Sinead Colton Grant, chief investment officer at BNY Mellon Wealth Management, favors the U.S. over international markets. And muni bonds look attractive. By Reshma Kapadia
An avid fan of horror movies, Sinead Colton Grant nevertheless didn't buy the scary setup for U.S. stocks and the economy that some were painting late last year. Instead, the BNY Mellon Wealth Management chief investment officer told clients that resilient consumers were likely to boost the U.S. economy, pushing the Federal Reserve to take a "less and later" approach to interest-rate cuts.
That was a prescient call, with U.S. stocks later charging higher and investors drastically rolling back expectations for rate cuts. Grant is still advising high-net-worth clients to favor the U.S. but now to broaden their shopping list beyond the much-loved megacap technology stocks and to rethink where their cash is parked.
Grant began on the trading floor at Chase Manhattan and then spent a decade focused on currencies before moving into asset-allocation roles at BlackRock and now at BNY Mellon Wealth Management, where she oversees $309 billion. Barron's spoke with Grant on April 9 and again via email about other areas of technology that should be on investors' radar, including backdoor ways to tap into the artificial-intelligence buzz, why she doesn't share the recent optimism about Japan, and the case for swapping some cash to fixed income. An edited version of the conversation follows.
Barron's: What do you expect from the Federal Reserve now?
Sinead Colton Grant: Even with the euphoria in December and the market pricing in six rate cuts, that felt very optimistic to us. At that time, we had expected four cuts. All the major indicators make us think that the outlook for rate cuts is certainly less and later. With the hotter consumer price index [report] and Fed Chairman Jerome Powell's comments, we now expect one 25-basis-point rate cut, likely in December. [A basis point is a hundredth of a percentage point.]
If interest rates stay higher for longer, which companies are at risk?
One of reasons we favor large-caps is because so many of them refinanced their debt when rates were ultralow, and most of that doesn't mature until 2030. That's not the case for small-caps, which have maturities coming due in the next 18 to 24 months. Some have already refinanced at higher rates because they expected rates would start to fall more quickly than they have. That's something we are concerned about. It's not tomorrow's problem, but there is a lot of rate stress [within small-caps]. We also see it in the real estate sector.
What should investors own within large-caps?
We think the rally will broaden. We like technology, healthcare, and industrials. Within technology, though, we are focused on names that are a bit less in the headlights, such as Cadence Design Systems, which is focused on chip design automation and emulation, particularly for AI. Unsurprisingly, demand for its chips is increasing exponentially. For consumers of these chips, it means a material reduction in design costs and faster time to market, so it helps support innovation across the board.
Every second conversation, someone mentions AI in some form. If it's an arms race, chip design companies like Cadence can support and accelerate it. We anticipate Cadence can grow earnings in the high-teens/low-20s for the next three years as its revenue growth increases from high-single digits to low teens, margins improve, and it buys back shares. While it trades at a historical premium -- at 35 times our 2025 estimate -- we think it is deserving of it, as revenue and earnings have accelerated, and it trades at a discount versus other high-quality software companies.
What's another way for investors to tap into AI?
Nvidia has had such a great run, but it's about where we look next. It's thinking more creatively about where AI will drive benefits -- like CrowdStrike Holdings. It is involved in information-technology security, which is the No. 1 focus of every chief technology officer.
Bad actors can leverage AI to increase attacks and do it more efficiently. CrowdStrike itself will leverage AI to better combat that. It is already one of the largest platforms with the highest efficacy rates, and it's leveraging vast data sets to distance itself from the competition. The market is underestimating the durability of growth, driven primarily by its ability to enter and take share in new markets like cloud and identity as well as by tailwinds from AI. While not cheap at 50 times 2024 cash flow, we see it as an elite asset that trades below our high-quality software comp group when we look into 2025 and beyond.
Do you still want to own the Magnificent Seven?
We are comfortable with their multiples -- and of technology and communications stocks generally -- because of the very strong free cash flow they generate. The Magnificent Seven has double the margin profile versus the rest of the market. On a relative basis versus the S&P 500 index, Apple, Amazon.com, Google [ Alphabet], Nvidia, and Tesla trade below their five-year relative valuation average on an earnings, operating-income, and cash-flow basis, whereas Microsoft and Meta Platforms are trading below a 10% premium, where they have historically traded versus the market.
While we don't specifically expect the Magnificent Seven to face big challenges, the multiple differential we see in these names versus the rest of the market and a bright environment [is pushing us] to identify value elsewhere. One example is healthcare, one of the most beaten-up sectors of the S&P 500 last year.
What stands out?
We like Danaher, one of the largest life-sciences tools and diagnostics manufacturers. It provides tools and services that facilitate drug development and life-sciences research. Its markets have been flat over the past 12 months, and will be pressured over the first half of the year, because its customers are small and midsize biotechs that have been more conservative with spending amid higher interest rates and concerns about a recession.
Typically, [spending from these customers] grows around 6% on an annualized basis, so the low recent levels of demand are unsustainable. Pharmaceutical margins are generally high, so drug companies tend to not delay spending for very long. We expect that this is more likely to be a second-half, not a second-quarter, rebound.
What are the risks to your soft-landing assumption?
There has been a significant elevation in the geopolitical risk, but we know that is hard to predict. We are watching energy markets and gold as a good pulse check.
And if we see significant acceleration in [economic] data that suggests a second leg up in inflation and feeds the narrative that the Fed could go from zero rate cuts to some hikes, that could cause equity markets to run out of steam quickly.
How are you hedging against these risks?
Fixed income is a very important component. We have been very excited about the higher level of yields over the past couple of years, with fixed income not only giving you diversification and being a port in the storm but also income. We have encouraged clients who were attracted by 5% yields in money-market funds to remember that those don't last forever and that high-quality fixed income is more attractive.
What looks attractive in the bond universe?
Municipals are attractive for taxable investors, especially at current levels. We are overweight munis with maturities of five years or less and bonds with maturities of 15 years and longer, and underweight munis with a five- to 10-year maturity profile. With rates higher for longer, lower-rated bonds will come under pressure, so we are also underweight high yield. For many clients, we also include an allocation to alternatives that includes different hedge fund strategies, including global macro, that can be dynamic or nimble.
You started your career in the global macro world. What is being missed by investors from that vantage point?
I'm not sure if it's being missed or misidentified, but we are underweight international and emerging markets. I see a lot of enthusiasm around Japan and the United Kingdom. But we need to see more from both before we can really say they are attractive.
In Japan, while there have been many great governance efforts to make companies more shareholder-focused, I don't think we have seen enough. I don't think we have seen inflation reach a level where we can be convinced that [Japan has beaten deflation] and the behavior of Japanese consumers has changed -- or that the dynamics of the economy are that different just yet.
Much of the boost to the economy and earnings has been driven by a weaker yen, which is at a three-decade low. Consumer confidence is also being impacted by the higher cost of imports. Should the U.S. economy slow even moderately, Japan will suffer twice -- through a stronger yen and weaker corporate earnings. China is Japan's largest export market, so slower growth in China will also weigh on Japan. I would like to see the economy expanding consistently for several quarters during periods of yen strength to confirm the independence of the recovery.
What's your outlook for China's economy?
There has been a significant destruction of value in the property sector, and that has hit the consumer. The problem stems from the stimulus China implemented in 2008-09 to overcome the global financial crisis, so this has been a long time brewing.
Look at any market where there have been significant property downturns. Think about what happened in the U.K., Ireland, and [continental] Europe. The market has such a scarring effect on the population, and the ripples through the broader economy are huge. The dynamics are different because of the scale of the Chinese economy, but it's hard to see how they can overcome it, absent the government putting in a massive stimulus. And every indication is that it isn't going to do that.
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April 26, 2024 21:30 ET (01:30 GMT)
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