Merrill's Former Top Strategist Says Today's Market Is No 1999

The stock market’s unrelenting rally this year has claimed its share of celebrity bears, the best known being JPMorgan Chase & Co. market strategist Marko Kolanovic.

It’s a story practically as old as Wall Street itself. Just ask Charles Clough, Merrill Lynch & Co.’s chief global investment strategist from 1987 to 1999, who stayed bearish through the dot-com boom of the late 1990s, but only was vindicated after ultimately leaving the firm.

Looking at today’s market, Clough says it’s nothing like that era.

Now 82 and still running his eponymous hedge fund Clough Capital Partners L.P., he sees companies generating the cash flow to justify their swelling share prices. The economy is doing well. Inflation and interest rates are poised to come down. And in his eyes, equities have plenty of room to move higher.

When comparing the current stock market to the dot-com bubble, “the differences are far more important than the similarities,” he said in an interview. “The cash generation and the scale of these companies suggest that they’ll be around for a long time and continue to be very profitable.”

Clough’s hedge fund celebrates its 25-year anniversary this year. Prior to joining Merrill, where he became one of Wall Street’s most revered forecasters, he spent time at Cowen & Co., the Boston Company, Colonial Management Associates, Donaldson, Lufkin & Jenrette, and Alliance Capital Management Co.

He also is an ordained permanent deacon in the Roman Catholic Archdiocese of Boston and serves in that capacity at his local parish in Massachusetts. (The conversation has been edited for length and clarity.)

BLOOMBERG: Despite some recent turbulence, the U.S. stock market has had an incredible run since last year. Does it have staying power?

CHARLES CLOUGH: We have a very positive view.

The most important thing that’s going on in the economy is inflation is coming back down. It got its start back in 2020 and 2021, largely because there was a series of enormous simulative packages. At the same time, there were supply restrictions because of Covid. We’re really in the reverse of that dynamic.

One of the things that makes us fairly confident that demand will be sluggish enough to help inflation come down is defaults on credit cards. Credit card usage really boomed in this expansion as fees went from 12% to above 20%, so that can’t be sustainable. We’re even seeing defaults on auto loans.

Meanwhile, the Fed is watching immigration add to the labor supply and more companies using short-term labor. So if you put demand and supply together, inflation continues to go down. If that’s the case, interest rates, especially on the short end, will come down too. This is all bullish for equities.

Our thinking is if you look out beyond the volatility that is happening right now, the right strategy is to stay invested, particularly in equities. And with the amount of money sitting at the short end of the yield curve today, there’s plenty of fuel for equities looking forward.

With Big Tech stocks dominating the market’s returns, there have been many comparisons to the dot-com bubble. Do you see similarities to that time?

It hasn’t gotten to the point where it remotely looks the way it did in the middle of the dot-com boom. The thing about that time is it really was a result of aggressive Fed liquidity flowing into the market. It started in 1998 with the Asian crisis, and the Fed’s response was to panic.

A tremendous amount of money came in just as the Internet was getting going. That money fueled what we think of today as a dot-com boom. But these companies were unprofitable. There were silly companies like Pets.com with the sock puppet, but none had business plans that made any sense.

There was no road to profitability. The companies were huge cash users, and they were not able to generate cash flow. Today’s Big Tech companies are generating massive amounts of cash flows. Also, there were hundreds of silly IPOs. That really has not happened in this expansion.

Earnings growth is finally expanding beyond the Magnificent Seven and the Fed has started its cutting cycle. Will other groups take over stock market leadership?

The large-cap tech companies are in a world of their own. But that doesn’t mean as interest rates come down, there can’t be other areas of opportunity.

You can see what’s going on in the aerospace and defense sector.It’s been a very quiet sector for the last 30 years, ever since the collapse of the Soviet Union, and now there’s an awful lot of technology and demand to catch up.

We look at the housing shortage. Builders have held up very well, and we think durables related to the housing cycle will continue to do well.

How have things been since leaving your role at Merrill and starting your own shop?

We’re at 25 years of life, which for a small boutique is a long time. In our portfolio mix, we have both partnerships and closed-end mutual funds. I guess the popular term is a hedge fund.

We’ve got two: one in the medical area, and the other, a broad-based long-short hedge fund. We think thematically where profit cycles will occur and then invest heavily in those industries.

The closed-end mutual funds have been around for close to 20 years and that turned out to be a pretty good balance of business.

The hedge fund sector has been in some decline for the last few years, although it’s a very efficient way of protecting money, so I think it will come back. In the meantime, it’s been good to have both of those businesses.

A year ago, we took on two exchange-traded funds, they’ve done very well. Right now, it looks like the firm is sustainable.

During the end of your tenure at Merrill, you were bearish at a time when Wall Street was extremely optimistic. What’s it like to go against the grain?

That’s just part of the job. There was no reason to get upset about it because the market can do anything it wants. We knew we were right, and we were able to keep analyzing the situation.

People were interested in what we had to say. And I think it worked out very well. I remember I watched Cisco Systems pretty carefully, because at the time it was probably the largest investment firm for the dot-com boom with all of the telecommunications infrastructure that had to be built.

When I first started going negative, the stock went up six times before it declined 95% from its high of $82 in March 2000 to less than $10 in late-2003.