2017 Stock Market Outlook: A Mid-Year Analysis

Steve Pomeranz: Well, it’s August and time for mid-year analysis as well as perhaps a little crystal ball thinking. Tushar Yadava, Vice President in the iShares Americas Capital Markets Research and Content team, joins me today to look at the current investment advice, environment, and kind of give us an idea what BlackRock is thinking.

Tushar, welcome to the show.

Tushar Yadava: Thanks for having me, sir.

Steve Pomeranz: All right, so we’ve had a very interesting first half of 2017. We’ve had markets rising; we’ve had US markets, international markets rising. We’ve had below average volatility. One of the key things that investors seem to be worrying about right now…

Tushar Yadava: Sure.

Steve Pomeranz: …is the current length of the cycle of the expansion in the US markets and the US economy. So, my question really is, it’s been a long time, it’s been an eight-year expansion, and there are feelings that it may be ready to die of old age.

What is BlackRock’s view of the remaining lifespan of this bull run?

Tushar Yadava: We’re actually quite positive that the run has longer to go. And I think there ar a couple of components there. The first is the market side, depending when you look at equities, especially in the US and globally.

We continue to sort of emphasize the fact bull markets don’t die of old age; they die because of, generally, because of recessions. And so, that brings up the economic point of view. And I think you rightly sort of say this economic cycle has been a little longer than previous ones we’ve experienced.

But I think if you think back to the other ones we’ve experienced in history, you could say that they have been a bit faster, and this one’s been a very slow, very gradual grind as we sort of recovered out of one of the worst recessions in modern memory.

And we are now starting to move along, but the pace isn’t overreaching itself, it’s continuing in this slow grind with pretty little variability in between it, and as we look at it in that context, the length of this cycle is kind of irrelevant. I think the pace and what’s left in it is what’s important to investors, and we won’t miss it getting away from us at the moment, and we don’t think that we are at a point where we’re close to potential output in the economy or even beyond it at a peak.

Steve Pomeranz: Interesting.

Tushar Yadava: And so, that’s a good sign overall.

Steve Pomeranz: Okay, well, the first most worrisome words when you’re in a long-term bull market is this time is different. I’m sure you’ve heard that before, the idea that we’re in a new dawn, it’s a new day, a new paradigm and so on, so, Tushar, is this time different?

Tushar Yadava: Well, [LAUGH] there’s always sort of equal measures of caution and insight from phrases that are that are incredibly reductive but that are incredibly insightful. And I think the important point to remember is, obviously, each economic cycle’s going to be different from the other. It’s going to be different than the 1950s; it’s going to be different than the dot-com era or the pre-financial crisis from the housing bubble.

So, there are differences in the cycle, in that respect. I think the insight that you can gain from it is, well, what’s caused cycles to end in the past? And that’s maybe over-leveraging, maybe a paradigm shift as you noted that causes investors to pay drastic amounts more for the same sort of economic value that they’ve been getting in the past, and while there are some signs of that, we don’t see anything that’s gotten, you know, “over its skis.”

And so there is cause for concern in maybe one or two little pockets, but those are well identified by the market, and we think that overall the health of the economy isn’t a risk from those areas.

Steve Pomeranz: All right, well let’s talk about volatility. Volatility has been very very low, almost historically low.

And some investors worry if this is not the calm before the storm. What do you say?

Tushar Yadava: Yeah, I’ll try and tell you that now, volatility is a lead indicator of nothing other than TV ratings and financial press readership. Because it is a symptom, it is a coincident indicator, and it’s something that we should just look at it in that respect alone.

And we have done a lot of work on volatility this summer because when we started our year ahead outlook it was all quite bullish. It was a decently rosy picture. Not much had changed for us actually. A lot of it’s come through. As you noted at the start, the stock indices everywhere are much higher.

But all we tend to hear from client meetings in our interactions is a lot of concern and a lot of complaining. And so, I think we spend a lot of time focusing on where those pain points are. And volatility’s one. And I think if you give me a minute here, I’ll give you the a-ha I think of our research and the big take away, is, for us, it’s not this mean reverting concept.

It doesn’t have a simple equilibrium that it’s gravitationally sort of pulled back to. If you think about it over time, it’s much more regime dependent. And our research has shown when you are in a low volatility regime, which we have been in for over 80% of the time since the 1870’s, it’s incredibly persistent and the likelihood of switching to a higher volatility regime is actually very, very low, and it’s driven by the economy.

So, when we looked at economic volatility, which, as I mentioned at the start, we’re really just not seeing. The likelihood that low volatility is some sort of warning signal, and it’s the calm before the storm, and you’re seeing all these animals rush for the shelters—it’s just not happening.

And I think that’s the big takeaway here is that low volatility is reflecting the fact that the economy is actually quite healthy and has very low volatility itself. And so, the stocks in the sort of option indexes are just pricing that.

Steve Pomeranz: Okay, well, I think that’s an understandable answer.

I think when you use the term regime you’re really kind of talking about the trend or kind of the state of the environment at this time, and I think, if I’m understanding you correctly, you’re basically saying that these so-called regimes tend to last a long time and they’re…today they’re based on the fact that economies are more stable.

They’re not over-heating, there’s not over-inflation, there’s not a lot of these problems that can afflict an economy. So low inflation, low-interest rates, a slow growing economy would lead to lower volatility and that’s not necessarily a bad thing. A lot of my people I speak to ask me firstly when they come in—I’m an investment advisor—and they say, “what about politics, across the world and especially right now in the United States? What about the political regime?” Let’s use that word in its historical context.

Tushar Yadava: [LAUGH]

Steve Pomeranz: What do you think the effect is of the government on the economy and, therefore, on our investments.

Tushar Yadava: Yeah, it’s a great question; it’s one that continues to come up, and we know it’s on investors’ minds. I think there are two things you can really look at here. You can look at what you can price in the future as likely to happen or happening, and there’s what you can’t price.

And I think the environment today is a lot of the latter, right.? We don’t know any firm details on tax reform. We don’t know any firm details on first health care before you can even get to tax reform in the U.S. So, it’s tough to reflect that in the way you price a stock or, if you think about it, a series of cash flows.

And then there’s the bigger geopolitics and the bigger concern about what if country x and country y begin to accelerate their dispute and getting into either a trade war, a real war. These are things, while you can see and it’s maybe driving some concerns which help to keep yields low in safe instruments and helps to keep safe havens like FX and gold continuing to be popular, it’s not at a level where we think that markets are overly concerned. Now that could dramatically change when that takes us to the former, where you can actually start to price what the outcome is. We just don’t see that happening at the moment and markets aren’t reflecting that either.

Steve Pomeranz: Do you see any case for gold in the current situation right now with North Korea?

Tushar Yadava: Gold is something that in any commodity that gives you a diversification benefit in a portfolio, is something that we like. We think about portfolios and asset allocation from a strategic point of view.

So, I’m holding it for long periods of time. And each instrument that I’m holding, or asset class I’m adding has a purpose to an overall goal. And, in that context, gold is a great diversifier. And we think that holding gold and other diversifiers from the majority of your holdings, which are traditionally stocks and bonds, is always a good idea.

Tactically, as an investment—I think this is going to rapidly appreciate or not—we haven’t seen gold dramatically rise as a result of tensions in Asia, for example. And what we’ve seen, which is a bigger sort of market fundamental driver, is the real rate environment in the US has changed because rates are moving higher and the pricing of inflation is starting to come back again.

And in those environments gold historically doesn’t do fantastic as a taxable investment, and I think that’s the message you need to sort of hold on to is, if you’re making a tactical bet, you need to have a driver. We don’t see the drivers being particularly strong at the moment for it.

But from a strategic point of view, why do I hold it in a portfolio? It’s among a list of really good diversifiers that you can add to a portfolio.

Steve Pomeranz: Okay, my guest is Tushar Yadava, he’s Vice President in the iShares Americas Capital Markets Research and Content team.

And we’re talking about, this year, we’re talking about investing, trying to earn a decent return on your money, trying to figure out what may happen in the near future and how to diversify. So, Tushar, we have seen foreign markets, I mean, obviously, we’re US based, so everybody else are foreigners, but…

Tushar Yadava: Right.

Steve Pomeranz: We’ve seen foreign markets significantly outperform US stocks this year, almost to the tune of twice the rate of return. When we look overseas, we look at developed markets, France, Germany, Japan and those kinds of country and then we look at emerging markets as well.

Give us a sense of what’s going on overseas. Give us a sense of, perhaps, relative valuations to the US and, perhaps, what you see going forward.

Tushar Yadava: Yeah, and for us, this picture is quite easy to paint. And I’ll talk about foreign markets, but ignore the accent for a moment.

So, what I will say is when we look at the world and when we look at global growth, we see it currently accelerating and in the moment of a sustained global expansion and we see it actually being a little underpriced by the market. And so, when that happens, we look at it and we say, “well, what are the areas that are most sensitive to an uptick in global growth and what are the asset classes that would be most sensitive to pricing higher global growth?”

And in each of those instances, the answers come back, “well, the emerging markets, Japan and Europe.” And then when we look at these stock markets and we say, “well, all right, what is the valuations telling us?”

Again, these are more reasonably valued markets that are moving based on good earnings, so good corporate performance, rather than just paying higher for a dollar of earnings, which has been a very big driver in the US here today. So, when we look at all of those, right, the answer’s sort of very easily comes back to Japan, emerging markets in Europe.

And then the last thing is the performance of the US dollar has surprised a lot of people actually this year in weakening, and that could be in part because global trade has been a lot stronger, so money flows have been reflecting that, flowing away and the dollar has been weakening.

And as a result of that in a good global trade environment, again, these are the nations, they’re current account exporters, right? So, they’re net exporters to the world that will benefit in that environment. So, the picture’s been quite rosy, the earnings picture’s been quite rosy as a result of it.

And when you add that all together, it’s a compelling argument to be looking at international investments, especially for the US because we tend to have a very strong home country bias in this country.

Steve Pomeranz: Very, very strong. You deal with countries and clients overseas. What is their bias like?

I know again, we love our home team here. How do they view the US and view their markets?

Tushar Yadava: Well, everyone has, and when I talk to my students, and actually, I can tell you everyone has a home country bias. I think the post-crisis era has been such a reflection of how the policy response was that you saw the US act first and boldest in a lot of ways.

And that’s dictated, I think, a lot of the way that policy has run globally afterward. And as a result of that, I think, when markets and foreign investors look at their own markets, they have their own home country biases as well. In Europe, they’re much more bond and dividend and value oriented, and they are, with the stock market culture, you could argue, in Japan, again they’re much more aligned to safe haven instruments. These biases sort of add up a little bit, but what we tend to see is—when they view this market, the US—it’s very much the leader in how policy is dictating globally in terms of monetary policy and what central banks are doing and also where they might take their cue from because the marginal dollar at risk is generally sort of flowing in this market here in the US.

Steve Pomeranz: A lot of money has been flowing overseas this year, billions and billions of dollars. Do you see that as continuing? Do you continue to see the continued outperformance of foreign markets versus the US, do you have an opinion on that?

Tushar Yadava: Yeah, we absolutely do for the second half of this year and that’s something we detail in our outlook again. I think what’s interesting to note here is—I’ll take the example of the emerging markets, but it’s certainly true for Europe and Japan as well—is that we’re still quite some distance off of what we would call the peak investment into sort of these foreign holdings.

So, emerging markets is just the example I used because it’s such a clear example. They peaked in terms of the fund assets, so [INAUDIBLE] tracking mutual funds and ETS tracking, emerging market instruments. That peaked in 2013, we’re still about $190 billion off of that peak. And that’s ignoring the growth in portfolios and the growth in assets over that period of time which could make it even greater.

So, it shows that the investors still haven’t returned to these international markets, and there is still some sort of gap to close, even though we’ve had such strong flows this year.

Steve Pomeranz: So, you see a strong possibility that those numbers will continue to rise and that foreign markets will do well.

Unfortunately, we are out of time, my guest Tushar Yadava, Vice President of the iShares Americas Capital Markets Research and Content team. And, Tushar, I guess one can say that iShares and BlackRock and the research that you get from all these other sources remains pretty bullish, correct?

Tushar Yadava: Yeah, I would say for the latter part of this year, that is definitely the case in our outlook.

Steve Pomeranz: Thank you very much. Thank you so much for joining me, Tushar.

Tushar Yadava: Thanks for having us on.

Steve Pomeranz: All right to hear this conversation again and to sign up for our weekly update and don’t forget to go to Stevepomeranz.com. Thank you, Tushar, that was terrific, appreciate your time.