Co-Chief Investment Strategists Matthew D. Miskin, CFA, and Emily R. Roland, CIMA, discuss why they like emerging markets as one way to position for a new cycle as the global economy recovers from the pandemic. In U.S. equities, they see signs of a rotation to value and small-cap stocks. Meanwhile, bond flows suggest a preference for passive investment, but the strategists make the case for an active approach centered on higher-quality credit and rising interest rates.
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. Today is February 25, 2021, and things are moving. Interest rates are moving, assets are moving, markets are moving, oil is moving, and vaccines are moving.
John Bryson:
So, I thought it would be a great time to reconnect with two of our frequent guests, Emily Roland, and Matt Miskin, to talk about what's going on in the markets. As you recall, Emily and Matt are co-chief investment strategists at John Hancock Investment Management. And, other chief architects behind our quarterly capital markets outlook piece called Market Intelligence. And, if you're not paying attention to Market Intelligence, I really think you should check it out, so go to our website. Matt and Emily, welcome to the call.
Matt Miskin:
Thanks.
Emily Roland:
Thanks for having us.
John Bryson:
All right, Matt, I'm going to start with you. I want to talk about flows; can you tell us how mutual fund and ETF flows are doing in general? And, maybe where are assets heading this year?
Matt Miskin:
Yeah, thanks, John. If we were to break that down into three buckets—fixed income, U.S. equities, and international—we're seeing pretty differentiated views on the overall markets when you look at these three buckets. So, within fixed income, we're actually still seeing a ton of money going into passive investments, highly tied to the Bloomberg Barclays Aggregate Bond Index (Agg).
Matt Miskin:
This is a bit of a head-scratcher to us because it is so Treasury heavy. The Agg index has about 37% Treasury bonds, and passive indices have greater duration, lower yield. We don't think that's going to be a sustainable trend in 2021. We believe it's going to get more active, things like multi-sector bond category, or core plus, or even bank loans. We think that's where assets are going to end up going, but we haven't seen that trend change yet, but it is what we think is in the works.
Matt Miskin:
The second one, U.S. equities. U.S. equities is definitely sniffing out a rotation. What we're seeing is flows are starting to come into U.S. value. They're being removed from us growth, and we're also seeing a preference for a smaller size. So, mid caps and small caps are also starting to see some flows. This aligns more so with our views and Market Intelligence, and we think this is a good trend that is likely to continue throughout the course of the year.
Matt Miskin:
And, then finally it's international, and international seeing more flows than U.S. equities, which can make sense as the rotation that's happening in markets plays out. But, there's a bit more of a preference for emerging markets within the international bucket, which we do think makes sense today, given the reflation and in essence, the better economic growth globally. So, two of the three makes sense to us mostly on the equity side. Fixed income and passive investing, we think they going to be the biggest change this year. And, we're positioning for that within our views in Market Intelligence.
John Bryson:
Yeah, that's really interesting because a lot of the research we've done on my team would say that active management can outperform quite a bit in fixed income. So, finding that alpha with a professional manager should be the number one focus, so any reaction to that?
Matt Miskin:
No, I mean, I think that is also something we've seen because the passive side is just so Treasury heavy. So, I think that is something that is going to become more of a realization this year. But, what we've really had is a tailwind for passive investors for the last several years has been lower, and lower, and lower interest rates. So, you've got this huge tailwind from duration; you're going to probably have that removed from you this year.
Matt Miskin:
So, duration is not going to be a tailwind; you're going to need to find alpha through corporate bond selection, or credit selection, or multi-asset positioning within fixed income and overlay. These are all things that will be additive, and I think that's going to support that research that you highlight very much so this year.
John Bryson:
Okay, and I'm glad you mentioned that tailwind with declining rates because I want to come back to that and see if we're in a reversal. But Emily, yeah, let me bring you into the conversation. I want your thoughts on where you think investors should focus in 2021?
Emily Roland:
Yeah, thanks, John. And, it's really building on the idea that Matt touched on in terms of a new cycle unfolding here. We look at economic growth continuing to improve globally, earnings growth really starting a new cycle here in terms of looking out into the next couple of years, and seeing analysts forecast to continued improvement in earnings growth.
Emily Roland:
So, we do believe that a new cycle is beginning here as we emerge from the pandemic. And, when we look at early cycle environments, historically, they're typically characterized by some of the things that we've been talking about in particular rising rates. And, they're typically led by areas of the market like smaller size and value. I'm starting to see market leadership. So, we do think that leaning into value here modestly, and having an overweight in areas down in market cap, in particular mid caps for us, is a nice way to approach this market.
Emily Roland:
From a sector standpoint, we're looking at areas like industrials as a way to think about this rotation into value and this reflationary environment that's starting to play out. Industrials are an area that so far this year have fallen a bit behind other value sectors like energy and financials. But, when we look at the earnings potential heading into the remainder of the year, we think it's an appropriate place to be for this post-recessionary environment. In particular, one in which we expect to see even more fiscal stimulus.
Emily Roland:
Internationally, emerging markets (EM) is still our favorite way to think about adding sensitivity to reflation and playing the idea of rates backing up here further. When we look at emerging markets, surprisingly, they've actually lagged behind their non-U.S. developed counterparts over the last decade. And they're just starting to break out of a holding pattern that they've been in for the last 14 years.
Emily Roland:
So, it's been a while since EM prices were around these levels, and there are some tailwinds today that didn't actually exist a decade ago. When we look at China and emerging markets broadly, they're really a play on the growing consumer class there. There's a large allocation in areas like technology and consumer discretionary. So, really the complexion of our emerging markets has changed a lot over the years, and we think it's an important place to have an allocation in a balanced portfolio.
Emily Roland:
And, then finally just looking at the fixed-income markets. You all covered a lot of this, but it's really about looking toward active management here, thinking about simply finding ways to outpace inflation in this environment. We got a couple of great years, as Matt mentioned out of high-quality bonds here.
Emily Roland:
And now it's time to really think about rejiggering portfolios for this new environment in which we're seeing rates back up. We're seeing a little bit more volatility, so having an allocation to credit, thoughtfully managed and still having an allocation to bonds that are going to act like bonds in a portfolio, is really the name of the game as we head into the remainder of the year.
John Bryson:
Wow, talking about inflation, talking about rates backing up, how much can change in a year. So Matt, Emily had mentioned, we're seeing some strong economic growth and she mentioned stimulus also. I want to dig into the stimulus comment. We've seen a lot of fiscal stimulus over the last year, and there's certainly talks of more. How are you thinking about the role of that stimulus in the likelihood for more, and how does that maybe impact infrastructure here in the U.S.?
Matt Miskin:
Yeah, so the prospects of further stimulus here are very likely to manifest themselves in the next couple of months, and we're looking at a $1.9 trillion stimulus package. The calculus behind this is really firmed up in the last couple of months, and it is political in nature because the democratic sweep in essence has made this a much more easy package to get through. And you think back of where we were last summer, the CARES Act was $2.2 trillion, and after that the Democrats and the Republicans were discussing fiscal stimulus.
Matt Miskin:
And even the Democrats back then had suggested something along the lines of more like $2 trillion. But, what we actually are receiving now, because in January, we already got a $600 billion stimulus package that was kind of just already embedded in the budget, and then we're going to do $1.9 trillion. This is even more than the original Democrat proposal that was the kind of the negotiation starting point between the Republicans. So, we're blowing out of, in essence, what we thought was the stimulus parameters we were looking at going into this year.
Matt Miskin:
What does this mean? One, I think it means that you can't just run a deficit and not have ramifications for it. And, I think this discounts that whole MMT, modern monetary theory, a train of thought that had been developing. If you run a big deficit, which we're on the brink of doing, we're already doing it, but we're going to really do it even more, that you got to pay for. And, Treasury yields are moving higher on the back of that, and it really comes back to the Fed now, and what is their reaction function to this.
Matt Miskin:
So, if the Fed does not increase quantitative easing (QE), they're already doing it, they're already doing QE, but they're not saying they're going to increase it. It's likely the 10-year [Treasury] is going to continue to push up, and I think [Jerome] Powell and the Fed is going to have to decide what point is the 10 year going up too much, where it's going to feed into the housing market because mortgage rates are tied to the 10-year Treasury. If the 10 year goes up too much, that's going to lead to higher mortgage rates, which leads to a weaker housing market.
Matt Miskin:
If you increase Treasuries overall because of the stimulus package, then that increases borrowing costs across the board for corporations and consumers. So, that's a negative impact of this. So, we've got to make sure that the Fed actually pushes back on this, or enables this not to get out of control. And, we think that's a development that could happen this year, but really it goes back to what Emily was saying within fixed income.
Matt Miskin:
If we're going to do all this deficit, and it's going to cause yields to rise, then you need to think about other ways than Treasuries to make money within bonds. And, that's getting more active in finding differentiated ideas there, and that's really what we're highlighting again.
John Bryson:
Got it, and then if it does play out to come back to the infrastructure thought, is that a positive way to play the stimulus package? Is that a way that you're talking to your clients about in a regular basis?
Matt Miskin:
Yeah, so the infrastructure—And, I'm sorry, didn't hit this on the first one but it was so long-winded. But, infrastructure in general, so we're starting to see a discussion more of that there might be less state in local aid and more infrastructure spending as a part of this stimulus package. So, that's something that's developing real time. Infrastructure will likely be a multi-year spending program.
Matt Miskin:
And, what we have found infrastructure wise is that you want to—The companies that will likely benefit the most will probably be more in the mid-cap space. So, think of companies that are not massive global players, but more are local players, and that's why it's more mid than large. And, then within mid it's more industrials material aggregates. These kinds of companies that are going to be doing either the cranes, the trucking, the materials, the equipment that you need for that.
Matt Miskin:
And so in essence, it brings you to meet cap value, because that's where much of the industrials sector is found is in mid-cap value stocks. These are cheaper types of stocks that would benefit positively from an infrastructure bill because they'll see increased demand. So, I mean, that's a part of our view anyway, because it helps that seeing a nice upswing in earnings, it's seeing an upswing from economic growth improving. But, infrastructure would be a nice kicker as well to see those companies improve.
John Bryson:
Okay, thanks Matt, and for the squares, I don't think you're long-winded unless you were saying my question was long-winded then I disagree with that. So, Emily, I want to pivot to you, talked about the fact that what a year it's been. If we look back to last August, I mean, you remember August, that was one of those warm months where Texas wasn't frozen over and there's no snow on the ground.
John Bryson:
U.S. Treasury 10 year was at, I don't know, 55, 60 basis points, and now it just crossed 144 basis points. So, this change in trajectory for the 10 year in rates in general, is it a trend or is it a temporary dislocation? And, how are you playing that in your views and exposures going forward?
Emily Roland:
Yeah, the 10-year Treasury seems to be backing up by the minute here, and frankly, we've been surprised by how rapid the back-up and rates has been. And, the key reason for that is that the economic data that we typically use, that we normally point to in terms of evaluating the direction of yields, it's just not there. If you look at, for example, the jobs market, there are still almost 10 million Americans who had jobs a year ago, who don't have them today. So, there's a huge amount of slack in the labor market, which normally wouldn't support this back-up and rates.
Emily Roland:
The other key piece is inflation. It's still very much contained here, so the bond market is telling you that inflation is going to move up, we're just not seeing it yet. When we look at CPI for the month of January, it came in at 0% on a month-over-month basis. So, this backup is really, in our view, a somewhat a response to more fiscal stimulus in the pipeline which is what we've been talking about. But, even more so this risk on mentality that's really been pervading the markets, and so people are selling high-quality bonds and they're buying our risk assets here.
Emily Roland:
As we think about positioning for this, it's really about the first kind of looking to see, again, Matt touched on this, how does the Fed react to this. The line in the sand for the 10 year over the last 10 years or so has been right around where we are now, 14, 15. And, we're going to need to see—If these levels start to bring in buyers, some of the technical strategists that we listened to as suggested that this may be an area of support where buyers start to come in.
Emily Roland:
So, we want to be careful here in terms of really kind of fully rotating a portfolio toward higher rates, as we do think there are some limits in terms of how far we go here. So, it's really about having some sensitivity to that as we've talked about, and potentially this is an environment in which equities have to do a little bit more of the heavy lifting in a 60/40 portfolio. And, as we look back on the last six or seven months of rising Treasury yields, and we look at cross-asset class performance, it's been a pretty great environment for equities.
Emily Roland:
Some of the areas that jump out to us again are smaller size, mid-cap equities, and emerging markets. Having a value tilt in the portfolio has been a really strong area of performance in this rising yield period. So, having some of that, looking to parts of the portfolio to benefit, but also really continuing to have a focus here on quality to balance that out in a portfolio.
Emily Roland:
So, just because we want to embrace value and more economically sensitive cyclical areas of the market, we want to have a modest tilt there. And we still want to maintain a quality approach to this market in the event that we do see some volatility start to play out in equity markets.
John Bryson:
Got it. Now, Matt, Emily has just said there's fear of inflation, but we're not really seeing it in the numbers per se, quite yet. I want to hit on oil and the fact that it's now over 60, and I'm hearing some calls for 80 or a hundred. I want to understand your thoughts and the networks’ thoughts on expectations for oil going forward. And how does that impact stocks and inflation overall if it continues to rise.
Matt Miskin:
Yeah, well is a tough one right now because it's so supplied driven. And what I mean by that is there's—The demand side of the equation is not heating up that much yet. We've looked at the energy information agencies kind of outlook, and they're seeing demand isn't going to be above 2019 levels in 2021. And, that's logical because we're not going to be fully reopened by mid-year and minimum.
Matt Miskin:
And, so I think the demand side is going to take longer, but what the supply side is, one, everybody cut production globally with OPEC, primarily, being the biggest production cuts. And, they're all kind of, I think, they're all looking at each other saying, "All right, when are we going to increase production?" And, there's a lot of money to be left on the table right now, because oil prices have stamped back at $60 a barrel. All major producers of oil can make money on this.
Matt Miskin:
And the U.S., for example, has really dropped its rig count. It's a number of rigs that are producing oil. The U.S. needs to get that rig count back up, and needs to get production backup. U.S. can counter the OPEC kind of choke hold on the oil market by becoming a bigger producer. And, that's the way that we really need to see oil come down, is to see greater supply come from the U.S. in our view in 2021.
Matt Miskin:
So, that's something we think is important, we think it's important for the U.S. economy because oil and energy resources have become a bigger and bigger part of the U.S. economy over time. So, that supply dynamic needs to change for oil prices to stop going up at this rate, but that is something we think could develop over the course of the year.
Matt Miskin:
And then, in terms of inflation, you think the headline CPI is going to have gas prices, obviously, as a part of that calculation. And gas prices are going to be going up, so that is going to lift the headline inflation. The core inflation, which removes food and energy, is not probably going to see as much of a tick up and that's what the Fed looks at, is core. And the reason why ... I think you look at the core right now, and a lot of that is housing. And think about it as renters equivalent, so rent is the biggest cap part of the core inflation calculation. And rents aren't going up, in fact, rents are coming down in major cities all over the country.
Matt Miskin:
So, what you're seeing is core inflation's remaining subdued, but oil and gasoline prices are likely to lift the headline. And, we would actually fade that a bit, we don't think that's going to blow out to the upside. We think that the oil market is going to see increased supply this year. There's already a lot of good news priced into the oil market. I'm sure we can go back up 70, $80 a barrel, but I mean, there's just so much untapped resources that are available on the supply side. We think that comes into the market this year, and helps put a little bit on this explosive move on oil.
John Bryson:
Yeah, thanks for kind of peeling back the onion on that, because I know that's on a lot of people's minds, and it's really helpful for you to go deep on what you should be paying attention to in terms of inflation numbers. Maybe not just the headline, but the core and digging a little bit deeper. So, we've covered a lot of ground so far, I've got two more topics I want to hit real quick. I know you're both busy, and I'm going to let you get back to your day jobs. So Emily, coming to you, U.S. dollar, it's been weakening since the middle of last year. Do you think this will continue? Or, are we at an inflection point where it's going to reverse?
Emily Roland:
Well, thanks, John. This is our day job and we're more than happy to be with you today. I think you've hit on some of the really critical questions right now, and certainly the dollar is one of them. And, just to back up on that, the U.S. dollar, the direction of the foreign exchange (FX) markets have really key implications for cross-asset class performance. In particular, in periods of weaker dollar, environments that tends to be a benefit for your non-U.S. equity allocations, in particular, emerging markets has a lot of sensitivity to that.
Emily Roland:
So, as we watch the dollar weaken, and it's down about 9% over the one-year period versus a basket of currencies. Just looking at the DXY Index, that has been a tailwind for a year. And it's a reason that we've increased our exposure to emerging-market equities, the recognition that, that's a way to sort of play this trend. I've used a little bit different on why the dollar has been weakening. There's a lot of theses out there about why it's happening, but let's just remember that this has been a risk-on environment.
Emily Roland:
Investors have been reaching for riskier areas of the market, and emerging-market currencies, other global currencies other than the dollar. The dollar is a safe haven or a risk-off currency, and that's the reason primarily that it hasn't caught a bit over the last year. We are at an inflection point.
Emily Roland:
Now, the dollar is kind of hanging in here year to date. It's come close to touching it's early 2008 lows of about 88 on the DXY, and we're continuing to get there and then kind of bounce higher. So, we do think that the direction of the dollar is going to be important here. We're watching it closely. Ultimately, we think that a shift in sentiment could really be kind of the key driver here as far as the next direction. So, we'll have to watch that closely and see what the implications are across markets.
John Bryson:
Thanks, Emily. And Matt, last one, we learned all of us early in our career that stock prices, they follow earnings. Give us a look at how earnings are doing this year.
Matt Miskin:
Well, to start, let's go back over 2020. In 2020, I'd say earnings came in way better than expected. For a recession year, earnings were only down about 12% year over year. In a typical recession year, earnings are usually down 30% to 40%. So, when clients ask about, how is it that the market's at all time highs? Or, how is it that this has come back so fast? Well, earnings have come back and they didn't drop as much as most times what happens in a recession year, so I think that's the first starting point.
Matt Miskin:
In Q4, we're actually seeing year-over-year growth. Again, that is a very abnormal thing to see in a recession year, but I think that speaks to how quickly the recovery has been. And, then for 2021, analysts are expecting North of 20% earnings growth. And, then again in 2022, another double-digit earnings growth off that, and so the market's forward looking, it's been improving earnings.
Matt Miskin:
And, as Emily and highlighted earlier, it's likely the beginning of a new cycle. Where these businesses had a tough year, not as tough as a typical recession, but earnings were curtailed. But, you get a stimulus package, you get a reopening of the economy, and corporate profits likely continue and improve in 2021 and 2022. And we think the key is the earnings component of the multiple on the market and as earnings approved, stocks to likely follow suit, and that's really what we're focused on in the years ahead.
John Bryson:
Excellent. Matt and Emily, always great to talk to you. I can't wait for your next tweet. Folks, if you want to follow them, they're on Twitter, emilyrroland and matthew_miskin. Emily, maybe I'll ask you, if somebody wants to get the mid-quarter checkup on Market Intelligence, what's the best way for them to track it down?
Emily Roland:
Yep, absolutely. It's available on our website, we started providing mid-quarter updates a few quarters ago, just updating all the relevant data. So, go to our website, reach out to your local business consultant, and they can get that for you. And then we'll be quickly producing the next version of Market Intelligence as well. And that one will be out in early April.
John Bryson:
Excellent, looking forward to it. Looking forward to talking to you all, probably in a couple of weeks. Folks, thanks for listening. If you want to hear more, please subscribe to Portfolio Intelligence podcast on iTunes, or visit our website jhinvestments.com to catch up on all the things that we're talking about. Thanks so much for listening to the show.
Important disclosures:
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.