ESG investing in 2020

Ruth Saldanha: NEI expects climate change and other responsible investing themes to dominate financial headlines in 2020. The firm also expects growth this year, albeit slower growth than last year. What are some of the opportunities and the risks? John Bai, Vice President and CIO of NEI Investments is here today to talk about it.

John, thank you for being here today.

John Bai: Thank you so much Ruth for having me. Really excited to be here today.

Saldanha: You expect growth in 2020, albeit slower growth than 2019. What do you see as some of the growth drivers?

Bai: Sure. Let us start off by saying that 2019 was really a bit of an odd year. We actually had some of the slowest global growth rates since the great Global Financial Crisis. But despite that, we saw very strong stock prices. Stocks were up between 20% and 30%, particularly in the United States and bond prices were up strongly as well. So, what was driving that? I'd like to attribute that to a phenomenon I call the reverse Goldilocks, where economy where typically when you talk about the Goldilocks economy, you talk about an economy that's strong enough to lift stocks, but not too strong that the central banks have to raise rates. Last year, we've seen the exact opposite. We had growth that was weak enough to get central banks to be accommodative, cut rates, lever their balance sheet, but not too strong to cause a global recession. As we start thinking about 2020, we think about more of the same, where we don't think that there's going to be an economic recession. We think that the central banks will be successful in avoiding that, and that will be good for stocks. But because growth is slowing in the developed markets, especially in the United States, we do expect the output gap or the difference between the potential GDP and actual GDP to be negative, and that's not inflationary. And because we don't see sustained inflationary growth, that will be good for bonds.

Saldanha: Let's talk about Canada in particular. Where do you see some of the opportunities right now for Canada?

Bai: Yeah. I mean, it's really interesting. If you think about Canadian investors, you look back over the last 10 years and I said that U.S. stocks have done particularly well, well, they've massively outperformed the rest of the globe. If you go back 10 years, the U.S. compounded annual growth rates were about 16%. In Canada, it was about 6%; emerging markets, about 6%; internationally, slightly better at 8%. But still a massive underperformance vis-à-vis the U.S. We look forward over the next 5 to 10 years, we don't think that trend is going to continue. We think there will be a reversion to the mean. That running U.S. equities have caused U.S. equity valuations to be stretched. They're at the high end of the long-term range. And the other regions like Canada, international, are at their long-term averages. So, equal growth but better valuations, better balance sheets. We think that that will normalize on a regional basis.

I think from a style perspective, where I think there's been a lot of press recently around the performance of growth versus value. I grew up in an era where everyone said that growth over the long term will trounce or will outperform growth. But certainly, over the last 1, 3, 5, 10 years, growth has trounced value. And so, we think that if – in fact, actually, Morningstar put out a report in September, just putting some numbers on this, that over the last 10 years, I think the value has underperformed growth by about 79% on a cumulative basis. And so, we think that that will, again, be a reversion to the mean. But I think you probably need a cyclical bounce back in the global economy to get more conviction around those first two things.

I think thirdly, I think another opportunity here is also on the responsible investing side. But we are seeing some really good trends on that side to suggest that there, that's a real area of opportunity.

Saldanha: On the flip side, what are some of the risks that Canadian investors should watch out for?

Bai: Yeah. In Canada, the key risk is for consumers and their stretched balance sheet. And I think that's not a new story. I think that's well known. One of the main reasons why the Bank of Canada has been the only bank, one of the few banks globally that hasn't cut interest rates yet, because of the fear that it's going to fuel even more debt and red hot house prices that we have here in Toronto and Vancouver and elsewhere in Canada. So, that's definitely one risk.

The other big risk, of course, globally is, if we will see contagion between manufacturing and the service economy. Right now, we've seen a big recession pullback in manufacturing activity that hasn't translated into the service economy. And that's largely driven because we've had very low unemployment rates, strong job growth, good wage growth. And that's really helped consumer spending. And again, what we're hoping to see is not a contagion on that front. And as well as, I think we're beginning to see climate change now being a big, big risk for many of the corporations and economies around the globe.

Saldanha: Thank you so much for joining us today, John.

Bai: Thank you very much for having me.

Saldanha: For Morningstar, I'm Ruth Saldanha.