Jon MaierAfter a strong four month run to start the year, are US equities ready to keep roaring, or is it time to consider opportunities overseas? In this webinar, TPW Investment Management’s CIO and Co-Founder, Jay Pelosky, and Global X ETF’s CIO, Jon Maier, and Head of Research, Jay Jacobs, discussed their outlook for the remainder of 2019.
The trio discussed a range of topics including:
- The impact of the Fed on US and international markets
- The implications of potentially lower for longer global growth
- Where to find potential opportunities in the US and overseas
- How to evaluate China and the emerging markets
Transcript
Jay Jacobs: Hi, everyone, this is Jay Jacobs. We’re going to get started in just a few minutes here, a couple of minutes past the hour. Stay tuned for the beginning of our webinar.
Alright, hello, everyone. Welcome to today’s webinar, “Where to Find 2nd Half Opportunities,” hosted by Global X, some of our friends from TPW Investment Management. I will pause briefly for some disclosures.
We will jump right into it. My name is Jay Jacobs. I’m the Head of Research & Strategy at Global X EFTs. Joined by two great market investment strategists, investment officers. The first being Jay Pelosky, Co-Founder and CIO of TPW Investment Management.
He has 32 years of buy and sell side experience with close – investing in close to 50 countries, over 15 years of personal capital invested in ETF based global multi-asset investment processes. He launched Pelosky Global Strategies to advise institutions, hedge funds, and RIAs on portfolio strategy and asset allocation. Prior to that, was a Morgan Stanley Strategist and MD where he launched single country and regional funds.
Also joining me today, Jon Maier, CIO of Global X ETFs. He leads the construction of Global X’s model portfolios including the Core Series, Equity Income, and Thematic Disruptors. You can often find him on our blog writing about topics related to market outlooks and investment strategy. Prior to joining Global X, he was a Senior Portfolio Manager at BofAML’s ETF Model Portfolio business.
Some great people on the call today. We’re going to kick it off by turning it over to Jay of TPWIM. He’s going to talk about their investment outlook, particularly their lower for longer growth and the implications it has for major asset classes. Then we’re going to turn it over to Jon to walk through his market outlook. We’re going to do a bit of a round table discussion at the end where we’re going to answer some key questions on people’s minds. With that, I’m going to turn it over to Jay.
Jay Pelosky: Okay, thank you. Excuse me, sorry, a springtime cold. Thanks, Jay. Yes, very excited on behalf of TPW Investment Management to talk about our principal theme at the moment, which is a lower for longer global growth path and what that means for investment implications.
TPW is a relatively new firm. We just celebrated our one-year anniversary. My partner Jamie Gardiner and I have known each other and worked together for six or seven years. We’re very excited about simplifying the complex world of Global Macro investing. To us, we use frameworks, and themes, and of course, ETFs, which are just wonderful instruments for global multi-asset asset allocation. We use those things to simplify the complex world of Global Macro. We do that through three distinct portfolio offerings: our flagship Global Macro Multi-Asset portfolio, our Global Macro Equity portfolio, and our Global Macro Income portfolio.
In terms of our investment approach, we begin with a multiyear horizon, a secular point of view that is original and independent to our firm which we call tri-polar world, which basically argues that regional deepening and regional integration in each of the three main regions of Europe, Asia, and the Americas is going to be the next iteration of globalization. This is a theme and a framework, a thesis that I’ve developed over the last six or seven years. It’s something that in my mind really helps one understand the forces that drive things like Brexit, the disagreements between the US and Mexico over NAFTA, and today obviously very current, the whole trade conflict between China and the US. To us, all this is part and parcel of a process of globalization that is in flux and that is moving towards a world of regional integration in those three main regions.
Underneath that framework, that sector of our framework, we look at things on a 6 to 12-month basis through our Global Risk Nexus scoring system. This focuses on economics, politics, policy, and markets across each of those regions as well as globally and really is a great simplifying tool in that it makes sure that we don’t miss anything, that we cover all our basis, and we can assess how the processes are moving across these different four categories. We do that in a monthly portfolio meeting process, which is replicable, consistent, and allows us again to create and drive portfolio construction in a way that we believe is differentiated from many of our competitors. Then, of course, we look at our portfolios and the markets on a daily, hourly, if not minute by minute basis, particularly in weeks like the last couple.
In terms of what we really want to talk about today is our view that we are in the process of a lower for longer global growth path. This is a great example of how our work, our processes led us to themes such as this because it really grew out of work that we have done since inception on two main economic issues: namely potential growth rates and nuclear rates of interest which are both original inputs to the economic section of our Global Risk Nexus process. In terms of potential growth rates, if you accept this idea that we are in a lower for longer global growth path driven by particularly the developed economies decelerating in most cases to their potential growth rates, then you have a very different way of thinking about markets, and headlines, and news flow for example, particularly I think in the case of Europe.
If you accept the thesis that Europe is decelerating towards its potential growth rate of roughly 1% based on declining demographics and not so great productivity, that’s a very different point of view than what you read in the headlines, and the papers, and Bloomberg, and the FT which is pretty much consistently filled with Europe is about to implode economically. Similarly, in terms of nuclear rates of interest, that understanding this concept and accepting it as a bedrock approach towards how you think about the world, and growth, and rates allows you to have a better understanding as to why rates are not going back to where they have been over the last 20 or 30 years. It’s because the underlying growth profile has changed and such the rate of interest that will keep growth at an even keel without inflation has likewise changed, both of them to lower levels.
In a lower for longer global growth path, one has to then say, okay, let’s say that we accept that thesis. How do we invest in it? What’s the investment process? Here, we have developed something we call the Three-Step Risk Asset Process or RAP. We like to try and keep things – again part of our simplifying approach, keep things simple, keep things focused on three-step processes or three regions, etc.
In the Three-Step Risk Asset Process or RAP, Step One is anticipate. Here we’re talking about markets anticipating what’s happening on the macroeconomic front. In this case, the decline in Q4 and the rebound in Q1 really reflects the change and focus of the Fed from tightening to going on hold and in China with China’s stimulus process.
Step Two is confirmation. You can have a point of view, but you need to have it confirmed. In this case, in this instance, we look for three different confirmation factors: the first economics in terms of data confirmation. We feel we have that in China. We are in process of that in Europe and Germany’s GDP numbers just today. Industrial production, consumptions, labor, wages, all those things give us a sense that Europe is in process of bottoming.
Secondly, we want to see a market confirmation of backups and long bonds in China and in Europe. We feel again we’ve gotten that in China. Obviously not the case in Europe with the bonds now at -10 or 12 basis points. That remains to see that confirmation signal.
Third, policy confirmation. Here the one that’s been top of news of the last week or so, the trade deal between – or the trade fight between China and the US which hopefully will lead to a trade deal. This obviously in our view, and we can talk more about it in the Q&A, either will signal a healthy pullback in risk asset prices over the last week. I think it’s pretty fair to say we were fairly extended in risk assets at the end of April, so timing was pretty good to have a little fright which leads to a pullback which we think could be healthy. Or if we don’t have a trade deal and we have further tariffs let’s say post the supposed Trump and Xi meeting late June, then I think that’s going to be a different environment for global growth, for our thesis, and for risk assets.
In the reallocation process, we start first with equity. We believe that underlying all of this is that we’re on the cusp of a significant shift in equity leadership away from the United States which has been the clear leader since 2009 in the bottom to the rest of the world, and in particular in our view, to the non-US developed markets which we think are poised to take equity leadership. Part of this is because of in the view of a lower for longer global growth path, one is going to want to be allocated to equity markets that offer room for multiple expansion. That is the case for the non-US developed markets.
On the fixed income side, similarly, we want to be invested in instruments that offer yield given that we are unlikely to have a recession since we’re going to have lower for longer growth. We’re unlikely to have significant inflation pressures which would force central banks to tighten rates. Things like US dollar emerging market bet, US high yield, preferred stocks, those types of things are of interest to us in and populates our multi-asset in fixed income portfolios.
To finish up, we’ve talked about equity. We’ve talked about fixed income. We’ve discussed the case of a lower for longer global growth path. We’ve touched on the risk of the – if there’s no deal between China and the United States. We have two other assets that we want to cover: one is currency and the other is commodity. Then we will end our part of the presentation.
In the currency world, it’s pretty amazing the lack of volatility in the G10 currencies, which typically suggests as the chart shows that the dollar is about to make a big move. The question then becomes, in which direction? Our view is going to be lower for a number of reasons including the very large twin deficits that we have, the fact that after years and years of US outperformance, investors are significantly overweight the US, as well as the fact that the dollar is by pretty much common agreement significantly overvalued versus pretty much all the different major currencies. That’s the currency outlook.
Then to finish, if we are correct and we are having a bottoming in global growth, and anticipating weakening of the dollar, that we believe should be pretty constructive environment for commodities including both energy and base metals. It’s worth noting that after years of underperformance, such underperformance that it virtually wiped out the hedge fund commodity players that commodities are performing quite well and actually led the major assets in the first four months of the year. I’ll stop there, and hopefully, if we have a chance to have questions, I’ll be happy to take any questions that might come out of my talk. Thank you very much.
Jay Jacobs: Thank you for that overview, Jay. That’s excellent background on your framework and how you guys are thinking about the overall state of the investment world. Now I’m going to turn it over to Jon Maier, CIO of Global X ETFs to share his market observations on what’s been happening in the first half of 2019 and what to look for the second half.
Jon Maier: Thanks, Jay, and thanks, Jay. Hi, everybody. What I want to do today is talk a little bit about what propelled the markets in Q1 and a little bit beyond and talk about where we’re going in some of the more recent market events and how that’s going to impact the rest of the year.
As we know, the market did pretty well up to May 3rd. The S&P was up about 18%. If you look at why that was the case, it was partly due to the Fed pivot, Fed becoming more dovish, better than expected earning which we found out the end of Q1 obviously, and then the expected deal, the US-China trade deal that was derailed over the past week or so. The market did very well, up 18%. Still up 14+%, pulled back some on the uncertainty about the China trade deal.
The first point would probably be some brief discussion about the Fed. The next move by the Fed, is it going to be an increase or a decrease? Why was the dovish – why was there a dovish pivot? There certainly was some softening of data. The probability of a cut in 2019 has declined since April 30th FOMC meeting. A cut potentially could happen if there’s a recession risk or inflation persistently undershoots, but I don’t think this is a likely scenario.
What is a little bit uncertain is how the Fed is going to react to a trade war. Generally, I don’t believe they are going to cut. I’ll discuss whether I believe that how extended this trade war will be from my perspective. There’s also the point of what would a cut really do with the Fed funds rate being so low already? The Fed may be more effective and potentially increasing the balance sheet on some sort of quantitative easing if they need to go that route.
I just want to move over to earnings. This was a pretty good earnings season. Just a few key points on earnings. We had 2% year over year growth. Overall, Q1 EPS is tracking again about 2%. It’s at about 4% above analyst’s expectations. Sixty-Six percent of companies beat on EPS, 53% beat on sales, and 42 % on both. Healthcare and tech have seen the most beats.
If you listen to the text on the calls, some of the text has been on the negative side and guidance has generally been down. When guidance is down, oftentimes, you can actually get beats because this past serving season, there was a lot of earnings revisions downward. Overall, EPS beat 5% over analyst’s expectations. When expectations are reset, the markets can react positively to that.
If you moved elsewhere in the world regarding earnings, earnings have generally improved. Fifty percent of European firms beat EPS expectations and 54% beat on topline expectations so far this year. Another positive was the April improvement in the one-month global earnings revisions ratio from 0.6 to 0.65. The reason I’m bringing up this number is historically when this ratio is rising, the next 12 months, we’ve seen an – with respect to ACWI, the ACWI was positive 88% of the time with averaging at 13% return, so there’s some positive news there.
In terms of market volatility, we’ve – for the most part this year, volatility has been low to nonexistent except for the past week we’ve seen a meaningful increase in volatility. If you look at the VIX, the VIX went from in the 12 range up to 20 on the 13th of May. It’s dropped back below 17, probably a little bit lower today, so the market has calmed down some. For the most part, trading volume and volatility has been very – has been low for the better part of this year.
Now, on the trade conflict side, here we have a jumpy chart looking at the S&P 500 and all of the news and tweets related to tariffs. I’m not going to go through all tariffs, the machinations of up and down and tit for tat, but in the first four months of this year, the markets benefited from what I would call a trade truce and the expectation that both the US and China, they were nearing an agreement. The re-escalation that happened on the 5th was a surprise to markets. That pulled up at 4% points off return for the S&P.
There’s a little bit of a waiting game. On June 1st, the US likely will increase tariffs on $200 billion of goods to 25%. Then China will have some retaliation on $60 billion of goods. There’s still a chance for that to not occur. I’m not going to guess at this point. It remains to be seen.
Possible scenarios for a China deal. The way I look at it, there’s three possible scenarios. There’s an imminent deal. There’s an escalation of tariffs followed by some brinkmanship and a full-blown trade war.
With the S&P near full-time high, a little bit off, Trump may be willing to accept some sort of pain to extract more concessions from the market from China because there’s some room within; the market’s still up for a few percent. Tariffs are somewhat popular with his base. We anticipate market volatility on both sides as we get closer to June 1st. I just don’t think a full-blown trade war is something that’s likely. If that’s the case, a full-blown trade war would likely pull back the markets, the global markets between 20 and 30%. The machinations back and forth with just an escalation, possibly a 5 to 10% pullback which is not inconsistent with a typical bull market.
In terms of assessing the impact of tariffs on Chinese goods sold in the US, if you look at the global economy, I think a full-blown trade war would reduce global economic growth by about a half a percentage point. In the US, from my perspective, the tariffs are inflationary and it just causes the consumer to pay more for goods, imported goods from China. That certainly could push inflation up. Then that could have some reverberations in terms of how the Fed would react and retaliatory tariffs could impact US exports and GDP overall.
In terms of China, an escalation would shave some growth off of China. In Europe, and there’s been news about this today and the markets are up based on this news today, this escalation in the China-US trade, just war for lack of a better word, could push off auto – increase in auto tariffs or auto tariffs in the US on European cars back. Now, there’s news today that it will be pushed back, the discussion six months. The market reacted positively to that. That’s a positive.
Just to close with this, some positive news, productivity, which is a measure of the labor market’s efficiency has been on a strong upward trend. The first quarter rate is the best we’ve seen in a decade. This is typically associated with the beginning of an economic cycle. That’s positive news. We view the current productivity data as on the US economy +3.6% year over year in the first quarter. This is a bullish signal for both the economy and the equity markets.
Again, it looks like we’ve been spared European auto tariffs for now for six months. The market is reacting positively. I think if Trump does go down the road of tariffs on cars from Europe, there will be retaliatory duties on – by the European Union. That being said, inflation is low. The unemployment rate is very low and productivity is very good.
I’m generally optimistic going forward. I believe there will be some sort of resolution with the US-China trade deal. It’s in everyone’s best interest. It’s not an easy topic. Pat infringement and technology transfer are some of the – and enforcement of those aspects are some of the bigger issues to deal with. Generally, a positive view for the second half of the year. Certainly, more muted returns than the 15% we have so far this year.
Jay Jacobs: Alright, thank you, Jon. This brings us to the third section of our webinar today, which is the round robin. We’re just going to kick it off with a few questions on top of people’s minds and have each person chip in with their answers here. First off the bat, and Jay Pelosky, I have to use people’s last names here, too similar of first names, maybe you can kick us off by answer this first question: investors have been waiting for international stocks to catch up with the US for years and it just hasn’t happened. Is this time different? If so, why might it be different going forward for the international stocks over US?
Jay Pelosky: That’s a great question, Jay. Certainly, at TBW, we hope so because we’re allocated that way. We are overweight non-US equity with a focus on developed markets and underweight US equity. Let’s go back to the top. Maybe, Jay, if I could ask you to put up on one of my slides the Step Three reallocate one, which is the equity one. It really gets to this question.
This chart shows exactly the point of the question. US has been a monster outperformer since the lows in 2009 in large part because of policy actions that the US took which Europe did not take and Japan did not take as aggressively. In the case of the emerging markets, the emerging markets really have suffered from a slower global growth path.
I think to start answering the question with something as an aside, I really think the current environment going forward or the environment going forward for EM broadly is challenging given a low growth global environment and given an environment where technology is really usurping the role of labor in the production or manufacturing function. Which means that capacity to get to the middle-income stage which typically requires a heavy industrialization or least has historically may not be available for the emerging markets going forward. I think that’s a real fundamental question that one has to think about.
Our view is that opportunity outside the United States exists more in the developed markets, so principally Europe and Japan. Let me give you at least three, maybe four reasons why. The first is as I – as we already touched on, in a lower for longer global growth pattern, we want to be in global markets that have room for multiple expansion. Not just earnings growth because earnings growth is most likely going to be muted. Multiple expansion if we go to the next slide, Jay, the chart on the left shows the capacity for multiple expansion in the non-US developed markets versus the US. That’s first: room for multiple expansion.
Second, a similar statement there, very undervalued markets. Third, we believe that growth is bottoming, so the earnings picture which Jon touched on in Europe has been actually quite good. It’s been quite similar to the United States, and yet, sells at a significant discount to the United States. Fourth, and importantly, these markets are extremely under-owned.
Europe, according to Bank of America, was the most hated market in the world. Japan, folks have basically completely forgotten about at least in the public equity side. On the private equity side, and this is interesting because typically private equity is a little bit early, on the private equity side, you’ve had firms like KKR say that Japan is their top priority anywhere in the word. KKR is most focused on the opportunities in Japan in large part because of leadership transitions as family companies sell as well as governance pressures to improve the return on equity, which is improving reasonably in Japan. Doesn’t get a lot of headlines, but the return on equity in Japan has improved materially over the last several years.
Then the last point, I guess point Number Five, is that we do expect the dollar with very similarly to the equity market chart we just looked at, the dollar has had a monster run and is now anywhere from 10 to 15% overvalued versus the other developed currencies. To us, you have in the Non-US markets, you have room for multiple expansion, earnings growth, currency appreciation, and a significant degree of increased interest by offshore investors. All of which would serve to have the next several years be the years where a non-US equity markets lead.
The last thing say is that these moves when they happen, these moves are multiyear. It’s not a quarter, or a month, or even a year. For example, prior to 2008, 2009, the non-US equity markets outperformed for three to four years. When that shift comes, it’s going to be a multiyear shift. We think we’re setting up for it right now.
Jay Jacobs: Excellent; and Jon, same question to you: is this time different? Should people be more excited about international stocks than the US at this point?
Jon Maier: Just because a market has underperformed doesn’t necessarily mean it’s time to jump into that market, but valuations are pretty good internationally relative to the US. That could be a reason to invest internationally. If trade tensions rise further, there could be a pullback to safety and that safety could be brought back to the US.
I think it’s still maybe a little bit early. There’s nothing wrong with being early. To Jay’s point, it’s a multiyear move. I think it’s certainly time to maybe dip a little bit more into the international space.
Jay Jacobs: Got it. Alright, amazing. Jay, if –
Jay Pelosky: Sorry, could I just jump in there.
Jay Jacobs: Go ahead.
Jay Pelosky: I think this is important. Jon, it gets to your point about if the trade tiff or trade arguments get worse. I think it’s really important to understand that if President Trump does what we call the full Monty, the full Monty is the full 25% tariff on all of China’s exports to the United States, all $500 billion. The $300 billion which has no tariffs on it at the moment is primarily technology goods: principally iPhones and laptops. That’s about 90% of the $300 billion just as an FYI.
In our view, if President Trump goes to the full Monty, the biggest sector at risk is US technology. The thing that’s really interesting, and this is not quite a case for the non-US markets, but you had Alibaba report today, for example, you have a very large tech space in Europe – sorry, in China and a very large one in the US. I think you can make an argument that’s really the battleground. The battleground between the US and China is not how much one imports or exports, but it’s who’s going to control technology in years ahead.
Interestingly enough, China’s tech is much more insulated that US tech. US tech is probably the biggest single, most exposed, most overvalued sector in the market when it comes to if we really do go to the full Monty. I think US tech is going to be very exposed. If we’re the safe haven of the US, which is where I just differ with Jon a bit, the safe haven is maybe not going to be the US. It could, in fact, be Europe and Japan, which has very little tech exposure. That’s, of course, hurt them badly in the last 10 years.
Jay Jacobs: Excellent, moving to our second question. Brexit, US-China trade relations, and a host of mayor elections all around the world are contributing to greater uncertainty this year. This is a little bit hot off the press; we commissioned a survey of high net worth investors and asked them is there a strong link between politics and the markets: 64% of them said yes. Yet, we asked them, should you trade more often around political elections in your portfolio; only 12% said yes, 88% mostly disagreed or neutral on that question. Question to you two, with all this political uncertainty around the world, does this introduce more uncertainty into a portfolio? Two, how might this affect portfolio allocations? Jon, maybe I’ll start with you.
Jon Maier: Sure, thanks, Jay. Those are very interesting stats. If you look historically, politics typically don’t move markets over time. What we are seeing in the latest cycle over the past couple of years, different news tweets, whatever, are moving markets. The question is, is that impacting how you’re going to invest and how you’re going to allocate.
I truly believe that you should take a longer-term view of investing. Some of these short-term, the noise that’s going on a short-term basis shouldn’t totally impact how you’re investing for the long-term. That being said, some of these issues are very big right now: US-China trade relations, potentially Europe in the background. I think you’d be errant not to consider some of these facts and how you’re allocating.
From a trading standpoint, I certainly think there are some opportunities to take advantage of some of the news. We’re advocating long-term allocations for clients who have long-term goals. I think it should be taken into consideration to a certain extent in how it’s going to affect certain aspects of markets going forward. In terms of allocations, I really think you have to go back to fundamentals. Fundamentals are the most important aspects of the market. That’s how I view investing.
Jay Jacobs: Jay, same question to you: are politics impacting portfolio allocations in your book?
Jay Pelosky: It’s interesting. One of the things that led us to form TPW Investment Management was our sense that understanding this idea that globalization is evolving into regional deepening and regional integration suggested that there were ways to profit from headlines such as Brexit for example. If you recall, going back to Brexit, when the results were first made public and people first were aware of it, everyone was very bearish on Europe. Europe was a place to not invest in 2016, early 2017. Yet, if you thought about things in the context of regional integration and regional deepening, Brexit was great for Europe in that it really forced the Europeans to think about having to integrate themselves further to protect against more departures such as the Brits. I think the last several years have definitely shown that you do not want to be the Brits in the case of separating from the European Union.
Similarly, if you think about President Trump’s election and his antipathy to Mexico and NAFTA, the peso went from 19 to 22 within a matter of weeks, a couple of months. If you thought about the world in the context of regional integration and understood that the value-added supply chains that crossed between Mexico and the US, you knew that there was virtually no chance that NAFTA would be broken up. Low and behold, you could have bought the peso at 22 and made a very good investment of return.
On things like that, big picture opportunities, we think the tri-polar world framework really serves to – serves us in terms of providing a differentiated point of view which we believe can help in selecting investment opportunities that would alpha. The only other thing I’d say is that tweets, for the most part, are not something you want to trade off of. I would just give you prior to the President’s tweets over the last Sunday, which was a shock to the market in part because of all the prior tweets. You had the Mueller report released and a new all-time high in the S&P on the same week.
Tweets know big action items like NAFTA, President Trump’s election, Brexit, and perhaps the China-US trade argument let’s say. Those are things you can invest. I do think the China deal, whatever comes out of this in the next couple of months will be something that will need to be significantly a part of one’s investment decision-making for the second half of the year.
Jay Jacobs: Alright, Question Three: in 2018, earnings growth in the United States was close to 20%. Jon, you talked about this a little bit earlier; we actually had good earnings in Q1 relative to expectations with +2%, but still a huge slow down from where we were in 2018 at +20%. What does this slowdown in earnings growth mean for investors? Should they be concerned or is this just a short-term blip.
Jon Maier: I think an earnings recession is – would certainly put pressure on valuations. I also think that the benefits of the tax cuts may have not fully filtered through. There’s still share buybacks that are occurring that would show – help earnings. If forward growth is driven by slowing GDP, then this could be more of a concern. We seem to be decelerating pretty quickly from 20% year over year to 2%. While guidance has been revised down and we are seeing earnings beats, I think it’s very likely that at least we’re not too far away from negative growth on earnings.
Jay Jacobs: Jay, what about you? Worried about earnings growth in the US?
Jay Pelosky: I think the likelihood of an earnings recession, so call it two quarters of negative year over year earnings growth is quite unlikely. We’re going to have positive growth here in Q1. It looks as if from EPS revisions work that revisions are turning up for the second half of the year. Not only by the way in the United States but pretty much across the global earning revisions are turning up. That’s something that we’re going to want to continue to see and see how the trade anxiety, see if that impacts those positive revisions.
The point I would want to make is that US EPS growth last year was an anomaly. It was driven primarily by tax cuts which are as Jon mentioned fading out. Going forward, the US is not going to have that big earnings grow vis-à-vis the rest of the world. The other factor obviously is technology, which is 25 to 30% of the US equity market depending on how you want to take it adding in communications and consumer discretionary, etc. The rest of the world doesn’t have that.
The interesting thing about earnings growth going forward is that tech EPS for 2019 is basically flat, plus or minus. I’m not sure what the most recent data is, but for 2019, tech sector earnings growth in the US is projected to be + or – 1 or 2%. When you take that earnings growth out, then the US looks a lot more like the rest of the world. I would definitely support Jon’s point about buybacks. Buybacks have been a huge factor in driving earnings for shared growth in the United States vis-à-vis the rest of the world.
Going forward, that too is likely to become less of a differentiator in the US favor in part because buybacks have already been so significant in the US and in part because others are starting to copy the US. You’re seeing buyback announcements and dividend announcements in Japan and in Europe to a much greater extent than you have seen previously relative to their own experience, but still well below that of the United States. There’s room in fact for buybacks to increase in the other parts of the world; much less so in the United States.
To me, the issue is, okay, what am I paying for earnings in different parts of the world? Then what is the outlook for those earnings? As we said before, a big part of our investment thesis in equities in a lower for longer global growth path, which we think is the path for the next several years, we want to be in places where there’s room for multiple expansion. The US at 18 times forward earnings has virtually no room for multiple expansion. Europe has 12 to 13 times; Japan at 12 to 13 times. Parts of the emerging markets have room for multiple expansion.
Jay Jacobs: Now, Jay, you mentioned a little bit about tech stocks and the fact that earnings are roughly flat this year. Yet, until just maybe last week, they’ve been flying pretty high. How should investors consider maybe approaching technology for the rest of 1019?
Jay Pelosky: Yeah, I think that’s a key question to Jon. I’m not sure I’ve done the best job of it. There’s probably many other people who’ve been much more right. It is amazing that tech led last year in the whole planning thing, and then collapsed in epic fashion in Q4, and then came right back stronger almost than ever. It’s almost like something rising from the dead.
Going forward as I said, to me, tech is – the US tech on a strategic multiyear basis is very much at risk to this ebbing globalization process. Tech in the US is valued as a global – as a beneficiary of a global supply chain. That global supply chain is breaking down. If President Trump has his way, it will break down completely. Secondly, US tech is based on a global consumer base; IE customers can be all around the world. That is being called into question in part by China wanting to have much more control over its internet, in part by Europe which doesn’t really have a dog in the tech fight, but is serving as a third-party regulator which everyone is going to agree with because everybody wants to be on the good side of Europe to get access to those 600 million or so eyeballs.
You have in our view what we term splinternet. The internet is splintering into multiple internets. Certainly, there’s a China internet which by the way is rapidly expanding throughout Asia. If you look at Alibaba’s results today, for example, they have now 23% or so of the Pan Asian cloud market. Amazon has gone from 15% or so several years ago to 11%. This is the battleground.
The China tech companies have – are much better insulated as I think I mentioned earlier in my comments. They’re much more domestic and going into Asia. Tech is becoming a driver to the regional deepening thesis that underpins our whole tri-polar world framework. The US tech is most exposed to these big trends which are going against it.
To me, I think tech strategically is not very attractive. Tech in the US, parts of it are attractive: cloud, etc. There are pieces. The good news about ETFs is that increasingly you can slice and dice big huge sectors like technology to get more refined exposure as well as of course being able to buy Asian tech or China tech as well directly and easily through ETFs. That’s the beauty of it. You can make those targeted investment decisions using beautiful vehicles like ETFs.
To me, I think tech is a challenge. It’s one of the reasons why we’re not all that keen on the US. We think if the trade fight becomes even worse, technology is most exposed and stands out like a sore thumb if the full Monty 25% tariffs on the full $500 billion, I think tech would be very – tech earnings and tech stock prices would be very negatively affected.
The last thing I’d say, sorry, Jay, the last thing I’d is to me it’s amazing people talk about a bubble in public markets. It seems to me with Lift and Uber that the bubble has been in the private sector, the private markets. It’s amazing to think about in Uber, and this is somewhat tech related, Uber – everyone who invested in Uber after 2015 has lost money; pretty amazing.
Jay Jacobs: Yeah, no, those are really interesting insights. What I’ve observed a little bit is you have this GICS reclassification that really split technology into half what I almost consider older-school tech which includes a lot of hardware companies and companies that are almost like consumer goods like Apple and communication services which is really more of a new-age software side of technology like social media companies and search engines. Yet, overall, I think the market has not fully digested that split yet. When we talk about technology, I think people are really thinking about both. The drivers are going to be very different.
We’ve looked at social media companies very closely. That’s really been one of the fastest revenue growth areas of the market over the last year, over 20% revenue growth. There are certainly technology platforms, but what drives that forward? It’s greater internet penetration, but it’s really a lot of consumer themes: people spending more time on their phones, people shopping online, people consuming tons and tons of ads via Twitter, and Facebook, or whatever you use around the world. I think it is interesting that there are these pockets within technology that I think are not going to be as affected by these trade wars that are much more consumer-led trends going forward.
Jon, curious to get your thoughts on the technology space. Again, flying very high in 2019 until recently. How do you think investors should consider approaching this sector or sectors?
Jon Maier: I’m sitting listening to the two Jay’s talking about technology and going pretty deep into technology. That just brings home a thought to me that technology is the future. Everything that we do is related to technology. To Jay Jacobs’ point about the reclassification of the communication services telecom sector, technology is being looked at in different, more segmented way.
I think technology as a whole is deeply cyclical with very long cycles. It’s very important obviously to our day to day. It’s something that’s part of everything that we do. Whether it be AI or other disruptive technologies, it will drive improvements in productivity. There will be certain periods of time where valuations are high in certain areas. It’s an area that’s unavoidable.
At times, you should bring up and down the allocation some. Generally, I would expect an overweight for most periods of time. Again, I think it’s a cyclical sector, but the cyclicality is really very long for technology.
Jay Jacobs: Alright, that brings us to our last question today. Doing well staying on time here. With a flat yield curve and tight credit spreads, where should investors look for yield in an income-oriented portfolio? Jay, we’ll kick it over to you.
Jay Pelosky: Wow, that’s a great question. As we touched on in our – maybe you can just bring up that slide, Jay. It’s that valuation slide and the fixed income slide. There you go, perfect. Look at that, nope. There you go, perfect.
Here we talk about fixed income. These are things that we like in a lower to longer growth world, which will mean lower interest rates, which means the yield plays we believe will continue to be sought after. The search for yield has now been going on for six, seven, eight years. We think it’s going to continue.
We like things like US dollar EM debt. We think that’s quite attractive. Basically, trades similarly to the 10-year US Treasury but yet offers several hundred basis points of pick-up in an environment where the emerging economies are in relatively decent shape.
We also like US high yield. This is controversial. We’ve had an overweight in US high yields in our Global Macro Income portfolio for most of the past year. Rode it through with some trimming and edging in Q4 and happy we did in Q1. Our basic view is that in an economy that’s relatively healthy where we’re not going into recession, where default rates are going to remain low, where there’s no big repayment mountain and a high yield repayment is pushed out to 2020, 2021, 2022, that you can put coupons in that high yield space.
Days like yesterday when the S&P is down 2.5% or two days ago, US high yield is going to be down for sure. That was a painful day. Over time, we think that high yield is going to continue to return the 5.5% yield give or take and has room for some capital appreciation.
Then finally, we like things like preferred stocks. Very keen on preferreds; they offer a very nice yield. They have very low volatility. We think they’re an absolutely great place to be. They’re a key part of our portfolio in both our multi-asset and our income portfolios.
We also like things like MLPs, REITs, things of that nature. We’re pretty willing to be fairly eclectic in looking at yield opportunities across the different segments of the fixed income and semi-quasi fixed income space both in the US and I’d say abroad. For example, we also have a position in European high yield at the current moment. I’ve had things like China debt and others’ EM local currency debt at different points and time in our portfolios. To us, the bottom line is a lower for longer global growth path means yield – search for yield is going to continue. You can participate in those yield plays without having to worry about inflation, and central banks coming into play, or recessions, and default rates, etc. rising.
Jay Jacobs: Excellent; Jon, last question of the day: with the flat yield curve and tight growth spreads, where are you looking for yield in an income-oriented portfolio?
Jon Maier: That’s a tough one. Everyone’s always looking for yield. I think currently there should be somewhat of a focus on quality and not just trying to necessarily maximize your overall yields. I do think there are some opportunities in the equity income space. I echo Jay’s thoughts on preferreds. I think preferreds have very low credit risk, and while they’re not technically a fixed income, they provide a very solid yield. Some could argue that they are a little expensive right now, but I would argue that they have stayed – they’re going to stay somewhat expensive. The yield is strong. The credit is good.
Your options are somewhat limited. They’ve been limited for a long time because of rates being so low. High-quality dividends, equity income, preferreds, MLPs, all good places.
Jay Jacobs: Excellent; well with that, thank you, Jay Pelosky from TPWIM. Everyone can read his research at tpwim.com including his Friday Musings which I always enjoy. Jon Maier, CIO of Global X, you can also read his insights at globalxfunds.com/research. Thank you, everyone, for joining today. Hope to speak again soon.
Jay Pelosky: Thanks, guys.
Jon Maier: Thanks, Jay.