Tim Melvin: How Investors Can Make Volatility Work For Them In 2024

Over the years, I have learned to ignore most experts, pundits, analysts, and economists — especially economists who are often in the media. Not only are they wrong a significant percentage of the time, but there is also no penalty for being wrong.

Paul Krugman can be spectacularly wrong as often as he likes, but someone will still pay him to pontificate.

Henry Kaufman, an economist who got things mostly right throughout the 1970s and famously called a major market bottom in the summer of 1982, once opined: “There are two kinds of people who lose money: those who know nothing and those who know everything.”

Most of the economists I have met are in the former classification. They are in offices in New York and Washington, crunching numbers and massaging data to reach their majestic conclusions. I get the impression they do not do their own shopping, pump their own gas or ever leave the sanctuary found inside the Beltway or between the rivers. They have degrees, usually a handful of them, from prestigious universities and find the very idea of being wrong impossible to digest.

I read some economists regularly and have very high opinions of their work. Nancy Lazar and the economics team at Piper Sandler are high on that list. Ed Yardeni sometimes comes across as too bullish, but he is right far more often than he is wrong.

Why Tim Melvin Watches These 2 Economists: Then there are two economists to whom I pay enormously close attention. They see data most economists and market strategists do not. Their employers own hundreds of companies in a wide range of industries all over the world. While doing business, they have borrowed hundreds of billions and maybe even trillions of dollars, so they deal with lenders at every level, again all over the world. Their companies own real estate all over the world in every imaginable sector. They also lend money for real estate projects — billions of dollars — and naturally, it is a global business. That goes for their direct lending business and corporate finance businesses as well.

These two economists are seeing data involving business operations, financing data, borrower capabilities and capital markets that very few of their competitors will ever even glimpse.

Henry McVey works for KKR, one of the world’s largest private equity and alternative asset management firms. KKR manages trillions of dollars for corporations, pensions, endowments, sovereign wealth funds and wealthy individuals.

Torsten Slok is from Apollo, a firm with an interesting origin story. Founded by former Drexel Burnham Lambert investment bankers, Apollo has grown into a major player in private equity, real estate and infrastructure investments.

Both just released their midyear review, and their unique view of the world has some consequences worth consideration:

Both economists predict significant market volatility due to political and geopolitical events.

They foresee stronger economic activity than most economists expect, particularly in the United States.

Both believe inflation will stabilize but remain north of 2%, possibly around 3%, making it challenging for the Federal Reserve to lower interest rates significantly.

The consensus is “higher for longer” interest rates. KKR predicts one rate cut later this year, while Apollo expects no cuts in 2024 and limited cuts in 2025.

KKR is more bullish on public equities, projecting a 6.5%-6.6% long-term rate of return. Apollo is less enthusiastic, seeing higher interest rates as a negative for tech and growth stocks.

Both highlight productivity improvements, particularly due to artificial intelligence, as a key economic driver.

They predict stronger-than-expected consumer activity, particularly among higher-income groups.

Both see slow but steady improvements in commercial real estate, with problems concentrated in a small handful of office towers.

Apollo said continued deficit spending could push government debt to 200% of GDP over the next couple of decades.

Tim’s Takeaways For Investors: We can put all this data together to come up with pretty solid ideas about where to focus our investing efforts right now.

With higher rates for longer, I am looking at discounted double-B or triple-B bonds. These could potentially outperform stocks in the coming years. These bonds often trade at a discount due to market conditions, not credit issues. 

If we can buy a bond with a 6.6% or higher yield to maturity, we could potentially match or outperform the broader stock market over the next decade. There’s additional upside potential if the Fed cuts rates, if the issuing company gets taken over by a higher-quality company or if the bond is called early. 

We are looking at bonds with 10 years or so to maturity, giving us a good balance of yield and potential price appreciation. 

Remember, as long as we get the credit right, we are contractually obligated to receive the stated yield to maturity.

I am also interested in heavily discounted preferred stocks, especially in banks and REITs. These offer attractive yields in the current environment. Many of these are trading at steep discounts due to market fears that I believe are overblown.

I have a particular fondness for fixed-to-variable rate coupons. Bank preferreds are attractive because the credit conditions are often better than the market is pricing in.

For REITs, I am looking at preferred stocks of companies with Class A properties in out-of-favor sectors like Manhattan office space and Sunbelt apartments. These are often paying fat yields while we wait for the market to recognize their true value.

A combination of higher, long-term increased government spending and improving commercial real estate creates opportunities in closed-end funds. I am looking closely at funds trading at a discount, particularly those focused on infrastructure and real estate debt. 

Look for ones with activist investors pushing for value realization.

Everything about this outlook, including consumer spending, government spending and real estate investing, makes me bullish on banks. We want banks with high capital levels, typically well above regulatory requirements. Look for strong loan portfolios with a history of conservative lending practices. I prefer banks that have been able to restructure their securities portfolios to take advantage of higher yields. Community banks are particularly interesting as they typically have limited exposure to the office real estate sector. Insider ownership is a big plus — we want management to have skin in the game.

Improvements in commercial real estate mean selectively looking at REITs trading at significant discounts to their net asset value. I am finding some REITs trading at around two-thirds of their net asset value. 

I am interested in industrial REITs, apartment REITs and some office REITs with high-quality properties. Grocery-anchored shopping centers and open-air shopping centers are also attractive in some markets. 

The key is to know the properties, their locations and the tenant mix of these REITs.

I am focusing on REITs with strong balance sheets that can weather potential economic storms.

Both traditional and renewable energy infrastructure companies with strong cash flows and shareholder return policies are on my radar.

We want to focus on midstream companies with steady cash flows and strong dividend policies. Natural gas infrastructure is particularly interesting given the global energy transition.

In renewables, we are looking at companies involved in solar and wind farm infrastructure. The key metrics here are low multiples of earned cash flow production and low multiples of asset value. 

We also like companies with a history of share buybacks and growing dividend payments.

Remember, in all these areas, we are making volatility work for us. We buy during down days when sentiment is negative, focusing on quality assets at discounted prices. This approach requires patience and discipline, but I believe it is the best way to generate superior long-term returns in the current economic environment. 

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