The U.S. equity market continued to rally in early 2024, even as the latest inflation data and the economy’s resilience prompted the U.S. Federal Reserve to dampen expectations for a full-fledged pivot to an aggressive rate-cutting stance through year end. What’s an investor to do in this highly uncertain environment? Matthew D. Miskin, CFA, co-chief investment strategist at John Hancock Investment Management, joins the podcast to assess where the most attractive equity opportunities lie while also gauging current risks. Matt explains why he continues to see strong potential in semiconductor companies and other technology stocks despite their lofty valuations. He also warns about the risks for equity investors should the flow of economic data cause the Fed to once again embrace a hawkish stance on rates. Finally, Matt assesses the latest quarterly earnings season, cost-cutting initiatives that may enhance profit margins but could hurt long-term growth, and the challenges that advisors and investors face in putting cash to work in today’s markets.
Our Co-Chief Investment Strategist Matthew D. Miskin, CFA, assesses where the most attractive equity opportunities lie in the wake of a rally in early 2024 that has boosted stock valuations, despite growing uncertainty over the interest-rate outlook.
John Bryson:
Hello and welcome to the Portfolio Intelligence Podcast. I'm your host, John Bryson, head of investment consulting and education savings here at John Hancock Investment Management. Today is February 26, 2024, and I've invited Matt Miskin, our co-chief investment strategist here at John Hancock Investment Management, to join the podcast and to talk about what's going on in the market. Matt, welcome.
Matt Miskin:
Thanks for having me, John.
John Bryson:
Hey, Matt, let's start big picture from a macroeconomic level. Where do we stand?
Matt Miskin:
John, I wish the answer was a lot easier, but it's complicated. I think that's what the kids now have on their Facebook or Instagram accounts. I don't really know, but it's really challenging. It looks choppy. It's hard to say that we're in a new cycle, but we can say that the data is incrementally getting better. So we ended last year and global PMIs were improving.
They've gone up for four consecutive months. PMIs are business surveys all over the world, whether it's services or manufacturing, they've been improving. We saw the ISM―that's the Institute of Supply Management―they do business surveys. The manufacturing side of the economy has actually started to improve over the last several months. So this has been one of the most challenging economic cycles, business cycles we've ever witnessed in the history of the U.S. economy.
Part of it is fiscal stimulus has been coming into the economy, whether it's the CHIPS Act, the Inflation Reduction Act. There's money that's still being spent. We've got stimulus out of China, but it has been this late cycle, prolonged late cycle period with choppy economic growth. So it has been challenging to use that as an indicator.
We've been focusing on the fundamentals more of businesses, and that's how we've really been looking to invest. Using that lens more so than the economic indicators.
John Bryson:
Okay. Now, if we look short term, certainly very short term, looking at last week, you could say that we're in a risk-on mode again, certainly for U.S. equities. Talk to me about what's going on there.
Matt Miskin:
Yeah, we've really come into 2024 with a more risk-on tone. It really, you know, ended last year like that. And, you know, at the end of last year, at the end of 2023, what we saw was a pivot party. So what does that mean? So that means the Federal Reserve said we are likely to cut interest rates in 2024.
Powell usually does not be that deliberate in suggesting rate cuts until it actually happens. But the bond market said, ‘Okay, you're going to suggest rate cuts. We're going to take that. We're going to run with it.’ And at one point, at the end of last year, they were pricing in six cuts. The bond market was. And so the thought of the Fed cutting helped lift equities.
And what we saw was this pivot party lasted … You know, I almost think about it as the Fed saying, you know, at the party, last call for drinks. Now, I haven't been up late enough at a bar where they've called for last call for probably ten, 15 years. So I don't really know what that's like anymore.
But nonetheless, that's what they were saying and they were hoping, you know, that would be last call. And then they were they'd shut off the taps. And in our view, what they are seeing now is they're backpedaling. They're saying, ‘We don't want to cut as much. We might not cut. We’ve got to push it out.’ And they're trying to just say, ‘Hey, we're shutting off the drinks here.’
But the thing is, the party is still going. So now there's only three rate cuts priced in at 2024. And by the day that is actually decreasing. But equities don't seem to mind it anymore. So it's unusual. But if the Fed becomes more hawkish, then that could temper some of this enthusiasm we're seeing in markets. And we want to be mindful of that risk as the year goes on.
John Bryson:
I like your analogy. I remember back to those days when last call was made and lights went on. I don't remember people filing out orderly. Maybe it lasted a little bit longer than the bar owners or party posters wanted it to last. Hey, let's talk about earnings. You know, we've seen a lot of companies report earnings up to this point. How are those numbers faring?
Matt Miskin:
Not bad, but not great either. So the way to think about this is, at the beginning of the fourth quarter of last year, the analyst community was looking for 8% earnings growth and really the whole year last year was predicated on Q4. Q1 earnings were great, Q2, Q3, not much earnings growth. It was all going to be this Q4 and the Street was looking for 8% earnings growth.
What they're coming in at right now―and we're getting almost all the way through earnings. We're at 90% of the way through S&P 500 earnings. Earnings are going at 4%. 4%, it's okay. It's not negative, but it's not 8%―what we're originally looking for. And then also what's happened is even though 4% earnings growth has come in for Q4, the 2024 earnings estimates at one point were almost 12%.
So the streak analysts were looking for 12% earnings growth in 2024. Now that's down to about 10%. So they said, ‘Hey, these are great earnings, but we've got to trim some of your estimates because this is so strong.’ The other thing that's happening in these earnings results are cost-cutting measures. So companies are coming out and they're saying, ‘Hey, we're coming out with decent earnings, but we're kind of concerned with the revenue growth slowing.
We've got to cut costs.’ So that's often when you're hearing about layoff announcements, you're hearing about other cost-cutting measures, and that's helping stock prices because the investors like to hear better margins. They like to hear the cost cutting. But if everyone's doing it at the same time, that can actually create economic weakness in time. So those are some of the things we've highlighted so far in the earnings results.
John Bryson:
So if you break it down sector by sector, could you highlight for us which ones are coming in stronger versus others―maybe the dichotomy that's going on?
Matt Miskin:
Yes, blowout sector by far has been technology. So technology companies are growing earnings about 20% year over year. In Q4, the original estimate was 13%. 90% of companies have beaten in the technology sector. So you hear about like, you know, the mega-cap powerful technology companies that have been doing well. And that's certainly part of it. But it is broad, in that a lot of companies are beating.
Semiconductor companies in particular have had a tremendous quarter, a lot stronger than we thought. And really, you know, the technology companies are expensive. We get it. They're trading at a high multiple, but they're high-quality businesses, great balance sheets, strong earnings, high return on equity. So that is our favorite quality part of the market. We're following the fundamentals more so than the macro right now. That's isolating that position.
And then the U.S. markets are growing earnings the best in the world, and that's the reason why we've been overweight the U.S.
John Bryson:
All right. So we've been talking about the U.S. a lot. Let's pivot a little bit. A big driver of macroeconomics in markets around the world is China. What is the latest coming out of China and what are you focused on?
Matt Miskin:
So they've been cutting interest rates. So as the Federal Reserve is saying, ‘We've got to, you know, basically push back on the more dovish narrative and remain restrictive.’ China is outright cutting rates. So they actually cut the loan prime reserve rate, which is actually what goes into their mortgage rate. And their 10-year Treasury yields or government bond yields hit 2.41% last week, which was the lowest in history.
So they're cutting rates because their real estate market is still weighing on the economy. Economic growth is okay. It's kind of muddling around, but it's hard because that's predicated on a lot of stimulus measures. So it's not that it's really powering ahead in terms of a reacceleration, but it's holding in because they're stimulating. To us, it is still a place we have been modest, had a modest, underweight, likely to continue, a modest underweight.
And really it's about the earnings. We think there's going to be volatility around these stimulus measures where you get this pop. We've seen a decent pop in Chinese stocks in the last month or so from mid-July here to the end of February. We're not looking for adding exposure yet. We think that we're going to need a global cycle reset.
So, you know, globally, when central banks start to cut, when global growth starts to really improve and we're starting a new cycle, we'll look at China and emerging markets more broadly. For now, we're holding off and we still have an allocation in terms of our views and Market Intelligence. It is just a modest underweight, though.
John Bryson:
Very good. And we've talked mainly about equities and sprinkle in some fixed income. I want to go back to fixed income. And to your point, at the beginning of the year, the market was pricing in six rate hikes. What are your expectations for the Fed going forward right now?
Matt Miskin:
We think they're on hold until something breaks. In essence, “breaks” isn't maybe a good word for it, but in essence, there's a liquidity event or something, you know, happens where the labor market starts to show cracks. It's hard to see it right now, frankly. We don't see it. The economy's awesome right now, but at some point, there is likely to be some risk that that manifests itself.
Matt Miskin:
It's hard to always predict it in the future, but usually after the Fed raises rates a lot and they did and they go on hold for maybe a year, year and a half, pretty much on average. And then they start cutting. Right now, the back half of this year looks to be where they would just start cutting modestly if inflation continues to decelerate.
If we see a recession, then we have a lot more cuts likely to come. Again, it's hard to see it right now. But in talking about the bond market, it's easy to get hyper focused about the Fed. What we're seeing in bonds is a lot of value. We are seeing the best yields we've seen in the better part of 10 years.
We were just running, you know, in terms of our Market Intelligence weekly publication, almost every major fixed-income asset class, the yields are better today than they've been on average over the last 20 years, and in some cases a percent or 2% higher than their 20-year average. So whether it's investment-grade corporate bonds, mortgage-backed securities, or municipal bonds, we're seeing a lot of great bond income opportunities.
And there are alternatives to stocks, because you can lock in these income yields and look for those payments for years to come. So we actually like the bond market a lot here. Even as the Fed is on hold, we do think they eventually will cut.
John Bryson:
That’s very good. So you mentioned Market Intelligence. I'll share with our listeners that your mid-quarter Market Intelligence updates are available online. I also noticed online you've drafted a piece on mid caps. Can you walk us through the highlights of that piece?
Matt Miskin:
Yeah, it goes back to this economic cycle and why it's so differentiated or unique. We're doing so much government spending, fiscal spending this year, in things like the Inflation Reduction Act. What does the Inflation Reduction Act do? It incentivizes businesses to make electric vehicle components like batteries here in the United States. Where are those battery plants or electric vehicle plants being produced? The Midwest.
So whether it's Michigan, Ohio, so on and so forth, Kansas, there's a lot of electric vehicle manufacturing plants being produced. The other one, the CHIPS Act, that's semiconductors. We basically ran out of semiconductors. We had a supply chain issue. We didn't want to do that again. We want to make the semiconductors here. So there are massive semiconductor plants being produced in the Midwest primarily.
And if you looked at where these plants are being made and you overlay the best real estate markets and jobs markets, they’re right next to each other. Right? So the best real estate markets in terms of like housing is by where a lot of these plants are being put up―where there are the lowest unemployment rates, where there are thousands of jobs needed because they're going to put these plants in place.
This is all mostly in the Midwest. We are playing, in terms of mid caps, high-quality industrial companies that are building out these manufacturing plants. These companies have a high return on equity. They've been around for decades. Their earnings are stable, and then they're seeing a pipeline in demand. The largest sector in the mid-cap index is industrials. The industrials typically are Midwest mid-caps that are benefiting from the fiscal tailwinds.
We also like that they're cheap. They're trading just below their long-term average multiple at about 15 times. So you're getting this great diversification from large cap, which is technology-driven, by going just to your cheaper valuations. You've got a different sector contribution with industrials being the biggest one, and then you've got a nice tailwind. So that to us is kind of one of our favorites.
It is our favorite way to play an incremental dollar in the U.S. equity market. It benefits the U.S. economy, or it gives you exposure to the U.S. economy―more so less expensive. A lot of good things going for it.
John Bryson:
All right. Hey, Matt, you covered a lot of territory in this podcast already. Any final advice that you give to investors that we haven't hit?
Matt Miskin:
So the number one thing I'm hearing from advisors right now is the really difficult decision they have to make about cash. And there's two pieces to this. So one, there is massive cash on the sidelines right now. We're looking at nearly it's just over, I believe, $6 trillion that is in money markets―the most in history. And money markets right now are yielding―it depends on the money market.
And this is part of the analysis or thesis here. You know, they're yielding almost 45 to 5%. And, you know, I know that looks like an attractive yield. So the first piece of this puzzle and what advisors are discussing with clients that I've really found to be fascinating is managing cash has never been as important that I've seen in my career as it is today.
And what I mean by that is if you have money, if you've cash is sitting in a bank account or somewhere in a money market, and you're not being diligent and understanding how much interest you're getting, you could be losing out on about 4% to 5% annual interest by just having it the wrong place. Certain bank accounts earn zero still, or near zero.
So it's maximizing managing your cash the best you can. That's the first step in the process. With advisors, what I've seen is, are they're getting more capital, more assets by just maximizing that cash income. Then the next step is, okay, cash is great, but it also has reinvestment risk. It is the quickest. When interest rates change, they're the quickest to feel it.
So if the Fed did cut rates, eventually money market interest rates would go down nearly immediately. Bonds, on the other hand, you're locking in the yields, and you can get price return if interest rates fall. So bond prices rise when interest rates fall typically. And so we're likely to see a pretty significant wave of capital into the bond market over the next several years as it moves from cash back to bonds.
In our view, it's unlikely cash flows to stocks directly because that's a huge change to your investment risk tolerance. And so it's more likely to go to bonds. And I think that's the discussion. We would dollar- cost average that if you could, over time and lock in that those assets into attractive yields like we've been saying in the bond market.
But that's the only piece of the puzzle which I think it's more simple and basic, which I love in this market because there's a lot of confusing things that don't make sense in this economy, this market right now. To me, just doing what you know you can do to help, and then thinking about the future, the long-term interest you can earn is something that doesn't require a lot of complexity but can be hugely valuable to investors.
John Bryson:
And I like that advice because that's the way a lot of businesses think about it―and institutional investors―is manage the cash effectively, think long term. Those are some strong components to a successful investment strategy. So thanks for sharing that. Hey Matt, you're usually on with me with Emily, but Emily is traveling and I understand you're traveling a little bit later this week, but thank you for joining us, folks, as always, thanks for dialing in.
I mentioned Market Intelligence. The quarterly update is available. I mentioned Matt and Emily's blog on mid caps. We've got a bunch of great stuff on our website, jhnvestments.com, so check it out. And as always, we appreciate you listening to our podcast. Thank you.