Gerontocracy is much debated and decried in U.S. politics, and not without justification. Yet there is value in the wisdom gained from experience, especially from someone who puts the lessons of the past into thinking about the future. That future is fraught with risks, he offers, but not ones usually associated with investing.
These are the thoughts gleaned from several recent extended conversations with Dan Fuss, the vice chairman of Loomis Sayles. Having just celebrated his 90th birthday, Fuss remains hard at work even if he no longer directly manages bond portfolios for the Boston-based firm. He describes himself as the grandfather of the office, providing guidance for other managers from his experience stretching back more than six decades.
That understates his influence, to be sure. Over the years, Fuss has become known as a bond-picker whose style is analogous to Warren Buffett’s approach to stocks. I readily recall one of our first conversations, when I asked him about his approach to investment management. “I like bonds that go up [in price],” he said, a challenge since bonds only promise par at maturity plus interest, unlike the theoretically infinite upside of stocks.
More than the next gross-domestic-product or jobs number, Fuss expresses concerns about geopolitics, climate change, and domestic disputes that have hampered governance. Where once his speeches to groups such as the CFA Institute focused on things like Federal Reserve policy, the economic outlook, and the like, now he emphasizes what’s often seen as exogenous factors, away and apart from usual investment analysis.
Fuss sees the Fed’s decision this past week to hold interest rates steady as, in part, influenced by the war in Israel against Hamas. The risks that the conflict could spread and cause significant economic repercussions, notably by spiking energy prices, are reasons to sway the central bank to stand pat. “A good way to keep your hands warm is to sit on them,” he observes, as another New England winter lies ahead.
With that in mind, he thinks the Fed is done with raising short-term interest rates and possibly could cut them a couple of times in 2024, which coincidentally is an election year. That’s in line with the federal-funds futures market’s expectation of the first reduction coming in June, according the CME FedWatch site.
Fuss’ worry about an expanded war in the Middle East joins his longtime concerns over conflicts between China and the U.S. creating a Thucydides’ Trap, when a rising power threatens to displace a dominant one, as well as Russia’s aggression against Ukraine.
One fallout from these risks is that the U.S. defense burden will rise. Though Fuss admits this is outside his bailiwick, he believes this pressure will be felt both on the government’s budget and on the Fed, which could be forced to pause in its fight against inflation. That could mean accommodating price rises in the 3% to 4% annual range, above the central bank’s 2% target, along with interest rates inching up.
With Washington carrying the burden of defense, even if it isn’t committing troops, the pressure will still be on spending, he adds. That puts a built-in inflationary bias into what, in theory, is a peacetime economy, albeit one with budget deficits that historically have been associated with wartime, conservatively running at over 6% of gross domestic product.
Fuss doesn’t necessarily see inflation soaring like it did in the 1970s, but he does think interest rates are likely to experience successive cycles marked by higher lows and higher highs. The implications for investing are likely to be the reverse of the experience of the past four-plus decades of disinflation and falling bond yields.
In particular, the traditional 60/40 allocation of stocks and bonds probably should be something more like 50/50, he continues. Fuss demurs about offering any recommendation on the equity portion, but suggests a definite tilt from long-duration fixed-income assets.
In the corporate market, which is his bailiwick, he prefers intermediate maturities due in about seven to 10 years. In that sector, he emphasizes issues trading at discount prices, of which there is an abundance from bonds issued during the ultralow-yield period of a few years ago. Such medium-term bonds would fall less in price than long-term maturities if yields rise, but could participate in a rally and would be unlikely to be called early should yields fall, he says.
While Fuss is constrained from naming names, one example would be a triple-B-rated (lower investment-grade) bond with a 1.5% coupon due in 2030, which was quoted on Thursday at around 77 ($770 per $1,000 face value). That would result in a yield to maturity of about 5.80%, compared with 4.68% for a seven-year Treasury note.
He also see opportunities in selected high-yield bonds but emphatically not across the spectrum of speculative-grade bonds. Specific risks for individual corporate borrowers are the key. That includes both the credit quality of the issuer and the particular features of each bond issue. Remember that each debt issue from an individual company has its own set of specific characteristics, such as coupon, maturity, call features, and security, while there generally is only a single class of stock.
But these particulars take a back seat to the key risks Fuss sees for his children and grandchildren. Climate change is top of mind, although he admits there are no easy solutions. For institutions focused on the long term, such as pension funds, he would want to protect cash flows over 10 to 20 years in ways that might benefit the climate.
Geopolitics and increasingly fractious domestic politics remain Fuss’ other major concerns—especially the apparent inability to come to grips with the fiscal deficit, which further constrains our ability to meet those challenges.
This nonagenarian has his eyes fixed not on the past, but firmly on the future, and the risks that it holds.
Write to Randall W. Forsyth at randall.forsyth@barrons.com
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