Sponsored by Cetera
Maria Rosati: Welcome to Wealth Management Spotlight interview series. I'm Maria Rosati, contributing editor for Wealth Management. I'm here today with Gene Goldman, Chief Investment Officer and Director of Research for Cetera Investment Management. Gene, we're delighted to have you here today and to discuss the market outlook for Cetera. With that, let's get started. Earlier on in the pandemic, we saw a lot of market volatility, and then it rebounded quickly. Why did that happen?
Gene Goldman: First of all, rebound. Rebound is an understatement. Think about this, the markets rallied about 50% since their March 23rd low. It's a huge, huge rebound. The question is really why. Why do we see stocks rally so much? It's really three things. Number one, the data is getting better. I'll talk about this a little later. Number two, there is so much stimulus in this economy, both from the Fed and from both also a fiscal standpoint. Third of all, the markets are really looking forward to better times ahead. You look at earnings for next year. We're seeing some expectations for a big jump in earnings for next year. All of these help to push the market higher and rebound from those March 23rd lows.
Maria: Just as a quick aside, how long was that bear market? This is probably the shortest bear market we've had.
Gene: Yes, it was definitely the shortest bear market we've ever had. I think it was from February 19th to March 23rd, so what was it was about? 30 days or so or probably like 20 trading days.
Maria: The next question, you viewed the stock market as a forward-looking mechanism. Where is the confidence coming from?
Gene: True. We've said this many times, especially to all of our Cetera advisors, is that listen, the stock market is a forward looking mechanism. It tends to look at events about six to nine months in advance. With that said, there's a lot of positive that the market's looking at down the road, and this is really justification for this rally. If you look at the positives, we can cite four positive points that help drive this market. Number one, as I mentioned before, the unprecedented stimulus, both from fiscal and monetary, it's about $10 trillion.
Just put this in perspective. That's about half of US GDP. We all know the old adage, don't fight the Fed. The Fed is putting so much stimulus into this economy. The markets aren't fighting it.
Number two, we've seen such a big improvement in economic data. March was really ugly. April got worse, but now we're seeing some better metrics. This recession is very different, and because it's different, we need to look at different metrics. With this in mind, we created what's called our, social distancing recovery dashboard and we take 14 of these high frequency data points, blend them together to give us an idea of where we are in the economy. We look at mobility stats. We look at TSA check-ins, unemployment claims. Again, it's a different recession. We need to look at different stats than we have in the past.
The third positive is earnings. Next year looks really good. There's also that adage that earnings drive stock prices. Next year earnings are expected to rise about 26%, according to the Factset, and even the second quarter of next year, so a year from now, earnings are expected to rise a whopping 44% versus this year. Then lastly, there is hopes for the vaccine.
We've seen a lot of news about different companies where they are in terms of a vaccine. I'm not a virologist, so we can't really weigh an investment perspective on that, but again, there's hope for the market that there is a vaccine coming.
Maria: You say it's a different recession, so I want you to talk a little bit about that. Then also given this is an election year, are we going to go back into a bear market, or what do you see happening?
Gene: Sure. Great, great question. Why is it a different recession? If you think about most recessions in the past, they've either been supply driven or demand driven, so usually, there's a shock on the demand side or the supply side. Case in point was the Great Recession. What happened is that we saw unemployment jump dramatically. Also, a lot of people lost their jobs, and unfortunately, demand dropped. We just stopped spending money.
This recession is a little different. It's a supply and demand shock at the same exact time. When we shut down the economy, this really impacted our supply chains. We really couldn't move goods around the economy. We saw factories closing. We saw supply chains really shifted and close down. That affected the supply side of the economy. On the demand side, similar to what we've seen before, just people stopped spending money because we were sheltering in place. It's a very, very different type of recession that we are going through. The interesting thing about this recession is that it could be the-- We just saw the end of the longest expansion in the history of the United States. It was 10 plus years. We could see the shortest recession ever in the history of the United States. It could be from basically March through June, so very, very short recession. To your second part of your question about do we see the bull market lasting given that this is an election year, simple answer is yes. We don't see a bear market due to those positives I mentioned before.
The point here is that, we have these three investment themes for the rest of this year. This really ties into one of our key investment themes that we do expect increasing market volatility, and we do expect a market correction. The good news is that we don't see a bear market. We don't see us going to market lows. Why increasing volatility? Why a potential correction? These are the concern that balance out those positives I mentioned earlier.
Number one is just the impact of the virus on consumer spending. We're seeing bankruptcies. We're seeing companies go out of business. We're seeing restaurants at 25% capacity. I think Yelp said that 26,000 restaurants are closing this year, and of those 26,000, 16,000 are permanent. This is going to really impact our spending. Even there's talk about K-shaped recovery where the economy fell and then the goods purchases are increasing, but services are coming down. Again, it's a very interesting-- It's a virus overhang in terms of consumer spending.
The second point is that stocks are up above 50%, since we talked about that March 23rd low, but earnings are down about 18 1/2% for this year. What this creates is a extended valuations. Right now on the S&P 500, on a 12 month forward earnings, you're looking at a P/E ratio of about 22. That's a little high. Third point is the election year. This is an election year. It is 2020. There's a lot of uncertainty, but whoever gets elected-- We are posting an election piece. We talk about this. Whoever gets elected, the returns will likely be muted, whether it's an incumbent, whether Trump wins.
We've seen historically, during an incumbent winning, the return from election date to inauguration is about positive 4%, or if the challenger wins, if Biden wins, it's usually about 2% gain for the challenger. The returns tend to be muted, but what we're really more focused on is that-- I'm not a political person, so I'm very independent. I'm not a Republican or Democrat, but a market concern is that if Biden gets elected as a Democrat and the senate goes Democrat, we could see a Democratic sweep. You could see increased regulations, potentially increased taxes, although I don't think the taxes are going to be rising anytime soon given the delicate economy.
The last point about the election which will cause some investors to freak out a little bit is just the potential for a contested election. What happens if it goes, it lingers longer than people anticipate? Again, uncertainty. Markets do not like uncertainty.
Maria: What do you see the impact-- We've talked about the US economy and the global economy and a recovery globally.
Gene: Sure. Again, this is another one of our themes. We have three main themes we've been providing to our advisors. One theme we just went over was increasing market volatility and a potential correction. Our second theme, it's a little controversial, but it's different than most firms out there. We have been saying for a while we expect a U-shaped economic recovery here in the United States. This U-shaped recovery is more conservative than the aggressive V-shaped, so we knew as the economy goes down and it slowly comes back up.
The question is, why not a V shaped, which everyone out there is saying. Even my mom called me yesterday. She says, "Jean, how come you recommend a V shaped? Why is it U shaped?" Why not a V shape? The economic hit is too big. As a reminder, think about during the stay at home orders, the shelter in place, 310 million Americans were at home. I was at home. My mom was at home. We were all at home. That's about 94% of the US population. We weren't spending as much money. Also, a V shaped suggest that we get back to pre recession levels by the fourth quarter of this year. It just doesn't make sense.
You look at past recessions. Simply take the average of how long it takes to get from the prior peak back to that level. In the last six recessions, it takes on average about 33 months. That's almost three years. The Great Recession took us 68 months that it could get from pre recession levels to back to where we are after the recession. Again, it takes a while.
Maria: You've said a little bit on valuations and volatility, but do you want to expand on that? Then what sectors do you think are going to lead the recovery?
Gene: Sure. It's a big question. What's going to lead to recovery? Let's talk about valuations and volatility first. As I mentioned before, valuations are high. If you look at valuation today, we're close to early 2000 levels, and they're a little high. The good news is that valuations can be higher because we have low inflation, and we have very low-interest rates. These are very supportive of stock prices. That's good news, but the problem is that higher valuations are pricing in absolute perfection. You saw this in the markets recently. Any little jitteriness about earnings, about the virus, about uncertainty, you see markets fluctuate dramatically.
Basically, what's going on with the volatility is that markets are trying to price in both headwinds with uncertain points in the economy and the markets going forward and these tailwind, these positives. The market is trying to figure out this whole-- just trying to go through and see what's working, what's not working. It's creating this market volatility. We do see high valuations, but they are justified, but they are pricing in perfection and increasing volatility.
To your second part of your question, which company, which sectors should do well or should lead the recovery? This really ties into the last theme that we've been telling our advisors is that we expect a very shifting investment landscape. Historically speaking, when you have a recession, recessions had consequences. It's led to a different or a change in market leadership. The best example was during the early 2000s. Everyone hated technology because coming out of Y2K, the tech bubble, no one liked technology.
After the Great Recession, because a lot of people lost their jobs unfortunately, companies spent a ton of money to buy technology to really streamline to increase productivity. Technology became a boom. Just like this, we do expect the market to shift after we get out of this recession. First of all, the biggest change we expect is that to go from a very narrowly focused markets, not just the FANG stocks, not just the trillion-dollar club to more of widening market breadth. For example, the S&P 500 today it's up about 5% year to date. If you take the equal-weighted S&P 500, it's down 5%, so it's a very narrowly focused market. We expect market breadth to widen leading the two results.
Number one, we do believe active managers are going to do really well in this environment going forward. Having a widening market breadth is going to benefit those larger firms with vast amounts of investment resources to analyze individual companies. The second point, and I know it's a long answer to your short question. I do apologize, but which sectors are going to do well in this economy? We do expect to see a rotation into more value sectors, especially as the economy continues to recover; financials especially if yields start to move higher, as the yield curve starts to seep, especially financials with exposure to capital markets.
We also like industrials. Whether President Trump or Biden wins the election, both have earmarked money towards infrastructure spending. Also, some supply shape change shifting is going to benefit industrials. Third of all, I know I'm going back on what I said earlier, but we do think technology is going to do well too because the working from home environment has really accelerated tech spend. We think technology will continue to do well. I know I said recessions changed, but technology is still going to be very, very important. From an asset class standpoint, we like small-cap. We like international. We like emerging markets, and again, we also like value.
Maria: With that, let's pivot to fixed income. In a low interest and low inflation environment, what's your outlook for the bond market?
Gene: That's a great question. The biggest debate in the bond market today is-- I think it's kind of funny, but the biggest debate is what is going to cross the 1% level? Either the 10 year Treasury yield or the 30 year Treasury yield? It's a great question because if the economy continues to weaken, you would expect the 30 year Treasury yields to continue to fall to hit that 1% level. If the economy strengthens, the 10 year Treasury yield will likely move past that 1%. I do think it's an interesting to debate. Basically, what's going to happen first?
With that said though, if you look at the bond market, there's some positives. The Fed is acting like a backstop, especially for corporates. They are supporting the corporate bond market. That's good for the bond market. The negative side is that we are in a 40-year bull market for bonds. Bond yields are near historic lows. You think about bond yields today. There's a very poor risk-return profile. We're not saying get out of bonds because you need to allocate bonds based on you or your clients investment objective, but you have to look at bonds with a grain of salt because they have a very poor risk-return profile.
Another negative for bonds right now is just there's too much debt issuance coming from the government to pay for all the stimulus, and this is going to put upward pressure on yields. I think about four weeks ago we saw a 30 year Treasury auction that was really disappointing because buyers weren't buying these treasuries as anticipated, just pushing yields up a little bit higher. The third point is something that we're watching carefully. The dollar is at two-year lows right now. This makes sense. People start to price in potential inflation down the road or increase Treasury issuance. If you're a foreign buyer and you're buying 10-year Treasuries, if I look at my Bloomberg, you're getting about 65 basis points per year for 10 years. If
the dollar falls 5%, which it could easily, 5%, that means a foreign buyer of a Treasury bond is losing about seven to eight years of yield just on a currency move. We do think that's a lot of negative pressure on bond prices which will likely push bond yields higher.
Again, to my original point, even with that said, it's also very important to use bonds as a stability in terms of reducing risk in our portfolios. Again, you do need to allocate some bonds to a portfolio based on you and your client's investment objective.
Maria: To wrap up, what's your advice on portfolio construction and asset classes, and what would you recommend?
Gene: Triple-leveraged cash. Just kidding.
[laughter]
Gene: Just kidding. Sorry. Funny. A bad answer to a good question. How are we positioned today, basically? We run both strategic and tactical portfolios. The strategic is long-term, of course. Tactical is where we are seeing a near-term opportunity. From a tactical positioning, we're neutral to US versus non-US relative to our benchmark. We were underweight international, but early this year around March, we increased our allocations to emerging markets especially as the virus start to clear through China, especially on our expectation of a weaker dollar which benefits emerging markets.
Domestically, for the last two years, three years, we've been overweight growth versus value, but we've been ratcheting that down. Now, we are overweight value versus growth. Slight overweight but still it's an overweight within our portfolios. We're also overweight small-cap and mid-cap. We're a little underweight large-cap. We really have a valuation bias. We like value, and we like small-cap because they're a little cheap relative to their averages. We do believe that especially with PPP, small-caps should start to benefit.
Within the equity, we also have a position in alternative investments. Maria, you and I talked about increasing market volatility. Alternatives are a way to mitigate some of the risks. When the rest of the portfolio is zigging, the alts are definitely zagging, so it's a way to reduce that risk in the portfolio. We have a little position in liquid alts. Then on the fixed income, given our discussion about bond yields likely moving higher and the uncertainty, we do have a below benchmark duration, so we're hedging against rising rates to an extent.
Secondarily, we are biased towards corporates. Going back as I said before, like the adage, don't fight the Fed. The Fed is buying corporates. Get in there. We're buying. We're allocating. We're overweight to corporates. That's our positioning.
Maria: Okay. Thank you for today. Thank you for your time and your insights. I look forward to speaking soon.
Gene: My pleasure. Thank you, Maria. Have a great day.
