A bumpy ride for stocks in 2018 sparked fears that the next recession was around the corner. But this year, we’re seeing a different story play out. Stocks have rallied. The question is, what’s behind the rally and can it last?
On this episode of The BID, Chief Equity Strategist Kate Moore discusses why she still likes taking risks in stocks, why we shouldn’t bet against China and how to take advantage of technological disruption.
Oscar Pulido: Let’s take stock of the stock market. After a bumpy ride in 2018, U.S. markets and investors alike started to fear that the next recession was around the corner. This year? We’re seeing a different story play out. Stocks have rallied. The question is, what’s behind the rally and can it last?
On this episode of The BID, we’ll answer these questions with Chief Equity Strategist Kate Moore. We’ll talk about why Kate still likes taking risk in stocks, why we shouldn’t bet against China, and how the tech sector has influenced nearly every sector of the economy. I’m your host, Oscar Pulido, we hope you enjoy.
Kate, thank you so much for joining us today.
Kate Moore: Yeah. I’m really excited to join The BID today.
Oscar Pulido: So Kate, last year, I think everybody knows was a tough year for the stock market, particularly the last couple months of the year – I think it made the holiday season tough to enjoy if you were looking at the stock market. But this year, global stocks are up 12 percent, the S&P is up over 15 percent: were stocks supposed to do this well, this soon?
Kate Moore: Well, it depends on who you talk to. The fourth quarter of last year was really surprising for all of us. The fundamentals hadn’t significantly deteriorated; we were actually still in a very supportive policy environment. There was some good growth data, and sure we knew that the comparisons in 2019 and things were going to be a little bit tougher. The magnitude of the underperformance was really outsized. And in particular, I was watching what happened to equity valuations, which dropped precipitously. And at the start of this year, we said, some of that has to reverse because over the course of 2018, we saw the worst multiple contraction or derating of the equity market, the third worst over the last 30 years. Most years after that happens, you see a snapback. But at the start of this year, not only did valuations rise and enthusiasm for equities return as people realized the Fed and other central banks were going to be supportive. But actually, the market kept running even while people became skeptical about the sustainability. So that was a long way of saying probably not that much; it shouldn’t have run as far as it has. But it’s interesting to note that we have a lot of good things happening in the equity market that I think are under recognized.
Oscar Pulido: And so do you think that momentum can continue throughout the rest of the year? Or is it unrealistic to think we’ll just repeat this performance quarter after quarter?
Kate Moore: If we have a mid-teens quarter for four quarters in a row, I’ll be retiring, truthfully. That will be a pretty good story for my personal account, and actually I think for a lot of the funds here. So no, I think that is unlikely that we’re going to have that magnitude of run. That said, it’s possible the markets run a little further, because one of the things that really drove the equity market in the first quarter was the tone from the Fed and other global central banks, namely that they are going to continue to be super-accommodative that we’re not going to get big rate increases, and that really has reopened I think the possibility for multiples to stay at higher levels and for the earnings environment to be supported. Valuations in equities are really dependent on where interest rates are frankly. And with interest rates staying very low, there’s possibility for equity multiples to go a little bit higher from here; not a lot, but a little bit higher.
Oscar Pulido: When we started on the year on rates, the belief was that the Fed was going to raise rates, albeit maybe very limited type of increases. But now, as I understand it, there is a belief that maybe the Fed would cut rates by the end of the year; I’m not saying that’s your view but that seems to be the market’s interpretation.
Kate Moore: Yeah. So we had some great debates at the November BlackRock Investment Institute Forum about what the Fed might do over the course of not just the next quarter but of the next four to six quarters. And I’ll tell you, those debates raged on into the beginning of the year when the Fed really changed its tone. But the market pricing of Fed expectations has been what’s moved the most I think that is what you’re referring to, where the market was expecting two hikes throughout the course of 2019, moved to a cut in January, bounced back up to no move, and is back down to a cut again, and perhaps two cuts over the course of the next twelve months. It’s been a little schizophrenic. We think the bar for the Fed to move either way – to raise rates or to cut rates – is extremely high, and so we’re expecting more of the same: no significant change in policy over the coming quarters.
Oscar Pulido: Last year was a great year for earnings, and some of that was helped by some fiscal stimulus, in the U.S., the tax cut. But this year it seems like earnings growth is slowing. So how does a slower growing economy, slower earnings growth, translate into still more equity returns ahead? It seems like those things don’t go hand in hand.
Kate Moore: Yeah. So let’s go back to 2018 and also 2017, because we actually had two exceptional years of global earnings growth. 2017 I always like to highlight. It’s a year where every major equity region posted higher than ten percent earnings growth. That was the first time that had happened since 2006, so it was a really exceptional year. And then last year, as you pointed out, super-charged by the tax cuts and fiscal stimulus, and led by the U.S., we had another really strong earnings year. Not every region growing ten percent or more, but many. And this year, we know the comparisons are going to be hard, and without a significant amount of fiscal stimulus or a change in policy, we’re just not going to get to those numbers. But I would be cautious in general about comparing GDP growth and earnings growth too closely. Actually, over any period of time, the relationship between those two things is very loose, sometimes non-existent. It’s because companies have a lot more levers to use and to pull when they’re working on their earnings. It’s not just a question of how fast the economy is growing. What do they do with costs? What are their labor pressures, what is the competitive environment? What is the interest rate environment, what is the tax regime? There are many other things that go into earnings. We have to be careful about being too reliant on history, because corporate balance sheets and behavior is different today than it has been in the past. Excellent quality balance sheets and companies that are behaving much more conservatively than they have in previous cycles, I think that leads to a longer duration earning cycle than we’ve ever seen. A slower growth environment is something we have to watch for. But it doesn’t always necessarily dictate the course of the earnings growth.
Oscar Pulido: When we think about the economy, I think about the bond market, which we talked about stocks, but this has been also a reasonably good year for the bond market, which some might interpret as not a good sign, the fact that bond prices have gone up, interest rates have come down, that that’s still telling us something about the outlook that maybe the recession is getting closer. Do you think that is what the bond market is telling us, or does this go back to central banks are going to be patient and therefore people are putting money to work across different asset classes?
Kate Moore: So I think there are two things to say on this one. The first is, both the equity market and the bond market have celebrated a much more dovish tone from central banks. It has been a rally in equities, a rally in bonds, it was one of those years where if you were just invested at all, you’re feeling pretty good as we start the second quarter. I think the fact that we’re going to continue to have low rates and actually supportive fiscal policy like government spending in a number of major regions, is going to be good for stabilizing economic growth, albeit at a lower level. But there is a second part of this too which is people are skeptical about the duration of this cycle. Even though we don’t have a lot of weak data points yet, at ten years into a bull market and ten years into an expansion, we’ve seen investors put a lot of money into bond funds in 2019 and take money out of equities. I would actually argue that positioning means that equities can grind higher, because they haven’t been buying into the rally. I do worry that there is too much enthusiasm for bonds, especially just based on the duration of the cycle.
Oscar Pulido: Right, I was going to ask you about complacency and whether you were seeing complacency from investors given the rally, but what you’re saying is investors are actually taking money out of equity funds.
Kate Moore: Yeah. There is not as much complacency as you would expect. There are some areas of complacency that we’re monitoring around certain geopolitical risks, where maybe the best case scenario for U.S. and China trade or European politics are getting priced into the market. But when it comes to overall equity enthusiasm, both the external fund flows data that we monitor as well as our internal analysis, it’s all kind of showing that people have been fading this move over the last three months. And that means I think the pain trade is higher.
Oscar Pulido: So let’s talk a little bit more specifically. As you think about regions, maybe that is a good place to start: are there specific regions of the world that you think the stock markets are better positioned to do going forward?
Kate Moore: We are actually holding our regional recommendations steady, the ones that we had at the start of 2019, and really for the bulk of 2018, which is our preference for the U.S., given quality, strong fundamentals, the great geographic and global reach of a lot of companies, combined with some strong growth momentum we’re seeing in the emerging world. Now emerging market stocks did – I’m trying to think of a really polite and kind way to say this, but really badly at the end of last year, and it felt completely unjustified. Yes, there were some policy and regulatory headwinds around China for example, but it wasn’t the end of the world, and actually we see great longer term demand and actually even near-term demand coming out of some of these markets. And the Chinese government has been stimulating, the consumer, giving incentives to purchase autos or white goods, which are like basically appliances, targeted credit expansion. And all of that stuff should help really stabilize the Chinese economy and demand. So, we see a lot of opportunity for emerging market companies and for equity markets that are geared towards the Chinese story.
Oscar Pulido: And that is interesting, because most of the China headlines are around trade and trade tensions, and that would lead people to believe emerging markets are an area to avoid. But you just touched on actually the positive headlines which maybe don’t get enough coverage, which is the Chinese economy stimulating. And that helps global growth and that helps maybe the performance of some of these markets.
Kate Moore: Absolutely. I think it’s a very poor trade to bet against Chinese political will too. Policymakers from all different parts of the Chinese government are very, very committed to stabilizing and expanding growth. They are committed to the consumer, particularly in targeted policies that encourage spending, whether it’s on autos or appliances, on credit to companies and industries that they want to see grow, and they are showing a huge amount of support for the technology sector, also communications and internet companies, that really are the next round of leadership for the Chinese economy. I think it’s important to watch what they’re doing where they are spending their time and attention, and not just on this conflict or perceived conflict between the US and China on trade.
Oscar Pulido: So let’s talk about the technology sector, which has been a phenomenal sector to be invested in over the course of this ten-year bull market. You can’t go far without hearing the terms 5G, artificial intelligence. Are there any other areas outside of those that you think are worth touching on? Or maybe you could touch on the 5G and AI themes.
Kate Moore: Yeah. So there are limitless themes it feels like in technology, and some of our technology investors here at BlackRock (NYSE:BLK) had actually sketched out for me at one time why we didn’t need to invest in any other sector, because within technology and now as part of communications as well, you were touching on all different parts of the economy. I think that is true. You have technology companies that operate in the healthcare space, technology companies that operate on the consumer side, technology companies that are replacing financial services. This is a broad and cross-sectoral theme, and there are great opportunities to invest in the disruptors and the winners across the entire market. I think really important – and this ties back to the China theme, though – as we think about 5G and AI and some of the most innovative and perhaps disruptive parts of technology, the Chinese are leading in many parts of the world. They have great partnerships with countries outside of the U.S. We would expect actually that some of this trade tension, even if we have an agreement in the near term will lead to a decoupling of the global tech sector and actually perhaps two separate tech protocols will be developed on a go-forward basis. If you really want to invest in technology, I think you have to own both U.S. and Chinese tech.
Oscar Pulido: You made a compelling case for the technology sector, but is there any other sector that we should be thinking about?
Kate Moore: Yeah. So we still really like healthcare. Healthcare has a couple different elements to it. It has a quality side to it where we have companies that have solid balance sheets that have the potential to continue to grow their earnings even in a slower part of the cycle. It actually has a technology and innovation aspect to it as well, which is quite exciting especially when you look industry by industry within the sector. And then you have a third element which is a demographics element, so a really long cycle where we’re seeing more and more consumption of healthcare products and services, and an aging developed market population that will be spending more and consuming more on the products and services in that sector. So we see a lot of reason to own it for the long term, and also at this point in the cycle.
Oscar Pulido: Kate, you’ve given us a lot of really good things to think about here, more tactically, but let’s just take a step back for a second, when you think about investing in the stock market for the long term, what are some basic things that you think we should be keeping in mind as we approach the stock market.
Kate Moore: Well, a few things that come to mind are that no one is so brilliant that they can time the market perfectly. Stick with high quality and growth themes in your portfolio for the long term, and don’t panic too much if the news flow turns the other way. I think it’s also really important to understand your own risk tolerance. I like to invest in emerging markets; I feel really comfortable owning EM for the long term. I understand that it’s going to be volatile, I understand that we can see swings in policy, whether it’s around trade or specific domestic policies that affect the prospects. But for me, compounding returns in emerging markets is extremely exciting. Understand your risk. I have a belly for risk so I can do it. And then I think the third thing is to recognize that taking a diversified approach is super important, because it’s not just good enough to know who is winning right now, but because every sector and every industry is being disrupted, you need to take a broad approach both on a geography as well as sector basis to your equity allocation.
Oscar Pulido: Great advice. We usually do something here at the end of our segment where we ask some rapid-fire questions that touch a little bit on your personal life, so I hope you’re ready for these. These are meant to be –
Kate Moore: I’m strapped in, ready to go.
Oscar Pulido: – quick responses. We talked about tech, what is the disruptive piece of technology that you’re most excited to use in your daily life?
Kate Moore: So I’m not sure how disruptive it is, but the technology that has most changed my life are my Sonos speakers. I’m obsessed with music, and being able to fine tune my music all over the apartment and at other homes, is super important.
Oscar Pulido: All from your mobile device I’m sure.
Oscar Pulido: I heard you’re an avid skier. Where do you like to hit the slopes?
Kate Moore: I will skill anywhere, but I spend most of my time at Jackson Hole which is my favorite place on earth. I am trying to convince the BlackRock Leadership Team to let me open an office in Jackson, just a hint-hint.
Oscar Pulido: I will join you if that is in fact the case, and I have to admit having gotten my three-year-old on skis this year was a big challenge, so maybe one day he’ll go to Jackson Hole as well. I’ve also heard you love to read. What book would you recommend right now?
Kate Moore: So I’m really into science fiction and fantasy, I read the entire Game of Thrones series before there was even a rumor it would become a television program, that’s how nerdy I am. One of the best books I read recently is called The Three Body Problem. It is a science fiction story that was translated from the Chinese. A bunch of our colleagues in San Francisco suggested I read it. I thought it was a fascinating take on both the impact of the Cultural Revolution on decision making as well as some real nerdy science/outer space type of stuff.
Oscar Pulido: And the last question, what is your favorite place to go in New York?
Kate Moore: Central Park. I have a golden retriever, and we spend a ton of time in the park, especially during off-leash hours, I’d say before 9 a.m. on Saturdays and Sundays, with a cup of tea and throwing the ball and watching my dog run around is one of my favorite things to do in New York City.
Oscar Pulido: And now we’re in spring so you hopefully have a little bit more time to be able to do that.
Kate Moore: Absolutely.
Oscar Pulido: Thank you Kate for joining us on The BID.
Kate Moore: Thanks for having me.
This post originally appeared on BlackRock.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.