Insights from the panelists at our annual roundtable
For seven years and counting, U.S. investors have lived in a financial paradox—fretting about slow economic growth while watching stock markets steadily climb. Will a new era of Republican rule add more fuel to the aging bull market, or generate a new kind of uncertainty? To seek clarity for 2017, Fortune convened our annual roundtable of market experts.
This year’s panel included Sarah Ketterer, CEO of Causeway Capital, a $44 billion asset-management firm; Sebastien Page, cohead of the asset-allocation group that sets strategy for $147 billion worth of target-date mutual funds at T. Rowe Price; Ann Winblad, cofounder and managing partner of Hummer Winblad Venture Partners, a venture capital firm that has been investing in enterprise software firms since 1989; Krishna Memani, chief investment officer at OppenheimerFunds, which has $219 billion under management; and Heather Kennedy Miner, global head of strategic advisory solutions at Goldman Sachs Asset Management (GS), which manages over $1 trillion. Here, edited excerpts from their discussion.
MATT HEIMER: Let’s start with what people on Wall Street have been calling the Trump Trade. Donald Trump surprised the pundits by winning the U.S. presidential election. Since then, stocks have been rallying and bond prices have fallen pretty sharply. What are investors anticipating and reacting to?
KRISHNA MEMANI: These moves reflect a change in conversation and a change in the tone for the markets. For the longest time we have been talking about disinflation and deflation. All of a sudden somebody comes in and wants to reflate the world. And that has changed the mood for the markets.
HEIMER: Heather, how is your team reacting?
HEATHER KENNEDY MINER: We are certainly looking at this as a regime change. I think that the equity market performance, postelection, really reflects an optimism about growth, particularly about earnings growth and lower taxes.
And to Krishna’s point, the backup in rates is really a reflection of higher inflation expectations. The good news is that business confidence has improved, consumer confidence has improved.
HEIMER: Sebastien, what are you talking about at T. Rowe Price?
SEBASTIEN PAGE: You can take the glass-half-full view or the glass-half-empty. The interesting thing is that the sentiment is going in different
directions for stocks and bonds. The stock market’s implied volatility is down 25% since the election. Bond implied volatility is up 30%. Typically, those indicators are 80% correlated.
So perhaps the Trump Trade is a bit overdone, if you take the glass-half-empty view. And perhaps the market is underestimating the number of shovel-ready projects for fiscal spending, on the one hand, and maybe underestimating the impact of trade restrictions, and in general less immigration, which is not very good for growth.
HEIMER: So these changes in implied volatility essentially mean that investors think that stocks have suddenly become somewhat less risky? And vice versa, bonds more risky?
PAGE: That’s right.
MEMANI: I think bond volatility has gone up because bond volatility was very low to begin with. What the high bond volatility is telling you is we were expecting rates to remain low and constant, and that is not going to be the case anymore.
SARAH KETTERER: What’s more interesting is what’s happening beneath the surface. There’s been this tectonic shift away from more economically defensive companies in consumer staples, utilities, and other interest rate-sensitive stocks—what we call long duration stocks, meaning they pay out cash over long periods. Those have fallen out of favor, and it’s been amplified postelection.
Meanwhile, value stocks, especially the more cyclical, the more financially oriented—this election gave them another boost, which they deserve.
HEIMER: Ann, technology stocks sometimes sit outside the economic cycles we’re discussing. How are the companies that you watch reacting to the election?
ANN WINBLAD: Net neutrality is probably a concern. Immigration plays very heavily, because all of these companies are global. We frequently fund companies that have immigrant cofounders.
We also look ahead to IT budgets. Those have been growing steadily, and the growth of these companies depends upon feeling confidence about other enterprises increasing or maintaining their spending on IT.
Tech investors also really need to look ahead to open IPO windows. We’ve had that window slowly open in 2016. There are a number of great companies that are capable of being public companies in 2017, and the market dynamics will really shape the public markets for new entrants.
MEMANI: I think what has changed with respect to tech companies is slightly more subtle. The markets were assigning very significant premium valuations to those tech companies because nothing else was going to grow in the rest of the world. That has shifted. I think the luster of tech as
being the sole growth arena has kind of come off a little bit. So those valuations have come down.
MINER: To comment specifically on taxes, we calculate that a one-percentage-point decline in the corporate tax rate can drive $1.50 of additional S&P earnings. And so if we’re talking about a corporate tax rate coming from 26% down to 20%, which is a suggestion that’s been made by some in the GOP, that could drive 10 percentage points plus in terms of earnings growth next year.
KETTERER: Not even counting the $2.4 trillion dollars that’s parked overseas. If that’s repatriated, and used to repay debt, for M&A, for capital expenditures, or returned to shareholders in the form of dividends, it could be very stimulative for the economy as well.
PAGE: And the interesting thing is that part of that reduction in the corporate tax rate is to be financed by getting away from interest-rate deduction at the corporate level. Which means that companies that are highly leveraged might not benefit as much as companies that have low levels of debt.
WINBLAD: I was going to comment on Krishna’s point, about the premium given to the fast growers. Clearly we should see growth rates improve in other industries. And we’ll see some of that growth-rate improvement because they are becoming more like tech companies. Look at General Electric as a good example. It effectively is a software company at this point. It started that process five years ago.
But I do think we’ll still see very fast growth in the core tech companies themselves.
HEIMER: Which are the “core” companies?
WINBLAD: McKinsey issued a report saying only about 18% of global enterprises are far into digital transformation. So it means we’ve got most of the planet still trying to digitize everything. Who are the beneficiaries here? The software arms merchants. They’re Amazon (AMZN), Microsoft (MSFT), Google [parent Alphabet] (GOOGL), and to some extent IBM (IBM) as well. Anyone who offers a cloud platform.
Around them are another set of young companies like Atlassian. Atlassian is a company that develops tools to actually write the code. Goldman Sachs has 20,000 developers. And those developers need to write code 30% faster to keep up with their peers who are digitizing the financial services area.
HEIMER: I want to talk about international stocks, in part because you’ve been seeing even more volatility in those markets as people wonder what a Trump administration will do with regard to trade. Sarah, what’s looking interesting to you?
KETTERER: Value stocks are coming back. And the impetus for this has been, in part, the shape of
the yield curve. The U.S. rise in yields has pulled up yields abroad. This is great for banking systems. European companies depend on their banks. They don’t have much of a debt capital market. And as a result, bank health equals corporate health.
So to the degree we could become more stimulative with fiscal policy in this country—accentuated by corporate tax cuts—the ramifications abroad are very positive. And we see this in the recent, really strong rally overseas in bank stocks. The only part of the world that’s more uncertain now is the emerging world, in part due to the very strong U.S. dollar.
MEMANI: Emerging markets may be slightly under pressure at the moment because of expectation
of Trump policies. But from a longer-term perspective, at the end of the day emerging markets are going to be the primary source of global growth for the foreseeable future.
We think the best approach to take with respect to emerging markets is really more about companies than it is about countries. So instead of allocating money to China, what you really want to do is allocate money to fast-growing companies in China. Tech is growing as fast in China, if not faster, as it is in the U.S. in certain sectors. We like Chinese companies like Alibaba (BABA), Tencent; banks in India like HDFC, ICICI; a couple of oil companies in Russia; grocery distributors in Russia.
HEIMER: Heather, what’s your take on looking abroad?
MINER: At Goldman Sachs we have a portfolio-evaluation tool. And we’ve looked at thousands of portfolios of U.S. investment managers. And one of the things that we see very consistently is that many are underweight in emerging markets. The average allocation to EM is about 3%. And if you look at an optimal balanced model, we would suggest around 8%. That familiarity bias, that home bias, I think, is particularly acute in U.S. investors.
HEIMER: Sarah was speaking earlier about a rotation into value stocks. But Sebastien, in the U.S., you are seeing growth stocks as being actually a better buy.
PAGE: Yeah, if you’re looking at growth stocks in the U.S., relative to value, in the large-cap space, they’re quite cheap. Their values were similar in the early ’90s and postcrisis—both periods where growth stocks did quite well following those cheap valuation levels.
But if you step back and ask, “What’s the macro story for growth stocks?” this is where we might defer a little bit. The population in the U.S. that’s 65 and older is expected to go from 13% in 2010 to 20% in 2030. That’s not good for growth. Debt? McKinsey estimates that the total stock of debt globally, household and corporations, over the last 15 years has gone from $88 trillion to $200 trillion. Lots of debt is not good for growth.
MEMANI: I think the point Sebastien’s making is an extraordinarily good one. Let’s not confuse a cyclical upturn in the U.S. economy, and to some extent in the global economy, for resolving the secular issues, the longer-term issues that we face.
Markets are discounting mechanisms. And in those discounting mechanisms, if we were expecting a certain trajectory of growth, and that trajectory got elevated because Donald Trump is now going to spend a trillion dollars and that is going to get that growth higher, we are supposed to mark our assets higher. Over time we will find out if all of this is for real.
HEIMER: Let’s talk about the relationship between technology and growth. In a sense, all large companies are undergoing technological transformation so that they can increase productivity and be more competitive. What industries are starting to benefit?
WINBLAD: Let’s look at the auto industry. The typical revenue per car is about $23,000 dollars. All the car companies have offices in Silicon Valley now. And they all are looking at making the car a platform for services [that can drive more revenue]. There are some very creative ideas here. We had Zipcar many years ago. Now Audi has its own version of Zipcar in Silicon Valley. Subaru has many different services that they’re offering in their newest cars coming out.
Look at health care. UnitedHealth (UNH) has done a great transition with Optum, building a big-data company side by side with a traditional health care company. We look at companies in the other industrial areas where they suddenly now see themselves as an “Internet of things” company. Caterpillar’s (CAT) a great example there. John Deere. It’s almost tractors.com now, not just a tractor, it is a smart vehicle.
Another good example globally is Unilever (UL). Jane Moran, the chief information officer, now calls herself the chief integration officer.
HEIMER: Sarah, of everyone here you’re the one who is doing the most bottom-up stock picking. Tell me how technology is shaping your thinking.
KETTERER: It’s early days, but there are so many innovations to counter this sort of secular gloom. I’d mention Komatsu (KMTUY). Talking to their management in Tokyo, I learned that every single one of those pieces of equipment, whether it be construction equipment or mining equipment, is chip-enabled. So operators know when the equipment needs service. They know what parts are wearing down. All of that data is going to a central location to be analyzed and then sent out and implemented.
HEIMER: The conversation about technology makes me think about the training it takes to ensure that everyone can make the most of it.
MINER: So look, this brings together a lot of this conversation. In the U.S., you’re seeing the outlines of a pretty significant infrastructure plan that can benefit owners of hard assets.
But we’re also quite hopeful that infrastructure and fiscal spending will include programs for softer infrastructure. [That means] thinking about retraining underemployed or unemployed folks back into the new economy.
If we actually get a sizable hard infrastructure program, many industries will benefit. But if we can also get soft infrastructure investment, that can drive higher productivity and, ultimately, drive greater output and reinforce monetary policy. That’s going to have the best output and growth impact for the economy.
HEIMER: Krishna, you’ve talked about low productivity being a barrier to growth. Can something like what Heather’s talking about help get us out of our rut?
MEMANI: I think at the end of the day, the driver of productivity growth is investments. If the Trump Trade, or if the expectation that growth rates are going to be higher than what we had assumed in that doom and gloom, then the pace of investment picks up. And if the pace of investment picks up, productivity certainly can pick up. This year may end up, in a really optimistic scenario, being the bottom of the productivity cycle.
KETTERER: I want to get back to what Krishna was saying about emerging-markets growth. One example I would give as a play on that is Prudential Public Limited (PUK). This is a life insurer listed in the U.K. market, so the baby was thrown out with the bathwater with Brexit. The referendum vote last June meant that U.K. stocks were considered just the worst place to be. Of course, we couldn’t get enough of them. And yet here’s a company with 70% of its earnings in Asia. In not just Hong Kong and Singapore, but rapidly growing places like Indonesia, Vietnam, Thailand, and China, where they’re typically in the top three in life insurance.
So if we can buy that cheaply and get a good dividend yield with it and there’s growth, that is about as good as it gets.
HEIMER: Ann, are the data arms merchants poised to take advantage of possible pent-up growth in emerging markets, or for that matter in Europe or Asia?
WINBLAD: All of these fast-growth companies look to expand to every possible market. And they’re looking to partner with innovators in other markets. The partnership between India and Silicon Valley is extremely strong.
But we do see some real talent shortages. And we are not graduating enough STEM majors here in the United States, given our rising cost of education. It is also really hard to retool people into these specialty skills rapidly.
We do depend upon a global talent base to grow these companies. That’s probably the biggest challenge and risk going ahead, given immigration issues that might happen.
PAGE: I didn’t picture myself as the most bearish person on the panel. But some aspects of the Trump Trade might be overdone. I want to reemphasize that. Don’t underestimate the impact of a hawkish Fed, and of rates going up and potentially putting a lid on growth.
MINER: This is a really important point that we haven’t touched on yet: Valuations, particularly for U.S. equities, are full. And at these valuation levels, history tells us that you can really only generate mid-single digits going forward. So you have a lower-return environment than what you’ve had in the last five years. And you have higher volatility. And that requires a psychological shift of investor mind-set. Because the reality is, you’re getting paid less for each unit of risk that you’re taking in your portfolio.
PAGE: And valuations are fairly rich in equities, but, boy, are they rich in bonds. Have we really reached the end of the 30-year bull market in bonds? Bonds have been getting expensive, and more expensive, and more expensive. A third of the global government debt stock is in negative nominal yield territory. The global aggregate, postelection, is at 1.5% yield. This is extremely low.
That means that nowadays small moves in rates up are going to lead to big drops in bond prices.
MEMANI: If you take a step back, what the world wants more than anything else is a good, well-paying bond. Income and sources of income, if you go around and ask investors, is still the biggest challenge that they face.
In our view, the best opportunity really is in senior floating loans, because those have basically no interest rate risk. Even if rates rise, the prices on those loans don’t come down. And they give you a 5% coupon.
HEIMER: Heather, are floating loans a part of your strategy?
MINER: I think bank loans make sense in a rising interest rate environment. We talk to clients building a diversified income portfolio.
We start with a core equity allocation: higher-dividend-paying stocks. We don’t want to buy the highest-dividend-paying, because you worry about the sustainability of those dividends. We add high-yielding fixed income, high-yield debt, emerging-market debt. We add bond proxies in terms of MLPs and REITs. And we overlay a buy/write strategy, which essentially allows you to own the equity market outright, and then sell call premiums to generate income for the portfolio.
So that type of diversified portfolio approach can get you to 4% annual income. Which is almost what we’re expecting for the equity markets.
HEIMER: Ann, when I started covering investing, there was virtually no big tech company that paid dividends. Microsoft pays a dividend now, Apple (AAPL) pays a dividend. How can the big tech companies best deploy these big piles of cash that they’re sitting on?
WINBLAD: Most of these companies grow through acquisitions. And we’ve seen the acquisitions get bigger. It used to be these companies were too young to buy big companies. Two decades ago, Microsoft wouldn’t buy a LinkedIn for 20-plus billion dollars. More of that’s going to happen. I think we’ll see some really unusual pairings too. We’ve certainly seen this in Verizon AOL (VZ).
The companies also have enormous R&D budgets. There is no national R&D anymore, per se. So venture-backed tech is the R&D arm of the world. When we see the innovation curves that have happened—cloud, big data, now intelligence, those are accelerating. Hiring is also accelerating. You see companies like Amazon where you’ve got 300,000 employees now.
KETTERER: I’d also point out that many of these great technology companies are listed in the U.S. market. The international developed-market indices have a mere 4% or 5% in technology.
MEMANI: I would say that there are really good tech companies overseas just as much.
KETTERER: But they’re not on the indices.
MEMANI: You have companies in China that you can buy—a Tencent, a Ctrip.com. You have tech companies in India that you can buy that are growing at a pretty rapid clip. In size, technology may be a larger footprint in the U.S., and it’s definitely more established. But the growth trajectory of technology in other countries may actually be higher than what it is in the U.S.
WINBLAD: In fact, looking at the number of billion-dollar M&A exits in the last two years, Stockholm ranked very high.
Infosys just invested in one of our young startups. Chinese companies are buying tons of small American companies, as well as investing in them. Global, cross-border investment is very, very substantial.
HEIMER: We could see real changes in health policy under a Trump administration. Where does health care figure in your minds right now?
PAGE: You have insurers that could benefit, pharmas that could benefit. But then hospitals go the other way because now you have fewer people who are insured.
HEIMER: Or at least that’s what we’re anticipating.
MEMANI: Within health care, biotechnology is a very interesting sector for people looking for growth. The way to think about biotechnology is basically as outsourcing of innovation that large pharma companies used to do. And because it is so uncertain, they don’t want to do that anymore. So they let these companies develop new technologies and products and then they go out and buy them.
WINBLAD: You look at IBM’s big bet on Watson. What was the first market they entered into with Watson? Health care. And that’s independent of all the innovation that’s happening in genomics. When you talk about biotechnology, the cost to start a young biotech company, to set up that lab, which is now all software and dependent on big data, is much, much less.
MINER: Clearly big data can be leveraged to drive revenues, to reduce costs and improve margins. As asset managers, we also have the opportunity to leverage big data.
We have eight times more data being created in 2016 than in just 2013. And asset managers who can leverage big data to find investment themes before they’re reflected in the market, we think, can drive outsize returns for investors.
HEIMER: So the 20,000 coders Ann referred to earlier—this is what they’re doing?
MEMANI: People who can implement technology in an efficient way are going to distinguish themselves in any industry. And I think Ann was right, this is going to be the biggest differentiator.
HEIMER: The price of oil has rebounded of late, but it’s still well below where it was in 2014. Presumably, if the economy strengthens globally, we’ll see energy prices rise. How do you factor that in?
MEMANI: From a secular standpoint, one has to wonder if the energy landscape has changed dramatically. Volkswagen is going to lay off 30,000 people because they are focusing on electric. And if that’s the general trend, then the outlook for energy from a longer-term perspective is, I think, something that one has to be slightly skeptical of. For 2017 though, if the economic cycle in the U.S. picks up, and China has picked up already, the outlook for oil prices is reasonably good.
KETTERER: We’ve been overweight in oil and gas, and more so since the fall in oil prices. The next 10 years we’re going to be using fossil fuels heavily. We’ve got a global supply of roughly 97 million barrels a day, and demand just a couple of hundred thousand barrels per day less. So we’re on the razor’s edge of having demand exceeding supply. There’s more upside in crude oil prices.
It’s worth looking at those beleaguered integrated oil and gas companies. Take Royal Dutch Shell. Here’s a company that has cut everything they can think of. They cut capital expenditures from last year’s level by 35%. They’ve cut their debt to equity down to 20%. The dividend yield is 7%.
PAGE: Our analysts in the equity group continue to take a bearish view on oil prices. They literally count the rigs everywhere, and their view is that the market is underestimating the supply.
MINER: We’re clearly at a turning point. Demand has been fairly stable here, growing at about 1.5%. Supply has become more price-sensitive. The U.S. shale industry is now the marginal producer. And rig counts went down to about 320 from 1,600. But now, with the rebound in prices, rig counts are back up around 500.
HEIMER: Can oil producers adapt more quickly to changes in supply and demand today?
MEMANI: Because of U.S. shale and because of certain political situations in the Middle East, the swing capacity is quite substantial. So the likelihood that oil goes from $50 to $100 under any situation is pretty small. And similarly the likelihood that oil goes from $50 to $10, is pretty small.
MINER: I would agree.
KETTERER: [Look at a company] like ABB (ABB)—the oil and gas industry is one of its major customers. And they’re in there with all these tools, both software- and hardware-oriented, to help these exploration and production companies be much more efficient. So they don’t need hundred-dollar oil anymore. Many of these companies can make a lot of money at $50 a barrel.
HEIMER: As a final question, what’s the biggest opportunity and the biggest risk in the year ahead?
MEMANI: So Brexit [and] Donald Trump’s victory effectively brought to the world the notion that we have to do something dramatic on the fiscal side, stimulating the economy with government spending. And if that actually comes about, then we have the potential of breaking out of some of these structural issues that we have been facing for a long time.
And the risk is something along the same lines. While the outlook for growth has improved, there’s a potential that the Federal Reserve gets forced into tightening much sooner than the gradual talk that they have been talking for a long time. And as a result, we end up with a recession in 2018.
HEIMER: Sebastien, how about you?
PAGE: Biggest risk: interest-rate risk. We’ve just been through this environment during which the 10-year bond yielded less than dividend yields on stocks.
This is very unusual by historical standards. It’s an upside-down world. People are buying bonds for capital gains, and they’re buying stocks for income. Interest-rate risk means that this could revert pretty quickly.
HEIMER: Ann, how about you?
WINBLAD: We’ve talked a lot today about how innovation and technology, here in the U.S. and globally, is really a driver for lifting many companies that we’ve thought of as “old economy,” to suddenly leaning into a “new economy.” That’s a continuing opportunity.
HEIMER: Thanks, everyone.
This is part of Fortune’s 2017 Investor’s Guide, which features experts’ picks of 21 stocks and two funds to buy for next year.