It’s just after quarter end, so Co Chief Investment Strategists Matt Miskin and Emily Roland are back to discuss their latest outlook for capital markets with host John Bryson. Citing a bottoming in U.S. economic data as well as hints of a turn around in earnings estimates, they point at higher‐quality components within tech, communication services, and healthcare, as well as the nascent leadership of mid‐cap stocks.With cash piling up ininvestors’ portfolios, the discussion also dwells on opportunities ininternationa lequities and where to search for yield opportunities in fixed income without incurring excessive risk—particularly areas that are enjoying U.S. Federal Reserve support.
John Bryson: Hello and welcome to the Portfolio Intelligence Podcast. I'm John Bryson, head of investment consulting at John Hancock Investment Management. As always, the goal of this podcast is to help investment professionals deliver better outcomes for their clients and their practice. Topics we'll typically address include advisor business‐building ideas, capital market updates, the latest trends in portfolio construction, and investment insight from our veteran portfolio managers across our global network. Today, July 9, 2020, we will be discussing the capital markets. I'm joined again by Emily Roland and Matt Miskin, our co‐chief investment strategists at John Hancock Investment Management. Emily and Matt are the creators of our quarterly capital markets outlook piece that we call Market Intelligence. Matt and Emily, welcome to the call.
Matt Miskin: Thanks for having us, John.
Emily Roland: Great to be here.
John Bryson: All right. So I know that you just released your third‐quarter Market Intelligence publication. Matt, how will the views change this quarter?
Matt Miskin: There's been some things that we've done on the margin as it relates to our views and I would say the most notable change is actually in the international markets. What we've done is we've gotten a little bit more cyclical in our positioning. In doing so, we've actually increased our exposure to quality and growth sectors. So think about healthcare, consumer staples, even industrials and technology sectors. We've gotten a little bit less; we've taken down some of the defensive positioning in utilities. We've seen a little bit better data on the international side. We've seen emerging markets start to perk up a bit. So that implementation decision, we believe, will help us on that international allocation, but in terms of the other positioning ideas that we have there, hasn't been a ton of changes.
Matt Miskin: We've stayed with quality on the U.S. side. We're maintaining a balanced portfolio of 60% stocks, 40% bonds in thinking of a typical asset allocation framework. And really what we're not advocating for is cash, and what we've seen is cash pile up significantly: 4.7 trillion. As I've said on this podcast before, we believe that, that cash has better places to be put to work today. In international, in particular, is where we're seeing the biggest evolution, if you will, of our views going into Q3.
John Bryson: Okay, great. And you mentioned cash—there's certainly some temptation as the market fundamentals seem to be a little bit different than the economic fundamentals, or the market reaction, I would say. Emily, Matt had talked about opportunities. Let's dig into it specifically around equities. Where are you seeing opportunities in the U.S. and abroad?
Emily Roland: Yeah, and I think that's a great way to sort of kick off the question because one of the key challenges that we face right now is that we are seeing a bottoming in terms of the economic data. We are seeing a nice recovery or a nice balance off of very depressed levels, and we're seeing a corresponding bottoming process starting to play out in terms of earnings estimates. So earnings estimates just fell off a cliff during the recessionary period. We're starting to see them then turn around a bit. We liked that so far, but we need to see more. Meanwhile, markets have priced in this earnings recovery already. So when we look at the nice returns we've seen in markets off of those March 23 bottoms, and then this depressed earnings environment, you're looking at a forward P/E ratio of nearly 22 times earnings, which I think creates a challenging opportunity in terms of our environment, in terms of identifying opportunities.
Emily Roland: So what we've done is we've been really targeted in terms of pinpointing opportunities within U.S. equities, and I'll focus on the U.S. because Matt did a great job covering international equities and what we're thinking about there. When we focus on the U.S. market, it really does continue to be about leaning into quality and that means owning good well‐run businesses with strong return on equity metrics, with really solid balance sheets, with low earnings variability. And that really results in gearing our portfolios toward sectors like technology and communication services, consumer staples, and healthcare with a little bit more defensive element there. So we continue to really like quality. We think it can do well in this choppy environment and also coming out of the recession when we get there.
Emily Roland: The other element that we've been focused on is doing some work around mid‐cap equities and to us, that really is the sweet spot of the U.S. equity market. And one of the things that we've noted in our analysis is that we've been in a period where mid caps are showing some of the largest underperformance versus the market that we've seen in quite some time, actually since the late 1990s. So we've been really in this period of low relative performance. We started to actually see mid caps show some leadership off of the March 23 bottom. It's very early, but if you look at previous recessionary periods, in the early 2000s as well as 2008 and 2009, mid caps really tend to bounce coming out of recession. And that's the reason that we want to look for some element of participation in the portfolio. And we really feel that mid caps are a great way to do that without taking on undue risk. So that's really where we're focused on within the equity markets.
John Bryson: Excellent. Let's get to the other part of the portfolio that we haven't discussed: fixed income. Matt, when we look at yields across fixed income for the last quarter or so, they've declined meaningfully. How does that impact your view and does it make it difficult to identify opportunities in fixed income?
Matt Miskin: Yeah, it definitely makes it difficult and it's a good point. The Barclays Aggregate Bond Index, which is typically a benchmark of most fixed‐income strategies, is yielding 1.27%, which is the lowest in history, and your starting yield is an important part of your total return going forward. You can't bank on falling yields forever. So we do believe that you're going to want to move away from the Agg, and try to find select opportunities. What you're going to see in the next version of Market Intelligence here going into the third quarter is trying to pinpoint where to look across the corporate credit spectrum, across credit ratings—to try to find incrementally more yield, but not go too deep into high yield, not to take too much risk. So we look at the BBB part of the market. It's yielding about 2.5% to 3%. even BB is about 4.8% in terms of its yield.
Matt Miskin: This is just on corporates and that's really on the edge between investment grade and high yield, and that edge, that line in the sand, is where we would look to attack in allocating capital within fixed income. One, you're getting a better yield. That's a plus. But two, you've got the Fed that is doing massive buying on corporate bonds, and they really are focused on investment grade. But the highest yield you can get with Fed support is BBB. Now they are also buying what's called “fallen angels.” So those are companies that had an investment‐grade rating before the end of March that have dropped below that, that are now junk bonds. The Fed will also support those. Those are in the BB part of the market, so that's that sweet spot to us. We want to make sure we have that kind of exposure so we can get some income, but also have the Fed support.
Matt Miskin: But as we look through fixed income more broadly, we're still a hair underweight high yield because CCC enables B. We think the faults are going to continue to be elevated there so we want to be mindful of that. And then emerging‐market debt, while the yields have come down a good amount, we've actually downgraded them to slightly negative on the quarter and prefer actually U.S. corporate credit a bit more so.
John Bryson: Great. And the last topic I want to hit on is really a topic that in a normal election year, we'd be spending a lot of time talking about, but with everything going on with COVID and social unrest, we haven't talked a lot about the 2020 election. Emily, I want to ask you your thoughts on that and how it impacts your views for the rest of the year.
Emily Roland: What election? Only kidding. We have four months now to go until the 2020 presidential election. It feels like a lifetime. 2020 feels like a lifetime, and we still have another half of a year to go here. But this is a huge question that comes up in so many of our conversations and, broadly speaking, our view is that any political regime can certainly influence short or even intermediate‐term returns and risk. But having too much focus on politics has really historically led to pretty poor portfolio management decisions. And so we do try to kind of underweight politics in our views, and we think that other factors matter a lot more than which party is in control, and it's really some of the things that we've already talked about today in terms of the economic backdrop and the earnings environment as well.
Emily Roland: And I think one way to kind of frame that is just by looking at historical market performance under different political configurations, which is something that we've done this quarter in Market Intelligence, and basically what it shows is across various scenarios—so whether it's a Democratic sweep, a Republican sweep, a Republican with a mixed Congress, a Democrat with a mixed Congress, any one of those scenarios, there's a pretty tight range of returns, and there's not really much of a meaningful pattern. So markets perform a little better under Democratic presidents than Republican ones. A lot of it really has to do with timing. So if you come into office at the depths of a recession, chances are you going to do pretty well over the next number of years. A Republican sweep, so that means a Republican president and a Republican House and Senate, produces better returns historically than a Democratic sweep.
Emily Roland: And meanwhile, a mixed scenario, when the president and the House and Senate don't align, has been better under Democrats than Republicans. So really the bottom line is that there's really no discernible sort of difference in terms of the political regime. So we think that it's important to discount that. I would note one other statistic as it relates to elections that in reelection years, so the ones where a president is up for reelection, those actually tend to do better than open election years. So really the idea is that, when there's an incumbent up for reelection, they want to be reelected so there are often policies that may be implemented that may be probusiness or promarket in order to focus on generating better returns for the market. So this certainly could be the case in 2020 as policymakers are pushing forward with this continued historic amount of fiscal stimulus in response to the crisis. That's been one of the key elements that's underpinning markets and, in our view, you may just not want to fight that as we head forward into the back half of the year.
John Bryson: Excellent. Matt, Emily, always a pleasure to talk to you. If the audience would like to hear more of Matt’s and Emily's market insight, you can follow them on Twitter. First, Emily. It's @emilyrroland. And you can follow Matt Miskin at @matthew_miskin. If you want to hear more about the other topics that we're discussing, please subscribe to the Portfolio Intelligence Podcast on iTunes or visit our website, jhinvestments.com to read our viewpoints on macro trends, portfolio construction techniques, business‐building ideas and much, much more. Thanks so much for listening to the show.
Disclosure: This podcast is being brought to you by John Hancock Investment Management Distributors LLC, member FINRA/SIPC. The views and opinions expressed in this podcast are those of the speaker, are subject to change as market and other conditions warrant, and do not constitute investment advice or a recommendation regarding any specific product or security. There's no guarantee that any investment strategy discussed will be successful or achieve any particular level of results. Any economic or market performance information is historical, and is not indicative of future results and no forecasts are guaranteed. Investing involves risks, including the potential loss of principal.