russell 2000 growth index went through a bear market this year. From the peak to the bottom in October, it was down over 20%. So while markets were relatively benign in the U.S., a lot of the excess in technology stocks was flushed out.

Russ, I think I’ve heard you talk about tech stocks being overvalued. Is that still a concern for you?
KOESTERICH: We actually like tech. I think there are ­pockets—and you can look at social media—that are expensive. But when you look at, for lack of a better term, old tech, we think many of the stocks are reasonably priced. What I am worried is overvalued are parts of the market that are generally considered defensive. Utilities, for example. Slow-growing, regulated industry. Those stocks used to trade at 25% to 30% discounts to the market. More recently they’ve traded close to par.

So where would you be putting your money to work now?
KOESTERICH: Energy is one area. I think some of the U.S. refiners are smart plays right now. Marathon is a great example. You know, we’ve been speaking about the energy revolution. And what Marathon is doing is getting access to a very cheap source of crude, particularly in the Midwest, where a lot of shale formations are based.

What else?
KOESTERICH: Let’s go back to another cyclical sector: ­financials. One of the things that has changed this year is we’ve gotten five years into a very long period of consumer deleveraging. And what that means is that after four or five years where U.S. consumer debt was either flat or going down, something we really hadn’t seen at any point in U.S. history, we’re starting to see consumers expand their ­balance sheet again. One of the beneficiaries of that is Discover Financial Services.

Mario, what do you think about financials?
GABELLI: The consumer net worth is about $94 trillion. Debt has been constant for five years at $14 trillion, but consumers’ net worth is up. So with more wealth, we like the money managers like T. Rowe Price. We think it’s a bargain. We own Legg Mason. And I’m buying Janus.

Not BlackRock?
GABELLI: I buy that by buying PNC Bank, which owns a piece of BlackRock, which eventually it is going to monetize. And I’m looking at NIMS. The net interest margin spread is going to go up. The Fed funds rate is going to go up. So some of these banks are accumulating cash and getting a negative return at low interest rates. That’s going to change when interest rates go up. That’s State Street, Northern Trust, and Bank of New York. They will do well when the net interest margin widens.

Mario Gabelli Photograph by Patrick James Miller for Fortune

“Debt has been constant, but net worth is up. So with more wealth, we like the money managers.”
Mario Gabelli

Another huge trend in 2014 was buyouts. Is that going to continue in 2015?
ELLENBOGEN: Yes. When I look at the pressure on companies, it’s, “I’ve done my cost cutting. I’ve expanded my margins. Now what?” How am I actually going to deal with growth, and how am I going to deal with the change of my consumer? So in my fund, I had four buyouts this year because large companies had to go do something.

GABELLI: I agree. Look, the merger upswing is not a short-cycle trend. It’s a legacy of what’s gone on in corporate America for at least five years, and it’s a legacy of the fact that change is accelerating both on the technological side and on the consumer habit side, and these companies cannot deal with it.

So, Mario, do you have any picks for companies that are likely to be bought out in 2015?
GABELLI: I’ve got a whole portfolio. One example, country and western is hot. Live entertainment is hot. There’s a company called Ryman Hospitality. It’s located in Nashville. Nashville is hot. It has $2.5 billion market capital plus a billion dollars of debt. They have Loretta Lynn. They have the Ryman Auditorium. Somebody’s going to come after them.

Rajiv, you seem a bit more worried about the U.S. stock market. Where are you putting money right now?
JAIN: We love tobacco. We have a lot of tobacco because the companies have tremendous pricing power. They don’t need volume growth. The company we like is British American Tobacco. About 60% of the company’s sales are coming from emerging markets. Volume growth is going to be either zero or less than that. But they have tremendous pricing power. And the company is buying back stock.

Sarah, where else are you putting money now?
KETTERER: There’s another area investors don’t like that I think is attractive: the big banks. Barclays trades at 75% of tangible book value. They just need to get through litigation and turn around their return on equity—which is likely, because they’re shedding unwanted assets and moving to more stable, core businesses. They have a very strong credit card business. That dividend yield will be 4%-plus in two years.

Other bargains catching your eye?
KETTERER: National Oilwell Varco, the world’s largest provider of rig equipment. What’s so interesting about this company is their dominance and their scale. And they’re very active in offshore, which is still an enormous part of the capital spending of oil and gas companies, as well as U.S. shale. So they’ve got those two strong areas for growth and tremendous financial strength. And at $71 a share, it trades at about 10 times next year’s earnings. One of its closest competitors trades at 14.

Henry, you talked about tech. Are there any other sectors that we should be looking at in 2015?
ELLENBOGEN: Airlines have re-rated over the last couple years. But when you look at Allegiant, this is a business that, since its beginnings, the lowest return on equity it’s had is 15%. All the other airlines want a fixed-cost business, and Maury Gallagher, the entrepreneur there, created a variable-cost business model. He didn’t want to go after business travelers and first-tier cities. He went for third-tier cities. And so he’s basically got a personal monopoly in these cities, and that gives him tremendous pricing power.

HENRY ELLENBOGEN, T. ROWE PRICE Photograph by Patrick James Miller for Fortune

“The way the millennials consume technology has really changed what they demand out of companies too.” Henry Ellenbogen

Mario, you get the final word. What else are you buying for 2015?
GABELLI: Well, I don’t know if it’s just for 2015, but we’re interested in Class A heavy trucks in the U.S. You have 240,000 of them. You’ve got a lot of grain. You’ve got a lot of oil that has to be moved. And trucks are going to do well. Trucks are making a lot of money because ­diesel prices are coming down, and ­transportation rates are holding up. So we’re buying Navistar. It has 80 million shares, and the stock is $35. They’re going to have $5 in earnings in five years. The company’s going to be sold. They’re going to do quite well. That’s the kind of thing we’re looking at right now.

Thanks, everyone.

This story is from the December 22, 2014 issue of Fortune.