Generally start with you. The markets seem to read a lot into
these jobs numbers that came out on Friday.
Is the market right to read that much? I think it's a little premature to
declare victory on either inflation or that we're going to achieve a soft
landing. The numbers were unequivocally good.
The ninth month in a row of beating expectations shows that this economy's
got more resiliency. The three month wage number it up four
point one percent is edging down to that more acceptable range.
But we've still got a lot of progress to be made.
And I think the market's overpricing, the Fed moving now where they've now got
40 basis points of cuts priced in in 2023.
Our base case is the Fed's going to raise to around 5, five and a quarter
and stick there for at least six to twelve months.
Sarah, what about it? I guess the question isn't so much what
is actually going to happen in the market as what the Fed is going to do
about it. Are we overreading what the Fed might do
in reaction to numbers like we had in Friday?
Possibly, it appears, at least our team feels that every piece of good news
seems to be offset by some bad news. The recession indicators that are
traditional, for example, are steeply inverted yield curve are certainly
present not just in the U.S. and other countries as well.
And then we have this falling commodity prices indicating slowing of demand and
then the excess savings that have built up during Covid that has been spent
down. And we have a higher cost of housing in
terms of mortgage rates. There are so many depressants on the
U.S. economy, not to mention foreign
economies. It's really hard to see our way out of
this without some type of significant slowing, probably a recession.
I wonder, to your point, Sarah, whether it's contradictory information.
I mean, we had JOLTS numbers out this week as well that indicated that the job
market is really quite tight, despite the fact it doesn't look like wages are
going up quite as high. How do you take all the data we're
getting and put it together so the investor knows where to go?
Well, this this is quite difficult. So from a bottom up perspective, the
best path is typically to be very diversified and then don't let any risks
aggregate any one particular area because it's hard to call.
Think about where we were a year ago when looked as if and leaving a
wonderful value rally tailwind. Everything going well, particularly for
places like Europe that had been struggling to get through Covid.
Then we had the Russian invasion Ukraine.
So these setbacks occur and the key is then to be in companies with tremendous
financial strength and endurance. David, I agree the importance of
diversification can't be overstated. If you look back at 2020 to the
importance of owning real assets in a portfolio was critical, really helped
performance. If you look at 2023, it's hard to make
big geographic calls. But we do think that underneath the
surface of the markets, things like value should still perform well in 2023.
They've got significant valuation support still going through this period.
Areas like high yield bonds are probably a good place to be and cash looks really
attractive at a 5 percent yield over the next.
Why a high yield bonds a good place to be right now?
Well, we think that gives you a pretty good protection in a more difficult
economic environment. You've got to yield to worst right now
at about eight point seven percent. And what the market is doing is showing
real confidence that through the cycle, defaults will be relatively well managed
in high yield. We think that maybe we'll get to a three
and a half percent to fort rate, but over 50 percent recovery.
So that looks at less than a 2 percent loss rate.
And with the yield the worst at eight point seven, that gives you a pretty
attractive return. And high yield bonds tend to have only
about a third of the downside risk that equities do.
So Sarah and Jim, obviously as cross asset, you focus more on equities.
What about it in the equities area? We heard just briefly that I've opened
Steve Rattner saying he thinks give me a hard year for equities.
Do you agree with him? Possibly for overall markets, after all.
In particular, the U.S. market has delivered mass returns well
in excess of what is typical. The risk free rate plus an equity risk
premium in the US, returns of less 10 years had been double digit percentage
per annum. That's quite something.
Let's just say we have more downward pressure on multiples.
The key then and I sort of coincide with Jim's remarks is get income and a number
of great companies listed globally are paying investors today.
That's really if all power went out in the show was over, I would just leave
one message, which is get that income soon, lower the duration of your holding
because that's in an environment where there's a real cost of capital is a
great strategy. So, Sara, I was a U.S.
equities have been valued more richly than, for example, European equities.
Do you expect actually that will come in?
Likely and maybe not in part due to the continued multiple compression that
we're experiencing in the US market, that should continue as long as they are
on a path of rising real interest rates. After all, everything is different now.
That era free money is over and we don't have a fed cook any longer.
Nor do we have other central banks there.
They are reducing their balance sheets, are taking liquidity out of market, and
fiscal spending is very much constrained by inflation factor.
Both monetary and fiscal are constrained by inflation.
And as a result now it's just all we have is earnings.
The liquidity part of their day and propellant to markets is likely to be
very muted for many years. David, I dare to the geographic
commentary that people tend to think about the countries that they're
investing in as opposed to the type of stocks that they're buying when they're
buying, for example, European equities. If you want to value exposure or you
want exposure to a reopening of the global economy, you want exposure to
Europe over, say, the US. So that's one reason that we've taken
off our underweight developed markets outside the US.
Better value exposure plus the dollar's probably had its wrong.
Let me bring something in that may or may not be relevant.
Jim, I'll start with you. What we're watching unfold in the
Congress, not being able to pick a speaker of the House for so many ballots
have gone on. Is that relevant to an investor at this
point at all, Jim? Well, it is.
The situation before this was they were not going to pass much legislation, so
that was not a market expectation. But now we've really put on the table
the risk of the debt ceiling. If there was an individual member of the
House that can call for a speaker vote any time they want, and if there is a
tie to the debt ceiling in this agreement that's being made to
potentially make Kevin McCarthy the speaker, that is going to significantly
increase the risk around that. The key will be could the Democrats get
the Republicans from Democratic leaning districts to go along with them to pass
the debt ceiling expansion, which is really what the American public wants?
Sarah, we've all seen any number of times the debt ceiling has been an
issue. One time it actually affected the
credit, the United States government. And usually it's gone away.
Does it factor into your investment decisions at this point at all the risk
on the debt ceiling? Well, certainly because the risk free
rate is critical when doing valuation work, because, after all, a stock is
just a present value of all the cash it can generate into perpetuity discounted
by this discount rate, where the risk free rate or the government bond yield
is essential to that. So, yes, it's government bond yields
rises and it's going to cause us to have to pay and be much more stingy in terms
of what we paid for stocks. So it's super important.
But the U.S. is in good company and fortunately, so
many major countries globally have a significant amount of debt to GDP and or
they have fiscal deficits that are sizable.
So I think if it weren't like that, the U.S.
would be penalized more. But unfortunately, we have brethren in
this race did have a significant amount of debt.