Why Merrill Is ‘Very Short-Term’ Hawkish

May 01, 2017 at 07:39 AM

Share & Print

In the current market slump, "gather ye rosebuds while ye may." That's the message from Christopher Hyzy, chief investment officer of Bank of America Global Wealth & Investment Management. Good opportunities tend to evaporate quickly in this market environment, which is why improved corporate earnings growth has prompted Merrill Lynch to be "very short-term hawks" in this and the next quarter as it seeks opportunities in select sectors.

In a wide-ranging interview with ThinkAdvisor, Hyzy identifies and discusses these, and provides other insights into the firm's current investing strategy, such as being overweight emerging markets.

Further, the CIO explores three key things that financial advisors need to watch closely in what he calls the "synchronized global recovery" now taking place, as well as forecasts when the next pullback will occur.

Asked about Merrill's provocative new ad campaign stressing that it "…puts the interests of our clients first," Hyzy discussed Merrill's investment process but declined to address fee-based versus commission compensation as it pertains to the Labor Department's fiduciary rule. The firm's apparent reconsideration of its move away from commissions on new advised retirement accounts is "out of my subject matter," he declared.

Last fall, the firm strongly supported fee-based comp for such new accounts. Recently, in a statement, it said that, while "We are continuing on a path to implement a fiduciary relationship for all retirement accounts," based partly on client and advisor feedback "there may be limited situations where a fee-based arrangement may not be in clients' best interest."

For those cases, the firm is "considering potential alternatives" to its fee-based Investment Advisory Program "in a manner consistent with a higher standard of care." It cites examples of "private equity and concentrated stock positions."

ThinkAdvisor recently spoke by phone with Hyzy, who determines the firm's investment view, and develops and manages asset allocation strategy and solutions' due diligence, among other responsibilities. Here are excerpts from our conversation:

THINKADVISOR: The current U.S. securities market and economic-political situation isn't easy, is it?

CHRISTOPHER HYZY: No, it's not. We're going through a slow [market] slump right now, basically a 3% pullback. It's really important to be realistic at all costs. We're not going to see easy things for a long time. However, in the U.S., growth overall, the profit cycle, direction of employment and housing are well on their way to subtle, continuous slow improvement. It will be very hard for any changes in the next 12, or even 24, months to move those four things in a wrong direction and for them to be a cause for concern.

How do growth investors stand right now?

Many are on the sidelines waiting for signs that say: This is close to all-clear. But this isn't a marketplace that's going to give anybody the all-clear sign. However, we expect those folks to trickle in as markets climb the wall of worry. They'll be slow to move into the equity side, and that's why we don't expect significant equity returns [this year] — more than likely 7% to 9%, including dividends.

What's critical for all investors and advisors to keep in mind?

It's important not to be a bear because in this market environment, opportunities are very difficult to stick for a long period — they come and go. If you're an ultra-bear, you're going to miss an opportunity that's unfolding right now.

What's that?

Earnings growth and revenue growth. So we prefer to be very short-term hawks in this current quarter and next, and look for opportunities in key sectors.

What's driving the market at the moment?

The profit cycle is starting to pick up. That's what has been missing in the last almost-three years. We think we're going to see 9% to 11% earnings growth — and we'll also get some revenue growth, which is the key distinction [compared to] what has occurred in the recent past. As we get close to the summer, we think the market will hit new highs.

What about corporate pricing power, which is usually a significant sign?

We're starting to see some of that in key sectors filter into revenue growth. It's not going to be tremendous or across all sectors, but it's better than zero — and markets care about the improvement factor vs. things deteriorating. It allows the investment community to climb the wall of worry.

What's the biggest threat to the market this year?

What we don't know. Investors are starting to get comfortable with real U.S. GDP growth of around 2-1/2% and nominal growth of around 4% to 4-1/2%. We haven't had that for almost two years. But any changes to that on the downside, and investors will go to risk-off mode and wait for signs that it's coming back. [The other big threat] is an unforeseen geopolitical event.

How much did Donald Trump's election to the presidency and his agenda contribute to the positives you've mentioned?

We attribute about 5% of the equity outperformance ahead of this latest slump to so-called animal spirits; that is, what's to come. It picked up business confidence.

When does the market become troubled again?

It starts to worry around the tail-end of the French elections and then when the next Fed hike is going to come. That's when your next pull-back should occur. We're not talking about a 5% or 10% pullback because that would have to include skepticism about the profit cycle and a pretty sizable unforeseen geopolitical event. But after that second pause, we expect flows to move from risk-off type assets into riskier assets like equities.

What particular things should financial advisors be watching?

They need to make sure they continue to see the current synchronized global recovery unfold and have confidence that that should continue through this year and well into 2018. It does continue to gather good, but subtle momentum. The last time we had this type of recovery was between 2003 and 2006.

What else do advisors need to be aware of?

Valuations, but looking at that just in absolute terms is probably incorrect in markets like this. Looking at it on a relative basis is also incorrect, but you should build a framework and a score card. We still see more elements in favor of reasonable valuations than overvaluations.

What geopolitical events happening right now should advisors track?

The French election and, ultimately. the Italian election. In the U.S., fiscal [issues] running the gamut from potential tax reform, infrastructure [rebuilding] and any changes to the regulatory framework. Last but not least: China. It's always disregarded when things are going well and always used as an excuse why things aren't. It's important to understand that China is going through a massive, long-term transformation.

You say we're in a "synchronized global recovery." How can countries plan to be in sync, or is it just coincidental?

First you need the United States or other major economy to be the leader of the growth package. In this case, the U.S. began the rise before everyone else because the U.S. went into the credit crisis first. Then China started to take the gavel and came in with a fiscal package recently, as their growth took a hit. So, once the two top economies of the world started to grow closer to trend, that helped emerging markets outside China, and it began to help Europe because Europe is the largest trading partner with China, as well as the U.S. And it started to help Japan too.

What happens next in a synchronized global recovery?

The expansionary phase. Central bank policy around the world needs to be somewhat coordinated, and that's what you're starting to see as well.

You mentioned that you're looking for opportunities in "key" market sectors. Which ones do you like?

This type of marketplace — a global synchronized recovery — usually supports better performance in small caps vs. large caps, and more value-oriented investments, like [investing in a single country, such as] Japan, and in emerging markets and value-based sectors, like energy, materials, industrials and financials. But you need to own both growth and value.

Please elaborate on emerging markets.

Emerging markets have the largest opportunity set due to where they're coming from. It's our most preferable overweight because they've been in bear markets, but now they have the ability to not just get up off the floor but to walk and potentially jog.

Why do you see the other sectors you mentioned as promising?

Financials are not just going to benefit from a more proactive Fed — rising short-term interest rates — they're also likely to continue to benefit from a consumer whose real income is still improving, though we're not talking gangbusters in terms of rising real incomes. But that feeds into better cash flow for banks, among other benefits.

And what about the rest of the sectors you indicated?

Because you can't go all in on value — since this isn't a marketplace that's rewarding it completely — you have to look at areas that are good value but which are traditionally growth sectors. That's health care and technology on the discounted value side. In health care, biotech can provide growth, but more speculative growth. Pharma can give you very good value with yield. Technology is still at a discount to so-called long-term market multiples even if you back out the very high-end multiples base of the late 1990s and early 2000s.

How about the energy sector?

It's a ping-pong match between higher oil prices and higher supplies, not to mention the geopolitical cloud within the oil patch. You really have to pick your stocks. It's a mixed bag. But there's some perceived value there.

And industrials?

The area we like most in industrials is aerospace and defense, which, on a very short-term basis is going to be more contingent on the value of the dollar as earnings are transferred back home from overseas. With a stable dollar, we're proponents of looking at some parts of the industrial side; and that would be squarely in the aerospace and defense area.

Do you advise shifting the portfolio asset mix in the current environment?

We would advocate at least a 10% overweight above whatever the institution's, family's or individual's equity policy is. We're underweight fixed income because over the full cycle, yields are more than likely to rise vs. fall. As yields grind upward, ultimately the flow from fixed income into equities will trickle in.

Some people are talking about a massive rotation from fixed income. Why do you say it will be a "trickle"?

Even though rising yields typically pressure fixed-income investments, the reality is that the enormous population that's retiring every day isn't comfortable changing their risk spectrum significantly enough to move from fixed-income to equities. That takes time, transparency and visibility into feeling comfortable — and it isn't happening.

I wonder why so many foresee a huge rotation, then.

It's an interesting dialogue. Unfortunately, there's a great lack of clarity in the world and an overwhelming pool of people who need fixed income to manage their lifestyle as they retire in the next 20 years. It's going to be very difficult for them to change their risk outlook.

What should advisors keep in mind over the next two to three years?

It's important to understand what a buffalo market is: an unattractive bull market. It has a lot of skepticism and sporadic volatility. A buffalo market is rather heavy and can roam for long periods in a herd-like fashion, yet it's easily spooked by something it doesn't expect and tends to take a break. This is in contrast to a bull market, which has very strong upward movement, akin to the 1990s.

Please explain the reason behind Merrill Lynch's new advertising theme, featuring the headline, "We're bullish on the future. Yours."

We're bullish on the millennials because there's a very significant demographic shift going on in our country and in the emerging-market middle class. There are the boomers, the millennials and the Gen Z's, plus the emerging-market middle class. The three largest pools of people in the world are collectively spending money on travel, leisure, entertainment and innovation technology. And that's incredibly bullish.

You cite Generation Z (aka the iGeneration), the one after the millennials. That's a pretty young cohort.

Yes, but they're incredibly well educated and tech savvy. That's really important.

Merrill's ad campaign also states that it has "…pioneered a unique, more personal approach to investing…that puts the interests of our clients first." What's unique compared to other firms' approaches?

From the standpoint of the investment process, what's unique is how we apply oversight in every step of the process, not just at the end, as do traditional oversight mechanisms. That is: How are you doing vs. benchmarks? Oversight needs to be throughout and transparent, and applied to all clients, whether institutions, individuals, families, endowments or foundations.

Anything else that's unique?

How we apply research and market strategy globally — it includes [looking at] real-life corporate activity — not just what one thinks about indicators that we all watch every day, and portfolio construction that isn't just asset allocation.

— Related on ThinkAdvisor:

—

NOT FOR REPRINT