Co-Chief Investment Strategists Emily Roland and Matt Miskin weigh in on the recent market volatility and what investors should focus on in the weeks leading up to the crucial U.S. election. The strategists also update host John Bryson on what the latest economic data is hinting about the growth trajectory during the COVID-19 pandemic. Finally, Emily and Matt share their highest-conviction ideas for the equity and fixed-income markets, the outlook for the U.S. Federal Reserve, and what credit spreads and currency markets are forecasting for the markets.
John Bryson:
Hello, and welcome to the Portfolio Intelligence podcast. I'm your host, 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.
John Bryson:
Today, we're going to focus on a capital market update with our Co-Chief Investment Strategists Emily Roland and Matt Miskin. As you may know, Matt and Emily are the engine behind our quarterly capital markets outlook piece that we call Market Intelligence. I'm going to jump right in with Emily and start off with the recent market volatility. We've seen it pick up in September, Emily, specifically in the last week or so. So what is causing this spike?
Emily Roland:
Yeah, thanks, John, for having us today. And we are starting to see markets show signs of volatility here after the September 2 high. We've actually seen markets tiptoe into that 10% correction territory here. And in our view, a lot of the ingredients have been in place for a bit of a setback. Markets have really been just showing an unrelenting pace of gains. We had been up about 60% off of the lows, a lot of bricks in the wall of worry having been discarded.
Emily Roland:
Things like election uncertainty. We're now about 40 days away from the U.S. election and lots of uncertainty there. A lack of progress in terms of fiscal stimulus out of Washington. We've seen a surge in COVID-19 cases, particularly in Europe, start to play out. And we've also seen an extension, or an expansion, in valuations with equity markets reaching around 22 times forward earnings up until the last week or so, which is about as expensive as stocks had been since 2002.
Emily Roland:
So we think markets were, after really accelerating—we just had our best August since about 1984—and we think it made sense that markets are taking a bit of a breather. As of now, we don't think it's the sign of something more sinister than your garden variety correction here. We watched credit spreads to evaluate the warning signs that something worse could be at play here. We're seeing high-yield bonds pick up a bit; they've gone from 477 basis points at the beginning of September up to about 520 basis points as of today.
Emily Roland:
So a little bit of spread widening there. Investment-grade corporates have really gone nowhere, so we're not really seeing any major financial stability breaking down here. And finally, we do think that it can represent an opportunity for investors to become engaged in the markets. There's a ton of cash sitting on the sidelines, about $4.6 trillion sitting in money market funds. Investors have really been hesitant to embrace this bull market. Equity mutual fund flows are actually a net outflow year to date, so that's all sort of a bullish signal that suggests that there may be another opportunity for investors to engage in the market today.
John Bryson:
That's great to hear, and it's always tricky in September—and today's the 24th of September, by the way, just for a reference point. It's always good to hear about opportunities in September, even though we're going to get some volatility. So, Matt, I want to turn to you and talk about one of the things you focus on a lot with Market Intelligence, which is the new jobless claims number. We saw it rise to 870,000, and we're really curious how you and the team and Emily are interpreting those numbers and their impact?
Matt Miskin:
Yeah, the initial jobless claims have remained stubbornly high, and it’s still almost 30 million people in the United States that are receiving unemployment benefits, so we still see that as a headwind to growth. We really need to reopen and get people back to work in due time. But if we look at the overall economy and where we've come from, we have made some significant strides. So the second quarter was horrendous: It was one of the worst quarters in the U.S. economy in history.
Matt Miskin:
But Q3 was awesome. Right now GDP is forecasted to be up about 30% in terms of the Atlanta Fed GDP Now forecast. So that is a massive rebound. But really, the data at the end of September is suggesting that, after such a big rebound and with the lack of that fiscal stimulus that Emily talked about, Q4 might be a low-growth quarter. And one that you're still positive, but it's not seeing that really huge acceleration off the bottom that we saw in the economy. And to us, this means that you want to be well diversified in a portfolio.
Matt Miskin:
And some of the sectors that we still have as higher-conviction parts of the market are consumer staples and healthcare; these are non-economically sensitive parts of the market. They actually tend to do okay, or hold up better, in a slower economic backdrop, and then we're still holding higher-quality growth names like technology and communication services.
Matt Miskin:
These are companies that we think are going to still see positive earnings growth, although low, so we're trying to position for a bit of a shift down in gear of the economic backdrop, but the market can still do well. And this volatility could still be setting up for an attractive entry point here, so we don't want to underweight stocks either, even though the economy has slowed down a bit.
John Bryson:
Great. And you mentioned the stimulus package, and Emily mentioned the election, two topics I definitely want to dig into more. I want to go back to Emily. You said about 40 days until the election. In my opinion, this year, we hadn't talked about the election all that much, but it's totally turned a corner and it is very front of mind for folks. What are the short-term and maybe longer-term implications for the election, Emily?
Emily Roland:
Yeah. This is a discussion that we're having with clients right now, and there is a lot of uncertainty as it relates to: “Will we have a contested election? Will there be challenges with mail-in voting? What if we don't know the winner of the U.S. election for weeks or even, or even months after the election?” And that's actually causing, unfortunately, a lot of investors to go to cash and to hide out as they await the coming election and the results, and we just don't think that that's a great idea.
Emily Roland:
We think staying invested is really important, and we do believe that we could have some volatility, so the best playbook that we have for this is the 2000 election. That's kind of the last example where we actually didn't know who the winner was, and we didn't know for over a month.
Emily Roland:
So we looked at that timeframe, and it was November 7 to December 13. I'm sure everybody remembers the issues in Florida: It was the hanging chads. It was Gore versus Bush. And, really, what we saw was about a 5% correction in the market, so we did see a little bit of a pullback. It was in the context of a longer-term bear market. So basically this was at the same time that we saw the tech bubble unwinding, so it's hard to say.
Emily Roland:
It's very likely, again, that you'd see some volatility around an event like this, but, really, the sort of longer-term economic backdrop, or the kind of the broader story at play, is going to be much more influential, in our view, in the markets. And I know we discussed this the last time we had our podcast, but our view is that the private sector and the economic trajectory have been much more influential in cross asset class returns than the political party who is in power.
Emily Roland:
So we think as long as we remain in this sort of modest growth, low inflation, low-rate environment that should continue to support the high-conviction parts of the market that we believe in right now. And Matt mentioned areas like quality growth and barbelling—that was the more defensive sectors. We don't think this is a great time to load up on high beta parts of the market or cyclical areas. We're going to wait to do that down the road until we have a clearer picture about which direction this economic recovery goes. But for now, just play it, stay balanced, keep those long-term goals in mind, and certainly stay invested, as we know that time in the market is a lot more important than timing the market.
John Bryson:
Absolutely. Yeah, I think we've heard from you and Matt a lot of a focus more on the fundamentals and economic growth and less on the election and its outcome, although many people need to understand that and ask questions about it. So, Matt, coming back to you on the other one. Fed Chairman Powell wrapped up his third day of congressional testimony. What did we learn from him? What are we hearing? How does the likelihood of a new stimulus package from Congress look? And how's that impacting your outlook?
Matt Miskin:
Well, the Fed has already done massive amounts to help the economy. And I think Powell right now is in a position where he feels like the Fed is the last standing source for benefit of this economy. And, really, Powell has rung the bell time and time again this week saying that fiscal policy support is something that should be really considered here in the next several months and that the Fed can't do everything.
Matt Miskin:
Monetary policy does have its limits. They've already cut interest rates aggressively, the balance sheet's already $7 trillion, they're doing ample quantitative easing. In the most recent Fed meeting, they already brought forward a very aggressive, what's called forward guidance, which is they tell you how they're going to predict interest rates in the future. In 2023, they believe that interest rates will still be basically zero. And that is, basically, three years of zero interest rates. We're hearing from other policy strategist around the Fed that it could be all the way to 2025.
Matt Miskin:
So they've done as much as they can in terms of saying interest rates are going to be low for a long time, we're going to be supportive to the Treasury market, the quantitative easing, and the corporate bond market. But, I think, fiscal policy probably needs to be brought forward to really help certain parts of the economy here. Overall, though, for fixed-income positioning, and as it relates to the Fed, the short end of the curve to us is just a really tough place to make money. Interest rates are so low— whether it's the fed funds rate at about 0%, all the way out to five years on the Treasury market is near zero.
Matt Miskin:
The 10-year Treasury is 60 to 70 basis points. That, to us, doesn't look like a great yield, but it's something. And then, to us, you want to find some investment-grade corporate bonds to incrementally get more yield. The Fed is buying investment-grade corporates, which would be supportive. And we think that is a key element to that thesis on investment grade. But we really wouldn't take a ton of risk here.
Matt Miskin:
We're trying to look at select opportunities in high yield, have that investment-grade bias, and then be in the intermediate part of the , because the Fed might not be changing any policy for much of the next five years. So you want to position for that, keep your bonds boring. And we think the Fed is probably going to be less of a factor, in terms of moving around policy and moving around fixed-income markets, in the foreseeable future.
John Bryson:
Yeah. And I think it was you that said on one of our prior podcasts, or maybe it was Emily, not only is it don't fight the Fed, but also buy what the Fed is buying. So having an understanding of where they are and how far fluid their forecast is, is certainly useful information.
John Bryson:
So, Emily, I know you and Matt are both talking to advisors a lot; you have a finger on the pulse of what's going on with them. Maybe you could expand on the equity sides of things. How are you talking with advisors about how they should position their equity portfolios?
Emily Roland:
Yeah, sure. So in addition to questions around the election, which we get a lot of, we spend a lot of time trying to help investors almost get out of their own way as it comes to this kind of intersection between politics and making investment decisions. We're also trying to help them find ways to stay engaged in the markets. And as Matt has mentioned, we want to continue to own risk assets here. Just connecting the dots with what Matt was saying around the Fed, this unprecedented—although I hate to use the word, I think it's appropriate—amount of support we've had from this ultra-dovish Fed policy has been a great, important tailwind for markets. And we want just to help investors continue to own equities, even though, where there's a lot of pushback against that, we just want to be really thoughtful about where we're taking risks.
Emily Roland:
We want to position portfolios to have less economic sensitivity across the board. We're advocating for more defensive sectors, like consumer staples and healthcare, and, really, pairing those with higher-quality parts of the market like tech and communication services, which Matt touched on, as well. It's really about identifying parts of the market that have the ability to provide a good return on equity for investors, areas that have the ability to maintain margins throughout a market cycle: good, solid balance sheets, well-run businesses. This is really where we want to be focused.
Emily Roland:
And the other element of portfolios that that kind of influences is U.S. versus non-U.S. equities. And we have suggested an overweight to domestic equities, the relative economic growth picture is a bit better here. Our earnings of fundamental environment is also improving on a relative basis in the U.S. We did see an environment in which the dollar began to weaken over the summer, which should be a tailwind for international investors. That's starting to come back a bit.
Emily Roland:
We do want to own international equities in a well-balanced portfolio. But we want to lean into international growth over international value. Again, that's another way to notch up on quality in a portfolio and be less exposed to more cyclical areas like banks. You really need a really resounding bounce in economic growth in order to see cyclicality show leadership, and we just don't think we're there yet.
Emily Roland:
So focus on quality, balance is beautiful. I know, the boring old way of investing in bonds, we still believe in it, we still think the 60/40 portfolio is alive and well, even though there's been a lot of ink spilled that would tell you the opposite. And we just think that investors should continue to follow their long-term plan here, and don't be too afraid of election market volatility. The fundamental backdrop is going to end up being a lot more important here as we head forward into 2021.
John Bryson:
Emily, some of the stuff that you said that was rather basic, I thought was the most impactful, that is take thoughtful risk and stick to the long-term plan. Matt and Emily, thanks so much. Love to have you on the podcast as always. Folks, if you want to hear more from them, follow them on Twitter at @EmilyRRoland and @Matthew_Miskin. Also, on October 8, we will be releasing the newest edition of the Market Intelligence book so please make sure to check out our website for more information. And lastly, if you want to hear more, 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. As always, thanks 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.