As markets continue to mend despite still-difficult economic conditions, Co-Chief Investment Strategists Emily Roland and Matt Miskin update host John Bryson on how their investment forecasts are faring in 2020. Their tilt to higher-quality segments of the equities and bond markets have been a tailwind, but high-yield bonds have rebounded more than expected. The strategists also describe why they continue to see a Nike “swoosh”-shaped economic recovery, rather than a rapid V-shaped bounce. Finally, Emily and Matt look ahead to the November election and explain why investors may actually want to pay more attention to the macroeconomic backdrop rather than letting politics influence portfolios.
John Bryson:
Hello and welcome to the Portfolio Intelligence podcast. I'm John Bryson, your host, head of investment consultant 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. Today is August 12th, 2020. And I'm joined again by Emily Roland and Matt Miskin, our co-chief investment strategists at John Hancock Investment Management. We love connecting with Matt and Emily. They always give us good insights as to what's going on in the market. They recently published their quarterly capital markets outlook piece that we call Market Intelligence. And we're going to hear about that from them. And we're going to hear about the year so far. So Matt and Emily, welcome to the call.
Emily Roland:
Thanks John.
Matt Miskin:
Thanks John.
John Bryson:
So Emily, let's start with you. Can you recap the year so far? And which specifically of your team's market calls worked out and which ones didn't?
Emily Roland:
Well, thanks again for having us. And it's almost exhausting to even think about the first half of the year and think about how far we still have to come in 2020, which has been a challenging one across the board. But I think certainly from an investing perspective, one of the hardest periods that we've seen historically. We saw this 20% decline in the equity markets in the first quarter, and then this major snap back in the second quarter, with stocks up over 20%. And now to start the third quarter, we're off to the races here again with equity markets up about seven percent. So lots of massive swings here. And we're proud of the way our views have played out in this environment. We stuck with our guns coming into the second quarter. We maintained our benchmark way to equities coming into the quarter, sort of resisting the impulse to fully de-risk the portfolio after such a massive draw down. We've continued to maintain a high quality bias in the portfolio. Quality's been among the best performing factors. And then having duration in our views via a overweight to high quality bonds. That's been a tailwind for us. Owning investment grade corporate bonds is one of our highest conviction ideas has also benefited investors. And then having overweight to, again, quality growth sectors like technology and communication services has also been an area where we've out performed.
Emily Roland:
There's always things we've missed. We're not perfect. Matt might be, I'm not. So there's a couple of things that have happened. Having an underweight to high yield bonds in the first half of the year, was a good thing. There were some risks inherent in the asset class. We wanted to lean into higher quality parts of the fixed income market. But there was a big opportunity to embrace high yields coming into the third quarter. We missed that. I think it happened fast. We saw this massive sort of narrowing in high yield bond spreads with yields coming down as we saw the fed sort of step in and provide liquidity to the fixed income markets. We did have, again, a mild credit bias in the portfolio. We have an overweight to areas like triple Bs that has benefited investors. But certainly, being able to identify that catalyst for high yield would have been important. I think we've missed that trade at this point.
Emily Roland:
Within equities, when you think about our overweight to US equities, that does extend to both growth and value, growth has had a great run. We've been happy to be overweight there. But value of course still has a ways to go in order to catch up. We did sort of take that value overweight from international equities. So it doesn't hurt quite as bad as international is also down from the year. But I think having that exposure to US value has been a challenge. We do think that there's a big opportunity there to see value sort of catch up as we start to see economic data improve.
Emily Roland:
And then finally, healthcare has been the one sector that we've owned that's been a bit of a drag. We still have a lot of faith in the sector. I think there's some political risk there that's sort of being priced in that may be overdone in our view. So broadly speaking, very happy with 2020 so far, and certainly the challenging environment continues as we head into the back half of the year.
John Bryson:
Yeah. Great job threading the needle on a number of those things. I guess my next question would be for Matt. When you're talking to advisors, are you still advocating for an overweight to quality to extend the duration? Are you still thinking US-focus versus international or what else has changed and is on your radar?
Matt Miskin:
Yeah, so, we've had a tremendous run in risk assets to start Q3. And there really hasn't been much of a hiccup in terms of the markets yet. And, we're hesitant here to kind of go over-extend ourselves on risk across our view. So we still like quality as a core element of the equity part of the portfolio. We still like satelliting around it, mid caps, some US value. But international is a place where we have become more interested. And one of the things that we did over the course of the quarter was we downgraded infrastructure as a theme on the international side and utility stocks in particular. We were really defensive even in our views on sectors internationally. And what we've done is we've moved to a broader way to implement international, calling on quality growth outside the United States as a compelling opportunity, sectors like healthcare, consumer staples, industrials, even some technology.
Matt Miskin:
And what we're seeing is internationally the earnings backdrop is still a little shaky. It's not bouncing as much as the US. We're trying to attack that earnings headwinds with a better implementation strategy. That quality growth to us is a compelling way to do it. In international overall, based on kind of the dollar weakening a bit and some more broadening of global equities, we do think you want to be opportunistic there. And that implementation shift to us is the first step to get the beta right in that bucket and asset class. And we'll see where kind of earnings trend in the next couple quarters. But for now actually we're keeping that slight US versus non-US bias because the earnings in the US still look a little bit better. But with that implementation change, hopefully we can overcome that earnings headwind.
John Bryson:
Okay. I want to talk more about earnings and dig into that. But first I want to come back to Emily and really talk about economic growth. We've seen a big disconnect between what the market's doing and what we've seen in terms of economic growth, but it's kind of come off that bottom. What are you seeing for economic growth as we look at the second half of the year?
Emily Roland:
So we do expect the pace of the economic recovery globally to moderate a bit. We've seen this really sort of important bounce off of really depressed levels if you look at things like PMI data, if you look at some of the improvement that we've slowly seen in terms of the jobs market healing. But the hard work really starts now. And coming off of those deeply depressed levels was somewhat expected. And we look at the April data sort of being the worst of it, and that's certainly behind us. And we don't expect to see a reversal in terms of the economic growth trajectory. But things are getting a little bit more challenging now. We're seeing things like consumer confidence, small business optimism start to take a breather here. Certainly the delay of some reopening economically speaking is putting some pressure on some of those key high-frequency data elements that we look at on a regular basis.
Emily Roland:
So we need to be careful here. Matt mentioned that the markets are really sort of priced in a very optimistic scenario here. We don't want to go over our skis with taking risks. And that really gets back to a lot of the comments that Matt made around our positioning, continuing to lean into high quality. We're not ready to call the all clear here in terms of the trajectory of economic growth. We're encouraged by some of the data, again. But we do think that the path from here remains bumpy, uneven, inconsistent. We want to continue to have that quality bias within the portfolio, but we also want to be aware of the fact that equity markets can continue to climb higher from here if we continue to see sort of positive news on the economic environment.
John Bryson:
I know earlier in the year, you talked about, both you and Matt, less of a V-shapes recovery and more of a swoosh shaped recovery, the Nike swoosh. Does that still hold and that's consistent with what you're thinking?
Emily Roland:
Yeah, it does. That's consistent with sort of that nice rebound off the bottom and then some moderation of the data as we sort of get on track. You have to think about how challenging the economy still is. We've got an unemployment rate of 10%. We've got a massive demand pit from COVID-19 across many parts of the economy and markets. And I think that's something that we're going to continue to need to contend with. Again, we're very encouraged by some of the improvement that we've seen, but it's going to take a while for us to get back to those pre-pandemic levels, which is consistent with that sort of Nike swoosh or fish hook-shaped recovery that Matt has laid out.
John Bryson:
Great. Matt, I want to come back to you. You did mention earnings and I want to come back to that. How have they held up over the last quarter? How do you feel about them going forward? Can earnings help us maintain this market that's hitting all time highs on a daily basis again?
Matt Miskin:
Yeah, so we've looked back on Q2, I think that earnings were really feared to be much worse. So anywhere in the ballpark of negative 45 to negative 50%. And you look at the GDP data, you look at some of the other economic data and we kind of translate that kind of economic backdrop to the earnings backdrop, that's how it looked. Well, when we look at the actual results and we're 90% of the way through now, Q2 results, we're tracking about negative 34%. Which, I know when you hear down 34% on a year over year basis, that doesn't sound great. But when you were expecting more like negative 45 or so, or negative 50, you'll take it. And what we've also seen is that the trajectory of earnings revisions on the S&P 500, which are really important for the price to earnings ratio that often is cited that the denominator that is actually the next 12 month earnings, those earnings revisions have started to increase. So they bottomed. And as analysts look out over the next 12 months, they're starting to see an improvement in the earnings backdrop.
Matt Miskin:
And we really do need this earnings engine to come back online because we are tapping out the multiple expansion component of the returns that we're getting. We're just about north of 22 times forward PE. To put this in perspective, the highest that it's ever reached was in 2000 at 24 times earnings. So we're getting close to kind of maxing out that multiple expansion component. But the earnings engine is starting to come online. And as long as that continues to trend higher, meaning earnings quarter over quarter and year over year, continuing getting better and the market can grow into this. And we think that the US market still looks compelling to us as a result of that.
John Bryson:
Thanks, Matt. And I want to expand on that a little bit further, and maybe I'll pull Emily into the conversation. As we talk about equities and we talk about the US opportunity versus the international opportunity, I know that Emily, you and Matt both pay a lot attention to the US dollar and you've seen it break down and now it's hitting levels not seen really since two years ago, we'll call it. What does that mean for international equities going forward? And how are you thinking about positioning portfolios with that in mind?
Emily Roland:
Yes, there's really three things that we look for in order to think about a more sort of positive view on international equities. And one of them is seeing evidence of a weakening dollar. And that's something that we've seen play out really since the end of the second quarter. And we look at the DXY, which is the broad trade-weighted dollar, it's down about six and a half percent over the last three months. So that's pretty meaningful. And our research tells us historically that in regimes where the dollar is weakening, it makes sense to be invested internationally. Usually that is because we see better relative economic growth overseas, or we see interest rate differential start to sort of play out.
Emily Roland:
This weaker dollar regime is a little bit harder to identify the catalyst for. One thing that we think a lot about is COVID-19 itself. And the fact that we've seen sort of a "cleaner opening" play out overseas, which has benefited economic growth there relative to the US, it's awfully hard to use COVID-19 as an input to our analysis, simply because we don't have much of a playbook for it at this point or one at all. So we're not quite yet in the dollar camp, in the weaker dollar camp, until we can really see evidence that economic growth is topping US economic growth overseas. We've seen some signs of that. So PMI has improved on a relative basis. Purchasing managers indices, which is one of our favorite gauges of economic health have done a little bit better overseas. And by the way, that's our sort of skin condition for wanting to more fully embrace international equities. We're seeing very early signs of that starting to play out. But our third condition is really something that Matt really hit on, which is that the earnings environment remains challenged overseas relative to the US. So we'd like to wait to see that third piece of the puzzle come into play before we more fully embrace international equities. But again, having a quality growth approach there we think is appropriate.
John Bryson:
Excellent. So bringing it back to home, I'm going to talk about my home. I just refinanced and I'm really happy about that on a personal level. But when I think about it across the market, yields are so low, it's becoming more and more difficult for people to find yield and the credit markets are getting more and more challenged. What are you telling advisors to consider as they think about how to position their fixed income portfolio? Matt, maybe I'd like to hear from you.
Matt Miskin:
Yeah. It's a great point. Mortgage rates did just come down near all time lows again this morning. You're seeing mortgage applications continuing to remain strong. And what you're seeing is the Fed policy is working. It is helping consumers refinance at low interest rates. It's helping corporations be able to roll debt into a new... Issue more debt. And then basically you take the old yields, get newer, lower yields. There's plenty of liquidity. So these are all good things. And that's what the Fed is intending. But when you're the buyer of fixed income and looking for opportunities, you've got to do the homework on the underlying risk that you're taking on some of these bonds.
Matt Miskin:
And when we look at high yield right now, the yield to worst on high yield is 5.3%. In fact, there was actually just a high yield bond issue where they came out with a sub 3% bond issuance, and that was the lowest on record. What you're seeing is high yield isn't high yielding anymore. It is more low yielding. And where we're struggling with high yield right now is the valuations are so rich, the underlying fundamentals are far from strong. We still see companies that are in essence having solvency issues. And so for us, you'd really want to be careful chasing income right now, chasing return within fixed income. And we continue to go back to the boring, basic, kind of core fixed income strategies of a intermediate type strategy, because the short end is yielding so little, the longer end can be very influenced from day to day price swings and volatility. So the middle of the curve looks good to us. And then a mild credit bias, so investment grade corporates as an overweight, mortgage backed securities, and then just kind of sitting there with some treasury bonds.
Matt Miskin:
But it goes back to kind of how I started with the conversation going to we haven't had a risk off environment really since March. The market's been melting up and pretty much just continuing this risk on tone. And we want fixed income in there for when it goes to risk off. And when equity sell off and fixed income holds up for us, and we're not losing that kind of narrative or thesis. We're very much keeping that in line. And so core fixed income, core plus fixed income, trying to find two to three percent yield today in the mix of MBS investment grade corporates is ideally how we would look at fixed income. But it is going to be a tough time. I think we have to look for any pockets of disruption in fixed income opportunistically in the next several months. And if you do get some dislocations in the market, active strategies likely will take a good look at that. And that's what we're hoping for to generate incremental returns as we look out at the next 12 to 18 months.
John Bryson:
Great. And the last topic that I want to cover today that I think is becoming more and more important to our Pfizer base is the November election. In a normal election year, we spend a lot more time talking about it throughout the year. It's been rather quiet, but yesterday Biden announced his VP pick, Kamala Harris. Does that appointment change your thoughts on a November election and maybe just your thoughts in general as we head into election season?
Emily Roland:
Yeah, John, pretty hard to believe there's now 83 days left until the US presidential election. And I think investors are certainly returning to that as they think about sort of where their position. And in terms of Kamala Harris, personally, I would say I think it's very exciting that we do have the first black woman to run on a major political party's presidential ticket. It's an exciting time for the country in that way. But as far as the investment markets go, it really won't have much of an impact in our view. And in fact, we spend a lot of time trying to really think about ways to minimize politics in terms of making investment decisions. And we recognize that's hard for investors. It's a very personal thing. It's an area where we can really feel our sort of emotions getting in the way of making good investment decisions.
Emily Roland:
But when we actually dig into the numbers, which we do in our latest version of Market Intelligence, what we found is that when you slice and dice market returns based on various political regimes, it's actually pretty hard to find any real meaningful patterns in terms of out or under-performance based on a Democratic regime, a Republican regime, a different type of setup where it's a sweep or a divided government. We really weren't able to really find a lot of conclusions in terms of when you want to be invested based on the political regime. And in fact, what we found is that the macro environment plays a much bigger role.
Emily Roland:
One thing that we did recently was just look at the returns under the last four years under Trump versus the previous four years under Obama. And what we've found is that market leadership was nearly identical. At the top we have areas like technology, large cap growth, consumer discretionary, US equities. As the bottom we have areas like commodities, energy, international equities. Very, very similar performance profiles. And the reason for that is that the economic regime has really been very consistent over the last eight years. We've had low growth, we've had low inflation, we've had easy monetary policy. And that's benefited sectors that offer more growth than the broader economy, more pricing power. And it's hurt areas of the market like energy and materials and commodities, which are more tied to the global economic cycle. So we actually would encourage investors to think more about the macro regime. And the fundamental backdrop is not discussed in the conversation on earnings. And really try to sort of minimize politics in terms of making cross-asset class decisions as we head closer to the election.
John Bryson:
Makes a lot of sense to kind of make sure you focus on the big picture and the long term. I know you both advocate smart, cautious investing and dollar cost averaging. I'm going to imagine that that continues to be the approach. I want to thank you both for being on the show. It's always good to talk to you and get your latest insights to the audience. Make sure you follow both Matt and Emily on Twitter. They're active on Twitter. And if you'd like to hear more about what John Hancock Investment Management is talking about to help you build your business, make sure you subscribe to Portfolio Intelligence on iTunes or visit our website jhinvestments.com to get our latest. 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 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.