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Brutal second quarter is ‘setting up better return potential,’ strategist says

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John Hancock Investment Management's Matthew Miskin joins Yahoo Finance Live to discuss second quarter returns, the outlook for the stock market, and the speed of the business cycle.

Video transcript

AKIKO FUJITA: And yet let's look at the broader markets now, though, because we've got Matthew Miskin. He's John Hancock Investment Management co-chief investment strategist. Good to talk to you today. You know, yesterday at this time, we were talking about potential capitulation, are we there yet. And then yet we saw the big declines yesterday on the back of the consumer confidence numbers that came out. Where are we right now in this phase, in how much more downside is there to come?

MATTHEW MISKIN: Well, Q2 is shaping up to be one of the most challenging quarters for investors that they've faced in history. Over the last 40 years, only 1987 was a worse quarterly return for a 60-40 portfolio than this quarter. And what we see is, really, stocks have gotten cheaper, bond yields have risen, and this is likely setting up better return potential for a forward-looking basis for clients and investors. Now, capitulation-wise and the macro-wise, sentiment is pretty washed out.

I mean, you look at consumer sentiment, it is pretty rough out there, some of the worst sentiment we've seen in history. But in terms of the macro story, what Brian was talking about with the Fed, that's the problem that we think is going to remain with us here a couple more months. We've priced in a lot of bad news, but unfortunately, we've got some more hurdles to get through as it relates to rate hikes before we're through this volatility.

BRIAN CHEUNG: Yeah. And Matt, what was kind of interesting was that you had the Fed chairman saying today that there is a likelihood that there's going to be some pain involved in this recovery, which, translation, maybe means the Fed can't avoid a hard landing, where you have unemployment rising and jumping, with inflation still high. Why are markets not falling more on that? Because it seems to be interesting-- I mean, it's interesting to me that perhaps we haven't seen more market volatility through what has been downgrades, essentially, in the Fed's outlook.

MATTHEW MISKIN: Yeah. So valuation-wise, I mean, we've trimmed off about 25% on the price-to-earnings ratio on the S&P 500 in six months. That's the fastest rerating in valuations since data going back to the '90s. So in a way, a lot of that is being brought, in terms of that rerating. But what we see as an opportunity is actually longer-dated or intermediate-term higher-quality bonds are not pricing that in, a hard landing.

The fact is the longer-end-- the 10-year, the 30-year-- yields have just kept going up amidst the Fed saying they're going to basically have to bring the economy into a slowdown or a potential recession. We think that's a mispricing. And also, there is high-quality stocks out there that are less economically sensitive-- good balance sheets, high ROE that are sold off 30% right now. So our view is that you've got to find opportunities here that aren't pricing in this slowdown. In the bond market, we see the biggest dislocations where intermediate, high-quality bonds like investment-grade corporates, mortgage-backed securities, even municipal bonds, look good to us.

And then on the equity side, things like health care and things like technology, even, could represent opportunities as the economy slows.

AKIKO FUJITA: So is now the time to shift things up, if you're looking sort of down the line here at the next 6 to 12 months? Is this the time to move into some of those sectors that you mentioned in anticipation of a more meaningful slowdown?

MATTHEW MISKIN: So within the fixed-income side, what we're doing is looking to increase corporate quality. So things, you know, companies with better balance sheets, move up the credit spectrum, so reduce high yield, reduce floating rate and bank loans, move that to more higher-quality bonds. Low quality has actually been a much better performer over the last year or so. The more low quality you were, the better off you were in bonds.

We think that's going to actually flip itself into the next 12 months. And there's a mispricing. You can get 3%, 4%, or 5% in high-quality bonds right now. Just look at that and chill in that part of the market while you wait. And then in terms of the equity market, we would rotate into less-cyclical parts of the market that have held up a bit better. But overall, stocks-, bonds-wise, we're trimming equity risk overall to more neutral, bringing up bonds.

We were underweight bonds. We're going to move that to more neutral. And then we're going to be patient and wait for more kind of durable bottoming here in the macro story before getting more risk-on.

BRIAN CHEUNG: OK. So, I mean, this sounds like a late-cycle play. So are you kind of saying here that by the end of the year, we could see an observable bottom?

MATTHEW MISKIN: It might be more like Q1, Q2 2023 at this rate. But the thing is, this cycle has moved so fast, and you've had to be nimble. I mean, we've gone from early cycle in 2020, 2021, mid-cycle '21 to the beginning of '22, and already we're late-cycle. And so this cycle overall was really just created because we pushed off the end of the cycle that really should have happened back in 2019 into 2020.

Because of all that stimulus, we pushed this out, this recession, and now we're going to have to get through it. It is probably going to take some time. The Fed is still going to be raising rates. High oil prices makes this inflation backdrop really tough to get through. But we think that you're going to see a good, really nice reacceleration in the economy probably going into the back half of '23. Be patient, but be ready also to put that money to work then.

BRIAN CHEUNG: Wow, that would be some timing if we reach the end of the bottom around the time that the NBER maybe declares a recession. But we'll have to see about that. Matthew Miskin, John Hancock Investment Management co-chief investment strategist, thanks so much.

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