Tom Pence feels vindicated by the stock market run-up. The 52-year-old managing director and senior portfolio manager of Wells Capital Management has stuck to scrutinizing individual companies for their immediate growth potential rather than fixating on the negative tone of many big-picture trends, and as a result saw four of the five funds he oversees beat stock indexes by at least two percentage points in 2013.
The flagships—Omega Growth and Discovery Growth—outpaced the Russell 3000 and Russell 2500 by 3.5 points and 2.1 points, respectively, through mid-December.
Pence sat down with IBJ editor Norm Heikens to discuss his investment philosophy and outlook for markets and the economy. The following transcript has been edited for space.
IBJ: Did 2013 catch you by surprise by how well the markets did?
PENCE: Not really. We’ve been bullish on the markets for the last couple of years, and our bullishness doesn’t stem from a macroeconomic perspective so much as it stems from talking directly with our companies. We’ve heard companies being pretty bullish about their growth prospects. That caused us to go into 2013 believing we had a strong year of growth ahead.
IBJ: Why not the macro signs?
PENCE: We pay attention to the macro signs, but there are people who do that too much. And I think there is a bias among policyholders, a bias among some of the macrostrategists out there to believe that it’s all about government intervention. It’s all about the Fed, and the Fed is totally driving the bus.
IBJ: What are you seeing for 2014?
PENCE: We always project 12 months ahead. My guess is, we’re going to be in the mid 20s [percent] for our companies for the next 12 months.
IBJ: The S&P 500?
PENCE: I would say 17 percent, maybe.
IBJ: What about the Dow?
PENCE: About the same.
IBJ: What are your top stock picks?
PENCE: Our Omega [Fund] portfolio has our very best large [cap], and our very best mid and our very best small. Favorite stocks, some big ones we have, would be Amazon, Kansas City Southern on the mid-cap side, and then on the smaller side, CommVault.
IBJ: Any Indiana stocks you particularly like, in any of your funds?
PENCE: None that we would really want to highlight. We don’t have any that are representative right now of our highest-conviction names.
ExactTarget was in our portfolio. That was acquired by Salesforce.com. We’re still very bullish on Salesforce.com. It’s not a super-high-conviction name right now because there are a lot of synergies that have to take place as they bring those companies’ offerings together.
IBJ: Any Indiana stocks you’re running from?
PENCE: None that I can think of. (Laughs.) We have some great companies in Indiana and good people running them, but everybody has different challenges at different times in their cycle. I don’t think there’s anything unique to Indiana that makes the companies challenged.
IBJ: You think the U.S. consumer is going to be a factor again in the next year or two. Why?
PENCE: A number of things. If you understand what’s happening in the retail space, even though we’ve gone through a very difficult fall, you actually started to see people continuing to show up at the stores. In November, the traffic was up significantly over last year. And consumer balance sheets are in good shape, and they are willing to go out and spend.
The other thing is, our belief is that there is an over-fixation again on government policy driving the market. People have thought what the market has needed in the last two or three years has been a Fed making credit easier to get and cheaper, and that will drive us into recovery.
Well, we have seen three years where we certainly have improved the balance sheets of consumers. We haven’t actually kicked into gear a lot of spending yet.
So I think that whole premise of cheaper credit—easier access to credit that worked all the way through the 2000s—is no longer working.
What people have failed to remember is what was happening back in the 1990s, and what was driving the economy back then.
We had a strong dollar. We had a strong consumer. We had a strong job market. And the U.S. consumer was positioned in a much more strong position relative to the rest of the world. That was driving the world economy.
But with the [World Trade Organization] bringing China in at the very early part of the millennium, you saw this enormous displacement of jobs being pulled out of the U.S. That really happened all over the world. So we saw stagnation in wages in the United States.
That had the effect of stagnating wages in the United States, but also making us become very innovative to continue to compete.
Today, nobody can beat manufacturing in the United States without huge efficiencies to compete with lower wages over in Asia.
But there is a change afloat, and it’s twofold. One, those wages are rising about 18 percent a year in Asia. So it doesn’t take a number of years of that kind of a growth disparity to having wages not really being a factor.
Secondly, we think that when you add in the efficiencies of robotics and technology the United States has put into manufacturing to compete, I think we’ve already offset the wage differential. That continues to make the United States even more competitive.
Lastly, it comes down to a capital-flow issue and the outlook for the dollar. You’ll start to see more investment come to the United States.
When that wage differential begins to completely dissipate, you’ll see more and more capital investing in a more balanced fashion around the world, and the United States is going to be a prime beneficiary. We’re seeing more manufacturing facilities, more distribution being built here in the United States, or definitely in North America, because it’s more competitive now and you can shorten your supply chains.
But the second thing is, you get those capital flows coming back. You put buoyancy back into the dollar. In the 1990s, that’s what we had—a very strong dollar.
The trends in the dollar are very solid. With solid growth here in the United States, an improving U.S. consumer and the prospect of a shrinking trade deficit because of oil imports into the United States, we can come up with a very positive scenario on the dollar.
That leads us to think we could be looking at a consumer wealth effect nearing what we saw back in the 1990s, and not one like we saw back in the 2000s, when they were primarily just running their balance sheets full of debt.
IBJ: If the Fed tapers, who benefits? Who loses?
PENCE: That may be above our pay grade. But it seems rational to think that if the Fed takes themselves out of the capital markets, the facilitators of the capital markets will take their place—the financial institutions, the banks.
IBJ: Do you feel investors are too bullish?
PENCE: We really don’t. Our research process here is one where we surround the companies. We talk to them about their investment prospects for the year ahead. We position them in the portfolio according to what conviction we have in them.
We have a lot of names where we have fairly high conviction that they can grow not only in excess of the market, but in excess of what Wall Street anticipates.
We don’t have high P/E multiples, so I believe that if those earnings materialize, we will see the stock prices follow.
We have had so many strategists come in here, and everybody believes the table is rigged, the Fed is running the show.
IBJ: The table is rigged?
PENCE: We asked the same question. Most institutional investors believe it’s like you’re going to a casino and tables are all rigged. They believe the Fed is completely driving the market.
There is an enormous contingent in the institutional investment community that believes government intervention is bad—across the board. Bad. It’s just a negative. So they simply won’t accept the fact that maybe there are some good things going on underneath at the micro level.
IBJ: So they’re missing opportunities …
PENCE: It’s now widely discussed. A lot of investors feel like they’ve missed this, because they focus too much on the macro. Everybody was betting the Fed was going to blow up the economy. It didn’t happen. Now the Fed is talking about tapering, and the market seems to be going up on the anticipation of that.
So I would challenge those macro strategists as to whether or not their dashboard was telling them the right things. The small investor, the individual investor, has been rewarded by doing the exact thing the strategists told them not to do—buying stocks of good companies that have good growth prospects.
We’ve had negative macro. We’ve had negative news out of China. We’ve had negative news out of Europe. And negative news out of Washington, D.C. Yet, the markets continue to march up.
That just shows you that there have been good things going on in U.S. industry and those things have been underappreciated for a long time.
IBJ: How long do you see the bull market lasting?
PENCE: That’s another question that’s outside of our pay grade. All we try to do is project a year ahead. We reset that view every quarter.
Most experts on business cycles would tell you the amplitude and duration of the business cycle is typically much different than what we see today. We’ve had a very restricted rate of growth because of outside factors. The duration of this cycle could be much longer than other cycles.
IBJ: There are people who think muted, subdued growth is the new normal for decades to come.
PENCE: It doesn’t look like that for . So we will have to reassess that after . But [in 2014] it looks to us that you could see the lifting of a number of headwinds.
We certainly already have the sequester in place, which everybody thought was going to be a huge negative to last year.
At the same time, you’re starting to see Europe slowly emerge from the funk it’s been in. And you’re seeing Japan becoming very aggressive about trying to stimulate their economy.
So we could actually have a significantly higher rate of growth [in 2014] globally than we have this year. But you could play that record every December for the last three years and it would sound the same.
IBJ: Based on your materials, the danger signs on the horizon seem more geopolitical than economic. China saber-rattling and so on.
PENCE: A little bit, yeah. In the Omega fund, we have 70 stocks that we think have very good growth prospects for the year ahead. The only reason we’re not going to see those prospects realized is if there is a significant drop-off in the gross domestic product growth rate, which we don’t foresee. Or there is a significant compression of P/E multiples because of some kind of a perception about the risk of equities.
So, yes, we’re of the opinion that into 2014, the growth prospects look very good but for a number of the factors that I mentioned.•