Post-election investment strategies discussed at nationwide client luncheons
As part of our regular client luncheon series, Capital Group Private Client Services portfolio specialist and political analyst Jeff Brown joined global and U.S. equity portfolio manager Ted Samuels to discuss whether the results of the recent U.S. election will alter their investment strategies over the next four years. The luncheons took place in nine cities across the U.S. from November 2012 through January 2013. Here are some insights from the event:
The conclusion of the November election dispelled some, but not all, of the uncertainty that has shrouded global financial markets over the past year. For instance, the looming fiscal cliff had investors nervous about a mountain of potential tax increases and spending cuts set to become eff ective at year-end. While the negotiations were bound to be tough and hard-fought, Capital Group Private Client Services portfolio specialist and political analyst Jeff Brown assured the crowd that he was confident a deal would ultimately be reached. He shared insights from his recent conversations with top legislative officials, and said they assured him members of Congress didn’t want to leave for the holidays knowing their inaction would have a potential 3% to 4% drag on U.S. GDP. However, he cautioned the talks from both sides would run uncomfortably close to their year-end deadline, given how far apart the two parties were. Although the outcome of the fiscal cliff negotiations is bound to have some impact on the broad economy, Jeff says it won’t significantly alter the way our portfolio managers make investments. They base their decisions on a company’s fundamentals and long-term growth potential. While specific government actions may impact business operations in the near- term, they rarely aff ect enduring plans for future growth.
Regarding the fixed-income market, Jeff believes bond rates will remain weak for a while as the government undergoes its deleveraging process. The Federal Reserve has indicated it will keep short-term rates low for some time, and long-maturity rates are also likely to remain muted. Excess capacity in the economy should continue to curb inflationary pressures.
The general decline in yields has helped municipal bonds, presenting what Jeff considers to be a unique opportunity for taxable investors. These securities have relatively strong yields, but extensive research is required to identify high-quality, low-risk issues. Despite the stable outlook for continued low yields, bonds still serve a vital role in diversified portfolios. Their ability to cushion equity volatility is particularly important when overhanging macroeconomic issues, such as the Eurozone’s long-term plan for Greece’s substantial funding needs and the U.S. fiscal cliff, could trigger bouts of turbulence in global stock markets.
Currently, client fixed-income portfolios have slightly longer maturities. Although interest rates aren’t expected to rise until the economy starts growing, Jeff said managers are keeping a careful eye on market indicators, and are ready to adjust portfolios and reduce maturities when rates move higher. They have been adding inflation protection through Treasury Inflation-Protected Securities (TIPS) and floating-rate municipal issues. Additionally, managers are focusing on revenue-generating bonds, which are backed by a revenue stream that can be analyzed. Given all the uncertainty of the current environment, active management is helpful. Investors incur risk if they buy bonds in a ladder strategy and do not touch them until they need them.
Global and U.S. equity portfolio manager Ted Samuels has been looking to the past to gauge what might happen in the future. He sees many similarities between now and the daunting period in the late 1970s/early 1980s. The U.S. had just finished the war in Vietnam and had seen a president resign. The country also faced challenges from OPEC, suffered high interest rates and confronted a hostage situation in Iran. The prime lending rate was 17.75% and unemployment was high. Japan was considered to be the biggest driver of growth, while U.S. companies weren’t seen as competitive. The stock market hadn’t done anything for a decade, causing an outflow of investments and claims by the media that equities were dead.
Today geopolitical instability exists in many areas and China has surpassed Japan as the undisputed leader of economic activity over the next generation. Economic confidence has meandered for ten years and is now very low. Once again we’ve experienced a decade of losses or nonexistent returns from equities, prompting investors to pull investments from stocks and put them into fixed-income assets despite declining rates. Such behavior is a little
Ted noted that 30 years ago corporate and government downsizing, as well as energy opportunities, helped bring on a bull market that raised the Standard & Poor's 500 index at an annualized rate of 18% over a four-year period. Since then, he says, investors have moved from a state of risk awareness to risk aversion to where they are now: risk avoidance. However, he sees several factors that could reawaken an appetite for equities in the next four years.
For one, U.S. companies are as competitive as they’ve been in 15 years. U.S. labor costs have gone down sharply relative to the rest of the world, mostly because Chinese labor costs have risen significantly. The U.S. is also very close to energy independence thanks to natural-gas drilling and high imports from other parts of North America. According to the latest estimates, the country will be energy independent by 2022.
Ted also discussed potential investment opportunities arising from the world’s emerging middle class. For a government to have staying power, he believes, it must satisfy the needs and desires of the country’s middle class. A renewed focus on the middle class—particularly in developing markets like China—should bode well for global consumer brands.
The advanced health care and specific consumer needs of aging populations offer another compelling investment theme. The front edge of the baby boomers recently turned 65 in the U.S. This age cohort has a disproportionally large share of disposable income and the vote. This is also true in China and Europe. Some members of our portfolio management team see opportunities in companies that cater to this segment of the population.
The elderly also have greater need for investment income, and this will likely translate into stronger demand for companies that pay and grow attractive dividends over time. This theme works on multiple levels because for a company to grow dividends over time, it must also be growing earnings.
Ted emphasized the importance of a company’s management team. He noted that we use our extensive research capabilities and long-standing industry reputation to identify innovative and talented corporate managers who can weather difficult economic climates and seize opportunities. An excellent management team is a very important starting point for portfolio managers when they are considering investing in a company, he said.
Last, Ted highlighted the attractiveness of current stock valuations. He pointed to the five largest companies in the S&P 500 to demonstrate how favorable the return on equities is compared with the 10-year Treasury note, which doesn’t offer earnings or dividend growth. Although decisions regarding stock and bond allocations should never be regarded as an either/or decision, Ted said he is concerned that the current focus on investments perceived as low risk fails to appreciate long-term income needs.
Though investors aren’t likely to increase equity investments until there’s more clarity regarding the macroeconomic environment, portfolio managers believe there are significant opportunities in the stock market over a long period of time. And while investing in them in an uncertain environment may feel like a leap of faith, over a long period of time, returns are always best when valuations are low, sentiment is glum and meaningful positives in the overall market aren’t recognized. Ted believes that’s where we are today. n