How Are Institutional Investors Viewing the Covid-19 Recovery?

Dwek: I think your last point is exactly it – there are a lot of regional differences. We have started to see growth divergences, with Asia clearly in the lead. The Chinese economy is expected to post positive growth for 2020 as a whole – probably one of the very few countries to do that. We know it takes time to get back to normal. Asia in 2021 is possible, the US probably more likely 2022, Europe will be 2023 and beyond.

Janasiewicz: From a business and a household perspective, that spending pattern matters the most. Specifically, in the United States, about 70 percent of the economy is driven by consumption and domestic demand. The US growth engine is highly dependent on the US consumer and that consumption pattern. If you extrapolate that out to the entire world, with China and the US being the global growth engines, you can see how important that is to the global backdrop. I think there’s quite a bit of pent-up demand waiting to be unleashed in here.

The economic numbers have been largely driven by the goods-producing side of the equation. I think when we start to get to that reopen theme, as the economy starts to return to normal, that shift will then go to the services sector side, but the bottom line here is that spending does matter.

Janasiewicz: I think the general trajectory of the stock market does have to fall back on the growth prospects, but shorter-term cycles within the stock market can deviate quite a bit. I think the big thing to hammer home on that difference is the composition of the equity markets. Typically, the S&P 500^® is much more manufacturing-driven, whereas the US economy is much more services-driven.

That means the goods-producing side of the equation still held up, which was good for corporate profits, which is why the S&P held up. Whereas the economic backdrop struggled with lockdowns, because the services side got hit pretty hard – but the services sector really doesn’t flow through to corporate profits, and that’s the bigger driver here with the S&P 500^®.

Janasiewicz: When I look at the number of people that are calling for a correction, as a strategist I think that’s a good sign, because that keeps that risk appetite in check. When everybody’s on the same page, everybody’s optimistic, everybody’s bullish, sentiment is getting extended, that’s when I start to get a little worried, because at that point, maybe the marginal dollar’s already into the market.

Dwek: That’s exactly it. Especially when you look at the performance in the last month or so with the vaccine news, with the US elections behind us, there’s a lot of optimism that’s embedded in the markets, and a constructive view that Jack and I still hold has definitely become much more consensus now. That consensus view is maybe what worries us.

There’s still trillions of dollars sitting in money markets, plenty of people who’ve missed the rally, so it’s going to be a question of the fundamentals holding up. So far they’re very strong, with ongoing support from central banks, which is pretty much a given at this point. We’re waiting for US fiscal stimulus, which looks like it’s going to come in the next month or so. It’s rare to see such a recovery so quickly after a crisis on the scale we’ve seen. But that’s also one of the reasons people think at some point, something’s got to give, and we’re going to have another downturn. But there’s all this cash on the sidelines, and that probably limits corrections as well.

Dwek: We’ve seen growth outperform for a number of years and we’ve seen that go almost to an extreme throughout the crisis, with technology, healthcare, and communication services proving defensive earnings, proving resiliency – huge outperformance.

But we’ve started to see a rotation already with the optimism about the recovery in 2021. You’re seeing people move back into cyclicals – whether you want to call it the reopening trade, the catch-up trade, the value trade, the cyclicals trade – ultimately we’re seeing this rotation come through and a bit of a move from the US to non-US.

I think it comes back to valuations. You have some people thinking – are some of these stocks too expensive for what I’m getting? Ultimately, when you’re expecting this type of rotation, or you’re thinking that you’re going to get more dispersion in the returns, it’s better for active management. Some names have really run up this year, and people think maybe fundamentals haven’t quite followed. Investors are hoping to have that active manager pick and choose those opportunities and those winners where you’re still getting a good deal compared to intrinsic value.

Janasiewicz: I have a little bit of a different take on valuations. To me, valuations are an opinion – we all have an opinion – you might be right, I might be right. The truth probably lies somewhere in the middle. I think the overriding factor is risk appetite. Risk appetite is what drives the market. We can overshoot in significant ways on valuations if risk appetite continues to grind higher. If risk appetite continues to remain very strong, we’ll likely overshoot what a lot of people consider expensive valuations.

Dwek: Well, at some point, they need yield. They need income to match liabilities, they need to match long-term commitments. Yield is going to be the biggest question for institutional investors. On the sovereign side, we’d expect yields to rise gradually as things reopen. In investment grade, you pick up a bit more yield, but there can be regulatory constraints. I personally like emerging market hard currencies. Local currencies should do well against the dollar, but you’re taking on a bit more volatility and you do have to be pretty selective. But we’re also seeing this move towards private assets, and I think that’s only going to grow in the coming years.

Dwek: Not a surprise. We’ve seen institutions leading the way towards ESG-related investments. We also saw a lot of these ESG strategies broadly outperform throughout the downturn in the spring. You’re seeing a bit of a regulatory push, at least in Europe, towards ESG as well. I think more and more investors don’t feel like they have to choose between ethics and performance, and that’s only going to reinforce the move towards ESG strategies.