Masterclass: 2022 Market Outlook
- 01 hr 07 mins 17 secs
One of the biggest surprises of 2021 proved to be inflation. Now that risk and many others are bleeding into 2022, begging the question “What will be the next wildcard for investors?” Four investment experts weigh in on where they see opportunities in the new year.Channel: MASTERCLASS
- Byron Boston, CEO and Co-CIO - Dynex
- Dana D’Auria, Co-Chief Investment Officer - Envestnet
- Malcolm E. Polley, CFA - Stewart Capital Advisors
- Thomas R. Wald, CFA® Chief Investment Officer Of Transamerica Asset Management, Inc.
MASTERCLASS: 2022 Market Outlook – December 2021
Jenna Dagenhart: Hello, and welcome to this Asset TV 2022 Outlook Masterclass. One of the biggest surprises of 2021 proved to be inflation. Now that risk and many others are bleeding into 2022, begging the question, what will be the next wild card for investors? Joining us today with where they see opportunities in the new year, we have Tom Wald, Chief Investment Officer at Transamerica Asset Management. Dana D'Auria, Co-Chief Investment Officer at Envestnet. Malcolm Polley, President and Chief Investment Officer at Stewart Capital Advisors and Byron Boston, Chief Executive Officer and Co-Chief Investment Officer at Dynex. Everyone, thank you so much for joining us, and great to have you with us today.
Malcolm Polley: Nice to be here too. [crosstalk 00:01:00]
Jenna Dagenhart: Well, if we've learned anything from recent years, it's to expect the unexpected. Byron, how can investors brace themselves for whatever unknowns, whatever shocks we might encounter in 2022?
Byron Boston: Thank you. First, let me just say that it's one of respect that the potential for surprises is highly probable. That is a phrase we've used at Dynex for multiple years now, and I believe all investors should embrace the fact that we are at a stage in the globe where surprises are highly probable. Respect the global macro economic environment. There are many factors that can influence the future path of global events, asset prices, interest rates. Those factors may not originate in the United States, as we've recently learned for certain with the pandemic. And just understand that these factors are... The catalyst may come for future valuation from all over the globe. We're in the middle of a shifting health environment, economic environment, geopolitical environment, climate, technology, demographics, and government policy worldwide is in flux. So we should be aware of the global overall macroeconomic environment and understand and where those factors are broad and may come from and may create multiple future scenarios.
Byron Boston: In addition, be aware of the technical factor that a huge influence, in terms of global asset prices, whether it's bonds, stocks, cars. Bitcoin has been the result of the enormous amount of liquidity that the central banks have pumped into the system. So again, back to government policy, as that policy is adjusted, and we're not sure yet exactly how that policy may play out amongst the central banks, be aware that will be a huge influence ultimately, in the overall valuations in the future asset prices. Maintain a flexible mindset, carry extra cash and liquidity, which is what we're doing at Dynex Capital, and scenario planning and preparation. Adam Grant has a book called, Think Again, I would urge everyone to be prepared to think again.
Jenna Dagenhart: Yes, anything is possible and we'll talk about liquidity and interest rates later in the program. Malcolm, as we get ready for 2022, do you think inflation will continue to be a problem or is the Fed correct in its view that it's transitory? I know the Fed has walked back that language somewhat, but what are your thoughts?
Malcolm Polley: Well, it's interesting people when they think of transitory. And I think the Feds mindset when they were thinking of transitory is that inflation goes back to what it was pre pandemic. And indeed, if you look at their forecasts, they really continue to believe that inflation goes back to that two and a half percent range, which we've never thought was going to be the case six plus percent we thought was a bit of a stretch. And we really have been in the camp that inflation does pull back a little bit, probably in a range of three to 4%, but that was really more because of a demographic shift that's taking place. That's really creating a supply demand mismatches and some continued fallout over supply and demand shocks created by the pandemic.
Jenna Dagenhart: It's pretty clear now that inflation will likely not be so transitory and it's likely to be with us for a while. Tom, how should investors deal with inflation that could be higher for longer?
Tom Wald: Jenna, it's been so long since investors have had to deal with the rates of inflation. We've been seeing over these past several months. I mean, we are now looking at your 30 year plus eyes on both the consumer price index and personal consumption, expenditures price index is. Another way to look at this Jenna, the last time inflation was this high, Michael Jordan had not yet won his first NBA championship. And Tom Brady had not yet started playing high school football. So it's been a while. I think what this really means for investors is shifting the lens on pretty much everything to real returns, investment returns above inflation, net of inflation.
Tom Wald: So, when you take that perspective cash is a negative return. The front end of the yield curve is a negative return. The long end of the yield curve is a negative return, all in comparison to expected inflation over at least the next year or so. Where investors need to look is toward those asset classes or strategies that can either inherently perform better in both an inflationary and arising interest rate environment, such as value stocks, high dividend paying stocks or stocks of companies with pricing power, and that are capable of passing on a higher cost on a customer base.
Tom Wald: For instance, healthcare stocks during a pandemic who has better pricing power than those companies who are treating patients and trying to end the pandemic. Beverage companies have [inaudible 00:06:17] for higher pricing power due to brand loyalty and back stocks, which could benefit in the year ahead from what we think could be a steep new yield curve. So, it's really twofold. Jenna, shifting more of a focus to real inflation, just in returns and seeking out those areas of the market with pricing power, and or that are better positioned for an inflationary and rising into straight market.
Jenna Dagenhart: Dana, when can we expect inflation to taper off? And do you think stagflation is still a concern?
Malcolm Polley: Well, stagflation was definitely a concern a little bit earlier in the year when we were starting to see some concerns around economic growth. I think that's dissipated. We've had some really good readings from a number of different reports on economic growth. I think stagflation at this point is less of a concern than persistent inflation. As we head into mid 2022, you'll probably see the inflation numbers start to drop. It doesn't mean, and I think this is important for certainly main street to understand, right? It doesn't mean that prices are going back where they were. We're now settling in on a new, higher equilibrium.
Malcolm Polley: And so the pain you're reading about where now you have consumer sentiment and the regular people saying I'm more worried about inflation and price increases than I am about unemployment. I think that dynamic to a certain extent is going to be with us for a little bit of time, even as the numbers, the actual inflation year over year numbers starts to taper off. Because of course we're going to be living with these higher prices. But I do think as we sort out these supply chain shoes, again, as we head into maybe early to mid 2022 not withstanding another variant that really puts everybody into lockdown. And I do think that's less likely, right? I think politically it's a lot more difficult now to put everybody into lockdown than maybe it was when this started. So, but not withstanding that happening. I think we will start to see the inflation number tapering off as we get into 2022.
Jenna Dagenhart: And the supply chain is really driving so much of the inflation that we're seeing today it seems. Malcolm, do you think the bottlenecks that exist along the supply chain persists throughout 2022 or will we get some relief? Hopefully no more ships stuck part.
Malcolm Polley: I can't speak to ships being stuck. I know that's dependent on what happens at the ports on either side of the United States, but a lot of the problem with supply chain bottlenecks came from the fact that people particularly manufacturers cancel materials orders because they expected demand to drop off dramatically. And that simply did not happen. So, when you have a demand may being maintained and supply gets artificially reduced, of course you get a lot of backups. In some cases like chip shortages, those backups are going to take a while to work themselves out. Simply because it takes a number of years to build capacity. And you've had a number of entities announced they're building capacity in the United States.
Malcolm Polley: So it's take a five years to get a plant operational. So it's going to be a while. There are certain industries where you'll see a degree of the bottlenecks shifting and easing somewhat, but we're really not looking. And we're really not expecting a large diminution of bottlenecks through a lot of 2022. If that happens, you probably get into late 22 or early 23, and the reduction in bottleneck, perhaps won't be as noticeable because they'll be really largely occurring over time as opposed to big shifts all of a sudden.
Dana D'Auria: Jenna, I would add one point to that too, that I think is probably relevant to folks, is that what we saw to reinforce what Malcolm said. We saw a lot of the liquidity that was put into the system chasing goods, as opposed to chasing services because people weren't able to use services. Right? So, to his point on this expectation that demand would drop. In fact, you've got a lot of money now, chasing goods, supply chain bottlenecks, preventing that demand from being met. And as reopening has occurred, of course, services opening back up and we saw a shift of more assets or more purchases, excuse me, going to services again. But I definitely think that was a big part of how the pandemic played out in this case.
Malcolm Polley: Dana, part of the issue of us getting shifting back to services, there's a lot of those services particularly in the hospitality sector that you're going to continue to have supply issues because you can't get people shipped into those jobs. It's not happening very quickly. And if you go into restaurants or other hospitality, entities service is bad and it's not through any fault of to those that are currently working, it simply, they don't have enough staff to meet the demand. And I really don't see that changing dramatically. And a lot of those jobs you can't automate away.
Dana D'Auria: We had people leave the workforce, let's face it, right. We are able to see now that we lost jobs, but we also lost people that are interested in taking those jobs. And they're probably permanently out of the workforce so that'll taper off. It's probably people who were on the brink of retirement anyway, and took an early retirement. So we'll get back to a certain extent equilibrium on that. But in the short term and the near term, I would say, it's still going to be painful.
Malcolm Polley: I agree on all this. The two classes of people we've seen fall away by a large were boomers 60 and over saying, "I've had enough I'm out." And women. And the boomers you're probably not going to get back into the labor force and women. It's going to take a while to bring them back as rightly or wrongly, they have largely been the caregiver. So, that continues to be the case.
Tom Wald: I think what's also interesting is just this really speaks to the historically anomalous conditions that we've had to invest through these last couple years, going all the way back to the beginning of the pandemic in the spring of 2020, COVID created the biggest demand shock since the great depression of the 1930s. And now here we are less than two years later. And COVID has already since then created the greatest supply shock of our lifetimes. And it's just interesting to see how folks in the economic and the market cycles have worked through that in such a speedy fashion and what that ultimately might mean for the longer term, once we're through the entire COVID cycle here, which has really pulled a 180 on us in a very short period of time.
Jenna Dagenhart: And who knows where the next shock will come from. Byron I know we were talking about that earlier, and I want to get your thoughts on inflation as well. How does the inflation outlook impact the mortgage business and how do you successfully operate a read in this environment?
Byron Boston: Let me say a couple of things on this, which are historical. Real estate has done well in inflationary environment. So the assets where we generate our income, we anticipate will do well. So we assume we'll have a larger opportunity set within that environment. One of the other offshoots has been when you look at history, everyone talks about the 1970s inflation situation. And the [inaudible 00:13:51] years what's really important is I have a lot of tools today that financial institutions did not have in the 1960s or 70s to deal with this type of environment in a rising rate environment. It's actually phenomenal. And in fact, many of the derivatives were created because of the problems that financial institutions ran into when... Especially when Paul Volker inverted the yield curve and rates were really high. So we're excited at Dynex. We do believe we'll have great opportunities in this environment, but as I listened to the other panelists, I said, and I go back to what the statement that I said earlier, surprises are highly probable.
Byron Boston: We have said this for multiple years, that at Dynex were very comfortable in this environment, because we're anticipating surprises. The economic data is very difficult to decipher at this point in time, it is an evolving environment. And one of the challenges is there's been an exogenous shock. It's a health crisis that has created an economic crisis that has been followed up with a ton of government policy. So, you asked yourself the question, do you know exactly what's going to happen with the health situation? Maybe we thought we did. Maybe we were surprised a couple of weeks ago when we found a new variant. And then you ask yourself, do you know exactly where government policy is going to go at this time? So you don't. So, do you hide in the shell, no, you don't hide in the shell. We have a lot of tools at Dynex capital and at other financial institution to be able to manage this environment versus what most others think about when they think about the 1970s inflation scare.
Byron Boston: And then finally at Dynex we believe the inflation... current inflation will be a hump it'll rise rapidly and it'll decline over time. Now the challenge is what's the timing. If you look at the historical chart and you look back at inflation in the seventies, or you look at the interest rate rise, it looks like a little hump. That's what it looks like over time. The problem is if you're right in the middle of the hump, you're trying to decide, well, are we rising? How long will we stay up here? And when will it come down to how rapidly will come down on the other side?
Byron Boston: So at Dynex we are really respecting the... I'm trying to avoid using the word uncertainty, but as I listen to the other panelists, it's just great listening to you because you've identified the surprises that have taken place. It is fascinating what is happening here? And I'm a nerd, I'm historical nerd, and this is a fascinating moment in history, but I will tell you as a CEO of a financial institution, we have more tools than the banks and the SNLs had in the 1970s and 1980s today.
Malcolm Polley: I think that one of the downsize in my perspective is that if you are looking at history. If you focus on the 1970s as the Genesis of the last inflation, I think you're focusing on a long period because interest rate cycles and inflation cycles tend to happen over very long periods of time. From 1940 to 1980 was the last major secular up cycle for people like me, all I've known is down remove and interest rates. So, if the assumption is that inflation is going to work its way higher, over short period of time. And I think that's an invalid assumption. I think that inflation gradually worked its way higher. Never really gets to what people are afraid of, right? Which is the 1970s, because the dynamics are different, but I think it works its way higher over time. And because of that interest rates work higher over time, the other or misconception I think is that if you're looking at 1970s, learn what happened with mortgages and interest rates. I think you're looking at the wrong period in time.
Malcolm Polley: If you look at 1993 and 1994, when Greenspan took rates of 300 basis points in one year, you see the real problem with rate sensitive things like mortgages that are exposed to negative convexity. Not only do you have price move because interest rates have gone higher, but you get extension risk because your prepayments really dramatically slow down. And I think that's kind of the biggest danger we see in the real estate market, particularly on real estate. On mortgage side is that you got a double whammy of trade rates do rise, you get extension risks and you get a rate risk. And on [inaudible 00:17:57].
Jenna Dagenhart: And going back to Byron's point about tools that we didn't have in the seventies. We definitely did not have cryptocurrency back then, but Dana, do you see cryptocurrency as a good inflation and how should investors be thinking about investing in crypto?
Dana D'Auria: So, it really depends on what you mean by inflation hedge. When you use the word hedge, generally, it means you've found a vehicle that moves somewhat in tandem with what you're trying to hedge, right? So if you think about what inflation is, even with a jump like we experienced this year, it's a slow moving process. As these things go versus say, Bitcoin or Ethereum or any of the cryptocurrencies, which are literally among the most volatile assets you can get yourself into. So when I read inflater, excuse me, crypto, as an inflation hedge, I shutter a little that's not terminology that I would use to describe crypto because in any given short term period that you might be looking to actually hedge inflation. Crypto is more liable than not to be way up, way down way out of sorts with what inflation actually pans out to be.
Dana D'Auria: Now, that being said, I think what people mean when they talk about crypto as an inflation, hedge is really over longer periods of time. Will I keep the purchasing power of my dollar? So it's more of a hedge in the sense that equities are a hedge, right? That if we... Going back to what I think Tom said earlier around what companies can actually pass on increases, right? Equities are an inflation hedge over the long haul and hedge. Isn't really the right word, but you keep your purchasing power to the extent that they're able to pass on these same increases and generate productive returns over and above. And so I think that if we're going to talk about crypto as what something you invest in, because you're worried about purchasing power, you have to think long run. And so you have to think about what is the thesis for crypto in the long run.
Dana D'Auria: And I don't think about that thesis in terms of inflation. I think about it more in terms of where is the world going, right? This is a new technology, hard to imagine that we put the toothpaste back in the tube, on it at the same time, there could be regulations. So how do you approach that technology? So all the questions you'd ask about investing in something like that, if you want an inflation hedge, you're stuck with tips and you're stuck with low returns, right? A true hedge where it's moving more on lockstep.
Jenna Dagenhart: Tom, what do investors need to watch for from the Fed in 2022. They have a bit of a tight rope to walk in terms of fighting inflation while also not putting economic growth at risk. And what about longer term rates?
Tom Wald: Yes. A tight rope Jenna I think is a very good way to put it. In my opinion, chairman Powell, and everyone else at the Fed have brand new jobs in 2022, they're old jobs for providing enough accommodation on liquidity to pull the economy out of the COVID recession and keep positive growth moving forward. So the job market could recover. Their new job is now fighting inflation. Those are two very different job descriptions, so to speak. I think now with the benefit of hindsight, of course, it's become evident in my opinion that the Fed got behind the curve this past year, and probably spent too much time, quote, unquote, fighting the last war. So to speak. They kept 120 billion of a monthly bond purchases in place probably too long. They probably should have begun tapering those perhaps last spring or last summer.
Tom Wald: And in the meantime, the inflation storm really began to brew. So my view is that the Fed is going to have to really move on the taper, begin reducing asset purchases by maybe about 30 billion a month and finish up that open market activity by the March, April timeframe. Then it will be open season on [inaudible 00:22:04]. And I think we'll probably get three core point increases on the Fed funds rate, taking the target Fed fund range to 0.75% to 1% by the end of 2022.
Tom Wald: I think long term rates will also rise in response to this. And as inflation continues to run hot, at least into the summer month or so, we could see the 10 year treasury yield challenge 2% by the early months of next year, and maybe doing quarter by the end of 2022. So, the tight rope here Jenna is that the Fed has little room for error. Too much economic slowing caused by rate hikes and not an aggressive enough papering and rate hike scheduled to combat inflation. If you don't get that combination, right. It could throw a wrench into the mix, which would then fan the piece of what we had. Just talked to that a few minutes ago, which I have to refer to as the 11 letter word that strikes ANGs in the heart of all investors, stagflation, I'm not forecasting that by any means. I do think inflation can subside to the 3% range by year end against the backdrop of a growing economy, but that's where the tight rope you so aptly referred to comes into play.
Jenna Dagenhart: And to follow up on that Malcolm, if inflation does prove to be more transitory, well, we need to worry about a higher interest rate sooner rather than later, it sounds like yes but...?
Malcolm Polley: Yeah, it's interesting because chair Powell was dovish. Then they get news that he's going to be reappointed, and all of a sudden he doesn't about face and starts to talk about, maybe we need to taper more quickly. So now he is moved into a little more hawkish standpoint. And our view has been the Fed has never led the market from an interest rate perspective. It's been the markets, you have people talking about worries about bond vigilantes, largely been absent, but the reality is the markets have always led the Fed higher and expect from an expectation standpoint. And, as Tom was saying, looking at for a 10 year around 2% or a little bit more for next year makes sense. We're in that camp as well.
Malcolm Polley: I'm a bit surprised in terms of how aggressively Tom is looking at from a rate increase perspective, but we do expect rate increases to happen next year. Totally not to the back half of the year. So the question is, how dovish is the Fed or how hawkish is the Fed? We think they stay somewhat dovish, although you end the tapering probably a little sooner than expected. And then as has been said, by Fed officials for the last number of years, a lot of their decisions will be data dependent. So if the data fax a more aggressive rate hike scenario, then that's what they'll do. Despite the fact that they've been trying to be more transparent in their decision making processes.
Malcolm Polley: I think former chairman Greenspan said it best more than a decade ago. And he said, "We're really flying blind." A lot of the data that we rely upon to make our decisions was built for a manufacturing economy. We don't have that economy of economy. And by a large the Fed is still dealing with the same problems today. The data that they use is built to explain a manufacturing economy and we really have a knowledge based economy and you get different results with different outcomes.
Jenna Dagenhart: To Tom's point, J Powell has two very different jobs. And to your point, it seems he is starting to approach things from a different direction as well. Dana, why haven't interest rates followed inflation and should we expect 10 year rates to rise?
Dana D'Auria: I think a lot goes into those 10 year numbers. And it's interesting to hear different views from the panelists around just where we could end up on those. So, investment sits at the junction of a lot of different sources of economic data. So I get to see, different research providers, different asset managers. And it really, I think the name of the game is what Malcolm is saying in terms of a lot is going to depend on what the data shows. So, do we expect tenures to rise? Yes, absolutely. That's going to happen. Tapering, probably does get accelerated, I think the Fed to a certain extent because they already signaled and [Flatout 00:26:35] said that tapering was going to happen on a certain course, but they're to a certain extent stuck and they might have even gone a little faster if they could.
Dana D'Auria: So, but they do want to be transparent. As that happens 10 years rise where we end up is going to be interesting and somewhat a function too, of what happens just with, as we said before, the pandemic variance. I think the Fed loses some credibility if it backs off, too much on tapering and or the tightening that's expected. I think, that dye is cast to a certain extent with the caveat. That again, if there's a massive hit to the shock from, the pandemic or what have you all bets are off you. The other thing I would say too, is that it certainly, and we'll probably talk about this later, but it certainly gives you some information on where to invest in the market and which sectors... technology, for example, has been really the defensive play for the last few years. I think any sign that interest rates are not going to rise as much as thought is certainly a tailwind for technology. So.
Tom Wald: I understand what I think that's really interesting is the tenure, which obviously is this bell mark bell weather rate that everybody looks at is how that's also affected by overseas rates. Because, here we are at these historically low levels still in a 10 year and yet you've got other regions of the world where the 10 year is negative or basically flat. And I think that comparison starts to... Probably suppress the 10 year lower than where it would normally be under these types of economic or inflationary conditions. While we not seeing these other regions of the world with their long term rates so low?
Dana D'Auria: I think that's a really good point. Europe and other economies, they've stiff, armed a rate increase even more than we have to a large degree. Right. And so the that's showing up in our numbers as well. It's a very good point.
Jenna Dagenhart: And does global central bank shift to post pandemic policy, Byron, how do you see that trickling down to mortgage rates?
Byron Boston: Let me just say that, remind you again, why I said a second ago in terms of government policy and mortgage rates, or whether you're considering German funds versus the US rates or the Swedish rate. This is all driven by government policy. Our housing markets are driven by government policy. If rates do rise, mortgage rates will follow. So, mortgage will ultimately rise, but there are factors that will help hold mortgage rates down that the use of more modern technology amongst the mortgage origination universe, the desire to maintain market share in the mortgage universe, mortgage origination universe will help provide some buffer. But at the end of the day, if interest rates were to rise, mortgage rates will follow. And that's the very simple answer, but there are a lot of factors here. And one large one is government policy.
Byron Boston: So, when I hear people say, "Rates are going to go to three or 4%." Then I'm going to say, "Well, what's going to happen to German bonds. What's going to happen to some other foreign rates. What are foreign investors going to do if our rates suddenly move to these higher levels?" And you will see capital cross borders. So it's complex in terms of where rates will finally end up. You must be willing and flexible, have a flexible position. If you're an individual, I would urge you to watch yourself in terms of your leverage I would urge you to maintain a level of liquidity and be prepared to look for better opportunities. Is what we expect in an environment such as that we face today, the central banks will try to adjust. But in my look back in history my career, which started in 1981. So I, I started under Volker I've seen so many central bank mistakes. It's unbelievable.
Byron Boston: So I don't worship Greenspan. I don't worship [Benacky 00:30:49]. I remember when he said taper, it was like, are you kidding me? You're saying taper. And it's not, I'm not criticizing them. They're human beings. Just like all of us here on this screen, they're trying to figure out the right decisions. And if we give them godlike status, we will ignore the fact that yes, they can make a mistake and markets can react to those types of situations in very violent fashions. So if I were to refer back to it [Malcolm 00:31:17] said about 1993 and 1994, there was a violent reaction to Greenspan. You didn't know what Greenspan was going to do. One time, he raised 50 basis points. Another time he raised 25, you did not have forward guidance.
Byron Boston: You did not have this type of clarity. And another big difference is you did not have the Federal reserve owning this many mortgage back securities. So they pretty much so nullified the negative convexity on that portfolio because they're not going to react to it. The mortgage duration on their portfolio extends. They're not going to go out and sell swaps or sell treasuries to try to hedge that duration. It'll be sitting on the Fed's balance sheet. If you go back to the 1993 and 1994 period, you had Fred Mac and Fannie Mae really be two of the larger portfolios in the market who are actually hedging and responding to that negative convexity. And that's a huge difference between today versus 1993 and 1994. So it's a fascinating period. I don't know how rates can get too high without bonds coming along and other foreign rates coming along. Also, I would urge you to keep your eye on foreign rates, because if our rates are going to go up, you're going to see those rates going up overseas also.
Tom Wald: Byron I think you're making an exceptional, a great point here where that there's an interconnectivity of interest rates globally. Now that wasn't with us in previous cycles and previous Fed cycles. And when you look at the longer end of the curve, that's going to be impacted, as much by what other central banks are doing than what our central bank is doing. And so it's created this global, a global interconnectivity of interest rates that wasn't around in past cycles. And I think investors need to be very keenly aware of as you just so after we said.
Jenna Dagenhart: And turning to the pandemic, Tom, we're almost two years into the COVID 19 pandemic and things don't seem to be getting much easier. As Byron mentioned, we've got a new variant of concern and case counts continue to rise. What does this current state of the pandemic mean for the markets?
Tom Wald: Great question, Jenna, because if you just said, we're almost two years in the pandemic now, and it can sometimes feel every time there's seems to be sunlight at the end of the tunnel, that light gets dimmer and the tunnel gets longer. And now as we begin 2022, we have a daily case count rising again, driven by the Delta variant. And we have the newly identified risk of the omicron variant. But I think those equally important from a pure market perspective is the tremendous resilience the US economy and our stock and credit markets have displayed in dealing not only with the pandemic over the last couple years itself, but all the cycles, the internal cycle of the pandemic that have come with it. Since the initial economic contraction caused by COVID in the spring of 2020, US GDP is up cumulatively since the second quarter of 2020 at about 13% and S&P 500 net operating earnings up about 90%.
Tom Wald: So I think you have to come to conclusion that who chose not to invest alongside our economy and the great medical and scientific communities fighting this pandemic have done so at their own opportunities to para. So as COVID cases likely do continue to rise into the early parts of 2022 due to both winner seasonalty and perhaps the omicron variant. We also have vaccine rates rising. We have booster dose administration increasing. We're now above 80% of the US adult population being either fully vaccinated or fully recovered from a previous case of COVID and will soon be seeing some new therapeutic regimens, such as [inaudible 00:35:26] antiviral pill that have shown strong efficacy in treating diagnosed cases of Covid. And I don't really see the country ever going back to anything close to the natural lockdowns we experienced at the beginning of the pandemic. So, my judgment here would be to go to your economy in the market once again, handling another upward cycle of Covid and also depending on the severing profile of omicron we actually could potentially be moving one step closer to heart immunity.
Malcolm Polley: And it's interesting if you actually look at the historical perspective of COVID relative to other pandemics, we're really following the same scenarios happened in previous pandemics, the economy recovers quite rapidly, the markets recover quite rapidly and you're back to quote unquote normal. And I think it's pretty clear that we are moving from pandemic to endemic, which means basically we're going to have to live with this in one way, shape or form with, for a long period of time. And it's just something we'll come get it used to much like we do with the common, cold and seasonal flu.
Tom Wald: And I think what fascinating about that point Malcolm is if you go all the way back a hundred years to the Spanish flu, there never was a vaccine. There never was a treatment cure for that. It's simply mutated into a less dangerous form and then moved on into the flu that we know today. So, I think that's a great point and look at where we are right now versus that cycle a hundred years ago. And the differences in the treatments and the vaccines that we have, I think are encouraging.
Jenna Dagenhart: It seems we might be getting our flu shots and our vaccines at the same time every year in the future. Byron, how can investors put their money to work in this type of market with so much increased risk and as we said earlier, so many unknowns?
Byron Boston: So, many investors are expressing themselves through purchasing funds, as opposed to purchasing individual stocks. Some are purchasing individuals stocks. Under all circumstances if you're buying a fund, I would take extra care to understand the managers who are managing the fund, the actual individuals. I would also take extra care to try to understand the risk that you were taking in that fund and what happened last March. It was unbelievable. There were moments where I was shocked to see what was happening in certain funds that those fund managers were taking that type of risk. Now it's great the Fed stepped in and saved a ton of financial institutions and really saved the financial system. But there were moments last year where I was very surprised to see the type of risk that certain asset managers were taking. So as an individual, if you are purchasing a fund and I know, you'd like to just purchase a fund and go to sleep.
Byron Boston: I don't believe this environment is going to be that simple. I would take some extra care in trying to understand the actual human beings who are managing your money. Then be very cognizant of the risk that you are taking. I think Dana, maybe you mentioned about technology and how the role technology has played the last couple of years. And I like the way you phrased it, but understand are they taking technology risk? Are they taking leverage risk? I would keep a really very keen eye in terms of who's managing leverage and who's not at Dynex Capital we're experts in terms of managing leverage. That is what we do. I will explain to anyone that please look at our backgrounds we are very skilled and very experienced in this job. And we take a very short, medium, long term view, which is what I also believe investors should do, because there are so many factors that are at play in the short term, maintain enough liquidity to make good long term decisions when great opportunities present themselves.
Byron Boston: I do believe there's going to be a day when there are better opportunities than there are today. And as much as we talk about interest rates may rise or equities, maybe do this. I consider it what I call a fat tail environment. In other words, the expected outcome doesn't have as much probability attached to it as we might normally think, or in a normal distribution. There's a lot of probabilities associating with the tale events. And in that sense, I would simply be careful carry liquidity, carry cash, be prepared to invest when opportunities are presented. And then finally, I'm not a huge buyer of the growing by the dip mentality. I hear it amongst friends, I am especially concerned about baby boomers in terms of buy the dip they're so flippant or comfortable with saying, you always buy the dip, the stocks always go up and then I show them, I say, well, you know, if you'd bought, I think it's the S&P in 2000, when the market cracked, you didn't get back to even for multiple years.
Byron Boston: And Lord knows that if you did it in 1929, and you had an index of the dower, the S&P I don't think you got back to even for 25 years. So I'm not a doom and gloom guy. All I'm trying to say, is that be aware of how many factors are at play today. This is a shifting time period in history of multiple fronts, geopolitical, economic, health, technology, demographics we're not sure where this will go. There's a lot of probability attached to the tail events. So as individuals be prepared to adjust, and again, similar to Adam Grant's book, be prepared to think again.
Tom Wald: Great points. I just want to reiterate a couple things that Transamerica, where we're a manager of managers platform, an $80 billion [inaudible 00:41:19] mutual funds. You could never know you remain as well enough. You've got to know those managers, so exceptionally well, which we really work on doing, but that is really a key understanding their processes on how they select security structure portfolios and manage risk. That's just an ongoing day to day imperative feature that I think all investors need to take into account.
Tom Wald: And I just... The [inaudible 00:41:48] I think is really fascinating too, because I had a grandfather who experienced the, market crack in 1929 and as you said for those who invested in all this stuff in 1929 they didn't break even on that investment to 1954. So, that was a 25 year [inaudible 00:42:06] that gave birth to the... I had that was two generations away from the baby boomers. We had the greatest generation in between, but that generation, really didn't know stocks in great numbers for the rest of their life. And my grandfather wouldn't have own stocks again after 1929. And it really wasn't that this [inaudible 00:42:33] the boom market that began in 1982 was really at the point where everybody who had personally experienced 1929 was no longer here or probably was not old enough to reinvest in the market, whether it took that whole generation to be flush out, to begin to great secular boom of 1982, it was all just really fascinating points that people like myself like to think about everyday.
Dana D'Auria: Jenna, I think one point to add to this too, and follows on very well from what Byron and Tom are saying is... and it sounds old time advice for, I think probably the panelists here, but diversification. I think it gets a bad name because people in the market that don't understand the market well. And I'm thinking about retail investors out there, who all of us, it's our job to protect these people. To Byron's point on the lost decade. If you were in the S&P 500, it was a lost decade. If you were invested in a global portfolio, you made a decent return, right? A global, 60, 40. You hear diversification failed when the market goes down. Everything correlates to one, that really obscures a very important point that I think is even more relevant now because of the rise of meme stocks and the way that new entrance to the market are approaching the market.
Dana D'Auria: They're approaching it with directed brokerage. They're approaching it with robo advisors where they just pick out individual stocks. You might have mathematically the correlations go to one in a market crash. That is not the same thing as saying, I am invested in one stock and that's the stock that goes bankrupt. Or I invested for some reason on Reddit. And I bought it very high and now basically I've lost 50% or whatever it is. So I think there's a misunderstanding out there about the value of diversification. I think diversification is live and well, I think it's really important, especially in the environment that we're in. And there is systematic risk and there is idiosyncratic risk. You can't diversify away the systematic risk, right. If you're in the market and the market tanks, you're going to feel it, but you can diversify away the idiosyncratic risk. And that's a big deal. It's the difference between all of your money taking all, dissipating or disappearing versus you've got to wait it out for the stocks that you own to come back for the market overall to come back. (Silence)
Dana D'Auria: I think we're seeing a lot of interest there and it's driven in, in large, I think by the fact that when valuations are high, expected returns are low. So public market equities are... they have lower expected returns going forward. We know what's going on in interest rates. We talked already about just the negative, real yields that you're getting there. So, your standard investor who's in the standard public market equity fixed income 60 40 is looking at this saying, "Wow, my expected returns aren't what they used to be, how do I diversify?" And I think there are a lot of avenues now to get into private markets, to get into hedge funds.
Dana D'Auria: Obviously you have to be careful to Byron's point. I mean, if there's a place that you need to be aware of what you're investing in, it's certainly this particularly on the cost side, but there are opportunities there. And I think we're seeing democratization of those types of opportunities. We're seeing more and more on-ramps where investors down the spectrum can invest there. So I do think that there's potential there for a lot of investors to add a leg of diversification and potentially increase expected return.
Malcolm Polley: And I would agree. I think that we need to look for asset classes that can try and enhanced returns by limiting as much as possible. The downside that the caveat I would add is that [inaudible 00:46:39] 90% of all asset categories that are existence today if not exist prior to 1990. So, you simply don't have data. And what would happen to the asset category? Assuming interest rates go into a long term, secular increase. You can, however, look and see how certain asset classes perform in a rising rate environment. But you got the this mass matching problem between a cyclical rate move and a secular rate move one is dramatically longer than the other. And the data don't necessarily translate. But yes you need to look at asset classes that can provide moderating against the downside in portfolios, which is really what we're concerned with, right. Nobody's concerned with upside risk, everybody's concerned with downside risk. And that's what we really need to concentrate and protecting against.
Jenna Dagenhart: And I won't go into loss version here, but I have a lot of thoughts. There as well to Malcolm's point, Tom, you look like you had something you wanted to say as well.
Tom Wald: Yeah, I was going to say the great point Malcolm just made on the downside risk is that the investment math favors out performance versus benchmark computer groups in down markets versus up market. So if you outperform your benchmark by 10% or 20% in a severely down market, you're going to have better long term returns than if you outperform 10, 20% in an up market, simply cause you're preserving capital when it's most important. And just mathematically that puts the wind at your back versus [inaudible 00:48:09] scenario so that the ability to minimize draw downs in really tough extended period, which we haven't had a whole lot of them, but really plays a major role in long term out performance for manager.
Malcolm Polley: Right. Which, really speaks what Byron was saying is you need to pay attention to the risk you're taking most people's typical reaction to trying to improve your returns is to take more risk when in reality, what people should be doing is trying to minimize the downside, which will by definition increase your long term return.
Jenna Dagenhart: Let's talk a little bit more about those risks and risk in general, Tom, if you had to choose one risk and one opportunity you think investors should be aware of in 2022, what would those be?
Tom Wald: So I think when you look at risk versus opportunity and what might be the biggest on each side, I think the biggest risk would be a Fed policy against the backdrop of both significantly rising COVID cases and a slowing economy, The risk being rate hikes, not proving to be enough in number or applied fact enough to curtail inflation, but they do start out the economy and stagflation becomes the real possibility. This of course would not be good for equity or credit markets. And I would attribute a lower probability to that scenario, but it is an identifiable risk.
Tom Wald: The greatest opportunity I believe is that COVID starts to fade into the rear view mirror, not so much in terms of its disappearance entirely, but more so that between the vaccines, the new treatments and potentially less severe mutations, it no longer restricts consumer activity. To the extent we've seen in the past and we also get mitigation of inflation, closer order to say three percent range as global supply chains, clear and overall consumer price reports begin to normalize. Under that scenario. I think you could see a real ramp up in both economic and earnings growth [inaudible 00:50:20] and stocks would perform as extremely well. So I would lean more forward that second scenario than the first, but they're both well within the realm.
Jenna Dagenhart: And Byron, if you had to choose what are the one or two market risks or risks to your sector that keep you up at night as we head into 2022 and beyond?
Byron Boston: First would be global macro risk. And in that category, I'll include geopolitical risk. Remember, we're dealing with Russia versus China versus the US versus [inaudible 00:50:55] where we're dealing with democracies versus authoritarian rule. There are a lot of factors that are at place so global macro risk, meaning that there's something globally takes place that really surprises us and we'll have to react to it. So we are conditioning ourselves to react that we want to be flexible and month in up in our mindset.
Byron Boston: Then number two, it's government policy. Look, we're sitting here. The current environment is a function of the response of so many governments around on the globe, both in fiscal and monetary policy. Those policies are influx. There's a huge battle over what exactly the government should do, whether it's the central banks or whether it's the fiscal policy. If the government flips in the United States will have a different policy around tax and spending than we've had for the last two years. And so those uncertainties are there. I know we're going to have to react at Dynex Capital. I want to be calm. I want to be disciplined. I want to be analytical and methodical in our decision making. And so when you say, what keeps you up at night? I just want to be prepared for the big game, as we would say, as an athlete would say.
Jenna Dagenhart: Going back to Tom's, Michael Jordan and Tom Brady analogy as I like it. Now Dana turning to you, what types of opportunities do you see in sustainable investing and what do we expect for performance in this space?
Dana D'Auria: Yeah, I love this topic and there's a lot you'd want to get across in a short period of time. So here's what I would say about sustainable. Coming again from a space where we cater to retail investors sustainable is thought of often as standard socially responsible investing, which is really the purview of endowments for a long period of time. There have been a lot of studies that we have done that said, "Hey these thin stocks that are removed from these portfolios, they outperform. So it's going to cost you performance if you want to invest in your social preferences." So, that's the backdrop. I think that we face as we approach this in terms of retail audience and really there's a few reasons why we've got to flip the script on that. One is, and first I'll say right if the goal was to divest from these stocks, of course they outperformed, right.
Dana D'Auria: If there was any success, then you would expect that the return on those stocks would have to increase because in fact, you did drive the price down. So, it was always interesting to me that that seemed to be some big surprise or revelation. The difference I think now is that there's an alpha thesis that goes along with a lot of these sustainable approaches. And the question is, will that alpha thesis play out? We've got a lot of studies out, meta studies on top of meta studies. I saw a meta study of a meta study. What are the returns to this new version of sustainable investing this ESG, where now I have an alpha thesis that not only am I divesting from brown stocks, but the brown stocks should underperform because their cash flows won't be as good because they have stranded assets, let's say, right?
Dana D'Auria: So there's an alpha thesis where in the old SRI there wasn't what I would say to people about this is that the studies are great, but the data's just not long enough to tell us that much right now. And we haven't seen the alpha thesis actually play out. So if you're seeing return differences, a a lot of it has to do with the fact that there is differences in views on the data of what even constitutes, a green stock versus a brown stock. So, that's muddying the waters. I think also you're seeing the effect of money moving toward this sector. So these stocks are getting bit up and if you're sitting in the stock, when it's getting bit up, you get a better return. So, I think the studies that are out there are hard to put a lot of faith in maybe you take them as directionally accurate.
Dana D'Auria: I think what's more important is do you want to express your social preferences in your investing? Which I think is how I'd like to approach this? I think it's great and fantastic fractional shares commission, free trading. It's not just people with a big chunk of assets to invest that can actually say, "Hey, I don't agree with this and I don't want to invest in it, or I want to support this." And you can do it in a way at tracking error that you can accept.
Dana D'Auria: As far as what the long run return potential is over that it's to be seen, right. It, really is to be seen when we go through physical risk transit risk, regulators changing the game, which companies are going to are going to pan out in this space. So two ways to look at this, I'll leave you, right. One is I want to express my social preferences. I can do that. It makes for better engagement with advisors. I should be able to do that now, the other is, am I going to get better return or lower risk? I would say the jury's out decent evidence that it is defensive. It has a quality indication to it. The alpha thesis has to play out.
Tom Wald: I agree to that. That Dana has some really great points about the whole framework that we're seeing with responsible investing right now. I think one of the interesting points is that just over the last couple of years, the perception of responsible investing sustainable and ESG has moved from one of an exclusionary process where you eliminate stocks, that you don't want your portfolio to an inclusionary process, where you included as a fundamental criteria that will hopefully drive alpha over the course of time and make for better companies that will then be provide better return for share holders. But I think the most important point that you brought up at that is just is that the data has to play out here. And these are not short term trends that can be identified in six months or a year or so really has to play out over the course of time. But I think how mainstream investors are potentially embracing this is really different than it was to couple years ago.
Jenna Dagenhart: Certainly. And as we wrap up this panel discussion, I do want to quickly touch on earnings. Malcolm earnings have been fairly strong in the current year. Can we expect them to be as robust in 2022? Can we expect equity prices to rise as much as we experienced in 2021?
Malcolm Polley: Well, I don't. I think it's pretty clear so far that all we're going to have earnings growth in 22. It's not going to be the level that we've seen it in 2021. In many cases was a snap back year, the companies were seeing earnings growth off of artificially depressed levels because of the pandemic. So they have big snap back really quick. Earnings growth is going to slow. And if interest rates stays still or rise modestly, particularly at the long end of the curve, basic, time value of money or basic discount of cash flow analysis would say that valuations all else equal, probably moderate. So you don't get as robust and equity market as we had in 2021, it remains to be seen. What we do know is that estimates coming from wall street are wrong. They always are. It's just a matter are they going to revise their earnings upward or downward right now? Our belief is that earnings estimates probably be revised modestly downward through the course of 2022.
Jenna Dagenhart: And looking back on 2021, it's not just equities real estate also skyrocketed. Byron you're well versed in the global risk environment. What's the current sentiment around the potential for a housing bubble given how high prices have already climbed. And where do you think we are in the housing cycle?
Byron Boston: The number one factor to think about is that housing demand far out strips housing supply at this point, there are not enough houses. There are more houses that need to be built. My steerts man's language way of say layman's way I say to people, I say, "All baby boomers and baby boomers, kids are now adults. And they all have the ability to form households." So, whether it's in apartment rentals or in home purchases, a lot of preferences have shifted also. So, when you look at the home price increases, you'll see places in Idaho or some other rural areas that have had these enormous price increases as remote work has come into fold where you see couples relocating from urban areas to more rural areas. And that situation is still in flux. But at the end of the day, there's still more housing demand than there is for housing supply.
Byron Boston: And let's not get confused versus the first decade of this century, that situation was very different where we had the type of lending, the type of capital flow that was overwhelming. The housing market, such that there was some really bad loans being made. This is a different situation. There truly is a very large demand for shelter, whether it's home ownership or whether it's apartments and you see rents rising, you see home prices rising. I wouldn't use a word bubble because there's real demand behind it, but where prices go and how they may shift over time will depend on the demographics. It will depend on how many new homes are ultimately built over the next four or five years. But if you compare and use the word bubble, I'm not in the camp of using the word bubble, I'd keep track of the demographics and how many people are really demanding homes and all real estate is local. Make sure you understand where real estate is really being demanded and how that's shifting and changing give in this remote work environment.
Malcolm Polley: I agree with Byron, I think it really is demographics driving this things. If you unpack the data in terms of home ownership boomers are reducing our home sizes. And a lot of the demand, as Byron said, is in smaller areas, more rural areas that are getting a lot of the millennials and Gen Z folks that are coming in to work remotely and get away from the hustle and bustle of the city where you've got more restrictions from a pandemic perspective. And you see the biggest demand is really in the first time home buyer range, where you're going to see a fall off probably in the higher end where we boomers are have reside. The Gen X does not have a large enough number of the demographic population on Gen X. It would be the logical buyers of our boomer houses simply isn't large enough to pick up that supply. So, as long as the millennials continue to buy houses, and I think in many ways the millennials are where the boomers were in the early 1970s. We should continue to see demand in the housing stock.
Tom Wald: I would say the most sobering statistic that I heard in the entire year Pat, is that the oldest millennial turned 40 this year. So, that's close to who all play into the province of what you both just mention just now.
Byron Boston: Can I give one [inaudible 01:02:09] it's a strange example, but it's true. So I had a friend and we were same age, two kids each, maybe 13 years ago, 14 years ago, they were one household, four people. Today they're four households. Both kids are out of college on their own. And the husband and wife got divorced. That's unfortunate, they got divorced. But the fact of the matter is 13 years ago was one household, four people today they're four households. There are numbers behind the current situation. There are real numbers there.
Jenna Dagenhart: All very important points. And we started the program by talking about some of the shocks, some of the wild cards that we've already experienced. Tom, what are some of the wild cards that you think investors should be watching for that could impact the market in 2022?
Tom Wald: Fact that I, [inaudible 01:03:01]. I always like to think about wild cards impacting the market because I think if there's one thing we've all learned and it ties into Byron's comments earlier about expecting the unexpected is that there's always variables lurking in the shadow or flying into the radar to that to some extent. Instead could have real market impacts. So, some of the ones that I think investors might want to consider in the year ahead, and we've touched on a lot of these, but beginning with the omicron variant, what's going to be the profile of that in terms of a transmissibility and severity and potential ability to... of that strength to evade current or future vaccines.
Tom Wald: What that could mean for COVID cases and what that could mean for the economy. I think related to that, we touched upon this earlier are some of the new therapeutics that are going to come out to treat COVID itself, as opposed to trying to prevent it, but actually treat diagnosed cases of COVID such as the me American Pfizer antiviral pills, I think if 2021 would the year, the vaccine might 2022 be the year of the antiviral treatment.
Tom Wald: Then of course, the global supply chain that we've talked about, whether or not those bottleneck market break when, and by how much that might occur. And that, of course, all the major impact on inflation. Another is that we've heard so much about the great resignation in the labor markets might that lead at some point to the great return. We've heard so much about millions of people leaving their jobs and leaving their workforce well, which has created these large worker shortages. And of course has contributed the rapid pay through replacement.
Tom Wald: But I think logic and personal economics sort of infer that a lot of them might have to come back at some point. And when they do, and at one pay, could have positive effect on the economy, in the markets. And I think the final one is the November midterm election coming up towards the end of this year. And we could see a shift in control from Democrats to Republicans in the house and Senate, which could be received well by investors simply by the inference of history, which is that markets have performed very well historically under split party leadership between the white house and Congress. So those are all things that to some extent or another are being talked about more or less, but I think they all could of some impact on the markets in year ahead
Jenna Dagenhart: And circling back to you, Dana, any final thoughts that you'd like to leave with our viewers?
Dana D'Auria: I think I'd like to leave with just, a really positive note, which would be, if anything came out of this pandemic that we can take with us, it's that innovation had to move, right. And when we have a shop like we did to the system, we have to innovate around it. And we did I think we moved forward probably five years in terms of how work from home and the technology use and how that was just spread out. And I think where you see that really working out in the numbers is in productivity and we've seen great margin increases this year as a result of it. So, those are things that are going to stay with us. Those innovations, those changes in home work, life balance. And I think those are positive things we can look to.
Jenna Dagenhart: And to your point, hopefully we'll continue to innovate in 2022. We'll everyone. Thank you so much for joining us.
Byron Boston: Thank you.
Tom Wald: Thank you.
Malcolm Polley: Thanks Jenna.
Jenna Dagenhart: And thank you for watching this 2022 outlook masterclass. I was joined by Tom Wald, Chief Investment Officer at Transamerica Asset Management, Dana D'Auria, Co-Chief Investment Officer at Envestnet, Malcolm Polley, President and Chief Investment Officer at Stewart Capital Advisors and Byron Boston, Chief Executive Officer and Co-Chief Investment Officer at Dynex. I'm Jenna Dagenhart with asset TV.