Morningstar Investment Conference: Recession Risks and the Markets

Plus, two Morningstar specialists share key takeaways from Larry Summers, Aswath Damodaran, and Liz Ann Sonders.

Morningstar Apr 28, 2023

Ivanna Hampton: Investing Insights has hit the road. We’re recording this episode from the Morningstar Investment Conference in Chicago.

Several big names in investing and newsmakers have talked about the outlook for today’s investors, and we have two Morningstar specialists here to share some of those key takeaways. Here with me, Russ Kinnel, he’s Morningstar Research Services director of manager research, and Morningstar Inc.’s chief markets editor, Tom Lauricella. How’s it going, guys?

Tom Lauricella: Good, good. Glad to be here.

Russel Kinnel: Good. Great, thanks.

Hampton: All right, so let’s get started. We noticed some trends among the speakers. Tom, what was the overall sentiment about the markets and the risk of a recession?

Lauricella: Among the most commonly mentioned themes these last couple of days has been the question of are we going to have a recession. This came up in almost every investing panel in one shape or form. And from where I sat, it seemed that the portfolio managers, the strategists, the analysts were all saying, “We’re going to have a recession.” The interesting question that everybody was up for debate and each individual manager, which Russ will talk some more about, is that the question is how big is the recession going to be, and what is the impact going to be? How much is that priced into the markets?

So probably that theme of a recession was something that we heard throughout, which, if we were sitting here a year ago would’ve been all about burgeoning inflation and how much the Fed was going to raise rates. Now it’s the other question of are we going to have a recession? What is that going to mean for investors’ portfolios and how they should be looking at the market?

Hampton: Let’s talk about the state of bonds. Pimco’s chief investment officer Dan Ivascyn, he spoke yesterday, what’s his viewpoint, Russ?

Kinnel: I think he is relatively positive. Hearing him talk about inflation getting down to about 3% by year-end, that seems pretty positive. He’s very excited. I think bond managers in general are excited because after an awful year, bond yields are now much more attractive, and so even just garden-variety investment-grade bonds will pay you a pretty nice return.

I think he also interestingly talked a lot about nondollar investments. Maybe bearish on the dollar, finding some of those outside-the-U.S. investments attractive. So, I thought that was pretty interesting.

Hampton: Growth stocks ruled until high inflation and rising interest rates showed up. Russ, what were some of the themes from the panel examining growth stocks?

Kinnel: They seemed kind of cautious to me. I was a little surprised because we have had that correction in growth, but many of them were talking about things like a long list of stuff to buy if we get another correction.

So, it seems like they’re fairly cautious today but hoping for a selloff so they can buy some more. It seemed almost bearish to me for growth managers to talk that way, and I think a lot of it has to do with just the top growth names are still very pricey by most measures.

Hampton: Let’s move on to Liz Ann Sonders. Schwab’s chief investment strategist talked about how recent global challenges rattled markets. Tom, tell us some of the key points she hit.

Lauricella: Sticking with this recession theme, she had some good advice for investors about how to think about a recession and the markets. And she was making the point that if you’re just waiting for the recession to happen, then the markets have probably already discounted that. And you need to think through it that markets are a discounting mechanism.

One of the things that she discussed and others discussed is whether or not the stock market is actually priced for a recession right now. That’s a different question than what that will mean in terms of the timing. And, of course, she also reminded us that timing the markets is ... trying to pick a top or a bottom is a fool’s errand, everybody will tell you that, although everybody tries to do it and thinks that they can do it.

But really it’s that question again of where are we in this cycle? To what degree has the market priced in a recession? Actually, as we’ve written on Morningstar.com this past week, we’re a little bit in limbo. And you did get that sense from a lot of managers that in the bond and stock market, they are waiting for the next shoe to drop in terms of movements in the markets, prices coming back further from where they are. There does seem to be a lot of skepticism about where we are now in relation to this question of recession and where the markets are priced.

Hampton: Larry Summers, former U.S. Treasury secretary, delivered a keynote yesterday and he dropped lots of nuggets. Let’s talk about one of the first ones, the banking crisis. Tom, what was his thoughts regarding that?

Lauricella: Again, this all feeds together. Larry Summers, it was a great session. He’s a wonderful speaker, it was a great interview. When it came to the banking crisis, he was making the point of how it’s the equivalent of a Fed tightening. And as we’ve heard from Fed Chair Powell and others, we just don’t know how much of a tightening it’s going to be. We’re still waiting to find out some information. These types of events take a while to feed through to the economy. It’s not something that’s an immediate shock, like the pandemic when everything’s shut down overnight. This is a very different experience.

And so, one of the points that Larry Summers made was we don’t know. Is this the equivalent of a quarter-point tightening? Is it a one-and-a-quarter point tightening? We don’t know yet. However, it’s a credit crunch that’s coming, and that is going to feed through to the economy and lead us into a downturn.

Hampton: So Russ, Larry Summers also talked about recession, soft landing, lead us to what his thoughts were.

Kinnel: In short, he said soft landing is a fairy tale that we tell ourselves. That we had so much excess growth in the economy that the only cure is going to be a recession that resets prices.

And so I guess the most positive thing was he didn’t think it was going to be a severe recession. He didn’t think it was going to be a global financial crisis, but he seemed very clear that the only way we would get back to a 2% inflation rate was through a recession, which is not the most cheerful thing to hear in the morning, but I think a realistic case.

Hampton: Does he think that companies are preparing for this?

Kinnel: I don’t know if they touched on that exactly, but I think certainly, it’s getting closer there. I think, as Tom mentioned, everyone’s talking about a recession. And so it seems like corporate America is certainly moving there, if not pretty close to it. It certainly slowed growth, wouldn’t you say?

Lauricella: Yeah. And he did remind us that during a recession the unemployment rate will rise, so we’re going to see unemployment rising. And actually this is something I believe Liz Ann Sonders touched on in that conversation, which is that the jobs market is a coincident indicator. We’re going to see the job market slow down when we go into a recession. So, everybody who’s sitting here who are saying, “Well, things are going to be fine. The job market’s strong.” She reminded us that it’s only when we’re in a recession that people start losing their jobs.

So, it’s an important thing for investors to think of when they look at the jobs data, that it’s going to be telling us what’s happening out there right now, not where we’re going to be.

Hampton: All right. The debate in Washington is around the debt ceiling. Does he think the U.S. is heading toward a possible default?

Lauricella: Larry didn’t see that as much of a possibility. I believe he kept those percentages down to the very low, low single digits, a real, real default, sub-2%. I believe he said a technical default, also low single-digit percentages.

So, it didn’t seem to be much of a concern to him. And I get the sense it’s a similar response from portfolio managers at the conference as well. It’s a potential hiccup out there but not something that they’re basing their strategies around.

Kinnel: I think Dan Ivascyn echoed the same view, that it’s a fairly low chance of a default, but he also thought we’d go right down to the wire on that debate. So, I think there’s cautious optimism on that front, too.

Hampton: All right. So something to watch over the next few months. If you’re an investor watching that, maybe you’re thinking, “Should I invest internationally? There was a session at MIC talking about is it ever a time to invest in international equities? Russ, what came out of that session?

Kinnel: I think the managers were pretty bullish and made a pretty good case that foreign equities are a lot cheaper than U.S. equities. These were value managers, so the valuations really matter to them. And I think that could make a pretty good case that foreign equities are cheap and they’re finding a lot to buy.

Interestingly, two areas they didn’t like were China and Japan, for very different reasons. Obviously, Japan in a very long near-bear market, and China over concerns that the government might take away companies’ freedoms, and so kind of a looming threat, like we saw with the for-profit education stocks in China. So, overall bullish, but not so much on the two big Asian markets.

Lauricella: I think also there is this idea and the fact that non-U.S. markets are generally cheaper than U.S. markets. Was that something that came up?

Kinnel: Yeah, for sure. I think that they are, and I think it’s a good point that if you step back, we tend to go in these long cycles to where the U.S. might outperform for, say, 10 years, and at that point we always start saying, “Why does anyone need to invest overseas? All the great companies are American.” And then boom, you have a year like the 2010, when the U.S. significantly underperforms because markets are cyclical. But this seems like a very long-running cycle as opposed to some of the others might only last six months. This seems to be one that runs 10 years or more.

Again, it’s another thing you really can’t time well, but it’s worth keeping in mind, and it’s worth appreciating the value of that diversification, as well as I mentioned, there’s some dollar bearishness, and if they’re right about that, again, that’s another reason to hold foreign assets.

Hampton: We also had NYU finance professor Aswath Damodaran. He talked about his views on ESG, and he pointed out some areas for improvement. Tom, what were those?

Lauricella: His main point, which is one that Morningstar recognizes as well in our data on this, is materiality, materiality of risks. And that’s an area where it’s still hard to sift through companies and hard to assess that, really. He talked about the question of whether it’s easier to measure goodness versus badness, I believe was the term. And that’s something that investors wrestle with, and it’s something that, if you are trying to assess the ESG risks of a company, that’s something that the marketplace and the analysis that goes with it, he feels can still be improved. And it was a good point there.

One thing, if I could add also just on the topic that we’re talking about in terms of the economy. He was making the point that what we’re going through in the markets right now is actually, it’s long overdue. Essentially a correction to some practices in the public and private equity markets where companies didn’t really have to have profits, that they had this unbelievably low cost of capital, and now we’re just getting back to a more normal. So, even as we go through the potential recession and interest rates and inflation at a more elevated level, it’s helpful for investors to remember that in a way, the past decade and a half was the outlier. And I think you heard that from bond managers as well, that they’re happy to have yield to actually play with, like you said. He had some good points on that front as well.

Hampton: Right. And also FPA Crescent leader Steve Romick, he talked about his first move during the dot-com bubble and the financial crisis. Russ, what were some of the lessons he spoke about that could be applied to today?

Kinnel: I think he pointed out that it can be very lonely to be on the other side of the hot markets. And so in the dot-com craze he was very much holding deep value and cash and oil while all of his competition was running up and putting up huge returns, and everyone was talking about him being out of touch. So, I think it illustrates the importance of sticking to your guns and I guess, just checking your facts and sticking with it, because every strategy goes out of favor at one time or another, and you have to stick to it.

And I think another part though is, you don’t want to double-down when you’re proven right and go on a buyer’s strike. And so when bonds started to get cheaper and sell off, he added corporate bonds really quickly after the global financial crisis and made a nice return as well. I think there’s a good point that you want to stick to your guns, but you also don’t want to have your head in the sand and wait for everything to go to zero.

Hampton: So, you need to be courageous and flexible.

Kinnel: Indeed. Very easy.

Hampton: All right. Russ, let’s talk about the major things. We’ve been talking about them throughout this conversation, let’s button it up. What were the major things that you thought emerged from this conference?

Kinnel: Definitely a lot more enthusiasm for value, a lot more enthusiasm for nondollar. But I think also, in general, when you talk about recession at the same time what they’re really saying is this next 12 months could be rocky. We have no idea if we’re going to make any money in the next 12 months, but the long-term opportunities are still there, that if you’re a long-term investor, you can find some really good investments right now.

Hampton: So, what you’re saying is that the next MIC conference, we should talk about this to see where we’ve come.

Kinnel: Exactly.

Hampton: All right. As we wrap this up, let’s have a fun question, what surprised you guys at MIC this year?

Lauricella: What surprised me? I think what surprised me the most was the degree to which there is such uniformity of opinion about a recession, that sometimes you have to ask that question of like, “Well, what if we only have a very shallow recession that doesn’t do what everybody thinks it’s going to do?” I had expected a little bit more variation of opinion about the odds of recession. Everybody seems to be, “It’s going to happen.” Doesn’t mean it’s not going to happen, but there is a real uniformity of opinion there across different asset classes, different investing styles.

So, there did seem to be a lot of uniformity of opinion. Also, just a lot of caution about valuations in the stock market, didn’t hear much bullishness out there. It was a pretty uniform set of opinions, and that was a little surprising

Hampton: That’s not fun. Something fun.

Lauricella: Well, anytime you see everybody saying the same thing, you get a little nervous. I mean, everybody can’t be right. Markets don’t work that way.

Hampton: All right. Well, you’re smiling about it. OK, Russ?

Kinnel: I think it was maybe surprisingly sober in general, that maybe outside of the bond managers, the stock managers are not champing at the bit to invest. And I think growth, in particular, I heard some pessimism, which surprised me just because we already had a decent growth correction. But I think it just speaks to if you stand back further and see how much growth has gone up, and just those top names in the Russell 1000 Growth still have really high valuations. And so there’s still a lot of pessimism there.

And of course, that’s another one where it’s very treacherous to be a growth manager because you absolutely have to get those top 10 names right. That means, either if you don’t buy those high-priced names and they go up some more, you’re going to look bad. It’s a tough spot to be for growth managers.

Hampton: All right, so thank you, Tom. Thank you, Russ. I know it’s early this morning.

Kinnel: You’re welcome. Thanks.

Hampton: All right. I want to thank lead technical producer Scott Halver, audio engineer George Castady, and senior video producer Jake Vankersen. You guys took an idea, you brought it to life. I want to thank everyone here who is watching us at the Morningstar Investment Conference, and thank you to everyone who is tuning in to this week’s episode. I am your host and a senior multimedia editor here at Morningstar, I’m Ivanna Hampton. Remember that name. Take care.