The Bid podcast

Episode 5: U.S. recession? Not quite

Ten years after the global financial crisis, markets have had a bumpy ride. Investors are starting to ask: is a recession on the horizon, or do we still have a ways to go? Richard Turnill, Chief Investment Strategist for the BlackRock Investment Institute, discusses why he’s still optimistic for the year ahead.

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    OSCAR PULIDO: It’s been ten years since the last U.S. recession, and while it’s nearly impossible to think of 2008 without also thinking about the financial crisis, it was also a year of growth and innovation. 2008 was the year that the iPhone 3G launched, helping make GPS accessible to more and more people. It was also the year that the Android operating system launched, the year America elected its first African-American president and the year that Michael Phelps set records at the Beijing Olympics. 2008 wasn’t just a year of struggle, it was also a year of human and technological advancements. So I wanted to find out, where were you in 2008?

    Where were you in 2008?

    MAN 1: I was a sophomore in high school. The one thing I remember from that year is, I used to wake up every morning early enough to read the newspaper when I was eating breakfast. And I remember one day, getting the paper off the driveway, and coming inside and opening it up, and on the front page, this was like March of 2008, it just said something about Bear Stearns, you know, going under, JPMorgan acquiring like overnight. I was like, I have no idea what Bear Stearns is, but this is weird. And so I just kept reading, and it was kind of interesting. Little did I know that was the tip of the iceberg of what was about to unfold.

    WOMAN 1: I was in Shanghai in 2008. I was working as a financial journalist, I covered the coal industry. I went down to a city in the Southern Province of Guangdong, China, which is a manufacturing base. I found factories that had closed, and workers that had been laid off and trying to find their unpaid salary. To us, it was a very interesting, sort of, I wouldn’t say precursor, but it gave us a view of something is happening there, but we don’t know what exactly was happening yet.

    MAN 2: I was working at Pepsi, and we were working on the renegotiation of our deal with the NFL. And at the time, the NFL had the highest TV ratings. And, you know, despite what was happening on a global scale in the financial markets, that one event, particularly the Super Bowl, continued to grow. For me, it was a beacon of optimism at that particular time.

    OSCAR PULIDO: Ten years later, financial markets have recovered substantially and the economy is in far better shape. But 2018 was a bumpy year for markets and we’re starting to ask ourselves a question: is a recession on the horizon, or do we still have a ways to go? On this episode of The Bid, we’ll get to the heart of this question with Richard Turnill, Chief Investment Strategist for the BlackRock Investment Institute. We’ll discuss what will drive markets in 2019, how to think about investing in times of uncertainty, and what has Richard most excited for the year ahead. I’m your host, Oscar Pulido. We hope you enjoy.

    Richard, thank you so much for joining us today.

    RICHARD TURNILL: My pleasure, thank you for inviting me.

    OSCAR PULIDO: Richard, let’s start by level setting a bit here, take our listeners behind the scenes. What is the BlackRock Investment Institute and how do you go about forming your views on the market?

    RICHARD TURNILL: The BlackRock Investment Institute is a function within BlackRock. It’s set up really to help our portfolio managers become better portfolio managers, better investors, but also to produce thought provoking investment insights for our clients. And we produce those insights both by originating work ourselves, examples this year would include work we’ve done on sustainable investing, on geopolitics, on the economic cycle, but we also work very closely with the asset class experts we have across all asset classes – equities, fixed income, alternatives – really to determine where BlackRock has an edge, where BlackRock has something not say, and to bring that to our clients with clear, actionable views.

    OSCAR PULIDO: We’re kicking off 2019 with our Global Investment Outlook. I’d like us to talk more about the three themes that you outlined in that outlook, but before we go into our views on the year ahead, let’s rewind a bit. 2018 could not have been more different than 2017. In 2017, stocks were routinely hitting new highs, growth was strong, particularly in the U.S., and it seemed pretty easy to be an investor. On the other hand, 2018 was marked by increased volatility and more muted returns. Richard, when you look back at 2018, what’s been the biggest driver of markets?

    RICHARD TURNILL: We fully agree that 2018 was a very tough year for investors; we’ve seen negative returns both in terms of equities and fixed income, globally. We see a couple of big drivers of markets last year. The first was the Fed in terms of continually raising interest rates, making cash a viable asset class competing for capital again, and as a result of that, having an impact on all investments. But the other factor turned out to be uncertainty associated with geopolitical risk. And actually I think one of the strongest messages our own measures of geopolitical risk – we produce a Geopolitical Risk Indicator – really tracked very closely the movement in markets. This rise in risk associated particularly with trade, also to some extent, with European fragmentation risk, that led investors to become much more cautious, much more uncertain. And it was that rise in uncertainty that in our views, was the key driver of market returns in 2018.

    OSCAR PULIDO: So if rising uncertainty, particularly geopolitical was the biggest driver of 2018, what do you think is going to be the biggest driver of markets in 2019? Perhaps you can talk a bit about the three themes you outline?

    RICHARD TURNILL: So we look forward to 2019, then, the first thing to say is geopolitical risk is still likely to be with us. But what we expect to be the key driver going forward is growth, and that leads us to the three themes that we see really moving markets in the year ahead. The first of those is that we expect to enter a late cycle growth slowdown, where the U.S. economy in particular, which delivered very strong growth in 2018, is set to slow. We’re already seeing slowdowns in other parts of the world such as Europe, and we expect to see growth come down much closer to its long term average around the world. The second theme is that we expect the Fed to pause interest rates as interest rates approach neutral. So big difference in 2018, where we saw the Fed persistently raising interest rates, as the level of interest rates gets closer to the long run, neutral level, we expect the Fed to signal a pause, and to wait and see just to what extent the growth slowdown is going to take hold. And then then the third and final theme is the need to better balance risk and reward in portfolios. This is likely to be another year of uncertainty, another year of volatility, and our views it that you want to have safe assets such as fixed income on one side of your portfolio to cushion you for that uncertainty, and then really take risk in those assets where you are being paid to take risks and where you see upside reward, and that would include U.S. and emerging market stocks.

    OSCAR PULIDO: Richard, you mentioned the term growth slowdown. It seems like markets and investors are increasingly worried about the next downturn, we’re starting to hear the word “recession” a little bit more these days. There’s been headlines around the yield curve inverting, we mentioned higher volatility before. So actually the question is, will there be a recession in 2019?

    RICHARD TURNILL: We see a very low probability of recession in 2019. Actually we’ve put some numbers in that, we see less than a 20 percent chance of recession in 2019. And why is that? Well in part, that is because the U.S. economy is entering the year with good momentum, good strong growth, and on top of that, we don’t see financial conditions as tight. The level of interest rates in the U.S. is still low in any historic context, and we don’t see the financial vulnerability, so for example, the level of very high leverage we saw in some parts of the market going into previous recessions. We don’t see those financial vulnerabilities there. So for the year ahead, we see low probability of recession. A growth slowdown, but low probability of recession. I think what markets needs to focus on is as we look beyond 2019, particularly to 2020 and 2021, as fiscal policy starts to tighten in the U.S., that risk of recession starts to rise quite materially.

    OSCAR PULIDO: So it sounds like at least in the near term, you’re still relatively upbeat on the U.S. economy, we need to start thinking about risk as we go into 2020 and beyond. Sticking on the U.S. for a second though, U.S. stocks have been leading the charge in terms of asset class returns, for much of the last five to ten years. Do you still think that is going to be the case? You mentioned cash starting to be a very viable alternative, so where are you more optimistic about asset class returns? Is it still the U.S. or are there other areas of opportunity?

    RICHARD TURNILL: We still believe the U.S. can lead the way in 2019. Actually these periods of late cycle slowdown, when growth slows as you get towards the latter stages of an economic cycle, actually historically, those periods have actually been good periods for stocks. The reasons for that are actually you typically get a potential Fed pause, and importantly, we still look for growth in the U.S. economy of above two percent in the year ahead – and that’s GDP growth – and that translates into earnings growth of mid to high single digits, and in that environment, with the Fed pausing, that still creates an environment where our base case would still be low, but positive returns from U.S. stocks in the year ahead. And it’s worth reflecting that the U.S. economy is one of what we think of as the highest quality economies, has a quality stock market, in the world, and where we have the greatest confidence on those growth expectations being met, in what is likely to be a much more challenging global environment in the year ahead.

    OSCAR PULIDO: Richard, it seems like we can’t talk about U.S. stocks without talking about the technology sector, certainly one of those sectors that got the most attention last year. We had news around privacy concerns, we’ve had ongoing headlines around trade tensions with China. Do you think technology stocks will bounce back here, or will it be another bumpy ride for investors in that sector?

    RICHARD TURNILL: Our view is investors need to be more selective within technology going forward. We’ve had a great ride for technology stocks for many years, but we’ve now got a number of headwinds. We’re seeing regulatory pressure around the tech sector, we’re seeing the tech sector buffeted by trade concerns and the battle for technology dominance between U.S. and China, and we’ve got some headwinds around what we describe as crowded positioning, technology has become a well-loved sector as a result of its very strong performance over the years. So as a result of those factors, we think that technology can still do well, but it’s going to be more about picking your spots within the tech sector rather than just holding the sector in aggregate. So for example, we’d still favor the software sector where we see strong secular growth at enterprise spending, around software, and where the valuation reset you’ve seen in the last few months has created much less of a valuation headwind going forward. So overall, I think a bumpy ride for tech, but still some very attractive opportunities within the tech sector.

    OSCAR PULIDO: And so if you’re more cautious on tech, albeit you do see some opportunities, but it sounds like the tone changing slightly, what sector are you most excited about in 2019?

    RICHARD TURNILL: The sector we see the greatest potential for, and we would have the highest conviction, is actually the pharmaceutical sector. And we see a number of positives there. So the first is that pharmaceuticals trade at a significant valuation discount. What does that mean? That means they’re cheaper than other traditional defensive sectors such as staples and utilities. But yet they have very strong balance sheets and they have very strong fundamentals. What do I mean by fundamentals? I mean, strong earnings growth driven by demographic trends, and visibility on that earnings growth, so a lack of patent cliffs, for example. And importantly, the pharmaceutical sector tends to be somewhat less exposed to the economic cycle than many other sectors, so less vulnerable in the scenario of a gradual slowdown in growth that we see going forward. It offers that attractive, long term growth drivers at reasonable valuations, but without the economic sensitivity. So we see very attractive opportunities within that sector.

    OSCAR PULIDO: Richard, in March, so just a few months from now, we’re going to hit ten years since the beginning of the bull market that began back in March of 2009. And we’ve been talking about markets and your views on the year ahead, but what does it mean for investors right now? How should we think about investing almost ten years since the beginning of the bull market at this point in the cycle? You touched on the theme of balancing risk and reward.

    RICHARD TURNILL: One important message is you really shouldn’t measure bull markets in terms of the years, in terms of age. Really what you want to focus on are where are the signs that the bull market is getting tired? Where are the signs that it’s potentially coming to an end? So you’re right, this has been a very long bull market, but it started at a very extreme level, after the global financial crisis. So it’s been recovering for some time. So when we think about investing now, what we have to take into account is the outlook for growth. We mentioned we were entering that late cycle slowdown phase. We have to think about risks in terms of monetary policy, the good news is we see the Fed pausing, we see monetary policy and interest rates in the rest of the world, remain very low for some time. And we have to consider valuations. Perhaps one of the most surprising features of this very long bull market is actually as yet that bull market has not led to extreme valuations. So when we look forward, we still think this is a market which is positioned for positive returns going forward, but risks arising. And volatility is likely to remain high. So what does that mean? It means you need to better balance risk and reward. So on one hand, one side of that equation, you want to have assets which protect you from any unforeseeable shocks going forward, whether that’s a trade shock or the economic cycle slowing more rapidly than we expect, and bonds play that role in a client portfolio. And actually we’ve seen it over the last two or three months, as markets have become more concerned about the growth outlook, just how well bonds have protected many investors’ portfolios from that volatility. But bond yields are still low, and what that means is on the other side, you want to own those assets where you believe you’re being paid to take risk. And there again, you want to be selective about where you’re really being paid to take risk. And we focus on two areas geographically. So one is U.S. stocks, we’ve already talked about that, we see the U.S. as being a resilient economy; the other is emerging markets. So why emerging markets? Well, first of all, many emerging markets have just had their recession, so many investors are worried about an upcoming recession in developed markets, but actually many emerging markets are in the early recovery phases from a recession. On top of that, they benefit from any pause in U.S. interest rates, and perhaps most importantly, you’ve had a significant resetting of valuations. And for investors who are able to take a long term view, we believe that emerging market stocks in particular, particularly those in Asia, offer attractive compensation for risk for what are still risky assets. There is likely to be volatility but you’re being paid to take that risk right now.

    OSCAR PULIDO: Just on that last point Richard, a quick follow up, it seems that we can’t go much time without reading a U.S./China headline, China being the biggest emerging market. But you’re saying that there is opportunity in emerging market stocks despite the fact that we still might have these trade headlines that cross the wires all the time.

    RICHARD TURNILL: That’s exactly right, and that is partly because you’ve seen the valuations of many assets exposed to those trade headlines reset, so the Chinese market is a good example. It’s now trading on 11 times earnings. China actually had an earnings recession in 2018, and actually what we’re seeing is the beginning of China rebounding from that, actually both signs that economic growth is starting to stabilize in China and actually we expect that the easing we’ve seen in both Chinese monetary and fiscal policy to impact the economy as we go through 2019 and see growth stabilize, but we’re seeing earnings growth already starting to bounce back. So again, that doesn’t mean there aren’t risk associated with emerging markets, there certainly are, and we expect those trade headwinds to be there for some time. But we want to focus on where you’re being paid to take those risks, and where we see some potential catalysts and actually China is an example of that.

    OSCAR PULIDO: Richard, before we go, I thought we’d have a little bit of fun here. I’d like to end with rapid-fire round. I’m going to ask you a series of questions that I’d like you to answer in just one sentence, if you’re ready for that.

    RICHARD TURNILL: I’ll do my best, Oscar.

    OSCAR PULIDO: Okay. All right, I’ve got a couple here for you. What’s going to happen to stock markets this year?

    RICHARD TURNILL: So, we’ll go for low returns but higher volatility. This is an environment where you should expect to get good returns from stocks in terms of high earnings growth, but given all the uncertainties we’ve talked about, you should expect that volatility will remain high; there will be some drawdowns along the way.

    OSCAR PULIDO: Okay. What is the next bubble in markets?

    RICHARD TURNILL: Well, I’ll answer this one even more concisely. I just don’t see a bubble in markets right now. One of the extraordinary features of this very long bull market is that it yet just hasn’t created any significant excesses. And when we look across the valuations of all assets, whether that’s fixed income assets or equities or private markets, we see some areas where valuations are high, but we see nothing today near bubble territory.

    OSCAR PULIDO: We’ve talked about China a few times, so will China be the world’s largest economy in 2050?

    RICHARD TURNILL: So I’ll just go for yes. For China to get there, that implies Chinese growth of around three and a half percent per annum over the next 30 years. Today, China is growing around six percent. So actually I think it’s very likely that China will be the world’s largest economy by 2050, and actually, potentially much sooner.

    OSCAR PULIDO: If you had one dollar, or in fairness, you’re in the UK, or one pound sterling to allocate, where would you put it?

    RICHARD TURNILL: I’m going to actually give you a broader answer here, because my view is that if you are making an investment decision today, you shouldn’t put that dollar or that pound into just a single asset class. What actually matters is that you have got a portfolio which is balanced between risk and reward, and reflects your investment outlook. So my answer is I’m going to put that one dollar into a well-diversified portfolio, which balances my risk between equity upside on one hand, and fixed income protection on the other.

    OSCAR PULIDO: And last but not least, 2019 will be the year of…

    RICHARD TURNILL: This is going to be the year of the driverless taxi, Oscar, because I think technology disruption is something we’ve touched on, but tech disruption is escalating and it’s having a bigger and bigger impact on all parts of financial markets. And one of the big headline events to look out for this year is the widespread use of driverless taxis for the first time. AI is coming.

    OSCAR PULIDO: Well, hopefully we’ll have a lot of passengers in those driverless taxis listening to your outlook on 2019. Richard, thank you so much for joining us today. It’s been a pleasure having you.

    RICHARD TURNILL: My pleasure, Oscar.

    OSCAR PULIDO: We’ll see you next time on The Bid.

2019 Global investment outlook
We see growth in the global economy and corporate earnings slowing. Greater uncertainty calls for balancing risk and reward in portfolios.
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