Read below for a full transcript of the conversation.
Host: Joining me now to talk about the market action is Christopher Wolfe, Chief Investment Officer at First Republic Private Wealth Management. Christopher, thanks so much for coming on the show. Volatile week ending on somewhat of a muted note. What's your takeaway?
Christopher J. Wolfe: You know, the big news of the week was the Fed and the Fed. I think, as you indicated a little bit earlier, said, Yeah, we're going to do the two-step step one taper, which means just buy less bonds. Now, keep in mind that they're still going to buy a lot between here and the end of next year, another $600 billion or so, according to the schedule that they've laid out. But the second step is actually the more important one, which is when do they start raising rates? And that's where Wall Street started to speculate a lot this week on when they will raise rates. They use something called a dot plot, where to all the governors see the hikes. But it really looks like that Wall Street's bringing in the forecast for the Fed to hike rates into 2022 and then a whole bunch more coming in 2023. So that's really the key development for this week. There was some other economic news that was important. And I think the last piece on the corporate side, you hit on it with Nike. But there was also Federal Express earlier this week and preannouncing saying, Hey, we're having supply chain issues, and that's going to be the dominant story, we think, in the third quarter for earnings. Mm hmm.
Host: Now let me ask you this, Christopher, were you surprised? Are you surprised by how investors did react to the Fed? Projections upped its expectation for inflation this year, almost by a full percentage point for four-to-four point two percent this year, but then also increased its expectations as to when it will raise interest rates for the first time to 2022 from a previous expectation of 2023. I think history would tell us that the market would have moved down on that, but it actually moved higher. What's your reaction?
Christopher J. Wolfe: Yeah, that's a really good question. I think we're still a little bit in the land of Tina, which stands for There is no alternative. You have negative real yields on cash. Bond yields are negative on a real basis. That just means that after inflation, the yield you get on the bond is minus. So you're still stuck in Stockland. Interestingly enough, the more that inflation picks up, the more likely you are to see corporate profits actually surprise on the upside nominal meaning after, you know, before inflation. Earnings per share numbers are likely to be pretty good, assuming the supply chain issues don't get in the way, so I think the markets are starting to digest that balance. You can put the Fed, I think, on hold. They've been very transparent in terms of the commentary about when they're going to taper and raise rates. I think the risk they'll back to your first point is that one, which is inflation and our view is likely to be a bit more persistent, be higher for a longer think of CPI with a three handle three plus for 2022. And there is some risk that if these supply chain issues persist, that that inflation story lags all the way into 2023. That's really the risk here because that means the Fed's going to have to move even earlier than I think the market expects.
Host: Interesting. Now what would you recommend to investors, Christopher, who are on the sidelines or even invested right now, figuring out what to do with their money?
Christopher J. Wolfe: Well, we have those situations now, and I think there's really three pieces of advice that we share with our clients, depending on how they're looking at their investments. The first is get started. There's really a big psychological hurdle if you're thinking about investing, so get started in a balanced portfolio is a good way to look at it. I'll talk about bonds in a second. The second thing is, if you're looking to be more targeted or specific, the economically sensitive sectors, in our view, look attractive relative to other things. You saw some action this week, for example, energy financials doing relatively well. A stronger economy, at least a nominally is pretty good for banks because yield curve is likely to steepen. It's also pretty good in terms of more jobs coming in online over the next several quarters. That should be good for energy demand and usage, at least in the very near term. So economically sensitive areas would be a place that we would go. I think the last is, I think for clients that are qualified, there are opportunities beyond some of the public markets and those are really more towards private investments. We're seeing the activity that the Fed sponsors with low interest rates, the cheap money story filtering into all sorts of markets. That's really where the inflation has been financial markets, inflation in public and private markets.
Host: Hmm. Christopher, how closely is your company watching the evergrande story out of China? We saw that the stock market tanked Monday because of fears of potential contagion if it does indeed default on its debt and not pay within this next 30-day window. Do you find that to be a concern for the stock market?
Christopher J. Wolfe: I think the stock market's got a long memory of things like the Typekit crisis back in the nineteen nineties and the global financial crisis in 2008 and looking and they're looking for triggers. What's the trigger point? It was Lehman having their loans called in. It was a tie back crashing, for example, and they're looking at evergreen and saying, Wow, I've seen this movie before and we want to call time out. Ever Evergrande is a situation that is certainly destructive in a lot of ways. Two parts of the Chinese capital market, but is it likely, in our view, to leak everywhere else and create a giant contagion effect? We don't think so. Two reasons we've seen the Chinese policymakers start to respond, and they're likely, in our view, to help work all of this out. Given that Evergreen is connected to so many different things inside the Chinese economy, it would be incredibly disruptive, meaning you didn't learn the lessons of 2008 to just let it go. So that's one. And second is the story, really. Here's one about financing can ever grant actually make their payments. It's not like there's twenty-two billion all do in one fell swoop today, so they have some time, not much, but they have some time to work this out. So our view is that we're going to see a bankruptcy. It's going to be a bit messy, but not contagion.
Host: We covered the headline yesterday that the auto industry expected to see its sales hit by two hundred and ten billion dollars this year just because of the semiconductor shortage. But these chips, they're in everything from our cars to our phones to our alarm clocks, our electric toothbrushes, our dishwashers, I mean literally there and everything. The fact that these supply chain issues are still so challenging in the chip space, how do you foresee that impact, you know, overall GDP growth and the ability for some of these companies to continue to grow here in the year ahead?
Christopher J. Wolfe: I think you hit it right on the head. This is going to be a lingering problem. It's one of the reasons that we expect inflation to be more persistent in 2022. And really, that gets down to the fact that semiconductor foundries, that the buildings, the plants you need to put in place in order to ramp up production. You can't do them quickly. They take a very long time to ramp up capacity. So the story here is one not just of COVID, but also capacity and the fact that there are chips in everything from refrigerators to TVs to phones. And not only are there chips, there's many chips in everything. So as we continue to consume all sorts of electronics, that foundry demand is going to be under a lot of pressure. So the bad news is not going to resolve itself any time soon. The good news is we're starting to see policymakers in Europe and the United States get it. And after we've disinvested so much foundry space in the United States, I think we're going to start a reinvestment cycle over the course of the next few years. So good news is longer term, we will have less of these issues, in our view.
Host: Does your company invest in cryptocurrency and regardless of what your answer is, why or why not?
Christopher J. Wolfe: Our clients have investments in cryptocurrencies. I can state that I think we're we look at cryptocurrencies. Our view is really a kind of two parts. The first is that there will likely be a lot of near-term risks as regulators continue to scrutinize what's going on in the cryptocurrency space. The news out of China a bit disheartening. But that's important because I think the medium of exchange versus store value question is one that's going to rage on until regulators settle it. The second piece, though, is that we're looking at what's behind cryptocurrencies much more carefully, particularly on blockchain technology and looking to invest in some of those spaces. So that's part of that private investment story where investors are qualified to do that.
Host: Mm hmm. I am wondering, too, when it comes to international markets. Christopher, knowing that this vaccine rollout has gone about as smoothly as it could in the U.S. compared to other countries, right? We still want to get more people vaccinated here, according to the Biden administration. But when you look at global investments, is the U.S. where you're concentrating your money right now or do you see opportunities in emerging markets and in Europe?
Christopher J. Wolfe: Yeah, it's a great question. You know, we have been looking increasingly outside the U.S. Our asset allocation generally favors the U.S., or at least it has over the last several years. That's been a pretty, a pretty good call, I think, for investors. But what we're finding are three things one, big valuation gaps between U.S. and non-U.S. markets that looks attractive 2's more operating leverage and sensitivity to any kind of recovery or changes in policy outside the U.S. Japan's a good example of that. We started to see earnings tick up, for example, as well as revenues on some a growth resurgence. Then the last piece for us is the concentration. The U.S. is is important for most of our clients, but we really want to think about that global diversification story and where we're finding these opportunities. We're using them carefully on emerging markets, treading very cautiously. We don't have a big allocation here and think that investors should be very, very patient in this space because there's more news to come on China reorienting the way it looks at capitalism relative to all of its other policies, keeping in mind that is using paying and the policy leaders in China need to think about being very, very communicative about their plans as they look for their setup for the new five-year plan coming out next year.
Host: What about taxes, Chris? My last question to you is how are you advising your clients to navigate their own portfolios as we head into year-end knowing that this tax policy is still getting worked out?
Christopher J. Wolfe: Well, it looks like there's a lot of changes that seem to. Be leaking out or coming out of the committee these days, and they are going to impact the way we think about investing, so planning ahead is a good idea. What we're finding are a couple of things. The first is plants are more sensitive to taxation, at least around the big liquid stock portfolios that they may have. And so migrating to a degree towards tax aware type strategies, that's one two is they're becoming more sensitive about the types of vehicles they use in order to avoid taxation. So certain types of hedge funds, for example, very tax unfriendly other types, more tax friendly. So being as an example, being more sensitive to the types of vehicles they own. And the third is, you know, there are some likely changes that seem to be impacting the way trust rules work, and that's something we have to examine a bit more closely. But that would be an area that I think clients would want to be interested in and make some changes if the laws do change.
Host: All right. Christopher Wolfe, Chief Investment Officer of First Public Private Wealth Management. Christopher, thanks again. Great insight.
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