In this episode of Portfolio Intelligence, Co-Chief Investment Strategists Emily R. Roland, CIMA, and Matthew D. Miskin, CFA, discuss their 2022 economic projections and investment outlook. The strategists also share what factors they’re currently watching, their expectations from the U.S. Federal Reserve, and their concerns for the U.S. and global economy in 2022. Finally, the strategists share their views on the positioning of fixed income and equity investments in 2022.
John Bryson:
Hello, and welcome to the Portfolio Intelligence podcast. I'm your host, John Bryson, head of investment consulting and education savings at John Hancock Investment Management. Today is December 15, 2021, and I'm excited to welcome back Emily Roland and Matt Miskin, our co-chief investment strategists at John Hancock Investment Management to hear about their thoughts for 2022. Matt and Emily, welcome to the podcast.
Emily Roland:
Thanks for having us, John.
Matt Miskin:
Thanks for having us.
John Bryson:
I got to ask first: It is December 15, and with all the supply chain disruptions are you both ready for the holidays? Emily, let's start with you.
Emily Roland:
Yeah. I woke up in the middle of the night last night. We have three kids, and I did that whole mathematical exercise where I tried to figure out if I’ve spent the same amount of money on each of the three kids, and I definitely haven’t. It’s wildly skewed in one direction, so I need to make up time for that. I like to shop local, so I’m not too worried about the supply chain problems.
John Bryson:
Good to hear. Good to hear. Matt, how about you?
Matt Miskin:
Got a couple gifts for my wife, but still looking for one more big one. That one takes a little bit more time, a little more thought, but the clock’s ticking here, so I got to get out there and get it done.
Emily Roland:
I think your focus is in the right place, Matt.
John Bryson:
I agree. I’m in the same boat, Matt. I have one person to buy for, but if you get it wrong, it’s a bad person to screw up. Yeah, I got one more to go.
John Bryson:
All right. Let’s jump in. You both recently released your 2022 outlook. Emily, I want to ask you what’s the overarching theme for 2022?
Emily Roland:
John, Matt and I are always trying to think of ways to find songs to put our thoughts into context, and this year we chose the Eagles’ song, “Life in the Fast Lane.” Our title of our new 2022 outlook is “Don't Get Too Comfortable in the Fast Lane.” The idea here is that thinking back to 2021, it was almost impossible to take enough risk to keep up with this market. As we look into next year, we simply don't see the highest risk, the highest beta, the most cyclical parts of the market leading, and instead we're looking to trim risk into strength here. We are always looking at the cycle. We use the U.S. Leading Economic Indicators to tell us are we in an expansion, is economic data decelerating. Right now, they're telling us that we're not near a recession yet, it's way too early to get defensive, but peak economic growth is behind us.
Emily Roland:
As far as catalyst into next year, we think about things like fiscal and monetary stimulus. We saw an explosion in stimulus in 2021, and we just simply don't see that again into next year. We'll probably actually never see it again in our lifetime. We may see some modest spending with the passage of the Infrastructure Spending Bill, but it's going to be spread out over a number of years and it's just not going to compete with what we saw this year. So, the comps are going to get more difficult.
Emily Roland:
Also, from a central bank perspective, from a monetary policy perspective, global central bankers are making a huge pivot here, going from really full speed ahead and implementing this almost warlike stimulus, to starting to pump their brakes. We have a key Fed meeting here coming up, and we probably are going to see that tapering timeline pulled forward, and rate hikes into next year. The Fed is really towing a fine line here, and it's going to be tough to get it right. There's an increased chance of a Fed policy accident into next year.
Emily Roland:
I know this sounds like an overly bearish message here; it certainly isn't. There is great fundamental support for owning equities right now. The earnings environment looks good. The economic environment looks good, particularly here in the fourth quarter. We just want to be careful about not adding significant risk or cyclicality to portfolios next year as we head into of this more normal or modest growth environment here in the U.S. And we can talk more about that I'm sure in terms of what that means for positioning.
John Bryson:
Yeah. Let's dig in. I really like that theme “don't get comfortable in the fast lane.” Matt, let's dig in a little bit more. Talk to me about the economy here in the U.S., maybe around the world. What concerns are popping up for you and Emily?
Matt Miskin:
Yeah. As we look into next year, Emily really highlighted some of the things that we're focused on, and that is just that the economy's great right now. You had a lot of fiscal support. You had all the stimulus checks to start this year. You had a supportive Fed. And next year it's just going to be more of the economy having to stand its own two feet. So, you're not going to get the fiscal stimulus. You're not going to get the support from the Fed. But the good news is that the economy's in a good position. As Emily has said, that Leading Economic Indicator is still very much in positive territory. They've actually ticked up a bit into the fourth quarter.
Matt Miskin:
I think for us the biggest risk and what concerns us is, I mean today is Fed Day, and we're looking at the Fed here. As Emily said, they're making a big pivot. They are likely to accelerate some of their ... basically tapering timeline. They're likely to raise rates and they've got to be thoughtful about that. I think for us, the biggest concern is that they could invert the yield curve into 2022 because the 10-year yield has been relatively low. We're talking about 1.4% around there; today 1.45. The two-year yield has crept up. An inversion of the yield curve doesn't mean immediately that we're in a recession. In fact, usually there's a year or so grace period after inversion, maybe even two years in some examples, but it's usually a sign that the Fed is tightening, that the cycle's evolving.
Matt Miskin:
I think for us, the economy looks great right now and we want to be positioned for that. I think as we go into next year, the cycle is evolving, and we want to start transitioning more to later midcycle. I don't think we're there yet. I'm thinking late cycle. That's the steps we're looking to take into 2022.
John Bryson:
Okay. Let's dig a little bit deeper. A lot of what you're both talking about is setting, I would say proper expectations for next year, but let's talk about what you expect from the Fed. Today is the Fed Day, the FOMC will release its results later, if you will, this afternoon. What are you expecting to hear today that people should be aware of? And how does that impact your expectations for next year?
Matt Miskin:
Yeah, so we do expect that accelerated tapering, so they may very well say that they're going to fast forward tapering and be done with it by March. Originally, it was more like mid-2022. So bringing that forward. We've done analysis on tapering; it doesn't really result usually in what you would think. The thought being that usually the Fed is buying less bonds, and when they're pulling back that buying, that yields would actually rise, right? Because less buying, same supply, higher yields. Oddly enough, we looked back the last two times they did this, they stopped QE2, and when they tapered QE3, yields actually fell. Really it was a signal that the Fed is providing less support and Treasury yields fell and more intermediate-term type strategies did better. So that's something you really want to think about as it relates to since the November announcement of tapering yields have fallen, which is actually looking more and more like past examples.
Matt Miskin:
The other thing we're expecting is they provide this summary of economic projections. All the FOMC members get to provide an estimate of where they see the Fed funds rate over the next several years. We believe that goes up. Right now, there's just about one to two rate hikes suggested into 2022. We just think it's more like two. The bond market's already there. The two-year yield's already high. The bond market's already pricing in almost three rate hikes in 2022. So, when you think about what the Fed says, you got to think about it relative to what the bond market's pricing in, or already being priced in. We don't think that they're overly aggressive, but they kind of meet more in line with the bond market.
Matt Miskin:
At the end of the day, though, the Fed changes its mind all the time. So while the Fed says that today, as we go into 2022, if COVID is still an issue, if inflation does come down a bit. If the economy does decelerate, then they can change their mind and they can pull off on that forecast. They're going to probably be hawkish. Inflation's been hot as of late. The market, again the economy looks good, earnings look good. They should be able to weather it for now, but we've got to kind of just really stay on this, stay focused on it because it very well may evolve as 2022 comes about and we got to watch it closely.
John Bryson:
All right. Emily, with all that in mind, how are the conversations going that you're having with advisors? How were you talking to them about positioning their fixed income through this?
Emily Roland:
Yeah, so this has been a tough year for fixed income. In fact, clients may get their statements at the beginning of next year and actually see a negative return for their core bond or high-quality bond allocation. That's actually pretty unusual. It's actually only happened two other times over the last 25 years that we've seen cash actually outperform bonds. And it doesn't make a lot of sense for that to happen because you should be paid more to lock your money up for a longer period of time. So it's a pretty unusual environment. And the last two it's happened very similarly to this year; we've seen a pretty sharp and significant back up in yield. It might seem like yields are low, but we started the year around 92 basis points. So, we have seen that back up in yields that's hurt fixed-income investors.
Emily Roland:
The good news is looking back over those examples in the last 25 years, the subsequent years always offered positive returns for high-quality bonds. So, we do think that this sets up for a better year ahead for fixed income investors, but we still see return potential very low. There's a high correlation between the starting yield for your bond allocation and the subsequent five-year returns. We're at about 1.8% on the ag right now, and that's about what you're going to get.
Emily Roland:
So for a lot of investors, even though we want that exposure, we want those high-quality bonds to be the part of the portfolio that acts like bonds, to be that diversifier, that buffer in periods of higher volatility; it's simply not going to cut it for a lot of the advisors that we work with. So we do want to own credit. We really are favoring corporate credit right now, BBB investment-grade corporate bonds, BB, so the higher rungs of the high-yield bond complex. We also want some bank loan exposure there. And we're targeting about 3% in yield with a combination again of that corporate credit and then some mortgage-backed securities and a little bit of treasuries there again to act as that dampener.
Emily Roland:
So really sort of hitting it down the middle here as far as that mix of credit and duration. We are modestly underweight duration really as a function of our preference for credit here. We want to figure out how to generate that additional income, that additional return potential without reaching too far for risk.
Emily Roland:
One area, you mentioned the conversations that we're having, where we're seeing mistakes frankly being made by investors is those that are overweight, cash, the shortest strategies. I think you're going to you're going to get hurt right off the bat given the inflationary backdrop right there. There's just nothing there in terms of yield potential. We're also seeing mistakes of investors reaching for the riskier parts of the high yield bond market in order to generate that return.
Emily Roland:
We've seen phenomenal performance from the lower rungs of the credit spectrum within high yield. Triple Cs have done great. We just wouldn't chase that into next year. Any sign of risk that we see will probably be sniffed out in this space pretty quickly in the form of widening spreads. So being careful on either side of the spectrum, either very, very low risk or very significant risk within fixed income, we really want to kind of meet in the middle, I guess that's another song, as far as the fixed income market goes.
John Bryson:
That can be the next white paper you have or blog piece. All right, so we've covered the fixed income part of the pie, if you will, quite well. Let's pivot to the other part, equities. Emily, how are you feeling about valuations? How are you feeling about earnings as we look into 2022?
Emily Roland:
Yeah, so we are modestly overweight equities. I think it ties into the conversation around fixed income offering very low return potential. We do think that equities need to do a little bit more of the heavy lifting. From a valuation standpoint, it's hard to say that equities are cheap at this point where the S&P 500 is trading at around 21 times forward earnings, but ultimately valuations have been a terrible predictor of returns. They work over very long periods, say 10 years, but they really haven't had much predictive power at all over one, three or even five-year periods.
Emily Roland:
So we tend to focus on the denominator and the P/E ratio, which is earnings. And over time earnings are going to drive prices. We highlight that often in market intelligence, and we certainly saw it this year. Just looking at year-over-year earnings growth in 2021 for the S&P 500, it was 45%. Yes, the market was up, but earnings growth was up even more. What we saw looking across the globe is that earnings growth in the U.S. was superior to other parts of the world, whether it was non-U.S. developed markets or emerging markets, and that resulted in better performance for the U.S. equity market.
Emily Roland:
So that's really important to us in terms of uncovering what the drivers of returns are. And looking out into next year, we see high single-digit earnings growth. We think that the earnings growth prospects are the best in the U.S. They're fine for non-U.S. developed markets and emerging markets. We think you've got to be a lot more thoughtful there. We really want to have a quality overlay looking internationally. In the U.S., it's really a mix of value and quality, and we're looking for those sectors that can generate that positive earnings growth heading into 2022.
John Bryson:
Excellent. Matt, Emily did a great job of helping us think about how clients should position their fixed-income sleeve. Do the same for us on the equity side. How are you having conversations with advisors on positioning?
Matt Miskin:
Yeah, as Emily highlighted, we’re … the earnings. This year kind of the tide lifted all ships and, and it was life in the fast line. The economy really accelerated it. It did help lift a lot of risk assets. Next year we think it's going to be tougher, and you got to find those companies that grow earnings. It doesn't mean it has to be growth companies. Value companies can grow earnings too. But where we see some of the best earnings prospect globally is in the United States. We just see the U.S. economy better. We see U.S. corporations running really efficiently. We see profit margins still being relatively high, even though we've got all these supply chains issues and higher input costs.
Matt Miskin:
We're tilting more to the U.S. And then within the U.S, we like large and mid-cap stocks more than small-cap stocks. Small caps just typically are an early cycle winner. You want lower quality, smaller cap right out of a recession. Into a midcycle environment, you typically want to tilt a little bit higher, move up in quality to mid and large. So we've got those two as recommended overweights, mid and large-cap U.S.
Matt Miskin:
From a factor perspective, we like value and quality. Value right now is still going to be benefiting from higher inflation, which is still very much in the near term, a huge development and something that can be a tailwind to value. And then quality is looking more into next year, And you want businesses with higher margins, better balance sheets, higher return on equity. That's what quality typically gets you. Those are the two factors.
Matt Miskin:
Sector wise, we still have technology as our quality play. We've got healthcare and industrials as value parts of the market. And even some of our value strategies are looking opportunistically within technology too. Not necessarily the FANG or some of the bigger names, but some of the other names there.
Matt Miskin:
We really see this balance still as the economy decelerates, which we're not there yet. We'll be looking for more defensive options. I'd say in the alternative space, infrastructure remains one of our favorite categories there. Very dependable businesses, any elastic demand for those kinds of services; toll roads, heat, utilities, those kind of things. Again, we're not there yet, but we would start thinking about it for later 2022.
Matt Miskin:
Again, U.S. has some of the best opportunity in the world, and that's really where we're focusing much of our overweights across Market Intelligence.
John Bryson:
Great. Thank you, Matt. Thank you, Emily. I know you're coming out with your next Market Intelligence in January, so I'm looking forward to that. You have been our most popular and frequent best on the Portfolio Intelligence podcast. So, thanks for a great year, much appreciated. I hope you get everything you're looking for this holiday season.
John Bryson:
Folks, thanks for listening. If you want to hear more from Matt and Emily, you can follow them on Twitter: emilyrroland and matthew_miskin. They're great at keeping us up to speed on what's going on in the markets and in the economies, so thanks for that.
John Bryson:
If you want to subscribe to the Portfolio Intelligence podcast, you can do so 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 a great year, everyone. Hope to talk to you soon in 2022.
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 is 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.