2020 Outlook

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INVESTMENTS ARE NOT FDIC insured nor are they deposits of or guaranteed by a bank or any other entity so they may lose value. American funds are not available outside the US us the following is not intended as an offer to purchase or distribute American funds outside the US wrapped. I'm Matt Miller. This is capital ideas. Your connection to the mines and inside shaping the World of Investments election-year stock picking next recession prognosticating and central bank rate. Cutting I liked this episode conversation as we bring you capital groups twenty. He twenty out equity portfolio manager. Rob Lovelace Economists Daryl Spence and Fixed Income Investment Director Margaret. Steinbach join. My colleague will will McKenna for a wide ranging discussion of global markets and economies in the year head topics that matter most to today's long term. Investor this podcast is eligible for continuing education credit. So pay close attention while you listen you'll find instructions for how to earn ce credit in the show. Notes for this episode now here is my colleague in your moderator Will Mckenna with our twenty twenty outlook hello and welcome to Capitol Capital Groups Twenty Twenty Outlook. I'm your host will McKenna today. I'm joined by ROB lovelace. Daryl Spence and Margaret Steinbach three of our investment veterans Prince. Who are going to help us? Make sense of the market and economic environment as we head into twenty twenty. And there's plenty to make sense of. I think next year also WANNA extend a warm welcome into those of you in the audience on now. We literally have thousands of advisors on this event. Or thank you for joining us and I also wanted to thank many of you for sending in so many thoughtful out for questions in advance and I literally have page after page of those great questions here and as we look through your questions. We saw four or five key themes emerge number one. We're entering a pivotal election year. So what are the implications GonNa be for markets and investors number two. We do see slowing growth in the global economy economy although the US continues to do pretty well. Do we see any signs of recession on the horizon in two thousand twenty weather in the US or elsewhere around the world in places like Germany. And of course we'll get into that with daryl them are three. International Markets have lagged the US in eight of the last ten years. Now this has been a recurring theme on a rob Bob. You'll help us tackle this question. When do we see that turning around? And maybe more importantly what's the right way to think about investing in international today because I think some things have changed. And you've got some perspective for us. They're finally Margaret you know rates in the US around the world going lower for even longer How low can they go and we got quite a few questions about negative rates? What are the implications? Could they ever show up in the US. So I think a good question for all of us to dig into and finally what does all that mean for for client portfolios in two thousand twenty so excited to dig into this safe to say we're going to cover all of those kinds of questions and more with this program now before we get started this. This event is available for c credit if you have a CFP or Sima designation now to get your credit you need to stick with us for at least fifty minutes so so stick with us to the end of the Webinar and we need you to pay attention. Because they're going to give you a short quiz that you'll need to pass in order to earn your credit. I should say this event is being prerecorded prerecorded. And that's so that we can qualify for c credit so now let me formally introduce our speakers. Starting With Rob Loveless Rob is an equity portfolio. Oh manager with thirty three years of investment experience and he is responsible for a number of our global investment strategies and was also vice chairman of the capital a group companies. Welcome Rob Daryl spent many of you know Darryl. He's our US economists he's been in the business for twenty six years and he will be addressing the US and global the economic outlook and also providing the exact date of the next recession. Margaret Steinbach is a Fixed Income Investment Director with twelve years of industry experience and a first time guest on this Webinar. Welcome Margaret Thank you for having me. I understand your husband is also in the Fixed Income Business and you guys are writing Children's book. Tell us a little bit about the title title of that book. Yes so he thought goodnight. Bond mass would be a good title for that one and it would ensure that our two year old son falls asleep quickly at night. Okay so folks lookout for that connects year some time. Good night bond math great to have you all with us. Happy holidays a ton of things to discuss. So let's go ahead and jump right in Dan Rob. I thought I would start with you. And no shortage of interesting things happening in the world and I know you just got back from China. I want to get to that in a minute. We often this has become. I'm a bit of a custom for us. Your Global Equity Investor. We usually start these by asking you to take us on a tour of the World Talk About your outlook for twenty twenty across the major ager markets around the world. You know I'm happy to do that. But it is important to remember that the world has changed and While it is important to focus on the different constituent that you in parts Correlations between the US and international markets went up substantially really starting in the mid to thousands accelerated accelerated by the great financial crisis. And they've stayed high ever since and so I think through the conversation will pivot more to a conversation around how how the world is actually one big investment pool as opposed to the traditional model that frankly most of us grew up with which was thinking. US and non us. You even frame the question that way and I think lots of asset allocation structures are set up in this sort of US non us in getting that number right. It may still be a fair in the in the fixed income world because of currencies and other things but I think in the equity world with the integration of companies and these high correlations. We've really moved into a different area so with that in mind. I guess what I'd highlight is most of the economies are being affected by the same thing relative to interest rates and monetary policy and coordination and other things that others will touch on And really that. The giant debate that the equity markets are wrestling with and have been for a decade around the globe is is inflation versus deflation every country I go to has some aspect of it. Just in Asia's you highlighted was in Japan. Japan is thirty years into this debate and so a lot of countries now and investors are looking to Japan to see if there are lessons learned. We did some things differently. which which I think has been one of the things that's helped the US and the US has also benefited from the fact that most if not all of the Internet companies are basically here? You're obviously there's a big group that's in China but they function mainly in a Chinese Internet and there's a fair amount in Russia but they operate in a Russian Internet so the rest of the world's Internet is really driven by companies that are predominantly in the US and it's led to this interesting situation where the US markets have done so much better over the last decade as you highlighted eight of the last ten years in any given year but really if you look at the compounding number it's it's really spectacular but if you look at the spread and the price earnings ratio. It's actually not that great. Which tells you that there's been value being created mainly by these tech and internet companies? Also by some of the pharmaceutical companies that have really allowed allowed the US equity markets to do so much better so when you go around the world as we used to go to a place like Europe what you find is those European companies that have done well are are the ones that diversified out of Europe and are doing business in the US or doing business in China or other emerging markets and when you get to Asia and you look at which companies are doing well. They tend to be the ones that are focused on doing business in China or doing business in the United States. So this is part of where this broad correlation comes in across the world. And you're you're left with the the economic discussion that we need to get into the two big engines that are doing fine right now. China and the United States. That's why the questions ended up there. Japan as I said has been trapped for for thirty years. Europe is pretty much trapped in a similar situation for at least a decade and the big question is are we destined for twenty more years in the developed world of what Japan is head of the lower for a lot longer or are we going back to the world that most of us have investors grew up in which is some inflation and and A A lot more volatility in in interest rates so. I think that's the big debate that we need to talk about today. SORTA way thinking much more on global frame rather than in these regional pockets. And we'll dig into that a much more. We get into equity markets in more detail and as you point out the US and China drivers in some ways. You're kind of stuck in the middle of this. This trade skirmish book come back to that. That's a great star Darryl When you pick it up and talk a little bit about the Economic Outlook let's start with the US? I want to hold hold off on our word recession. We got plenty of questions about that but just start with. US What's your outlook for the US. Economy in two thousand twenty. We think we're going to get a bit of a reacceleration. I mean maybe a different different way to phrase the inflation deflation. Debate is even though you said. You didn't WANNA get into a recession or no recession. And I think we're starting to get the answer to that but what we've had add in the US economy for awhile. What we've been calling this tale of two economies? You have kind of a weak industrial sector because of the trade war because of the inventory stocking eighteen preceded the trade war while at the same time you have a really really healthy domestic economy which is largely the US consumer and so you look at the growth of those two areas as of the US and they've diverged pretty dramatically. It's very similar to what we saw back in. Twenty fifteen in two thousand sixteen and the end of that episode essentially the Industrial Austria sector recovered. And we think that is likely to be the case this time around so as we move through the remainder of two thousand nineteen and into twenty twenty. We think some of these fears will. We'll be moving out of the markets and you're starting to see that I think perhaps with some of the bond yield movements equity price movements that we've seen over the past couple of weeks But a lot of that is predicated predicated on no further escalation in the trade war. And we seem to have found some type of truce here and we don't think you need to go backwards. Terrorists don't need to come off to you. Continue to have a more optimistic outlook in twenty twenty but You probably can't have much more of an escalation either and again. We think we've found some type of truce but it's kind of day to day when it comes to this type of stuff. So that's the one caveat and all that I would say you mentioned a pickup again in manufacturing. What do you think will help drive that? Well one would be a truce in the trade war for sure. I mean. The two areas that have caused the manufacturing sector weakness or exports. We're starting to see some indication that those are rebounding and the other had been the inventory. Stocking that occurred in anticipation of the trade war when you look at say inventory sales ratios across the manufacturing sector. They're starting to come down so a simple turn. In those two things. We think will lead to better activity and better output again. That assumes no further escalation in the trade war to any signs of recession session on the riser. You and the team don't see that certainly twenty twenty and and maybe it's pushed out a ways we don't I mean there's always a chance you get some type of shock that by definition. You almost can't can't see coming but keep in mind. That recessions aren't just about the amount of time that's gone by or how long the economy has been in an expansion there about excesses and imbalances that a built up in the system that ultimately need to be corrected and we do actually see some late cycle excesses and imbalances building up. A lot of it is concentrated in corporate corporate debt and leveraged loans. But even then just because you have a lot of excesses and imbalances building up doesn't mean they have to cause a recession you need some type of catalyst that automatically causes those things to be problems and then the excesses are the accelerate but ultimately push the economy into a recession and historically and we think this time around to the most likely catalyst is tighter monetary policy and in fact over the course of two thousand nineteen we moved in the opposite direction so even though these risk areas are still out there until so we probably get meaningful tighter monetary policy and tighter liquidity conditions or essentially a reversal of the conditions. That have allowed this this debt and this leverage to build up. It's probably not a reason that it has to unwind anytime soon. So our best guess and guess is the word I would emphasize there is probably some time. Late twenty twenty one would be the most likely timeframe again assuming that the Fed eventually gets back into the tightening game. That could be a while. That's a good segue Tamar one quick. Follow up you know. I saw you speak recently at a Barents Ernst Conference and you mentioned a couple of things one. Was this idea that corporate debt. And we'll get into that. Margaret in terms of the growth in the triple be part of the market may not be callous. That might be more of an accelerate writings. Get going you also mentioned. There's a sense that recessions that emerged from the corporate sector are tend to be a little less severe than those that emerged from banks or housing. Or Taylor about that. Before we transitioned Margaret. Yeah I think one of the biggest concerns that investors this happens when we do inevitably most likely get into a recession that is going to be two thousand seven two thousand nine all over again and you know it's really hard to determine harming how bad these things will be in advance but are read of history. Is that recessions that originate within the corporate sector tend to be less severe than those that originate within then the household sector or certainly involved the banking system and even though we're talking about a fairly significant amount of debt a lot of that debt is actually held outside of the banking banking system. So if there is an issue with that we don't think it will impact bank balance sheets like the housing bubble did when it blew up in the global financial crisis so again that's a read of history. I mean an example of a recession originating in the business sector of the corporate sector would be the Internet bubble lot over investment ultimately that had to be unwinded but in terms of its impact on the consumer in the overall financial system. It wasn't that large and the recession ended up putting miles. We love hearing from our listeners. So keep those reviews coming to tell us how we're doing by reviewing capital ideas on Margaret. Let's transition to view from bond. Land House the Bond Market Outlook Luke Shaping up for twenty twenty. Yeah so. I think it'll be an interesting year ahead. So we've seen heightened levels of policy and certainty both geo-political in trade policy. He would expect that. Uncertainty to remain heightened. Going into next year will get clarity on the direction of the economy. So we'll find out in the coming months whether or not this is is what we would classify as a late cycle slowdown. Or if it's the beginning of more protracted downturn and what we've heard from the Fed is that they're done cutting we think there's a high bar to further cuts from here so the bond market is pricing in about thirty basis points of additional cuts from here but I think what. The market's actually pricing is. Some probability that we do inter more protracted downturn in the Fed has to cut to zero and some probability that we come out of this and the Fed does doffing now. We think there's a high bar to the Fed cutting from here but we think there's an even higher bar that the Fed continues to hike this cycle. We think there's not enough momentum. I'm in the economy. We think inflation is unlikely to rise to a point where the Fed feels that they need to hike from here. And what's interesting is that they're really reevaluating. The tools that they used to target inflation. So we expect to get an announcement from the Fed next year in regard to that. So they're going to probably be using some kind of an average inflation target target which really means that. They're going to be easier for longer. So we've been talking about lower for longer interest rates for years and so now when I go auden and speak to advisors. I'm not just saying for longer. I'm saying lower for longer and longer and longer they'll give us a sense of you. Know is that years. Here's it many years is it. At what point does our team see them having to come back to to hiking again. I think there's a really high bar for the Fed to hike the cycle barring a significant pickup inflation and I'm talking sustained inflations above two and a half percent so the feds preferred measure of Inflation Corp.. Pe today is about one seven so we're pretty long way away from that if you look at the forward market it's pricing lower rates for a very a long time so as of this morning. It's suggesting that the tenure yield will be two and a half percent in ten years time preloader so that gives you a sense of time. Exactly exactly that's great. Daryl I WANNA come dig into the equity markets in more detail with rob after this but One of the things you mentioned that that parents conference which really really struck me and would love for you to share with our audience. His good to remember that the cuts. We've seen this year in two thousand nineteen. It takes a while for those to flow through the system. I don't know if that at six months nine months whatever the case may be but sale a bit more about that and when might those cuts really started filtering into the economy. Yeah I mean. Monetary Policy Works with a lag essentially essentially what that lag is can kind of vary cycle to cycle. But let's call it six to eighteen months as a as a range and that would suggest we would start to see more of the impact of it as as we exit two thousand nineteen and head into the first half of twenty twenty. You're already starting to see it in a recovery in the housing market with sales and construction activity. Picking up and you would start to see it again. In some other areas particularly of the uncertainty surrounding the trade war starts to be reduced because that will encourage firms to maybe ramp up their capital expenditures. which is a little bit and low rates can certainly help with that as well but I'm an agreement with The Fed staying on hold for a long period of time if anybody wants to head into the holiday season with some and cocktail party Trivia. Here's one if you look back over the past twenty five years The amount of time that core. PC inflation has been at or above two percent which which is the feds unofficial target is twenty five percent so they have a inflation target. That is really actually pretty difficult to hit. And they've kind of put themselves on record is not really doing anything until they actually hit that. So I I think Margaret's up spot on at least from our economic point of view that there's a pretty high hurdle for them to raise rates dates given that it's just very difficult to get inflation rates at that level to start with. That's pretty great those of you in our audience. If you're multitasking. I would pay attention right now because that will probably end up on the quiz so twenty. Five percent of the inflation has been above the two percent target. Rob Back to you you reference some of this. In the way the world is changing for equity I investors one of our initial audience questions that I thought I post you is here. We are in the US US markets are at or near all time highs. You know how long can this continue to see this Heading into two thousand twenty. What's your perspective on the the? US market on market levels. It's interesting when I talked to some of our younger associates because they're nervous because the equity markets hitting all time highs as a thirty four year veteran. I have to say I've seen a lot of all time. Highs in the market. The Equity Equity Market has this bad habit of going up over long periods of time. In fact that's the core of what we all do for our investors It's kind of premised on the fact fit equity markets over time will be positive without that we wouldn't have the money for people's retirement and other needs so that's the good news so I kind of celebrate every time we hit an all new high and especially in this case when it's really Pretty linked to underlying earnings. There has been some multiple expansion that we've seen across the world but it has really really been driven by underlying earnings. I think what what's getting everyone's attention right now. Is there definitely has been a bit of a roll over on margins so corporate profit margin's Were expanding Post great financial crisis in part. Because I think people were planning for a slower economy and slow revenues that actually didn't come mm-hmm and with the general technology implementation that's come across. It's made companies more efficient at least on a cost basis so margins have been steadily increasing. And then that's really peaked in the last year or two so with a slowdown I think people have extrapolated from that slowdown in margins and then concerns about a recession. Shen are we there for in for some type of correction in the market and I think that would be a very logical thing in the world that most of us grew up in the seventies eighties nineties into thousands. The challenge right now is with interest rates as low as they are. It's very hard to see alternatives to equities and again having having been in Japan recently and looking at their thirty year experience and they're it's not a total analogy because they were able to invest outside of Japan and other equity markets. The chance sounds we have now is the kind of only one market. It's all one market and so you can't move as easily from one place to the other so there is no sort of free lunch anywhere in the world at least in the equity markets. That's a bit of where I think that homogeneity comes from and so that search for companies that can continue to grow the top line or more impressively actually expand margins during this period gives them a value. That's higher today than maybe it was in the past and this is what's allowing I think those companies to have and sustain high multiples. And if you look over again. Long scopes of history when interest rates have been this low for sustained periods. Peas do tend to be high So in some ways what's remarkable is how moderate the price earnings ratios are Because we have enough of these fast growing companies so the ratio is pulled up by very high multiples support for a handful of companies. That are very big and growing fast that are generally in the internet or healthcare area. But they really are growing their businesses so they are actually growing going into those multiples in a way that wasn't true in the late nineties with the Internet companies where I think at that stage the Internet stocks were twenty five percent of the SNP or twenty five percent of the US. That's mark in only five percent of the earnings today. They're twenty five percent of the US market and twenty five percent of the earnings so that rings are supporting the earnings are there. I mean it's just a very different world MARQUESA. Hitting all time highs multiples are high margins enrolling. There's there's a whole bear case that we've all built and you know we said it multiple times this has been the most hated bull market ever I don't know that we have a measurement of that forever but I'm going to go with it right And it will continue to be that because everyone knows because they learn these lessons in the seventies eighties nineties. Two thousand. They know all the lessons they know all the things that look for the flags are up. We should it'd be concerned and even if it does happen even if there's a recession it can't be a very extended bear market inequities because there's nowhere where else to get the returns right that you need. And it's going to continue to be driven towards particular securities that either pay high dividends or that are able to grow their top and better yet at bottom lines. That's great so some of the fangs. For example like Google alphabet that have the the kind of earnings that might support their he or some of the so-called defensive defensive stocks that pay those steady dividends are are the ones that people are focused on. I think it's across different sectors of the market but certainly in technology but a lot of the software as service companies are also creating value. Right now there are areas in healthcare mainly biotech but some others. That are doing that. So all through the tech food chain and it but it's not every company you can't really do this by sector. It is absolutely a stock picking environment and a lot of times. It's been recognized and so everyone looks around and says well everyone already knows that this is going to be growing. I have to look somewhere else to find value in this. Is that question between value versus growth right but in this environment actually. The most valuable thing is a company. That's growing it's top line. And if there are actually even expanding or maintaining margins through that that's an incredibly valuable and hard to do thing in a environment mid that isn't expanding and so I think we've created another false debate of growth versus value because people think value has to be these sort of ugly companies. That aren't growing. I think the rare commodity is that company. That's actually able to grow in this tough environment right. I think that leads us into a a great way to think about companies in the international sphere. You brought up a little bit of this earlier and for those of you. In Our audience rob and his colleague David Pollak Black recently authored a Great piece of content. I think the guy to international investing the gets into this quite a bit of detail. I know a couple of charts that you helped develop some of your favorites are this whole theme that If you think all the best stocks in the US again there's almost this conundrum of eight at the last ten years the US market better but this year forty five of the top fifty stocks were outside the US. How can that be? And then I know you also focus a lot on the the the composition of the index in the US versus outside and the fact that those indexes kind of mask. What's really happening underneath? Talk a little bit more about that whole concept that's up and help borrowers understand. How should they be thinking about that? In today's world I don't guide to international investing is as compelling good night bond map it is it it is a good read and has some interesting slides. And No I. I think the conundrum that you highlight really well is. The conversation usually starts with how impressive. What's what's going on in the? US is The companies that are here that are really unique particularly in the tax base somewhat in biotech and or healthcare areas in in particular and those are the ones really driving growth and the US has done better eight of the last ten years the compounding since the great financial crisis has really been remarkable will. So why would you invest anywhere else. thirty percent of the revenue of. US companies comes from outside the US. Why wouldn't we just consider the SNP Great Global Fund to invest? And I think maybe that's the first piece that begins to show you the flaw in the logic which is okay. Thirty percent of the revenue comes from outside the US. But that's a really badly constructed global strategy right right. I mean right. Wouldn't you rather by the best companies than just say. Oh great I'm getting some you know. US companies that do business outside the US and a lot of that non US exposure. Actually it comes from supply chain as opposed to being the Coca Cola's or others that really have real revenue outside of the US. So why don't we look for the best companies around the world. And Ah again we've got a slide that shows over the last ten years a majority of the stocks in any given year. That did better. We're based outside the US and a lot of times it's because they do business in the US so a lot of the consumer products companies a lot of the luxury companies and other companies have done well are domiciled outside the US. So the great thing that we've noticed is you no. We don't care as much about zip code anymore where a company gets. Its Mail is not a good proxy anymore for where they do business. You really need to get in on the fundamentals and think about where companies are doing business in some of the best businesses to get exposure to growth in China are domiciled in Europe some time in the US and some of the ways to get it things that are happening in the US or actually domiciled outside of the US So you really want to just focus on the best companies wherever they're based because of this construct that we've had for so long of versus non. US We tend to have regression to the mean kind of an approach and think well the US has done well so non. US necessarily will catch up. I have a hard time arguing that because the difference in the multiples forward pe of about seventeen in the US and maybe thirteen and change outside the US is mostly explained and by structural differences in the index outside the US. The index is dominated by financials and commodities and materials companies mainly oil companies the US this is dominated by Internet technology and healthcare sort of old economy outside and new economy inside the correct for those to the multiples are actually pretty similar. So what it tells you. Is that actually. Everyone's doing their job. And when you have a fast growing company like a SNL that's based in Europe. Guess what it trades at say multiple as the other technology equipment providers so you have to change the mindset of US versus non us to find the best companies wherever they're based. Make sure you're finding someone that's doing that analysis says because why would I limit my universe to one third of the companies arbitrarily because they happen to have decided to be domiciled in the why not invest in great companies companies. That happen to be based in Japan that happened to be based in China that happened to be based in Germany And this is why the conversation what's happening with the German economy. Or what do I think. Income Brexit almost becomes moot. It's not what matters anymore. What matters is where the companies are doing business? What the business lines that? They're in and are are they able to grow in this tough environment and we're finding as many or more opportunities outside the US in the US. Even though I think overall the US market will be one of the best market. Market's going forward. So that's a conundrum but the reality of it is if you can find those great stocks based outside the US you'll do even better than the US market. That's great perspective if give us a little flavor you mentioned SNL and of some of those top industries company examples within those. You know I think you guys have talked about luxury. And you're you guys have talked about certain areas in Japan automation you talked about healthcare and some places. TSMC semi's and others give it gives a sense of those best industry industry leaders there. Well I think there's two categories. I think they're those industries now. That where you have logical pairings one of the other things that's happened over the last ten years maybe longer is there's been a lot of consolidation in almost every industry and so you're now down to a few players and interestingly there's usually one in the US and one outside the US so oh you know Intel and Tsmc Boeing Airbus Have Nike. And so so. What's interesting is again you you could say I'm just going to arbitrarily? Say we should buy the one in the US because the US market is going to be better. But in fact Airbus's done better than Boeing even before the recent issues Addidas has recently done better than Nike. So you have to look at each of these and know what's driving each of the companies. That's great so let's turn to you Margaret. Thank you rob great perspective respective. Our audience really wanted to understand you know within the bond market. What do we see as relatively attractive as you look out? Twenty twenty whether that's treasuries corporates high-yield mortgages oranges. Amd How are we thinking about those different areas. I would say it's hard to argue that anything is really cheap today and so it's a matter matter of what's relatively cheap and we're finding that higher quality areas of the bond market more attractive today so treasuries agency mortgages we really see. Corporate valuations is being pretty full. So if you look at investment grade corporate debt spreads there at about one hundred five basis points today if you look at high yield spreads spreads about three ninety today and that's very close to territory where on a go forward basis over the next two years corporate tend to underperform treasuries and so it's not necessarily an outlook on the economic environment but at this point and economic cycle and in the market cycle looking at valuations. We think it makes sense to bad higher quality. I know we've been using the phrase focus on upgrading your core portfolios at equivalent to what. You're talking about stay focused on that higher quality at this point in the cycle yes. That's that's right. Bonds more or less attractive or appealing following the tax cuts. How are you thinking about that? yeah so there's a lot of volatility around tax reform and questions is about whether or not unions would lose their tax benefit and with cutting tax rates for individuals would still be attractive and once the dust settled what came to light. What is that? News actually became more attractive for many investors so for corporations that buy Muniz because they have a lower tax rate Muniz became less attractive for them on the margin margin but even though tax rates came down for a lot of individuals effective tax rates went up especially for those of us who live in California New York Getting rid of a lot of the deductions and so Muniz continue to be attractive today. I mean if you look at relative valuations compared to taxable markets. I think the break even tax rate is around twenty twenty five percent today so anyone who pays twenty to twenty five percent in taxes or more actually benefits from owning Muniz compared taxable bonds are still attractive for a lot of investors Rosen high. You'll have been very tight. You have to be very selective there but we talk about emerging markets debt as an interesting being perhaps alternative to getting that kind of enhanced income as long as you're kind of comfortable with some volatility would tell us about emerging markets bonds and how we're thinking about that absolutely it's a really compelling sector so structurally speaking it's high quality I think more so than maybe the market perceptionist receptionist so over half of the emerging market that Universe is rated investment grade today the sector over the last fifteen years has produced strong risk adjusted returns compared to high yield bonds compared to equity markets emerging market equities. What I found is that individual investors tend to be a bit more comfortable emerging market equities but actually emerging market debt has produced stronger risk adjusted returns over the last fifteen years and again looking at a landscape where nothing is is really cheap emerging market debt offers pretty reasonable valuations today so the yield is about six and a half percent if we're looking at a blend of half dollar half local local-currency and that particularly attractive to US probably just a newer less familiar asset class for folks? I mean difference between equities and bonds. There shall we dive into the deep end of the pool with negative rates. Maybe Margaret just frame this up for us. I mean how should we be thinking about this phenomenon. I know the number behind negative data. There's a very are large. One has a tea in front of it. How should we be thinking about it? I would describe negative rates as An experimental policy. It's really a crazy easy idea. It's certainly not something that we all read about. When we were coming up through school I think it will probably be future textbooks for children and our children's earns children but this is a brand new concept that's come into the markets in the last few years there's about fifteen trillion of of negative yielding debt? Today and this is because central banks around the globe including the European Central Bank and the Bank of Japan have embarked on negative policy rates as a way to try and stimulate growth and their economy is now we can talk about whether or not it's been helpful to growth. I think the jury is still out but as a result and the fact that we continue to be in a pretty muted growth low inflation flation environment across the world. That's also suppressing long-term rates as well to cut him an anchor on the US rates and other long-term rates. That's right. We love hearing hearing from our listeners. So keep those reviews coming. Tell us how we're doing by reviewing Tampa ideas on. Let's pivot now to the trade in the global trade outlook raw. Why don't you start us out? Just in China be curious to hear what the mood is like over there around this topic but also how do you think this is going to play out. And and then maybe are you thinking about doing things differently in your portfolio as well. Yeah no we really do have to pay attention to this. Being in Hong Kong in particular was was a pretty stark reminder that the world exchanged Hong Kong everyone knew had changed since nineteen ninety seven. I think until the current regime in China what Hong Hong Kong was hoping for was that China would become more like Hong Kong and and with the way the reforms were going. It looked like that's where it was but president. Xi is definitely taken China in a different direction and so now it's very clear to Hong Kong that those rivers flow together. The way that they had hoped is not happening. And that's where you're seeing the tension come from And I think we really do need to step back from the trade war and realized this is a broader conflict. It's happening on multiple fronts. Clearly there's tension in in the Internet area that most of us don't see every day but it's happening and lots of other areas in which we see tension the only consensus in Washington right now now is around a hard line on China. You could literally take the extremes from both ends of the political spectrum and not how we should achieve it. But they're in alignment on that right. That's something to take note of. So we're in that challenging transition of the rise of an economic power China is the second largest economy. It will be if it isn't already the second largest largest market and so it's very interesting for us as investors to try to figure out. Should I invest in this or is this tension something that should scare me away. And it's partly why I we're looking at a whole array of things to invest in because there are some goods in companies that China can't replicate and those those seem like great places to be They're having a hard time manufacturing planes for example and they wouldn't want only one supplier and Airbus so Boeing is a very valuable company to them one day. It won't won't be but it looks like a decade or more before they can really get into volume growth emerged demanded skyhawks. We have to understand that. The trade negotiations Sion's are the piece of a much bigger puzzle and it's a very political puzzle and only seeing slight parts of it so again. The market's going to be overly focused on it. Both bond and equity markets are super focused on our the tear center. The tariffs out. But I think the signaling of that is masking this much broader and more important trend trend. That's going on of a major transition happening around the world and right now the two sides aren't talking. They're not even using the same language in terms of what what that transition really means. And that's something that is going to dominate conversations for awhile going forward so we may recite in the short term the trade trade negotiations for either. US political reasons. Because we're coming into Christmas. And why would we want all the consumer goods to be taxed because that might hurt someone politically and or an election period but the the reality is whoever's elected it's going to have a big impact on the US. I think it's going to have very little impact. On our approach to China branch is going to the hardline going forward and you look at a lot of companies obviously are the multinationals taking a lot of actions to adjust. What are you seeing out there in your travels with companies and who was positioning themselves? Well to kind of adapt to this new situation. Yeah I mean this is what makes multinational such interesting bellwethers to watch because as they are very adept at moving so with the change in Hong Kong. That we've already seen and you know. It looks unlikely that China's going to allow as many Chinese tourists to go there so the luxury a good companies have already begun to adjust. You know most of the more you have stores and other Chinese cities order to Singapore Korea and other places that the Chinese tourists are now going so for for some of them actually. They're not seeing any change in their top line because it just shifted to other stores. But I just think it's a signal that there'll be a hollowing out in Hong Kong going forward from from a business standpoint and what we're seeing broadly to your question in terms of changes are most companies that have manufacturing in China are trying to figure out other other options but Vietnam Malaysia Thailand. Even Latin America can only take a very limited amount of it. The scale of. What's it's happening in? China is so huge. So that's a multi year if not multi decade change. But you're seeing it happening. Those are the kinds of trends that we try to identify. Get ahead out of investments that were making because it will lead to build up in other places so you can't turn on dime but somebody's benefiting from this and I don't know if you're starting to see that yet in economic data data in some of those other countries but I know you guys try to measure or quantify what are the impacts of this and tariffs and so on Darryl. How are you seeing? This unfolded folded. You mentioned some of the potential mini deals. That may happen for political reasons but house economic seem looking at this. Yeah I I think to the extent anybody is benefiting from it. It's very very very incremental on over a long period of time whereas those who are being hurt by it it's much more immediate At least from a US perspective we talked about the difficulty Z.. With exporters right now. Global Trade is actually starting to fall even though the global economy is not in a recession and a lot of that just simply has to do with the impact that this is having on global trade but a lot of the higher prices haven't really been flowing through to the US consumer if you look it. Broad measures of inflation. Barely see him flipping address at earlier. I'm there are some isolated things like washing machines. Where you've seen more significant price increases but for the most part the people who are really bearing the brunt of this are the producers themselves? Also if you're on the Chinese side there's a couple of things you can do You can hope for a currency depreciation which we've gotten a little of that offsets some of the higher tariffs And you can just take you get in your margins and a lot of Chinese companies. It seems like they're doing that. So that's where the damage is occurring. I guess from a macro perspective the seems pretty manageable again. Given even where we've gotten to in assuming that we can kind of stay here. I guess where we'd start to worry is the more unquantifiable stuff. If you get into world of embargoes boycotts you know firms on either side of the ocean physically can't get the products that they need to produce the goods that they sell. I mean that's how companies go out of business and that's how this thing could really become much more economically damaging but for now it seems to be pretty manageable and a lot of the pressure is being put on the corporates. It's not flowing through to the end consumer at least in the US. Can I just as important additional trivia fact to this I think global trade actually peaked four or five years ago so long before this process and this is just an acceleration of that in terms of physical goods But one of the things that we've focused on is that actually it's hard to track it per se but digital trade. In other words the movement of information information across borders has increased and continues to rise so another one where a lot of the indicators a lot of what people think about is moving cars from from continent to continent but actually the integration in the digital world is increasing and you may not see it in terms of shipped goods but it could actually be manifest in terms of delivery every a product in country the benefits of which though flow to a US company. which is set up the chassis on which that transaction happened the way we measure trade has not caught up with some of the realities of how it's done it ties into that international story in the way we measure those indexes And Margaret Incredibly Monetary Policy. You know I know. We have a chart. Just a picture of all the countries that have been cutting rates and some just admittedly in response to the amount of policy and trade uncertainty out. Their houses affecting monetary policy team thinks about it so trade policy uncertainty certainly has fed through to the industrial side of the economy which errol described earlier tale of two economies. And it's a large reason that we've seen global central banks easing policy including here in the US. Now that we've gotten a little bit of clarity or a little bit of respite. That is is done cutting for now. But I I would expect if we see in a reemergence in this uncertainty going into next year they they they could cut further. It's a very fluid situation. And as rob mentioned you know sentiment seems to Change Day to day depending on the headlines and so I think a big takeaway for us as investors ours is to stay focused on the big picture the long term stay invested. That's a very good segue. I wanted to now begin to election years and margarethen investing testing and the topic. We got a lot of questions on very much in our clients minds and I think a lot of the audience's questions had to do with or what I read into them was help us help our clients understand that they can stay invested and don't have to be so uncertain. I Know Rob you've talked about and we went back and looked at the data and in these fourth years you do see not a real decline in people investing in mutual funds and a real acceleration in money to money market. And you've talked about that idea of it's not the people redeem money. Just they stopped by mutual fund. So we see that coming through the data you know. At the beginning of this report we looked at. I think all the election and years going back to nineteen thirties a call at twenty two cycles. And what we found so interesting was when you compare that election year to all the other years. There's you see this real volatile period in the primary season so call it. January through may wear where the election years very sideways choppy markets. While the rest of the years. Do Fine but then at the end of that kind of uncertain primary period here we go. We get back on track and often those election years from that point forward did better than other. You're so I saw that is really a roadmap for what we ought to expect for for twenty twenty and to help stay the course amid that volatility but Darryl as we think historically speaking overall hasn't really made much of a difference whether a Republican or Democrat crowd wins the White House as it relates to investors. Well you can make data say whatever you want it to say as you know and I'm sure you'll start to see it over the next year that the stock market in historically has done better when Democrats have been in office versus Republicans. But that doesn't mean necessarily and I don't mean this is a political statement that Democrats for better for the stock market's causal it's a term in the course of both economies and stock markets. And even when you look at those averages bridges there is great variation underneath those averages that you need to be cognizant as well so even though one number may be bigger than the other. That doesn't mean that it's any more consistent so you know in my mind presidents in administrations get far too much credit or blame for the state of the economy and ultimately the state of the market simply. Because a a like I said before there's far too many different variables that determine where the economy is going to go and there's actually very little influence ultimately that a president can have probably the biggest ones would be tax changes like we saw those tend to be temporary tend to be one time boost or headwinds to economy and then the economy kind of comes back to do what the fundamental suggests it was going to do anyway and so you know looking out over four years you know. Our outlook is that the next year or so we'll start to see an improvement in growth. What it's is going to look like at the end of the next four year presidential cycle? Frankly I have no idea. But that's what's going to determine what the market does not necessarily whether it's a Democrat or Republican Publican in the office. Yeah well said I mean you know robs you think about investing through this this kind of period this change anything for you thinking differently about it. I mean clearly certain areas areas for example in this cycle healthcare stocks and a focus on pricing are very much in the news. And you see some pressure there Maybe those are good opportunities for long-term investors astor's like us but are you kind of looking past the horizon on this. How are you approaching this inside your own portfolios? Well I think you summed up well at the beginning and I think this cycle will be particularly I pronounced in terms of that uncertainty during the primaries in particular and maybe throughout because we have a few candidates in the Democratic Pool but have a pretty fundamentally different view of how the economy shaped and so you know that uncertainty that would come if those candidates are the ones chosen rosen a real different visions for how the economy and government is going to interact with the economy leads to uncertainty and uncertainty always pushes people out of equities equities and into into more conservative investment. So I think that's why this primary period will be particularly pronounced because we may not have a lot of centrist the voice And so if you have extremes that tend to get people worried depending on who. The candidate ends up being on the democratic side. I think we're pretty clear. You're on where the Republican policies are not going to be a lot of course change. I don't think that will be what determines whether we're off to the races once. We have a candidate because we have you know sorta centrist in whatever pro-market they are right We'll determine it but we have candidates that are pretty challenging to to the structure of a lot of the capital markets that we need to pay attention to so I think that makes it a little bit different. What am I doing? I turn over my portfolio about ten percent a year. I'm trying to take the long-term view. I think that's the advantage that we we have a capital group is really taking that longer term view and so I tend to look for opportunities that are presented particularly in the healthcare and other areas where there's always as a fear of regulation coming in but the reality is those companies with good drugs. That actually are helping people and better yet. Maybe even cures so permanently only helping people will be able to get into the market and they will get paid for it so when everything becomes a concern because a new policy is going to come in. It's going to destroy a sector that's usually overblown those present those opportunities so I try to always turn it into a buying opportunity but on the margin I think even our pharmaceutical and drug analysts have. I've been saying let's be really specific about the companies. We want to own through this period. Because it's proven every election cycle to be one of the choppy as sectors. It really has ask. And then I think to the extent that the capital markets and some of the financial companies would also be ones to watch cycle depending on what happens with the Democrat candidate. Right I WANNA get all three of you on a kind of a closing statement speed round but let me pick on you for one second rob because one of my no cars here. It's probably buried but it just said innovation evasion at the top of it. And you saying you turn your portfolio over ten percent so you basically have a ten year horizon you think about the last ten. We've had a number of great innovations probably the smartphone pocket being the top of that list but some true game changing innovations in pharmaceuticals healthcare. Other places is let's take a step back away from all the uncertainty and and clouds that we've been talking about would love to get your views on what are you in the team thinking about and seeing out there in terms of innovation over that longer term that we might be excited about watching closely really anticipating over that long horizon. Yeah you know it's interesting that I'm actually GonNa Start on the opposite side of that a little bit because one of the concerns that always come up when you're investing in Internet stocks is what's that next platform platform because you know as we move from desktop to mobile You know that had a big change on who the winners and losers are and so. What's interesting right now? Is actually how how few challengers there are coming up in the Internet space. I mean you're just you're not hearing about new social media platforms there. There is software as a service the SAS stuff but that's where the innovation seems to be. But it's not really challenging the Google's Alphabet Amazon like that all seems is to have calmed down a bit so interestingly. There's a lot of runway there and I think for a while. People were thinking of virtual reality as as maybe that new platform. But but you know from what I can tell. The goggles are still too big and happy and ready player. One world is just not here yet and I think the real leap cheapest probably quantum computing But the technology is a decade out. So if you probably hear it talked about more that is a game changer. The winners and losers will be completely different. All the current encryption is rendered vulnerable by these computers so talk about a game range right so all the governments are gonNA need to upgrade. Everyone's going to need to think about how they upgrade to these hyper fast computing capabilities. So you're going to hear about that for a longtime before it actually becomes a thing kind of like a We've done with a Well Yo hey I am and other. Ai Comes in kind of. I mean I think that's sort of arrives one day. It's sort of a there's a destination whereas AI keeps evolving and developing in. You know blockchain is in there too but again i. I'm not sure I've seen that thing in terms of the technology world where I'm clear in terms of innovation in healthcare. We're just beginning now to see. It's customized therapeutics. You know to your genome to your specific areas where they're actually identifying the mechanics of how things work and being able to really get at it the cost or it's crazy high right now but the exciting thing is is as with many things you know. I think the first computers were unbelievably rights. It's if we got better at them and then they you know they figured out how to do an in more efficient ways right now. It's the issue on the on the personalized medicine is the turnaround times or too long and the the cost too high and the getting better at both right right. That's fantastic. What I'd love to do is maybe come down the line here and if each of you would please summarized Brize Your Thoughts Your Alec for Twenty Twenty leave our audience with a couple of key takeaways darryl? If you don't mind I'll start with you. Yeah I would say you know be relatively constructive active on the outlook. Obviously geopolitics is a risk very difficult to predict those types of things but we do think it will likely settle out in the short term acknowledging analogy some of the long term issues that are going to be around for a while and so that's a fairly constructive market outlook. But there's no doubt in our minds that we are late cycle particularly ticky Louis in the US and as we talked about earlier there are excesses and imbalances building that we need to be wary of and to start preparing at some point for how we might want to you. Act when those things start to become a bigger issues and particularly where they go from being tailwinds to activity to ultimately being headwinds. That's Great Margaret. Your thoughts uh bond markets in twenty twenty and a couple of key takeaways share. So I think we've covered the potential for heightened policy uncertainty. How that could lead to higher volatility the and maybe a better buying opportunity particularly in corporate von spreads than the Fixed Income Universe which we mentioned earlier have been very tight I think? In terms of portfolio construction were really recommending balanced between interest rate risk and credit risk and then based on relative valuations. There may be skewing it to taking a bit more interest rate risk than credit risk again hoping expecting a better buying opportunity and this type of a late cycle environment. You really want. We think for the bulk of your fixed fixed income allocation to come from the core universe and from there you can get a good balance of interest rate and credit risk great so typical sixty forty if that forty he is bonds. Call it thirty percent should be core. Yes something like that Not core plus in disguise. which is maybe a different topic? And there's enroll for a portfolio. Certainly but you know those higher total returns come at a cost and keep those on the margins. Yes exactly great. Good could advice and for you Sir Twenty Twenty Outlook in key takeaways for the audience. What I think my key takeaway to everyone? WHO's managing money right now? Make Twenty twenty the year in which you create a new framework for how to invest globally. move away from the US non US construct and think about really how to invest in the best companies companies wherever they're based that old structure served us well for forty or fifty years. It's time to trade. In in terms of my specific for the year I think equity markets will be higher by year or end having had a real roller coaster ride as we get through all the political trade. Everyone so focused on these things and everyone so so ready to sell the equity markets. I just can't imagine that we don't have some real swoon during the year but once we have clarity on whoever that president is going to be. I think we'll we'll be off to the races. Because equities the place to be in this low interest rate environment. The good companies will have continued to do well and people will finally at least have certainty about where we're headed. That's great great. Picking up on two things. There are number one. You know a good part of our job here. Capital Group has helped you all in the audience Help your clients during this period so expect just to hear a lot from us to give you the perspective. You're going to need to keep them staying the course. And then secondly rob you know we talked about your bond allocation. So let's say the sixty equity in the sixty forty Instead of doing the classic forty. US TWENTY-NINE US think about putting some global Strategies in there can swing it for you. They can swing it for you and have that flexibility is a good time to have flexibility rather than be constrained in this kind of market right. Well that's all the time we have today. And I want to thank you all so much. Raw Margaret Daryl for your insights into the financial markets and economies around the world. We really hope you in the audience found this discussion helpful and we look forward to working with you in twenty twenty and once again. 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