Chris Hyzy: Okay. Thanks, everyone, for joining this week’s Street Talk Call. It’s a fascinating mix in my opinion of macro and micro so far not just today, but this week alone from the hawkish move by the Bank of Canada that caught some markets by surprise to the 20 – 30 year spread in the U.S. Treasury market inverting first time since the 20 year was brought back some few years ago. Then when you take a look at corporate revenue announcements, still beating well above the pace that was expected and obviously, earnings are following there, highlighting the fact that our theme of accelerated and higher than normal operating leverages puling through which is keeping margins despite labor cost inputs going up and despite supply chain disruptions and price inputs going up, these margins are hanging in there and staying well anchored at very attractive levels. You’ve got a fascinating mix of macro and micro but deeper than this is a trend that is already starting to gather pace and we’ll see more of this in our opinion in 2022 and most likely through into ’23. We highlight some of this in what we call this latest report, The Book of Great: Lessons Learned. This was just produced this week and went out. It talks about The Great Separation and the report we originally wrote back in May of 2020 and then the trend line that occurs from the fall down in the economy and the onset of the pandemic to accelerated pent up demand and how that filters into the corporate world, how it filters into the market, and then now we are now marching towards what we call the new era or the new dawn or the new frontier. So that report is titled, The Book of Great: Lessons Learned and there’s five to six major lessons learned and that brings me to the topic for the call today. It’s a deeper topic. It’s about prior cycles versus this cycle. Prior cycles for most folks going – dated back to the 1990s and really accelerated during the global financial crisis period, we saw prior cycles that you could articulate them as the great moderation, and that was simply perhaps a fancy term to say that inflation was not an issue. Disinflation, in other words, deflationary forces were more or less at bay. That was a world of excess supply. Now that you can argue we are in the The Great Acceleration. Acceleration of innovation, acceleration of very strong convergence between what big data and science are doing, and also the great acceleration in changes to monetary policy and how these new regimes are taking hold. That’s also a fancy way to say the fact that we’re leaving the deflationary/disinflation world and we’re now entering into a new regime that is highlighted by the level of inflation and the question is how do portfolios need to adjust as we move further into that cycle? So that we’ll focus on today. In other words, starting out of the gates again, prior cycles, excess supply world. Now and back then, demand was not strong enough to challenge the oversupply. There was talk about over capacity, there was talk about overheads, and cost of goods sold going up, just in time inventory, and the actual demand stock around the world for a variety of reasons, both goods and services, was not excessive and it didn’t match frankly the oversupply nature of the global supply chain hence disinflation or deflationary forces were constant. Every time the fed hiked during that type of cycle, that’s when you had a bite into risk assets, a bite into the equity markets, a bite into growth overall and that turned inflation, which may have looked like it was heading towards a target of 2%, it turned it upside down and it moved it much lower than that 2% target and the Fed had to relax and in some cases add to the balance sheet, induce a quantitative easing again, or in fact cut interest rates back down to zero. So now totally different regime in our opinion. We’re now in an excess demand world. We highlighted that throughout the last 18 months but it continues to accelerate. We are already above potential output and that is being picked up obviously in supply chain disruptions. In 2022 it is our belief we are likely to go further above potential output for the economy as the full reopening occurs and the pandemic potentially turns into endemic type of nature. In supply chains right now as far as we’re concerned as it relates to delivery times, as it relates to prices paid, and a few other logistics bottlenecks, they’re now easing. We’re seeing it in some of the auto chip areas. We’re also seeing it obviously in the warehouses beginning to open it up. It’s going to take time but supply chain easing are also happening at the same time we expect further reopenings heading into 2022 and then accelerating throughout that year. So wages in our opinion will continue to play catch up. CPI, Consumer Price Index, staying elevated, unemployment low right now heading lower because the labor market is very tight. This is not stagflation. You’re going to hear a lot about stagflation because growth in the third quarter came in at about 2%, well below what most people were looking for heading into the third quarter but actually above where some of the worst forecasts were which were a negative quarter but that’s just in our opinion high frequency noise quarter to quarter. The trend itself is back towards expansionary mode, so we don’t see stagflation. In other words, really low growth with high inflation. We actually see above average nominal growth with elevated inflation. So the bottom-line is this isn’t an entirely new regime/a new cycle. One that has to think about reigning in inflation through the Federal Reserve and other central banks around the world. This will be a process and it will likely be a consistent one out next year and into 2023. So from our approach, this is the pivot factor for portfolio positioning, market levels, the activity that goes on within market internals in other words, underneath the indices, and across all asset classes – equity, fixed, the commodity spectrum, areas of alternatives, and then ultimately as it relates to sector factor positioning, size and style, and in fixed income squarely around the duration of the portfolio. As far as broad averages are concerned, in the coming months -just to shift away from a little bit of the longer term speak for the call and more towards what we expect in the coming months – number one, we expect total returns in equities to begin to normalize back to basically more normal levels, towards the single digit like levels. A lot of reasons for this but mostly it has to do with the extraordinary gains that have been deployed and garnered in the markets for the last two years. A lot of reasons for that, but the reaction function goes like this. If inflation stays elevated and rates adjust to this and rates adjust to this new regime, ultimately that emits a response by central bankers. As that response occurs, the backdrop of growth, nominal growth, should still remain healthy in our opinion and the growth segment of the indices, in other words, the high growth portion of equity indices with higher rates, even higher growth than what the third quarter produced and overall portfolio repositioning, the growth segment will likely have a lower ceiling on it. It’s just a way to say that there’s room for improvement and now performance begins to slowdown relative to the last two years. As that happens, because indices are overly weighted by the high growth/mega growth areas, it is likely that that creates overall broad pressure. Not necessarily to the downside, but the other part of the market, the more value oriented, the more cyclical oriented, the smaller areas in the market are going to have to work overtime to be able to produce attractive returns. It is our belief that you get a more balanced move in the market versus the extraordinary moves we’ve had and over the next 12 – 24 months you start to de-escalate, if you will, towards more normal return versus the extraordinary ones that have occurred since the onset of the pandemic. Number two, if this is the case, then volatility increases not necessarily in risk assets. Time will tell on that but we believe volatility around interest rates across the curve begins to pick up and therefore the Fed’s response in how that filters into markets becomes even more important than we had already been discussing. Does the Fed get overly hawkish because of the levels of inflation staying stickier for longer at higher levels? Does the fed stay overly dovish and just begin to remove their emergency policies and ultimately bump rates very slowly or are they more balanced as potential Fed make up changes and at the same time, the realization that inflation targets have been surpassed and it will be needed to be addressed? It is our belief at this point, and there’s a lot of information between now and when Fed lift off is, that the Fed will try to be more balanced. They’re clearly, in their communication right now, trying to detail out to the marketplace/the broader community that they still have a dual mandate. The mandate is full employment and price stability and as they bump rates some time next year and continue to slow down bond purchases, they will likely to remain more balanced. We’ll see how that filters through. Right now, the Federal Reserve’s policies are still very easy and money growth is still running well above average. Inflation is likely to stay elevated and not drop considerably as far as we are concerned and as far as some in the marketplace are already discussing. So what do we do? The cyclicals in general should be under upward pressure as the expansion picks back up and reopening moves forward. Sectors more leveraged to the above trend nominal growth should outperform. The value area should continue to play catch up to the extraordinary outperformance in the past decade of growth and the long duration growth areas, some of which are reporting this week and throughout next week, you’re starting to see these reports come through, that these big story areas with little earnings are likely to come under further pressure. Many of them have already corrected considerably off of their peaks that they had in 2020 but as it relates to their pure fundamentals, their long duration nature itself is going to take quite a long period of time for some of these areas to pull through high enough earnings where interest rates are not going to affect that. So we are more enthusiastic about parts of the technology sector that are more cyclical in nature and that are benefiting from the reopening versus those very long duration, very little earnings, very little profit areas that are priced/unpriced for sales. As it relates to overall corporate levels, the companies that have pricing power have solid staying power in this cycle. As we switch further into this new regime - pricing power has not been around for quite a long period of time. It is now here and the excess savings by the consumer is allowing for majority of these pricing power areas to filter those higher prices into consumer land and consumer is paying that at this point. At some point those prices do get too high and demand starts to be curtailed by that but we are still very early in that cycle. So in our models, in our portfolio suites in CIO, we continue to focus on balance, on diversification, on cyclicals, and value but also a good book end on the areas of growth that are more cyclical, not the longer duration growth areas. Then as it relates to some of the solutions across the board, we’re looking for managers and solutions that are advocating and owning the areas that have pricing power. The big unknown is what the fed’s tolerance level for consistent above normal inflation is and well above their target. What’s their tolerance for that? Well find out more obviously in the coming 6 – 12 months. Right now the futures market for federal funds is concerned are suggesting pulling forward a rehike to June of ’22 and then a second one in November. BofA Global Economics team believes it’s later in 2022 versus the original market expectation of ’23 but certainly the futures market is now starting to pull that forward to mid-’22. We’ll see how that goes and we’ll see what the fed does when it tightens but it’s not about when, it’s about how much in our opinion. How much do they rein inflation? How sharply do the moves start to accelerate or not? That will likely continue to filter into the broader asset classes, more specifically the interplay between equities and fixed income. So overall, this is backdrop frankly that is bullish for nominal GDP growth. Obviously, with elevated inflation and above potential output and production in the economy, you get higher than expected nominal GDP growth and that filters over into corporate revenues. This is bullish for corporate revenues in our opinion in this particular new regime cycle. All of this started with the extraordinary monetary growth mixed with the fiscal outlays which frankly together at the highest level still by far in the post-World War II era hence the fact that we are in an excessive pent up demand cycle relative to supply. When you back out and you look at inventories across the board, many people are suggesting that inventories are actually above where we were pre-pandemic but the gap between supply and excessive demand is wider therefore you’re seeing still the supply chain disruptions. It’s all going to come down to the Fed’s response. It comes down to how far out the easing goes in the current regime and then ultimately, how the fixes to supply chain disruptions. It does come down to inflation in the end and whether or not the fed reins in any quicker or sooner rather than later and by how much. When you step back, autos are now starting to get back into the pent up demand cycle, housing is still accelerated, and durable goods demand in general still is very high. So this is all emblematic of a cycle of huge pent up demand and therefore our portfolio positioning is moving more and more towards that area. So what do we do? We increase diversification by adding or increasing the exposure to cyclicals and the value areas of the market if your portfolio’s overly exposed to growth and it’s top heavy. Two, we look to shorten duration. If the portfolio is not there yet as we head towards a more or less dovish cycle for monetary policy. Number three, consider adding to small caps if you’re underweight. Four, we’ll likely have to be more active underneath the indexes with positioning below the market indices being more active overall, more based on sector positioning, and clearly factor positioning. With that, we might have to actually increase portfolio rebalancing if volatility does pick up like we expect. So that’ll do it for today. Thanks for listening.
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