Transcript
Speaker: This is HSBC Global Viewpoint, your window into the thinking, trends and issues shaping global banking and markets.
Speaker: Join us as we hear from industry leaders and HSBC experts on the latest insights and opportunities for your business.
Speaker: Thank you for listening.
Speaker: Good morning, everybody.
Speaker: So this session couldn't take place at the more
Speaker: appropriate time.
Speaker: We're entering a very turbulent period in terms of investment and in terms of geopolitical balance in the world.
Speaker: And we have a great panel to address this complex issue.
Speaker: Luke Bars, who is the head of Fundamental Equity Client Portfolio Management at Goldman Sachs Asset Management.
Speaker: Janet Henry, who is the global chief economist of HHBC, also dubbed the crisis economist because we've gone through many, many
Speaker: global crisis in Europe at HSBC, and Pete Doronkiewicz, who is the Chief Administrative Officer of Global Assets, Reddington.
Speaker: We're going to start with a broad question, which has to do with the view about the way in which recent macro events, economic events, financial, geopolitical, tech environment, whatever,
Speaker: had or will have a decisive impact on the markets?
Speaker: Luke, we're going to start with you.
Speaker: Yes.
Speaker: So firstly, thank you so much.
Speaker: And by way of background, I run our equity fundamental bottom-up business.
Speaker: And so a lot of our perspective is thinking about equity markets and where we see value in that asset class.
Speaker: And obviously, it's been a pretty tough backdrop really since November of last year.
Speaker: We've seen change in the exogenous environment, specifically around inflation risk, around central bank policy, and then obviously around Russia, Ukraine in the last few months.
Speaker: Some of that is possible to price.
Speaker: You can look at equity markets and say, OK, I understand that if interest rate cycle is starting to move a little bit more against me, if we're going to a slightly more hawkish environment, I can price that into equity markets.
Speaker: through my discounting mechanism.
Speaker: And so part of the reason you've seen this retrenchment in growth assets across the equity space is if you've got those long duration securities, if you've got companies that are generating cash flows into multiple years into the future, there is some natural discounting that happens as interest rate environment works against you.
Speaker: But our headline view here, as we look forwards, is that the impact of that on equity market valuations is far less than what is being priced in today.
Speaker: When we look at our models and we take some of those long-term secular growth themes and we think about companies that are well-placed to benefit from that growth, we would see maybe a 5% or 10% change in implied intrinsic value through that discounting mechanism.
Speaker: not the 50-60% change that we've seen in some cases in some industries over the last three or four months.
Speaker: And so when we think about what's impacting markets today, and I think it's fairly obvious what those exogenous forces are, there's obviously some downside risk that we have to factor in, and I'm sure we're going to talk about it in due course as it relates to the continuation of inflation, whether that has a meaningful impact on consumer sentiment, how we can hopefully resolve what's happening in Russia and Ukraine.
Speaker: But from a simple equity market perspective, we see a very interesting entry point in some very high quality assets if we're looking at it from a longer term perspective, based on the fact that whilst there are risks, marketers in some cases overreacted to those in the immediate.
Speaker: Thank you very much.
Speaker: Pete.
Speaker: From an economic and fundamental perspective.
Speaker: Not outside of the war, not much is different to the way it was in 2021.
Speaker: And yet we had a pretty good year in 2021.
Speaker: So for me, the most fundamental thing that's changed is the tone in markets.
Speaker: You know, ultimately you can do all the macro analysis you like, but when the markets change what they want to see,
Speaker: Everything changes, as you can see, and we've gone from a market which was very much a trust me market to approve it to me market.
Speaker: And you can see that in the valuations of a lot of stocks that Luke's talking about.
Speaker: I think from our perspective, we are obviously long term investors and I think there will be opportunities that come out of this, but we're certainly not rushing because we do fundamentally think that the market dynamic has shifted.
Speaker: We're fundamentally into a different environment.
Speaker: And I think the most important thing is that you've gone from an environment of very, very easy money, of quantitative easing, now into an environment which is the opposite.
Speaker: And so the effect that you had of people being pushed down on the risk curve by central bank actions is now effectively washing back in reverse.
Speaker: And that is going to be very, very meaningful.
Speaker: And we'll have to see where the central banks have got the stomach to actually go the distance in terms of seeing how that plays out, because I think it is going to get potentially pretty ugly in some areas.
Speaker: Thank you.
Speaker: So we've actually done this in an interesting order.
Speaker: Usually you start with the big picture economist.
Speaker: We do it in reverse for the next.
Speaker: You talk to people on either side who then tell you how to invest.
Speaker: So I will take more of a big picture view and actually address the first part of your question as well, which is what developments have led to where we are now.
Speaker: Because we know that one of the big challenges that we were already facing before the 24th of February was multi-decade high inflation.
Speaker: And as I see it, the very high inflation that we see currently was already a function of a stronger than expected recovery since the lows of the pandemic.
Speaker: Yes, it varied between different regions, but
Speaker: Compared to those really dark days at the start, it has been stronger than expected, fueled by an enormous policy stimulus.
Speaker: As you said, there's huge amounts of liquidity provided by central banks and spent by governments and individuals.
Speaker: And that happens against a backdrop of constrained supply.
Speaker: Some of it we expected, the supply chain disruptions, some of it we didn't.
Speaker: A lot of the uncertainties in labour markets we did not fully anticipate.
Speaker: And already people are drawing comparisons with the 1970s because inflation was already very high when we had the oil embargo and the supply shop then.
Speaker: And I think that's what we are facing now with the Russia-Ukraine situation and, of course, with COVID in China.
Speaker: This is happening just at a time when inflation was already high.
Speaker: And central banks were already concerned about what to do.
Speaker: And as you say, a lot of the outlook does hinge on how central banks cope with this, how they shrink their balance sheets, as well as raising interest rates, and how much of a sacrifice on growth they end up having to pay in order to restore their credibility on inflation and prevent some kind of wage price spiral from unfolding.
Speaker: Thank you very much.
Speaker: So now we're going to delve into the details and we start with you, Janet, of course, because we're going from the macro to the particular.
Speaker: We look at countries, regions and asset classes.
Speaker: So can you be more specific and tell us where you feel confident about in terms of countries or regions that appear as relative safe havens compared to the rest?
Speaker: And where do you see the greatest risk in the months and years ahead of us?
Speaker: As a consequence of what we have now, which was already high inflation and now this big impact on commodity markets, though clearly in the last few days they've been particularly volatile as well, it is a redistribution of income from commodity importers to commodity exporters.
Speaker: So therefore anyone that is a big net exporter of commodities is going to fared better.
Speaker: And I would say it is a relative world.
Speaker: It's hard to believe that anyone's a genuine winner from the current situation.
Speaker: but it is all relative and it certainly in our world it is the oil producers in the gulf region and the wealthiest ones that are going to see the biggest income gains as a consequence and what you've got to remember a lot of those gcc countries actually were quite sensible with hindsight in 2020 they reigned in their spending it was you know
Speaker: Oil briefly hit zero, remember?
Speaker: Then it was in the 20s and they had to, just as every other country in the world was spending a lot of money, they had to get their public finances in order.
Speaker: So we like commodity producers, GCC.
Speaker: We also like some of the Latin American countries where there's more of a risk premium, commodity producers, and they've got positive real interest rates.
Speaker: And amongst the advanced economies, we still think the outlook for demand growth in the US is a lot better than it is in Europe.
Speaker: Obviously, even for central banks, this is an impossible world.
Speaker: You've got Fed governors saying they have no idea where interest rates are going to be in the next year.
Speaker: So much about the macroeconomic outlook.
Speaker: hinges on political decisions, but it's going to be challenging.
Speaker: And so much about the European outlook depends on how the sanctions escalate from here.
Speaker: But the growth risks are more in Europe this year, more in the US next year, depending on how far the Fed has to go.
Speaker: And on the negative side, what are you concerned about in terms of regions?
Speaker: On the negative side, I'm worried about, it was all pretty negative, actually.
Speaker: It was a relative story.
Speaker: You know, this is a world where we've got a war, we've got risk aversion, and we've got central banks tightening policy in terms of raising rates and shrinking their balance sheets.
Speaker: So 2021 was the everything rally.
Speaker: This is not going to be the everything rally in a world where there's a lot less liquidity.
Speaker: There will be relative outperformers.
Speaker: My feeling is that the major central banks
Speaker: will ultimately do what they need to to bring inflation under control.
Speaker: The question is just what is the damage that is inflicted on growth as a consequence.
Speaker: But that might not be necessarily a policy error.
Speaker: A mild recession might be better than actually getting back to a period you had in the 1970s or early 1980s
Speaker: where you had a persistent wage price spiral because of the tight labour markets.
Speaker: So, yeah, I'm worried about the ongoing consequences of war and sanctions in the short term and over the medium term.
Speaker: OK, so GDC countries, some Latin American exporters, commodity exporters and the US compared to the rest.
Speaker: You can, Pete, in terms of asset classes, which ones give you relative confidence moving forward?
Speaker: I think we have to just understand the time horizon here.
Speaker: I think it's a very difficult scenario, very much in line with what Janet said.
Speaker: If you're trying to take a view on the next one month, three months, even six months, there's many exogenous forces that, look, if we see some degree of resolution in Russia, Ukraine, if we would see some evidence that the Fed was getting ahead of the curve and you actually start to see inflation top out, there's a lot of upside risk to equity valuations at this point.
Speaker: Similarly, if we don't see that evidence, if we see further challenges in Europe and we see that very likely possibility of recession coming through, then markets are going to continue to be slightly constrained and challenged by that backdrop.
Speaker: But when we think about it slightly longer term, obviously as an equity investor, we have to think slightly longer term.
Speaker: Actually, there is part of this discussion that, whilst very much in line with what Janet said, is very relevant, which is what your valuation entry point is.
Speaker: And what we've seen in equity markets is very material correction in valuations.
Speaker: Obviously, part of that was the recovery we saw in 2021.
Speaker: So you went from almost peak valuations at the beginning of 2021 to more moderate valuations because the earnings recovery came through.
Speaker: And then what you've seen in 2022 is just a material escalation in risk aversion.
Speaker: And so actually for a lot of what we see as high quality, long term growth themes within the equity space, entry points are now pretty attractive.
Speaker: If you take places like Japan and China, we're now trading comfortably in bottom quintile valuations.
Speaker: So you have to take a little bit of a view on the long term dynamics in those markets and the fact that you can still find growth and get comfortable with some of the regulatory backdrops.
Speaker: But that is an entry point we haven't really seen for six or seven years.
Speaker: And some of those high growth themes.
Speaker: So let's think about some of the online consumer related plays where there's very tough comps year on year and you've seen material trade down in expectations over the last couple of months.
Speaker: You're entering into those names at valuation entry points we haven't seen since 2014 or 2015, despite the fact that actually the fundamentals materially improved over that period, even versus two years ago.
Speaker: You think about the acceleration you've seen in adoption rates and penetration rates for things like e-commerce, digital payments, online gaming, social media.
Speaker: All of that valuation optimism has been corrected in the last six months.
Speaker: So it's not to say that 45 times price earnings multiple is the right number to pay in November last year.
Speaker: But when you look at those businesses and you think about how sound they are fundamentally, the fact that growth is still coming in 20%, 20% plus, and you're still seeing very high ROE, 25 times multiple is probably also not the right number.
Speaker: And so that for us, as much as it's a long term view, as much as you might have to bear a little bit more downside risk in the near term, is where we're allocating capital at this point, because we think on a three to five year horizon, that is an entry point you just haven't seen for quite a long period of time.
Speaker: I think within the asset class, that makes a lot of sense.
Speaker: I think the challenge that I think you've got probably two points to make.
Speaker: People got pushed, and this is going to sound terribly pejorative, and maybe it is, but
Speaker: people got pushed into unbalancing their portfolios over the last 10 years, right?
Speaker: The activity of central banks and the kind of the very focused rally in terms of the things that kept on working, just kept on working.
Speaker: So everybody has moved their portfolio more towards those things, more or less.
Speaker: Some people maybe only a little bit, some people a lot.
Speaker: So you have big overallocations to growth stocks, big underweight in duration, and all these themes are playing.
Speaker: People are underweight emerging markets, people are underweight alternatives because they haven't worked in as long as anyone can remember.
Speaker: And we're going into a different environment.
Speaker: Already this year, you're seeing all those things are starting to work.
Speaker: Alternatives have been, generally speaking, fantastic and have actually protected to a huge degree.
Speaker: So for me, say, what do I want to buy?
Speaker: That's almost kind of not really the problem.
Speaker: The problem is what do I want to sell?
Speaker: Because apart from the Alts book, everything looks awful.
Speaker: Everything's been blown up.
Speaker: And people are going to start wanting to get back more balanced portfolios.
Speaker: And that's just going to mean locking in losses.
Speaker: There's kind of no good way out of this because pretty soon you're going to be able to buy high quality U.S. investment grade bonds at a 5% yield.
Speaker: And that demands a place in a portfolio.
Speaker: I haven't been able to do that since 2012.
Speaker: I mean, okay, I could do it for about three days in COVID.
Speaker: But outside of that, I haven't been able to do it back for 10 years.
Speaker: That's a sensible portfolio allocation.
Speaker: So, so then, okay, fine, but what do I sell?
Speaker: That's going to be the more challenging conversation for people.
Speaker: And I think you're going to see is these portfolios that have become very, very unbalanced are going to start moving back towards looking like more like they did in the two thousands coming out of the tech shock.
Speaker: So we'll see.
Speaker: One point I'd make on that, because I think it's very relevant is
Speaker: Obviously, the markets over the last decade haven't ever felt easy, but actually in many cases they've been quite easy.
Speaker: If you had your traditional 60-40 portfolio, it's generated you north of 10% in dollar terms on 9% volatility.
Speaker: You haven't had to do too much as long as your long risk assets to generate a very healthy outcome.
Speaker: The reality is going forward over the next decade, that traditional 60-40 portfolio is going to be far more constrained.
Speaker: I think there is a degree to which you are going to get a little bit more income and yield coming out of your fixed income portfolio, which is helpful.
Speaker: We first have to play through that duration risk story.
Speaker: And if we look at some of those 60-40 portfolios today, you're probably expecting a 4%, 4.5% return.
Speaker: So for a lot of investors who have return objectives or liabilities that they have to meet, which are going to be above that level,
Speaker: You've got to be a lot more thoughtful in terms of how you're going to capture that return, whether that's adding alternatives into portfolio, whether that's being more thoughtful in terms of the allocations you're making within equities, within fixed income, to make sure you can find those higher growth drivers.
Speaker: That for us is going to be a key part of, to Pete's point, building a balanced portfolio, but being thoughtful around how you can still meet those longer term objectives.
Speaker: But the big flows, I think, are still because you've got all these things coming down the pipe.
Speaker: But once you've got the constant tightening effect, you've got the effect of higher rates is broadly going to push people into hedging more liabilities, selling some growth assets.
Speaker: All these factors ultimately, to me, make me think, yes, equity is looking an awful lot better than they did six months ago.
Speaker: but probably this looked more like, you know, kind of we're going to get rallies in more of a bear market environment than, you know, just an outright return to great equity markets.
Speaker: Can I add one point on this?
Speaker: Again, it's just from the macro point because I broadly agree with what the others have been saying.
Speaker: But I think what we have at the moment is a very kind of unequal distribution, both in the corporate sector and in the household sector.
Speaker: I mean, actually, the listed sector is generally in good shape.
Speaker: They've got fat margins, as you would expect, coming out of the pandemic.
Speaker: They've got high cash reserves.
Speaker: We know a lot of the debt is in the small and medium-sized companies.
Speaker: That's probably where we see some of the pressures.
Speaker: Similarly, we've got it geographically.
Speaker: We've already had certain really vulnerable frontier-type economies that have already defaulted or gone to the IMF.
Speaker: And we've got it in the household sector.
Speaker: We're not even forecasting a full-blown recession, even though for a big chunk of the population, this is going to feel like a recession in the coming year because they are seeing the surge in the cost of living.
Speaker: They are seeing the brunt of the food and energy prices and border inflation.
Speaker: They've got a higher inflation rate.
Speaker: Those of us that have got very high savings rates and have accumulated a lot of savings over the course of the last year.
Speaker: So I would probably agree, coming at it from a different angle,
Speaker: that there's just going to be a lot more differentiation between the companies and the elements of the economy that benefit in that unequal world, whether it's on the corporate or on the household or the geographical side.
Speaker: And a lot of it comes down to the underlying vulnerabilities that are exposed where money is a lot less readily available.
Speaker: Thank you very much.
Speaker: It seems to me you're all relatively sanguine about the long-term outlook.
Speaker: You recognize that there is going to be a lot of turmoil volatility in the next few months.
Speaker: Most of your assumptions depend on whether monetary tightening will be orderly and effective.
Speaker: What will it take to change your views?
Speaker: What is a big macro event that you take into consideration that will force you
Speaker: to change your view.
Speaker: Can we address this in just a few seconds?
Speaker: Because, for example, Janet, you said you don't foresee a global recession.
Speaker: Many people do.
Speaker: Many people think that we are on the verge of a global recession.
Speaker: Many economists would... They do, but I don't know of a single house that's forecasting a full-blown recession.
Speaker: Right.
Speaker: Is the truth of the matter.
Speaker: It's very easy for headlines to follow, you know, to come out with big, oh, we're definitely going to have a recession.
Speaker: We know that the squeeze on real incomes at the moment in any normal world would absolutely deliver a recession.
Speaker: In the UK, we're forecasting about a 4% drop in real incomes in the current year.
Speaker: In any normal world, that would be a recession.
Speaker: Now, actually, because of this savings picture and indeed the credit picture, because in the US and in the UK, you are seeing a pickup in borrowing at the moment, it's very difficult to forecast.
Speaker: Recession risks have risen and we know that most Fed tightening cycles end in a recession.
Speaker: The question is, even if we do go into a recession, how deep a recession and how long lasting.
Speaker: is it actually going to be?
Speaker: So I wouldn't say we're completely sanguine about the outlook.
Speaker: I completely agree with the long term views.
Speaker: And I think ultimately central banks will be able to address it.
Speaker: But there is huge uncertainties, as we know, regarding the war and the medium term consequences.
Speaker: We've already seen it in European defence spending and European energy security that will have implications.
Speaker: I think from our perspective, the key here, and Janet just made this point a second ago, is you've got to separate from the overarching asset class level view relative to the company or idiosyncratic specific view.
Speaker: Because it is hard for us to get particularly bullish on generic market outlook.
Speaker: There's a lot of exogenous risks.
Speaker: We think valuations are a little bit more attractive than they have been.
Speaker: So that could give you a good starting point.
Speaker: But there's a lot of forces that clearly can hamper risk assets over the coming even three to five years if we can't get a handle on some of them.
Speaker: But when you start to dive in, and obviously this is the luxury we have as bottom-up fundamental investors, when you start to dive into the individual businesses, you can find those companies with very clear alignment to some of those longer-term secular growth themes, be it the emergence of a more youthful consumer who is spending money online and different products, be it the alignment to clean tech, clean energy, and the shift we're likely to see towards renewables, be it the emergence of new techniques within the biotech space, as well as that just generic technological advancement.
Speaker: If you can find those businesses that are well aligned to that innovation story,
Speaker: have the competitive positioning, that they have some degree of pricing power and have traded off in many cases in the last couple of months by 50 plus percent.
Speaker: But that is an interesting and exciting start.
Speaker: It's just you have to separate that from the overarching backdrop, which still is uncertain and clearly can continue to be quite challenged.
Speaker: Thank you.
Speaker: It's exactly the opposite of what we just said.
Speaker: I mean, we're going into a QT environment, so liquidity is being withdrawn.
Speaker: If central banks decide they can't handle that, essentially, they'd rather just stay hooked on the kind of sugar rush of just pushing more freshly printed money into the system, then that would obviously change the view.
Speaker: But I sincerely hope we're not going to see that.
Speaker: So it's a whole, which makes it difficult to elaborate this strategy.
Speaker: Yeah, absolutely.
Speaker: Okay.
Speaker: If I had to sum it up very briefly in just three words, I think it's very cautious optimism on your part, the three of you.
Speaker: Code for differentiation among countries and regions for you, Janet, and the portfolio rebalancing for you.
Speaker: So thank you so much.
Speaker: Thank you for listening today.
Speaker: This has been HSBC Global Viewpoint, Banking and Markets.
Speaker: For more information about anything you heard in this podcast or to learn about HSBC's global services and offerings, please visit gbm.hsbc.com.
