Chris Hyzy: Thanks very much, everyone, for joining this week’s Street Talk call. A lot of development in the last week alone to discuss and then provide our view on first and foremost, I wanted to provide some insights on some new reports that are about to be released and two that have already been released. One in which is our third quarter Investment Strategy Overview. We’re putting the initial stages on that, attempting to answer many questions on clients’ minds about what’s going on in the broader markets, what’s going on around the world, and in particular, the direction in the economy and ultimately how that feeds into the corporate sector. Last but not least, any particular changes - or not - on asset allocation and viewpoints on different asset classes. Right now we are still of the view that this is a bull whip type of market where you have some concerns that develop and the ultimate worst case scenario or the conclusions that most people were talking about does not materialize, one of which is emanating out of China and the other of which is the debt ceiling. As those conclusions continue to wane and the delta variant continues to fade, the third reopening of the U.S. economy, not to mention the globe, is starting to kick into second and third gear once again. So we believe this is more akin to a bull whip where you fall; you attempt to go into historical pullback levels; you don’t reach those levels because of all the dry powder that is out there on investors’ sidelines whether it’s institutional or retail investors; and ultimately the engine, the core engine, the profit cycle continues to move forward. So we’re titling that The Bull Whip overall at least here in the near term. In the longer term we’re still very bullish as it relates to demographics, the housing cycle, the Millennials, not to mention the Gen Z culture in terms of innovation. Innovation cycle in our opinion is very early - very early because the tech sector gets all the claim to fame and in some cases the communication sector as it relates to innovation but really innovation is happening everywhere even in the utility sector, the consumer staples area. And what this is doing is this is increasing capital expenditures, number one. Number two, it’s allowing for corporations to have elevated operating leverage. And when you get elevated operating leverage, productivity goes up and when the productivity goes up - even with inflation worries, ultimately in the long run inflation comes back down even if it remains stickier here in the short term. That’s our story. We’ll continue to highlight that in the coming year/in the coming few years and from time to time when the profit cycle takes a breather and sometimes when it peaks that’s when we’ll start to pull back risk but at this point there’s a few points of note that I’d like to mention. First and foremost, the other two reports that I mentioned that are out have to do with climate change and climate disruption in general and what it means for portfolio construction. We have a question and answer piece out there on what investors need to know. Also what is out there on the website is “What could climate change mean for your investments?” More to come on that as we work through developments around this topic and then ultimately, how that feeds into what corporations are doing and what certain societies are doing.
As it relates to the here and now, I want to highlight six particular areas. The first and foremost one is what the Fed did yesterday. What they did is simply put, increased transparency. Many people expected the so-called buying less bonds. In other words, tapering by the Federal Reserve to occur in November. That’s what they basically stated. They didn’t explicitly say November, but they did point to in the very, very near term and it was likely November from our perspective and that’s what the economics department has been discussing for quite some time, but first and foremost, it was just another level higher in transparency. As you get greater transparency about what the Fed is about to do that means greater ability to plan - countries to plan, governments to plan, corporations, and investors so we basically put a check mark by increased transparency there. The third part about the call was about rate lift-off. Short-term interest rates in the futures market are already pricing in what the Fed said yesterday. In other words, the fancy terms dot plots have been pulled forward. Two of them have been pulled forward and now half of the FOMC Committee, Federal Open Market Committee, actually is looking for rate lift off in December of 2022 so pull that forward from the first quarter of ’23 - again, increased transparency. What is it doing today? The rally yesterday off of that news was building off of the big fall back on Monday and then the two-day meeting Tuesday and Wednesday by the FOMC culminated yesterday in greater transparency, taking one concern off the table for investors. For those who were on the sidelines, with that one big concern taken off the table, there is money coming back into the marketplace. When you take a look and step back from a longer-term perspective, the most important part about yesterday’s communication and yesterday’s information feeding into today is twofold. Number one, the debt concern over in China is not just waning, it’s going away as it relates to the biggest concern but it’s not going away in its entirety. People are starting to realize this is more of a growth hit than a financial system hit. That’s important. Number two, most importantly here in the United States, the Treasury curve is steepening. When the Treasury curve steepens, this is a signal that economic growth is reigniting. It’s going higher not just on a nominal basis, but a real basis and this happens at the same time that the delta variant is beginning to wane overall across the United States. The northeast still has issues with the delta variant but largely speaking in aggregate levels across the United States. The second or third reopening of the U.S. economy is gathering momentum. The Treasury curve is steepening and we are now looking at a few other points of interest that are supporting what we call a reflationary environment. Number two, the yield overall across the curve – short, medium and longer yields – are still deeply negative. When you have deeply negative real interest rates, that’s the front side of good inflation. When you have the front side of good inflation, that’s where risk assets in our opinion are more supported. Number three, the profit cycle is still heading higher. The estimate revisions lately coming out of Nigel Tupper’s area which is the Global Quantitative Strategist, looking at estimate revisions in all corners of the globe out of B of A Global Research, still suggests that each of those estimate revisions are going higher. Japan happens to be the highest but all above one. When estimate revisions are going higher and guidance is headed higher, that’s where the profit cycle in our opinion doesn’t slow down. It actually picks back up and that’s what we expect third, fourth quarter, and then into the first quarter of next year, so profit cycle still heading number. Number four, a ton of dry powder to buy the pullbacks as long as fundamentals are stable. Fundamentals are all over the board. Real growth was coming down. It spooked investors. Nominal growth was going up. That’s the good side of inflation but yet the actual curve, this Treasury curve, was flattening at that time suggesting that maybe growth is not going to pick back up. We thought differently. The news obviously coming out of the Federal Reserve plus what you’re seeing in corporations and their latest guidance is suggesting that there’s a third reopening occurring. As spending goes back up, corporations increase capital expenditures and at the same time there’s a lot of dry powder to buy the pullbacks. That is what we determine as the bull whip effect and that’s bullwhip effect and that’s where we’re at. So a ton of dry powder out there. There’s a number of ways to slice that but still we’re looking at over $5 trillion on the sidelines which is almost about 25% of GDP in the United States. An all time high. Number five, inflation is still again at the stage in which it is considered good inflation. As its front side of the rise happens, you get pricing power, wages go up, increases consumer spending, increases consumer confidence. Business confidence stays high because they still can’t find labor to fill the job openings. So it’s still supply-driven versus demand-driven at this point. Demand is elevated for obvious reasons. A lot of it’s to do with pent up demand and supply is having a hard time to catch up. That is a tough problem to have but not a bad problem. The Fed’s preferred measure is still in the 2% - 2.5% range overall and that’s the personal consumption expenditures. So until that starts to rise significantly and match consumer price index, in some cases PPIs, we still believe that the rise lately in inflation is still on the front or good side but inflation overall should be stickier for longer. This is not an issue that’s going to go away any time soon. There’s simply too much money thrown at a very difficult problem. The healthcare tragedy and that money is still out there and in many respects, has been unused and still out there to be used even if demand started to come back down. There are still supply chain disruptions that need to be cleared out. It’s not going to happen in the short term in our opinion. It’s going to take at least all the way through 2022, perhaps ’23 to clear out that supply chain therefore supply catching up to demand should still be an issue next year. Therefore, operating leverage needs to continue to stay high and margins in our opinion should not come down much even if labor costs go up because the demand curve is still there. Pricing power is evident. It’s being passed on into the consumer land. They have the money to spend still at this point and they continue to do so. It is in our opinion something to watch but overall, inflation should stay stickier for longer. Last but not least, number six. The delta variant is fading. If you take a look at a number of different metrics. What is not fading however is the harmful side of what has already occurred with the delta variant, and that is hospitalizations and the mortality rate. Those areas are still going up and we need to see those come down hopefully in the coming months as we get further and deeper into the northeast wave. Overall, all risk assets in this opinion right now, in our opinion, all risk assets are being supported by two main things – the steeper yield curve which is beginning to happen now and deeply negative real rates. That’s reflationary in nature. Are elevated valuations – we get asked this question a lot - are elevated valuations a big issue if real rates are deeply negative and the profit cycle is still heading higher? In our opinion, the answer is no. People are comfortable paying elevated valuations if you have an increase in transparency and where rates are going, a steeper curve, reflationary forces, a lot of money on the sidelines, and the profit cycle heading higher. We remain overweight equities, we remain overweight the U.S. relative to the rest of the world, we remain large cap friendly, and reflationary sectors friendly overall. We continue to believe megatech remains both a value and growth sector as well as attractive yield sector and high free cash flow. Therefore in our opinion, it remains an anchor in a portfolio as far as sectors are concerned. As China’s property developers get wanes or the concerns wane – not over. A lot of restructuring needs to happen and a growth hit to China is obviously coming from this but as that continues to wane and remains in a controlled setting, new concerns should take center stage on the debt ceiling. We expect headline worries over a shutdown to grow and likely pressure the market. Once again, something that we have seen before and something the market is used to. We’re not out of the woods yet in terms of headline risk there and we do see some weakness or at least some negative volatility but in our opinion, the market wants to get to new highs. It is pointing to negative real rates, it’s pointing to a steeper curve, it’s pointing to a controlled debt environment, over in China, a work out that is coming, the delta variant rolling over, and a second or third reopening in the economy happening, and that is supportive of rising profits overall. That’s what we expect. That’s our opinion and that is asset allocation friendly towards equities. That’ll do it for the upfront comments for today. Thanks for listening.
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