Transcript:

Operator:  

Now without further ado, I'll introduce today's speaker. Amanda Agati is the Chief Investment Officer for the PNC Financial Services Group, Inc. She is PNC's investment voice responsible for PNC's overall investment strategy, portfolio and risk management, investment solutions, and the development and execution of the investment policies for PNC Private Bank, PNC Private Bank Hawthorne, and PNC Institutional Asset Management.

During the Q&A, she will be joined by Dan Brady, who will help moderate. Dan is the Chief Investment Strategist for the PNC Asset Management Group. In this role, he oversees all investment strategy related to activities for PNC Private Bank, PNC Private Bank Hawthorne, and PNC Institutional Asset Management.

Now I'll turn it over to Amanda, who will lead today's discussion of key market and economic fundamentals and how they may affect investors in 2022. We hope you find the conversation insightful and enjoyable.

Amanda, the floor is yours.

Amanda Agati:  

Okay, great. Thank you, Ian, for that kind introduction, and good afternoon, everybody. I am so delighted to be with all of you, albeit virtually, this afternoon to talk through so many aspects of our investment and economic outlook. As always, there's no shortage of material to cover. I think this year in particular we have a lot in store for you and so, without further ado, I'm just going to dive right into it.

I'm very grateful, just before we get started, I have Dan and Ian as my wingmen here to help out with any issues and questions and chat things that come along as we go. So, please, as we move through the presentation, we're going to save Q&A until the end. But please do submit your questions. We're going to try and address as many of them as we possibly can in the short time that we have together today.

So let me get started with our first slide. Today, of course, is Groundhog Day, and of course, I could not miss a chance here to pay homage to not only Bill Murray, one of my favorites for sure, but also his classic iconic 1993 film--but through the lens of the markets and the economy. That's the catch here. So hopefully, you'll appreciate some of the references as we move through here.

Well, we're definitely feeling much more optimistic than Bill Murray's character, so let's not start off here on an overly bearish message. We do have some of the same distinct feelings of deja vu heading into this new year here.

I'm very sorry to report that the groundhog did indeed, see his shadow earlier this morning here, and so 6 more weeks of winter, believe it or not, puts us at March 16. I don't know if it's interesting, fascinating, or eerie for those out there who may be a little superstitious, but that's actually the date of the highly anticipated March Fed meeting. So the cold spell of market volatility that we've seen kick off this year is not likely coming to an end any time soon if the groundhog is accurate in terms of his prediction. So the key message here, right out of the gate, we're not overly bearish, but we do think investors need to buckle up and buckle in because it's definitely going to be a bumpy ride these next 6 weeks.

So here's a quick snapshot of one of our favorite publications that we update on a monthly basis, and it's intended to be really dynamic and evolve as the markets and the economic landscape evolve. It's called The Good, the Bad, and the Ugly, and it's really a snapshot of all of the crosscurrents, all of the key things that are top of mind for us from an investment strategy perspective. I think it's a good frame of reference for my comments today.

If you take any single slide away from this conversation, it's really this one. This is the Cliff Notes version of all of those key messages, and I think it's also really where our feelings of deja vu are perhaps captured best--the essence of deja vu is captured best here. Many of the same issues that we wrestled with over the course of 2021 are still very much in the driver's seat as it relates to 2022. So things like inflation, supply chain challenges, global monetary policy support, a high volatility regime, elevated valuations, and earnings growth, just to name a few. But there's so many recurring themes sitting on the slide today that would be so very similar, if not exactly the same at this point at the start of the year in 2021. And so I think this is a good frame of reference for many of the topics that we're going to walk through together this afternoon.

So let's start with our first official Bill Murray reference here. "Do you ever have deja vu, Mrs. Lancaster?" "I don't think so, but I can check with the kitchen." I think it's just a hilarious way to start things off here. And really important in terms of checking in with that proverbial kitchen, aka our investment process, to really see what economic themes are likely to be in the driver's seat for 2022 and are really top of mind for us in terms of the path forward. So let's dig into this a bit here.

So the first slide in this section is really more of a textbook-style start to this section. One of the three key legs of our investment process stool is business cycle analysis, with the other two being valuations and technical. And based on what we have sketched out on this slide, we know that market cycles go through four distinct phases, but it's rarely as simple and it's rarely a smooth progression from one phase to the next.

This is the ideal state. But we know the reality is anything but ideal here, and so there's certainly no neon flashing sign to tell us when a phase of the cycle has shifted and, most importantly, no two cycles are really alike. And so without the groundhog's prediction here to give us a sense of when the cycle is going to shift, we do believe we're nearing the end of the accelerating expansion phase. It was a record-breaking market collapse, an economic collapse followed by a record-breaking market rally and economic recovery as a function of the pandemic. So I don't know about all of you, but I certainly have some whiplash already, talking about the phase of the cycle shifting here.

But with it we do think come a number of new opportunities for investors, really across asset classes, and we think many of those will emerge over the course of 2022, even as the phase of the cycle shifts and growth starts to slow a bit. So again, not overly bearish here, but I think this is helpful in terms of framing what that path forward might likely look like.

So to dig into it a little bit more, again without the help of the groundhog here, here are some of the key characteristics of a slowing expansion phase of the cycle. I think what's really interesting about this is we check every single box based on what we're seeing in terms of current economic data and leading economic indicators. So I'll just rattle these off really quickly, but we'll dig into them a bit as we continue the conversation this afternoon.

Earnings growth, particularly for the S&P 500, is in a decelerating but still positive mode. That is absolutely a theme that will dominate 2022 and beyond. Financial conditions--we'll talk about that as well--still in accommodative territory, but perhaps a bit less so than what they have been since the depths of the pandemic lows.

Also an important consideration for the path forward for equity and fixed income markets and certainly the economy at large, the shape of the yield curve changes quite a bit as we move through cycles, and we're definitely in a flattening pattern here. So we check that box as moving to the slowing expansion phase.

Credit spreads, though, they have widened a bit here in the recent bout of market volatility, remain very well-behaved, and so we would characterize them as somewhat narrow to flattening out here. And I think that is emblematic of potentially a cycle shift here or a phase of cycle moving forward into 2022.

Inflation. I will give you a little bit of a perhaps controversial take, in that we believe we're passing the peak in terms of the rate of acceleration around inflation. That is also a key theme in a slowing expansion phase of the cycle, and we'll talk a little bit more about why we think that's the case.

And then final point, leading economic indicators in a decelerating mode, a slowing growth rate, certainly here that second derivative, that rate of change slowing, it's still in very positive territory. And so again, not an overly bearish message at all to move from the accelerating expansion phase to a slowing expansion phase, but we do need to reset our expectations as investors accordingly for this shift to occur.

Okay, so let's dig into some of the economic meat, as it were. We'll start with some thoughts around GDP and economic growth. So last week's Q4 GDP report was a bit of a mixed bag, although if you look at the headline number, it was really strong--5.5% real GDP growth for Q4. Can't argue with that in terms of a result.

If we zoom out and look at all of 2021, real GDP increased at about a 5.7% rate, the best year of growth since 1984. Of course, we set a really low bar for ourselves as a function of the contraction in 2020. We were down 3.4% that year for reference. But still, in all, we consider it a really strong result, and a really significant acceleration occurred over the course of 2021. That being said, even though the headline numbers were solid, some of the underlying components were a bit more mixed, as I said.

Yes, the economy expanded strongly, but most of that growth came from inventory rebuilding, obviously a necessity. Companies are playing catch-up in terms of rebuilding their stockpiles, rebuilding their inventory from the runoff over the course of the pandemic and the lockdowns here. But we want to see that follow through, and that will be important in terms of a theme to keep this economic recovery going over the course of 2022 and beyond.

Consumer spending was certainly solid. We think consumers are in very healthy shape. We'll talk about that in a little bit more detail. I think that will continue to be a dominant theme for 2022. And trade moved from being somewhat of a drag to about neutral, so notable there in terms of the shift.

But fixed business investment was very, very modest in terms of a contribution. That is going to be a key. We really want to see that accelerate over the course of 2022 to have any shot at seeing this economic recovery accelerate here. That's kind of the missing link, I would argue, in terms of the outlook.

And then, of course, RESI--I think we are all understanding and aware of some of the challenges there. But RESI was a small drag, so net-net, it didn't move the needle too, too much.

Our Economics Team believes that growth in the first quarter is likely to be pretty soft. I think that's very understandable, given the lingering effects of what we're seeing from the Omicron variant and certainly the ongoing labor shortages. But we do think, just as we saw in 2021, this slow start to the year and then a systematic acceleration in growth over the course of the year, we think that that will be a story for 2022 as well. So, deja vu, certainly as it relates to the economic growth backdrop.

The Econ Team's forecast is about 3.5% growth for all of 2022, so that translates to about double the economy's long-run growth potential, so another really solid year from an economic growth perspective. But of course, there are always some caveats and some risks to that forecast. And so I'll just rattle off a few for you to the extent that we see any new variants as a function of the pandemic that may trip us up a bit in terms of that projection.

Supply chain issues or disruptions that linger longer than what we currently believe to be the path forward certainly can get in the way. Ongoing labor shortages--how fast do workers return to the labor market will be a key variable. And then the new one that seemingly came out of nowhere in the last couple of months is what happens with Fed policy and monetary policy in general. Is there a scenario where we end up tightening too quickly where it might actually impede economic growth this year? That's certainly something that we're going to keep our eye on very, very closely as we track through the year.

All right, so let's talk about the consumer for a minute. We see a very similar positive story for the consumer materializing in 2022. A couple of high-frequency data points listed on this page. For those of you who have been tracking our work over the course of the pandemic, we have indeed narrowed and shortened up our line of sight to track some of these higher-frequency data points as a part of our investment process, and it's really to understand what the all-important consumer is doing. What does behavior ultimately look like? Has the pandemic fundamentally changed consumer behavior, or are we seeing a reversion to pre-pandemic levels? And so if you just take a look at a few of the examples here on the slide, consumers have clearly returned to their old way of life when it comes to retail sales. But in others we do see that there are some fairly significant changes.

Of course, office jobs, working remotely, business travel, a series of other potential challenges, open table reservations have certainly recovered quite a bit, but are nowhere near where we think they should be if we're reverting to pre-pandemic consumer behavior. So we do expect consumer spending to remain solid throughout the year. Certainly, an improving labor market. Certainly, strong wage gains that we're seeing here right now should ultimately translate into strong income growth. And so we do think that the consumer will be a dominant force in 2022 and a key catalyst for economic growth and for this market rally to continue.

What I think will be interesting to see is whether the pendulum swings from spending largely on goods to services. Of course, the key variable, and that being what happens with the pandemic and if we see any new variants coming to pass here or not. But as the economy continues to track towards a full reopening and we see people being much more comfortable to go outside again, we do think that that pendulum is going to swing. And so that may ultimately translate, perhaps a bit later in the year, but that may ultimately translate into a recovery in some of these higher-frequency data points as the year progresses.

This is really important in terms of market positioning, really, because the market has rallied in anticipation of returning to pre-pandemic levels, particularly for categories such as value-oriented exposures, cyclical exposures, and even smaller cap stocks. And so the challenge at this moment is really that we haven't seen the underlying fundamentals rebound to the same degree.

We have certainly seen a rebound, especially off the depths of the pandemic lows. I don't want to discount how much forward progress we've made here. But we do think that there's still a bit of a disconnect between where the market is pricing recovery and where the underlying fundamentals are. And so 2022 could be a very pivotal year for that thesis to either play out in a positive way or a negative way. We're a little suspicious. We're a little skeptical about some of these categories returning to those pre-pandemic levels.

Okay, so let's talk inflation for a minute, clearly a pain point. This is probably the understatement of the webinar here. Inflation clearly remaining a pain point, not only for consumers, but clearly for the Fed and the notable shift in their tone just in the last couple of months, and certainly now for investors, too, especially given all the volatility and the pullback that we've had to kick off this year. Although I have to say, caveat, that we do think the rate of change, that rate of acceleration in inflation and inflation-related indicators that kicked off last summer in a fairly significant way is starting to slow and may ultimately be coming to an end. And so we do believe that as comps track higher--that is, they get tougher on a year-over-year basis as we move through 2022--that may take some of the inflationary fire out of the backdrop.

It doesn't mean that prices are going to fall. That is not the story that we're talking about here. But we do think the optics, that rate of acceleration, will start to slow, and I think that that will be certainly a positive from a market sentiment perspective. Even still, with those comps coming in and the optics looking a bit better, the core PCE based on the Econs Team is still projected to end the year at about 3%, so clearly above the Fed's 2% target, still clearly justifying the Fed taking some action here to change policy support and reverse some of the unprecedented policy support we've had since the onset of the pandemic.

The wild card as it relates to inflation, though, really comes back to supply chain issues, from our perspective. And so this is really, in our view, the single most important catalyst to the path forward in 2022 outside of a policy-driven catalyst. And it's this dynamic of supply chain disruptions, supply chain challenges, and even how we get from here to supply chain normalization, that's really going to be a dynamic that's in control throughout the year. And so that's a key variable that we're going to have to watch very, very closely to track progress and to track the pace of growth going forward.

One simple example--it's a bit anecdotal, but I think it's the poster child for this dynamic around supply chain disruptions and challenges--is, of course, the semiconductor industry. We've seen just significant bottlenecks and challenges in semi and chip manufacturing. Last summer the consensus expectation was that the shortages in manufacturing capabilities were going to stabilize and/or recover by the end of Q4 of last year. That clearly has not happened. And so the expectation now has been pushed out to the mid to latter part of 2022. And so this, again, is going to be a dynamic that's with us over the course of the entire year.

Obviously, chips and semis are a critical input in all sorts of durable goods across the global economy, and so this is a bit of a bellwether. This is definitely a mile marker in terms of the pacing and timing of our getting closer to normalization. And so we think really that is the single biggest catalyst to helping calm some of the inflationary fire here over the course of this year. It's not really Fed policy that needs to do it. I mean we may need to come at it from a multifaceted perspective here. But we do think that at the heart of it, supply chain disruptions are the biggie here, the whammy effect here as it relates to inflation. All right.

So let's shift gears and talk about market technicals. Clearly, the groundhog saw his shadow as a reflection of the quote here on the screen, and so we do indeed think the technical backdrop for the equity market is going to remain a fairly stiff headwind in the very short run. From a technical analysis perspective, just about every asset class in equity land has fallen below most of the major moving averages, and any last trend lines that could be tied back to 2020 have really been broken. So in terms of the path forward, we're setting our sights not so much on moving averages, but longer-term, if you can even call it that way, longer-term technical indicators, so indicators such as market breadth and even correlations.

When we look at market breadth, and that is certainly--we refer to that as the number of companies above their respective 200-day moving average--that variable does indeed keep trending lower. And so we really are looking for signs of stabilization as it relates to breadth to really signal an all-clear, at least that we've kind of settled in here in terms of the volatility and the equity market backdrop.

We're also looking at, as I said, intrastock correlations, and correlations actually remained pretty low relative to what you would have expected in such a severe and very short-term market pullback. So in other words, what we're saying here is that this is not a market where all of the stocks are moving together.

It was pretty orderly. It was pretty rational, in our view, in that the highest valuations and really the non-earners were the ones that got hit hardest in the bout of volatility that we had in late January. The rest of the constituents and the various indexes certainly did take a bit of a hit, but it wasn't the sign of everything converging to one. There was no contagion or any kind of concern around that. It did indeed feel pretty orderly. And so from that perspective, we do feel somewhat confident in the technical backdrop here, even though we think things are going to continue to be choppy, at least through the Fed meeting in mid-March.

So we've been in a high-volatility regime ever since the start of the pandemic, but it has clearly been quite a few months since investors have had to wrestle with the sharp downdrafts that can come in a high-volatility regime like this one. Case in point--last year the biggest drawdown in the S&P 500 was only, or just 5%. And really, what's happening here is that the market is just simply worried that the Fed is going to end up reacting too fast and that the policy reversal, or the tightening of monetary policy coming from the Fed, could ultimately derail the economic expansion that's already in this slowing expansion or down-shifting kind of mode.

Case in point here, we went from maybe one to two rate hikes over the course of 2022 to four to five as a consensus expectation in about 45 days, so talk about whiplash. And it's not necessarily coming in the form of 25-basis-point increments. There is some chatter and there is some rumbling around 50-basis-point hikes potentially being on the table. And so the market has struggled mightily to reprice that kind of a regime shift into the backdrop, and of course it's translated into fairly significant volatility here in the short run.

If you take a look at this slide, so top left, the CDOE volatility index, commonly referred to as the VIX, spiked pretty significantly in the January downdraft that we saw in the market here. It's starting to settle in a little bit, but still pretty elevated by historical standards, pricing in about 22 versus the long-term average about 18.5.

If we look at the right-hand side of this slide, that's the VIX futures curve. So if we look out over the next 6 to 9 months, what is the market pricing volatility at over that period of time? And you can see we're sitting at pretty elevated levels, even higher than the current spot price. So sitting at about 26, that's clearly signaling a heightened period of uncertainty ahead of us, and I think that makes sense given the policy winds of change kicking up here in a fairly significant way.

But believe it or not, volatility is not just an equity market story; it's actually very much alive and well in the bond market as well. So bottom left of this chart is the bond market's equivalent of the VIX. It's called the MOVE Index. It is sitting at March 2020 levels, believe it or not. I suppose that's not entirely surprising, given how volatile the path for market-driven interest rates have been, even in the face of no movement on the policy front up until recently. But then, of course, we have this change in monetary policy looming large here, too, so not at all surprising to see a lot of choppiness in fixed income markets as well. Bottom line here, this is not an overly bearish message.

A high-volatility regime does not automatically translate into negative market returns, even though that's kind of how we've started things off this year. It's really just a reflection of our view that larger-than-normal price swings are likely to be the norm rather than the exception. So that's why I said in the very beginning, buckle up and buckle in, because this high-volatility regime is going to continue to dominate in 2022, just like it did in 2021. Deja vu.

All right. So let's shift gears again and talk a little bit about equity market fundamentals. I love this quote. "That was a pretty good day. Why couldn't I get that day over, and over, and over?" 2021 really is very much reflective of this quote. It was a combination of strong earnings growth, positive, if not strong, if not robust earnings revisions, coupled with multiple expansion. It really was investing Nirvana, and I would love for that to be a deja vu moment here in 2022.

Sadly, that is not quite going to be the case here, so this is the opposite of deja vu as it relates to that thesis here. So let's dig into some of the details on this one. So the consensus estimate for Q4 earnings growth is about 23%. We're right in the thick of Q4 earnings season right now, and so I wanted to give you a few thoughts on where we are today and then we'll zoom out and talk about what the year may bring.

What's interesting about that is all else being equal, 23% growth sounds like a home run. The reality is it's actually the lowest growth rate for all of the quarters in 2021, despite still being very, very strong relative to prior years. And so this is that slow your roll. This is that rate of acceleration showing up here in the earnings growth backdrop.

We're setting a higher bar for ourselves coming into 2022. Comps are tougher, and so we are indeed seeing that rate of acceleration start to slow. Frankly, it's a healthy shift. The sustainability of these really record-setting year-over-year earnings growth beats and raises is not healthy, so we do need to settle into a more rational, systematic acceleration going forward. And so that's what you're seeing play out with Q4, and we think that that will be the story for 2022.

In terms of Q4 earnings season specifically, we still have a ways to go, but what we're seeing so far is that the leaders really are leading. And so, of course, I'm talking about large cap tech. We've seen really strong positive results so far coming out of those areas. But the companies that were really expected to deliver the strongest growth on a year-over-year basis, energy sector in particular--and dare I call out one name, Boeing, also really significant expected contributors for growth--are actually coming in somewhat mixed. And so the beat rate relative to expectations is actually coming in lower than what we've seen in prior quarters. Again, Q4 earnings season not over yet, but just tracking based on where we are today, that's kind of the impression that we're getting from it.

I think more importantly, though, it is the pace and path of revisions over the course of 2022. So while we're seeing a little bit less robust than expected results for Q4, that expectation for growth is being pushed out. We're kicking the can out a few quarters, and so net-net, we're not seeing revisions for 2022 deteriorate, we're actually seeing them move higher. The expectation for growth for the S&P 500 in 2022 is about 9%. Again, all else being equal in a non-pandemic year, you can't argue with 9% as a successful earnings growth expectation for the year. The challenge is the monster comparison from 2021 is going to finish somewhere in the neighborhood of 50% or more. So again, a massive deceleration on a year-over-year basis there.

And so I think the notable thing here is one, the slowing, but still very positive growth. But two, in the very short run given this dynamic playing out, we do think that the macro backdrop is likely to be the dominant force. That is even if earnings season for Q4 ends up being a bit better than what I'm reporting to you now, we don't know that it's significant enough to really overcome the headwinds of Fed policy change here in the short run. So we think that dynamic is going to be a bit of an arm-wrestling match in terms of the dynamic between earnings growth, earnings revisions, and what ultimately happens with Fed policy, so we're going to keep a close eye on that. In the absence of earnings growth beating Fed policy here, we think things are going to continue to be choppy, that the market is truly going to revert to that higher-volatility regime in the short run.

All right, so let's talk valuations. Even with the recent pullback in the S&P 500, we're still sitting at a forward PE of about 20 times, and this is about 5 multiple points or so ahead of its long-term average, and so it's really hard to argue that the market is cheap, even at these levels. Again, a dominant theme from last year that's repeating here in 2022.

You take a look at this chart here on the right-hand side primarily, so the bars. Anything growthy in terms of asset class categories looks pretty expensive relative to history here. But I would argue in a slowing growth environment like we are finding ourselves in or about to be in, investors tend to pay up for quality growth and defensible growth characteristics. And so we think the fundamentals in many of these growth categories actually justify valuations at these levels.

The trick is that with regime changes, like what we're seeing catalyzed by Fed policy reversing here, often come multiple rerating. And so I think the two charts here on this slide help frame the potential magnitude of multiple compression that can come from sustained elevated inflationary readings and sustained higher interest rates.

So if you take a close look at the chart on the left-hand side of this slide, with CPI running at somewhere in the neighborhood of 7% year over year, and based on this analysis going back to the 1950s, the trailing 12-month forward--the trailing 12-month PE for the S&P 500--should be somewhere in the neighborhood of 13.8 times, whereas the current for the S&P 500 is a whopping 24. So my initial reaction is to say, "Look out below!"

But the reality is this is not a prediction. This is not a forecast. This is just, historically speaking, how multiples can come under pressure under various tranches here. And we do think, again for all the reasons I talked about earlier, that inflation will start to subside, that we'll see a little bit of a reprieve on that front before we start to see really significant meaningful multiple compression.

When you look at the right-hand side of this slide, look at that chart there, it's the dynamic between the 10-year Treasury yields and multiples. And so with the 10-year sitting at right around 180, the trailing 12-month PE based on this analysis--I know it's hard to figure out where the dots reside there--but it would be basically 25 times, so largely in line with, or pretty closely aligned with, the 24 that I just quoted relative to the other chart. And so of the two competing analyses here, it's really the still favorable interest rate backdrop that's supporting equity market multiples for the time being.

We're obviously at a crossroads with policy rates here, but that doesn't necessarily equate to higher long-term rates, which is why we're not seeing this massive re-rating in equity valuations being a reset, that it hasn't been significant and sweeping, and we think that the market can work through this dynamic over the next few quarters, for sure.

So if equities seem expensive based on some of the slides that I've already showed you, I will just say look out as it relates to fixed income asset classes, because we actually think fixed income asset classes are much more stretched from a valuation perspective. And so a simple comparison here of the implied equity yields on the left-hand side to the yield to worst on the right-hand side for a number of fixed income asset classes, if you look at the investment-grade bond category, the duration of IG corporates is actually near its all-time high. If you look at high-yield bonds, the yield for high-yield is sitting at about 5.3%. And interestingly, on an inflation-adjusted basis, that's a negative yield right now.

With the market volatility recently, we certainly have seen high-yield spreads widen a bit. But at about 330 basis points, it's not even back to the peak levels in early December catalyzed by the Omicron variant coming into being. So we're staying in fairly well-behaved territory here. And I think it tells us from a credit market perspective the recent pullback that we have seen is not due to a breakdown or weakening in the underlying fundamentals, it was really a sentiment-driven correction. At the end of the day, it's hard to call the yields or the spread high at these levels, based on what we have here on the slide.

And it's certainly not offering much of a margin of safety for fixed income investors either. This does not mean sell your fixed income. It really just means we need to reset our expectations around what fixed income can or will do in portfolios at these levels, total returns likely to remain under pressure, especially in the face of the Fed raising rates, and we think the choppiness, aka that volatility regime, is going to continue to be higher for fixed income asset classes than what we are used to. So again, buckle up for fixed income investors in 2022. All right.

So with that as a good segue to fixed income fundamentals--whew! Watch out for that first step; it is a doozy. The Fed last embarked on a rate hiking cycle in 2015. That was almost 7 years ago. So I think it's natural for investors to feel like they stepped in a slushy puddle of ice, like poor Bill Murray did in this scene. So we thought this was very apropos to kick off the fixed income portion of our session today.

So the bond market's attention--and really, that's a reflection of what we can see here in terms of the movement in yields and rates--is really focused on what happens with the Fed tapering its balance sheet and how far and how fast they move policy rates higher. You're clearly seeing it in the movement of rates and in the shape of the yield curve in anticipation of what the Fed might do.

I think most notable here is that the 2-10 spread has compressed, i.e., the short end has risen quite a bit, again in anticipation of what the Fed might do, but the long end really hasn't budged all that much, leaving a yield curve spread of just 60 basis points, which is pretty narrow relative to the onset of past tightening circles. This is the bond market's interpretation or signaling that the bond--or that the business cycle is slowing, aka the growth outlook is slowing, and therefore it's acting as a bit of a cap on longer-term rates. This isn't a dire scenario. This isn't a bearish scenario. We just think the long end is much more less in control, if at all, by the Fed. And so it's that dynamic of this phase of the cycle shifting and the slower growth outlook coming into control.

Certainly, financial conditions have tightened lately, yes. After all, that is indeed the point in terms of moving back from the unprecedented policy accommodation that we've had since the onset of the pandemic. But we're not even at 12-month highs, considering how severe the equity market pullback has been. So there's a disconnect there.

We're still, from a financial conditions perspective, still in very supportive territory for equities, but for all the reasons we just talked about--the still below absolute yields, a flattening yield curve, and the relatively tight spreads--are just going to continue to pose challenges for fixed income investors, not only in 2022, but beyond. This is again a deja vu theme ringing true here.

From a fundamental perspective, corporate credit balance sheets really are still very much rock solid. Yes, rates have moved to their highest levels in a year, and yes, spreads have widened a bit, but again, as I said earlier, are very well-behaved. And so with the strong earnings backdrop that we are tracking very, very closely for 2022 and beyond, we think that that's very supportive for fixed income fundamentals.

So you might say, "All right, well, we're starting to see spreads widen a bit here." That historically has been a canary in the coal mine, or a signal for some kind of looming breakdown. We don't see that to be the case at all. We actually see this as confirmation that the underlying fundamentals in the backdrop continue to be quite sound. So very, very solid in terms of positioning in credit-oriented fixed income asset classes, even though we recognize that valuations are indeed fresh.

At the end of the day, there might seem like an awful lot of cross-currents facing investors. I just took you through 43, almost, minutes of all the things that are top of mind for me from an investment and economic outlook perspective. But don't drive angry. "Don't drive angry," says Bill Murray, as you can see on the slide here. In our words, there are plenty of reasons for investors to still stay positive on the path forward in 2022.

So where do we go from here? A lot of words on the page here. I'll try and wrap it up so we can get quickly to the Q&A portion of our session.

To reiterate what I said earlier, we do believe we're passing the peak in terms of the rate of acceleration by many or most economic indicators that we track, and comps for 2022 are starting to get a lot tougher. So clearly, this expansion is showing signs that those base effects, those comps from last year, are starting to fade. But a peaking growth phenomenon is not at all the same as a no-growth phenomenon and certainly not the same as a negative growth phenomenon. It's really just a #slowyourroll environment going into effect for this next phase of the cycle. When we look under the hood, earnings continue to be quite solid.

But in the market that's pricing still for near perfection, not all surprising to see volatility pick up here, because there's not that much headroom or shock absorber when negative news comes into the narrative like it did over the course of January. And so we do indeed expect market returns for 2022 will largely track the path of earnings growth pretty closely. Another solid year, but definitely a slower pace of advancement and without the tailwind from multiple expansion that really has been a defining moment or a key driver shaping the last couple of years. And on the right-hand side, as a reflection of that outlook, you can see relative favorability by some of the key asset classes that we're focused on.

Final slide. And while we certainly do not expect a record-breaking market performance to repeat in 2022--I'm sorry, that is not the deja vu theme that we're going for here, although that would be amazing if it was; I'd be happy to be wrong about that forecast‑‑we do think the fundamental backdrop is pretty hard to beat here. So we don't want any of you to feel overly concerned here as we kick off 2022, but it definitely feels a little bit deja vu.

And with that, I'm going to turn things over to Dan to get the Q&A portion of our session started.

Daniel Brady: 

We've already been getting a ton of questions throughout this call, and so what I wanted to do was try to aggregate them in covering the themes that they really seem to address. So thank you for submitting those. I know we covered the waterfront here, so certainly no shortage of topics that we want to dive a little deeper in.

So Amanda, the first question that really seems to be on investors' minds is this inflation backdrop. So from that angle, can you talk about how we would really want investors to think about positioning should that inflation narrative stay longer than we may have anticipated here?

Amanda Agati:  

It's a great question. It's one that we have continued to get, month in and month out, really since last summer when the inflationary fire started to kick up in a fairly significant way. There's a number of levers that we can pull in terms of portfolios to think about hedging exposure relative to an elevated inflationary backdrop. The automatic go-to, I think, is an obvious one. So real assets, real estate, it might be private real estate for those who can access that certainly, but also publicly traded REITs tend to be really good and accurate hedges against an inflationary backdrop. Another thing I would call out, an inflationary backdrop that's sustained at these levels, cash flow generation is actually king, and also growth is king.

And so when we look at things like large cap dividend growth and quality dividend growers in particular, we actually think that they are very well positioned to be that inflationary hedge in portfolios, and they haven't participated to the same degree as some of the other asset class categories in large cap in particular in terms of that valuation multiple expansion. So we actually think there's an opportunity there for investors.

And then believe it or not, I'll go to the opposite end of the spectrum and say emerging market equities. Again, in an inflationary environment like this, you really want to find exposures that can outgrow or outpace the rate of advancement in inflation. And so we actually think the emerging markets story, though controversial, is one of the brightest stars in the equity asset class universe from a growth perspective. And so, fundamental story, they're very sound. We think that that makes sense as a hedge against inflation. And so I would call that out there to make sure you're taking a look at that exposure in portfolios here in 2022.

On the fixed income side of the equation, for all the reasons that we like emerging market equities, we think emerging market debt is pretty well positioned again from a valuation perspective. Not quite as stretched, not quite as tight as some of the other fixed income asset class categories we cover closely. And then we think the thesis is very strong there in terms of the fundamental backdrop for emerging markets.

We also like private or structured credit, again, for those who can access it. It's really an extension of high-yield, just in private markets. But valuations haven't expanded to the same degree there. We really haven't seen a credit cycle materialize there either. We still think there's some runway for that to accelerate. And so we think that that exposure is pretty well positioned from an inflation hedging perspective.

We like leveraged loans--I'm cringing a little bit saying that, but I'm throwing that out there. Near-zero duration, we think, is very well positioned, given a rising rate backdrop, certainly hedge against rising rates and inflation and then to a lesser degree, high-yield. Again, you have to pick your spots very carefully there. We think actively managed exposures in high-yield make a lot of sense here, especially at this point in the cycle, but that's also one that has been historically a very good hedge against rising inflation.

So those are a few things that come to mind as it relates to that question.

Daniel Brady: 

All right, thanks. Well, then, I guess I'll take it in a different route. Since you brought up emerging markets from an inflationary backdrop, another question that we seem to be getting a ton about, so I thought we should do this one next, just going a little further in that thesis behind emerging markets, behind China, can you just elaborate more on that angle?

Amanda Agati: 

Sure, yes. So emerging markets, again, just to reiterate, brightest star in the equity asset class universe, fundamental backdrop, really, really strong from a growth perspective. It's been so frustrating. It was one of our top picks in 2021 in terms of positioning and outlook there and with China's significant intervention policy adjustments. Even though it was only focused on a very narrow subset of the index, it led to this broad-based sentiment overhang, really, over the course of 2021.

And so, coming into the New Year, we actually see China taking a bit of a different tone, a much more accommodative approach from a policy perspective. And so this one is where we're seeing the pendulum swing pretty significantly in the opposite direction from interventions tightening to much more accommodation. And even in the face of the challenges from the sentiment overhang last year, we didn't see the economic or earnings growth backdrop deteriorate at all. Actually, the fundamentals stayed pretty sound.

And so when we look at relative valuations, we've seen everything pretty elevated across the asset class universe. But relative to the developed world, we actually see emerging markets as quite attractive, especially given how strong the underlying fundamentals are. To the extent that they need to do anything from a policy perspective, either as a function of the pandemic or otherwise, we see the emerging markets as having more policy tools in the toolkit than most of the developed world. So we think that that's important as a backstop.

Again, it's not our base case. We don't think that they will need to do anything meaningful there, but it's waiting in the wings in case we need it. And then from a yield pickup perspective, very attractive relative to the rest of the developed world. In a growth-starved and a yield-starved world, we just think emerging markets is really well positioned for 2022 and beyond.

So those are some of the key things in terms of the thesis that are top of mind for me as it relates to EM.

Daniel Brady:  

Okay, great. So we've talked about inflation, talked about emerging markets as an asset class. I love Q&A because you get so many different types of questions, so I'm going to go in a different route. We've got a couple about cryptocurrency markets, so I'm going to just address that as a question. Thoughts around the whole concept, the ecosystem of cryptocurrency?

Amanda Agati: 

Well, let me just say we could have spent our entire hour together on the topic of cryptos. I'm mindful of the time here, and I'll try and give you the Cliff Notes version of it. If you want to dig deeper into all things crypto, I'll give Dan and the strategy team a shout-out as it relates to this. They did a really extensive deep dive into the world of crypto and how we think about it from the investment process. And so if you have not seen that yet, do reach out to your PNC advisor or PNC contact. We'd be happy to share all of what we're thinking as it relates to that through the lens of that paper.

A couple of high-level thoughts: we're clearly in a crypto winter at the moment, to pick up on the Groundhog Day theme a bit. While I think a lot of people are concerned about, "Is this a passing fad? Is this crypto winter a function of that?" we actually think they have staying power. It's certainly seeing its fair share of boom and bust cycles, but when it's a $2 trillion to $3 trillion ecosystem, it's really hard to dismiss or ignore any longer. At the end of the day, though, these are the most volatile assets on the planet, so you really need to know what you're getting yourself into when it relates to crypto, because they are not all the same thing. One coin does not equal another. In terms of being a store of value, is it a replacement for gold, aka digital gold? Is it a token for a new method of payment system, et cetera? I think at last check, there's something like 9,000 or more coins, so there's definitely a buyer beware investment opportunity here.

What I think is interesting about it is not so much the coins themselves, but really the underlying technology. What are those future use cases, those new business models that can be borne out of the blockchain technology? I liken it a little bit to the Web2 and 4G scenario or advent of those things that really gave birth to companies like Uber and Lyft, and now it's Web3 and 5G and supporting the Internet of Things and artificial intelligence and so on. And so I think it will be very interesting to see, though it's very, very early innings, what will be borne out of the blockchain technology. That's the part that's interesting to me, the innovation and the growth and the runway that may come from that.

The challenge in the short run is that it's very hard to access many of those exposures. And so for the average investor, the easiest way to gain access to blockchain technology or crypto in general is through the coins, and I think that's why you've seen so much investor attention and fixation on the coins themselves--bitcoin, ether, and so on. The list goes on. But I think that's definitely one to watch for sure in terms of the path forward. It's not just a story for 2022. We think that this is definitely a multiyear runway for innovation and growth.

Daniel Brady:    

Okay, great. 

Amanda Agati:     

Yes, I was just going to say I'm sorry that we couldn't get through any more questions, but I think we probably should end it there. So maybe I'll just stop us there and say thanks so much for taking time out of your busy schedules to join us this afternoon. I hope you found this interesting, helpful, insightful, maybe a little bit entertaining as well.

If you have any additional questions--I know there were many that we weren't able to address--please do reach out to your PNC contact. We want to make sure that we address all of your questions and concerns along the way.

So thanks again, Happy New Year to all of you, and Ian, I'll turn it back to you.

Operator:    

Thank you so much, Amanda, and once again, thank you all for joining us and have a good rest of your day. Take care.