Portfolio intelligence podcast: investing with patience in a higher-for-longer rate environment

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 speakers, 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.

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John Bryson:

Hello and welcome to the Portfolio Intelligence Podcast. I'm your host, John Bryson, head of investment consulting and education savings here at John Hancock Investment Management. Today is April 8th, 2024. And it's also eclipse day here in the U.S. So I have invited the sun and the moon of our investment world to the podcast. We've got Emily Roland and Matt Miskin, our co chief investment strategists here at John Hancock Investment Management, to talk about their views going forward. Matt, Emily, welcome.

Emily Roland:

Thanks for having us.

Matt Miskin:

Yeah. Thanks for having us.

John Bryson:

How about that for, hokey opening with the eclipse? Pretty good.

Emily Roland:

I was just trying to remember if the sun goes in front of the moon, or the moon in front of the sun, but we can figure that out later.

John Bryson:

We'll go talk about that later. We've got all day to figure that one out. Get your eclipse glasses out. Perfect. Hey, Emily. I want to I want to jump right in and talk a little bit about last week. Friday, we saw us nonfarm payrolls numbers that came in very strong. Manufacturing here in the U.S. data is looking pretty good and improving. It's leading many to think that the rate cuts are on hold for a while. What is your take?

Emily Roland:

Yeah, John, big report. Last Friday we saw the jobs openings rise to over 300,000 for March. We watch really closely to see what the revisions are. Those were actually positive for the last two months to the tune of about 22,000. And the job gains were spread across areas like healthcare, government, leisure and hospitality—all seeing pretty significant gains. The unemployment rate falling, the participation rate rising. So it was another in a series of strong economic readings that we saw last week. You mentioned also the ISM manufacturing index rising as well. New orders coming in. That's one of the key leading indicators that we that we watched closely, the highest in about 18 months. So seeing some positive, economic data. The bond market is definitely shifting in terms of the probability that it's placing on a rate cut in June. We're now looking at about two cuts. You'll probably remember that it was as many as six to end, last year. But to us, you know, it looks like the economy's probably too hot for the Fed to start cutting here in June, given the fact that it's taking a while to get back down to the Fed's 2% inflation target, higher commodity prices as of late certainly not helping in that effort, and the labor market remaining pretty tight here.

So, we do think that cuts are going to be pushed off. But our view is that once they do happen, they're probably going to be a lot more significant than the market expects. We have this data in the newly, released version of Market Intelligence that just came out. So please check this out. But that we've looked historically at Fed rate-cutting cycles, and typically the Fed actually cuts by four and a quarter. So that's 17 rate cuts in a typical cutting cycle. So, while we do think, we're in a period of higher for longer, ultimately the cycle will likely play out the way it does traditionally where there is some type of event—liquidity issue, some type of financial accident—and the Fed starts cutting and they do so by a significant amount, which should be a big tailwind from a duration perspective for fixed-income investors. I think the key right now is to be patient, because today, you know, everything looks pretty awesome. And it's pretty tough to see that type of event on the horizon.

John Bryson:

Well, hey, Matt, let's talk about the market impact of this newest information. How are fixed-income and equity markets reacting?

Matt Miskin:

So, equity markets don't seem to mind, at least as of yet. You did see some volatility as part so certain FOMC members are now saying, ‘Why are we even cutting at all?’ And just last week Neel Kashkari actually said that, and we saw some equity volatility. But Powell really hasn't changed his script yet. And I think as long as Powell is giving the market cover, equities are okay with it. The bond market is seeing some mild pressure because Treasury yields have been rising. We still have a quite a bit of income we're going to be receiving over the course of the year. We started the year with about a 4 to 5% yield, depending on, you know, your kind of higher-quality bond implementation.

So, you know, we're going to still see about three quarters of that distributed to us over the course of the year. But, Treasury yields have been marching higher. Usually that is something that then weighs on the economy, and creates almost a feedback loop, which does help bring down inflationary pressures. But for now, I think there's a bit of a honeymoon phase for equities that are saying, ‘We're okay with this because the data is so strong.’ We also have earnings season coming up.

So, we're going to have to see if equities can roll through that with, you know, this kind of tailwind. But in terms of bonds, you know, again, as Emily was saying, you know, you’ve got to be patient. We're getting paid to wait. Last year, the 10-year started … 10-year Treasury yields started at 3.88%. It ended at 3.88%, but it went as low as 3.3 and as high as 5.

We very well could be in another year where we're bouncing around with Treasury yields. But may not go as far as, you know, the market thinks. We might end up back where we started. And we want to just be patient there. For equities, we don't want to chase here. We want to make sure we're finding good quality companies, having some value exposure, and we think that's the best way to kind of ride out this near-term volatility.

John Bryson:

That's very good. You both said patience is warranted. Hey, Emily, I want to go back to you. We talked a little bit about manufacturing. Globally, it's also improving. How are you feeling about international opportunities right now?

Emily Roland

Yeah. So, we are maintaining, John, a still a modest underweight to international equities. We still have them in our in our overall portfolio views. But we think it's really important to be active in the space. In fact, we do have a preference for international value stocks over international growth. And a key reason for that is that we're always following the earnings. Matt referenced earnings season coming up. You know, we think it's really important to kind of look at international equities in particular through the lens of the fundamentals. Where can we find the best earnings growth? Where are the best opportunities going to be for an active manager in an environment where earnings growth internationally is .. is pretty modest or, you know—to use a technical term—a little blah overseas, while it's more robust here in the U.S.

So when we look at things from a style basis, the earnings trends are simply better on the value side. You know, you think about growth versus value stocks. If you own growth stocks, you want their earnings to grow, which is exactly what they're doing here in the United States. But there's a notable dynamic playing out abroad, where actually international value earnings are growing faster over the last couple of years than international growth earnings. Some of that is due to Japan, which dominates value indices. But overall, that's where we would be tilting portfolios within international indices. We also have a preference for non-U.S. developed markets versus emerging-market equities, given some of the structural challenges we're seeing in EM across China. Some major issues with their property sector. They're moving away from capitalism. There are some longer-term demographic challenges there. So looking to international developed is really the best opportunity across those markets.

John Bryson:

Okay, Emily, a clarification on technical terms. Is meh better than blah, or is blah better than meh?

Emily Roland:

I would go interchangeably on those two.

John Bryson:

Okay. All right. Good to know. Just wanted to clarify. Thank you. Hey, Matt, you mentioned earnings season is coming up right around the corner—starts on Friday. So what are your expectations?

Matt Miskin:

Yeah. So right now, the bar isn't too high. So the analyst community for the S&P 500 is estimating about 3% earnings growth for Q1. And that seems about right to us. It's from there that it gets more interesting. So the street analyst community S&P 500 earnings estimates is that they keep ratcheting up every single quarter and then go almost as high as 20% by year end.

That to us seems less realistic. You know, right now, what we're seeing is this margin compression backdrop where revenues are now growing at about 2 to 3%, which isn't that bad, frankly. And it's about right. But costs for companies are going up a similar amount. Earnings on a last-12-month basis are basically the same they were 2 to 3 years ago. Prices are certainly higher. So that means that the multiple—the valuation—of the market has kept going up. And it is the highest it's been for the last couple of years.

And so, you know, for us it's about finding those profitable companies, those ones with the best margins out there as a part of our quality view. And then we want to have it at a reasonable price, because everything has just gotten more expensive over the last 6 to 12 months. So, our mantra right now is quality a reasonable price, barbelling the quality factor with profitability, with the value factor. And to us, that's managing both the quality risk—or solvency risk or lower quality risk—and the valuation risk in the markets today. But you know, we're going to start with financials here as early as Friday. And the banks and then, you know, we've got some of the bigger market cap companies coming in the weeks ahead.

John Bryson:

Very good. Hey, Emily, back to you. You mentioned that you and Matt had just finished up the first-quarter Market intelligence. And I think you're delivering that tomorrow, and it will be recorded and posted on our website. Are there any opportunities that you're seeing that we haven't discussed on the podcast?

Emily Roland:

Yeah. So, Matt talked about quality at a reasonable price, which continues to be a key theme for us in terms of opportunities. On the equity side, I would say another one that we're continuing to have a lot of conviction is U.S. mid-cap equities—especially since we are seeing this reacceleration in inflation, reacceleration in economic growth. Again, it may be choppy here, as Matt mentioned about bond yields. You know, we can we continue to see this kind of late-cycle chop in the economic data. But we are right now seeing that seeing again a kind of a growth impulse around the world. And we think that's really, mid-cap equities in the U.S. are a great way to play that.

A lot of it is a result of stimulus. We are still employing stimulus, to the tune of almost $2 trillion in deficit spending. And a lot of that's being funneled into industrial production in the United States. It's being supported by things like the CHIPS Act and the Infrastructure and Jobs Act. We've both spent a lot of time in the Midwest over the last quarter, and it is absolutely booming there. You're seeing a manufacturing renaissance, playing out through things like EV production and semiconductor facilities, battery production. It's also been helped by onshoring, so supply chains coming back from China and other parts of the world to the United States. That was a trend that was in play prior to the pandemic. But that's really been accelerated since then.

So, we look at the mid-cap space as having an overweight to the industrials sector. So, these are companies that really are a play on this onshoring and manufacturing renaissance that we're seeing. Mid caps also are a bit more cyclical than some of the areas that we are also focused on, like U.S. large-cap, high-quality tech companies. So, it's a great way to take advantage of a part of the market that's a little bit more cyclical and also on sale. The valuations are quite compelling there as well, especially on the mid-cap value side, to complement that quality exposure that Matt talked about.

John Bryson:

That’s exciting to hear that the opportunities in mid caps in the growth in the Midwest are both really good for America. And Matt, speaking of America, we are in an election year. Are there any research or insights that you come across that you'd want to show that listeners?

Matt Miskin:

You know, we just are looking at, under the Biden administration, what the best-performing parts of the markets have been. And it is very counterintuitive to what you would have thought. So under the Biden administration, the number one performing sector has been energy stocks. And I'm talking traditional fossil fuel, drill-baby-drill, Texas oil companies. So, not alternative energy, which, you know, really, there's been more of an environmentally, a kind of alternative energy push under the Biden administration. Those stocks haven't done well. We are producing more oil than we ever have in this country's history. Other sectors that have done well under the Biden administration: financials, industrials, mid caps, mid-cap value. And under the Trump administration, if you were to look back under that playbook, it was tech, it was growth, it was Chinese stocks. So we have this in Market Intelligence.

To us, it is speaking to the lack of connection between policy—or rhetoric—and market performance. That's why we do not use politics in portfolios. In fact, it's often giving you the exact opposite results as you would have thought. The hardworking families of America are what drive the economy. Corporate profits drive markets. And often the starting valuations matter the most, too.

I mean, under the Biden administration, coming in after energy prices have been taken down so much because of Covid, that was a starting point. There was a lot of deep value available at that starting point, and now it's come back. So again, we're doing a lot more of the work of what's driving the economy, what's driving the markets. It's earnings. It's corporations. It's the jobs market. And, politics, I'm sure it’s going to be a big, you know, reason for a lot of ink to be spilled and a lot of media and links to be clicked. But we're trying to mitigate that as much as possible and focus on the fundamentals.

John Bryson:

Really helpful. We spent a lot of time talking about separating the good information from the noise, and you continue to bring us back to the good information. Folks. Matt and Emily can do the work for you. They're always keeping an eye on the market. You can follow them on LinkedIn. You can go to our website and get their most recent research.

Like I said, the Market Intelligence update, it will be up there soon. Matt. Emily, thanks so much for joining us. I want to wish you a happy eclipse day. Be careful. Wear sunglasses and it's done. You got it. and for those that are listening to the podcast or want to subscribe, please follow us on iTunes or visit our website, jhnvestments.com. You can catch up on all the different things that Matt and Emily are talking about, and all the different business-building ideas we have to offer. Thanks so much for listening.

Important disclosure:

This podcast is being brought to you by John Hancock Investment Management Distributors, LLC, member FINRA, SIPC. The views and opinions expressed in this podcast are those of the speaker, are subject to change as market and other conditions warrant, and do not constitute investment advice or a recommendation regarding any specific product or security. There is no guarantee that any investment strategy discussed will be successful or achieve any particular level of results. Any economic or market performance information is historical and is not indicative of future results, and no forecasts are guaranteed. Investing involves risks, including the potential loss of principal.