I'm happy to say we do not have anything like the tragedy of 9/11 that we're
confronting right now. At the same time there's a fair amount
of pressure on the market to the insurers say in this environment.
How does one construct a portfolio. Well it's not all doom and gloom when we
think about portfolio construction. There are ways to build portfolios that
are resilient to inflationary environments across asset classes that
the typical 60 40 equities fixed income portfolio has struggled this year.
But within equities there's companies that are more resilient like dividend
growers. These are companies like that continue
to grow their dividends over time. Broadcom is a great example of that.
In fixed income an area that people may not be thinking about for approaching a
recession is high yield. You can get returns of over 8 percent in
high yield fixed income. So you're paying to wait until spreads
tighten and the companies are higher quality than they used to be.
And then finally outside of public equities and fixed income look at real
assets. Farmland is an area which has built in
inflation escalators often in their contract so they can benefit as CPI
increases. Also private real estate even the real
estate market has issue on the private side.
Similarly leases with built in inflation protection.
Those are key for markets where inflation is going to be increasing.
So that's a lot to chew on. But let's start with one of them which
is credit and high yield. Where are you on that.
So we're very constructive on high yield.
It's our largest tactical overweight with a yield the worst of eight and a
half percent or so downside risk of about a third of the equity markets in
the high yield markets. You need to think about high yield as a
risk asset. So this is not something we're taking
investment grade bonds and putting it into high yields.
It's much more of an equities substitute.
In this environment. But that kind of return looks really
attractive here. Another aspect I would mention is
geographic exposure within equities. So we have a slight overweight to the US
and underweight ex U.S. and an emerging market equities really
reflecting the significant growth issues inflation problems that are being
realized overseas. That's another way to give clients some
confidence that we're positioning for what we think is going to unfold over
the next 12 months. And lastly I would say the real asset
side we also very much support having some inflation exposure whether it's in
global listed infrastructure which has that pricing power or on a long term
basis commodities where we think you can get in a basket of listed commodity
producers a yield near 6 percent which is really attractive in this
environment. So we're actually more concerned about
commodities excluding energy because we think that commodities are very exposed
to demand destruction. But energy is a different story where
supply remains tight demand should remain strong.
And what we love about energy producers is that they're being very disciplined
this cycle. They're returning cash to shareholders
rather than just working to just increase volume.
Good for those companies and to keep oil prices but beneficial to them.
But to put together if you will the slight overweight to us.
Not much more than slight that Jim talked about.
And what you just said about energy because given this energy situation one
might say it's more than a slight overweight to us.
Where are you. We are probably more constructive on the
US and the rest of the world. We think the U.S.
will continue to be that the safe haven trade because of the resilience of the
economy versus the rest of the world. Europe could run into stagflation airy
issues with their aggressive increases in interest rates while the economy
suffers in emerging markets are challenged because of the continued
lockdowns in China and some of the other areas that are having issues.
So I think non U.S. is going to be a struggle especially
with the strong dollar in it. So I would add to that from a U.S.
exposure standpoint we also like the energy sector and the other one that we
like our technology stocks they have really struggled this year improved the
valuations clearly in long term growth leader globally.
And so it's a bit of a balanced approach within a U.S.
equity portfolio like both energy and technology stocks.
Interesting technology stocks tend to struggle though when interest rates are
increasing because they're considered long duration stocks an area for example
semiconductors which have even underperformed the technology benchmark.
But I think you can find value in some of these areas.
This goes back to dividend growers. Broadcom is a company that within the
semiconductor space tends to be kind of offensive and defensive more resilient
business with their enterprise demand and also with their software mix and a
nice dividend that's growing over time. So so as you're putting together your
portfolio do you take into account the possibility or even some say likelihood
of recession or not. Because for example when you say high
yield high yields a good thing. I get a little nervous if we're going
into anything. It's a real recession right Jim.
So you have to have a view on what the recession will be if it unfolds.
We're at a 50 50 probability in the US but we think it will be shallow.
The banking system is in dramatically better situation than it was through the
global financial crisis. So credit creation won't really be hurt.
Household balance sheets are not in bad shape so it's much more likely to be a
shallow cyclical recession in high yield with a starting yield.
The worst of eight and a half percent gives you a very nice cushion in the
environment. I agree with that.
We're looking for areas given the environment there where are you getting
the best bang for your buck. And so even though we do predict a
recession you're getting paid to wait in high yield.
With that kind of return you can have that resilient income producing
portfolio in equities with dividend growers and then look for those asset
classes that actually can benefit from inflation like within real assets.
How important is liquidity in all this when you.
I'm talking about real estate for example farmland.
Things like that. That sounds like I'm giving up something
on duration right. You're giving up something.
You're giving up some liquidity. You're also dampening your volatility.
That's why we recommend a balanced portfolio.
You want to make sure that you have your public and your privates within your
portfolio so that you do have areas where you can get liquidity if you need
it. But also the resilience and less
volatile pieces of the private asset classes can be beneficial especially in
this year which is unique for the 60 40 typical equity and fixed income
portfolios if you will have had been highly correlated.
All fixed income obviously is not created equal.
Where are you in investment grade. So we're significantly underweight
investment grade. We just don't think that the nominal
yield or the real yield opportunity looks particularly attractive in our
number one risk case around sticky inflation.
Investment grade bonds are not going to do well in that environment.
So that's an underweight in our taxable portfolios.
Do you agree sir. Generally we would prefer high yield
over investment grade for the same thing.
You're getting greater returns more bang for your buck from high yield.
And where are you on tack Jim. Teddy's he's tech might be a good idea
although as you said if the interest rates are going up typically that hurts
tech. Yeah I mean generally bigger picture.
The macro environment is not good for long duration technology stocks.
That's why you need to be selective in where we're looking for.
What we said kind of offensive and defensive tech together the companies
that either or more resilient because they have healthy growing dividends or
they have pricing power so they can survive the environment the trade of pre
pandemic. We're all technology stocks kind of all
did well. I think that's over.
I would just say that the market knows that interest rates are going up and
have gone up and that has killed valuations within the technology sector.
So we think that's what's set up the opportunity today.
Tech stocks have discounted a great amount of the higher rates.
But it's interesting if you look at 2023 markets are actually less hawk less
hawkish than the Fed. So there's a mismatch there 20 22
markets now caught up to the Fed same level of hawkishness.
But twenty twenty three markets are saying you know what we expect less rate
hikes. And the Fed expects and we'll see if
that happens probably depends on if we hit that recession and inflation finally
dropped significantly. We've had this discussion terrific
discussion but we have not mentioned health care or biotech at all which
strikes me given what we've been through with the pandemic everything else.
What do you think about health care. Just big regulatory risk.
So the biotech stocks have been crushed. Now maybe that will present an
opportunity when we've got better clarity from a regulatory standpoint.
But I think that's been the biggest headwind for health care.
That's an issue for health care. But also when people are looking for
growth stocks in the tech stocks are out of favor.
They tend to go more defensively in terms of growth.
Health care does fit that area. So when you get into these risk off
environments for growth health care can actually outperform.
What about when you mentioned dividend growers but what about balance sheets.
What about the old classic issues. Are you paying a lot of attention that
at this point here we are because in an inflationary environment where costs are
going up and costs of debt are increasing I think this is where balance
sheets and high quality companies become very important.
Jim mentioned that small caps less interesting.
You know they can be more at risk in periods such as this if their balance
sheets aren't as strong and they are smaller companies.
So we think that is a key factor as well as pricing power.
Who's got the pricing power to overcome inflation.
So we're a big believer in quality within the equity portfolio.
We want to do it on a sector constrained basis because you can find yourself way
mismatched against the overall market. But quality of capital deployment
quality of balance sheet condition all good things for long term stock
performance. I say the biggest one for last and we do
have ranch time. China.
Should we be concerned about China and the lack of growth in China.
Jim absolutely. So we think that the growth initiatives
that have been taken have been anti growth.
We think that the zero cold policy is going to be a problem for at least the
next 12 18 months until they get their own world class vaccine.
And we just don't see that on the horizon yet.
Where are you in China. Is there anything I think there's just
going to be macro issues there that are difficult to analyze and that makes it
tough to invest in. At the same time they could change their
course. Right.
And then leading to the party Congress and the President Xi needs to get the
economy going. Seems a little late to be doing that.
I think he would have done that earlier refusing to do something really big.
I may have talked about that a lot but we haven't really seen the execution.
That's what we'd be waiting for.