Portfolio Intelligence podcast: opportunities arising from recent market volatility

John Bryson:
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 3rd, 2022, and things are getting interesting. So I've invited back popular guests, Emily Roland and Matt Miskin, our co-chief investment strategists at John Hancock Investment Management, to talk to me about what's going on in the marketplace. Emily, I'm going to start with you. We are off to a very volatile interesting year here in 2022. We've seen the S&P and other entities drop 10%, maybe more. What's happening? Can you walk us through what's going on in the world and maybe put this recent bout of volatility into some historical context?

Emily Roland:
Absolutely, John. Thanks again for having us. Definitely an interesting and volatile start to the year with the S&P 500 flirting with that 10% correction territory throughout the month of January after having reached a high on January 3rd. And just putting it in context with history, this is actually the biggest pullback that we've seen since September 2020. So it's been a while. We've forgotten a little bit to be conditioned for volatility. In fact, the biggest drawdown or peak to trough decline that we saw in 2021 was only about 5%. And that's really unusual. In fact, an average year sees a pullback of 14%. An average year sees about three pullbacks of at least 5%. So it doesn't feel that great. It happens. We were probably due for it. And I think always important to remember that every correction that we've ever had, looking over a longer term, has ultimately proven to be a buying opportunity. Sometimes it takes a little bit more patience. That's where we're at right now, but we certainly are looking and thinking about opportunities that have opened up amidst this corrective price action.

Emily Roland:
A few things, I think the markets are a bit spooked about here to start the year. First and foremost, is this very hawkish policy shift that the Fed and now other central bankers around the globe are joining in on. It's funny to remember it was just, maybe funny or not funny, about 18 months ago that J. Powell told us that the Fed wasn't even thinking about thinking about raising rates. And now clearly they're off to the races here suggesting that we're going to see the first rate hike of the cycle in March and the wind down of quantitative easing as well. So markets like it when liquidity is plentiful, markets like it, equities in particular, when financial conditions are very easy and we're starting to see that punch bowl being pulled away, which is one thing that the markets are not loving right now. The Fed doesn't have much of a choice. Elevated inflation is with us. And so we do see that as a key sort of brick in the wall of worries right now.

Emily Roland:
Omicron's another one. We're seeing a dampening impact on economic activity as it relates to Omicron. We're seeing it affect labor supply shortages. We're seeing it affect some of the high frequency data that we look at. Things like TSA travel information. I know I was at Logan Airport a couple weeks ago. There weren't very many of us there. Seeing people stop in engaging and in services. We do think that that is contributing to a bit of an economic air pocket here in the first quarter. I mean, you're also seeing some tensions clearly escalate between Russia and the Ukraine, which is causing some jitters. So lots of worries right now at this time, but I think if we take each one of these as we move through the conversation and I'm sure we'll address some of them, we do think that there is some opportunity here that's opening up.

John Bryson:
Great. We'll definitely talk about the opportunities. Matt, I want to pull you into the conversation. I know you and Emily think about investing across asset classes, and you think about all the different options available to you. What are you watching right now in terms of across asset class performance? What's working, what's not? Has there been anywhere to hide from this volatility?

Matt Miskin:
Yeah. Thanks, John. What we're seeing is that the value style is holding up much better than the growth style across global equities. And what we're really focused in on is within the tech space and the growth space in particular, we really want to focus on those companies that have better earnings, solid balance sheets, and what I would broadly call quality. What we see is that as much as... Is when you go down in cap from large cap to mid and small cap, the growth side of the house, those business had really high multiples coming into this year, post the pandemic, and they also didn't have great earnings. I mean, their earnings were really pushed out. There was the thought that they would grow over time, but investors are going to be impatient about waiting long time for growth and earnings when interest rates go up.

Matt Miskin:
And so as we go down to the midcap space, the small cap space, we're really embracing value more than growth. We do like quality in large cap growth, but we're trying to filter through there to see the ones with the best balance sheets and best earnings, but value stocks in essence are about flat. Russell 1000 Value Index year to date is only down about 1%, whereas the rest of the market is down more. And so their value side is holding up well. On the fixed income side, the floating-rate securities, bank loans and floating rate is modestly positive or about flat year to date. That's holding up well as interest rates have come up and obviously thinking more of selective credit there and those that have more floating rate optionality within the fixed income market. But in terms of broadly speaking, we're seeing stocks down, bonds down. And it's a tough pocket here for a broader portfolio, but when things are cheapening up, when yields are higher in bonds and valuations are cheaper in stocks, we tend to look at that more opportunistically. And that's exactly what we're doing today.

John Bryson:
Okay. Emily, I'll come back to you. Thinking about all this volatility, and I know you look forward 12 to 18 months with your forecast. But with the volatility that we've seen with maybe the more aggressiveness, hawkishness with the Fed, have your views changed given that, given the volatility? And asked another way, we're hearing a lot of questions from people: is now to get out of the market, let the volatility ride itself out, or should people stay invested in stocks?

Emily Roland:
Yeah, John, we've been having a lot of conversations with advisors and their clients. I think that question comes up over and over, and the answer always comes back to, what do the fundamentals look like right now? Is the case for owning stocks still there? And there's a few things that are suggesting, yes, you want to continue to emphasize stocks in portfolios. The first one is that the economy is still very much in positive territory. We look at the US leading economic indicators that The Conference Board puts out. It's been a good gauge of where we are in the cycle, that increase is coming out of recessions, it declines and gets towards zero when it looks like a recession's imminent. And we're still very much in positive territory and the high single-digit range right now.

Emily Roland:
Yes, we're coming off the boil. A year ago, in the spring of 2021, not only was the economy expanding rapidly coming out of the recession, but we also had about $5 trillion of fiscal stimulus sprinkled on top of an economy that was already doing well. So that fiscal impulse is beginning to fade. We actually are looking at more of a fiscal drag into this year, but the economy we think can stand on its own two feet. When we look across the different elements of the leading indicators, eight out of the 10 of them are positive. Seeing a little bit of a challenge as far as consumer expectations, consumer sentiment goes. A lot of that's related to elevated inflation, but broadly speaking, we do think that the economy can continue to grow. Even if we do see two or three rate hikes this year, remember when the Fed hikes, it's during periods where the economy's doing well. So that's a check for us as far as owning equities.

Emily Roland:
Other things we look at, corporate earnings. Over time, stock prices follow earnings, and we look at next 12 month earnings estimates. So essentially what analysts on the street are penciling in as far as their expectations for earnings growth over the next year, and it continues to move higher. We still see companies having recovery potential as the pandemic moves away. And looking into 2022, it's not the earnings nirvana that we saw of last year, 45% plus earnings growth, but we're looking for mid to high single-digit earnings growth in 2022. And we think that that's something that's relatively telling as far as what the equity market should be expected to produce. So corporate earnings are still growing. In fact, because prices have come down, stock prices have come down and earnings estimates have gone up, we've actually seen a bit of a reset here in terms of valuations. So to Matt's point, stocks are cheapening up, certain pockets of opportunity are opening up based on this price action.

Emily Roland:
We're also watching high-yield bond spreads. That's the final thing we would look at. That's essentially the additional cost of debt for low-quality bond issuers. They have perked up. We are seeing spreads widen a bit. We're over 3% now, but in a historical context, they're at levels suggesting that they're still ample liquidity. We're also seeing liquidity in the form of money market assets remaining near all-time highs at four and a half trillion dollars, consumer savings and bank accounts, $18 trillion. And then finally corporate balance sheets really being in the best shape in history with trillions in cash available. So there is ample liquidity, which is another reason we do want to continue to embrace equities in this environment.

John Bryson:
Continuing down that path, in the past you've talked about owning quality, owning value in the midcap space for where we are on the cycle. Has any of those views changed US versus international? Anything getting more appealing versus the other?

Emily Roland:
Yeah. We still see the best economic growth prospects and earnings growth, most importantly prospects here in the US. We do want to have an allocation of international equities. We're being really thoughtful about how we approach that market, given the less supportive earnings backdrop. Still okay, but just not as good as it is in the US. So we're really emphasizing quality growth internationally, sectors that have good cyclical upsides, strong secular growth stories like technology, industrials. That's where we want to be internationally. And that's going to lead you to an emphasis on growth over value.

Emily Roland:
In the US, it's really this combination of value for continued upside potential in the economy. In particular, we're looking at sectors in value that can create good profit margins, areas like industrials that have high operating leverage or high fixed costs and the ability to pass higher prices along to consumers. So looking there at the industrial sector opportunistically, and then again, pairing that with quality growth. So those companies and sectors that have great earning stability, good organic growth drivers, and the ability again, to grow revenues, to grow margins in increasingly difficult period.

John Bryson:
Excellent. Hey Matt, let's pivot to the fixed income side. We started to talk about how bonds have had a tough start of the year. Do you think the pain will continue? Do you see signs where bonds performance will turn around?

Matt Miskin:
Yeah. As we look out over the course of the year, we see a flattening yield curve. And what that means is that the shorter maturity bonds in the treasury market, like the two-year yield, for example, will go up more so than the 10-year yield. And we actually see that over the course of the year growth moderates to more normal levels off of the stimulus-induced levels that we reached. We also see inflation coming down once the comps get higher, which actually is about April of this year. That's when the inflation comps really come up. So we think inflation does moderate over the course of the year. So you had all this hop and we actually see downside potential for treasury yields and longer term maturities like the 10 year.

Matt Miskin:
The way that we're still looking at the bond market is through the lens of corporate bonds. We think you got to do the work. And similar to stock pickers, you got to be a bond picker. Parts of the bond market we're looking at opportunistically are triple-B corporates. I know they used to be looked at as a negative because there was downside or downgrade potential that everybody was worried about. But what we're seeing now is upgrades. We're seeing companies that were triple-Bs now going to single-As. We're seeing double-B's high-yield bonds going to triple-B. And what they're seeing is their balance sheets are getting better, the cashflow is getting better. And so we're looking for those opportunities. They're now yielding about three to 4% in the corporate bond market. We think that's going to be very competitive on a going forward basis, especially on a risk adjusted basis, relative to other assets that are out there.

Matt Miskin:
We do have a satellite allocation of floating rate as recommendation in Market Intelligence. So about 70% kind of core plus with a 30% of multi-sector and floating rate. That to us is about a five-year duration and about 3%, 4% yield. That's kind of where we would sit.

Matt Miskin:
I think just to put a bow on this, the way to think about bonds throughout the cycle is you're going to hate bonds before you love them. And what I mean by that is when the Fed's raising rates and treasury yields are rising, bond prices are usually struggling. They're challenged. They may be down. But then once you get late cycle enough where the Fed stop raising rates and the cycle moves to late cycle, well then usually it can be disinflation or deflation. It can be an economic contraction. We don't think we're there yet, but you want to have bonds in the portfolio, even though you may hate them now. Because if the cycle keeps going, you very well may love them in that turn that the economy can take. Again, we think that's more of a 2023 or beyond story, but that's part of balancing a portfolio is managing both the inflation risk and the economic growth risk that could present itself here over the next several years.

John Bryson:
Excellent. All right. You've brought up a couple of interesting things here. I think what I would summarize with is this volatility, it's been a while, but we know it comes in certain points in the market, and this is when the best managers shine. So the opportunities are out there for the stock pickers and the bond pickers to do their job, dig in, find the opportunities and ride out the volatility. So it's great to connect with the two of you. I like how you always bring us to a long-term focus. That is much appreciated.

John Bryson:
One last thing, or two last things. Emily, I have seen that you and Matt have launched the new weekly video series for advisors. Can you tell us about that? And then also tell us when to expect the next Market Intelligence mid-quarter update.

Emily Roland:
We have John. We are so excited to bring our weekly updates that we've been producing for advisors for years now to a video format. A quick hit, three or four minutes, about what has happened in the previous week. Key data points, key earnings reports that we're looking at in the week ahead, some themes that we're contending with, and some investment ideas around some of the dynamics that are unfolding in the markets. So check that out. It is on our LinkedIn pages. We're aiming to post those on LinkedIn on Monday mornings. They'll either come from Matt or from me. Give us some likes, let us know what you think about it. And we are also, again, as you mentioned, producing a mid-quarter update from Market Intelligence, very timely right now, given some of the big moves that we've seen to start of the year. So that should be out here sometime in the first or second week of February. So please check our website there for that.

John Bryson:
Folks, I highly recommend you follow Matt and Emily and check in with this weekly video update. It's a great resource for you to stay on top of what's going on. Last thing I'll say is we have a Market Intelligence Inside The Network webinar coming up on February 14th. We're going to dig into the fixed income landscape to find out what's going on there. We've got Emily on the call. We also have Howard Greene from Manulife Investment Management, and Nathan Thooft from Manulife Investment Management. Howard's going to talk about the broad fixed income landscape. Nate's going to talk about the different alternatives out there to insulate your portfolio. And we've got Nathaniel Whittier from Bain Capital, our floating rate manager to talk about the opportunities and floating rates. So a lot of things going on at John Hancock Investment Management that we want you to be aware of.

John Bryson:
Well, folks as always, I want to thank you for listening in. Matt and Emily, I want to thank you for sharing your insights today. It's always great to connect with you. Folks, 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. Thanks everybody.

Emily Roland:
Thanks, John.

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.