Mark Haefele is probably the most influential voice in the market you’ve never heard of.
A former lecturer and acting dean at Harvard University who was also once a hedge fund manager, Haefele is now global chief investment officer at UBS Wealth Management.
In that role, he oversees the policy and strategy for about $US2 trillion in assets.
Business Insider caught up with Haefele last month at the UBS CIO Global Forum, one week after the UK’s surprising vote to leave the European Union.
He discussed why he was still bullish on US stocks, what to expect now that the vote for a British exit from the EU, or Brexit, is a done deal, and which US election outcome investors are ignoring.
This interview has been edited for clarity and length.
Akin Oyedele: Has your outlook changed since Brexit?
Mark Haefele: We’re overweight developed markets, US equities, and European high yield. We still are. The global growth forecast has come down a little bit, but I think the difficulty is from here, something like 96% of Swiss bonds and a very high proportion of global high-grade bonds are now trading at negative interest rates. And we see our clients increasingly kind of refusing to invest in these negative-yielding assets. And so, we still think that that will drive some people into equities, perhaps more into dividend-yielding equities going forward.
But emerging markets are still difficult here because there’s a lot of dollar-denominated debt in the system. And the political risk extends into the emerging markets. The US remains relatively sheltered from a lot of these things.
I think that the major change is that it’s going to be much harder for the Fed to raise rates. And it has helped yield assets, but we think it will also help dividends and stocks. I think those are the major changes.
We didn’t have big bets on Brexit or “Remain” going into this because it was so, so close. I think where we’ve grown a little more cautious in particular is on the European banks, because the lower interest rates will mean that they have less of a yield curve, and that can impact their earnings. We don’t see a systemic risk, but an earnings risk.
Oyedele: You weren’t betting strongly on either side of the referendum, but it seems a lot of people in the market were expecting a “Remain,” if you looked at the rally into the Thursday vote. Why do you think markets got it wrong?
Haefele: First, there was the polling data. Second, there were the betting markets.
And then, the third is something we have a little more experience with, which are the referendum processes in Switzerland, because they do this a lot. It is very hard to predict the outcomes of these referendums, say versus traditional elections. They’re very different.
What I think is interesting about this referendum in particular is that to the extent they polled people after they voted, it seems like some of them lied about how they voted.
And so it means that process is more unpredictable going forward, and I think it means that people should have probably less faith in the polls around the US election. Maybe some people will vote for Donald Trump but won’t admit it, for example.
Oyedele: How much of a risk to markets are the US elections, and what do you see as the best-case scenario?
Haefele: Most of the scenarios for the presidential election are overpricing the risk. Typically, the president isn’t all-powerful in the United States because of separation of powers, the fact that tax bills have to originate in the House of Representatives, for example. And typically around elections, you don’t see elections affecting US equity returns that much in presidential years. So, given all the other things going on, I don’t think it necessarily has to be an effect.
The scenario which I think the markets are not pricing in is Trump getting elected and the House of Representatives going to the Democrats. I think that kind of complete reversal might be underpriced by markets, and I think it would take them a little while to get used to that.
Oyedele: Shifting back to Brexit, one of the things we’ve seen is a flight to safety — to US Treasurys and to the dollar. And the dollar matters a lot to the Federal Reserve. How long do you see this flight persisting, and what does it mean for the Fed?
Haefele: We’ve seen currencies bear the brunt of this initial move around Brexit. The US dollar has rallied significantly over the past few years, so we don’t think that there’s necessarily another big move up from here.
But I think you’re right to focus on this because it will absolutely limit what the Fed can do. It will limit how far they can diverge from other central-bank policies around the world because should the Fed hike rates from here, it will likely strengthen the dollar. And given the amount of dollar-denominated debt in the world, given the impact that the Fed hiking would have on market liquid, I think the Fed has shown that it is increasingly aware of that fact.
Oyedele: Are there any assets right now you think are particularly attractive? And because of the sharpness of the move that we saw after Brexit, is there anything since then?
Haefele: [For non-US investors] I think the European high-yield market is still very attractive because the ECB continues to purchase corporate bonds in Europe, and this should help contain spreads.
In equities, we still like US equities. It’s kind of relatively insulated from some of the problems in Europe. The US economy is doing well — the wage growth should help stimulate the economy as well.
One of the interesting recommendations that we put out is for the bonds of gold producers, because while the gold price has run up a lot in the short term — and so that’s very volatile — it should improve the prospects for the gold producers, and their bonds have an attractive yield. So, that’s kind of a more specific recommendation.
Oyedele: Do you find gold stocks attractive?
Haefele: We prefer bonds because we see in our clients around the world a tremendous reach for yield. So anything with a decent coupon is attractive, and because of the high gold prices it should improve the prospects for a lot of the gold producers. So it’s for us the least volatile way of taking advantage of higher gold prices.
Oyedele: Are there any regions right now that you are wary of, and why?
Haefele: I think there’s a lot of uncertainty in Europe. A lot of people going into the Brexit crisis were looking at the valuations of Europe versus the United States and saying that on a historic basis — say on a PE basis — Europe is relatively cheap compared to the United States. But given our concerns about European financials, that’s not how we wanted to express things in our global portfolio.
All that said, there is a lot of risk priced in globally because while China seems to have stabilised itself over the near term, we certainly are concerned about how they address their debt problems and their slowing growth over the longer term. Japan is probably going to have to increase both fiscal and monetary stimulus, given the low growth there.
But a lot of this was kind of already in the system before Brexit. We’ve seen our clients say even Brexit was only one of the political risks this year. And then, they still kind of haven’t put the economic picture together given the turmoil that we’ve had in Latin America, the very significant swings that we’ve seen in Japanese markets and in Chinese markets as well. I think it’s a very interesting time because we still have this massive stimulus that the central banks are providing into the system.
So when the politics calms down, say, as it did from March to June, you can see the S&P 500 rally back. But we just don’t know how long of a period where we don’t have that political risk or some other factor pop up.
So I think people have been cautious, and they remain cautious. But just as you saw this Brexit come in and we saw the US stocks rally back quickly, so now that they’re positive on the year, that’s what makes it really difficult for investors right now. Because if you’re betting on bonds going lower from these very expensive levels, you could suffer a portfolio loss that would be very difficult to recover.
Oyedele: Stocks have been stuck for over a year now, not hitting all-time highs and sort of been in a very tight range. What do you think would be the catalyst that turns sentiment around?
Haefele: I don’t think we’re going to get out of a period of very low returns for major equity markets anytime soon. But the dividend yields are attractive on equities compared to high-grade bonds. So, even if you’re more or less stuck in a range and you’re collecting your dividend, people should hold stocks in their portfolio. They’re not super cheap, but they’re not super expensive.
At the same time you’re limited in your alternatives. It would not take much — even a slightly better economic picture could send the bond [yields] up from these historic lows, and then you’ve locked in losses on the bond side.
I think the main thing that all this shows is that a globally diversified portfolio is really important, and that means cross geopolitical regimes because we’ve seen increasing experiments with fiscal policy, monetary policy, and now political processes. And it’s not clear who the winners and losers will always be. And so, clients who are diversified do better. In asset-allocation strategy, where you have bonds as stabilizers and stocks to try and provide you some upside, and dividend yield, that’s actually worked really well.
Oyedele: And on fiscal and monetary policy, one of the arguments out there is that what the US economy needs right now is fiscal policy. But it’s just not as easy to do politically. What’s the scope of fiscal policy in the US?
Haefele: Infrastructure in the United States needs major investment. And so, fiscal policy is an attractive economic stimulus, and it could have a decent return on investment. But it is very politically charged because who decides on how that fiscal stimulus is spent, for example, is very political.
So, one of the things that we would like to see is more blended finance where governments partner with people in the markets so that good investments are made with kind of a private-sector view towards the money being well spent.
The danger is that the fiscal stimulus works out like in Japan. Japan has had 20 years of fiscal stimulus. It’s racked up the debts, but it hasn’t really led to the economic growth that they were hoping for.
Oyedele: How much of a risk is China right now?
Haefele: I think China is going to be in the news less in the next, say, six months than it was in the past six months, which doesn’t mean that there aren’t risks there, given the fact that their economy is slowing as they make a historic transition to a more consumer-driven economy. They’re also having significant elections coming up next year. So there are continued risks from China.
On the other hand, what we’ve seen is that they still seem to have a wider and more effective set of tools to manage things in the short term. While there’s diminishing returns on stimulus, it still has an effect. And so we’re watching things like housing prices to see how that ends the fixed-asset investment, to see how this GDP growth is going to develop.
But certainly, the main thing that people will watch especially now given the global turmoil, is what are the FX reserves doing and are they being depleted at a quicker rate. We think that the yuan will depreciate, but it will stay below seven yuan to the dollar. And so if it moves significantly from there, I think people will put it on their radar more.
Oyedele: There was quite a steep devaluation on Friday after the UK referendum, sneaked in under all the Brexit noise.
Haefele: In a way they were smart. I think they prepared markets for it a little better because they said, “Look, we’re going to value the currency versus a basket,” and these other trading partners’ currencies fell, and they devalued a little bit as the dollar strengthened. But Chinese markets are holding up pretty well through this, which I think helps a lot.
Oyedele: Is there anything on your radar that you think people aren’t focusing on enough right now?
Haefele: I think that one of the things is how this change with the UK in Europe influences European defence policy and the evolution of NATO. In a way, the postwar world order in Europe is being questioned by this. And the US spends 3.5% of its GDP on defence. The UK spends 2%, Germany spends 1.5%, and Japan spends 1%. And I think those kinds of questions about who pays more for defence are starting to bubble up not just in Europe, but I think it’s also an undercurrent in this US election as well.
Oyedele: What’s your view on how that could impact markets and sentiment?
Haefele: Terrorism can impact sentiment a great deal. But typically if you look at terrorism, it has an impact on oil prices, and so that’s a place that we would look. But we think that given the supply-demand equation for markets, while these events are human tragedies, they haven’t been a primary driver of things.
Oyedele: So why do you think it’s such a concern then, if its impact has been disconnected from markets so far?
Haefele: I think that people price risk differently — otherwise there wouldn’t be markets. And it’s uncertain how people react to disturbing events and how they think it relates to the economy. For us, part of our investment process is to focus on the longer-to-medium term and try to look past some of the short-term noise towards what’s going on in the underlying economics.
And so through this crisis, for example, we’ve been watching credit spreads very closely, particularly in Europe and sovereign spreads in Europe. And seeing the reaction of the bond market versus the equity markets helped us to hold through this crisis because we didn’t see that affecting the underlying levers that would impact in a significant way either the increase of contagion or the global growth story kind of significantly.
If the credit spreads were to blow out and borrowing became significantly more expensive in Europe, then I think we would be changing our forecast.
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