Leon Cooperman – Bonds are the Risky Asset
This article is based on a presentation from John Mauldin’s 2020 Virtual Strategic Investment Conference, which was held from May 11 to 21.
If rates stay low, the returns on stocks will be better than for bonds, according to Leon (“Lee”) Cooperman. “Bonds are the high-risk investment,” he said.
Cooperman spoke yesterday at John Mauldin’s 2020 Virtual Strategic Investment Conference. He is retired and previously founded and ran a hedge fund, Omega Advisors. He is a billionaire and philanthropist, having signed the Giving Pledge, a commitment to donate at least half of his wealth to charity.
The U.S. stock market is “reasonably fully valued,” Cooperman said, “not dramatically overvalued.” One reason he believes it is not overvalued is because of its composition, with 25% in high-technology stocks.
If the market is appropriately setting interest rates, he said, that means you will only make 2% to 4% in stocks. He based that on assumptions that the labor force will grow at 0.5% and productivity will grow at 1.5%, producing 2% real growth in the economy. To that he added 2% inflation, which would provide a 4% nominal return. He acknowledged that it will take several years to get to a 4% yield on the 10-year Treasury.
He said that a 4% yield implies a 17 P/E multiple for stocks. Applying that multiple to $150 per share in S&P earnings leads him to conclude that the market is fully valued.
Cooperman expressed deep concern about the country’s fiscal situation, which underlies his conviction that bonds are riskier than stocks.
We already had a trillion-dollar deficit before the virus problem, he said. “Someday this is going to catch up with us.”
If the dollar weakens and “inflation catches up,” Cooperman said, “the game is going to change.”
But at their fully valued levels, stocks present risks, Cooperman said.
For example, changes in the market structure make stocks more dangerous, he said. “The machines run the market.” Algorithmic traders buy strength and sell weakness, he said, and exaggerate price movements. Without commissions and with the weakening of the Volcker rule, there is more volatility. Cooperman said that 80% of trading volume in stocks is done off the exchanges. The uptick rule, eliminated in 2007, gave rise to high-frequency traders, which create “unnecessary volatility,” he said.
“The machines know everything about price and nothing about value,” Cooperman said.
Risk-parity traders are using approximately 10-times leverage, and when they need to unwind positions they must do so in an aggressive fashion. That adds to the unnecessary volatility, he said.
On the geopolitical front, he said we need to worry about China. It is being set up as the “whipping boy,” and we need to be concerned about the effect of that on the market.
Stock repurchases, which have buoyed prices, are over, he said. Profit margins are mean reverting and will head down, according to Cooperman.
“Buffett is having difficulty figuring it out,” he said, “so there is no reason to be bold.” At the recent Berkshire Hathaway meeting, Warren Buffett expressed concerns about deploying his capital in the stock market.
Although he is retired, Cooperman still manages his own money through a family office. He disclosed some of his positions.
He described a “two-tier market.” Tier 1 are the stocks that are no longer cheap. Among them, he said he owns Amazon, Google, Cigna, Centene, JP Morgan, Microsoft, Facebook and Fiserv. Tier 2 is the other part of the market, which he said is cheap but “has a lot of hair on it.” Those include cyclical stocks. He said he has 6% of his assets in energy and expects the price of oil to get to $50/barrel. His positions include Parsley Energy, WPX, Ashland Global Holdings, and Energy Transfer Equity (which he said has a 16% yield) and Trinity Industries. All told, he has about 30 positions.
Cooperman said it is considerably easier managing his own money than running a hedge fund. Running a hedge fund with quarterly liquidity makes it difficult to have a long-term focus.
Cooperman recounted how he got involved in a high-profile spat with Elizabeth Warren.
When Warren’s presidential campaign was at its peak, Cooperman made what he described as an “uncommon” (for him) political comment. At an investment conference, he said that a Warren presidency would cause the market to go down 25% or, even worse, not open the next day.
Warren responded, via Twitter, that she was asking only for 2% of his wealth.
He responded by writing what he called a “respectful” letter, explaining, among other things, his opposition to a wealth tax.
She responded by calling him an “insider trader,” which he said is an unproved assertion. (In 2016, the SEC charged him and Omega with insider trading. He settled the suit for $4.9 million without admitting wrongdoing.)
He called Warren a socialist and Bernie Sanders, a communist. “She is a politician in the worst sense of the word,” he said. “A wealth tax is nonsensical.”
Cooperman agreed wealthy people should pay more in taxes, but he questioned what that rate should be. He said 50% is reasonable, but not 75% or 90%, like Bernie Sanders and Elizabeth Warren want.
The problem is that, with many state and local taxes, we are already past a 50% marginal tax rate, according to Cooperman.
He acknowledged that inequality is a divisive problem that demands a solution. His approach is through education, which has been a target of his philanthropy.
“We need to bring more people into economic prosperity,” Cooperman said, “ideally through education.”
We need faster economic growth to absorb the growing population and to solve inequality, he said. Among his philanthropic efforts, Cooperman has donated $25 million to fund a scholarship program for 500 inner-city children. He said that 35% of children in Newark, NJ, will go to college, but only 5% will graduate. His graduation rate, through that program, is 95%.
The country is moving to the left, he said, and will do so more quickly if Biden wins.
He said he is an independent, but had recently changed his registration to Democrat in order to support and vote for Michael Bloomberg in the primary.
Cooperman is not happy with the candidates in the presidential race.
“With a nation of 300 million people,” he said, “we ought to have better choices than we have.”