NEPC's Phill Nelson, spoke with Pensions & Investments about the Federal Reserve's "permanent interventions" in the market and why a bigger allocation to US and Emerging Markets equities could pay off.
Investors should maintain — or even add to — their equity allocations in coming years against the backdrop of a new market-supportive policy regime capable of sustaining higher valuations, contends Boston-based consulting firm NEPC LLC.
A bigger allocation to Chinese equities could pay off as well over the long term, once investors get more accustomed to the mix of opportunities and competition that's set to characterize U.S.-China relations going forward, said Phillip R. Nelson, a Boston-based partner and director of asset allocation with NEPC.
Mr. Nelson, in a recent interview, described the mix of monetary and fiscal policies that came together last year — only to be supercharged by the coronavirus crisis this year — as one of "permanent interventions."
The U.S. Federal Reserve has effectively added a new mandate — "providing stability for market sentiment" — to its previous brief of restraining inflation and supporting employment, Mr. Nelson noted.
"We view the Fed's influence as attempting to exert control over investor sentiment and ensure sentiment does not materially decline and become a negative feedback loop with the 'real economy,'" — effectively a more assertive version of the so-called Fed put," said Mr. Nelson in a subsequent email.
In this environment, the Fed looks set to support markets with an "easy policy forever" approach, while forging a symbiotic relationship with the U.S. Treasury — taking the debt that Treasury will have to issue to aggressively respond to inevitable cyclical downturns onto the Fed's balance sheet, Mr. Nelson predicted.
In this new policy environment, which can prevail for the foreseeable future, investors "have to be" in equities, and price/earnings multiples that would have deterred allocations in previous cycles may be less relevant, Mr. Nelson said.
Strong support from central banks is "creating an environment in which high price/earnings multiples are likely to persist, (and companies with) stable cash flows and decent moats are likely to do well," he said.
And for companies that are growing faster than their peers, such as technology companies now, there are reasons that equities "can keep on running," said Mr. Nelson, adding that "valuations as we would normally see them are maybe not as representative as we would have thought over the last 20 years."
Meanwhile, NEPC executives are "encouraging our clients, on a strategic basis, to have an overweight to emerging market equities" relative to the indexes they track.
That call rests on the strength of consumers in China, primarily, but in other North Asian markets as well such as South Korea and Taiwan, as those economies have started to open up after successfully squashing their coronavirus outbreaks.
The growth of consumption in these markets "is still an underappreciated story (and) is likely to be a secular driver for years to come," whether or not exports falter or supply chains are shifted away from the region, Mr. Nelson said.
"We're starting to see an emerging markets story and a developed markets story that can exist independently," and that has left NEPC recommending clients stay invested in U.S. equities but over time add exposure to China and other North Asian markets, he said.