Future Returns: Ignoring Market Noise for the Long-Term
When it comes to volatility in the stock market, long-term investors are advised to ignore the drama.
When it comes to volatility in the stock market, long-term investors are advised to ignore the drama.
Simply, short-term market reactions—justified or not—are just that, short-term. As Deepak Puri, Deutsche Wealth Management’s chief investment officer for the Americas notes, many of the issues causing the market’s recent swings—from the Federal Reserve’s decision to scale back economic stimulus, to concerns over whether Congress will lift the debt ceiling, to worries over China’s regulatory crackdown on a range of companies—are finite, and unlikely to have a long-term effect on the outlook for stocks.
“A lot of these issues we are grappling with have a finite shelf life, and if you look past that, the path of least resistance for the market is still on the upside,” Puri says. A key reason? Negative real interest rates—that is, rates adjusted for inflation— “create a favourable backdrop to own equities,” he says.
While the yield on the U.S. 10-year Treasury note has risen 17 basis points in recent days to 1.482% as of Monday’s close, rates are still relatively low, and the stock market—although expensive—still presents better risk-return characteristics than other sectors, such as Treasuries or investment-grade corporate bonds, Puri says.
“To find a better alternative for equity markets is pretty difficult at this point,” he says.
Penta recently spoke with Puri about where long-term opportunities lie, and where investors should look for value within stocks.
‘Structural Forces’ Continue to Support Stocks
The reason equity markets continue to be worth investing in despite already considerable growth is what Puri refers to as the positive, long-term structural forces “which have more sustenance” than finite concerns, such as the debt travails of China Evergrande Group, a large property developer.
Concerns over the implications of Evergrande’s inability to handle its debt burden contributed to a more than 600-point fall in the Dow Jones Industrial Average on Monday, Sept. 20—a drop that was erased by Friday, although on Tuesday, stocks were nosediving again as the 10-year yield continued to rise.
The substantive, structural forces Puri was referring to include the favourable macroeconomic environment created by low and even negative interest rates. Low rates mean investors should be much more comfortable owning stocks, he says.
As Puri explains, if investors worried about pricey stocks were to put all their money in cash and Treasury bills paying an interest rate of about 0.05%, it would take 1,000 years or more to double their money. By contrast, it would take seven-and-a-half years for investors to double their money in stocks, given equity markets historically have risen 10% a year. Even a more conservative estimate of a 5% annual rise in stock market returns would lead investors to double their money in 14-and-a-half years.
“Compare 14-and-a-half years versus a millenia if you are sitting in cash,” Puri says. “The alternatives to really challenge high-quality blue chip equities are limited at this point.”
Another structural boost comes from governments in both developed and emerging markets, which have stepped in with spending to counter the economic blows of the pandemic. Puri believes these actions point to a longer-term trend of increased spending by governments as a percentage of GDP. In the U.S., the spending began with stimulus to blunt the effects of the pandemic, and it continues with expected spending on infrastructure—from roads and bridges, to green technologies and “human infrastructure” such as spending on child care and education.
“That’s a structural shift that’s taking place that creates a favourable outlook for companies sensitive to that spending,” he says.
And, Puri notes, corporate earnings continue to grow at double-digit levels. Even though earnings growth is expected to moderate, and the stock market could swing lower should earnings growth dip, the overall outlook for earnings, and the ability of companies to pass on higher costs, remains strong.
Of course, these forces don’t mean equity markets will continue to go up in the short-term, as Tuesday’s market action shows. Bond yields are rising, the coronavirus pandemic remains a factor and could still derail growth, and the inability of Congress to address the debt ceiling could be crippling as well.
“Any sort of disappointment [about] liquidity, better economic growth, or a Covid resurgence could derail that linear trajectory we’ve been seeing in the stock market,” Puri says.
Where to Find Value
Puri says he often advises investors to look at what they own. Many don’t realize how much exposure they have to big technology names including Amazon or Alphabet, which dominate sectors such as consumer discretionary companies or communication services, for example.
Although the economy’s reopening has been delayed by the considerable setbacks caused by the Delta variant of Covid-19, Deutsche Bank expects the reopening will accelerate as vaccination rates rise, and that cyclical businesses, including banks and consumer discretionary companies, will benefit.
If investors are worried about inflation, Puri says they could consider investing in Treasury Inflation Protection Securities—bonds that adjust the principal payment according to inflation rates—or in bank loans, which, because of their short-term nature (generally one-year or less) have little exposure to interest-rate risk and can deliver slightly higher returns than Treasuries.
A Different Approach to Bonds
Typically, bonds serve two purposes in a diversified investment portfolio: they provide a hedge when stock markets slide and a return from the bond’s appreciation and coupon. In the past, the same security provided both, but “no longer is that possible,” Puri says.
Investors can own bonds for hedging—without expecting much in the way of returns—or they can own bonds that generate a yield (such as emerging-market bonds or high-yield corporate bonds), although the latter will behave more like risky assets, including stocks, than as a hedge.
“For most individual investors, you should have both,” Puri says. “ A fixed-income component purely for hedging—for when things don’t go well, volatility spikes, and equity markets are going down—and another part that gives you income.”
Stay Invested in China
China’s regulatory reining in of Alibaba Group Holding Ltd., the ride-hailing company Didi Global, tutoring services such as New Oriental Education & Technology Group, and debt-laden property developers such as Evergrande, raises concerns about investing in China, but Puri doesn’t advocate investors shun Chinese stocks.
For the near term, Deutsche Bank’s view is that for China specifically, and Asia in general, “it’s too late to sell, but maybe too early to buy,” considering the potential for further volatility.
Longer term, although Chinese growth prospects are down slightly, it’s important for investors with return on their investments as a primary motive to “keep China in your portfolio,” he says.
Many large Chinese companies “are big and profitable in their own regard, and are market leaders,” Puri says. “For a global investor, you need to keep your eyes open. If you are looking for return on your investment as your primary motive [for investing], keeping political and ideological views aside, then keep China in your portfolio.”
Also, the regulatory crackdown has a lot to do with China wanting more visibility into how companies do business, its desire to curtail monopolistic tendencies, and to promote Chinese family values. While the next few months could still be volatile, Deutsche Bank expects the upcoming reelection of China President Xi Jinping next year will create a more favourable macroeconomic backdrop.
Still, he notes, the country, despite its growth, is considered an emerging market. “This is a stark reminder that there are risks that are non-security specific related in these markets,” Puri says.
Chris Dixon, a partner who led the charge, says he has a ‘very long-term horizon’
Americans now think they need at least $1.25 million for retirement, a 20% increase from a year ago, according to a survey by Northwestern Mutual
Government spending, including Biden’s Inflation Reduction Act, has helped drive a gap between clean-energy spending and fossil-fuel investments
Investments in solar power are on course to overtake spending on oil production for the first time, the foremost example of a widening gap between renewable-energy funding and stagnating fossil-fuel industries, according to the head of the International Energy Agency.
More than $1 billion a day is expected to be invested in solar power this year, which is higher than total spending expected for new upstream oil projects, the IEA said in its annual World Energy Investment report.
Spending on so-called clean-energy projects—which includes renewable energy, electric vehicles, low-carbon hydrogen and battery storage, among other things—is rising at a “striking” rate and vastly outpacing spending on traditional fossil fuels, Fatih Birol, the IEA’s executive director said in an interview. The figures should raise hopes that worldwide efforts to keep global warming within manageable levels are heading in the right direction, he said.
Birol pointed to a “powerful alignment of major factors,” driving clean-energy spending higher, while spending on oil and other fossil fuels remains subdued. This includes mushrooming government spending aimed at driving adherence to global climate targets such as President Biden’s Inflation Reduction Act.
“A new clean global energy economy is emerging,” Birol told The Wall Street Journal. “There has been a substantial increase in a short period of time—I would consider this to be a dramatic shift.”
A total of $2.8 trillion will be invested in global energy supplies this year, of which $1.7 trillion, or more than 60% will go toward clean-energy projects. The figure marks a sharp increase from previous years and highlights the growing divergence between clean-energy spending and traditional fossil-fuel industries such as oil, gas and coal. For every $1 spent on fossil-fuel energy this year, $1.70 will be invested into clean-energy technologies compared with five years ago when the spending between the two was broadly equal, the IEA said.
While investments in clean energy have been strong, they haven’t been evenly split. Ninety percent of the growth in clean-energy spending occurs in the developed world and China, the IEA said. Developing nations have been slower to embrace renewable-energy sources, put off by the high upfront price tag of emerging technologies and a shortage of affordable financing. They are often financially unable to dole out large sums on subsidies and state backing, as the U.S., European Union and China have done.
The Covid-19 pandemic appears to have marked a turning point for global energy spending, the IEA’s data shows. The powerful economic rebound that followed the end of lockdown measures across most of the globe helped prompt the divergence between spending on clean energy and fossil fuels.
The energy crisis that followed Russia’s invasion of Ukraine last year has further driven the trend. Soaring oil and gas prices after the war began made emerging green-energy technologies comparatively more affordable. While clean-energy technologies have recently been hit by some inflation, their costs remain sharply below their historic levels. The war also heightened attention on energy security, with many Western nations, particularly in Europe, seeking to remove Russian fossil fuels from their economies altogether, often replacing them with renewables.
While clean-energy spending has boomed, spending on fossil fuels has been tepid. Despite earning record profits from soaring oil and gas prices, energy companies have shown a reluctance to invest in new fossil-fuel projects when demand for them appears to be approaching its zenith.
Energy forecasters are split on when demand for fossil fuels will peak, but most have set out a timeline within the first half of the century. The IEA has said peak fossil-fuel demand could come as soon as this decade. The Organization of the Petroleum Exporting Countries, a cartel of the world’s largest oil-producing nations, has said demand for crude oil could peak in developed nations in the mid-2020s, but that demand in the developing world will continue to grow until at least 2045.
Investments in clean energy and fossil fuels were largely neck-and-neck in the years leading up to the pandemic, but have diverged sharply since. While spending on fossil fuels has edged higher over the last three years, it remains lower than pre pandemic levels, the IEA said.
Only large state-owned national oil companies in the Middle East are expected to spend more on oil production this year than in 2022. Almost half of the extra spending will be absorbed by cost inflation, the IEA said. Last year marked the first one where oil-and-gas companies spent more on debt repayments, dividends and share buybacks than they did on capital expenditure.
The lack of spending on fossil fuels raises a question mark around rising prices. Oil markets are already tight and are expected to tighten further as demand grows following the pandemic, with seemingly few sources of new supply to compensate. Higher oil prices could further encourage the shift toward clean-energy sources.
“If there is not enough investment globally to reduce the oil demand growth and there is no investment at the same time [in] upstream oil we may see further volatility in global oil prices,” Birol said.
Chris Dixon, a partner who led the charge, says he has a ‘very long-term horizon’
Americans now think they need at least $1.25 million for retirement, a 20% increase from a year ago, according to a survey by Northwestern Mutual