The BID

Global markets at the limit (Part 2)

El segundo de una serie de dos partes en nuestro Investment Forum BlackRock

El crecimiento global parece estar listo para un alza durante la primera mitad del 2020. Pero la mayor desigualdad en la distribución de la riqueza y en el crecimiento de los ingresos, y el aumento repentino del populismo ponen a prueba los límites en múltiples dimensiones. ¿Qué significa esto para cómo invertimos?

En este episodio de The BID, el segundo de una serie de dos partes, iremos tras bambalinas en nuestro Foro de Inversiones para escuchar a líderes de opinión e inversionistas en el camino hacia el crecimiento global, los límites para la política monetaria y tipos de interés, y lo que esto significa para inversionistas en acciones y bonos. Hablamos con Jean Boivin, director de BlackRock Investment Institute, Elga Bartsch, directora de análisis macro de BII, Mike Pyle, estratega de inversiones en jefe de BlackRock, Tom Parker, director ejecutivo de inversiones de ingreso fijo sistemático, Tony DeSpirito, director ejecutivo de inversiones para la división Instrumentos de Renta Variable Activos Fundamentales en EE. UU., y Bob Miller, jefe de Ingreso Fijo Fundamental de Américas.

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  • Jack Aldrich: Previously, on The Bid:

    Philipp Hildebrand: So the way we framed this discussion over the last two days is really to say on the one hand, we have a cycle that continues to be in place. It gets extended, again supported by further monetary policy easing. And at the same time, longer term, we’re seeing limits across four dimensions, which is really the theme of the whole two days.

    Jack Aldrich: Welcome back to The Bid. On our last episode, we heard from BlackRock’s Vice Chairman Philipp Hildebrand and others on key issues stretching the market environment today: inequality, monetary policy, globalization and sustainability. So if markets are at or approaching limits across these dimensions, what does this mean for how we invest?

    Today, we’ll continue our discussion from the BlackRock Investment Institute’s 2020 Outlook Forum. We’ll hear from members of the BlackRock Investment Institute, like Jean Boivin, Elga Bartsch,and Mike Pyle, as well as investors like Tom Parker, Tony DeSpirito and Bob Miller. We’ll talk about the path forward for global growth, the limits on monetary policy and interest rates, and what this means for stock and bond investors. I’m your host, Jack Aldrich. We hope you enjoy.

    We’ve been in a bull market for over a decade, and our base case for 2020 is that the global economic expansion can continue. We see growth stabilizing and inflation, or the rising prices of goods and services, firming. There’s been a lot of worry from markets that we’re late in the cycle, but we believe the risk of a full-blown economic recession remains contained.

    But the global growth story has many moving parts, from geopolitical issues like trade tensions to the economic trajectory of China, to how consumers are feeling across the world, particularly in the United States. To get a better sense of what’s at play, I talked to Elga Bartsch, Head of Macro Research for the BlackRock Investment Institute, and Tom Parker, Chief Investment Officer of Systematic Fixed Income.

    Jack Aldrich: Elga, to pick up on one component of our discussions around growth generally: tariffs and geopolitics. How are you thinking about those things in the context of growth?

    Elga Bartsch: Yeah, so I do think that the growth outlook is very strongly influenced by these factors. Especially if you have such a material escalation, with geopolitical and trade tensions in particular as the one that we had over the last twelve to eighteen months. So that was clearly a major headwind, a protectionist push, if you like. The question is whether that will continue into next year. I think there are a number of indications on why that might not be the case, and that could allow the global economy to pick up a little bit of pace, allow investment spending to also sort of normalize a little bit, global trade to normalize. But I do think that there will potentially be other factors that give especially corporates making investment decisions time to pause and maybe hold back. And I think there will be a lot of focus on domestic politics here in the U.S.

    Jack Aldrich: As we’re talking about geopolitics, let’s talk about China. Tom, how are you thinking about particularly growth in China?

    Tom Parker: Well, China has been extremely important for growth really in this whole post-financial crisis period. If you think about the rallies that we’ve had, we’ve had the combination of monetary policy with a big boost from China spending. And so each of the upticks that we’ve seen, even the surprise one in 2016, really had this China dimension to it. And so it becomes a really key variable as we talk about whether this slowdown will be kind of an L-shape or if it’s going to start to move up the other way. And I think a lot of it’s going to be very dependent on, does China stabilize? Or does China start to move up to some extent? I think we believe that this is a little different in kind, in terms of the nature of the stimulus and how internal it is to China, rather than they’re trying to save the world again and save their customers. So we don’t really expect as much for the economic rest of the world. We think it’ll be good for China, it will help stabilize China, but we’re not sure that it really helps the rest of the world as much as previous stimulus did.

    Jack Aldrich: I wanted to draw back the conversation from China to the U.S. Thinking about the U.S. consumer, a signpost for growth in the past: Elga, how are you thinking about the U.S. consumer?

    Elga Bartsch: I think the U.S. consumer is currently in a very good state. It’s really what keeps the U.S. economy growing. Because we can see that the manufacturing sector, notably investment spending, is really struggling. So it’s really consumer spending, which has a high service component, that is really keeping the U.S. economy moving forward. And that’s sort of a reflection of really strong fundamentals. You have a strong labor market with still a very robust pace of job growth. We have an increasing pace of wage increases and still relatively modest inflation. And indeed, leverage that at least for the consumer sector overall, is still gradually coming down. So all in all, very solid fundamentals.

    Tom Parker: Yeah, it’s been interesting from a market perspective. I think it is the underpinning of why the U.S. economy has been better than expected. And certainly every time we see job growth seemingly slowing, it seems to have a second life to it. And certainly the rate of decline is much lower than I think any of us would have predicted at this point in the cycle, which is making the consumer stronger. The watch things are to see if that starts to change. If we’re seeing this weakness perhaps in profits and in corporate spending start to result in things that seep their way into the consumer. There’s some preliminary signs, but not much. So it’s really more a worry right now than something that you’re actually seeing. I do think the consumer has benefited from the stimulus that nobody’s really talked about, which is the huge drop in rates that we had when really the whole 10-year collapsed. 

    Jack Aldrich: And from a markets and particularly an investment perspective, how should investors be thinking about these trends and factoring them into their 2020 plans and outlook?

    Tom Parker: Yeah, I think everybody is kind of centering on this slow growth, slow inflation. Which has actually been a very conducive environment for carry in the credit markets, and for equities. The environment hasn’t been as conducive under the surface, as we’ve had a lot of factor rotation go on, and huge returns to momentum with a momentum crash, and then a value crash. And so we’re seeing a lot of money moving risk on, risk off. And in my mind, a lot of that is driven by the fact that the economic volatility is actually quite low. And so policy matters more, and we’ve seen a lot of policy volatility with trade and now with the election. So I think that’s my biggest kind of worry into 2020, that we’ll probably see the same. 

    Jack Aldrich: You partially answered my question, but I was going to ask: What keeps you up at night?

    Elga Bartsch: What worries me from an economic perspective is really the long-term impact of the sort of unwind of globalization, partial unwind of course. Because I do think that it puts some sand into the engine of the global economy. And what that means in terms of the long-term growth outlook, in terms of the long-term inflation outlook, the mix between growth and inflation is not clear. And if we had a less favorable combination of growth and inflation than we have had in the last several decades, so where you have maybe continued growth disappointments, as well as inflation overshoots, that could be a very difficult environment for investors to navigate.

    Jack Aldrich: So we’re seeing two sides to the story: on the one hand, global growth is continuing, and a strong U.S. consumer has underpinned an especially strong U.S. economy. On the other, policy is uncertain, and globalization may be unwinding.

    Tom mentioned one driver of growth: interest rate cuts. In 2019, we’ve seen that central banks have been able to pull this lever as a way to keep the economy going. But interest rates have been testing limits on how low they can go. The U.S. has seen three rate cuts this year, and around the world, interest rates have even dipped into negative territory. We’re nearing the limits of how effective monetary policy can be.

    To get to the bottom of this, I talked to Jean Boivin, Head of the BlackRock Investment Institute, and Bob Miller, Head of Americas Fundamental Fixed Income. I asked them how they’re thinking about the challenges ahead for central banks, and what these limits might mean for bond investors.

    Jean Boivin: I think we need to distinguish what’s happening now, versus what’s going to happen over the next few years. 

    Jack Aldrich: That’s Jean Boivin.

    Jean Boivin: And I think one of the biggest questions for us is over the next couple of years if we do have a significant downturn, what really can we expect from central banks in terms of policy response? And I think we’re coming to the conclusion that it’s going to be pretty tricky. There’s not much left in terms of the conventional ways and even unconventional ways of central banks to stimulate the economy. We think the interest rate channel is getting exhausted. And that raises a bigger question about what’s coming next. I don’t think we’ll be working to respond to the next recession, so then that requires venturing even more boldly into new spheres. All of that involves some more coordination between central banks and the government in terms of spending and finding ways to support that through monetary support.

    Jack Aldrich: And when you think about the year ahead, what key signposts will you be looking out for? 

    Jean Boivin: Yeah, so I don’t know if Bob agrees with this, but I think it’s not about central banks. We’ll be watching what the Fed is doing of course, and we’re in a pause now and we need to see what’s coming next. But I think the bigger question for me will be what the budget authorities, the governments will be doing. Because that’s really where the biggest lever will be. I think markets will be very excited to see if there’s more action on that front, and if it’s not coming, then that’s where the disappointment will be coming from.

    Bob Miller: I think that’s precisely the point. It’s less about the near-term reaction from central banks. It’s much more about the degree to which we get broad policy cooperation. So government and central banks working more closely together, which you could argue is a decline in central bank independence. At least in a strict definition of the term. But I think this is critical to the next several years. Not necessarily next year, but over the next several years, into the next decade. I think we’re going to be facing situations where central bank policy, as Jean described, has been exhausted to differing degrees. There’s a substantial amount of policy space left in the U.S., not necessarily relative to history, but relative to other central banks. But there’s broad policy space. So the combination of fiscal and monetary, and perhaps regulatory, or even immigration policy, et cetera. Because if it’s not occurring, I think we’re going to see very stressful situations in markets. If it is occurring, depending upon the composition, you can definitely – at least it opens up the possibility of more elegant solutions.

    Jack Aldrich: And actually to segue into the market component of this, how do you see all of this reading through to fixed income markets? Particularly, how are you thinking about opportunities in the year ahead? 

    Bob Miller: It’s really tricky. As Jean said, the traditional interest rate channel, i.e., the factor that determines the return of your bond investment, the interest rate channel has been largely exhausted in a number of places around the world. And the question is, how negative can rates go in Japan or in Europe? And will we have negative interest rates in the U.S.? In other places outside the U.S., rates are already low and/or negative. So the benefit of your bond portfolio providing your diversification – your offset when stress is high and equities are under pressure – it’s increasingly unclear that your bond portfolio is going to behave the way it has traditionally behaved in providing that type of protection. I still think it’s very valid in the U.S. It’s considerably less clear that it’s a valid investment tool outside the U.S.

    Jean Boivin: Yeah, I completely agree. I think on a strategic basis, you need to be a lot more selective and granular about the place where you get your exposure in fixed income and protection. And I think the U.S. case is still there, and I guess you get more conviction saying how far European rates have gone, so there’s more room. But you want to maybe rethink carefully European and Japanese exposure.

    Bob Miller: Yeah, and one just small but important caveat with respect to the U.S. It works particularly well for a U.S. investor. For a non-U.S. investor, you’re required to take the currency risk if you want the pure duration benefit of a long bond appreciation in a stressful environment. The fixed income diversification properties outside the U.S. have declined substantially.

    Jack Aldrich: Bob, Jean, what keeps you up at night?

    Jean Boivin: One thing I would highlight given where we started the conversation, is we both seem to be on the same page that we expect over the next few years more coordination between central banks and governments. That can happen in a deliberate fashion, which would be what we hope is going to happen. But there’s a big risk around that, and one of the big risks is if it happens on a slippery slope without a plan, where we open the door for monetary financing, or financing budget deficits with central banks’ money, without proper guardrails, that could be a pretty scary world. And that’s about undermining central bank independence. And given the populist waves we’re seeing, I don’t think we can discount that from happening.

    Bob Miller: I would strongly echo that point. In the long history of the U.S. and other large economic engines globally, the deliberate, thoughtful, optimized approach to policy coordination rarely occurs outside a stressful situation, right? So most of the time, the decision-making process only gets to the point of making really difficult decisions when under tremendous stress. So I worry that we have to get into a higher volatility, more stressful economic regime in order to motivate the decision making process to the get to the point that we’re talking about. 

    Jack Aldrich: Jean and Bob noted the challenges ahead for bond investors: With interest rates exhausted around the globe, bonds may no longer be able to offer the returns or the diversification benefits that they once did.

    How about stocks? Large public companies have shown near-record profitability across geographies in 2019. This is a result of lower input costs created by global supply chains and new technology, declining tax rates, and expansion to new markets. This has created winner-take-all companies, particularly in tech, that have delivered hefty gains since the financial crisis.

    But can greater profitability and stock market gains continue in 2020, or are these trends at risk? I spoke to Tony DeSpirito, Chief Investment Officer for Fundamental U.S. Active Equities, and Mike Pyle, BlackRock’s Chief Investment Strategist, to find out.

    Tony Despirito: Well, Jack, without a doubt, corporate profits have been rising over the course of the cycle. 

    Jack Aldrich: That’s Tony Despirito.

    Tony Despirito: That’s not atypical, that usually happens in a cycle, although we’re at historic peaks. It’s been driven by a number of things, whether it’s global supply chains, whether it’s low interest rates, low taxes. All of these things have conspired to increase profit margins at companies. That’s been a good thing for investors. The expectation is for that to continue. I think that’s a risk; I think as an investor you want to look skeptically at that. And I think that’s where individual stock picking comes in. So while I don’t see a lot of upside for the market for margins from here, I do see a lot of specific companies that can grow their margins, either though pricing power, cost cutting or through capital deployment. I think the opportunity is much more at the stock-specific level than at the market level.

    Jack Aldrich: Let’s talk about valuations. How do you define them and how are you thinking about them?

    Tony Despirito: We look at valuations in multiple ways, but I think the most common way to think about valuations is P/E multiple. Price divided by earnings. At first blush, valuations look on the high side. The market’s about 17 to 18 times earnings. Historical average is 15, although we’ve been certainly way higher at different points in history. But I don’t think you can look at valuations in a vacuum. I think you have to look at them relative to returns on other assets. Interest rates, for example. So we’re in a low rate world. We have been since the global financial crisis. With the 10-year Treasury at less than two percent, I think that tells you that the returns you can earn from equities, even at these valuations, is quite attractive. I look at the yield on the stock market, on the S&P 500 it’s 2%. That’s higher than what you can make on a ten-year Treasury. And, of course, the income from a 10-year treasury is fixed over the next ten years, whereas the market, if companies do their job, that income, that dividend should grow over time.

    Mike Pyle: Yeah, I would add to that. Precisely because interest rates appear to be so structurally low, that means that equilibrium valuations for risk assets, or really assets across the spectrum, are going to look different than they have in history. Comparing the PE today to the PE 20 or 30 years ago is not necessarily the best way of thinking about valuations in today’s context, with the structure of today’s economies and markets. I think, not unlike Tony, I view risk assets, equities as kind of fair to sort of a little on the north side of fair. But so long as the expansion remains intact, so long as there continues to be both economic growth and that growth sort of flows through to growth in revenues and profits, feels like a still sort of constructive attitude to take towards equity markets.

    Jack Aldrich: As you look towards 2020 what key signposts will you be looking for in the markets? 

    Tony Despirito: One is monetary policy has been loose, financial conditions have been strong. Those have all been supportive to the market. I expect that to continue, but that’s certainly critical. The economy continuing to move forward. We expect low growth, but we expect positive growth to continue. So those are all positive things that we’re thinking about.

    Mike Pyle: I think we expect financial conditions to remain easy, but also expect that the change in policy, the sort of dovish turn is largely behind us. And that dovish turn has driven a big expansion of multiples, or the number of times over earnings the price is trading at, in 2019. I think we’re also, as Tony said, expecting growth to continue. I think a little bit of the question for 2020 is with the expansion of multiples kind of maybe mostly behind us from this dovish turn in central banks, can we see a handoff to earnings growth again? That may not be the type of growth in a lower growth-world that sort of supports the types of gains that we’ve seen this year. But, again, I think that backdrop of supportive financial conditions, positive even if low growth, and valuations that still look in the range of reasonable suggest to us a pretty constructive attitude towards risk assets in 2020.

    Tony Despirito: Investors should have positive expectations for the market, but muted expectations. Kind of mid-single-digit returns from here forward I would expect to be more of the norm.

    Jack Aldrich: To that end, what keeps you both up at night when you think about risks to this scenario?

    Mike Pyle: I do think after two days of discussions seeing the extent to which it’s a shared assumption that as we go into 2020 there may be some temporary peace on the trade side. Obviously that supported the rally and risk that we’ve seen over the last month or two. Until that plane lands and we get that piece I think it’s something I’m going to be a little concerned about.

    Tony Despirito: I think risk control is incredibly important at the portfolio level, to always be thinking about what your risks are. We spend a lot of time thinking about stress tests, various scenarios that we can imagine and how portfolios would react in those scenarios. But I also think one of the things that’s most important is to stay invested in the market. I can draw you a 40-year graph of all the things that you could have worried about over the last four years. And if you use that as an opportunity to exit the market, huge mistake. 

    Jack Aldrich: So there’s still opportunity in stock markets, but with some risks and a healthy dose of skepticism. But Tony mentioned one thing that’s key: the importance of staying invested. Yes, we are seeing limits to markets ahead, but we also see the expansion holding up. 

    So where did we net out? Growth and inflation are set to become key drivers of markets in 2020. Monetary easing from central banks is largely in the rearview mirror, and a temporary trade truce looks likely. We see global growth making a shallow recovery in the first half of the year, and don’t expect a recession. This causes us to be moderately pro-risk when it comes to investing.

    But markets will be tested in 2020. The U.S. Presidential election looms large, with a wide range of policy outcomes. China seems less willing to stimulate its economy. Corporate profits face challenges ahead, like rising wages and increased regulatory scrutiny. And negative or ultra-low bond yields make government bonds less able to act as a as portfolio stabilizer in stock market selloffs. These and other issues will be critical to the year ahead.

    Thank you for joining us on this episode of The Bid. We’ll see you next time.