- Keith Parker, chief US equity strategist at UBS, says one of the elements that worsened the stock market’s 10% correction earlier this year was simply doing it’s job.
- In a wide-ranging discussion, Parker broke down the main catalysts for his bullish 2018 forecast, opined on President Donald Trump’s newly announced tariffs and the prospect of a trade war, outlined his biggest fear for the market, and broke down his sector picks.
When the stock market melted down in early February, blame was spread far and wide. But even then, everyone seemed to agree on one aspect of it: the shorting of volatility made everything worse.
The evidence was largely indisputable, and everyone carried on as price swings normalized once again, much wiser about the exacerbating effect of such volatility strategies.
Keith Parker, the chief US equity strategist at UBS, has a unique view on the whole debate. He argues the much-maligned volatility-targeting strategies fulfilled their role as “natural rebalancing mechanisms,” even though the resulting selling pressure was jarring. As an extension of that, he views the 10% correction as a healthy reset for the market, and sees greener pastures ahead for stocks.
Parker forecasts that the benchmark S&P 500 will finish the year at 3,150, making him the most bullish strategist on Wall Street, according to a Bloomberg survey of 24 firms.
In an interview with Business Insider, Parker broke down the main catalysts for his bullish 2018 forecast, opined on President Donald Trump’s newly announced tariffs and the prospect of a trade war, outlined his biggest fear for the market, and broke down his sector picks.
This interview has been edited for clarity and length.
Joe Ciolli: Your recent research suggests that you view the stock meltdown in early February as healthy for the overall market. Why is that?
Keith Parker: Getting these bouts of worry as fundamentals remain solid helps to lengthen the cycle for equities. We would still get later-cycle type behavior from investors, but February is a reminder that a lot of volatility-targeting products are natural rebalancing mechanisms to keep the market from really moving into that overexuberant stage. They’re keeping the market from a level that could spell a more menacing correction.
Ciolli: So the correction wasn’t that big of a deal?
Parker: In terms of order of magnitude, 10% down in 10 days is extreme, historically speaking. You saw net US equity fund outflows of $43 billion, and a record unwind in futures and options, and we saw ETF short interest go up $30 billion. When you add that up, it’s tremendous, and the order of magnitude was even bigger. But it wasn’t as bad as it could’ve been.
It wasn’t as bad as it could’ve been.
Ciolli: On a broader basis, you’re on the record as constructive on US equities. What’s been helping the equity recovery, and what will drive stocks higher in the future?
Parker: There’s pent-up demand on the M&A front, because deal activity fell off a bit going into the tax debate, around policy uncertainty. Now there’s something like a $2 trillion annual pace for announced deals on US public targets — about 7% of total market cap — and that’s just mind-boggling.
Meanwhile, buybacks are a form of return of cash flow of earnings. To the extent that we have earnings growth of 15%-plus this year, that should mean buybacks and corporate bid activities remain pretty solid.
Also, the ability of companies to bring back cash and profit that was previously trapped abroad is a big deal. When you take down the wall that is the US tax code for bringing back profits, that’s an incremental positive to the return-of-capital story.
Ciolli: So which one is most likely to lead the charge higher?
Parker: We have five pillars: consumer, corporate spending, margin upside, corporate bid, and the ability for rates to normalize and equity multiples to sustain high levels. The biggest driver, given the market cap of tech and industrials, would be the corporate spending theme. Higher profit growth and weaker productivity — that really necessitates corporates having to spend to generate that incremental growth.
Ciolli: What’s your take on the tariff / trade war scenario? Is it truly a force to be reckoned with?
Parker: At first steel and aluminum tariffs were broad, and then there were some carve-outs for Mexico and Canada, which was a positive.
After steel and aluminum, the next incremental risk is around China action, following the intellectual property investigation. We do see rising risk of trade actions. And when you have US imports of China products at $500 billion, the headline risk is considerable. That includes cell phones, computers, apparel and other consumer goods.
I see multi-nationals at risk over the next few months.
The other risk is around retaliation. Those companies with high revenue exposure to China could be at risk, and the market typically discounts speculation like that before anything happens. I see multi-nationals at risk over the next few months.
Ciolli: What are your thoughts on the economic landscape? It seems like there have been some mixed signals lately.
Parker: With inflation, you’re reaching a point in the cycle where it becomes more difficult to generate non-inflationary growth.
In terms of the crosscurrents, there are two points. Number one, you’re going from low inflation back towards target, which is possibly reflective of solid demand. Second, the wage inflation seen in early February really triggered part of the equity selloff and rise in rates. When you have that risk, investors remain worried.
The fact that after-tax paychecks, given the tax cut for the consumer, are going up 2-4%, should see consumption growth remain solid in the months going ahead. That should be an important offset.
Ciolli: Is there an economic sweet spot, and are we in it?
Parker: For markets, we are. The speed limit is such that people aren’t going too fast, and traffic is reasonable. Accidents happen when people are driving too fast, and there are lots of cars on the road. Later-cycle behavior tends to happen when you get things moving in a positive direction all at once — also known as overexuberance.
Ciolli: There’s been speculation that hedges haven’t been working as well lately, on a cross-asset basis. Do you buy that?
Parker: Typically, in the later cycle, when inflation and cash rates are rising, the correlation between bonds and equities turns less negative. That’s because cash starts to become more attractive, so investors move out of those areas.
Inflation becomes a key driver of why some of those hedges — whether it’s fixed-income, utilities, REITs, or staples — may be underperforming during a volatility spike. Those rate proxies don’t work as well in a selloff that’s driven by inflation and rate worries.
Ciolli: So what can investors expect going forward?
Parker: When you have an environment where the correlation between bonds and equities makes it so there’s no natural hedge, it moves portfolio-wide volatility up. Fed rate uncertainty also creates volatility that affects every asset class. The combination of that drives some portfolio de-risking, like we’ve been seeing.
Fed rate uncertainty creates volatility that affects every asset class.
Ciolli: Are there any sectors you favor? Ones you don’t like?
Parker: We’re long consumer discretionary over staples, on the view that this consumption boost from the tax plan will start taking effect, and lead to higher top-line growth over the coming months. Discretionary is relatively cheap versus the market, relative to history.
In terms of the corporate spending theme, we like tech and industrials over bond proxies like REITs and utilities. As rates move up, companies need to invest to make labor more productive.
As for our defensive preference, we like healthcare shares at this point in the cycle. We’re still cautious on the yield proxies. We do like the banks within financials as rates move higher, and as the Fed’s path of hikes gets a bit steeper.
Ciolli: What’s your biggest fear for the market right now?
Parker: For better or worse, we’re in a backdrop that’s shifted to worrying about inflation and rates. In an environment where growth expectations are still solid, to the extent you have a weakening consumer that persists, that can keep markets afloat. Changing the narrative to higher rates, higher inflation, and weakening growth — that would be the biggest risk to the market. The consumer is key.
For better or worse, we’re in a backdrop that’s shifted to worrying about inflation and rates.
Ciolli: What’s the best advice you can give to a young investor, or someone starting out in investment management?
Parker: Save when you’re young. The benefits of annual compounding interest when you don’t need the money now is tremendous.
Investing early, and investing in growth assets like equities is recommended. Diversify exposure as well, possibly looking outside the US into something like emerging markets. Equity valuations aren’t cheap, but over the long-run you have corporate in a strong growth backdrop, and you have a government doing pro-business policies.
Stay with secular themes. Over the long run, certain sectors and industries have defensible business positions — in technology, healthcare, and industrials — will outperform during this.
For better or worse, we’re all functions of our own experiences and biases. The younger millennial generation has witnessed a financial crisis, housing collapse, and stock market collapse — all very recently. There’s temptation to believe that could continue happening again. It’s getting over that inherent cognitive dissonance with investing that allows you to put money to work. And over the long run, it does pan out.
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