Here are a few highlights from the conversation today:
- “The election is quite close, but there is no big wave. And that means there’s likely to be less stimulus than had there been one.” – Stephen Dover
- “The blue wave is not happening and that has serious implications for the level of stimulus that we expect. It also has implications for the way that that stimulus gets to the economy, how much of it we get and ultimately what that means for our future growth rate, not just from here until inauguration day, but really through calendar year ’21.” – Gene Podkaminer
- “The question now is not, how do we deal with the next recession? We’re certainly in that next recession or that next trough, but how do we get out of it in a way that makes sense for a lot of the industries that are at risk?” – Gene Podkaminer
- “Tomorrow’s inflation expectations are really driven by today’s policy outline. Monetary policy directly determines, and influences what happens with inflation. So while global inflation is currently modest, that could change with a really strong growth outlook.” – Gene Podkaminer
Stephen Dover: Welcome, Gene.
Gene Podkaminer: Thank you, Stephen. It’s a pleasure to be here today.
Stephen Dover: The election is quite close, but there is no big wave. And that means there’s likely to be less stimulus than had there been one. There is likely to be not the big tax changes that there were thought to be. No big large green infrastructure plan and probably fewer changes in health care. The markets have reacted quite positively to what’s going on at this point. But Gene, what’s your take on the current investment environment?
Gene Podkaminer: Yeah, there is a lot going on, like you said, and you’ve only really touched on part of it, which is the global implications of the US election. There’s also, of course, the elephant in the room, which is the coronavirus situation, which continues to evolve. In addition to everything else that you mentioned earlier, I believe that now everybody, including myself, is an amateur constitutional scholar and amateur epidemiologist. And so, I’ll certainly weave that into some of the commentary here. As we think about portfolios writ large, and as we think about a time horizon that extends beyond the next month or two, but really encompasses a year or longer, we’re trying to build durable portfolios based on a couple of macro factors, including what happens to global growth, global inflation, and of course the efficacy of monetary and fiscal policy. So as we put all of that together, it’s a lot less about who wins the top of the ticket, but much more about what are the global ramifications of a divided US government. What does that mean for stimulus and how does stimulus translate to future growth? Does that growth necessarily drive up inflation and how do policymakers react and respond to new conditions as they see them on the ground that may be, of course, caused by coronavirus. It may be caused by a partial recovery to the trough that we’ve seen before. So there’s a lot to process here. And of course not all of it is immediately knowable, but as you mentioned, the market has sent some pretty clear signals and it seems like the implication is that there is some degree of certainty and maybe certainty isn’t exactly the right word to use, but we can certainly rule out some scenarios that aren’t happening. As you mentioned, the blue wave is not happening and that has serious implications for the level of stimulus that we expect. It also has implications for the way that that stimulus gets to the economy, how much of it we get and ultimately what that means for our future growth rate, not just from here until inauguration day, but really through calendar year ‘21.
Stephen Dover: So it’s been interesting if a lot of analysts, when they look at the market the last few weeks, you know, the argument is that because of stimulus going to happen or not happen, there’s less likelihood of stimulus. But the market’s actually rallied, the last few days. I’d argue part of that is because there’s more clarity, like you said, actually in terms of the outer dimensions of what might happen politically and also interest rates have weakened a little bit, so there’s more fuel for the economy, but what is your outlook particularly for stimulus? How important is that to your asset allocation decisions?
Gene Podkaminer: Stimulus is becoming increasingly important. Over the last couple of years, as we’ve hit the lower bounds for the efficacy of monetary policy. So as interest rates really crept down pretty low to the point that policymakers like the Federal Reserve and other central banks don’t have a ton of firepower left. There’s been a passing of the baton from that monetary policy to fiscal policy, which is, of course, guided by government. And it allows government to infuse cash into the economy, preferably to individuals and to sectors that need that cash to continue functioning and to continue to grow. So the importance of fiscal policy at this point really can’t be understated. It is hugely important. And I think what’s also interesting is that everybody’s doing it in a slightly different way. So if you look at the way that the US is talking about fiscal policy, it’s different than the UK, it’s different than Europe. But what remains the same is that, it is hugely important in providing a lifeline to the economy and stimulating growth so that we can get past the current issues and move on to a time where that growth will really start paying dividends. Up through January or February, global markets, for the most part, we’re on a tear as you know, and that has changed materially. The question now is not, how do we deal with the next recession? We’re certainly in that next recession or that next trough, but how do we get out of it in a way that makes sense for a lot of the industries that are at risk?
Stephen Dover: What’s your thinking in terms of adding risk or not given the election and the path of the COVID.
Gene Podkaminer: And so the way that we’re thinking about risk this year is maybe a little bit different from the way that we normally do. It depends on the time horizon, there’s a really strong dependence on, do you view your portfolio out through the next year or two or three, or are you fixated on a point in time that is date certain? And as we came through the beginning of this year, clearly coronavirus was an unknown-unknown, started to really send ripples through the entire global ecosystem. And there did come a time that it did make sense to lean into risk through August. And once we got to August, there were two things that were on our minds. One was, of course, the US election and the implications of it. And the second one was what happens to COVID from here. So what do treatments and therapies look like? What does the spread look like? What does the economic impact look like? And arguably, the COVID situation is more serious than the election situation because the election will have an end. I think a lot of participants in the voting process really wanted that end to be on election day. Today’s Thursday and we haven’t quite hit the end of that yet. But the point is that when you shrink your time horizon, typically that means less opportunity to take risks now that we’re through the election and we can snap back to a time horizon that’s more like a year in length, we think that there is the opportunity to start adding risk. And part of that is because the alternatives to equity are relatively scarce. When we think about what typical investors can put their assets in, aside from global equities, of course we have global fixed income and all of its different flavours, government bonds, and credits. We also have emerging market debt, both hard currency and local currency, but then also there are some actual alternatives things like commodities or TIPS [Treasury Inflation-Protected Securities] where we look at inflation, or even private real estate. And so those are some areas that we’re starting to explore to understand if they offer a better alternative to fixed income, which has had relatively anemic returns, or if it’s better to put that risk purely back into equities.
We have been historically overweight the US because it’s offered a really compelling advantage over other equity areas globally. If we look at the tech sector and how that’s sustained outperformance. Also, it’s a relative beneficiary during the pandemic. We expect EPS [earnings per share] to recover in 2021 in general. We’re pretty constructive on 2021 globally, but especially for the US. And when we look at valuations relative to the rest of the world, they’re pretty solid. And we think that they can probably sustain structurally higher P/Es [price to earnings]. So that’s all advantage US, but we’ve certainly been trimming that US overweight down. We’re also overweight the Pacific ex-Japan countries. So if we look at Australia, if you look at New Zealand and a couple of the other countries that make up that area, there’s an improving COVID profile in those countries. If we look at Australia, they recently cut rates in order to provide a boost to consumers. That was certainly helpful. And we’ve seen the housing market stabilise as credit has grown, and overall demand has been trending higher and Pacific ex-Japan. So that’s another area that we are overweight.
Stephen Dover: A bit interesting and perhaps surprising to some people within Europe. Now you’re underweight the continent then a bit and overweight to the UK, despite the Brexit coming up and everything else. What’s the thinking behind being overweight the UK?
Gene Podkaminer: The thinking behind it is that it’s a relatively cheap region. Again, relative compared to some of the other developed market equity regions. There’s a potential for a snapback, and especially a rebound in a post-Brexit world. Now, we’ll see what actually happens with Brexit. It is a big question mark, but there’s no doubt that in a post-COVID world, there’s a pretty high dividend yield on that market as well. I would say that we’re not as positive on the UK as we were earlier in the year. Again, something that we’re revisiting and as we compare it to its neighbours across the pond to Europe, which has been very hard hit during the crisis, it’s been much slower to recover from the coronavirus crisis. We have been historically overweight the US because it’s offered a really compelling advantage over other equity areas globally. and some significant headwinds that have been impacting all kinds of different sectors. So Europe compared to the UK, compared to some of the other regions that we’ve talked about, is definitely struggling and has some work to do. Now, earlier in the programme, we talked about fiscal policy. Europe has a pretty clear fiscal policy response that it’s putting in place. We’ll see how that plays out.
Stephen Dover: I want to make sure we get to both fixed income and of course, alternatives as well. So within the fixed income space, of course a couple framing ideas or questions are your outlook on inflation and your outlook on the US dollar.
Gene Podkaminer: Yeah, so the inflation outlook is that we haven’t seen inflation recently, and we don’t necessarily expect to see a lot of inflation in the future. So let me dig into that a little bit. Tomorrow’s inflation expectations are really driven by today’s policy outline. So we talked about monetary policy earlier that monetary policy directly determines, and influences what happens with inflation. So while global inflation is currently modest, that could change with a really strong growth outlook. That’s probably not the base case, but that certainly could happen. And given our recent experience with rising debt and deficits, we ask, does the path to repayment take a detour through reflation land? Also, if we think about the future configuration of these global economies, if they’re less globalised, perhaps we can expect even more modest future inflation. So the inflation outlook certainly is muted, and we expect that to remain so for our horizon, which is about a year when we think about globally, where we can invest in fixed income. So I’m going to break this up between government bonds and then credit and emerging markets. We don’t necessarily see a stand out place to say yes, put your money here for the next year or so.
Stephen Dover: The question that probably a lot of people have is the yields are so low. Cash is virtually zero. Should they be reaching a little bit for more yield within high yield or anything else or what’s the risk-reward payoff there for trying to reach for a little more yield? Yeah.
Gene Podkaminer: And that is one of my favourite asset allocation questions, because it really wraps up everything that we’re talking about into a simple decision, which is there is a great relationship historically between government bonds and equities, that one really protected against the other. So you would have a portfolio that was balanced between equities and some government bonds. And typically that provided you with a smoother ride. Now, the more that you take those government bonds and transform them into something that’s more sensitive to global growth to that growth factor, the weaker that protection becomes. So the stronger that correlation between what happens in equity markets and what happens in say high yield or an investment-grade credit. So if an investor is just looking at one part of their portfolio, if they’re just looking at fixed income, scratching their heads and asking themselves, what should I do with my fixed income allocation, maybe the answer is, well, take a little bit of incremental more risk. So go into something like investment grade, go into some other spread products, but, and this is the big but, if you do that and look at the entire portfolio context, recognise that you now have an equity part of your portfolio, and then a fixed income part of your portfolio that performs a little bit like equity light. And that is why when we think about asset allocation, we’re really looking at it from a holistic perspective, the entire portfolio. So both the fixed income allocation and the equity allocation and how they work together. Just looking at either on their own isn’t that helpful.
Stephen Dover: That’s great, Gene. And I think to me, really an interesting report on that the correlation, if you will, between equity and fixed income is so tight now that you don’t get the diversity effect. And that’s why let’s move to alternatives. So maybe a little thought around how you use alternatives for diversity.
Gene Podkaminer: Absolutely. So the alternatives allocation that we have is really geared towards exposure to the real economy. So it’s an inflation exposure. And when we think about, say the commodities allocation, there are risks within the energy space, and we’ve seen those a flare up over the last year. We think that they’ve subsided somewhat. So when we look at what OPEC [Organization of the Petroleum Exporting Countries] has been doing and providing a floor to some of these prices. When we see demand improvement potentially in 2021, that helps us square what’s going on with commodities. And we can also talk a little bit about industrial metals in there as well, and precious metals in general, the commodities picture, again, looking out longer term over the next year, looks fairly good for us as a correlation diversifier in the portfolio. When we look at TIPS, the big driver is that breakeven valuations continue to look really attractive versus history. That is a key consideration for us. So the breakeven levels, they’re not pricing in that much of a premium given the quantitative easing that’s happening out there. And because our inflation forecast is coming in relatively modestly, that should bode well for breakevens also. Now you mentioned real estate and it’s hard to escape what’s going on in the real estate market currently, but with a longer-term view, we do think that the real estate market will recover and be another good diversifier for an equity and fixed income portfolio.
Stephen Dover: That’s great. So, there are a lot of people out there that are sitting on a lot of cash and are wondering if it’s too late to take risks. What should I do now? And just to make it fair, let’s say they have a horizon of at least five years.
Gene Podkaminer: So with a five-year horizon, it seems like equities offer a fairly compelling risk-reward tradeoff, and let’s not kid ourselves, equities are risky. They are volatile. They swing around quite a bit, but over five years, given the alternatives in looking at fixed income and looking at some of the real assets that we talked about earlier, equities do seem like a compelling tradeoff with that kind of time horizon.
Stephen Dover: Gene, thank you very much.
Gene Podkaminer: Thank you, my pleasure.
What Are the Risks?
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Investments in fast-growing industries like the technology sector (which has historically been volatile) could result in increased price fluctuation, especially over the short term, due to the rapid pace of product change and development and changes in government regulation of companies emphasising scientific or technological advancement. Value securities may not increase in price as anticipated or may decline further in value. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Smaller company stocks have historically had more price volatility than large-company stocks, particularly over the short term. Bond prices generally move in the opposite direction of interest rates. As the prices of bonds in a fund adjust to a rise in interest rates, the fund’s share price may decline. High yield bonds carry a greater degree of credit risk relative to investment-grade securities. The risks associated with a real estate strategy include, but are not limited to, various risks inherent in the ownership of real estate property, such as fluctuations in lease occupancy rates and operating expenses, variations in rental schedules, which in turn may be adversely affected by general and local economic conditions, the supply and demand for real estate properties, zoning laws, rent control laws, real property taxes, the availability and costs of financing, environmental laws, and uninsured losses (generally from catastrophic events such as earthquakes, floods and wars).
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