First 200 Days: What Investors Need to Know

The Perspectives Podcast

First 200 Days: What Investors Need to Know

With

Candace Browning,

Head of BofA Global Research

 

Chris Hyzy,

Chief Investment Officer,

Merrill and Bank of America Private Bank

 

 

Edward J. Hill,

Senior Vice President and Public Policy Executive,

Bank of America

 

 

And Savita Subramanian,

Head of U.S. Equity and Quantitative Strategy

and Head of ESG Research,

BofA Global Research

 

 

 

 

 

 

 

 

 

Please see important information at the end of this program.

 

Candace Browning:  While 2020 was a time of incredible change and disruption, 2021 will almost certainly be one of transition and renewal. We are entering into a new phase of the global health crisis as vaccines are being rolled out. A new administration has laid out an ambitious agenda to support American families and workers, and the economy continues to recover from last year’s steep recession.

So what might we expect as 2021 unfolds?  And how could investors prepare for the changes ahead?

[THEME MUSIC]

Hello, and welcome to this edition of the Perspectives podcast. I’m Candace Browning, head of BofA Global Research. On this episode, we’ll look at the key issues and events to watch for in the first few months of 2021, and how they could shape the path of the economy and the markets. We’ll explore the top priorities for the new administration and Congress and also the sectors that could drive innovation and growth, and we’ll share our insights on how investors can make sense of all these changes.

Joining me are Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank.

Chris Hyzy:    Hi, Candace.

Candace Browning:  Savita Subramanian, head of U.S. Equity and Quantitative Strategy and head of ESG research for BofA Global Research.

Savita Subramanian: Hi, Candace.

Candace Browning:  And Ed Hill, public policy executive for Bank of America.

Ed Hill:                       Hi, Candace.

Candace Browning:  Great. Well, Ed, let’s start with you. Joe Biden is now President of the United States and has begun to implement his core agenda, both the House and Senate are essentially under Democratic control, which should help him to pass his key initiatives. So Ed, what do you see as the most important priorities for the new administration in the coming weeks?

Ed Hill:                       So Candace, on his first day in office and in fact for a few days before that, he came up with two major legislative proposals. One, another COVID relief package that he priced around the $1.9-trillion range that includes money for state and local governments, more money for vaccine distribution and testing for COVID, money for schools, money for expanded unemployment benefits; and also an additional $1,400 to top off the recent $600 checks that went to Americans making less than $75,000, making it for a total of $2,000. So that’s a $1.9-trillion package all in.

The second bill that they came out with on his first day in office is an immigration bill. This bill is rather progressive in terms of it would provide a pathway to citizenship for everyone who is in this country as of January 1^st, and so that could have a big impact obviously on labor markets, a big impact on consumption. So those are two big proposals he came out with. He’s also indicated the administration’s interest through executive orders of moving forward on a host of issues in the climate space, more in the immigration space and also in the racial justice areas as well.

Candace Browning:  So Ed, as a follow-on to that, what about clean energy or a large-scale infrastructure spending bill, both of which could be very important sources of new jobs. Or potentially even tax reform or healthcare reform? How likely do you think it is for any of those types of really large-scale initiatives to gain momentum?

Ed Hill:                       Taking the last one first on healthcare reform, recent history suggests there hasn’t been a great deal of agreement between the two parties and even though Democrats control both chambers of Congress, they have such narrow majorities. They don’t have big enough majorities that I think that healthcare is a likely area that Congress can tackle.

But two of the other areas you talked about, infrastructure and taxes, perhaps they can do something on that. The Administration proposed a $3-trillion infrastructure package. Now, that will be over multiple years, perhaps over a four- or five-year period, so consider it, think of it maybe $400 billion a year. And actually, that’s going to wrap in many of the issues you talked about like include money for green infrastructure and the like. It’ll remain to be seen whether or not they can get the votes to pass that, whether or not there’ll be enough Republican support, but that is something I think you’re going to see a big push from the Administration.

And they’ve also talked about adding tax provisions to that larger infrastructure bill to offset the cost of it, like raising the corporate tax, which the Biden campaign had proposed raising from 21% to 28%, raising either capital gains and dividends to ordinary income rates for those making over $1 million, or raising the payroll tax by putting taxes on both employers and employees that make over $400,000. Whether or not they’d be considered in a package later this year regarding infrastructure remains to be seen, but that’s something that the Administration is seriously considering.

Candace Browning:  It does make sense that they would consider some changes to the tax code considering the fact that $3 trillion here and $1.9 trillion there in spending, you’ve got a lot of spending, so the concern is obviously how to pay for all of it.

Chris, let’s turn to you and talk a little bit about the outlook for the economy. There are growing concerns over new variants of the coronavirus and we’ve also seen setbacks in rolling out the vaccine.  Millions of Americans are still unemployed, small businesses are struggling, but there are strong positive signs that the recovery is actually occurring. So, what do you think is most needed to keep this recovery going?

Chris Hyzy:                Yeah, Candace, you hit it at the start of the question which is vaccine logistics that covers everything from distribution to supply and demand to the access overall between the first dose and the second dose, and what’s the timing of all that to hit at the heart of the working population of the economy? In order to get jobs back, the 10 million jobs that were lost and let’s just say half of them to get back, you’re going to need a little bit more of the heart of the working population to begin to receive the vaccinations. That’s number one. That’s the bridge.

And then the other part of the bridge is the relief packages, the second, third or fourth relief packages and stimulus that Ed described. And last but not least, those jobs coming back. So that creates not just a bridge or sugar high to an economy. It creates a longer-term growth trajectory to the economy, so that’s probably what’s most needed.

Candace Browning:  Got it. That all makes sense. Thank you, Chris.  Savita, I’d like to get your take on how the market has been reacting to all these disruptions that we’ve experienced, which lately has been, as far as I can see, to just essentially shrug them off. And there are a number of investors who worry that we’re in or approaching a bubble. So what’s your perspective on this, Savita? Does your outlook for corporate earnings support these levels of equity prices?

Savita Subramanian: It’s a great question, Candace, and if you look at last year, despite the fact that we were in a global pandemic and one of the worst recessions ever, the market closed at all-time highs and that feels like a little bit of a disconnect.  But I don’t think it suggests in and of itself that we’re in a bubble because the market correctly anticipated an earnings recovery that we’re likely to see this year. This year we’re looking for 20% earnings growth, so assuming that earnings are on track for a strong recovery, I would argue that the market is, you know, it’s not cheap by any means, but it’s not necessarily in bubble-like territory.

Furthermore, when you think about the decision between stocks and bonds, despite the fact that the S&P 500 is trading at somewhat elevated valuations, the income potential of stocks still massively eclipses that of most comparable fixed income instruments on a quality-adjusted basis. Just to put this into context, over 70% of stocks in the S&P 500 still pay a dividend where the yield is higher than that of the 10-year Treasury (as of Dec. 2020), so we’re still at really attractive levels of yield versus other asset classes.

Candace Browning:  So Savita, let’s drill down from the overall market into the sectors that make up the market. What do you see for areas like industrials, technology, healthcare, consumer? What sectors do you see doing well as we move into 2021 and which ones do you think could be more challenged?

Savita Subramanian: I think everything we’ve heard so far from the Administration and Ed’s comments earlier suggest that policymakers are really focused on improving the economy and closing out inequities across income divides, which I think translates into a focus on the real economy rather than asset inflation. So, investors we think are best suited seeking out the most GDP-sensitive areas within the market, and these would be sectors like industrials, like energy, even financials could do well in that backdrop. We think that healthcare is another sector that could see more friendly government spending trends as well as corporate spending. So these are areas of the market that we think could benefit from the current economic and fiscal environment.

Now, the areas that could see some challenges are really kind of past leadership, if you will. So think about technology or communication services, these are areas where we think they could see challenges for a number of reasons. One is just simply the regulatory backdrop and when you think about some of the anti-monopolistic rumblings that we’ve heard from policymakers, these could hit some mega-cap tech stocks or at least provide an overhang on these stocks for the foreseeable future.

On the consumer, I think what we’re really going to see over the next 12 months is a shift from consumption of hard goods, which has been relatively healthy throughout the recession, to more pent-up demand in the services areas within the consumer economy. I also think that there could be some pent-up demand for a manufacturing spend, for CapEx, especially if we do see any sort of infrastructure bill penned in Washington. So those are some of the areas where we think we’re going to see more benefit, is outside of hard goods and into services and manufacturing and CapEx beneficiaries.

Candace Browning:  Lots of change.

Savita Subramanian: Yup.

Candace Browning:  So Ed, let’s swing back to you and take a look overseas and our foreign-policy. First, how do you see the U.S.-China relationship evolving under President Biden? And then number two, do you think that we’re going to return to a more multilateral coalition building approach to foreign policy than we experienced during the Trump Administration?

Ed Hill:                       Yeah, the way I sort of think about China is first to think about Europe.  And what I mean by that, Candace, is that the U.S. is going to try and repair and strengthen our relationship with Europe and perhaps other allies in Asia so that they can build these multilateral coalitions that you referred to to help pressure China.

I think that the Biden Administration doesn’t want to be soft on China but what they want to do is get away from this sort of unilateral approach that the Trump Administration pushed, whether it be sanctions or tariffs or import restrictions and really move towards a more multilateral approach to build an effective campaign against China.  Whether it be for concerns about their economic activities, whether it be concerns about their human rights activities, or whether it be concern about their military ambitions, sort of using the rest of the world as allies in this process.

Candace Browning:  Very interesting comment, makes a lot of sense to me. So Chris, what’s your outlook here? Are there other geopolitical issues or risks that you’re watching for?

Chris Hyzy:                Most certainly.  Here’s an interesting thing to think about. What if the U.S. and China relationship is really a relationship of one that it’s a race towards innovation? It’s a race towards building the next wave of the modern economy; i.e., the digital economy. It’s a race to secure the supply chain. It’s a race to build semiconductor facilities. It’s a race to secure earth’s rare metals to supply that. And if in fact we are going to a world in which we’re more concerned about infrastructure and climate solutions, then the need to secure natural resources is going to be in our estimation a lot more important than it has in years past.

So this is the paradigm shift that we all talk about. This is changing the nature of what asset allocation may be in the years ahead, as well.  But more importantly it has a lot of implications ultimately on the thematic end of what could drive portfolios underneath the indices.

Candace Browning:  On that note, let’s talk about some of the larger themes that we follow, such as innovation and automation, and the move, as you mentioned, Chris, the move towards reshoring of supply chains and manufacturing and the growth of sustainable investing.

So how do you and Savita see these types of underlying shifts affecting that outlook for growth and the markets? And Savita, let’s start with you on that.

Savita Subramanian: Sure. I think the big change is that sustainable investors now have an ally in the White House and the ramifications there are important. So, within environmental, social and governance or ESG investing, I think what we’re starting to see within that area is a shift from thinking more about governance, towards a pivot towards environmental and social factors. So the E and the S in ESG are starting to really take center stage. So, you know if you think about it, we rejoined the Paris Accord. Climate change is top of mind for every investor.  Managing emissions is a topic that comes up more and more across all types of businesses, not just your commodities-oriented business models.

Moving to reshoring, this is a theme that we’ve been talking about for a while and I think if there’s a little bit of a nuanced shift; rather than just bringing jobs back to the U.S., really thinking about this more as establishing global ecosystems between countries with shared governance and social values. So I think we could see a pickup in relations outside of just bringing jobs and manufacturing back to the U.S., but also reforming alliances with regions of the world like Canada or Europe or areas where we could start to see more of an ecosystem approach to reshoring.

 

Candace Browning:  And Chris, what are your thoughts on that?

 

Chris Hyzy:                Yeah, I think Savita nailed it there when she talked about looking at the E and the S within ESG. That’s number one. Number two you talked about at the outset of the question, which is innovation and automation. It is estimated, at least some of the initial work that we have done, that 14% of all jobs may be automated within the next nine years through into 2030.

Now, the knee-jerk reaction is to say, “My goodness, if that’s happening, actually that is going to hurt jobs.” But the reality is as you automate the jobs that can be automated, you create capacity for new jobs that are either supported by government expenditures, i.e., clean energy, or simply capital flows where the greatest risk-adjusted return is and companies shift their business models to feed into that.

But what absolutely is critical to all of this is to allow the economy flexibility to get through times of crisis like this, bring jobs back, be supportive by government expenditures where necessary, and then allow capitalism and shareholder activism at the same time to thrive.

Candace Browning:  So we’ve talked about the economy and some of the initiatives that we’re going to see the administration do.  Let’s sort of switch gears a little bit and talk about actual steps that investors can take from here.

Savita, what do you think is the potential path for equities?  Are there any areas of the market that you think are really going to gain traction, and also what about small cap versus large cap and value versus growth?

Savita Subramanian: Yes, lots to unpack there, and as you mentioned, this is a year of big changes.  We’re reopening the economy, we have a new administration in place, so changes are something that we should get accustomed to.

                                    So let’s talk about what those changes mean. Well, I think renewed hopes of an infrastructure bill, which was considered a nonstarter under more of a gridlock scenario, would be a big benefit to industrials, which is one of the biggest sectors in the S&P 500 and hasn’t really had its time in the sun for a while. Healthcare I think is also likely to draw dollars from both corporate and fiscal spending. So those are two sectors that we’re bullish on for the year.

                                    Now, when you think about size and style, I think it really comes down to the economy.  Everything we’ve heard so far out of Washington D.C. suggests we’re going to work on supporting the economy. Well, what does that mean for small caps? Small caps are much more economically-sensitive than large caps; therefore, a recovering economy and a recovering profit cycle, that’s a great petri dish for smaller companies to outperform.

                                    Similar story for value. Investors tend to go for the cheapest areas of growth when profits growth broadens out and that’s exactly what we’re expecting over the next 12 months.  So we would be emphatically in favor of small caps and value stocks despite the fact that they’ve actually already begun to demonstrably outperform.

                                   

Candace Browning:  Well, great. Well, thank you, Savita. And Ed, let’s turn it back to you. I mean, you speak with clients on a very regular basis, what are they telling you are their key concerns?

Ed Hill:                       Yeah, so getting back to what Savita and Chris spoke about earlier, climate is something I think investors are very interested in and the Biden administration is going to take a comprehensive whole government approach. Also, the Biden administration is going to take a very aggressive approach at looking at anti-trust related issues and mergers and acquisitions. This could have a particular impact on big tech. 

And one other area that I get questions from investors a lot is regulation of the financial sector. So it’s important to remember that financial regulators, and I’m particularly thinking about the FDIC, the Federal Deposit Insurance Corporation and the Federal Reserve, the regulators serve fixed terms and can’t be replaced by the president and, therefore, the pace of change in regulation of the financial sector may be a little slower than perhaps some other segments of the economy.

Candace Browning:  Okay, great. Well, Chris, let’s wrap it up with some portfolio guidance for our listeners. How do you recommend we invest in today’s market and can investors still find good opportunities in equities?  And for people looking for income, what options should they consider given that interest rates are so low and probably likely will be low for a while?

Chris Hyzy:                Yeah, as Savita said there’s a lot to unpack. We have a laundry list of risks that are still out there and we do every year. So what do you do? Well, first and foremost, maintain a very high level of diversification. And that involves filling gaps in a portfolio that may have underperformed over the last year, over the last three years, maybe the last decade. And Savita mentioned many of those areas: small caps relative to large, some of the value areas relative to growth, and cyclicals, in general, relative to defensives.

                                    That also includes taking a look at markets outside the United States. They have significantly underperformed for the better part of the last decade. And if indeed we continue to see reflationary policies, it does support areas like the emerging markets. Emerging markets are very cyclical, so this is more of a rebalancing and a tactical move.

                                    On a secular, longer-term basis, Candace, we see 2021 as the first year, the base year where long-term investors begin to actively increase their risk budget. That means raising equities relative to fixed income and cash in their portfolios simply because fixed income, for the first time in many years, particularly longer-dated yields, are backing up and rising, which could impact or pressure returns in fixed income. That means switching from income-producing areas that have generally been in fixed income to dividend-producing, dividend growth areas that have a thematic element to them across sectors within equities. We see this is as a long-term theme and we expect it to support portfolios in the years ahead.

Candace Browning:  Thank you for that, Chris, and on that note, we’ll end it. Chris, Savita and Ed, thank you so much for sharing your insights. I know we’ll all be watching very closely as events unfold.

And thank you all for listening to this edition of the Perspectives podcast.  My co-hosts have been Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank; Savita Subramanian, head of U.S. Equity and Quantitative Strategy and head of ESG Research for BofA Global Research; and Ed Hill, public policy executive for Bank of America. I’m Candace Browning, Head of BofA Global Research.

Thanks again for listening.

This podcast was published on February 8, 2021.

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