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. The goal of this podcast is to help investment professionals deliver better outcomes for their clients and their practice. Topics we'll address include advisor business-building ideas, capital market updates, the latest trends in portfolio construction, and investment insight from veteran portfolio managers across our global network. Today, March 12, 2020, I'm joined by Emily Roland and Matt Miskin, our co-chief investment strategists at John Hancock Investment Management. Emily and Matt, you and your team are the engine behind our quarterly capital markets outlook piece titled Market Intelligence, and it's a great time to have you on the call. Markets have officially reached bear market territory. Emily, why don't you give us an update on the recent developments and set the stage for where we are today.

Emily Roland:

Thanks, John. And yes, I think we're all in a bit of mourning today as we're seeing that the loss of that longest bull market in history with an official 20% decline in equity markets, and what we're seeing today is a pretty remarkable environment in which volatility has just reached levels that we haven't actually seen since 2008 with the VIX, which is one of the key measures of volatility, reaching levels over 50 this morning. That's pretty astonishing in our view, and we're seeing really indiscriminate selling this morning, almost panic selling, as nothing's working for investors across the board. Credit spreads continue to come under pressure here. From a macro perspective, the Fed is doing what it can. We had that surprise 50 basis point rate cut a couple of weeks ago. We have another Fed meeting coming up next week. We expect them to continue to be aggressive, potentially continuing to lower rates, perhaps to the tune of 50 or even more basis points at that meeting.

The baton is looking to be passed here to fiscal stimulus. We are hearing reports that the Congress is attempting to get some measures through here that should help small businesses help consumers through this volatility. It is however becoming more likely that we will see a recession here in the U.S. Our base case is for a technical recession, so negative GDP in Q2, and then most likely negative GDP in Q3. Everything is still in flux. Our expectations there will depend on a lot of different factors, all depend on the severity of the containment efforts that are in place. Here, we're looking at things like university closures, that's happening in our family, and certainly other school closings and commerce being affected by this globally. As always, things are moving quickly, things will change, and as always, there will ultimately be opportunities when we do emerge from this.

John Bryson:

Yeah, it certainly seems like every couple of minutes is a new headline for us to worry about, but Matt, let's bring you into the conversation and talk about our investment portfolio. Let's start with fixed income. Fixed income is supposed to be the diversifier in our portfolio, kind of mitigate some risk and volatility. What's happening in fixed income?

Matt Miskin:

Yeah, when we look at the Treasury market, yields are certainly down since the start of the year. You think about where we came from 190 basis points on the 10 year, it feels like a long time ago. We dropped to almost 30 basis points, which was a bit of shock and awe, and we backed up to about 70 basis points. Nothing in this kind of environment moves in a straight line, and really to us, if Treasury yields back up, we would look at that as an opportunity looking for high-quality fixed income. When we look at mortgage-backed securities, they are starting to sell off a bit, and just feel the all-out kind of selling that we're seeing across markets, and then investment-grade corporates are starting to price in some default risk.

High yield has been much more challenged, which we would have expected, but the higher-quality parts of the bond market are still holding in much better than equity risk—much better than broader credit risk. And what we believe we're seeing, at least in some of this higher quality stuff finally being sold, is that bigger investors, perhaps hedge funds or other investors that do need to meet either margin requirements or other capital requirements are selling the things that actually worked for them. So the stuff in the portfolio that were positive year to date, you're starting to see some profit taking there. We wouldn't really extrapolate two days of kind of this price action too far. We still think that high-quality fixed income is the best to blunt the negative impact of kind of a slowing economic growth environment, or just kind of this downward pressure in global equities.

So fixed income's still very valuable in our view for investors, and as yields back up in certain parts, we think this could be an attractive entry point. If you nibble and start to dollar cost average into that over the next several months, you can actually likely see some income generation that may be more attractive than where we were a couple of months ago for forward-looking returns.

John Bryson:

All right. Now if you're paying attention to the TV, a lot of people are overreacting and panicking. I guess a common question on people's minds in terms of equities is, should I get out now and avoid some of this panic and buy back in later. Emily, what are your thoughts about what people should do with their equity portfolio?

Emily Roland:

Sure. Well, first of all, I'd say don't turn the TV off if Matt and I are on there, but you can, if there's anybody else. All kidding aside, things are moving so fast here to the downside, as I mentioned when we started, and if you look at this decline that we've seen from an all-time high on February 19 down to a bear market of more than 20%, this has never happened so fast. The last time that there was even close to this fast of a decline was all the way back in the 1920s, so we've definitely seen very, very quick decline, which if you think about it, could potentially be followed by a very sharp rebound. So the challenge now that we're looking at is that investors who are selling, they may end up missing out on that rebound. It doesn't feel very good right now, but ultimately, we don't want investors to be out of the market.

The other thing that we watch is valuations, and we have to remember where we came from here. Starting the year, we were at 19 times forward earnings on the S&P 500. That's about as expensive as stocks had been in over 15 years. When you look at levels today, we're looking at about 15 ½ times earnings on the S&P 500. That's getting us that closer to averages. So in other words, stocks certainly could get cheaper from here. But the more we see this contraction in P/E, the more opportunity that we potentially see open up in terms of scooping up those opportunities; again, dollar cost averaging into these opportunities. And when we look back on this, I know it's hard to think about three years from now, but we will look at this point in which lower prices became attractive, and ultimately, investors need to remember that lower prices over long periods of time translate into higher returns.

Right now, we're really following the narrative that we began the year with. We've been leaning into quality. We've been talking about a more defensive approach to asset allocation, particularly overseas as economic growth really wasn't great overseas coming into this; it was a little bit better here in the U.S. So we've advocated for leading into some defensive sectors in the U.S., areas like utilities and consumer staples, healthcare, and overseas we've talked a lot about embracing more defensive strategies, things like infrastructure-related equities, so we continue to think that those are the right places to be, and we continue to look for opportunities going forward as stocks cheapen up to embrace equities more fully. We're not quite there yet.

John Bryson:

Okay. And if you're looking for those quality, types I named is strong balance sheets, companies with repeatable earnings process, so they'll get penalized but take advantage of those opportunities.

Emily Roland:

Yeah, exactly, and we're seeing that happen. We look for, and like you said, earnings stability, good strong balance sheets, low earnings variability, ability to maintain margins. Those types of companies we think are able to weather a storm, they tend to do well in various market environments, and we continue to be positioned there.

John Bryson:

Great. And earlier, you had mentioned the economy and the potential for a recession. So I think a week ago, we probably weren't talking about a recession, but Matt, now we are talking about a recession. If we want to get a sense for the severity of a potential recession, what are some of the signals you're looking for in the market?

Matt Miskin:

Yeah, when we typically look at the macro backdrop, we try to use leading economic indicators, and there's never been a time where these leading economic indicators feel like lagging economic indicator, and because things are evolving so fastly with this coronavirus and the preventive state actions that are be taking. So what we're doing in terms of what we're looking at, it's all about the jobs market from here. So if people can keep their jobs, and this is a relatively swift, but there's significant in terms of economic duress. As long as this can come back in the third and fourth quarter, we think that this remains actually a relatively manageable technical recession. But the first quarter, or the first quarter we're going into, Q2, is likely to be a negative GDP quarter to the tune of perhaps, some of the strategists or economists we're talking to are saying, negative three percent; some are saying negative one percent, but it's the Q3 number we're really watching because if that's negative half a percent, it's a technical recession.

We still think that Q3 gets better than Q2, but Q3 could be positive if all the stimulus that is done now filters into the back half, and you see a faster rebound. So if you do get tax cuts, if you do get the Fed cutting to zero, meaning mortgage rates come down, if oil prices are lower, meaning gas at the pump is actually more affordable. You add all these things together, and in our view, while the short term is pretty significant economic damage, the duration may be less than what we've become accustomed to. And so that jobs market, if it isn't, if we can sail through this a bit and we don't see major layoffs, initial jobless claims comes out every Thursday, for example, it just came out today, and it was actually down to 211,000.

As long as that holds in and doesn't blow out to the tune of like in 2008, we think that we can back come back in the back half, and that goes back to what Emily said. This can move fast on the downside. It can also move fast on the upside, and instead of timing that, a well-balanced portfolio might be a better way to weather the storm.

John Bryson:

Yeah, I think that's what it comes down to. In a tough market like this, everyone wants to react. They want to pay attention to the current headline. I see both of you looking at glancing at your phones to see what the next headline is. That makes sense. But it's tough in an environment like that to think long term. Let's think long term. What is the long-term approach people should be taking right now?

Matt Miskin:

Yes. So last year, we saw a lot of cash move to the sidelines and $500 billion plus went to money markets, and much of that is likely the advisor community. So congrats for raising cash, for being a bit defensive for those that have then going into this. But the question is now, if you have an investor that you're working with, or you're an investor that has a 5-, 10-, 20-year time horizon, this might be an opportunity to dollar cost average over the next several months, because valuations are attractive, because credit spreads are wider, meaning that yields are getting more attractive. These are the type of times that while it doesn't feel good short term, there could be more downside. Putting money to work step-by-step can lead to better results over, 3-, 5-, 10-year windows. And again, that's something we would be thinking about as an investor.

John Bryson:

It makes a lot of sense. We did a conference call in March of 2009. I remember I was hosting the call and the overall message was, now's a good time to start layering back into the market. It's going to be bumpy, but it's a great buying opportunity. So those are some of the things that I think people need to consider long term. Well, Matt and Emily, thanks so much for your insight. Folks, if you want to hear more, subscribe to the Portfolio Intelligence Podcast on iTunes, or visit our website, jhinvestments.com, to read our most recent viewpoints on macro trends, portfolio construction techniques, business-building ideas, and much, much more. Thanks for listening to our show.

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. The goal of this podcast is to help investment professionals deliver better outcomes for their clients and their practice. Topics we'll address include advisor business-building ideas, capital market updates, the latest trends in portfolio construction, and investment insights from veteran portfolio managers across our global network.

I'm joined today by Emily Roland and Matt Miskin, co-chief investment strategists at John Hancock Investment Management. Emily and Matt, you and your team are the architects behind the quarterly capital markets outlook piece we call Market Intelligence and we had a great plan going into our first podcast—and then corona hit, coronavirus. Emily, what do we do with this right now?

Emily Roland:
Thanks, John. Yeah, it's certainly been a challenging week. In fact, the worst week we've had in markets since 2008. Global equity markets are down anywhere between 10 and 15% and we're really not seeing any kind of winners or losers actually stick out to us. We've got U.S. equities, non-U.S. emerging markets all down. All 11 sectors of the S&P 500 now in negative territory and really seeing sort of indiscriminate selling from investors across the board as the fears of this virus spreading not only physically but also the economic impact of this virus causing investors really to be capitulating here. Bonds are holding up well, which makes a lot of sense in this environment. We've seen the 10-year Treasury break down all the way through historic lows below 125 at this point and that has reinverted the yield curve. The yield curve—portions of it are once again inverted, which means the bond market is basically screaming at the Fed that they need to do something here in terms of monetary or potentially even fiscal stimulus.

When we look across the board, we always focus on the macro data and we're looking at some of the more timely indicators that we're seeing in the markets right now and while the bond market is basically telling you that we're in a recession or about to be in a recession, the macro data right now really isn't confirming that narrative. We look at things like business surveys, PMI data that's actually come in a lot, not great but less worse shape than a lot of folks have expected. Things like consumer confidence fell just slightly here in the U.S. but still up, and also initial jobless claims coming in fairly decent rising a little bit this week, but still okay. So the real-time data right now is kind of mixed rather than falling meaningfully as the bond market again would be suggesting.

The final thing I would point out is kind of where we started. Believe it or not, the all-time high in the S&P 500 was just over a week ago. So this correction has happened very, very quickly and it comes at a time where valuations within stocks had gotten quite rich. And we had an over 30% return last year and then we came into the year with an environment in which there had been a ton of multiples expansion based on a lot of liquidity provided by central bankers globally, which had lifted markets meaningfully. But the economic backdrop had failed to really meaningfully reaccelerate yet. It was just starting to do so, we were becoming more open to this idea of economic growth re accelerating but at this point we're really kind of hitting the pause button on this as these virus fears play out.

John Bryson:
So if it's hitting the pause button, do you have concerns that if we have a week, if the bleeding this week continues in the next week, it's really going to impact global growth. And then what about the supply shock impact of this? Are you worried about that, and what are you hearing from the network?

Emily Roland:
Sure. The thing that's really most interesting and different from previous examples of epidemics that have infected or impacted markets is just the size of China's economy. So when we had SARS in 2003, which is one of the key examples that everybody's talking about, the Chinese economy was about $2 trillion. It's a $14 trillion economy today, which means it's far more connected to global supply chains. It certainly remains the driver of global economic growth and for that reason we're seeing a bigger impact to the global economy and it's not just contained to China and Europe, which tends to be more connected as well. So really we're seeing this impact economic activity, but we're not yet seeing that follow through to the actual hard data, which we'll be looking for in the next few weeks.

John Bryson:
Okay. So Matt, you've been out in the road this week talking to financial advisors. What do you tell them to do with this information? How should they be thinking about positioning portfolios?

Matt Miskin:
Yeah. The first thing we're looking at is the fixed-income part of the market and really fixed-income portfolios that we've been analyzing and looking at have tended to have a bit of a credit bias, meaning high yields, a portion of those fixed-income portfolios and also a lower duration bias. So not as much duration as the aggregate benchmark. And actually we've been kind of advocating the opposite of those two directions. So we really like higher-quality bonds versus lower-quality bonds. So think investment-grade corporate bonds, mortgage-backed securities, even Treasuries. These are things in the core part of the bond market that tend to have a negative correlation to the S&P and broader equity markets. Now they're paying off. So I know investors and clients have hated bonds for a long time, "Why do I have bonds in my portfolio?"

Well now they're starting to really shine and that's why we own them. And then you also need that duration component too. Being in the short end in high-quality bonds, it's not going to kill you; cash isn't going to hurt you here. But if you're in the intermediate part of the curve, that is more of a ballast than being on the short end. So really it's about increasing your credit quality and moving out in the curve to the intermediate part of the curve. I know yields have dropped a lot and it's hard to look at that and kind of allocate back in the intermediate part of the curve, but if you want to limit your equity risk, you’ve got to think about duration as that antidote to that and that's really what we've been talking about. Equities? Yeah, there's little things you can do on the margin here. We're actually looking at it more opportunistically.

As Emily highlighted, the baby's being thrown out with the bathwater—everything's getting sold. That's when you can find relative opportunities and a fundamental approach looking for better businesses with higher ROE, better margins, lower debt to equity. These are the kinds of stocks primarily in the U.S. that we'd be looking to actually allocate to. We're not calling a bottom. There's no sense of even trying, but you've gotten a big discount in the last week, about a 15% discount on some pretty good businesses out there. We try to look at that opportunistically, try to nibble on that within an equity portfolio. But it's about starting with fixed income, getting that right in a broader multi-asset portfolio context.

John Bryson:
I've been hearing a lot this week about program trading and just the market in general selling off and futures selling off. Are you finding that quality companies are getting sucked up in that vacuum?

Matt Miskin:
Yes, yes, absolutely. So you know, program trading or algorithmic trading, it's basically sell first and ask questions later and they're using headlines; they're using headlines to trade off of, which may or may not be right. They may or may not be really what's going to happen in a week from now, a month from now, a quarter from now. So it's about being disciplined. It's about looking at the fundamentals. We think some businesses are going to be better off and better able to wade through a weaker global growth environment than others. Some of the tech stocks that are starting to get hit here that are, still got a lot of cash on their balance sheets, still likely to generate some revenue or earnings growth this year, maybe not a lot but even some versus others that are more levered, more tied to kind of systematic risk.

So we're tilting into consumer staples, technology, healthcare, those type of businesses. But then the heavy cyclical sectors think industrials, materials, energy, we wouldn't be as favorable on those. So there's opportunities today and those algorithmic traders might be actually giving you an opportunity and we take advantage of that.

John Bryson:
All right, so Emily, if there's opportunities today as Matt's alluding to, where do we go from here? What do we look for in the marketplace and in the economy to give us hope and guidance?

Emily Roland:
Yeah, there's really three things we would be looking at today to kind of gauge how much worse things can get and where those opportunities may come from. And the first is it's really about the Fed and this market's been about the Fed a lot over the last couple of years. And we talked about this liquidity-driven environment with three rate cuts and balance sheet expansion last year as being responsible for some of the great returns that investors earned in markets. And we also talked about the Fed that about the fact that because there's portions of the yield curve that are once again inverted that the bond market is telling the Fed to cut. So the next Fed meeting that we have is March 18^th. We're going to be watching very closely for signs of what the Fed does here. Their goal heading into 2020 frankly was that they wanted to stay on the sidelines.

That may or may not be because it's an election year, but they felt like they did a lot in 2019 to appease markets and they'd really rather not lower rates again. The bond market is telling them to; federal funds futures are telling them that the bond market's pricing this in. So it'll be interesting to us to see if the Fed provides that boost that markets are looking for. Certainly, policymakers in China have been doing an awful lot in order to reaccelerate or kind of stave off the challenges there. The other thing that we would be watching is just earnings revisions. So heading into 2020 we were looking at an environment in which analysts expected about nine and a half percent earnings growth for the S&P 500 and that was a key reason that we've been leaning into U.S. equities is that kind of checkmark we had given to the earnings environment.

Now—right now—you look at where things stand for 2020 and those earnings expectations have come down a bit, one or 2% and we're seeing 1% shaved off of Q1 earnings growth, which was already, the bar was quite low at about three and a half percent, that's come down. We're also seeing a little bit being shaved off 2020 earnings estimates, but we'll be watching that piece very, very closely to see kind of how much this impact is going to impact corporate fundamentals. And then the final thing we would be looking at is the economic data and specifically the survey data. We have really been relying an awful lot on things like PMI data. We like it because it's a monthly survey, very timely indicator of purchasing managers at manufacturing firms around the world that gives you a sense of how business conditions look. Some of the early indications that we've seen in terms of PMI are unsurprisingly a little bit of a retraction but not maybe quite as much as we had expected.

So over the next couple of weeks, we'll be receiving more data and we can really start to gauge kind of how impactful this is going to be on in terms of global growth.

John Bryson:
What about investor sentiment? I know if we look at the U.S. consumer it's going to have a big impact on how we do going forward. Any thoughts on investor sentiment and how that's changing this week?

Emily Roland:
Sure. I mean, one thing that I would say regarding the consumer first is that the consumer certainly has been the ballast of the U.S. economy and really the workhorse of an economy that's been shaky in other ways, and as long as the jobs market holds up, as long as consumer spending holds up in the U.S., that's incredibly important in terms of the health of the economy and all signs are that that is remaining intact. The other side of sentiment to think about in our view is really around flows. And if you look at what happened last year, investors just piled into fixed-income funds and really eschewed equity funds even though we were right in the middle of one of the best markets for investors from an equity market perspective. So a lot of this depends on when investors start to think about opportunities to buy the dip. And we'll be looking at that fund flow data for clues that this capitulation might start to come to an end over the next couple of weeks.

John Bryson:
All right. And Matt, it's really hard in a week where the markets have fallen 3% or 4% a day to have a long-term view and have a level-headed approach to it. What are you telling advisors? How are your conversations going with them about kind of setting expectations with their clients?

Matt Miskin:
Yeah, I mean the first thing is that the financial advisor role right now is paramount and you could just tell that so many clients and investors are really relying on their advisor and it's a challenging time to obviously be an advisor and have that responsibility. I mean, we put out all this content, whether it's Market Intelligence, whether it's the blogs on our website, whether it's trying to do this podcast, we're trying to support you in any way we can, but it is certainly a challenging time. I mean, our family members are calling us as strategists asking us what do we do? What do we do? And you know, it's kind of saying, "Hey, you should have a financial advisor that puts you back on your plan and makes sure your time horizon, your risk tolerance, all these things are in place and not to overreact to these type of things." And that's really what we're advocating for as well. But it is certainly a time for financial advisors to shine and that's what we're seeing in our day-to-day conversations.

John Bryson:
Great. Well I love hearing your quarterly commentary every couple of months and I'm looking forward to the next one. There's a lot going on in the marketplace. We always want to be available. If you're interested in hearing more, I would say to dial into the John Hancock Investment Management website. If you like this podcast, please subscribe. All of our information is available on jhinvestments.com. We've got information on macro trends, portfolio construction, business-building ideas, and much, much more. 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's 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.