Bernstein hosted a webinar with some of our leading investment professionals from our Investment Strategy, Economics, US Equity, International Equity, Fixed Income, and Tactical Asset Allocation teams to discuss what 2021 might look like for the global economy and markets. When will the pandemic end, how will the economy recover, and is there a bubble in everything? These are some of the questions we consider as we look at 2021.
00:01 - 00:36
Hi, everybody, and welcome to The Pulse, where we cover trends in the economy, markets, and asset allocation for long-term investors. I'm Matt Palazzolo and to kick off 2021, we hosted a webinar featuring many of AllianceBernstein's top minds on the markets to share their outlooks for the year. This webinar took place on Thursday, January 14th, and their views are our latest up to that day. Our Co-heads of investment strategy, Beata Kirr and Alex Chaloff, led several of our senior investment professionals in a discussion of their perspectives on the global economy and a range of asset classes.
00:37 - 00:49
Beata kicked off the conversation with the latest update on the vaccine rollout and Bernstein researchers' biopharma sector teams' most recent estimate for the timeline to get COVID-19 under control.
00:50 - 01:17
I think we all have to acknowledge the incredible outcome that science has had to get us here. When we had webinars and we're having discussions in the first quarter, even the second quarter of last year, it felt improbable at that time that we could be discussing the rollout of potentially five vaccines with high efficacy on a global basis in the first half of 2021.
01:18 - 01:51
And that is indeed what we are doing. Scientists solved incredibly complex problems to get us here. And what we see is that we all acknowledge that the rollout has been slow in the beginning and that's to be expected. Logistics and operational challenges are high, really across the supply chain, from production to manufacturing to distribution. But even with those logistic challenges that we've already seen, what we expect is 200 million vaccinations by the end of May in the US.
01:51 - 02:25
That already takes into account multiple vaccine providers, including the J&J vaccine, which we've just recently seen, really high efficacy with a one-dose version. What does this mean for COVID? Well, in our base case scenario, what it means is that we'll likely see cases peaking in mid to late February and substantial case decline as a result after that. And that will be due to a combination of the vaccine as well as, frankly, how many people have unfortunately already had COVID.
02:25 - 02:31
Now there is that downside case and what B.1.1.7 prevalence, R not equals 4,
02:31 - 03:02
translates to is that that is the new strain that is much more infectious. So that is an infection rate that is substantially higher than the current most predominant strain. So that's something we have to keep our eyes on and we're going to see real data around that and vaccine efficacy being tested with that strain effectively in coming weeks. Building from the baseline of a weak first half of 2021, followed by a stronger second half of the year enabled by the vaccine rollout,
03:02 - 03:35
our chief US economist, Eric Winograd, weighed in with his views on the economic recovery. We are working with the assumption within the economics team as we do our forecasting, that we'll be able to divide this year roughly into two halves, the pre-COVID half, or the current COVID half, and the post-COVID half. Our hope, which I know all of you share, is that the second half is a lot longer than the first, and then we get there sooner than later. But we're working with the assumption roughly laid out in your slides. And what I think you see is a pretty optimistic forecast, right?
03:35 - 04:03
We are talking about an environment in which those sectors of the economy that have been most impaired, travel, leisure, and some of the high-touch service industries in particular, should be able to reopen; an environment in which households and consumers have robust savings built up as a result of the stimulus programs from last year, and where the extension of stimulus programs agreed to by Congress and the outgoing administration late last year should provide even a little bit more fuel.
04:04 - 04:21
I would point out also that President-Elect Biden is planning an address tonight to talk about the possibility of even more stimulus. So we're talking about an economy that, if it is allowed to open and if people are allowed to resume something approaching normal life, has the possibility of growing quite robustly.
04:21 - 04:41
And we're forecasting, I'm forecasting growth for the US this year of close to 5 percent already. If we assume that additional stimulus passes, if the things that the President-Elect Biden talks about tonight come to pass, then there is some upside risk to that. So we really could be growing quite rapidly, particularly by the second half of the year.
04:42 - 05:16
The discussion of the economy's growth prospects and stimulus led to Eric's views on inflation and interest rates. And so the Fed, in order to reinforce the credibility of their target, is trying to push inflation up above it. Now their target is 2 percent. I would observe that they have discussed the idea of trying to run inflation closer to 2.5 percent in an effort to make it average 2 percent. Right. They want an average of 2 percent, meaning that if we know during the crisis or during poor economic periods inflation will be below 2,
05:16 - 05:20
it follows that it must be above 2 when times are good.
05:20 - 05:50
And so I think that even though we are forecasting robust growth this year, even with the forecast for 5 percent and some upside risk around that, even with the economy regaining significant momentum, the Fed is still not going to raise interest rates. And in fact, I doubt that they will even pull back on quantitative easing. I think the Fed is going to stay very easy for a very long time to come. We should expect policy rate, the policy rate to be close to zero for several more years. And we should expect the Fed's balance sheet to continue to expand.
05:50 - 06:21
One of the preconditions for that will be to see if the inflation expectations series measured here move back to and sustainably stay at around 2.5 percent. And as you can see, we still have quite a long way to go. Eric also weighed in on the market's fears of another taper tantrum similar to that one experienced after the global financial crisis as the markets seized up when the Fed discussed pulling back on some of its stimulus efforts. We think this is definitely going to be an issue that the market comes back to at some point, either in 2021 or the next couple of years.
06:22 - 06:55
I think Chair Powell wanted to emphasize that when they are considering doing that, we will get clear communication from him or from an official FOMC statement. It won't come from just some random policy speech on a Tuesday morning. So they're really going to be very measured about how they do it and they're going to try very hard to avoid the mistake that they made in May of 2013, you'll recall what's now called the taper tantrum, where Chairman Bernanke discussed possibly reducing the pace of purchases at a time when the market wasn't expecting it.
06:55 - 07:13
It caused yields to move up very sharply in a way that was, that was disorderly and that caused some economic disruption. So the Fed has learned from that experience. They're going to give us a lot of runway on this and they're going to communicate as clearly as they can to prevent this process from being disruptive. And that's what Chair Powell was telling us.
07:13 - 07:30
Matt Norton, the Co-head of our municipal bond portfolios, discussed the outlook in that space, highlighting both how municipal bonds perform in rising rate environments and the scope for active management to find the most attractive investment opportunities in that specific market.
07:30 - 08:02
Municipal investors look at the after-tax Treasury yield movement, so muni yields move a lot less than Treasury yields because they move on an after-tax basis. So historically, when Treasury rates have gone up, munis have done better than Treasuries and other fixed income asset classes. And even when you project out from today's low yield levels, even if Treasury rates go up to 145, but even if they go to 150 or higher, you're still having positive returns and you're still significantly outperforming cash.
08:02 - 08:11
Additionally, as active managers, we can find bonds that even outperform just the generic bond. Right? There's going to be a lot of money flowing to state and local governments.
08:12 - 08:44
There's some undervalued bonds in A and BBB part of the market. If you can find bonds that get upgraded, you can do even better than these numbers. And so actively managing a portfolio and investing in an asset class that should hold its value and outperform cash in a rising rate environment is certainly something that we expect to happen for munis. Speaking of bonds, our other Co-head of investment strategy, Alex Chaloff, highlighted the role of bonds in a portfolio and the challenges which bonds are facing with yields as low as they are today.
08:45 - 09:01
We'll have more to say on this in coming months. But he highlighted how investors may have to be more creative or may have to more explicitly trade off one of the desirable attributes of bonds for another desirable attribute. Bonds in a normal market really have two jobs.
09:01 - 09:30
They need to produce income and they need to provide stability. They produce a cash flow and they offset equities during tough stock markets. And when you don't have a healthy yield, it's really hard to offset equity risk. So we are building a solution that provides more yield, more spendable yield. We are basically recreating what a bond used to be, an old fashioned bond, and whether that means a yield of 3 percent or 4 percent or 5 percent.
09:30 - 09:53
We're not there yet. We're still working through the final mechanics. But I would just say, there's no such thing as a free lunch. Whatever you want to do to produce more yield means you're taking on more risk. But, and a big but, there are some things you can do to provide specific protections around the risks that you might be taking just to drive more yield.
09:53 - 10:25
One of our leading equity portfolio managers, Shri Singhvi, mapped out the path for companies' earnings to rebound sharply in 2021 and 2022. This is one of the major points surrounding our generally positive view on stocks, despite valuations appearing high at first glance. In addition, it's one way in which we're distinguishing between sectors and within companies whose stocks we're investing in. In order to understand how can we get such strong earnings
10:25 - 10:50
on the other side, we have to understand what happened during the pandemic. In 2020, as sales dropped roughly about 5 percent for the S&P 500 companies, it took companies some time to take that costs down. So their earnings were down 15 percent. But now companies have really reduced their cost structure. And what that means is, as the recovery happens, post-COVID,
10:50 - 11:25
and with fiscal stimulus, the strong operating leverage that these companies can see on the upside in 2021 and 2022 can really surprise us on the upside. And one final nuance I do want to make is, the decline in earnings that we saw in 2020 were not uniform across companies. Technology and healthcare companies, their earnings grew actually somewhere around 6 to 7 percent. Whereas more cyclical sectors like energy and industrials, their earnings were down 50 percent. Financials were down 25 percent.
11:26 - 11:55
So as we think about the earnings growth in 2021 and 2022, you're going to see this coil spring effect for some of the sectors with particularly strong earnings growth. Stuart Ray, who oversees much of our international stock exposure, highlighted the differential in valuations and growth prospects for companies overseas and why US investors should pay attention to them. It's true that equity markets in general are looking forward to better earnings growth in 2021.
11:55 - 12:07
But international markets, particularly Europe, went through a deeper dip last year. So the dip, it did means more potential for recovery. So we expect a higher earnings growth figure in international going forward.
12:08 - 12:27
And coupled with that, it comes with a cheaper valuation. So that re-rating in the US in recent years has widened the gap between the valuation for the US market and international markets. It's true that the US does tend to trade a bit more expensive than international markets, but that gap is significantly wider than average. So that presents a valuation opportunity.
12:28 - 13:02
After a year like 2020, risk management is at the forefront of everybody's minds. So it may surprise you that our tactical risk management overlay has actually been overweight to stocks in recent months. And so to explain why, Brian Brugman from our Dynamic Asset Allocation Team offered his perspective on how they're blending exposures across different asset classes in search of the right balance for today's markets. We've seen elevated return potential from equities, and as a result, as you mentioned, Beata, we've been modestly overweight to return seeking assets like equities which have benefited performance.
13:03 - 13:23
Looking ahead, we continue to see above-average return potential from equity markets, supportive monetary policy, fiscal stimulus, and improving growth later in 2021, as well as the COVID vaccine rollout will likely drive equity returns that are above average, though not nearly as strong as what we saw in the latter half of 2020.
13:23 - 13:52
As a result of this, we're modestly overweight returns seeking assets, diversifying this exposure across the US and international markets. We're also underweight some risk mitigating assets like bonds due to the low level of yields, but have extended the maturity of bonds that we hold in order to increase their income and defensive potential. Finally, Beata, we've shifted some of our defensive allocations to other risk mitigating assets such as safe-haven currencies like the Japanese yen.
13:52 - 14:23
Brian also weighed in on the critical question of valuation in the market. While price-to-earnings multiples and other metrics look high, once you adjust them for the level of interest rates and expected returns in other asset classes, stocks actually don't look overpriced. We've done a great deal of research to try and understand what measures of valuation are effective at assessing the market's return and risk environment going forward. Earnings multiples are one measure you often hear mentioned as a valuation measure for the broad equity market.
14:23 - 14:42
Today, that yield is near its all-time low, lower than before the GFC, indicating that equity markets by this single measure are expensive. Importantly, however, though, what we found is that looking at simple measures like earnings yield alone aren't effective over time at managing return or risk.
14:42 - 15:02
The reason for this is that it doesn't consider how the rest of capital markets are priced. It doesn't include healthy alternatives to equity like bonds or cash and how those are valued. Our research has shown that because this includes the perspective of how these alternatives to equity are priced, this measure is much better at identifying when valuations are stretched,
15:02 - 15:27
risks are high, and equity markets are fragile. Today, as we look at the equity markets and in particular valuations measured this way, we see that markets have certainly repriced very meaningfully from the COVID lows, but they continue to offer a meaningful amount of excess yield, more than we had in 2017 to 2019, when returns were very strong and well before that of the global financial crisis in 2008.
15:27 - 15:33
So thank you all for listening. I hope that these insights from across our investment team are of particular interest to you today.
15:33 - 16:08
For more of our views for 2021, check out the link to our blog, which we call Context, in this episode's description. If you've enjoyed this podcast, please subscribe and rate us on Apple Podcasts, or Google Play, or wherever you listen to podcasts. Also, e-mail us your thoughts, or questions, or any feedback that you might have to insights@Bernstein.com, and be sure to find us on Instagram and on Twitter at BernsteinPWM. As 2021 gets rolling, please stay tuned to The Pulse for more of our views on what's shaping the economy and moving the markets.
16:08 - 16:20
And as always, be well. Bernstein: Making money meaningful for individuals, families, and foundations for over 50 years. Visit us at Bernstein.com.
- Matthew D. Palazzolo
- Senior National Director, Investment Insights—Investment Strategy Group