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Economic Insights

In this podcast, director of strategic asset allocation Giulio Martini talks about the investing lessons from another turbulent political year—1968.


PODCAST - 2018 Midterm Elections

The Investment Conversation- Investing in Uncertain Times

In this podcast, director of strategic asset allocation Giulio Martini talks about the investing lessons from another turbulent political year - 1968.

VO: Welcome to The Investment Conversation, Lord Abbett's ongoing podcast series.

Will Andrews: I'm joined today by Giulio Martini, Lord Abbett's director of strategic asset allocation. Giulio, let's get straight to the topic today. We're going to talk about the charged political environment in the United States right now in the run-up to the midterm election.

You've pointed out that it contains certain similarities to another turbulent time. Namely 1968, a year many of us remember for a lot of wrenching and very meaningful events. Why is this a relevant comparison for investors today? '68 was a year that was marked by violence, assassinations, and really, a lot of political upheaval. How does that really line up with what we're seeing today in 2018?

Giulio Martini: Well, Will, what I think we're seeing really globally are challenges to the established political order in many different countries. And of course, in the United States—that's represented by the election of Donald Trump and the challenges he's posed both to the Republican Party and the political establishment more broadly.

And I think a lot of people feel like this is certainly the most polarized political environment that they've experienced in their lifetimes and that it's really full of surprises. That every day brings an unpredictable turn of events in the policy sphere and that, therefore, we're living in just a turbulent environment that has to be, in a sense, negative for markets. And I think it's useful to just remember what happened in 1968 to put a year like we're living through into a longer-term historical context.

The way that year began was that on January 23rd, a U.S. Navy ship the "USS Pueblo" was seized by North Korea in a clear act of war. It was then followed shortly by the North Vietnamese launching the Tet Offensive, which was really the first time that the American people started to realize that the U.S. was losing the Vietnam War.

Then on April 4th, there was the assassination of Dr. Martin Luther King, setting off race riots in cities around the country. Then on June 5th, in the middle of the presidential campaign, Robert F. Kennedy was assassinated. It appeared at the time that he would be the candidate of the Democratic Party for president.

Then on August 20th, the Soviet Union launched an invasion of Czechoslovakia, bringing kind of an opening that was taking place in that country to an end and clamping down on a movement that seemed to be offering some liberalization. On August 28th, we had the Democratic Convention in Chicago, which led to violence on the streets, and scenes on television of the Chicago police beating up the demonstrators.

And then on November 5th, we had one of the most contentious elections in American history, where Richard Nixon was elected with less than a 1% margin and only barely over 43% of the vote. So that's a pretty turbulent year in terms of truly shocking and unexpected events.

And when you look at that, you would guess that the stock market would have suffered. And on the days those events took place, it did suffer. But at the end of the year, the stock market was up 7.7%—over the course of that entire period. So I think 1968 is just helpful for us now because it shows you that what really drives stocks are not political events, even terrible, terrible events, but the underlying fundamentals of growth in the economy, increases in earnings for companies, and ultimately how you can value those in a broader financial environment.

Andrews: And you, in some pieces you have written for the Lord Abbett website, [you] discussed the need to focus on the current fundamentals of the U.S. economy. And that said, just give us a picture of where we are right now and what investors should be looking at.

Martini: Well, I think we're in a time where things are shifting a little bit. What we had was a global recovery that was really driven by a recovery in global trade that started in early 2016 and had a positive effect on all countries. And so we saw a couple of years where economic growth was better than had been expected, and as a consequence, company earnings were performing better than expected.

Now, what we're seeing is a little bit of a cyclical downturn in trade, and in contrast, the United States is really accelerating in part because of the stimulative effect of the fiscal policy package that was passed and of the tax reform that was put into effect late last year.

So the United States is really getting a domestic stimulus that contrasts with the negative effect of the downturn in global trade in the rest of the world. And so we're really seeing the U.S. economy pick up just as the rest of the world turns down.

Now, that's actually good in the sense that U.S. economic growth spills over to other countries and cushions the downturn. But in the United States, what we've got are earnings that are up in the second quarter [based on data through mid-October]. They were up almost 25% year over year for the S&P 500. This quarter so far they're coming in at about plus-20% year over year.

The expectations for next year are in the high single digits right now. And that's not what you're seeing in the rest of the world. It's really the effect of the cut in tax rates and the improvement in the U.S. economy that U.S. companies are doing so much better than what we're seeing elsewhere.

Now, that's coupled with an environment in which the Fed [U.S. Federal Reserve] is tightening and rising interest rates are not good, generally, for markets. But the Fed has really telegraphed its strategy to us very clearly. And it's pursuing the strategy of tightening by about 25 basis points every quarter, until it reaches what it considers to be a neutral rate in the zone of 2 3/4% - €3 1/4% for the Fed funds rate target, really. Or the range, I should say.

It could be that if the economy turns out to be stronger than expected and the Fed has to tighten by more, that that leads to a little bit of a negative reaction. Because what you really worry about a little is a situation where strengths today leads to the expectation of weakness tomorrow.

And the way that happens is when a strong situation today leads to more monetary tightening by the Fed, inducing expectations for future growth to be pulled down. But that is characteristic of an environment where inflation's accelerating. And that's really not where we are right now. We're in a situation where strong growth is pulling rates up towards normal. But because inflation has been so well behaved, it's not generating expectations of weaker growth in the future.

So we're in a pretty nice environment right now, and have been for the past couple of years. It's more pronounced in the United States than elsewhere. But globally, it's still a pretty good economic environment.

Andrews: What are some of the takeaways from this current environment in terms of what types of strategies people might want to consider? Or should they sit tight? What should they think about right now?

Martini: Well, I can tell you what we're doing. And, you know, what we're doing, I think, is a little bit more aggressive than what you see out there in the world on average. You know, I've noticed recently that cash levels are somewhat higher than they've been recently. So it looks like investors have gotten a little more cautious.

So it looks like the world has pulled in its risk exposure a little, and we have not done that. We think that the environment in which the U.S. economy has accelerated and inflation has not picked up is very, very positive because it hints at the fact that maybe our long-term growth estimates and our productivity growth estimates are too low. And if those should be revised up, it would be a tremendous positive for stocks and for risk assets in general. And there are increasing signs that that could be taking place in the not-too-distant future. So we're still optimistic. We're still overweight equities. As you might have guessed from what I said before, it's U.S. equities that we're overweight.

But also, and I think this is a little bit more of a contrarian type of allocation, we're still overweight credit and high yield. And a lot of investors are shying away from that because spreads between high-yield and Treasury bonds are tighter than they've been on average historically [as of mid-October]. But they're still well above the tightest that they were, looking back at 2006, and before that, in 1997.

And in such a good economic environment, the yield advantage that you get in high-yield bonds, combined with what could be further spread tightening, and what has been a very low environment for defaults, makes them look very attractive to us.

Andrews: This has been great information, Giulio. Thanks a lot.

Martini: Thanks, Will.

VO: That's it for this edition of The Investment Conversation. As always, you can access a full range of investment commentary and analysis at Thanks for listening.


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