The big shift: New market forces and ways to prepare

The big shift: New market forces and ways to prepare

 

 

Hosted by:

Chris Hyzy

Chief Investment Officer,

Merrill and Bank of America Private Bank

 

Featuring:

Ian Bremmer

President of Eurasia Group and GZERO Media

 

Michael Hartnett

Chief Investment Strategist,

BofA Global Research

 

Savita Subramanian

Head of U.S. Equity & Quantitative Strategy

And Head of ESG Research,

BofA Global Research

 

Alex Lin

Senior U.S Economist,

BofA Global Research

 

Joe Curtin

Head of CIO Portfolio Management, Chief Investment Office

Merrill and Bank of America Private Bank

 

Marci McGregor

Senior Investment Strategist, Chief Investment Office

Merrill and Bank of America Private Bank

 

 

 

Please see important information at the end of this program. Recorded on 3/21/2022.

[PROGRAM OPEN WITH TEXT OVER MONTAGE OF VIDEO CLIPS]

 

Geopolitical risks

 

Changing global markets

 

Inflation & rising rates

 

New investment trends …

 

… And opportunities

 

The big shift: New market forces and ways to prepare

Please see important information at the end of this program. Recorded on 03/21/2022.

 

 

CHRIS HYZY:

Hello and welcome!

[LOWER 3rd]

Chris Hyzy

Chief Investment Officer

Merrill and Bank of America Private Bank

 

I’m Chris Hyzy and I’m pleased to be hosting this conversation on “The big shift: New market forces and ways to prepare.”

 

We’re experiencing a lot of change in the markets, the economy and our world.  We’ve seen inflation and oil prices soar and the tragic outbreak of war in Ukraine.  On the other hand, the job market here is booming and the U.S. economy continues to reopen. 

 

These are really big shifts – with important implications.

 

The experts I’ll be speaking to will help unpack what they could mean for your financial life, including how we invest and think about the risks and opportunities.

 

The program is divided into segments so you can watch them one at a time – or all together, depending on what you prefer.

 

Here’s a snapshot of what’s in store.

 

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Ian Bremmer

President of Eurasia Group and GZERO Media

First, I’ll be joined by my special guest Ian Bremmer, president of Eurasia Group and GZERO Media.  Ian is a leading expert on geopolitics and a best-selling author.

 

We’ll discuss what recent events around the world could mean for our future, including the crisis in Ukraine, the U.S.-China relationship, climate change, and other key shifts Ian is following. 

[GRAPHIC CARD]

Michael Hartnett

Chief Investment Strategist

BofA Global Research

Next, I’ll speak with Michael Hartnett for his views on global financial markets.  We’ll explore how major pivots in policy, the economy, innovation and other trends are reshaping the investment landscape – in both the short and longer term. 

[GRAPHIC CARD]

Savita Subramanian

Head of U.S. Equity & Quantitative Strategy

and Head of ESG Research

BofA Global Research

Alex Lin

Senior U.S. Economist

BofA Global Research

 

Next, Savita Subramanian and Alex Lin with BofA Global Research will share their outlook for the markets and economy here in the U.S.  We’ll discuss the potential path for inflation, interest rates and economic reopening – along with U.S. equities and sector opportunities, during what could be an extended period of market volatility.

[GRAPHIC CARD]

Marci McGregor

Senior Investment Strategist,

Chief Investment Office

Merrill and Bank of America Private Bank

Joe Curtin

Head of CIO Portfolio Management

Chief Investment Office

Merrill and Bank of America Private Bank

For our final segment, I’ll be joined by Marci McGregor and Joe Curtin, two of our top experts with the Chief Investment Office.  We’ll unpack why the changes we’re seeing today could have important implications for how we invest.  And we’ll offer actionable ideas and strategies you could consider now to prepare for the risks and opportunities ahead.

 

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The Geopolitical Landscape

With that, let’s go to my conversation with Ian Bremmer.

 

CHRIS HYZY:

I want to go through a little bit of the major pivots that have been going on.  Monetary policy, major pivot, we've also seen fiscal policy outlays.

[LOWER 3rd]

Chris Hyzy

Chief Investment Officer

Merrill and Bank of America Private Bank

But more importantly, the bigger shift that you've talked about going on for a long time is this movement and acceleration towards a G-zero world and that is being expanding right now because of the crisis in Ukraine.

 

Take us through that power vacuum world over the next few years with China on the stage, the U.S. on the stage, Europe and then the Middle East.

 

[LOWER 3rd]

Ian Bremmer

President of Eurasia Group and GZERO Media

 

IAN BREMMER:

Putin invaded Ukraine because he saw the G-zero; because, you know, he saw that the United States pulled out of Afghanistan.  Syria, the first invasion of Ukraine, the first invasion of Georgia, Libya, Myanmar, Venezuela, Haiti. Why is that happening? It's because the United States, the most powerful country in the world does not want to be the world's policeman. Does not want to be the architect of global free trade.

 

Now it turned out that the Russian invasion was a step too far and has brought the Americans and the Europeans together in ways that no one would've expected.  But do we think that's going to last? And do we think that that will be applicable beyond Ukraine in other parts of the world? And most countries would say, “No.” Certainly the Middle East governments would say, “No.” Certainly the Chinese would say, “No.”

 

The alignment with the United States is with core allies among advanced industrial democracies. It's not with the soon-to-be largest economy in the world, China, it's not with American allies in the Gulf States. It's not with the developing world, India, 1.4 billion people. So what we are seeing is not that the United States and China are suddenly fighting each other tooth and nail, but rather we're seeing an absence of global leadership. A vacuum in an environment where there are big global challenges.

 

CHRIS HYZY:

With that potentially comes de-globalization. It's been widely talked about.  Regional alliances with trade, perhaps labor, but most importantly right now, with where energy is, in the context of energy supply and access to natural resources. Take us through your thoughts on how that is a big shift.

 

IAN BREMMER:

Well, Russia for the last 20 years has been an energy superpower in Europe. That's over, going forward. And the reason for it is because of globalization. It's the big, cheap regional market, so that's who you buy from, if you don't care about politics. If you don't care about the disruption that can come from a geopolitical risk to yourself.  Suddenly you do.

 

And so, what does that mean? That means that globalization starts to get unwound. I mean, oligarchs, billionaires from Russia, can they go anywhere they want and spend their money? In a globalized world, the answer is yes. In a non-globalized world, even countries like Switzerland and Monaco say, “No.” These are neutral places that suddenly are saying, “No, politics actually does matter.” This is a step too far.

 

And so, I would say what we have is a shift in trajectory of globalization that is increasing costs, it's fragmenting at the margins. It's certainly in areas of national security saying, okay, those are going to become larger and internal or with allies.

 

But the most important trend of globalization in the past 50 years has been bringing China into the global economy. That is not over.  It is at risk and if it turns out that the Chinese are full in with the Russians, irrespective of the Americans and others telling them, “don't you do this,” we could then have a breach. That's a risk, but it's not where we are today.  And frankly, I am reasonably optimistic, even though I don't have strong conviction about it, that we will continue on that path for the foreseeable future.

 

CHRIS HYZY:

There's a lot of talk now about the dollar’s reserve status over the next, let's just say five - 10 years. Is there a viable alternative right now, even though many people are talking about this very large economy, soon to be the largest, in China and how that may compete with the dollar? Take us through your thoughts there.

 

IAN BREMMER:

As long as the Chinese economy is closed and as long as the RMB is not free floating, then the answer is no, there's not one major viable alternative.

 

Now, the Chinese could decide that they were going to open it up, but they'd have to deal with massive capital outflows as a consequence for years, because a lot of the Chinese people holding that RMB would be much more comfortable in much more sustainable currencies like the dollar, right? So that's why they're not doing it. So it's precisely the fact that there isn't a viable alternative and the Chinese get it that kind of ensures that that continues to be true.

 

So I think if you told me a 30 year time horizon life looks very different. You asked me a five year time horizon, where states are the principle actors on the global stage. In that environment, yeah, I still think the dollar is the global reserve currency.  Now 10, 20, 30 years out, we could be moving into an environment where actually states increasingly aren't the primary actor on the global stage. Where, for example, technology companies could become that. Now that happens, the erosion of the U.S. dollar has the potential to be much greater in ways that people haven't been thinking about, but we aren't there.

 

CHRIS HYZY:

The world to your point is becoming more digital, right? From the standpoint of almost everything we do. You've talked about recently this concept of a “techno-polar world.” Switching to now the technology end of things.  Take us through your thoughts on that concept.

 

IAN BREMMER:

So, you asked me at the opening about the G-zero world.

 

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The G-Zero world:

·        Bipolar world – U.S. vs the Soviets

·        Unipolar world – U.S. and its allies

·        Nonpolar world – no global leader

And that means that geopolitically, you used to be bipolar, U.S. versus Soviet, cold war. Then for a brief moment, you’re unipolar, the United States and its allies after the Soviets collapse and now, increasingly, you’re nonpolar. Nobody is the global leader out there, even though the U.S. is the most powerful.

 

And that is true when you talk about the world of physical things. You talk about commodities, you talk about physical people, talk about land, talk about aircraft carriers, all that kind of stuff.  But now what happens when we talk about the digital world, the virtual world, the virtual economy data, right? That kind of information, which has economic importance also has security importance. The sanctity, the protection of your data, personally, your companies, your government.

 

Well in the digital world, governments are not sovereign.  Technology companies are.  They actually create the platforms, they make the algorithms, they determine the security, they determine whether you're even able to be on or off of the platform and that is not a non-polar world. It's a techno-polar world. That wouldn't matter much if the digital world was just a hobby, if it was the internet that, you know, you’re just playing on.

 

But, when the digital world become is critical for national security, when it becomes critical for the global economy, when it becomes critical for how you live your life and your political views and how you get information, suddenly the power of those tech companies and what they're interested in accomplishing and are they aligned with governments or not, or do they even think governments are very relevant for them going forward, suddenly becomes absolutely critical.

 

What we see is that our lives and the way we even think geopolitically are being shaped by companies that are making those determinations functionally outside of the rule of law.

 

CHRIS HYZY:

Another major force in addition to a techno-polar world is climate. We're seeing stories every day, every week and we're also seeing how difficult it is to transition from a hydrocarbon productive world in the energy space, to a greener technology and in the timeline that we're trying to do it.

 

What's your thoughts on the climate end of things, as it relates to not just technology, but the access, and then where do we go in terms of national security in the climate end of things?

 

IAN BREMMER:

So, the interesting thing and very aligned with what we were just talking about is that the reason that we are making a transition on climate has more to do with non-state actors than it does with just big governments.

 

[LOWER 3rd]

By 2045, a majority of the world’s energy could likely

come from non-carbon sources.

I mean, we now know that by 2045, a majority of the world's energy will largely come, will likely come from non-carbon. That's incredible. And five years ago, no one would've assumed you you'd move that quickly.

 

But that's happening despite the fact that the central government in the United States and the central government in China, the two largest carbon producers, by the way, in the world, carbon emitters in the world, are not doing most of the leading. The Europeans are doing a lot of leading, but frankly, so are the banks. So are a lot of corporations. So are a lot of young people around the world who are saying, “We aren't going to buy your products unless you change your views on carbon.”

 

The COP26 summit in Glasgow was by all accounts, an outperformer. It was more successful than people would've thought because there are plenty of actors that are not the G2, that are driving response to one of the most important crises, global crises in the world today.  It's a global problem. We don't have global leadership and yet there is leadership. People find a way when things are critical to respond outside of existing broken architecture.

 

CHRIS HYZY:

So one final question here. Crisis times, whether it's financial crisis, humanitarian crisis, wars, conflicts, etcetera, have a way to galvanize a community, galvanize a world.  In your opinion, over these next five, 10 years, as all of these shifts are still taking place, does the world become more of a galvanized end of things, around innovation to help with the future versus try to gain power of the future? Take us through your thoughts there.

 

IAN BREMMER:

I think that there will be much greater, unexpected leadership as a consequence of all of this. So I'll give you an example. 10 years ago, Europe almost fell apart. Go ahead to 2022, you now have the Europeans leading the world on climate regulations, leading the world, in some ways that Silicon Valley doesn't like on data and privacy regulations.  And leading the world in the response to the Russian invasion of Ukraine.

 

That's interesting. Why are you seeing that? Cause they have to. Because they recognize that the way that they have lived for the last 30 years was inadequate and unacceptable to the challenges that they're increasingly facing. So, I think you will see an incredible galvanization of people all over the world in responding to these crises, but it may not be from the places that you would traditionally expect.

 

CHRIS HYZY:

Ian, as always thank you for being here today.

 

IAN BREMMER:

Great to be with you.

 

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Outlook for Global Markets

CHRIS HYZY:

With that backdrop, let’s go to my conversation with Michael Hartnett for his perspective on global markets.

 

CHRIS HYZY:

Michael. Thanks for joining me today.

MICHAEL HARTNETT:

Pleasure.

 

[LOWER 3rd]

Chris Hyzy

Chief Investment Officer

Merrill and Bank of America Private Bank

CHRIS HYZY:

We just heard from Ian Bremmer discuss the entire geopolitical scene. Let's put things in perspective right now.  You've long talked about commodities being a diversifying element at this part of the cycle in a portfolio. 

 

But you also talked about a higher inflationary backdrop.  And you talked about this movement of re-globalization, regional alliances, and we're seeing that play out in front of our eyes.  Give us your view on the global financial market landscape right now as we work ourselves through 2022.

 

[LOWER 3rd]

Michael Hartnett

Chief Investment Strategist

BofA Global Research

MICHAEL HARTNETT:

Well, I think 2022 is year two of a new era, quite frankly. I think that we've lived for 40 years with lower inflation, lower interest rates, higher profit margins. And it's been a wonderful, wonderful world to be in if you own equities or corporate bonds. I think that that era has come to an end.  It's come to an end partly because COVID really represented, sad as it was as a pandemic, the real climax of monetary stimulus and all that that meant so far as asset returns are concerned. 

 

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New era of big global shifts

·        Low inflation to higher inflation

·        Globalization to more regionalism

·        Growing focus on inequality

And I think what it also meant is it was the turning point for inflation and you're mentioning things that also contribute to that turning point, the shift from globalization, which we've enjoyed for the past 30, 40 years to one of more regionalism, little bit more geopolitical isolationism dare I say. And other things that will contribute to that are things like the fight against inequality, fiscal stimulus and so on and so forth.

 

So I think looking forward, we're just going to have to deal basically with an environment where we have higher inflation and higher interest rates, it’s really as simple as that.

CHRIS HYZY:

Now that's also impacted supply chains, not just of energy, commodities itself, goods productions, but also labor.  Take us through your thoughts as we work through this. And we're coming out on the other side, take us around the world.

MICHAEL HARTNETT:

If we just take regional equity markets, clearly the dominant one continues to be the U.S. I think the case for the U.S., even though I think that the direction of yields, the direction of interest rates, the inflation, the Fed, all of these things make me less bullish looking forward so far as the U.S. market is concerned. 

 

The bull case, however, is where else are you going to put your money? It's the only market really that's done incredibly well in the past 20 years. Today, I think last week, actually Europe, believe it or not, it was 20% lower than where it was 20 years ago. I think Europe's interesting because I think the need for independence with regards to energy, with regards to defense, the flip from fiscal austerity to fiscal stimulus, these are big picture things for Europe, existential things for Europe. And I think that that could, could cause Europe to do better going forward.

 

Emerging markets are ever very much dependent on what China does. I think if China remains part of our global world order, I think that emerging markets also are going to do quite well, because remember the dollar is the other thing to take into account here. I think if the dollar peaks this year and I think it will, then emerging markets come back into place.

 

So I think rest of world equities look actually quite interesting, just over the next two or three years,

CHRIS HYZY:

You brought up the dollar.  You mentioned that you think the dollar might peak. Is this because of high deficits, is it just because a supply of dollars out there.  What is that trend that you're seeing that gives you comfort, that you might see this weakness in the dollar?

MICHAEL HARTNETT:

I think the dollar, first and foremost symbolically, is extraordinarily important so far as risk assets are concerned. If you remember in March of 2020, the dollar was the only asset that went up because there was absolute fear raging across all markets. And the moment the dollar peaked was the moment the equity market and the bond market began to recover.

 

So it's an extraordinarily important sort of symbolic symbol of risk appetite. Personally this year I think the dollar's going to run into some issues. The Fed is very much behind the curve. But I think it's more a credibility issue so far as the Fed is concerned, really driven by the inflation.

CHRIS HYZY:

Recession risks have risen. The probability of recession has risen if you take a look at counterparty measures and other financial stress mechanisms or indicators.  Help us square that rising recession risk. And is it a shock in terms of the actual event or is it the fear that the event could happen?

MICHAEL HARTNETT:

Well, for investors, it's the fear that they'll react before the recession, and markets, as you well know, are extraordinary brilliant storytellers, and if you can read the tea leaves well enough, you often get a head start on what's going to happen. So for example, the inflation shock that you mentioned earlier on, the rate shock that we're going through right now, you could tell that through commodities, you could tell that through the banking stocks and so on and so forth.

 

I think what you'll be watching, what I'll be watching very closely going forward as to whether we are moving towards pricing in greater recession, is traditional things that you watch as you're going into recession.

[GRAPHIC CARD]

Recessionary indicators to watch

·        Yield curve

·        Weakening U.S. dollar

·        Consumer related stocks

·        Housing market

One could be the yield curve. Another could be the dollar we just spoke about, if the dollar starts to weaken when the Fed is raising interest rates, could be a sign that the currency markets are saying uh-oh. And then within the stock market, it's anything to do with the consumer, anything to do with the housing market, those are going to be very critical indicators as to watch for.

CHRIS HYZY:

What turns investors’ sentiment around? Right now it's fragile, a large wall of worry for obvious reasons.  What turns investor sentiment to get back to the other way, at least to just create some stability?

MICHAEL HARTNETT:

Well, I think you're getting there already. I think the market's already beginning to anticipate a ceasefire, whether they’re right to or wrong to, we’ll see. But certainly the markets are beginning to anticipate a ceasefire at some point in the spring. You can see that with the price of oil, which has already fallen 20, 30, percent from its high. So those are two things I'd watch very closely.

 

The third is really that you don't see the treasury yield become unanchored. I think that the equity investors are very sensitive to the messages they're getting from credit markets, the messages they're getting from bond markets. So again, if the Fed's credibility can stay input sufficiently that A) financial conditions remain relatively stable and B) the market can discount a soft landing rather than a hard landing, markets are going to regain their footing, clearly, in the spring, and you're going to avoid a big bear market.  You're probably more likely going to be in a consolidation channel for much of the next six months.

CHRIS HYZY:

Under the big umbrella of the big shifts where financial markets are going to try to figure out the big themes for the next, say, five, six years, dare we say decade. I know it's hard to tell right now, but given your insights, what big themes do you see out there?

MICHAEL HARTNETT:

Well, there's one big macro theme which is inflation and the impact that that will have on commodities or small-cap stocks or rest of world stocks or value stocks. That's a big theme.

[GRAPHIC CARD]

4 big investment themes

·        Inflation - Impact on commodities and other assets

·        Security – Including defense and cybersecurity

·        Healthcare - Including biotechnology

·        Energy – Less reliance on fossil fuel

I think relating to what we've seen in 2022 and the conflict that we've seen between Russia and Ukraine. I'd say there were three.

 

One is security. There'll be greater defense spending, greater spending on cyber security areas like that going forward. I think related to COVID, there's a big story with regards to health, biotechnology, I think those are going to continue to be big themes going forward. 

 

The third one of course is energy, which again, relates back to Russia, Ukraine, and the need to develop less reliance on fossil fuel. It's very tough and again, maybe you need to see all the prices higher to generate that outcome. But I think energy, health, security, together with inflation would be the big four for me.

CHRIS HYZY:

And then within that, would you say climate, climate risk?

MICHAEL HARTNETT:

Without question, I mean that factors into the energy theme and the security theme as well.  Both of those sort of converge in terms of climate. So I think climate's going to remain a big one too.

CHRIS HYZY:

Be more diversified in the next 10 years versus last 10?

MICHAEL HARTNETT:

Without question.  If you think about it, Chris, the last 10, 15 years, if you had FANG stocks, investment grade bonds and private equity, I mean you really sort of cleaned up, so you wanted a really concentrated portfolio that was very U.S. dominated.

 

[LOWER 3rd]

Having a well-diversified portfolio across asset classes

and regions will be key going forward.

I think going forward from here, you just need to be much more diversified, more commodities, more rest of world stocks, more sort of bonds and so on and so forth.

CHRIS HYZY:

It's a great place to end. Thanks for joining me.

 

[GRAPHIC CARD]

U.S. Markets and the Economy

 

That makes the perfect segue for my discussion with Savita Subramanian and Alex Lin for their views on some of the big shifts happening here in the U.S.

 

[LOWER 3rd]

Chris Hyzy

Chief Investment Officer

Merrill and Bank of America Private Bank

 

CHRIS HYZY:

Alex, let's start with you first: What three or four big shifts do you see out there? Is it the energy situation? Is it supply chain, labor, inflation, nominal growth? You could pick so many.

 

[LOWER 3rd]

Alex Lin

Senior U.S. Economist

BofA Global Research

 

ALEX LIN:

Sure, I would say one of the first things is really that since the pandemic began, that we have seen a big rotation towards good spending, right? Just thinking about the consumption basket; it's shifted about four percentage points towards goods. And this has contributed to the other, the second big shift, which is inflation, right?

 

We're now seeing the strongest inflation that we've seen in many years.

 

[GRAPHIC CARD]

U.S. inflation at a 40-year high

In Feb. 2022:

·        “Headline” CPI (Consumer Price Index)

 rose 7.9% year over year

·        “Core” CPI (less food and energy)

rose 6.4% year over year

 

Source: U.S. Bureau of Labor Statistics, 03/20/2022

 

Basically, think about headline CPI, it's at eight percent, year on year. In terms of core CPI, it's at six and a half percent, year on year. And that's the strongest inflation prints since the early 1980s, which is the last time that the U.S. dealt with major inflation.

 

And this leads to essentially this next shift, which is we're now going to have to deal with a Fed that is probably going to hike rates the highest levels that we've seen in some time.

[LOWER 3rd]

The Federal Reserve could hike interest rates a total of

seven times in 2022 and another four times in 2023.

They're probably going to hike rates another six times this year, another four times next year. And so they're probably going to try to get policy into a restrictive setting.  And that's going to create a lot, a much more challenging environment for the economy and probably for markets.

 

CHRIS HYZY:

With all of this as a backdrop under that big pivot that Alex talked about, Savita, take us through your thoughts right now on the markets, given what you thought coming into the year.

 

[LOWER 3rd]

Savita Subramanian

Head of U.S. Equity & Quantitative Strategy and Head of ESG Research

BofA Global Research

 

SAVITA SUBRAMANIAN:

What we've seen so far has actually been relatively, you know, anticipated. What we've seen is inflation beneficiary sectors that benefit from inflation have outperformed and sectors that don't benefit from inflation have underperformed. So that's in line with Alex's expectations of moving into more of an inflationary environment.

 

We're also seeing areas of the market that could benefit from higher interest rates and higher cash yields outperform. So where we're seeing the strength in the U.S. equity market is really in the cash heavy, free cash flow, yielding areas of the S&P 500, of the Russell 2000 and that's what we really like going forward. 

 

Because if the Fed is going to hike six more times this year and potentially a few more times next year, that basically creates an environment where cash yields grow pretty significantly and that's actually a good thing for U.S. stocks because right now they're relatively cash rich. So I think that it's not all bad for equities. 

 

But the volatility that we've seen this year is also something that I think could continue for the next couple of years.  And I think what we need to really tether expectations to is an environment that could look very different from the last 20 years where we had generally disinflationary pressures. We had a lot of disruption coming from tech. We had no upward pressure on interest rates and I think what we're in for is a very different environment, not necessarily anathema for stocks, but it's going to be different.

 

CHRIS HYZY:

Well, let's talk about differences because under the big shift theme, there's a lot of differences from what many people have seen, as you've said, Savita over the last few decades. 

 

So, as we look out over the next few years and we have a higher nominal growth backdrop, we have higher inflation, the need for commodities as a diversifier in a portfolio should rise. Talk to us, Alex, about the labor supply and demographics. What's your view on that? And how does that feed into the broader backdrop of growth under the big shift theme?

 

ALEX LIN:

Sure, it is still the case that in the U.S. that we are dealing with an aging population.  Ad a lot of the boomers, right, they're one of the largest demographic cohorts in the U.S., they are in retirement, or they're now approaching retirement age. A lot of those people are falling off and so it is the case that labor supply is actually probably still going to be very challenged going forward.

 

And it's actually been very challenged over the past year. Right? We saw a big move lower during the pandemic. Right? A lot of those people were early retirements and that's explaining our belief that the labor supply issue is probably going to persist going forward. And that's really one of the key elements for why we're expecting inflation to remain elevated. Right? Because we know that there's very significant hiring demand in the U.S. 

[LOWER 3rd]

The ratio of job vacancies to unemployed Americans

reached 1.7 in January 2022.

Source: U.S. Bureau of Labor Statistics, 03/09/2022

Just thinking about the kind of job vacancies to unemployed ratio as kind of a signal of labor imbalances.  That ratio has moved up to 1.7. So they're now 1.7 job vacancies per unemployed people, again, just really highlighting this labor imbalance.  That's motivating the Fed to want to tighten rates to hopefully ease some of those demand pressures and allow it to kind of rebalance towards where labor supply has been trending essentially.

 

CHRIS HYZY:

So does that portend higher productivity, reinvestment, CapEx in the corporate sector to deal with that issue?

 

ALEX LIN:

I think so, yeah. Another big shift, I guess, to your point that we've seen in this cycle compared to the last cycle, is that the CapEx trajectory has been so much stronger. Essentially, if you looked at the last cycle, it kind of moves sideways.

 

[LOWER 3rd over b-roll]

Capital expenditures (or CapEx) by U.S. companies has

picked up strongly since the pandemic.

But since the pandemic it's really just soared higher and if you look across various expectations in business surveys and what have you, they're all still sending variable bullish signals.  And I think with these labor supply issues, to your point, there is a desire to invest in more CapEx, invest in more automation to account for the fact that you just can't find the same amount of skilled workers as you could before.

 

CHRIS HYZY:

Savita, that's a great point. You and I have talked about this for probably two to three years. You were early in this, talking about the coming CapEx cycle.  Take us through your thoughts on the shifts that are going and your sector thoughts and particularly what you see now in technology given the repricing that's going on.

 

SAVITA SUBRAMANIAN:

Yeah, absolutely. So I think that Alex's point about almost a necessity for companies to spend on automation is paramount right now. And when you look at the labor shortages, when you look at the actual wage inflation that we've experienced in the U.S., I mean, it's staggering, if you think about what companies are shouldering today, relative to the cost of labor that they were paying a couple of years ago.

 

On top of that, we have an environment where companies are shifting from global to kind of near-shoring or on-shoring their plants and part of this is for national security reasons, other reasons include just carbon emissions.  It's more intensive to move stuff around the world rather than grow it in your own backyard. So lots of different things are moving around and creating a scarcity of labor in the U.S.

 

[LOWER 3rd over b-roll]

Greater spending on automation could benefit

industrial companies and semiconductors makers.

And what we're seeing is that companies have actually started to pencil in a much higher spend on automation, so this could benefit industrials companies, it could also benefit technology like semiconductors, we think is an area where we're going to see massive unit sales growth. 

 

What I worry about is that we're in an environment where investors have grown used to the idea that high secular growth tech companies just lead the market every year for perpetuity and that might not be the case going forward.

[LOWER 3rd]

Consider cyclical areas of the market that could benefit

from capital expenditures and higher inflation.

So we might want to look for some of the cyclical areas that'll benefit from CapEx, from a little bit of inflation, some of the less labor intensive areas of the market that could take some of the CapEx spending. So I think those are the areas that look really interesting in this environment.

 

CHRIS HYZY:

Okay. Savita, let's talk about another wave. Another shift.  Talk to us about the next wave of environmental, social and governance investing.

 

SAVITA SUBRAMANIAN:

So, a lot of changes have taken place within ESG investing, but one thing remains the same, the momentum continues and we're continuing to see flows into environmental, social and governance types of strategies or sustainable investing. The next generation, “Gen Z,” cares about ESG, even if they don't call it ESG. They care about allocating capital based on their values.

 

[LOWER 3rd]

ESG investors are also looking for companies/sectors

that are improving their operations, such as energy .

But what I think is different is instead of looking for companies that are best in class, ESG investors are now looking for improvers. So for example, energy was considered an uninvestible sector and most ESG funds are quite underweight energy. But I think what's interesting is that energy companies are essentially reinventing themselves.

 

So energy companies got the memo, they have set carbon emissions reduction dates. They are paying their CEOs in line with meeting those targets. So they're really putting their money where their mouth is and saying, “We're going to get better. We are going to become a more investible concept” in this environment of the world scrambling to get to net zero.

 

So it's a really interesting time to be an ESG investor, but I think it's a lot more nuanced than it was maybe five or 10 years ago.

 

CHRIS HYZY:

And still evolving.

 

SAVITA SUBRAMANIAN:

And still evolving. Absolutely. Lots of work to be done.

 

CHRIS HYZY:

So, let's end on this one final question as it relates to the big pivots and shifts that are going on. Alex, take us through the big one that you see, is it monetary policy? Is it the supply chain disruption? What is it between now and, let's say, mid-part of 2023?

 

ALEX LIN:

I would really say it's the Fed. And the reason I say this is because I think recently there have been a lot of concerns about recession fears, especially with these commodity shocks. 

[LOWER 3rd]

Federal Reserve hiking cycle could be a

key policy shift in the coming year.

And from our perspective, that's probably not going to be the main driver of the recession, actually. It's probably going to be the Fed hiking cycle. The Fed ultimately wants to engineer a soft landing, but if you look at history, their track record is not that great. But we do actually think that the Fed needs to get to restrictive policy, because again, we are dealing with such an elevated inflation pressures and you really, you can't fight inflation without a little bit of pain. 

 

But getting that right level of restrictive policy is going to be a challenge and that's really the main thing that we're kind of concerned about as we get into 2023.

 

CHRIS HYZY:

From your perspective, Savita, what turns investor sentiment for the better between now and the same timeframe, mid-2023?  And knowing full well, all the work you've done longer-term thinking -- time in the market versus trying to time to market? Can you put that in perspective?

 

SAVITA SUBRAMANIAN:

Absolutely. So I think that what we're all learning to do is navigate volatility and we've seen that come back with a vengeance this year. Let's think about how to craft your portfolio in an environment of rampant volatility.

[LOWER 3rd]

High-quality stocks tend to consistently outperform

during periods of rising market volatility.

And one of the things that we've learned in our quantitative work is that there is a very strong relationship between the outperformance of high quality stocks and periods of rising volatility.

 

So the name of the game is stick with quality, look for companies that are generating predictable free cash flow, where their earnings are not going to be eaten up by higher wage pressures or spending on CapEx, but companies that are taking CapEx and that are relatively labor light.  We would also look for companies that benefit from inflation, like energy and even select financials.

 

To the second half of your question is, really the idea that when it comes to equities, time is actually one of the best arbitrage opportunities that we have as investors.

 

[GRAPHIC CARD]

Increasing your time horizon pays off

 

Investing in the S&P 500:

One day timeframe:

 

·        About a 50/50 chance of making or losing money *

(probability of a coin toss)

10-year timeframe:

·        Probability of losing money declines to just 6%*

*Probability of negative returns, based on S&P 500 total returns from 1929-Feb. 2022

Source: S&P, Bloomberg, BofA U.S. Equity & Quantitative Strategy

And the reason I say this is if you think about the S&P 500 making money on a one day basis, you have a little bit better of a chance than a coin flip it's about, you know, 53% that the market goes up in a day and a little less than 50% that it goes down.  But if you extend your time horizon to about 10 years, that probability of losing money drops almost to zero, it drops below 10%. So over a 10 year period, the S&P 500 has gained over 90% of the time.

 

And I think that is one of the advantages that we have as individual investors is thinking about the long term; buying companies, sticking with them, maybe not looking at your portfolio every day, but maybe letting some of these stocks ride and thinking about this as more of the long game, rather than a short-term trading strategy.

 

CHRIS HYZY:

Well, shifts or no shifts. That's a great place to end. Savita, Alex, thanks for joining me today.

 

ALEX LIN:

Thanks for having us.

 

SAVITA SUBRAMANIAN:

Thanks.

 

[GRAPHIC CARD]

Portfolio Strategies to Consider Now

 

CHRIS HYZY:

For the final segment of our program, let’s go to my discussion with Joe Curtin and Marci McGregor.  Together, we’ll consider how investors could make sense of all these new market forces and the shifts happening around in the U.S. and the world – and offer steps you could take now to prepare. 

 

CHRIS HYZY:

Joe, Marci, thanks for joining me today.

 

[LOWER 3rd]

Chris Hyzy

Chief Investment Officer

Merrill and Bank of America Private Bank

 

We had a lot of great insights from our previous guests about this big shift, market forces. How does that take into account everything that's going on? Not just what we've been through with the pandemic, but the crisis in Ukraine.

 

And then following on, all of the different interplay that's going on right now: rising commodity prices, higher inflation, higher nominal growth, interest rates, the dollar, everything.

 

So with that in the context, Joe, let's start with you. Do the core principles of investing change?

 

JOE CURTIN:

You know Chris, I don't think so.

 

[LOWER 3rd]

Joe Curtin

Head of CIO Portfolio Management, Chief Investment Office

Merrill and Bank of America Private Bank

I think it really just highlights the importance of those core principles. You should always know why you're investing. 

 

[GRAPHIC CARD]

Core investing principles

·        Know why you’re investing

·        Have an asset allocation that’s right for your goals

·        Rebalance your portfolio as needed

What is the best asset allocation plan to meet those goals with the least amount of pain that you need to take on.  And then you should really use these moments where we have volatility and lots of rotations in the markets to think about rebalancing. 

 

So I would say at the end of the day, if someone hasn't thought about rebalancing, this is an area that they really should sit down with their financial advisors and have a deep conversation about it.

CHRIS HYZY:

Marci, you talk to a lot of investors, a lot of clients, a lot of advisors.  What are the big things on their mind right now, given everything that's going on? And in particular to the big shift in monetary policy, big shift through the pandemic, and then obviously the higher geopolitical risk we're all dealing with.

MARCI MCGREGOR:

Yeah, so what I'm hearing from investors is uncertainty, right?

 

[LOWER 3rd]

Marci McGregor

Senior Investment Strategist, Chief Investment Office

Merrill and Bank of America Private Bank

We're coming off of a pandemic where we're moving, hopefully, from pandemic to endemic stage with the crisis, but now there's a geopolitical crisis going on and an inflationary regime that we haven't seen in nearly four decades, right? And inflationary regimes then themselves tend to be volatile and they tend to be uncertain. So I get it. That's the number one thing I'm hearing from clients.

 

And, you know, it takes me back to our core principles and the one that really shines for me, is staying disciplined. We put a lot of thought and energy into our long-term plans with our financial advisors. I think of it as a roadmap.

 

[LOWER 3rd]

Staying disciplined to your financial plan or “road map”

can increase your chance of meeting your long-term goals.

What does a roadmap do? It helps you when you feel lost. And that's what I think people are feeling right now. So discipline to that long-term plan actually increases the odds that you'll meet your long-term goals.

CHRIS HYZY :

So time in the market versus timing the market is the focus we would like, but that doesn't mean do nothing. What does that mean in your perspective in terms of time in the market? Joe talked on rebalancing - tactical adjustments, adding themes to a portfolio?

MARCI MCGREGOR:

Absolutely. So of course, lengthening your time horizon improves your experience in the market historically.  But I think you should also position for where we are in the cycle, right? We're mid to maybe late cycle right now. So you have to position for what is a strong economy, an inflationary regime where maybe inflation will moderate, but it's significantly elevated.

 

[LOWER 3rd]

Consider exposure to more cyclical areas of the market,

as well as longer-term investment themes.

So you want to be exposed to cyclical areas of the market, to equities, even though they're volatile.  And then you mentioned long-term themes. I always think about what are the areas that are maybe glacially moving in front of our eyes, but with the hindsight of a decade, or the decade, you're going to see that the health crisis, the geopolitical crisis acted as an accelerant.  Those themes are important to position for you for where we are right now.

CHRIS HYZY:

And Joe, it's difficult to work through a cycle, stay disciplined, stay consistent. It's harder to do that even when it's more volatility. So take us through your thoughts on this new found volatility, supply shock, energy shortages, commodity shortages -- being accelerated right before our eyes and potentially lasting longer.  How do you account for that in a portfolio, in the core? Or do you add to it?

JOE CURTIN:

I would say you add to the core, right? You don't abandon it. So, this would be a good time where you start thinking about rebalancing into those areas that do really well in equities, in an inflationary environment, until that subsides.

And what is that, right?

[GRAPHIC CARD]

Equity opportunities:

·        Value-oriented investments

·        Cyclical sectors

·        Commodity-oriented investments

·        Natural resources / energy stocks

That's going to be the value side of the equation, the cyclical sectors. It might be certain commodity-oriented investments or natural resource stocks, energy stocks. Right, that’s on the equity side.

 

And as interest rates go up, you really want to start underweighting your bonds,

GRAPHIC CARD]

Fixed income considerations:

·        Lessen exposure to Treasury and agency bonds

·        Consider adding to credit/corporate bonds

·        Shortening your duration

·        Underweighting fixed income

And looking at those sectors that get maybe the most negative impact from rising interest rates, like Treasuries and agencies, and start really favoring credit and shortening up duration and underweighting fixed income. And then once the interest rates rise to the level of inflation or close to it, then you start thinking about taking back some of the equities and buying fixed income.  

 

So the key is really use this part of the cycle, right? When you have volatility, certain things did bad, certain things did really good. Rebalance and continue to rebalance because things will eventually normalize.

CHRIS HYZY :

So rebalancing in the core to areas that potentially are going to do better than what we've seen recently in a non-inflationary environment. But then adding an overlay to protect it further or benefit further from rising prices, particularly in the commodity arena.

CHRIS HYZY :

So another question to you, Marci, in terms of underneath the indexes, we've talked about this before.  Some of the trends will likely be more interesting below the index versus at the top of the index, which many of us have enjoyed for the better part of a decade. Underneath the index, what do you see as rotating right now? Is there a big rotation going on, a big shift?

MARCI MCGREGOR:

Yeah, there's a significant rotation going on in this market. And I think it's the cyclical sectors like Joe mentioned that are going to lead the way. So if we think about, you know, areas that benefit from higher commodity prices, so like energy and materials, sectors that maybe benefit from rising interest rates, like financials.

 

But I also think, you know, corporate profits are strong, but we're no longer in an environment where a rising tide lifts all boats, there's going to be winners and losers in this market.

 

[LOWER 3rd]

High-quality companies with lower earnings volatility

could do well in the current market environment.

So I also think about quality.  Companies that have lower earnings volatility or variability is another area I would focus on in this rotation. So its value, it’s cyclicals. Don't abandon growth, right, it's not a binary decision. It can be ‘and’ in a well-diversified portfolio. But I do think it's those inflation and rate beneficiaries that are going to lead this market.

CHRIS HYZY:

Now let's go back to portfolio construction in terms of life stages, Joe. Talk about the different stages of the investment cycle and how to take a picture of all that, given all of these shifts that are going on for those who are about to retire, those who are just starting out, those who are trying to grow wealth. Take us through that. 

JOE CURTIN:

Yeah, depending on where you are in your life, let's say somebody who just graduated, it's about accumulation, right?

 

[GRAPHIC CARD]

Younger investors:

·        Begin saving and investing for long-term growth

·        Establish a plan

·        Let your next egg build

 

Taking advantage of savings opportunities, investing for longer term growth and establishing that plan and that nest egg and let that work for a while.

 

[GRAPHIC CARD]

Younger investors:

·        Begin saving and investing for long-term growth

·        Establish a plan

·        Let your next egg build

·        Consider “buckets” for different goals,

i.e. college savings

And then as they formulate a family, as they have children, they might have segregated buckets of money for college education, but they really should start adding more to those assets, continue to build the base. And every now and then, life throws its speed bumps at us.  There might be a change in family circumstance, could be a divorce, really starting over again, reestablishing and then taking stock, “How do I get back on track?

 

[GRAPHIC CARD]

Nearing retirement:

·        Take a step back to reassess your goals

·        Consider adjusting your risk tolerance

In retirement:

·        Ensure you’re positioned for living

30, 40 years in retirement

·        Reevaluate your plan as needed

And then those closer to retirement, I'd say, take a step back. What does your portfolio look like relative to your goals, and with the great performance we've had in the markets, maybe this is time to reassess, “Am I taking on too much risk? Should I de-risk a little bit, prepare myself for those initial years in retirement?” 

 

And then those in retirement, it's ensuring that you don't de-risk too much because you may still have another 30, 40 years in retirement. So you’ve got to ensure that there's still growth to supplement the income. So the idea is, as you progress through life, you should really reevaluate your plans.

CHRIS HYZY :

See, that's a great point, reevaluation. You -- really hard to reevaluate something without advice and guidance, particularly higher volatility backdrops, late cycle moves, geopolitical risk. We've all talked about this. How important is advice and guidance in the framework of the big shifts?

MARCI MCGREGOR:

I think it's more important now than ever. You know, I mentioned this environment feels uncertain. That's the number one thing I'm hearing from clients. So that guidance is critical. I also say make your goals personal, right? Because I think it increases the odds that we're going to stick with it, right? If it's a very personal goal, not something off 40 years on the horizon, I'm going to be more likely to stay disciplined.

[LOWER 3rd]

An advisor could help you create and/or reassess

your long-term plan or “road map.”

So I think advice right now is more critical than ever, because times feel uncertain, a lot is going on in the world, and paying attention to that long-term plan, that roadmap, I think is the most important thing we can do as investors.

 

CHRIS HYZY:

That's a great way to end. Practical insights, great takeaways. Marci, Joe, thank you for your time. 

 

And thanks to all of you for joining me for this program.  We hope you can put at least a few of the insights we shared to work for you in the weeks and months ahead. 

 

Here are a few final thoughts to keep in mind:

 

[GRAPHIC CARD]

Final thoughts to consider:

·        Be well diversified across and within asset classes

·        Use market pullbacks to add to areas of underexposure

·        Review your asset allocation and rebalance as needed

·        Stay disciplined and focused on your long-term goals

 

First, be sure you’re well diversified within and across asset classes. This is particularly important as events continue to move quickly and volatility remains elevated.

 

Second, consider using any pullbacks in the equity markets to add to areas you may be underexposed to – including higher quality investments.

 

Third, make a plan to review your asset allocation regularly and rebalance your portfolio as needed.

 

Finally, have a consistent and disciplined investment process and maintain a clear focus on your long-term financial goals.

Also keep in mind that everyone’s situation is unique. An advisor is a great resource for helping you understand how the ideas discussed here fit in your overall financial picture.

 

If you’re currently working with an advisor, we hope you’ll continue the conversation.

 

Thanks again for watching.

 

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