Allan Janssen (AJ): Welcome to Soundbites – weekly insights on market trends, and investment strategies, brought to you by Investment Executive, and powered by Canada Life. I’m your host, Allan Janssen. For today’s Soundbites, I’ll be speaking with Michael Arno of Brandywine Global Asset Management, and Jennifer O’Hara Martin of T. Rowe Price. Michael is an associate portfolio manager and senior research analyst on Brandywine’s global fixed income team. Jennifer is a vice-president of T. Rowe Price Group, and a portfolio specialist in the company’s U.S. equity division. So, we’ve got bonds and equities well covered as we discuss opportunities that may await us in 2022. I started by asking Jennifer how equity markets look.

Jennifer Martin (JOM): Well, thanks Allan. Global markets face more uncertain prospects as we look at 2022. And right now, markets continue to be really noisy, driven by macro factors, notably the broad spread of the Delta variant and the recent emergence of the Omicron variant. Other factors influencing markets include elevated inflationary pressures, fears of the impact of potential central bank tightening on equity markets, and of course rising uncertainty as it relates to what is happening in China. So, all these factors pose potential challenges for economic growth and earnings at a time when equity valuations appear elevated — at least in absolute terms.

AJ: And Michael? How would you describe the state of the bond market?

Michael Arno (MA): Thanks Allan. So, entering ’22, a similar backdrop to what Jennifer was highlighting with valuations in the equity market, bond markets — especially in spread sectors — also are at their tighter end of historical ranges. We’re facing peak policy support with a number of developed market central banks ending QE and moving closer to rate hikes, in addition to less fiscal support. It’s that shrinking balance sheet that will probably ultimately cause challenges for risk assets, both in equity and fixed-income markets. So, we’re watching those pretty closely. The signs of a policy change in China will be important for ’22, following a pretty negative credit impulse in ’21. Given their concerns with overall debt levels, it’s unclear how aggressive they are going to be this time around.

AJ: Well, Jennifer, given all the variables, can you give me some names in the equity market that look attractive to you, and maybe explain what makes them look so attractive?

JOM: Well, this is a really fun question to answer. There are several to share by geography. And here’s just a sampling. Evotec [of Germany], which is a health care company in Europe — it’s Europe’s largest contract research organization — has been producing solid double-digit earnings growth, which we think will continue, driven by secular tailwinds, deeper customer penetration, and end markets that choose to outsource these services more often. If we head over to Southeast Asia, there’s a company called Sea [Singapore-based], S-E-A. And it’s an internet platform. We think the company is strongly positioned in gaming — video gaming — and e-commerce, two segments of the internet economy that should benefit from really demographics, rising wealth, better mobile infrastructure, and increasing internet penetration in its target market. If we head over back to the U.S. and financials, look no farther than Charles Schwab [Corp.]. It’s a premier franchise that’s highly levered to rising short-term rates, with a sizable scale advantage over competitors. Longer term, we believe the company can deliver durable earnings per share as it continues to gather assets, drive scale efficiencies, and grow its bank with low-cost brokerage suite deposits. And, finally, I’m going to end in China. Kanzhun [Limited]. It’s a consumer discretionary name. It’s an online Chinese recruitment platform. It’s a very disruptive business model. More important, it has limited impact from verticals hurt by the recent regulations and weak economy, given that the company is still in the fast-growth and under-monetized stage of its life cycle. So those are just a sampling. And that’s the benefit of a global portfolio. There’s always something to talk about.

AJ: For sure! So, Michael, what bond classes look good to you in ’22 and why?

MA: Yeah. So, in the context of a positive growth backdrop, decelerating inflation, which allows the Fed to be gradual, we think that high-yield corporate credit should continue to perform well on a relative basis. Default outlooks remains very benign. Maturities pushed out with refinancing. But we definitely want to be mindful of the duration risks that have crept into the high-yield space with longer-dated, lower-coupon issuance. You know, as companies have taken advantage of the low-rate environment, they’ve extended the typical maturity out to 10 years and took advantage of those low yields. So, we think shorter duration bonds of quality companies, solid pricing power offering attractive carry are good places to sort of hide out right now. Those are some of the key characteristics.

Within structured credit, non-agency mortgages in the U.S. remain pretty attractive. The fundamentals obviously are clearly attractive given the strong labour market, excess savings, solid household balance sheets, really good loan-to-value ratios, and the large wealth effect from rising asset prices. Investment grade, again, a segment where you want to be very mindful of the duration risks in that market. We think some segments of the investment grade market offer some defensive characteristics, just in case we do get that accelerating inflation and the Fed has to accelerate policy faster than people think. And then, lastly, I think you always want to take a look at the laggards for the year and try to understand what could reverse that. So local emerging markets have been clearly one of the laggards in 2021 on a combination of rates backing up and currencies selling off. This has been driven by higher inflation, political noise, which is putting some premium on parts of the curve. So those are some of the things we’re watching for in 2022.

AJ: Michael, I’ll stay with you. Are there potential opportunities just over the horizon?

MA: Yeah, I think that the two big key themes for ’22, especially the early part of period of ’22, are going to be China moving towards a more stimulative policy, and how aggressive or how moderate that will be. You know, markets expect that they would want a fairly solid economic growth for [this] year. And then, secondly, inflation pressure. You know, obviously that is a key for many developed market central banks. The Fed is forecasting maximum employment to be achieved [this] year. So far, you’re not seeing a wage-price spiral just yet. But we think it will be very important to watch those month-over-month inflation prints, and see if we get any slowing of inflation. So, I think those will be two of the keys in trying to assess the direction of the global economy in ’22.

AJ: Very good. Jennifer, then, same question to you. What’s going to impact equities in the early part of this year?

JOM: Sure. I mean, while world economies are beginning to recover and learning to live with Covid, it is entirely possible we experience extreme growth [this] year, if developments are skewed significantly positive. So, there are no further variants, vaccines prove very good against current variants, vaccination rates increase, and we push the world toward herd immunity. I mean this could result in a boon to companies, for example, in the travel and leisure space which, you know, have been somewhat dormant over these last two years. And so, that’s another way of thinking about what other potential opportunities could be in 2022.

AJ: Any last thoughts on opportunities?

JOM: Well, given all the opportunities and unknowns defining global equity markets today we’re balancing the portfolio to ensure it isn’t overly defined by a few stocks or sectors, and we remain focused on identifying, really, an idiosyncratic set of names across sectors and countries with the ability to deliver durable long-term growth.

AJ: What about you, Michael? What would be your message to a room full of investors?

MA: Similar to what Jennifer was saying, we’re taking a fairly balanced approach as well in portfolios, given valuations in credit-spread sectors trading at the tighter end of historical ranges. We think there is good scope for some carry opportunities in credit, just being mindful of the valuations. So not reaching for yield. Just looking for good solid companies, good balance sheets that offer attractive carry and being more diversified within the portfolio as well.

AJ: Well, those are today’s Soundbites, brought to you by Investment Executive, and powered by Canada Life. Our thanks again to Michael Arno of Brandywine Global Asset Management, and Jennifer O’Hara Martin of T. Rowe Price. Join us every Wednesday at InvestmentExecutive.com, where you can sign up for our AM newsletter and never miss another Soundbite. I’m Allan Janssen. Thanks for listening.

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