White Papers

Until recently, we had been living in a disinflationary environment that started in the 1980s. We believe three factors – Deglobalization, Demographics and Decarbonization – have led us to a secular reflationary environment. As a result the next decade is going to look quite different than the 2010s, with a number of critical implications for investors.

The transition to net-zero emissions (NZE) involves a fundamental change in the structure of the economy, and will likely be messy, implying periodic supply shortages and even more volatile energy prices. Further, inflation and nominal interest rates will probably be higher and more volatile, especially relative to the levels of the last two decades. This has not yet been priced into markets.

China has launched a new policy framework, “Common Prosperity,” which escalates government steerage of the economy and features two critical initiatives. First, Beijing is taking action to tame the country’s real estate obsession. Second, the “summer blizzard” of regulatory actions has targeted a wide range of tech-related sectors including fintech, social media, online tutoring and gaming. Here, we examine the implications for investors of the pendulum swinging ever further in favor of the state.

Our latest piece is an update to a 2020 white paper titled “The Epoch Core Model: Our Proprietary Stock Model.” The Epoch Core Model is a systematic, rules-based expression of our free cash flow investment philosophy. In 2017, we implemented substantial changes to the model and created three industry-specific versions of it. More recently, we developed three machine learning versions of the Model and will introduce a new signal derived from activity in the securities lending market. In this paper, we describe these model enhancements as well as our research agenda for the next three years.

The recent surge in start-ups and unicorns reflects the broadening of the digital revolution across industries, and suggests improving productivity and free cash flow. Further, although the digitization of the economy is still in early earnings, we expect digital platforms to represent the majority of market cap by 2025, with tech, health care and communications the most promising sectors.

Inflation risks are at a four-decade high due to today’s combination of a generous Treasury, an overly tolerant Fed, and a reopening economy. While our base-case scenario assumes only a brief period of above-target inflation, investors should brace themselves for more inflation scares, which will likely remain a key driver of equity markets well into 2022.

Both sides of the political spectrum have been increasing their calls for regulatory action on the Big Tech companies. Here we explain why tech will continue to be the most dynamic sector of the economy, and why we expect greater breadth in tech market leadership and the emergence of entirely new sub-sectors.

More than just our proprietary stock selection model, the Epoch Core Model (ECM) is a rules-based expression of Epoch’s free cash flow investment philosophy. Learn more about the components that make up the ECM and how it’s being used to enhance the firm’s investment processes across strategies, to surface ideas for further research, to prioritize our research queue, and to inform our portfolio construction process.

The last six months have been profoundly transformational, with the COVID shock acting as an accelerant for the digitization of the economy. This radical transition is especially advantageous for asset-light business models. All companies will be acutely affected, although the biggest winners are platforms, with their economies of scale and low marginal costs.

The dispute between the U.S. and China is clearly not just about trade, or even technology. At stake are the values that will determine the architecture and governance of the global world order.

The current hype about two-sided digital platforms, blitzscaling and winner-takes-most markets has fueled a surge in IPO listings and produced stratospheric valuations that are difficult to reconcile with free-cash-flow (FCF) fundamentals. The big question is, are we repeating the excesses of the dot-com boom? In this paper, we look at the reasoning used by those who think history is repeating itself including IPO supply, profitability and VC funding. We also look at the weaknesses in those arguments and why some believe that the current situation is different from the dot com bubble, such as median age of tech IPOs and sales growth. Finally, we explore how investors can look at these companies through a free cash flow lens.

Does a stock’s price and its P/E ratio tell you how much a company is worth? Conventional wisdom says yes, but we think otherwise. In this paper we explore:

• The theory behind the discounted cash flow (DCF) valuation model and the underappreciated role that ROIC plays in the model
• The P/E ratio and find that it does not tell us what most people think it does, nor does its offshoot, the P/E to growth (PEG) ratio
• How we can use what we have learned about the DCF model to deconstruct P/E ratios in the real world to better understand what they do tell us

Three developments (the unwinding of QE, the soaring US budget deficit and the impending wall of maturities, especially of corporate bonds) will engender higher volatility and wider credit spreads. There is also a risk that interest rates will start rising for “bad” reasons (that is, an increase in fixed income supply). Each of these outcomes would be a headwind for high duration strategies.

Modern Portfolio Theory (MPT) dominates investment thinking today, but the pre-MPT view of the world still holds valuable insights. Our new white paper explores the limits of MPT in aiding successful investing.

The Digital Age and the transition from “atoms” to “bits” implies a capital-light economy in which technology is being substituted for labor and physical assets. Its impact is widespread and stretches beyond the technology sector. In the third part of our technology focused series we explore:

• The evolution of technology and why it is so noticeable today
• The key differentiator between the first and second machine ages
• Technology’s impact on microeconomic factors such as demand and marginal revenue
• Why the digital age entails a radical reevaluation of macroeconomics
• Implications for investors

While regulators and many investors are focused on leverage, we are more concerned with liquidity risk, which was at the core of the 2007-2009 crisis and will likely be again at the next one. As central banks move toward “quantitative tightening,” higher interest rates and waning liquidity are the most significant global macro risks, especially given that many assets are trading toward the high end of their historical ranges.

It has long been common practice in the investment world to divide the market up into “value stocks” and “growth stocks.” What do these labels really mean? “Value” connotes that the stocks in this category are undervalued, and should therefore outperform over time, while “growth” implies that these are stocks with faster earnings growth.

The rapid expansion and implementation of technological innovation has become a key factor in the behavior of the economy and capital markets. In this paper, Investment Strategist Kevin Hebner and Co-CIOs Bill Priest and David Pearl explore how tech has become the new macro, including a look at how:

• Tech is positive for all three return on equity (ROE) components
• Profit margins have soared over the last two decades
• Asset utilization improves with technology
• Tech impacts leverage and payout ratios
• Platforms and their network effects have resulted in a winner-takes-all market
• Disruptive innovation will affect all economic sectors

The rapid expansion and implementation of technological innovation has become a key factor in the behavior of the economy and capital markets. In this paper, Investment Strategist Kevin Hebner and Co-CIOs Bill Priest and David Pearl explore how tech has become the new macro.

Passive ETFs have influenced the informational efficiency of the stock market: trading costs have risen, stocks are more correlated with each other than they used to be, and valuation is now partly affected by whether a stock is in a widely traded index or not. Read this paper to learn more about the impact that passive investing has had on market efficiency and what active managers must do to in such an environment.

CEO and Co-CIO Bill Priest and Investment Strategist Kevin Hebner discuss how president-elect Trump’s economic policies could have a positive cyclical influence on earnings within the context of secular stagnation and higher interest rates putting pressure on valuation multiples.

Epoch’s investment philosophy can be summarized by saying that it is the ability to generate free cash flow that makes a company worth something to begin with, and it is how management allocates that free cash flow that determines whether the value of the business rises or falls. In this paper, we address the former of this statement and answer two questions: 1) Why does free cash flow matter more than earnings in determining the value of a business, and 2) do free-cash-flow metrics help investors identify stocks that outperform the market?

Over the last two years Lawrence Summers has been an energetic proponent of the secular stagnation thesis whereby the increased propensity to save and the decreased predilection to invest acts as a drag on demand, reducing both growth and inflation, and pulling down real interest rates. In this paper, Investment Strategist Kevin Hebner joins co-CIOs Bill Priest and David Pearl to explore the underlying components of Mr. Summers’ thesis and their investment implications.

Return on Invested Capital (ROIC) is a crucial metric in evaluating companies, yet investors pay more attention to growth in earnings, which can be misleading. In this white paper, learn more about the opportunity for investors to earn superior returns by focusing in a systematic way on harvesting the benefits of owning companies with high ROIC. Our Capital Reinvestment strategy focuses on companies that use their free cash flow to reinvest and acquire, and in doing so have a persistently high level of ROIC well in excess of their weighted average cost of capital.

International trade has moved to center stage in the U.S. political debate, with anti-trade tirades and protectionist rhetoric dominating stump speeches and media coverage. Against this backdrop, Co-CIOs Bill Priest and David Pearl join Investment Strategist Kevin Hebner to explore three key questions:

• Why does trade matter so much?
• Why has protectionism become such a prominent issue in 2016?
• What are the economic and market implications if the protectionists prevail?

Recent events in China have sent tremors across global equity markets. Read and learn more about the sources of these tremors, their interplay with our twin themes of secular stagnation and contagion, and the important investment implications they bring.

The Shareholder Yield strategy is approaching its tenth anniversary. Since its inception, it has established a strong track record. But with widespread expectations that the next ten years will be different, it is fair to ask: was this strategy simply right for the time? Or is it, as we believe, a core strategy, relevant for all times? In the attached white paper, we lay out the case for the relevance of the strategy in the coming decade.

This continuation of our previous paper furthers our examination of the recent performance of active managers and considers both the theoretical and empirical arguments.

In our most recent whitepaper, we discuss the case for active management. The paper looks at the recent performance of active managers and then considers both the theoretical and empirical arguments.

One of the most important issues for investors in 2015 will be understanding the implications of the precipitous fall in oil prices. In our latest perspective, <em>2015 Oil Outlook</em>, we provide a framework for thinking about oil prices and where they are headed.

At Epoch, we invest in companies that we believe are good capital allocators. This means finding companies that have a track record of successfully investing free cash flow for profitable growth and returning excess free cash flow to owners. If management does not have high-ROIC projects to pursue, including acquisitions, the “next best use” of that cash is to return it to the owners. We see dividends, share repurchases and debt pay-downs as equivalent ways to achieve that objective.

Bill Priest, David Pearl and Ken Hightower outline how the “power of zero” (quantitative easing and ultra-low interest rates) and the “power of the word” (the most significant being Mario Draghi’s “whatever it takes” statement) have held sway over equity markets. The paper describes the perils and opportunities ahead as these influences wane.

The Federal Reserve has signaled the end of quantitative easing in the U.S., conceptually if not tactically. CEO and Co-CIO Bill Priest discusses the global implications of a higher discount rate on various financial assets in our new white paper.

Epoch has been wary of financials, particularly large banks, since before the financial crisis.  In the U.S., however, banks have recapitalized their balance sheets, reduced leverage, and have a greater level of transparency than in the past.  While revenue growth will likely be slow for as long as the yield curve remains suppressed, some now have the ability to generate excess capital and return it to shareholders.

John Tobin, Bill Priest and David Pearl examine the outlook for Japan in our new white paper. They discuss whether the new fiscal and monetary initiatives will be effective and lay the ground work for sustainable long-term growth and why the portfolios we manage continue to remain underweight Japan.

David Pearl and Ken Hightower outline what has been driving equity returns, how that is changing, and where we see opportunity.

Bill Priest and Ken Hightower examine how a monetary policy of financial repression has replaced fiscal policy and how this has been the catalyst for the recent period of unusual equity returns.

It is difficult to have an opinion on markets or specific stocks without having a view on the future of the euro. We outline three possible scenarios, our expectations, and the investment implications.

Bill Priest examines the difficulties facing the euro and how excessive government debt is taking a toll on GDP growth globally. This will leave equity strategies focused on the expansion of P/E multiples at a disadvantage to those that emphasize companies growing their cash flow, returning capital to shareholders and taking intelligent advantage of globalization.

Are dividend-oriented investments a “crowded trade?” Valuations and interest rates can be interpreted differently, but in the end, high-quality companies with growing cash flows that consistently return capital to shareholders earn their return.

Dividend strategies are regaining popularity. But pursuing dividend yield alone can lead to poor results. Investors need to understand a company’s sources of cash and should view cash dividends, share buybacks and debt repayments collectively in assessing management’s strategy to create shareholder value.

Bill Priest and Ken Hightower address the root cause of our current economic ills. While expectations for equity returns are being lowered, we believe stocks can still provide attractive returns over the long term.

Today, there are many reasons from both a beta and an alpha perspective to maintain or increase a strategic policy allocation toward the non-U.S. small cap asset class.

Value, a word commonly used in our profession, means many things to many people. We share our perspective of value, as reflected in our free-cash-flow methodology, and how it relates to the conventional concept of value.

Read to gain a better perspective from a portfolio standpoint regarding what the events of Japan could mean in a broader global context.

In 2010, the equity markets were driven predominantly by “macro” forces, resulting in an environment characterized most accurately as “risk on” or “risk off”. High correlations of returns existed among and within many industry sectors.

In a world likely to offer 6-8% long term equity returns on average, we discuss a strategy that should weather the challenges that lie ahead and provide a “9% Solution” with lower volatility over the long term.

With a long term perspective, certain equities may be viewed as a “safe” asset now.

Epoch seeks equities positioned to survive and perform well no matter which “gang” wins the day.

Changes in the investment landscape are creating new opportunities in the equity markets, especially relative to fixed income.

The power of zero interest rates have had an impact on the stock market. However we believe it has run its course with respect to its influence on valuations.

Read to gain insight into the 2009 underperformance in U.S. small cap stocks with a comparison of the Russell and MSCI small cap indices.

The battle between the “Power of Zero Interest Rates” and “Deleveraging and its Consequences”.

Dividends – in the form of cash, share buybacks and debt repayments – will be a primary determinant of total equity returns in the years ahead.

The causes, implications and lessons of the 2008 financial crisis.

Have we taken the easy way out of the most difficult economic problem in over 70 years and how should investors adjust their approach?

The liquidity crisis subsides and leads us to take a cautiously optimistic outlook on the recovery of the economy.

An explanation for the financial crisis and the case for why certain equities now offer compelling long-term value.

Dividends really matter; and capturing them in a low cost, diversified manner is both important and rewarding for investors.

The benefits of global trade and why a solely “Buy American” policy is a bad idea.

A review of government intervention during the 2008 financial crisis and the outlook for recovery.

There are reasons to maintain a conservative outlook, but values exist.

The recession train has officially left the station. We look at what’s next for the global economy.

Erratic weather patterns and an uncertain global economy; the comparisons are enlightening.

Insight on the global economy’s failing health, the nature of the illness and potential cures.

The U.S. economy faces extraordinary challenges.

Words of guidance for the informed investor to help steer clear of the rough seas on the horizon.

There are two sides to the story of the oncoming recession: the real economy and the financial economy.

Bleak times: a look ahead into the recession of 2008.

The current and future destruction of equity capital within the banking system and its impact on the real economy.

When Marco Polo traveled to Dadu¹ in 1271 via the Silk Road as a member of Pope Gregory X’s delegate to Kublai Khan, the first Mongolian Emperor of the Yuan Dynasty (1271-1368), he did not know that he would spend the next seventeen years in an empire that not only ruled China, Mongolia and Persia, but also commanded an economy with the most advanced technology on earth.

A look at the fees charged by hedge funds and their effect on the investor.

Examining the forces that fueled the market’s climb, our expectation for an impending fall, and the wild ride in store for debtors, lenders and, most importantly, investors.

Bill Priest addresses the Institute for Private Investors on the topic of “sustainability and disequilibrium.”

A look at the bursting housing bubble and the impact on the future of the global economy and financial markets.

An examination of Epoch’s investment philosophy which is based around the changing order of the sources of equity return.

A look at 2007 and what lies ahead.

More signs that point to the weakness and vulnerability of financial services stocks.

How our insights and experience tell us that simply wishing for a robust economy will not result in one.

A discussion of the concept of “punctuated equilibrium” and the manner in which this theory of evolutionary biology can be applied to today’s financial landscape.

How informed investors can build a winning portfolio in the current market environment.

Inflation concerns and peaking interest rates portend a slowdown in housing and economic growth.

Financial and economic forces behind the recent equity market decline.

Why dividends are an important source of equity returns.

What drives today’s equity returns and how can we capitalize on these trends?

Trends and issues for the new year’s investment landscape.

The growing significance of free cash flow and shareholder yield as a dominant driver of future equity returns.

A clear and simple approach, designed to identify stocks that will protect our client’s capital and provide a return on their investments.

The benefits of globalization.

More signs point to inherent weakness and vulnerability of financial services stocks.

Today’s investors are witnesses to a fierce battle between two methods of stock market valuation – the battle between accounting and finance. Why is this battle so important and why are the stakes so high?

Looked at from a distance, the world is working surprisingly well. Almost all nations are experiencing real growth and interest rates are remarkably low. Indeed, rates are lower than almost anyone postulated a few months ago. Few things matter in finance more than interest rates. It is this rate that becomes the discount rate in one form or another for virtually all investments and provides the key metric when valuing public securities.

A closer look at the housing market, where the continuation of low interest rates has created a bubble and is poised to play a vital, and potentially problematic, role.

Our “long only” investment philosophy and winning the “free ante”.

For some readers, the title of this paper may recall one of the most popular movies of 1985. In “Back to the Future,” Marty McFly, the film’s young hero, returns to the past in order to gain insight into the future. At Epoch, we believe the same approach should be taken in the field of equity investing: in order to profit from the stock market’s future, you need to understand its past. In the following pages, we’ll explore how the history of equity returns can be used to optimize stock selection, portfolio construction and total value creation.

Despite dark clouds in the distance there are plenty of investment themes to capture.

The yield on U.S. Treasury bonds touched its lowest point in decades in 2003. What does this mean for future markets and returns?

Near the end of 2002, we authored a thought starter entitled, “Value vs. Growth– Does it really make a difference?” This essay examined the period March 1993 through September 2002, and appears below.

The world is being ” rewired” in the first decade of this century. Globalization started in earnest in 1989 with the fall of the Berlin Wall and has accelerated in the early years of this new century. Prior to 1989 our world consisted of Europe, Japan, and the U.S. China, India, Russia and the rest of the world’s populace mattered little.

If the real economy and the financial economy are two sides of the same coin, what are the linkages, where can they be seen, and what drives changes within those linkages. Figure 1.A draws a link between the size of the real economy, measured by Gross Domestic Product, and the size of the financial economy, measured by the Wilshire Total Stock Market Index, from December 1970 to September 2002.

The “small-cap versus large-cap” question is a classic dilemma within the investment community. Regardless of an investor’s preference, one thing is clear. If research matters, it matters most in small-cap companies.

The genesis of this study occurred when a client provided BEA with a list of commissions per share paid by all eight of its money managers. The client wanted to know why the cents per share numbers varied so much from manager to manager. We replied that neither the size of the trades nor the effects of trading on the price paid for the security had been taken into account.