Brian Jacobsen, Ph.D., CFA, CFP, is a senior investment strategist on the Multi-Asset Solutions team at Wells Fargo Asset Management. In addition to his role at Wells Fargo, he is an associate professor at Wisconsin Lutheran College. Jacobsen’s research and teaching center on economics, finance and investing. ETF.com recently spoke with him about his thoughts on the global economy and financial markets.
ETF.com: The U.S. stock market has performed poorly this year, even as corporations release blockbuster earnings numbers. Why is that, and what will it take for stocks to get out of their funk?
Brian Jacobsen: We’ve been debating this. We think it’s simply because there’s a big dose of skepticism about whether the first quarter, or 2018 in general, will be the point of peak profits for businesses. Beating on last quarter’s earnings doesn’t mean anything to investors who are pricing securities based on the future. It wasn’t enough to just “show me the money” in the first quarter; it’s now about proving it going forward.
We fall in the camp of believers who think profits aren’t peaking yet. There was a high bar going into earnings season that many companies jumped over, but we think the bar is pretty low for growth in 2019 and beyond. That’s why we’re still leaning cyclically with our allocations.
ETF.com: There’s been a lot of talk about the economy and the equity bull market being in the late part of the cycle. Do you agree with that assessment, and what signs do you look for as indications the economy and stocks are about to enter a downturn?
Jacobsen: The economy and bull market have been in the late part of the cycle for a while, so this feels like a “forever young” type of economy and market. The clock doesn’t help with timing when a recession or bear market will hit.
Credit spreads haven’t moved meaningfully off their lows. The yield curve is flattening, but it’s not flat ,and it’s probably six Fed rate hikes away from inverting. New orders numbers are still healthy from the ISM [Institute for Supply Management] surveys. Consumer confidence is high. These aren’t the conditions that typically precede a recession or a bear market.
ETF.com: Do you see the yield curve inverting anytime soon?
Jacobsen: The Fed is still in a hiking mood, but their mood can change with the data. We think that’s healthy.
Rather than being on autopilot with hikes, they’re flying on the basis of the flow of information and the way they interpret what that information means about the future. We think they’ll stop short of hiking to a point where it inverts the yield curve.
Their long-term target for the federal funds rate is around 2.8-2.9%, and our expectation is that it would take them hiking to around 3.25% to completely flatten the curve.
ETF.com: Does that mean Treasury yields are unlikely to reach the highs we saw during the last cycle—above 5%?
Jacobsen: We think we’ll fall short of the highs of the last cycle. Five percent was in an environment where inflation was above 3%. We don’t foresee inflation getting back to those levels.
ETF.com: You’ve written a lot about generating income in a low-yield environment. With the U.S. 10-year Treasury yield around 3%, would you still consider this a low-rate environment? And how should income-seeking investors position themselves with the potential for rates to move even higher from here?
Jacobsen: It depends on your perspective. If you anchor your perceptions to the last 30 years, this is still a low rate environment. Inflation-adjusting yields still make this a low rate environment. But when inflation expectations are lower today than they were in the 1980s and 1990s, that tends to lower nominal yields.
Real rates are also low, but unless businesses are going to borrow money hand-over-fist, real rates could stay low for a while. Tax reform has made it such that there’s less reason to go on a borrowing binge.
So, we think rates are low, but they’re likely to stay low. That’s why we like searching across multiple asset classes and multiple geographies for income opportunities. Traditional dividend-paying stocks and bonds likely won’t cut it in today’s environment. That’s why we mix global dividend strategies, high-yield municipal bonds, REITS, emerging market debt, along with investment-grade and high-yield bonds, to try to create sustainable and stable income. It’s hard to create sustainable and stable income with only U.S equities and U.S bonds.
ETF.com: What does it mean to have a truly diversified portfolio across asset classes? Should commodities be included in a portfolio?
Jacobsen: We like to diversify across risk premia as well as asset classes. Risk premia are the expected compensations for getting exposure to the unknown variables of the future like growth, rates and inflation. Stocks give exposure to growth, but so do high-yield bonds. Treasury bonds give negative exposure to rates and inflation.
Commodities give exposure to surprises in inflation. We don’t believe there will be a lot of surprises in the inflation picture, so we’re finding it hard to justify a permanent long-only position in commodities.
We do think there can be opportunities through long-short strategies that favor commodities in backwardation (futures prices are below spot prices) and disfavor those in contango (futures prices are above spot prices), but that’s not for everyone.
Economic progress is about producing more with less, which tends to mean using commodities more efficiently. That’s why commodity prices in general have a tough time keeping pace with the broader market.