Charles Schwab Investment Outlook Highlights

 Charles Schwab Investment Outlook 2016

Columbus, Ohio: February 11^th, 2016

Patrick Wallace and Cindy Jones had the opportunity to attend the annual Charles Schwab Investment Outlook held each year in Columbus, Ohio. This one day conference brings together experts in their respective fields to give their insights on the markets, economy, politics, and investment strategies. This year we were excited to see Chief Political Strategist for Horizon Investments, Greg Valliere and Chief Investment Strategist for Charles Schwab & Co., Inc., Liz Ann Sonders in addition to several new speakers. Below are some highlights from each session:

The 2016 Presidential Race and Beyond

Greg Valliere from Horizon Investments

• The chances of a recession are fairly slim due to a strong labor market and a strong consumer. We are starting to see signs of wages growing coupled with lower oil prices which is beneficial to the consumer.

• Regarding the Election: Greg does not see Bernie Sanders as the Democratic nominee. He felt that everyone underestimated Trump and that he is a serious candidate even though Marco Rubio is the most talented politician and is still in the race.

• Greg mentioned that Hillary Clinton is not guaranteed the nomination either. Bill Clinton is a blessing and a curse. The polls suggest that people don't trust her which is a big problem. There’s still a lot that can come out regarding her emails and the Clinton Foundation. The big wild card is that she can be indicted. If Hillary were to be indicted or bad news continues to plague the headlines, Greg’s prediction is that Joe Biden might come back especially if the Clinton email scandal gets larger. 

• Greg felt that Michael Bloomberg is a viable candidate however his net worth of $37 billion could be viewed as not being able to connect to the middle class which is where Trump and Sanders have had support. He is pro Wall Street and negative on guns and could be a more centrist party candidate. 

• Greg felt that defense stocks will continue to do well no matter who wins.

• There are serious issues that need to be addressed that no candidate is talking about such as drugs, nuclear threats, entitlements, and underfunded promises. There is a lack of seriousness among the candidates; in fact the candidates are talking about the opposite: more spending and tax cuts.

• The “do nothing” congress is making some progress. They have put together a five year infrastructure deal and we can now export oil. Greg felt that if oil gets down to $25 per barrel and stays there for some time we could hear more talk about a bailout for the energy companies. 

   

Opportunities and Key Risks in Global Markets

Olga Bitel from William Blair, Penny Foley from TCW, and Danielle Singer from Invesco

• All three speakers gave their opinions of the risks and opportunities from a global perspective. There was a consensus among the speakers that low oil prices are a major risk for several global economies. While low oil prices are viewed as a net positive in the US, it’s not so good for a lot of other countries especially those that are commodity driven. Olga and Danielle mentioned the banks, especially those that have lent to emerging markets, that are going through a currency crisis are a big risk.

• As far as opportunities in the global markets, each speaker had different ideas given their respective area of expertise. Olga felt there was opportunity in Latin America. Brazil and Argentina especially have a lot of opportunity in the second half of 2016. Brazil has ample room for the central bank to cut rates given low growth, high inflation and high interest rates. 

• Penny, who has a focus on fixed income, felt that opportunities are available by picking countries that are going through a large change like Ukraine or Venezuela or countries that are going through a restructuring. However, you have to be very selective and do your homework.

• Danielle felt there was opportunity in the currency markets by pairing currencies and making trades based on further currency devaluation. She felt there are pockets of opportunities in emerging markets. She also likes Poland and Hungarian debt.

• Olga felt that China has had a hard landing in manufacturing and real estate. However, health care and anything consumer-based or service-based is growing and doing well. She felt that China is likely to grow at 5.5% to 6% in 2016 however the growth rate will decline over time.  China’s problem is weak global demand. 

• Olga said the US is close to fairly valued and we need to see consumer spending continue higher. She felt the risk of recession is low. If there is a recession, it will be shallow and short lived. The US is further along in the recovery over other developed markets. Her team at William Blair likes to look at trucking data to get a sense of the economy. There is industrial weakness due to a slowdown in the energy sector.

Generating Income in Periods of Tightening Liquidity

James Kochan with Wells Fargo Funds and Richard Byrne with Benefit Street Partners

• ^{James is the third consecutive speaker who felt that the risk of a recession is low in 2016 and 2017 due to employment growing, income growing, housing sector starting to pick up, and that inflation does not exist.} 

• There is an inventory correction in oil and a correction in manufacturing but not necessarily a recession.

• James felt that a reasonable expectation for GDP growth would be 2% to 3% in 2016 and the Fed will raise rates 2 to 3 times in 2016. 

• He said that the greatest risk we face in fixed income is negative returns. He does not like treasury market right now with the 10 year yielding 1.60% and felt the sector is overvalued.

• Investment Grade Corporates are more fairly valued according to his assessment. Especially the A to BBB component. 

• He felt that there is good value in the high yield market with yields at 9.75% which is an 800 bps spread over treasuries. This spread is generally 500 bps.

• He felt that Municipals are overvalued and there’s a lack of supply. However, state and local governments are healthier and starting to talk more about infrastructure spending. There might be better values later in 2016. 

• Overall, he likes the corporate bond market best for opportunity. 

• Richard Byrne’s research showed $250 Billion in credit was used to finance the Energy Sector since the financial crisis. Richard has been bearish on debt for some time due to D.E.B.T.:

  • Discipline: or lack thereof. During low interest rates, people went beyond their risk profile to find yield. Issuance set records in the CCC space the past 3 years. Leverage ratios kept creeping higher and a lot of excesses occurred. 

  • Economy: not as good as before. Earnings and GDP are trending lower. 20% of the debt market is energy, metals, and mining companies. The high yield space consists more of the "Old economy" and not the FANG stocks which have performed well.

  • Bankruptcy: The default rate will go higher especially within the energy sector. Up until this point, failing business models have been able to refinance with low interest rates. Now, we are going to start to raise rates and when defaults start you might get back to zero.

  • Trading: Liquidity is good when the economy is doing well, however it's not so good when you need it and want to get out. The high yield market size has doubled since the recession. Dealer inventory (banks) have gone down by half and liquidity is drying up. 

• Richard’s conclusion is that it’s a good credit picker's market currently. All debt, good and bad, has gone down.

• Richard likes BDC's as a tactical debt instrument. 

2016 Economic and Market Perspective

Liz Ann Sonders with Charles Schwab & Co., Inc.

• _{Liz Ann typically starts with a saying from Sir John Templeton that says “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria”. Following this quote, she felt that we are still in a secular (longer duration) bull market but we may be entering a cyclical (shorter duration) bear market. In other words, we are in the mature phase but not "die on euphoria".}

• Our markets recently have been more linked to the Shanghai composite. However, US exports to China are minimal at around 7%. 

• Liz Ann also mentioned that the risk of a recession is low. 

• The market has pessimistic expectations for the Fed in terms of raising the fed funds rate in the near future. She didn’t specifically say how many increases we will have this year but reaffirmed that the pace of additional rate hikes will be slow and a slowly rising interest rate environment is favorable for the market.

• She felt that the Dollar is likely in a long term bull market which will hurt the manufacturing sector. Exports, while only 13% of GDP, have declined dramatically due to a stronger dollar weakening manufacturing.

•  In terms of valuation, looking at forward P/E we are fairly valued except the E (earnings) is waning as the energy sector is impacting earnings. We can have an earnings recession without an economic recession. However, sentiment is pessimistic which is a bullish indicator for the markets.

• Liz Ann’s conclusion is that she is still optimistic about the market. However, we can be in a cyclical (shorter duration) bear market but within a secular (longer duration) bull market and expect more volatility.