Tune in and listen to the conversation in our latest “Talking Markets” podcast. A transcript follows.
Renee Anderson: Thank you for joining us today, Ed.
Ed Perks: Thanks, Renee.
Renee Anderson: Ed, let’s start with your high-level views of economic and market conditions right now. Reflecting back on the last 12 months, and what you see for the rest 2021?
Ed Perks: You know, certainly at the start of the pandemic, we did see that severe drawdown in markets, followed by what to many of us was a very surprisingly rapid, albeit narrow, market recovery of major indices. And that was dominated by themes that, you know, clearly were emerging alongside the pandemic within fixed income. Lower for longer drove fixed income markets with long duration being really the dominant theme—while growth, particularly the work from home beneficiaries and mega-cap technology leaders, were really driving equity indices higher. This was more than just a phenomenon around growth being scarce. Many of these companies were experiencing significant improvements in fundamentals, despite the damage that was being done to the broader economy. Clearly very profound shifts in our lives, in our livelihoods, and that this was accelerating many of the transitions that were already underway and we felt like that dynamic could certainly remain a powerful driver for some time to come. At the same time, it was clear that a tremendous divergence was being created between the “haves” and the “have nots” in the market. And this offered real value to those with a longer-term time perspective. As markets started to discount the post-pandemic period, particularly following the announcements of several successful vaccines, certainly putting a big risk factor like the US election in the rear-view mirror, we really started to see some normalization, some convergence, if you will. I think that’s been an important theme for investors to consider.
Certainly, greater breadth has characterized the markets the last few months; cyclicals and many dividend-paying sectors and companies have experienced significantly improved outcomes. We know the leadership was in growthier areas initially in the pandemic. Whereas if you look at dividend payers, the MSCI USA High Dividend [Yield] Index is a good example, it took really untill the end of the year to get back to pre-pandemic levels. And those are levels that we still sit at today. So, while some divergence clearly has been recovered or normalized, we continue to believe that this is the likely path of travel for markets as we move through 2021.
Renee Anderson: How do you think about downside risk across markets?
Ed Perks: There are a lot of ways to think about downside risk. As interest rates in general, move lower, do high-quality, long-duration, fixed income instruments still offer downside protection the way they have historically? And, we don’t think it’s been completely eliminated, but certainly a lot of the benefit that investors have been able to accrue in equity drawdowns historically from those fixed income instruments is quite muted at current levels. I think that’s a debate that’s certainly played itself out in multi-asset portfolios. I think we have to think about diversification, across not just sectors, but also asset types, asset classes and security types as being an important driver of maintaining some of that benefit that typically accrued to multi-asset portfolios by holding things such as longer-duration Treasury securities. So, clearly a challenge that many investors will face as we move through 2021 and into the next several years.
Renee Anderson: Let’s get more granular now. Starting with inflation, a lot of different opinions on what to expect with inflation. What’s your view, short term and longer term?
Ed Perks: Yeah, it really remains one of the critical factors to think about certainly relative to fixed income investments. But I think also relative to expectations for equity markets over the longer term. You know, central banks, the Federal Reserve in particular, have really pivoted its policy approach to let inflation, if it were to start to pick up, to let it run a little bit hotter than maybe they have in prior cycles. So, I think that adds an element of risk that we haven’t had in prior markets. But I think it’s very clear that inflation that might set in because of a snap-back to more normal functioning that could happen in a relatively short couple of quarters kind of timeframe is very different than inflation that might be setting in, in a more permanent fashion, more durable that certainly will get a much more of their attention. I think, in the short term, we’re generally of the view kind of core durable inflation will remain somewhat subdued, but as we think about entering 2022 and beyond, it could become a greater factor given the amount of stimulus, the amount of spending, and that pent-up demand that that certainly exists.
Renee Anderson: Let’s talk about the rest of the world for a minute. Where are you seeing regional strengths or weaknesses as we move to an eventual recovery from this global pandemic?
Ed Perks: That’s a great question, Renee. It’s really something that as we see even today, the experience of different regions around the world, in terms of just dealing with the pandemic and being able to move forward, has really been quite varied and also inconsistent, certain regions have flare-ups and have had real challenges that only to get control of the situation again. So, as we’re moving forward, the US does offer a lot of potential to come out of it as we’ve seen vaccination programs starting to improve, starting to accelerate, still pretty nascent. But in a short period of time, we think we could be approaching a more normal path than other regions, particularly, Europe or some of the emerging markets. And that’s where I think we have to be careful and be a bit more specific in kind of the geography or region we’re talking about. Emerging markets certainly led by China’s impressive dealing with the pandemic and ultimately even delivering some economic growth in 2020 where most reaches of the world were in contraction. So, we think there are areas of the emerging markets, in Asia in particular, that do offer some opportunity for investors.
Renee Anderson: Do you have a view then about currency and where we see the dollar in terms of relative weakness, given some of the different shifts around the world?
Ed Perks: Yeah, and that has been an important theme, Renee, that we have seen as we’ve moved through this period and certainly the substantial amount of fiscal stimulus being undertaken by the US and anticipated with the new administration coming in. And I think that’s an important area of focus in terms of the path for the [US] dollar. You know, at the same time, we’re not expecting real further deterioration in the dollar. So very similar to my comments around where opportunities might exist, I think thinking about the dollar on a relative basis to other major currencies really needs to be done in isolation. We don’t necessarily see a big growth differential. We think we could be entering a period of synchronized global recovery, but there’s no expectation at this point that that recovery that we’ll be experiencing in the US will be significantly deficient on average to the rest of the world. And that certainly would be something to watch and a concern for, you know, material further dollar weakness, but at this point we expect, on a broad basis, a stable dollar.
Renee Anderson: So, thinking about opportunities outside of the United States, are any of these shifts and changes that we’re seeing impacting income-oriented opportunities outside the US or total return relative valuation ideas?
Ed Perks: Yeah, I think it’s a bit early in that stage, but I certainly think as we think about the potential path of the global economy as we make our way through 2021, that certainly is something that we’ll increasingly look at and focus on. US equities have been a very strong performer on the global front, but it does ultimately raise the, I think, question in our minds about potentially more attractive valuations in other regions. Certainly Europe, in particular, is an area where dividend yields historically have been higher. So, it always gets a bit more of our attention when we see opportunities, if we think the backdrop is improving meaningfully. I think we can look across a wide range of sectors and find some attractive opportunities to invest in.
Renee Anderson: So talking about sectors, I’m going to ask about three in particular. Let’s start with utilities, typically [interest] rate sensitive. How should we think about valuations and, you know, the appreciation potential for the utes [utilities] sector from here?
Ed Perks: That’s something that we think on a relative basis in particular, when we think about absolute valuations, the group’s fairly in line with where it’s been in historical cycles, but on a relative basis, was probably one of the groups that was left behind a bit more in that great divergence that we experienced at times last year. In addition, I think there are some really important themes I think we’re going to see out of the new [US] administration. Clearly an intent to really move forward on some infrastructure spending, and additionally, the challenges regarding climate change and the need to invest in sustainable, whether it’s solar and wind. That’s a theme that we think is playing out broadly across the sector and will likely stay with us for quite some time.
Renee Anderson: The next industry I want to ask you about is REITs [real estate investment trusts]. Thoughts on that space today?
Ed Perks: We do think that, while there are some valuations that look attractive, there’s a very high level of uncertainty, as I think we’re experiencing. Now, this is a limited set, but certainly, the office market in particular, I think the shifts that society made during the pandemic. I think we still need to navigate exactly how those shifts play out as we move forward into the post-pandemic period. And I think that has potentially meaningful implications for the real estate sector.
Renee Anderson: The third one is the energy sector. Could you give us kind of a deeper dive into the energy space?
Ed Perks: We have seen a lot of volatility from that sector, no doubt, not just the impact of the pandemic setting in early last year, hurting demand expectations, but also many will recall, at the time, a supply war breaking out. So, it was really quite the perfect storm for many companies in that sector. And it resulted in the severe decline in prices with futures trading negative, as I think many of us will recall, for a brief period of time at least. I think, on the positive side, what we’ve seen is a self-correcting mechanism, both the levers that individual companies have to pull in terms of making adjustments to how much the backdrop for supply and demand and has changed, you know, but also the capital markets. And I think this is an important aspect as we move forward. Each energy cycle, I think, has played a part in influencing how investors think about allocating capital or investing capital in the sector, the type of returns needed, but also the life cycle of that investment period. And, you know, in many areas, investment in the energy industry does occur with decade-long investment cycles. And that’s where I think societal changes and pivots towards electric vehicles, while happening initially at a modest pace, these trends are clearly with us to stay and certainly will play a greater role going forward.
So, it’s really a twofold story. One of kind of self-correcting improvement in fundamentals. That’ll time nicely with normalization and economic activity in a return of important and meaningful components of demand, air travel being the most obvious, I think we’ve all probably seen in our own communities traffic starting to creep back in on roadways, on highways, but certainly air travel is still well below where it was pre-pandemic. That’ll be an important driver of increasing demand in the short term. And then, I think the longer term, more secular-type shifts are something that we’re going to have to monitor. It is worth noting that many of the companies within the sector, the major energy companies in particular, are playing quite an active role in helping transition our economies globally to more sustainable fuels.
Renee Anderson: So maybe a more macro-type of a question. We had the transition in Washington to a new administration. What are your expectations for how that new administration’s policies might impact markets on the shorter term and the longer term?
Ed Perks: There are numerous, and I think this is something that really has played out over a bit longer period of time, and it certainly maybe started in just understanding who the candidates would be and ultimately the outcome of the election. Within financials where regulation may see some increase, it certainly may not be to the extent that maybe markets were potentially fearing or preparing for had the election gone in a different direction. So, the combination of [interest] rate movements, of economic improvement, of regulatory framework that will be workable, I think is important for that sector. I touched on it a bit in utilities where we see infrastructure spending, where we see the greater embracing of climate change and moving to a more diversified fuel, set that’s driving our economy, that being positive as a result of the election as it relates to the individual sectors and companies’ prospects.
Renee Anderson: So the word of the past year has been “unprecedented.” So maybe I’ll just ask you to share some of your insights in terms of maintaining a steady hand through these periods of volatility and uncertainty generally.
Ed Perks: As we’ve experienced the different challenges over the last several decades, one thing that I think that’s really run clear is, and I think resonates significantly in the experience we’re having now in these markets, that reacting to the situation around us from a longer-term viewpoint. So, looking at what’s happening and thinking about what will this mean over the next 12 months, 18 months, three years, five years. And that’s really what drives the ability to ride through, at times, unprecedented levels of volatility or uncertainty in markets. And, that’s certainly what we were experiencing in March and April and the very early days of the COVID-19 pandemic. Markets started to react, but they gave investors, certainly those with focus on income capture and appreciation potential, an opportunity to think about making shifts. And I think maintaining your focus on what moves are right or are available enables us to have that steady hand despite what’s happening around us.
Renee Anderson: So Ed, what are you most optimistic about as you start thinking through the rest of this calendar year and into the next?
Ed Perks: What I’m optimistic about is just the progress that we’ve made, the tremendous accomplishment of our health care system and not just dealing with the challenge of the number of cases, but the development of the treatments, the development of the vaccines, the production of the vaccines. And yeah, while we had some challenges initially, I’m really encouraged by the number of vaccinations that are now happening on a daily basis, the number of vaccinations that we’re going to be ramping to here in the near term. That certainly gives me a lot of confidence. And thinking that, as we move through 2021, better days are ahead. So that’s clearly my focus.
Renee Anderson: Terrific. So, I want to say thank you, Ed, for sharing your perspectives and really appreciate your time.
Ed Perks: Thanks, Renee. It was great to be with you.
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