Welcome, Chris and Karin, and thanks for your time today.
Great to be here, Neel.
Thank you.
We'll start with you, Chris.
Obviously the markets have done very well so far this year.
As you think about the rest of 2017, what are the key issues that you are thinking about
in terms of portfolio positioning?
Well, the first half we all saw, you know, volatility come way down, and volatility through
this whole last part of the cycle has been relatively low to begin with.
We've had some kick starts of interest rates coming up and then ultimately for inflation
to kind of pull itself back a little bit and interest rates fell at the beginning of the
year, rose a little bit and then kind of came back right around the middle part of the year,
and the focus was more on fiscal policy in the United States as it relates to what the
headlines would read.
But really, the market focused mostly on the profit cycle, and that's why stocks, in particular,
in the United States, and globally, for that matter, really followed growth overall, growth
in the economy around the world, which was better than expected, and then ultimately
down into the profit cycle, and multiples started to rise and you hit all-time record
high in various market indices.
Right around the mid-point, and this sets us up for the second half of the year, the
switch is on, right now, and the switch is a little bit more about paying attention to
what central bankers are doing and the policy switch that is potentially on the way, and
that means being a little bit less accommodating.
And if that does occur and the economy slows down, then risk access would be a little bit
under pressure.
We expect the profit cycle in the United States and globally to continue to gather momentum.
It may slow down off of the first quarter hyper growth that we saw in terms of 15 percent
in the United States, but slowing down isn't necessarily a bad thing when you look at the
full trend, and we expect the profit cycle to move forward, interest rates to grind higher,
equities to grind higher and non-U.S. growth in particular to surprise to the upside.
So that's a great backdrop.
So, there's a lot of issues there, Karin, and if I could go to you and get your opinion
on the U.S. economy, because I think that's the most important variable here, right?
Look, I'm optimistic.
I think you can almost discount the first quarter.
We've had six years in a row where the first quarter was a little lackluster, and we've
always seen a little bit of a bounce back in the second quarter, but by and large...
...what we've seen here in the U.S. is something around two percent growth, underpinned by
a very solid base of a consumer who has a job, is feeling fairly confident, has had
that job for a while, by the way, has de-levered since the crisis and now is in fairly good
position in terms of their net wealth and what their disposable spending is.
So, you have that nice, strong consumer, and now what we're looking forward to is that
other part of the economy, which And that would entail businesses feeling more confident,
which they do, and seeing them start to deploy their resources in terms of capital expenditure,
in terms of investments in R&D or plants and equipment.
so I'm fairly optimistic about the, what I would call like the macro underpinnings of
the U.S. economy.
And the nice part about it is, it's not just the U.S.
It's more broadly based, and that, I think, tell us that if there was any kind of pullback
or small shock, the global economy is more resilient.
Let's talk a little bit about interest rates, as well as what our expectation for different
central banks is, because I think we've reached a pivot point, so to speak, in terms of central
banks being a little bit more hawk-ish.
So Karin, maybe I begin with you.
Sure.
For the Fed, I think, so far this year in 2017, we've had two rate hikes.
I do think that we're going to see another one later in the year, possible in December.
That would give us three rate hikes this year in 2017, and then, you know, looking for another
round of three rate hikes next year in 2018, if all goes kind of according to plan.
So that brings the Federal Funds rate, the short-term overnight rate, all the way up
close to two, and that's pretty meaningful when you think about where we came from, which
was near zero a short time ago, just a few years back.
And Chris, just to follow up on that, what's your quick assessment of global inflation
where it is?
Every time we mention the word inflation, for those that have been around for a while,
immediately think of the late seventies, early eighties, and my goodness, inflation, what
if it comes back?
Well, there's good inflation and there's bad inflation.
The central banks are trying to induce good inflation, and we're at a point where we're
below the level of what their targets are, generally speaking, across the world, and
their thought is, it's transitory and we will, we will start to rise up towards good inflation
levels of two percent in most regards.
The thought is this, that's the short-term thinking.
Over the long haul, a tick-up in inflation, or good inflation, is actually a good thing.
Yep, now - I would agree with that.
Now, let's talk about Washington, because if anything can throw off all the forecasts
that we talked about, especially what the Fed does, it's the fiscal policy.
Well, I think the realistic expectation is that everyone is trying to work together to
come into some sort of pro-growth policies for widening the base across the board, But
in terms of tax reform, healthcare reform, ultimately an infrastructure bill, you know,
those are likely late 2017, early 2018.
Ultimately speaking, pro-growth policies are needed across the board to get the economy
back to an accelerated rate that will allow a widening of the base across the board at
all segments of the, of the U.S. economy.
And I will say that the markets are not discounting much or expecting much from Washington, so
anything we can get would be an upside.
Yeah, I mean absolutely.
One thing I would just add is that even now with our current growth forecast, we're not
pricing in expectations of heroic changes in Washington, so we started the conversation
with me saying I'm fairly optimistic.
That's whether or not we get everything we want from Washington, so I think it's a good
starting point.
And Karin mentioned again an important part about, she said we're fairly optimistic, despite
anything that may or may not happen in Washington.
And we've been pretty steadfast in that outlook for the one simple part about the profit cycle.
And it's not just the U.S., it's globally.
So as long as that buffer zone through the profit cycle is there, markets and investors
will continue to look away from what may or may not happen in Washington.
Let's move on to investments now, and Chris, let's begin with you on equities.
Like you said equities have done really well, in fact, somebody had told me at the beginning
of the year that bond yields would be lower and Washington would not make any progress
on pro-growth fiscal reforms and equities would be up 10 to 20 percent - very hard to
drive that, right?
What do you think?
What's your expectations from equities going forward?
You know, if the cost of capital is low and the return is above that, that's a good thing,
and that's what corporate America is experiencing right now is a little bit of a tailwind from
capital investments which they hadn't seen before.
So as long as your profit zone is there and still has the momentum to it, the valuation
in the market that market participants are assigning to the profit cycle is shifting
the equity class upward.
So generally speaking, our overweight in equities continues.
We expect that to continue.
If anything happens to the profit cycle, we'll reassess.
And would you say U.S., international, emerging markets?
Well, because of the dollar was so strong in late 14, all of 15, a little bit of 16,
that really hemorrhaged or pressured a lot of the non-U.S. markets versus their performance
in the U.S. markets.
The U.S. markets outperformed, for the better part of the last five years, and generally
speaking, that's a little long in terms of relative sustainability, so we still believe
the non-U.S. equity marketplace is the area of bigger improvement than the United States,
so we would have a higher allocation there than normal.
Perfect, and Karin, if I could finish the equity section with a comment from you about
each sector, what are some of the sectors that you like?
I think financials are doing pretty well very recently.
They started the year maybe with expectations outrunning what they could deliver, but they
started to pick up.
And I think a lot of this has to do with the fact that people are starting to realize,
sure, banks do better when the yield curve steepens, but banks do better just when the
rates rise, and rates are rising at a nice gradual steady fashion thats very good for
banks.
They are also finally realizing, I think, that the regulatory pressures for some of
this will start to just come off a little bit with this new administration and it's
clear that they're going to take a lighter touch and a lighter approach to interpretation
of existing regulations, so all of that is favorable for the banks.
So I think ultimately the financials are in a good place.
The other sector that I would point to, is healthcare.
It's had its own sort of rocky moment, partially because of Washington and the politics and
the question marks around drug pricing and so forth.
But within of course healthcare, there's pharma, there's drugs, there's hospitals, there's
lots of biotech.
We also think that biotech, generally, it's a play on the tech story.
At one point, it looked like it overran itself, but that was a year, year-and-a-half ago,
and now it looks like there's an opportunity to get back in.
And tech generally is a good, it's got good fundamentals.
But ultimately, tech is a story of growth and it's a story, really, if you think about
it crosses almost every other sector.
Every business in business today has a technology aspect, so tech is huge in the long-term growth
theme, I think.
So, let's talk about the bond market.
This is an important asset class for our clients, right?
But in an environment of rising interest rates, this is a tough asset class where everything
is relative in terms of how you position.
So, it's a good point.
When you see rates rising, that means prices are falling and it's hard to make a case that
holding bonds from a total return perspective is going to be a net win when you know the
price is falling.
But bonds play other roles.
They're a great diversifier.
They're a nice source of income, a steady stream of cash, and they allow you to kind
of reduce the overall risk in your portfolio.
The only thing I would add to that is we talked about cyclically versus secularly, cyclically
grind higher in rates.
A lot of us have been waiting for that for a while.
It happens and then moves back lower, happens and then moves back lower, but cyclically
grind higher in rates.
Secularly, when you look at demographics, we've talked about this already, inflation,
the aging world, et cetera, it's going to be really hard for interest rates to sharply
accelerate to a level across the whole curve that we've seen in prior cycles.
So low long-term rates for a long period of time, albeit slightly higher than right now,
creates a pretty good backdrop overall for an asset class that is a diversifier versus
your risk assets like equities.
So, Chris, when clients hear about everything that's happening in the market, there's so
many different undercurrents.
How do you put that in the context of, one's financial goals and priorities?
I would first characterize the whole macro backdrop as low and slow, and that could be
applied to a lot of parts of the broader global economy.
So, in that broader backdrop of staying on goal, it really is about starting with a macro
backdrop, looking at asset allocation, looking at return on capital, be more diversified
as we end this cycle into the next one is of paramount importance.
Utilizing fixed income, not just for higher cash flows like we're used to but as a hedge
on your risky assets.
Equities in general should still support a higher return on a relative and absolute basis
than the fixed income part of the spectrum.
And you're going to have to rebalance more, use more portfolio reconstruction.
Pay attention to taxes more, because as we end this cycle, there, in our opinion, the
returns at the back half of this cycle are slightly lower than what we've been able to
enjoy since the credit crisis.
So be more active, be more diversified, pay attention to taxes, understand the world backdrop,
and remember, at the end of the day, long-term cycles are what matter, versus what the secular
noise is in the short-term.
Thank you again for being here.
Thanks for your insights.
Karin, thank you very much, Chris, thank you very much.
Thank you.
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