Chris Hyzy: Thanks, everyone, for joining this Street Talk Call for this week. Recently we published our Viewpoint for the month titled: The Reopening has Begun. What I want to do is spend some time first on the recent market action and in the context of this twist is what we’ve been calling it or flash repositioning. This really occurred obviously as yields have been backing up. We call this a torque move in yields. It’s one that is sharp in a jump like fashion. It catches some people by surprise but not all but it also creates concerns as to why it’s happening, and that’s the big point I want to address here. Is it reflation overall with a better economic activity? Is it inflation expectations jumping up? Is it a force portfolio risk management decision that is going on or is it something else? This is typical at this point in time in the cycle after a major run in the global equity markets but risk assets in general. Then as yields begin to back up after that - some second guess the move in yields, others try to find excuses for the yields - we’re simply just going to watch the market action and it is our belief that through these market action the typical cycle as yields back up unfold with some potential atypical policy changes down the road and we want to address that. So while all this is occurring, there’s a broader repositioning that’s going on across investor segments. Again, this is natural. This is normal. What’s possibly not normal is the quickness/the speed of this in today’s more programmatic type of investment world where the linkages between risk management portfolio positioning is at a greater level than ever before and the fact that you see different investor segments in the markets that you’ve had in most recent times, you likely tend to get sharper repositioning moves. This is happening across the board. It has happened before the pandemic hit last year. If you remembered the fourth quarter of ’18, we always pointed out point in which policy changes that the Fed led to very solid nervousness around the overall level of growth and there was a big move in the markets literally within weeks. That would typically take, in our opinion, somewhere closer to 12 – 16 month move and this is the world we live in at this particular time as it relates to how quick things can move but this is what happens when you get a high debt widening out deficit economic environment at the same time you see low yields shifting to different levels and that's where we are right now. So what’s happening in equities is long term yields are backing up. Technology is obviously being sold off. There’s many reasons for this but the biggest reason is technology is the largest position out there in the indices. It’s the largest position on the part of the asset management arena. It’s the largest sector overall and it generally benefits from a low yield, low growth world. We’ve seen this for the better part of 10 – 12 years when the US economy and the global economy has performed below average expectations as it relates to growth. This back up in technology as a feeder to buy into smaller sectors like energy as a feeder for some of the cyclical areas – less growth, more value - in some of the areas outside of technology that have benefitting from a potential full reopening. As this continues to happen, because technology's the largest weight in the market, as Savita has pointed out – Savita Subramanian, the Head of BofA Global Research US Investment Strategy - she’s pointed out this is likely to continue the weigh on the broader market until stabilization occurs so we want to address that. As technology is the choice or the source of funds at this moment to feed into other sectors, we’re starting to see the cyclicals gain into phase two. Phase one is just get up off the ground, start to perform better technically/structurally, and now you’re starting to see some earnings estimates coming out of the first quarter heading into the second quarter start to get revised upwards for cyclicals even though we’re not yet at full economic activity, which we expect sooner rather than later but the cyclicals have a tailwind at their back and we expect this to continue. We also believe that as perceived and real inflation hedges continue to move up, which is squarely on the shoulders of the energy sector, copper, copper beneficiaries, or copper price hike beneficiaries and individual areas within the industrial metals, those should continue to have a tailwind as well as the reflationary backdrop continues. We already mentioned small caps, emerging markets, and the more value oriented of the world getting up off the ground, going from phase one to phase two which is now about their earnings and fundamentals and it’s less about stabilization of their prices and money flow coming into those sectors. Last but not least, travel, leisure, and entertainment – those are the areas that are widely known as the epicenter areas that have also stabilized and are getting ready for the full reopening as our Viewpoint has been titled. Then overall, you get the second tier movement which is phase three. After stabilization of technology, which we expect some time between now and the summer months and after the phase two movement into the value and the cyclical cohorts, you got a second tier segmentation in our opinion that separates the post pandemic technology moves that should stand the test of time versus what benefited just from the pandemic restrictions, and that is more than likely to happen toward the end of this year - maybe third quarter in our opinion - and getting ready for what we title The Last Phase of the Workout Process. Phase five which is called The Next Frontier. Until then, second guessing is likely to continue to come and go and this second guessing goes like this – is this the beginning of a bigger, more daunting sell off? Can technology even stabilize in the face of a backup of continued higher yields? Is this the end of the market’s current cycle and should we be preparing a much lower risk portfolio? We don’t think so at this point. There’s many sings that point to this is still early to mid in the market cycle with many gyrations and many second guessing periods, particularly as yields back up and particularly as Federal Reserve remains ultra-accommodative and new fiscal policy gets placed into the world order, not to mention just the US. So there’s many, many different points I want to address here. In our latest Viewpoint we do address 14 developments between now and the end of the year that we believe will continue to unfold that I’ll address in a moment but as far as what’s going on right now in market action, I want to point to one particular area. When you take a look at market breadth, this is what technical indicators and technical strategists look at very, very closely to give a feel for the participation across the marketplace. Right now breadth remains very strong and overall, this is not typically happening. This doesn’t typically happen during market peaks or market tops. What typically happens is you get a major movement towards a narrow segment of the market likely exhibited just before the drawdown in the fourth quarter of 2018. Right now breadth continues to widen out. What’s happening is, with technology being a source of funds as a sector feeding into smaller sectors, is lending itself a little bit of pressure on the broader market as we’ve already highlighted but breadth remains in favor of the investor who’s looking to rebalance their portfolio back up in equities. Then the other point I wanted to mention is small cap discretionary stocks are at absolute and multiyear highs which also is a sign of broad participation. Energy and banks and transports and broader services are also exhibiting improving trends and not typical of market tops. Finally, credit spreads are obtained and the dollar’s stabilized. Therefore we view this is a rotational twist. A torque up in yields that’s forcing some repositioning underneath the market and causing some pressure on top of the market but not indicative of a market top in our opinion.
So in this regard, we wrote down 14 different developments we see unfolding in the coming 12 months or at least for the balance of the year. First and foremost, one is the leading economic indicators led by the yield curve and equity markets should continue to increase and approach pre-pandemic levels sooner than all other cycles that we have analyzed. Typically this does not happen within a 17 month timeframe, and that’s what we are currently pegging as the turnabout between where we were at the low point of leading economic indicators to where they eventually get back to pre-pandemic levels. In our estimation, that could happen in the next six months. Number two, consumer spending to surprise to the upside as consumer pent up demand is unleashed and the excess savings that we estimate close around the world close to $3 trillion are released into the broader economy. Not all of those savings are released. Some go into investments. Some go into the broader economy. We believe this time around, given the tragic developments through the pandemic and the effect on consumer behavior and psychology, we expect this time around to have a little bit of a higher savings rate. Nonetheless, the sheer amount of savings out there should beget higher spending in the next 6 – 12 months. Number three, overseas economies still set to trail the US growth rate but benefit from US consumer spending. The global manufacturing renaissance already occurring outside the states and improved domestic backdrops. Four, global government bond yields especially in the US to drift higher and pulled up by the US as inflation expectations increase in economic activity surprises to the upside. Reflationary assets to rise on the back of favorable supply and demand dynamics. This is already occurring particularly in the energy sector and material sector and unprecedented growth in money supply to continue at portfolio repositioned to reflect this. Six portfolio rotation in equities to swing back and forth as asset managers increase cyclical while still lowering mega growth positioning. Now, that mega growth positioning we expect in the next couple of months to begin to stabilize. The reason here is that when you take a look at some of the valuation resets that have occurred in the larger companies within the mega growth, particularly within technology area, you back out some of the high flying, high beta, high momentum areas, you start to see valuations get back to attractive levels again and we expect in the next couple of months that the technology sector should beget a better valuation and for longer term investment repositioning, that would be attractive in our opinion. In the meantime though, this is likely to weigh on broader indexes from time to time. Number seven, pent up demand for travel, leisure, and entertainment and lodging is the wildcard in our view. High demand and activity in this space, mixed with an increase in cyclical positioning while technology stabilizes, should help push indices higher in general as earnings surprise to the upside across most sectors in the coming months. That is, in our view, the key to the second half of the year. Eight, investor sentiment remains optimistic on the economy but slightly cautious in our view on the broader markets given inflation concerns, still debt and deficit worries, and fears that investors still have as they’re investing at a perceived market top given the high valuations. We expect some choppiness in between earnings announcements to address this. Number nine – coronavirus and vaccine data to continue to improve especially in the number of vaccinated individuals relative to their number of active infections. Ten, fiscal stimulus, fiscal relief, money growth, and monetary accommodations still remain the four tailwinds to higher asset prices in our opinion. 11, concerns remain regarding commercial real estate despite improved reopening prospects. In the larger cities, commercial real estate is likely to remain in a workout process but should regain its footing quicker than expected or at least than consensus expects in our opinion. 12, oil prices could surprise to the upside as years of capital investment discipline begets a supply deficiency just as the global economy is reopening. We’re watching this space very closely. The final two – 13, China- US relations likely to take a back seat. Continue to take a back seat to domestic issues but lurk in the background as the technology “war” prods on. Finally, thematic investing including sustainable and impact investing, helps provide a catalyst to portfolio returns as positions are repositioned in our opinion.
Finally, before we close out the initial comments here, I wanted to readdress the flash repositioning. For us to stabilize here in the broader marketplace particularly in the risk asset spectrum, we believe the five following short term events that need to be pulled through which we expect to happen in order for the broader market to stabilize. The first is this, 10 year yields will need to stabilize somewhere on the 1.5% level and remain there for set period of time before their next move up to stop the torque yield and moves and overall the curve to remain steep enough. That’s point number one for stabilization. Two, as this occurs, technology shares would need to stabilize as yields stabilize and a focus back on fundamentals. Three, economic growth and profit growth to continue to surprise to the upside but instead of expectations, it becomes real data. Four, oil prices to remain in a broader $50.00 - $70.00 a barrel range. Why is this important? Because it’s still the most important input as it relates to overall consumers expenses and that also feeds out into gasoline prices. Five and finally, the Fed to remain accommodative but now shift to a balanced about risk approach and that needs to be done in words first, in our opinion, and the shift overall in the years post 2021 into a real action or policy change development. In our opinion, these four factors would push volatility down to lower levels, stabilize the flash repositioning that has been going on, and allow investors once again to focus back on the fundamentals. For this we still believe weakness is a rebalancing and buying opportunity in the broader equity marketplace. That’ll do it for the upfront comments for the Street Talk- The Reopening Has Begun.
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