Portfolio Intelligence podcast: What does November’s rally tell us about bonds and rates?

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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 November 30th, 2023, and markets are rallying. So I have invited Emily Roland and Matt Miskin, our Co-Chief Investment Strategists at John Hancock Investment Management to the podcast to tell us what's going on. Matt, Emily, welcome.

Emily Roland:

Thanks for having us.

Matt Miskin:

Thank for having us.

John Bryson:

Hey, Matt, I'm going to start with you. November was one of the strongest months for stocks in years, we've really seen a turnaround. Can you talk to us about what's going on?

Matt Miskin:

Yeah, John, it's been all about inflation starting to decelerate. So we got a CPI report that came in 1/10 of 1% lower than estimates, and lo and behold, that really has helped in the course of November. Stocks getting a relief rally here and the Fed likely is going to be on pause, the market is getting more confident in that, but also we saw this massive sentiment shift. So there were a lot of investors, if you look at the AAII sentiment index, that went from bearish to bullish over the course of the month. Really to us, it's been this whipsawing of sentiment that’s driven much of the market this year. We've increased the multiple, the valuation on the market, but we're really trying to focus on the fundamentals. Earnings results in Q3 were pretty good, they were about 4% year over year, so that was a positive into November as well. But it's been a great rally. The VIX is low, volatility is low, high-yield spreads are tight, but we also want to be careful here, this risk-on rally, it is in the face of some weaker economic data points here and there. We want to make sure that we're focusing on the higher quality, fundamental parts of the market even after this nice rebound we've seen in November.

John Bryson:

Okay, really helpful. Hey, Emily, I asked Matt the stock question, let's pivot over to global bonds. They're also rising at the fastest pace since 2008. Can you talk to us what's going on in the fixed income space?

Emily Roland:

Sure, yeah. So finally some great news on the fixed-income front here. I think it's well deserved after what we've been through as bond investors over the last year or so. But really, the catalyst was this massive decline in bond yields in the aftermath of that October CPI report that Matt talked about. In fact, if you look at the start of the month, the yield on the 10-year Treasury was 490 basis points, and we're hovering here at the end of November, right around 430 basis points. So roughly a 60 basis-point move in the 10-year Treasury yield, which is obviously quite remarkable here. So big tailwind obviously as inflation continues to come down.

I think one thing that's notable here is that bonds are starting to become a lot more competitive with cash. We talked about this rally across stocks. We talked about the rally in bonds. Potentially, going forward, cash, which has been king over the past year, maybe one of the bigger drags on portfolios. We look at things like money market assets, which are now at $5.8 trillion. In talking with advisors in our travels, we're hearing that there's an interest in moving cash into other areas. So we do want to be fully invested here. We're focused, and I know we'll talk a little bit about outlook, but we're focused on areas that are offering higher quality fundamentals here and we are watching closely if the rally across both stocks and bonds does continue, cash is probably not the best place to be.

John Bryson:

Got it. So I'm hearing some cautious optimism type of a commentary from both of you. So Matt, coming back to you, you mentioned inflation, the numbers are coming in weaker, so that's a good thing, inflation is receding around the world. You talked about the Fed being on pause. We're hearing more and more talks about Fed cutting next year. Some people even saying as early as first quarter, what's your take?

Matt Miskin:

Yeah, it very well could be in next year. On average, Emily was nice enough to give me the statistic this morning, but it's about eight months from the last rate hike to the first rate cut. Right now, July was the last rate hike so if you do eight months off that, I mean, yeah, you're looking at first or second quarter. We try not to be too precise because it is an average. But the other thing we look at is that after the last rate hike, usually longer-term Treasury yields like the 10-year Treasury yields falls six to 12 months later, to the tune of usually 100 basis points. So the last rate hike was on around July 26, the 10-year Treasury yield then was 3.85%. We went up over 100 basis points, which again is historic, has not happened in modern history. But if things become more normalized, then Treasury yields likely fall and they could fall from that, even that 385 number, at least historically that's what's happened. So we do see downside risk on yields.

We see the Fed on hold. Central banks around the world are actually starting to consider even rate hikes next year and starting to put that out. The ECB and the Eurozone just actually printed a two handle on their inflation, and if globally inflation is coming down, the Fed policy and central bank policy around the world is too restrictive and they're going to have to start worrying about growth more or the employment rate more than inflation. We think that's going to be a theme into 2024. We want to make sure that we get these bonds now when we can get these great yields because if they disappear into next year, it's going to be hard to get it back.

John Bryson:

Interesting stuff. I mean, there's a lot of moving parts. Emily, help us bring it all together for the advisors and the investors out there. 2023 was a volatile year. We're seeing some positive momentum. How are you talking to advisors about positioning portfolios for the rest of this year and into next year?

Emily Roland:

Yeah sure, John. So we know we're macro strategists at heart so we always believe that the most important input to making cross-asset decisions is understanding where we are in the economic cycle. We still think that we're in a late-cycle environment where the lagged impact of Fed tightening simply has not tipped us into an economic contraction. It's proving to be a pretty resilient late-cycle environment, almost a never ending one in which we're seeing a lot of strength still from the labor market, but we are seeing expectations moderating into next year. So you look at the analyst community is now penciling in 11% earnings growth on a 19-times forward multiple on the market, which to us is pretty optimistic. So what you've got to do on the equity side is find those areas of the market that can be more resilient in the face of a potential contraction. Quality continues to be a big focus for us. These are stocks with great balance sheets, tons of cash. A limited need to have to issue debt or equity in an environment where the cost of capital is extremely elevated and may stay that way for a bit.

The poster child for quality is mega-cap tech. We still like tech, we think it makes sense to pay up for it, but of course, leadership in the market's been really narrow and we've seen some pretty egregious valuations on large cap growth stocks, particularly across the magnificent seven. So we want to diversify from that. We want to find areas that we can still get some multiple expansion. We look to areas like mid-cap equities in the U.S. which are trading at a significant discount to their long-term average, and we think can benefit from trends around onshoring or reshoring as supply chains come back to the U.S., as fiscal spending continues benefiting this industrial revolution that we're seeing happening across the United States.

We also think that more defensive parts of the market like healthcare stocks and utilities, which have been left in the dust frankly so far this year, could see a bit into next year as we witness this change in consumer behavior. I think potentially you'll start to see consumer spending fade as excess savings are drawn down, as student-loan payments resume, and as the cost of borrowing is incredibly elevated across mortgages, auto loans, credit cards, we may see a shift away from the things that people want to buy, but they're still going to do the things they need to do. So areas like healthcare and utilities could benefit from that.

Then finally, we've talked a lot about bonds. We want to still look to fixed income as really doing more of the work in portfolios into next year. We do think that there's an opportunity not only to benefit from a potential duration tailwind, but also just keep it simple and look at the income that's now available in high quality bonds as again, being a big source of or a more potentially significant source of return in portfolios certainly than it has been over the past couple of years here.

John Bryson:

Yeah, we've talked about it for so long, looking for more yield and fixed income and now we have it and we just have to make sure investors take advantage of it.

So Matt, I want to pivot. On a bit of a sad note, we lost a legendary investor this week. Charlie Munger, he was a longtime friend and business partner of Warren Buffett. He taught us and many investors, a lot of lessons. Are there any lessons you learned from him that you can share with our listener base?

Matt Miskin:

Yeah, I mean, it is terribly sad and just looking back on his career, it is something of, I guess, envy is the word I could use. Just hearing such a great investor, such success over the years, but you got to make sure there's a couple things you do right. One, I think his consistency and longevity of it, just staying at it for this many years and being in his career for that long. Then the value philosophy, John, I think about right now, I mean, we're going to be seeing a presidential election within a year. Talking to advisors, this is probably of the most challenging environment to work with clients, making sure that they don't let politics get into their investment portfolios and not to make investment decisions based on political views. In that old traditional value philosophy, it is removing that noise, focusing on the fundamentals, being objective, and to be consistent with that and not let yourself get pulled into those things.

So I often think about that old school value philosophy and consistency is why clients work with a financial advisor, because they can actually adopt some of those, that process, that philosophy, and that investment approach through having help because as we all know, the human brain is something that is not built for investing and it makes it very difficult to stay the course. So there's a lot of feelings obviously with it, and it's something that I think we're always trying to strive for here as well in having that kind of long-term value approach to investing.

John Bryson:

Yeah, long-term value approach, focus on the fundamentals, eliminate the noise, and when you need help, rely on a professional. So that's great.

Hey, Emily, my last question on the podcast, we're closing out the year. This podcast is all about helping financial advisors and investors be better at what they do, help build their practices but also it's important to help out the podcast moderator, myself. You're one of the go-to people I have for Christmas gift ideas. How do I get this Christmas right with my wife? What ideas you want to share with me?

Emily Roland:

Well, John, I've been putting Christmas lists together for you for about a decade now, and I feel like I've directed you pretty well. There's no doubt about it, the top gift of the year this year is the Dyson Air Wrap. It's one of the most important haircare tools of our generation. If Janet doesn't have one already, I would walk, not run. I was going to say trading at a discount. They're selling at a slight discount right now across a number of different places. So very much recommend that, and I think you'll be in very good graces.

John Bryson:

All right, I went to the pro. You have been helping me out for years and you will continue to help me out.

Matt, Emily, thanks so much for helping us out this year, it's always a pleasure to talk to you. Folks, if you want to hear more from Matt and Emily, they are the architects behind our quarterly capital markets outlook piece titled Market Intelligence. They do mid-quarter updates, and they have weekly video series. You can also follow them on LinkedIn at Emily R. Rowland and Matt Miskin, Matthew, excuse me, underscore Miskin on LinkedIn. So check out what they're talking about. They are all over the markets and always sharing great advice.

If you want to hear more, obviously subscribe to the Portfolio Intelligence podcast on iTunes or wherever you listen to your podcasts, or visit our website, jhinvestments.com to read viewpoints on all things investing, business, building ideas, and much, much more. As always, thanks for listening to the show.