#WellSaid

The Wellington Blog — A diverse marketplace of ideas, where our investment professionals share and challenge each other’s views. They decide independently how to draw on those ideas to sharpen their investment decisions, unconstrained by any single “house view.”

Japan has experienced deflation for much of the past 30 years (Figure 1). That’s the general consensus, so why my titular question? Because what Japan has not had over the past three decades is the sort of broad wage-service deflation that is most feared by economists. Instead, I would characterise Japan’s deflation as having been mostly idiosyncratic in nature.

Figure 1

Is Japan's deflation cycle at the end?

Deflation was mostly idiosyncratic

Japan’s protracted battle with deflation was largely attributable to specific dynamics, including the country’s botched policy response to its 1980s asset-price bubble, whose collapse in 1991 ushered in Japan’s so-called “lost decade” — a period of economic stagnation that lasted until 2001. In addition, I believe the massive…

MACRO
THEMES
Paul Cavey
Paul Cavey
Macro Strategist
Hong Kong

Factor investing – tilting a portfolio toward securities that have certain attributes (e.g., attractive value, quality, momentum, etc.) – has become widely accepted and practiced in the world of equities. Within fixed income, it is in a more nascent stage.

However, we believe that applying a factor-based investing framework can lead to valuable insights into what is driving performance in different sectors of the bond market. Even more important, it may allow investors to better position their portfolios to take advantage of…

MARKETS
THEMES
Brendan Fludder
CFA
Research Manager
Boston
Samuel Steere
CFA
Investment Director
Boston

With an unstable relationship between the US and China looking like a long-term geopolitical reality, pressure to relocate manufacturing away from China is growing. Could neighbouring India, which has a similar population size and rate of economic growth, be positioned to benefit from the shift?

I believe this is not a realistic expectation. Understanding why requires a quick recap of India’s industrial history.

Constructing — and dismantling — the socialist edifice

In the decades after India gained independence in 1947, while East Asia was opening up to the rest of the world, Indian manufacturing stagnated under a series of protectionist trade policies and a socialist industrial model that stifled competition, discouraged innovation and encouraged downsizing rather than expansion. Labour was protected to the point of dysfunction, while education and skills languished in the hands of a corrupt and inefficient bureaucracy. India’s location did not help — in a historically poor region far from key sea routes, with poor connections with the West and East Asia.

Reform came in the early 1990s when a spike in oil prices sparked by the Gulf War coincided with a trough in remittances from Indians in the Gulf. With FX reserves for imports and debt servicing running dangerously low, a desperate Indian government secured an emergency loan from the International Monetary Fund in 1991. In exchange, the government implemented sweeping reforms to open up the economy.

By the 1980s, India’s growth was accelerating fast. But it was arguably too…

MACRO
Tushar Poddar
Tushar Poddar
PhD
Macro Strategist
London

When I think of “old school” emerging markets (EMs), I think of Mexico. What started out as an exercise to determine if Mexico could be a “Biden trade” soon turned into my belief that some Mexican equities could perform well going forward regardless of the election outcome.

Mexico is not a “COVID reopening” trade, in my view, because President Andrés Manuel López Obrador (AMLO) neither locked the country down aggressively amid the pandemic, nor took any bold steps to stimulate the market. In fact, by not pursuing deficit spending in response to COVID, Mexico’s balance sheet may hold up better than most EMs’ heading into 2021.

More to the point for investors, some Mexican companies appear to be pivoting toward…

MARKETS
THEMES
Jamie Rice
Jamie Rice
CFA
Equity Portfolio Manager
Boston

I was recently asked, “How can you be confident that value investing will work again, when the historical results look so skewed to growth?” It’s a fair question. Looking at the Russell 1000 Growth and Value indices, growth is ahead on a one-, three- five-, 10-, and 30-year basis, and indeed since 1978, when data is first available. Among the most striking results are the one-year returns (37.5% for growth and -5.0% for value) and the 10-year annualized returns (17.3% for growth and 9.9% for value).1

However, these numbers mask how quickly the picture has shifted. As recently as February, value was beating growth since inception. And before the global financial crisis, value was ahead by more than 2% annually over almost three decades since 1978. Perhaps more importantly, there has been a strong cyclicality to the performance of growth and value that makes some “extreme” periods seem a bit more ordinary.

Haven’t we been here before?

In 1999 and 2000, growth was beating value since inception — and on a trailing one-, three-, five-, 10- and 20-year basis. Then, too, investors were asking, “Is value dead?” But value was…

MARKETS
Adam Berger
Adam Berger
CFA
Multi-Asset Strategist
Boston

1. When might a COVID vaccine become available?

In light of the recent positive news on the COVID vaccine front, it is possible that a vaccine could be authorized for use in the US as early as late 2020. Additional vaccines could be authorized or approved during the first quarter of 2021.

The logistics of vaccine distribution will be daunting. Under Operation Warp Speed, vaccine developers have already been manufacturing vaccine inventory at some risk, in anticipation of favorable efficacy and safety data. Nevertheless, the immediate demand will likely far exceed the initial supply.

Priority will be given to high-risk health care workers and first responders; then to people of all ages with comorbid conditions that put them at elevated risk of poor outcomes, along with older adults living in crowded circumstances; then to all adults over age 65; and so on. It’s likely to be well into 2021 before everyone in the US can be offered a vaccine.

2. What’s the prognosis for those infected?

It’s a moving target and depends on several factors, including the underlying health and age of the patient, the ever-improving medical knowledge of optimal case management, and the availability of medications active against the virus.

The observed death rate from COVID-19 has dropped considerably since the pandemic first reached the US and now stands at…

CORONAVIRUS
THEMES
Bob Deresiewicz
Bob Deresiewicz
MD
Global Industry Analyst
Boston
Wen Shi
PhD, CFA
Global Industry Analyst
Boston, MA

The short answer is not right now, but potentially down the road. And I believe it’s less about how high inflation can go than it is about the portfolio implications of even moderately higher global inflation, which investors haven’t experienced for most of the past 30 years.

It may seem odd to talk about inflation these days. However, the substantial level of coordination between monetary and fiscal policymaking following the COVID-19 shock, with many central banks providing ample space for fiscal stimuli by buying up newly issued debt, has led to inflation coming up in many discussions with clients lately. A string of recent data releases has also helped put inflation risk back on some clients’ radars.

Nonetheless, I think it’s fair to say that many clients remain to be convinced that inflation poses a real threat to their investment portfolios, particularly because…

MACRO
Nick Samouilhan
Nick Samouilhan
PhD, CFA
Multi-Asset Strategist
Singapore

Did you know?

  • Renewables are expected to meet nearly 30% of power demand in 2023.1
  • Efficient production and use of materials could help cut CO2 emissions by 25 gigatons.2
  • The world consumed 92.1 billion tons of material in 2017.3

Amid recent natural disasters and growing awareness, climate change has become a focus of social discourse, and we believe the ranks of market participants seeking solutions are growing. Many impact issuers contribute to environmental sustainability and help society better prepare for climate change. Here we share some of the environmental and climate-related innovations we are…

SUSTAINABILITY
Tara Stilwell
Tara Stilwell
CFA
Equity Portfolio Manager
Boston
Campe Goodman
Campe Goodman
CFA
Fixed Income Portfolio Manager
Boston

The US election is just days away. Voting has begun in earnest and markets are on tenterhooks. Here are our latest thoughts, including how investors might position for November and beyond.

Who’s afraid of the big, bad blue wave?

There’s been a marked shift in the perception that a blue-wave outcome — where Democrats win the White House and both chambers of Congress — would be the “worst-case scenario” for financial markets. That’s because the current impasse in getting another fiscal stimulus package passed would likely be broken with both chambers controlled by Democrats, paving the way for passage of a large stimulus package worth around US$2 – 3 trillion. (See October 8 blog post, Who’s afraid of the big, bad blue wave?, for additional thoughts on that.)

How we’re interpreting the polls

As of this writing, former Vice President Biden retains an Electoral College advantage, with…

 

2020 US ELECTION
Nanette Abuhoff Jacobson
Nanette Abuhoff Jacobson
Global Investment and Multi-Asset Strategist
Boston
Michael Medeiros
Michael Medeiros
CFA
Macro Strategist
Boston

With the prospect of a Democratic sweep looking more and more plausible with each passing day leading up to the US election, some observers note that such an outcome could usher in major policy shifts in taxation, health care, energy, and perhaps tech regulation for 2021 and beyond. Should investors start repositioning their portfolios accordingly? Not so fast.

Nick Petrucelli’s macro insights

I tend to be skeptical of government policy-driven trades playing out to the extent that financial markets often anticipate. Indeed, there have been several political changes in recent years whose impact on assets has turned out to be fleeting and, in some cases, just the opposite of…

2020 US ELECTION
MARKETS
Nick Petrucelli
Nick Petrucelli
CFA
Portfolio Manager
Boston
David Lundgren
David Lundgren
CMT, CFA
Director of Technical Analysis
Boston

I was strongly bullish on Russian equities for most of 2020, but have become decidedly more cautious on the market of late. Why? Potential controversy around the upcoming US election is one reason, but there’s more to the story.

First, the good news

I recently spoke with 16 Russian companies across the financial services, internet, telecom, retail, steel, and oil & gas industries. The good news is that Russia’s economic activity is rebounding, while both corporate and consumer sentiment are inching higher. In addition, the risk of a second COVID-19 wave hitting Russia appears to be relatively low as of this writing. Here’s a cross-section of the sanguine comments I’ve heard from company executives lately…

2020 US ELECTION
MACRO
Jamie Rice
Jamie Rice
CFA
Equity Portfolio Manager
Boston

The US Federal Reserve’s (Fed’s) recent adjustments to its monetary policy framework are impactful for short-term investor returns, affirming our expectation that short-end interest rates will likely remain at or near zero for at least the foreseeable future. This brings short investors back to the dilemma many knew all too well post-2008: With most deposits and money market funds earning next to nothing in yield, how should I invest my liquid and reserve assets?

For clients’ second-tier cash bucket (reserves or excess liquidity), here are three suggestions to modestly increase income without adding significant risk.

1. Increase duration flexibility for excess reserves

Money market funds are governed by strict rules that limit the investable universe. There has also been a surge of inflows into money markets (Figure 1), further suppressing potential income from assets meeting the money market criteria. Thus, we believe expanding one’s opportunity set beyond the traditional money market rules — while still remaining on the short end — may…

MARKETS
THEMES
Caroline Casavant
Caroline Casavant
Investment Analyst
Boston
Andrew Bayerl
Andrew Bayerl
CFA, CAIA
Investment Director
Boston

The short answer is that they up and left, at least judging by the percentage of value managers (80%) that were recently underweight value stocks (Figure 1). Some observers may offer reasonable arguments for why such positioning seems justified in the current environment, but the fact is that value equity managers have traditionally tended to lean into relative valuation extremes like today’s. Instead, most are leaning away.

Figure 1

Opportunity in value stocks? 80% of value managers were recently underweight the group

Déjà vu all over again?

This calls to mind a 20-year-old quote from retired Wellington Portfolio Manager Ed Owens that is relevant again today. In January 2000, Ed opined that “value is particularly attractive now, because it has…

MARKETS
Andrew Corry
Andrew Corry
CFA
Equity Portfolio Manager
Boston

The upcoming US election is arguably the biggest near-term risk facing global markets right now. Questions continue to swirl around both the election process and the potential outcome, not to mention the looming specter of post-election controversy if it appears that President Trump has lost. The large number of mail-in ballots could mean delayed results and legal challenges, perhaps even civil unrest.

In addition, risk markets would be inclined to initially react poorly to a “blue-wave” scenario where Democrats win the White House and control both houses of Congress, which would likely pave the way for higher corporate taxes and increased government regulation. As of this writing, that looks to be a…

2020 US ELECTION
MACRO
Nanette Abuhoff Jacobson
Nanette Abuhoff Jacobson
Global Investment and Multi-Asset Strategist
Boston

Baseball legend Yogi Berra famously remarked that “it’s tough to make predictions, especially about the future.” Political elections are no exception, of course. But as difficult as forecasting an election can be, predicting market reactions is arguably even more challenging. That being said, with the 2020 US elections only a few weeks away, now seems an opportune time to think through the various potential outcomes and their implications for fixed income and currency markets.

While most market participants are focused on the presidential election, which party controls the Senate is of equal importance in the event of a Biden victory; it matters less under a Trump presidency given that Democrats control the House of Representatives, with little chance of a flip there. Thus, the three possible outcomes to consider are…

2020 US ELECTION
MACRO
Brij Khurana
Brij Khurana
Fixed Income Portfolio Manager
Boston
Joe Marvan
Joseph Marvan
Fixed Income Portfolio Manager
Boston

With the US elections only a few weeks away and Democratic nominee Joe Biden holding onto a comfortable lead in most polls, the prospect of a so-called “blue-wave” scenario — where Democrats win the White House and seize control of both houses of Congress — looks more and more plausible with each passing day. (Granted, polls are notoriously fickle and a few weeks is an eternity in politics; anything could still happen between now and November 3.)

Many investors are wary of a blue-wave outcome, fearing it would spell bad news for the US economy and markets. But would it really? After taking a closer look…

2020 US ELECTION
MARKETS
Michael Medeiros
Michael Medeiros
CFA
Macro Strategist
Boston

While the UK equity market appears attractively valued and has the potential for a rebound, I remain neutral on UK equities for now as I believe the uncertain political outlook provides a poor basis for active risk taking. In essence, the outcome of the Brexit negotiations is hard to judge, and a non-cooperative outcome could prove highly disruptive for the UK economy and equities. In my view, this risk is not priced into the market at present.

The UK has had a poor COVID crisis

The UK’s health and economic outcomes have been in line with the worst in Europe, and managing this twin crisis will remain problematic in the near term. At the same time, the UK faces longer-term challenges, such as changes in the migration framework, a sharp rise in minimum wages and the perennial issues of low productivity growth and a large current-account deficit. Together, these near-term and structural challenges create a…

CORONAVIRUS
MARKETS
Jens Larsen headshot
Jens Larsen
PhD
Macro Strategist
London

I think the US Federal Reserve (Fed)’s newly unveiled framework for its long-run goals and monetary policy strategy, combined with its recent statements, signals a fundamental change in how the central bank will conduct monetary policy from here on.

Prior to the 2008 financial crisis, the Fed would tend to hike interest rates when the unemployment rate fell below NAIRU.1 The Fed’s latest statement made clear that this is no longer a sufficient reason to raise rates, unless accompanied by inflation exceeding its target in order to deliver a 2% average inflation rate.

A closer look at the new framework

In general, the communique was dovish in that the Fed is basically saying that it will need to see both low unemployment and above-target inflation before it will consider hiking rates. The Fed’s policy rate is likely going to be…

MACRO
Brij Khurana
Brij Khurana
Fixed Income Portfolio Manager
Boston
Climate 101 is an ongoing series designed to enhance basic understanding of climate change, including terminology and concepts, and to communicate our current research themes.

Author and financial commentator Nassim Taleb introduced the concept of black swans, rare occurrences — often macro or market shocks — viewed after the fact as obvious or bound to happen, but that were difficult to predict or prepare for. Carbon prices may be black-swan-like for their potentially substantial impact on markets coupled with a lack of collective preparation or understanding. Let’s call them green swans.

What are carbon prices and why do they matter?

Carbon prices are costs, or taxes, placed on each metric ton of CO2 produced. The objective of a carbon price — derived via regulation or the market — is to…

SUSTAINABILITY
Alan Hsu
Alan Hsu
Global Industry Analyst
Boston

Did you know?

  • A 10% increase in mobile broadband adoption may correlate with up to 2.8% increase in GDP.1
  • Each grade a child completes may raise his or her earning potential as an adult by 10%.2
  • Small businesses employ 50% of workers worldwide and create seven of 10 jobs in emerging markets.3
  • By some estimates, cybercrime costs an estimated US$600 billion annually, or nearly 1% of global GDP.4

In many ways, these are the modern essentials: broadband internet and mobile technology; online education and financial services; and home, workplace, and product safety. These products and services help people climb the socioeconomic ladder, become more productive and competitive, and contribute to economic growth.

Digital divide

Internet access can make getting an education or a job or accessing financial services easier by increasing users’ productivity, providing agency, lowering costs, and enabling transparency. In many countries, the digital gaps between rich and poor, and between men and women are still…

SUSTAINABILITY
Tara Stilwell
Tara Stilwell
CFA
Equity Portfolio Manager
Boston
Campe Goodman
Campe Goodman
CFA
Fixed Income Portfolio Manager
Boston

While economic activity is likely to recover slowly in the euro area, I believe the risk of a much worse outcome has abated. Improved macroeconomic policy should lead to a stronger recovery, driving further reductions in the valuation gap between US and euro-area stocks.

The COVID-19 crisis has caused a deep recession in the eurozone, and I don’t expect activity to return to end-2019 levels until mid-2022. A recession of this magnitude leaves many kinds of economic scars. Jobs and businesses are destroyed, and the necessary reallocation of labour and capital is expensive and takes time. Balance sheets are damaged as a result of falling incomes, and the continued uncertainty constrains investment and consumption.

On the plus side, I believe Europe’s management of the health crisis and the economic policy response have been strong enough to substantially reduce downside risks to…

CORONAVIRUS
MARKETS
Jens Larsen headshot
Jens Larsen
PhD
Macro Strategist
London

Citing consumer welfare and competition concerns, a rising chorus of voices is calling for more government regulation of the most dominant players in the US technology sector. As recently as late 2019, the co-founder of one household tech name even opined that government should step in and regulate the tech giants. The sector’s perceived impact on the upcoming national elections has helped fuel what some observers describe as growing “anti-big-tech” fervor.

So, what might come of it? It depends who you ask, but in my view, probably not a lot. I think federal privacy legislation will be on the roadmap if an agreement can be reached, but changes to antitrust law and/or content regulation seem…

THEMES
Brian Barbetta
Global Industry Analyst
Boston

COVID-19 impact on global supply chains

Localization. Digitization. Industrial protectionism. In the wake of COVID-19, the world is eager to form more resilient supply chains. These efforts could affect a range of industries as well as fiscal and monetary policy. In this 17-minute audiocast, Geopolitical Strategist Thomas Mucha speaks with members of our Global Macro Team about the future of global supply chains.

video-iframe

CORONAVIRUS
MACRO
Juhi Dhawan headshot
Juhi Dhawan
PhD
Macro Strategist
Boston
Jens Larsen headshot
Jens Larsen
PhD
Macro Strategist
London
Thomas Mucha
Thomas Mucha
Geopolitical Strategist
Boston

The US Commodity Futures Trading Commission (CFTC) just released a report entitled “Managing Climate Risk in the U.S. Financial System.” The CFTC’s Climate-Related Market Risk Subcommittee, of which I am a member, began working on this project late last year. Our goal was to drive recommendations for mitigating and adapting to the physical and transition risks that climate change poses to financial markets.

The subcommittee’s 35 experts represent a range of industries, including financial markets, agricultural and energy markets, data and intelligence service providers, the environmental and sustainability public-interest sector, and academic disciplines. This disparate group voted unanimously to approve the release of the report.

Among the key findings for financial markets are that climate change poses a “major risk to the stability of the US financial system” and the American economy, and that the US should…

SUSTAINABILITY
Chris Goolgasian
Chris Goolgasian
CFA, CPA, CAIA
Director of Climate Research
Boston

The Federal Open Market Committee’s (FOMC)’s September statement and press conference did not deliver any big surprises. The upshot is that the US Federal Reserve (Fed) appears to be committed to maintaining its “dovish” monetary policy stance for the foreseeable future.

Look no further than the Summary of Economic Projections (SEP), released in conjunction with the FOMC meeting minutes, in which the majority of participants indicated that Fed policy rates should remain around zero through 2023. This was largely expected, given the recent shift in the Fed’s inflation framework: Whereas the Fed has historically targeted an average inflation rate of 2% over time, under the new framework, the Fed could allow inflation to…

MACRO
Jeremy Forster
Fixed Income Portfolio Manager
Boston
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