Institutional investors recently gathered in Madison, Wisconsin, to hear thought leaders address the topics of asset allocation, risk management, and the state of financial markets. As part of the program, representatives from Fidelity Investments, Goldman Sachs, and the State of Wisconsin Investment Board (SWIB) shared their frameworks for decision making and presented competing visions for how the next 12 months are likely to unfold. They also hinted at how they would position portfolios for optimal advantage.
A brief recap of their presentations follows:
Goldman Sachs Sees Decelerating Growth But Pockets of Opportunity
Noah Weisberger, head of the tactical macro equity team within Goldman Sachs’ Global Markets Group, focused on global macroeconomic indicators, including Goldman’s own proprietary index, which were pointing to modest but stable growth in the United States, continued strength in China, and Europe pulling itself out of recession — barely. Goldman’s Global Leading Indicator (GLI), an aggregate of key macroeconomic indicators from around the world, is currently seeing decelerating growth. Historically, Weisberger noted, slowing economies are almost as likely to revert to expansion as they are to move into a contraction phase.
In terms of portfolio positioning, Weisberger considers the U.S. and emerging market equities, oil, and copper all to be priced as if the economy was contracting. Within equities, Weisberger asserted that consumer staples and energy sectors have been among the most resilient when the economy is slowing or contracting. He described strong corporate profit margins in the United States as a political risk, implying that they amounted to a big “stash of revenues [for the government] to potentially go after.” Weisberger also endorsed Goldman’s well-publicized call to buy U.S. equities from earlier this year. (Post-conference update: Evidence of further deterioration in economic activity prompted Weisberger to turn negative on U.S. stocks.)
Fidelity Warns of Systemic Risk, Sees the United States Better-Positioned Than Most
Dirk Hofschire, CFA, Fidelity’s senior vice president of asset allocation research, considers the secular challenges facing the world’s economies as the greatest since World War II. Drilling down, he sees a significant “downshifting” of China’s secular boom, referring to China’s current state as a “growth recession.” Accordingly, he does not expect a repeat of the past decade when Chinese growth fueled outsized returns for emerging markets and commodities. The fading export boom, an overextended housing sector, and a rapidly declining working age population are some of the biggest challenges facing China and also reasons to steer clear of China-dependent assets.
Hofschire suggested that Europe may look a lot like Japan over the next 10 years — rolling in and out of crises. The necessary deleveraging of the financial system will effectively starve the private sector of the credit necessary for any sustained expansion. Near term, he sees the primary risk being the impact of potential eurozone membership changes. The best case scenario, in Hoschire’s view, is that the crisis is not dragged out and Europe “federalizes” their banking system, but he doesn’t expect substantial progress within the next year.
Despite pronounced economic sluggishness, Hofschire sees the United States as relatively attractive. A lack of wage pressures and commodity price weakness should keep profit margins robust. And signs of stabilizing consumer credit and housing offer the potential for a boost from what are typically early-cycle economic drivers. At the same time, he cautioned that the United States remains susceptible to an external shock, like Europe, or an internal policy shock, like the looming “fiscal cliff.”
Within the United States, Hofschire maintains a bias to equities versus bonds and favors sectors with significant domestic exposure, including technology, energy, industrials, and utilities.
Wisconsin Public Pension Fund Chief Calls De-Risking a “Crowded Trade”
David Villa, CFA, chief investment officer at the SWIB, focused on his expectations for wage growth, which impacts the liabilities of pension funds and has implications for the level of risk-taking and required returns. Villa is projecting wage growth of 3% over the next year and targeting a 7% portfolio return. While he did not share much in terms of how SWIB’s portfolio is positioned, Villa did characterize the de-risking move from equities to bonds as a “crowded trade.” At the same time, he advised that investors should not be “seduced” by the sharp earnings growth off of recent cyclical troughs and shared that his outlook for emerging economies was “not constructive.”
While a recently released study singled out Wisconsin’s pension plan as the strongest in the United States, SWIB is facing the same pressure as all plan sponsors to meet return targets and benefit obligations in what has been a sustained and artificially low interest rate environment. In a recent interview, Gary Brinson, founder of Brinson Partners, neatly summarized the dilemma plan sponsors currently face and how “financial repression” has impacted them. Underfunding and the financial crisis have left many states and municipalities in dire straits, and he sees a restructuring of plans as inevitable.