The Bid podcast

Episode 8: Treading a trail
to trade wars?

Through a macroeconomic lens, life has rarely been better. Soaring life expectancy, better standards of living, and unprecedented access to goods and services have defined existence for a majority of global citizens. Yet beneath the surface, profound malaise brews. Populism and political polarization threaten the foundation of this prosperity: free-flowing global trade.

In this episode of The Bid, Gerardo Rodriguez, Senior Investment Strategist and Portfolio Manager for Emerging Markets, explores how a potential slide toward global protectionism threatens economies and investors alike.

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    Elizabeth Koehler: Talks about trades are saturating the news cycle today, and between proclamations of new tariffs, NAFTA negotiations and talks on Chinese trade practices, worries about a slide toward global protectionism are looming over markets. But will words turn into actions, or are these worries misguided?

    In this episode of The Bid, we look to separate signal from noise with Gerardo Rodriguez, Senior Investment Strategist and Business Manager for BlackRock’s Emerging Markets Group. I’m your host, Liz Koehler, we hope you enjoy.

    Gerardo, thank you so much for joining us today, it’s great to have you.

    Gerardo Rodriguez: Thank you, Liz, great to be here.

    Elizabeth Koehler: Your story is incredibly interesting. You joined BlackRock after more than 14 years in the Mexican Ministry of Finance, where you really spent the bulk of your career participating in the rules-based world order, governing trade and finance. That multi-lateral model is clearly facing some new pressures, whether it’s populism in Europe, the policies of the current administration in the U.S., among others. What does it look like to see where we’ve come to today, given your background, and what do you think the future holds?

    Gerardo Rodriguez: It is a bit of a conundrum what we’ve been seeing lately, because the polarization and geopolitical risks have been going up, precisely at a time in history where people are doing much, much better than in the past. You can look at it from many different dimensions: life expectancy, the capacity to buy things. The world is producing a lot of stuff that is much cheaper right now. So the standards of living across the world are improving and inequality on a global scale has also been improving. So why is it that people are increasing their demands, it looks like, to politicians and asking for a larger seat at the table? In a sense, you have a similar trend taking place in many different places in the world. We’ve seen somewhat similar episodes in the past, perhaps, prior to the First World War where again, the world experienced a massive improvement in economic dynamics. The same thing happened after the Second World War, leading to the student protests and Vietnam protests here in the U.S. When people do better, their expectations rise pretty fast and they demand more. And it’s just not possible to keep that up. And also, you get in the U.S. precisely that immigration has been going up: Fourteen percent of U.S. residents are foreign-born. This is a multi-year high, and that drives some level of anxiety in certain areas of the population. Politicians are able to capture that to get to office, and that drives a lot of these populist movements that we’re seeing in Europe and certainly the type of policies we’re seeing here in the U.S.

    Elizabeth Koehler: So new tariffs, particularly on steel and aluminum imports, have revived a debate on protectionism, both in and beyond the U.S. What do you see as the potential impact of this on the markets?

    Gerardo Rodriguez: The tariffs themselves on steel and aluminum are actually not that relevant by themselves, but I think that the key element here is the strategy that the U.S. is following to back up this policy initiative. Because the use of national security as a justification for these types of tariffs is going to be challenged very likely in the WTO world. There is a perception that that’s not the whole story. And the U.S., actually, when they excluded countries like Mexico and Canada but they use the threat of steel and aluminum as a way to get concessions in NAFTA, actually weakens the case for the U.S. when it comes to the WTO. So what will happen when you have this argument at the WTO 11 of other countries challenging the fundamentals of this policy initiative in the U.S.? There is no precedent. And then what is the U.S. going to do on this, to what extent is the U.S. willing to challenge the WTO as an institution? So again, the tariffs themselves are not that important, but the implications for the global order for trade may be at stake with this recent initiative by the U.S. And we need to watch for that, we need to be careful.

    Elizabeth Koehler: So what you’re saying is, while limited trade actions may not hurt the risk-on sentiment, the potential escalation into a possible trade war could be a pretty disruptive geopolitical risk and we have to watch it, is that fair?

    Gerardo Rodriguez: Well, that is one aspect, and one of the risks is that countries retaliate. Europe has already listed a few things of Harley Davidson and a few other things being produced in key states here in the U.S. But also, there is the issue of whether the WTO is going to be able to handle all of the challenges to the concept of national security as a driver for these decisions, and what the U.S. is going to do about that. At some extreme level, can you think of the U.S. actually leaving the WTO and then leaving the global trade dynamics without a proper set of rules that are accepted by everybody? That is not good for trade, that is not good for the U.S., and that is not good for the world.

    Elizabeth Koehler: Expanding a little bit on what you were describing and in line with talks on tariffs, we know that BlackRock has been monitoring the NAFTA negotiations pretty closely. And we know there is some potential that the U.S. might withdraw from the agreement should attempts to renegotiate fail. What do you see as some of the risks of that type of withdrawal?

    Gerardo Rodriguez: NAFTA is an interesting example, because going back to the thing of WTO that we were discussing, the fears around NAFTA and the reason behind the big selloff in Mexican asset prices and to some extent Canadian asset prices was precisely that the U.S. seemed to be willing to do away with the treaty altogether, just to withdraw from the treaty and leave Canada and Mexico. That wouldn’t be good for economic activity in the North American region. Fortunately, what we’ve seen is that the U.S. has been willing to sit at the table and to come up with a constructive improvement of the treaty itself. And this is very relevant, because to the extent that the U.S. addresses the things that they want to improve when it comes to trade, to the extent that they try to address that through institutional means, I think that that’s good for the world. The U.S. or any country can have a different opinion. They can pursue their own interests, but if they do that through the rules-based global trade order, I think that the world is going to be okay. The problem is when you actually challenge the institution itself. So going back to the NAFTA case, so far, what we’ve seen is significant progress on different chapters that are being improved in the negotiation process and I’m sure that this will get to a positive end. So it looks like the probability of the U.S. withdrawing has been going down materially and because of that, the selloff that we saw again in Canadian and in Mexican assets last year is actually coming back.

    Elizabeth Koehler: Another key part of the trade debate is obviously the U.S. and China relations. Do we see tensions escalating in the short-term?

    Gerardo Rodriguez: So here I think that we have the highest level of risk when it comes to China. And it is because China historically, since they joined the WTO in 2000, they have had the most aggressive trade practices to protect their industries. And because of that, there’s plenty of room, not only for the U.S. but for other countries to challenge China in a more open manner. The non-trade barriers that China has established and continues to use are just massive. And because of that, it is really hard to do business with China, say, to export there, and also to create investments in a free manner, just the way that we’re used to in the western world. So because of that, the U.S. is now exploring this so-called 301 Section, which is related to intellectual property, because there is some evidence that the Chinese government forces foreign companies to have a partial local ownership and forced technology transfer in that way. So we’ll see what comes out from this specific initiative, but it is very likely that the U.S./China trade dynamic is only going to deteriorate going forward.

    Elizabeth Koehler: So despite worries about global protectionism, as we’ve talked about, we’re still constructive on risk assets at BlackRock, and particularly on emerging market equities. What’s behind this constructive view?

    Gerardo Rodriguez: Well, it is true that it is a bit hard to reconcile all this trade and geopolitical risk going up on one hand, and on the other, equity markets across the world doing so well. And looking forward, it looks like this situation can continue. So what is driving the performance of risky assets? It is mainly the good performance of economies. We haven’t had such a synchronized acceleration of global growth since the Crisis, and we saw that clearly last year, not only being a U.S. story but Europe certainly showing significant improvements, Japan, certainly China surprising on the positive side, and emerging economies in general doing relatively well and being at a much earlier stage in the economic cycle with plenty of policy room still to foster growth. So with earnings growth in emerging markets above 23% last year and projections for this year between 13 and 15%, equity markets are likely to continue well-supported in the emerging world going forward.

    Elizabeth Koehler: So despite the fact that we know EM can bring much-needed growth to a client’s portfolio, we also see that many investors tend to be dramatically under-invested in this space. Why do you think that is?

    Gerardo Rodriguez: These under-allocations have been particularly relevant in the current cycle. This has been one of the most unloved rallies for risk assets around the world. What we’ve seen in the past two or three years is that equity markets are doing really, really well, but people are still hesitant to embrace this trade. It is somewhat related to the damage done during the Crisis. But when it comes specifically to the case of emerging market equities, it is an asset class that tends to be more volatile than U.S. equities. And because of that, what we see is that people are just reluctant to invest. The average allocation of U.S.-based investors is only around three percent. And there are around 40% of U.S.-based portfolios that own no emerging market exposure. So recently, there have been different initiatives to try to find ways to reduce the volatility and make the emerging market investment case more appealing to the average investor in the U.S.

    Elizabeth Koehler: And help keep clients invested so they can gain access to that growth over time.

    Gerardo Rodriguez: Yes. And the emerging market story is one particularly of higher expected growth, and with that comes higher expected returns. So how can you participate in that and at the same time, perhaps, avoid the big drawdowns that may come with a higher volatility asset class? That is the challenge of emerging market equity investing.

    Elizabeth Koehler: Makes sense. Last question, you like to run and you’re a big podcast listener. Can you give us a sense of some of your favorites?

    Gerardo Rodriguez: Well, I think that podcasts are actually the perfect match for outdoor and indoor running. One of my favorite podcasts is Freakonomics. The Tyler Cowen podcast, that is one of the best economic podcasts. EconTalk also is one of my favorites. I like Tim Ferriss as well. And for those that like sports, The Bill Simmons Podcast is actually pretty good.

    Elizabeth Koehler: Great. Thank you so much Gerardo, we really appreciate you sharing your insights with us today.

    Gerardo Rodriguez: Thank you for having me here.

2018 investment outlook
A synchronized global expansion has room to run in 2018, but 2017 will be a tough act to follow.
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Episode 7: Maxing the factors of market outperformance

How can investors beat the market? One group at BlackRock is challenging the notion of traditional stock picking, instead zeroing in on certain factors to help lead to outperformance.

In this episode of The Bid, Head of Factor Investing Strategies Andrew Ang explores how scientific, rules-based approaches to active and index investing have created unprecedented drivers of return.

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    Dennis Lee: How can investors beat the market? While the age old question unfortunately doesn’t have one answer, one group at BlackRock spends their days thinking about this very differently. Rather than relying on traditional methods of just picking individual stocks, this team zeroes in on certain factors to help lead to outperformance. Forty-five years ago, if you invested one dollar into the MSCI World Index, you would have about $34 dollars today. Not bad. But if you invested that same dollar into MSCI Momentum index, you have $98 dollars. Much better.

    In this episode of The Bid, Andrew Ang, Head of Factor Investing Strategies, explores how scientific, rules-based approaches to active and index investing have created unprecedented drivers of return. I’m your host Dennis Lee. We hope you enjoy.

    Andrew, thank you so much for joining us today. You publish a monthly commentary called Andrew’s Angle, which gives your perspective on factor investing. But before we dive deeper into that and factor investing itself, I do want to explore a little bit more about you personally. So how did you get here, how did you end up as a leader in this topic?

    Andrew Ang: I started off as a professor; I was a professor at Columbia for 15 years and in 2015, Larry Fink invited me to join BlackRock. And I’ve always studied factors, I’ve always believed in the power of factors. And I’ve worked with very large institutions as a professor and advisor and consultant. At the leading largest institutions that are practicing factor investing, factor investing has become a culture. It’s become a way for their private market colleagues to talk collaboratively with their public market colleagues, to look at their whole portfolio in one and to understand the risks, to look at efficient sources of returns, and to build robust portfolios to meet their liabilities and to serve their beneficiaries. It’s become far more than just factors in investments. And I wanted those same benefits for factors not only to be available to the largest, most sophisticated institutions, but to a widespread audience.

    Dennis Lee: You often write that factor investing isn’t some new invention. As you mentioned, institutional investors and active fund managers have been doing this for decades. So what’s really changed that we’re making those methods more broadly available, and how are we able to do that? Does technology play a key role?

    Andrew Ang: It plays an absolutely essential role, and you are absolutely right that these things are not some new invention – they’ve been done for decades. Value investing dates back to 1934. Two professors, Benjamin Graham and David Dodd, at my former institution, Columbia, wrote that seminal book, Security Analysis, in 1934. The first references to momentum that I know of in its modern form, of cross-sectional and times series momentum, date back to 1928. But I think it’s very similar to your phone. And on your phone, you have maps and hotels and you have airlines: all of those things we had 30, 40 years ago. But the ability to put that onto a phone has transformed our lives. And so buying cheap or finding securities that are trending, finding companies with high-quality names, gravitating to safety in minimum volatility strategies, finding companies that are smaller or more nimble, none of that is new. But the ability to do that transparently, to do that in a multi-asset context, to put it into an efficient vehicle, tax efficient and efficient from an implementation point of view, well, that is like the phone. It transforms our portfolios. The best revolutions are those that take something that is familiar but they put it into a new form, make it widespread, democratize it, and thereby, transforming our lives.

    Dennis Lee: So I want to get a little deeper into the mechanism of factor investing. If I were to set out to invest on my own, buying cheap stocks, companies with strong earnings or trending companies, why wouldn’t that work? And how are factors different than what some investors are already doing it on their own?

    Andrew Ang: You might be satisfied with a pure market exposure, you might be the market, but sometimes you want to beat the market. And you might start to add some of these return enhancing factors like value, quality, momentum, or size. You might also want to reduce your risk. You would like retain the same type of market returns, but experience a less volatile path and minimum volatility strategies allow you to do that. So there are some managers that are factor investors in disguise. And it’s very similar to what has happened in my music playlist. Now I’m old enough that I used to buy even cassette tapes. I used to buy LPs, I used to buy CDs, and I used to buy plenty of them just for one track. But the ability of iTunes or streaming radio, Spotify or whatever music service that you have, has improved my playlist and I buy exactly what I want, listen to tracks that I want at the time that I want. And as a result, my music experience has improved. In asset management, it used to be like that, that you used to go to one fund manager and you had to buy the whole LP, or the whole cassette tape. But you don’t have to do that now. You can buy factor exposure, we can buy market exposure, and we can buy security selection and pay appropriate prices for each of those. And one of the exciting developments now is to look at some managers, traditional managers, that are really just doing static factor exposures, but we can take that in a more efficient way: Tax efficient, cost efficient, and from an investment perspective, with more efficient factor exposure.

    Dennis Lee: Great. Help me understand something: if factors seek to outperform the market, are investors taking on excess risk by incorporating them into portfolios?

    Andrew Ang: It’s a great question. Because I think who wouldn’t want to buy cheap and find companies with high-quality earnings and look for those companies that are going up? So all these factors give us long-term performance, but we have to deviate from the market in order to do that. And sometimes, that means we might underperform the market. But in the long run, a large body of academic literature – six Nobel Prizes in fact – and long investment experience by practitioners have shown that these types of factors lead to high, risk-adjusted returns. We also might think about reducing risk with minimum volatility, but again, these are long-term statements over a full market cycle. We might expect the same return as the market, but with reduced volatility. In the short-run, sometimes we might deviate from that market and we might open ourselves to some disappointing returns, relative to the market.

    Dennis Lee: There is a perception that factor investing is an unconventional way of investing. What are some of the mental barriers that investors have? Why isn’t everyone jumping aboard the factors train? It seems like everyone should.

    Andrew Ang: Everybody is already a factor investor. The difference is whether people are doing this directly and having meaningful conversations about which factors would be appropriate and targeting them and holding them in efficient vehicles, or whether they are doing factors indirectly, in an ad hoc manner, sometimes that they might not know about. I like to think of factors as to investments as to what nutrients are to food. And there is nothing wrong with ordering off the menu. You might have an appetizer, main course, and dessert, but sometimes you have to look through to the nutrients. You might be allergic to something, you might be training for a marathon so you need another dose of a nutrient that other people might not have. And those are especially powerful situations where looking at the nutrients of investing, factors, will improve our portfolios.

    Dennis Lee: So one last closing question, what are you most excited about in the next several years? How do you think factor investing will evolve?

    Andrew Ang: We’re just at the beginning. The next couple of years we’re pushing the frontier of these factors: value, momentum, quality, size, minimum volatility strategies, carry or income, beyond equities to fixed income, to other asset classes. We look at this going long and short, not just in long-only vehicles. We look at fully holistic views of our portfolio, recognizing the factors in our private markets, like real estate, private equity, infrastructure, just as easily as we do in our public equities portfolio. We think about factor allocation and balancing those nutrients, mapping them to our asset class foods. This is so exciting; factor investing is in the beginning innings, and I think at the best funds, the largest, most sophisticated funds, factor investing has actually gone beyond just investing in factors. It’s become a common language that all these investments share so that we can meet the objectives of the whole fund and our total portfolios.

    Dennis Lee: It’s almost the genome of investing overall.

    Andrew Ang: I think it’s the soul of investing.

    Dennis Lee: Andrew, very much appreciate your time and thoughts today. For our listeners, if you’d like more info on factor investing, check out Andrew’s Angle on We’ll see you next time on The Bid.

Episode 6: Steeling for a market snapback

With unexpected momentum from U.S. tax reform and potential volatility spikes from central banks globally, investors need to be prepared for potential snapbacks. Jeff Rosenberg discusses the role of fixed income in a market that’s heating up.

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    Elizabeth Koehler: In a market where equities dominate headlines, fixed income has stayed relatively out of the spotlight. 2017 was an incredible year for stocks, and while expectations are tempered for 2018, it seems this bull will keep on running.

    But it’s precisely in these times where fixed income plays an important role in portfolios, and needs its time in the sun. On this episode of The Bid, we’ll talk to Chief Fixed Income Strategist Jeff Rosenberg about why fixed income is still important to portfolios today, perhaps more than ever, and what investors can expect in the year ahead. I’m your host, Liz Koehler. We hope you enjoy.

    Jeff, thank you so much for joining us today.

    Jeff Rosenberg: Thanks Liz, great to be here.

    Elizabeth Koehler: So we have a small challenge on today’s podcast. As of this recording, the Dow is over 25,000, even Bitcoin is worth almost 15,000; but we’re here to tell a compelling story about fixed income.  So before we dive into the drama of tightening credit spreads or the potential rise of inflation, I just want to ask you: What gets you out of bed in the morning? What do you love most about being a student of fixed income?

    Jeff Rosenberg: Well, I hope our listeners will find fixed income dramatic, rising inflation and tightening credit spreads. It's not quite the sexy story that Dow 25,000 or Bitcoin is, but I’d answer the question first by saying, I’m not a student of fixed income; you have to be a student of the markets. Larry says that a lot, it’s a big theme here at BlackRock. You can’t understand what is going on in interest rates without understanding what is driving the Dow to 25,000, what is going on with Bitcoin. What gets me out of bed in the morning? I’ve always been interested in this job because I’ve been very interested in financial markets, the idea of a place and a measurement, the price of the amalgamation of all of these individual actors coming together. And you can see in the summary measure, the price and its movements, all of this incredible complexity and diversity. My entry into the field was the quantitative aspects, the incredible application of hard science to finance. But what we found, particularly through the Financial Crisis, is that you can’t only view it from this perspective of hard science. It’s ultimately the actions of human beings – it is a social science, not a hard science – when we’re talking about financial markets. I spent a lot of my academic and practitional career applying hard science techniques. It’s this intersection between people, the arts and science together. That’s what gets me out of bed in the morning, and what got me out of bed this morning was my 10-year-old with a 102 degree fever. So he’s staying home today.

    Elizabeth Koehler: I’m sorry to hear that.

    Jeff Rosenberg: Yes.

    Elizabeth Koehler: But I really like that blend of art and science. Getting back to your point about complexity, sorting through the complexity, what do you think were some of the most important headlines of 2017?

    Jeff Rosenberg: There were so many. There were obviously the obvious ones, the politics, the election. The ones that I think a lot of U.S. investors maybe forgot about is how important the French elections were, and that was a huge surprise and a big change for currencies, for market performance. Our European colleagues are much more centered on that; U.S. sometimes can get a little centered on the Republicans and the tax bill, and obviously the administration and Trump. But that was a really big deal: We went into 2017 with a lot of fears over European disintegration, we were going back to that. Macron really changed that narrative quite dramatically and had some significant investment implications. The other big significant headline is the one that we just absorbed. If you asked most people expectations on fundamental tax reform, it wasn’t supposed to happen in 2017. That was not where the center of the market distribution was, and it really kicks us into the 2018 outlook as a critical theme. But that was a surprise that it happened as quickly as it did.

    Elizabeth Koehler: Great. So you mentioned the 2018 outlook, and in that outlook, you’ve written that we believe inflation is poised to make a comeback. What does that tell us about the economy and what do you feel that means for investors?

    Jeff Rosenberg: So I guess to understand the theme “inflation comeback” is to answer another of the previous questions, the significant headlines, and even the significant surprises of 2017 was that in the U.S., inflation disappointed. And we came into 2017 off of 2016 with inflation on the rebound and a lot of expectations in 2017 that that would continue, and it didn’t. It turned the opposite direction. And so “inflation comeback” for 2018 is about that experience in 2017 really being a temporary one-off, technically driven with wireless services, being really temporary. But there is another part of the narrative that is still evolving relative to when we published “inflation comeback,” which was really prior to that other major significant headline in 2017, which I just mentioned, which was the tax bill. And the tax bill is creating some additional momentum to the outlook in 2018 that is not really fully factored into markets, into expectations for growth and inflation. And on top of that is the spending part of fiscal policy. So when you put tax reform together with spending initiatives, and all these initiatives are uncertain and they’re in front of us in terms of the headlines, you are talking about the potential for a major uptick in fiscal policy’s contribution to growth. And I think it’s one of the core issues for our 2018 outlook, is just how much of a lift do you get and at what inflationary consequence, how quickly in terms of realized inflation. More importantly, because I think it will happen sooner, is how quickly does it affect inflation expectations?

    Elizabeth Koehler: Jeff, we’ve seen little volatility coming out of the last few rate hikes and we’ve projected the Fed is poised for three rate hikes this year, possibly a fourth. Are markets pricing this in, and what should investors be watching?

    Jeff Rosenberg: The question is very U.S.-focused, and here I would say we expect the least contribution to volatility from the Fed relative to what we might see from, say, the ECB and the BOJ. When it comes to what is priced into the markets, about two and a half hikes are priced in. It’s moving during this time period that we’re recording this quite aggressively, so I’ll put it that way. And so you still have a market that is underpricing relative to three, and certainly underpricing relative to the possibility of four. There are a lot of good reasons for why that is the case. You’ve had a persistent disappointment with regard to the pace of Fed hikes. 2017 was the first year that the Fed delivered on its projections for three hikes. And that was kind of surprising. 2018 is shaping up much to be the same with the upside potential. My earlier comments around growth and the contribution from fiscal policy might push us even beyond that. But the Fed has been very clear to be the most transparent and gradual and to put itself on autopilot. Where we have real potential for volatility in global rates markets, and even if you’re not invested in global rates markets and it’s just a U.S. fixed income portfolio, the impact back on U.S. rates is from those other central banks, the ECB outlook and the BOJ outlook. We saw a little bit of this volatility in terms of some of the changes to the sizes of the BOJ, a lot of anticipation as to what the BOJ is going to do with regards to its program on yield curve control, and a lot of anticipation as to what the next evolution of the ECB will be. And this will start to happen around June or July. In September, the ECB is going to have to clarify what they do next with their balance sheet, and there, there is a lot more uncertainty because there’s not been as much forward guidance for the 2018 outlook relative to what the Fed has done.

    Elizabeth Koehler: That’s great. Well, just like there’s been no lack of headlines in 2017, it sounds like there is a lot to watch heading into the new year, too. Jeff, when we look at BlackRock’s own 2018 investment outlook recommending taking risks in equities over credit, and that credit spreads themselves are tightening, how should investors think about investing in fixed income?

    Jeff Rosenberg: So just to elaborate a bit about the context, because the premise to the question is about contextualizing fixed income relative to overall portfolio allocation. So the broad BlackRock Investment Institute outlook for 2018 is, to summarize it very simply, a supportive growth environment, inflation comeback, reduced return expectations relative to risks, relative to 2017 where everything went right. But still a pro-risk portfolio stance where for most of the regions of the world, we have overweight recommendations to equities. And so the tightening in spreads at this level, given what has occurred over the last couple years, leaves less room for tightening going forward. And in fixed income, that lack of tightening means most of the return potential from credit exposures comes from income. And if you have an income-centric portfolio, that’s a very good place to be. We think it’ll still continue to be that way in 2018, and a benign environment for defaults and default risk given the backdrop of economic growth. But if you have a portfolio that already has a tremendous amount of equity exposure, then what should we be doing in fixed income? We should be focusing on fixed income for its diversification properties, that’s ballast, that’s higher credit quality, it’s more liquidity, it’s less fearful of duration in that kind of environment because duration is a friend. Now we expect interest rates to rise, so there is a cost to this diversification, there’s a cost to the ballast. So some of the strategies we want to employ within fixed income are, “how we can minimize those costs of rising interest rates while maintaining some of that core role of fixed income?” And those solutions are pivoting toward more floating rate exposure, having some of that floating rate exposure in higher quality floating rate exposure. Traditional floating rate is bank loan kind of exposures. Those are very high income but higher credit risk, more economically sensitive instruments. If we’re looking at the higher income areas of the market like high yield, we might pivot more of that toward bank loans, take out some of that interest rate risk. And looking at TIPS as a substitute for ballast in my fixed income portfolio because they’re going to have a little bit better performance outcome in an environment of rising rates, because of where they’re pricing inflation we think is underpriced relative to where we see some inflation expectations. In a world where if everything goes well, you’re not going to need the diversification and interest rates are rising, but you have the diversification in case everybody’s forecasts, including our own, prove to be wrong and in which case fixed income is going to be important.

    Elizabeth Koehler: I think fixed income is very exciting, and what you’re telling us is that the role of fixed income really matters, so it’s critical for clients to understand what they want their fixed income to do in their portfolio and to invest accordingly. One last closing question that we get from some of our clients, which is around book preferences. So you’ve recently authored the annual blog post by BII, outlining our strategists’ book recommendations for the holiday season. On our last episode, Richard Turnill mentioned he was looking forward to picking up The Secret Scripture by Sebastien Barry. Which book are you looking forward to reading this winter?

    Jeff Rosenberg: I did author that post and my recommendation—I’ve already read it—so my recommendation was to reread it, and it was in reference to the Bitcoin enthusiasm, and it’s Charles Kindleberger’s classic Manias, Panics, and Crashes. And so that should give you a hint as to where I stand on Bitcoin. And I think we’ve seen some of that already. And so that was a good read.

    Elizabeth Koehler: Wonderful. Well Jeff, thank you so much for sharing your insights with us today. I’m sure we’ll continue to circle back with you and the rest of the BlackRock Investment Institute as the year unfolds. Thanks for your time.

    Jeff Rosenberg:  Thank you.

Episode 5: What’s greater than great?

The global economy seemed to hit its stride in 2017, and 2018 looks to be starting off on a similarly high note. Global Chief Investment Strategist Richard Turnill dives into the drivers of this run, and answers the tough question: Can it persist?

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    David Brodnick: MAGA. MAH-GA? “Make American Great Again.” However it's pronounced, the saying harkens back to a purportedly better economic time. And when was this golden age, exactly? Estimates vary, but if we had to pinpoint one period in the past, the 1960s feels about right – it was a time of astounding, stable and prolonged economic growth.

    Now surely there's more to national greatness than the duration of economic cycles. But that said, by this measure, the current one is just months shy of being the second greatest in U.S. history. In this episode of The Bid, Richard Turnill, our Chief Investment Strategist, will dive into the drivers of this tremendous run of economic growth we’ve seen and ask the tough question: Can it persist? I'm your host, David Brodnick, we hope you enjoy.

    Richard, thank you so much for joining us today.

    Richard Turnill: My pleasure, great to be here.

    David Brodnick: So it was this past summer that we last spoke, and I recall this collective feeling that the global economy was just starting to hit its stride. Obviously since then, we’ve heard the phrase synchronized global expansion kicked around a lot in the financial media. Can you just characterize for us what exactly transpired in the back half of 2017?

    Richard Turnill: Well, first of all, David, it was a tremendous year for investing in risk assets and we’ve candidly been surprised by quite how strong returns have proven to be. We’ve been positive on markets, but candidly I don’t think anyone has expected to see a 20 percent return from the S&P and even higher returns from many international markets. And what has driven that has been this synchronized lift in global growth. Growth has been above trend in every major region simultaneously really for the first time since the global financial crisis, and it’s that breadth of growth which I think has given confidence to investors to reenter markets. At the same time, volatility of economic data, the volatility of earnings has been incredibly low. So this has been a near perfect environment for risk investing, and in that environment you’ve started to see many investors reassess their portfolios and reassess the appropriate risk premium in markets, and that’s clearly provided a big lift to many equities in particular.

    David Brodnick: So looking at the corporate bond market and stock market, over these past couple months and given where valuations currently sit, it seems that the markets are pricing in a continuation of this sort of goldilocks environment. Do we share the view that this sort of backdrop is likely to persist?

    Richard Turnill: Well the first thing is I would hesitate to use the term goldilocks because, certainly for people in my generation, I associate goldilocks with the late-1990s, with a period of highly elevated valuations, the perception that this time it’s different. And actually when you look at markets today, yes, they’re pricing at better outcomes. You’ve seen a rerating across equities and fixed income since the beginning of the year, but they are far from pricing in at any sort of extreme outcomes very different from the peaks of previous cycles. I don’t think we’re anywhere near the type of goldilocks market environment that we saw previously. So when look forward, where we do agree is that we think there is favorable economic background, that being one of stable growth, central banks very gradually raising interest rates or exiting QE. And where we really differ from the consensus is how long this cycle could run. We see the cycle having potentially years to run. So we are in our view approaching the middle of the cycle, approaching the point where output is reaching full capacity in many economies led by the U.S. But what we’re seeing historically is once you reach that point, typically the cycle runs for several years. And this is a cycle where growth has really played out in slow motion. And even though we’re starting to build up some capacity constraints, the rates at which that is happening implies that this cycle could well run for another two years if not significantly longer.

    David Brodnick: So we seem to be of the view, it sounds like, that markets haven’t reached the state of euphoria similar to the late-90s or let’s call it 2006/2007, so we’re not at the sort of extremely stretched valuations that would give us pause. What kind of tells would you be looking to see that would suggest to us that we might be entering this latter stage of the cycle?

    Richard Turnill: We’re in the ninth year of the bull market now and the S&P is hitting all-time highs, many global markets hitting all time highs, Bitcoin up four digits, Da Vinci painting being sold for a record price. There are lots of potential signs that commentators will point to and say, look, clearly this is a sign of euphoria in markets and it can’t be sustained. We disagree on two fronts. So first, we disagree that what we’re seeing today across the bull market is anything close to euphoria. The second point is even if there was euphoria, what history teaches you is that can last for a long time. So why do we think we’re not seeing signs of euphoria today? Well, the first is when we look at the valuation of markets, markets are trading at above their long-term average, in most cases. They’re trading above their long term averages because volatility is incredibly low, we’ve had significant financial regulation, the world is a safer place, and the financial system is a safer place than it was going into the global financial crisis. We’ve got huge excess savings which are holding down the level of bond yields. And that justifies higher valuations. So we take all these things into account – actually, when you look at valuations across most risk assets, they look very reasonable to us, they don’t look stretched, they certainly don’t look extreme. You also just don’t hear the language of “This time it’s different,” you don’t hear that, “Yes, of course you can justify record valuations because growth is going to be strong forever, the cycle is dead, technology is changing the world, inflation is confined to history.” The reality is, most investors are actually still relatively cautiously positioned. And the reason for that is that the memory of the global financial crisis is a very vivid one. What are we seeing in terms of flows? Now we’re seeing that flows are coming back into risk assets, but really in a very gradual way. What we’re not seeing is a great rotation. Particularly, when you look in many client portfolios, what you see is those portfolios are still typically relatively conservatively positioned. In fact, this year we’ve seen record flows into fixed income assets. So that feels like an environment which is a long way away from a euphoric one. And then finally, I would add we would look for signs of financial leverage in the system. One of the big warning signs/big red flags particularly in the 2005 through 2007 period was this big buildup in financial leverage, which is often a warning sign of a potential shift to a different risk regime. In fact, all major shifts to sustained higher volatility regimes have been associated with some pickup in financial leverage. And in aggregate, we don’t see that today.

    David Brodnick: So this may come as a shock to you, but as the host of a podcast, I am myself a millennial. For those of us who enter the workforce, the entirety of our professional and investment career has been on the back of the global financial crisis. We’ve been in this period of consistent gains as we cross the decade mark on this economic cycle. For those of us who haven’t experienced a significant economic downturn or a significant market shock within our lifetime, what would your advice be as someone who has seen the tech bubble, seen the financial crisis from the driver’s seat?

    Richard Turnill: So David, it’s interesting. Thinking about this, there are a lot of people here at BlackRock, a lot of people who invest in markets, who simply have never seen a bear market. They’ve never seen a major recession. They’ve only seen markets go up persistently, they’ve only had their professional lives in an environment of low volatility. I go back in time, I saw Sterling getting kicked out of the ERM back in 1992, the building and then bursting of the tech bubble was an extraordinary environment. I recall looking out of our offices here in London and seeing a queue form outside of Northern Rock over the road. I thought a run on a bank was something consigned to history. So one of the lessons to me is that you’ve got to be open-minded. You’ve got to imagine an environment in the future which is potentially very different to the one that we’re having today. And we believe in this favorable environment, we believe that it will last a long time. But it will change at some point in the future, and we have to be very cognizant of that. The second thing is, I think you have to learn to adapt to the environment, in that I know many people doing careers now, working in industries now – those industries didn’t even exist when they left college or university. And I think from a financial markets perspective, again talking about my own experience as well, which is that many of the best investment decisions that I’ve made in my career were not made because I had amazing foresight and I had the ability to predict major turning points in markets. But I was able to react when they happened and react quickly. It’s easy to think the world will always be one way, and when it changes, sometimes it’s very hard to react to that. And part of that is about thinking ahead and really answering some of the questions you’ve asked today, David, which is “What would make you change your view?” And then when you’re seeing that, being in a humble enough position to actually recognize that the world has changed and you need to change your thinking and the way you make decisions.

    David Brodnick: So a bit of a digression here: My own reading this holiday season I’m looking forward to is Andrew Lo’s adaptive markets hypothesis, confronting the bounds of one’s rational construct or heuristic to the world is such an important skill. As you’ve reflected upon, Richard, it’s that the gains aren’t made necessarily when the markets are on the upswing and you’re outperforming your benchmark sizably and everything is rosy, but it’s being able to be adaptive when a period of fear or concern strikes and the ability to be positioned, be it professionally or within your portfolio, appropriately that can be the greatest cause for success in the long term. Richard, I’m hopeful that over the holidays you will have spent some time in front of a fireplace reading some wonderful book – I know BII recently released their holiday reading list. What book would you suggest to our listeners as a good read for this time of year as we look to confront another year of investing?

    Richard Turnill: So this is always a tricky question, because the reality is what I want to say is that I’m going to read some amazing academic book that everyone is going to think I’m super-smart, I spend my life reading literature such as Andrew Lo’s book, which you just highlighted, which is a tremendous piece. But the reality is when I clock off and go and sit in front of a fire somewhere, I really like to read fiction and unwind and take my brain away from the turbulation of financial markets. So one of my favorite authors is an author called Sebastian Barry. He’s been around for a while but I’ve only recently started reading his novels. I’ve read two so far: A novel called Days without End, which is about the Indian wars and actually the American Civil War, and then a subsequent book, called A Long, Long Way, which is actually about the Irish in World War I. And he’s a tremendous author, writes beautifully, he always write from an Irish perspective, in fact, many of his books are based around multiple generations of the same two Irish families. And for sort of no good reason, I seem to be reading them in reverse order, in that I think his original book that was really brought into the public was called The Secret Scripture, which I have not yet read and recently downloaded onto my Kindle. I’m looking forward to sitting down the next couple weeks and reading that.

    David Brodnick: Terrific. Well, Richard, thank you so much for spending the time with us today and here’s hoping you have some restful time off ahead of you.

    Richard Turnill: David, great to speak to you. Thank you very much.

Episode 4: Is geopolitics the next investment x-factor?

From North Korea’s nuclear program to expansion in the South China Sea, geopolitical risks are permeating the news cycle regularly. We inventory the risk landscape with Isabelle Mateos y Lago and delve into China’s 19th Party Congress with Wei Li.

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    David Brodnick: Lately, it seems like we've been constantly under the pall of geopolitical risk. Things like North Korea's nuclear program and China's expansion in the South China Sea are just a couple of examples of stories that seem to be permeating the news cycle. And to be clear, this feeling isn't imagined. According to Stanford University's geopolitical risk index, global risk has climbed higher in the past few years than at any point in the past decade. This all begs important questions for investors. Is this sense of foreboding just an unfortunate fixture of 21st century life, or does it carry real implications for how we should invest? And indeed, could good political foresight help drive better investment outcomes?  We'll dedicate this episode of The Bid to finding out, inventorying they risk landscape with Isabelle Mateos Y Lago, our chief Multi-Asset Strategist, and confronting developments in China with Wei Li, head of iShares ETF investment strategy for EMEA. I'm your host David Brodnick. We hope you enjoy. 

    Isabelle, thanks so much for joining us here today. So you've spent a lot of your career in the world of policy making at the IMF and elsewhere, and you're no doubt a keen observer of developments on the world stage. Can you help level set for us; is the geopolitical landscape really more hazardous today than it's perhaps been in the past?

    Isabelle Mateos Y Lago: So I think, look, there are objective ways of measuring the level of attention to geopolitical risks in the world, and they do point to a sense of elevated risk and elevated anxiety right now compared to history. I think it's also fair to say that because markets are more interconnected globally, the same event has a bigger impact on global markets than it might have had 30 years ago when investors in the U.S. or in Europe cared much less about what was happening in the rest of the world. 

    David Brodnick: So as we look at the global, macro-political risk landscape, are there any particular hazards that you think are ones that should be particularly on the minds of investors these days?

    Isabelle Mateos Y Lago: At BlackRock, we've decided to try to be less reactive in the way we look at geopolitical risks, and so we've actually come up with a Top 10 geopolitical risks that we think require special continuous monitoring. To mention two that are particularly top of mind right now, one would be the discussions around NAFTA, which we feel could be quite significant particularly if they break down. Another one would be the U.S./China relationship, which has the North Korea dimension folded into it, and that's also something with potentially very significant ramifications. So we're trying to look at these 10 risks along two axes. One is how likely are they to turn from a risk into a shock? And the other one – the other axis – is what would be the market impact if this risk turns into a shock? And we're in the process of developing quantified metrics to assess both, and that's a very interesting line of work.

    David Brodnick: So, Isabelle, just to dive a little bit further on this idea of connectivity amplifying the effective geopolitics on the global stage, what are the catalysts behind this? Emerging markets have grown in terms of their representation in equity and bond markets, global supply chains are becoming increasingly interconnected, but how should we think about this as an amplifying effect? 

    Isabelle Mateos Y Lago: Many countries didn't used to allow foreign investment on a large scale. I think today most of them do, so global investors simply have a broader opportunity set. Now for a long time, this didn't make much of a difference because investors in developed markets were perfectly happy with the opportunities they were finding there, and only a small number had appetite for the extra risk and volatility that you tend to find in emerging markets. But in recent years with yields and returns in general being depressed in developed markets, a number of investors have learned to like the extra kick to your returns that you can find in emerging markets. And that's good, that's just allowing better returns to portfolios everywhere. That's healthy. But it does mean that developments in one part of the world are having an impact well beyond the region or the specific country. I think also realistically, a lot of what's been driving this globalization is the growth of China. So you could say, you know, there's emerging markets, but there's also China that has an outsized impact on both trade flows and capital flows, and what China buys and sells has an impact on all asset markets, on commodities markets, et cetera. So that's been a key driver of market prices globally.

    David Brodnick: So just to conclude things here on a, you know, not overly glum note, clearly all of the news in the world today is not bad. There’s a lot of positivity, and I know BlackRock leaders are engaging very heavily with a number of individuals across the world who are advancing very pro-growth, pro-reform, economically liberal agendas. Are there more positive geopolitical themes out there that are important for investors to be considering alongside the multitude of risks that inevitably grab headlines?

    Isabelle Mateos Y Lago: So if I go back to our dashboard of the Top 10 geopolitical risks, I think it's fair to say that if you look at the last six months, maybe, the majority of them have been getting worse. But there are definitely some good trends, and I would say one of those is the risk of fragmentation in Europe, which has gone down very, very significantly since the spring; one would say really since the election of President Macron in France on a very pro-European platform. I would say another trend is the pursuit of healthy globalization outside of the United States remains very, very strong, and you hear statements in that direction every day coming from leaders in Asia, and in Australia and China and Japan, and in Europe as well. There's increasing focus on not just growth, but the quality of growth and the sustainability of growth, which is really a common thread that you find in many, many countries across the world, China being a prime example and one that is very important because it is the second largest economy in the world and one of the fastest growing ones. But it's also the case in Europe, which has restated very firmly its commitment to the goals of the Paris Treaty on climate change. So there are very positive trends, and likewise, an appetite for trying to harness technology in a way that supports higher standards of livings rather than undermining jobs and living standards in a number of countries.

    David Brodnick: Wonderful.  Well, Isabelle, thank you so much for sharing your insights with us today, and I'm sure we'll continue to circle back with the BlackRock Investment Institute as these geopolitical concerns evolve.

    Isabelle Mateos Y Lago: Thank you very much. 

    David Brodnick: China's 19th Party Congress concluded on October 24th, leaving investors, China watchers and podcasters alike with a real grab bag of treats: New insights into the path forward for the world's second largest economy, the shifting power dynamics at the top of the Chinese Communist Party, and the rare chance to use the word quinquennial. We're fortunate to have Wei Li join us from London to help us read the proverbial tea leaves around this notable political happening. Wei, thank you so much for joining us this morning.

    Wei Li: Thanks for having me, David.

    David Brodnick: So let's start with a really basic question here: For those not close to Chinese politics, what is the National Party Congress, and why does it matter?

    Wei Li: Every five years the Chinese Communist Party presents a new cohort of senior leaders. The Party Congress is probably the most important date on China's political calendar. It took place this past October, and we saw the unveiling of the latest group of senior party members. They will decide China's next stage of development, and the implication of that will likely last longer than simply just a five-year term the new leaders will serve until the next Party Congress in 2022. But we're not done yet, though, because it's important to know that the Party Congress is really just the first phase of the leadership reshuffle in China. The second phase is the NPC. It's short for the National People's Congress. That takes place in March 2018, and the difference is that the Party Congress in October is about the leadership of the party and the NPC is about the leadership in the government. In between these two very, very important dates, we also have the Central Economic Working Conference, which is happening in December, and this is an annual event instead of once every five years where the party leaders will discuss economic policies for the next year and they also set the very important GDP growth target.

    David Brodnick: Wei, the opacity of the Chinese Communist Party is the stuff of legends, and perhaps even more so in the Xi era. What would you say are the high points of this conclave in terms of policy-making and signaling of what may be taking place within the leadership ranks of the Chinese Communist Party?

    Wei Li: Internally, we're talking about how China will pursue innovation, environmental protection, SOE and supply side reforms, and higher standards of living. Externally, we're talking about how China will likely become more assertive in foreign matters and seek to raise its standing on the international stage. The second aspect of the Party Congress is really about how President Xi Jinping has consolidated greater power after the leadership reshuffle and seems now really well-positioned to push forth even the most challenging structural reforms. Specifically, if you think about the five new leaders replacing the retiring members of the seven-member Politburo Standing Committee, they are really a combination of Xi's supporters and reformists from the other camps. So really, subsequently, we expect various reform and cyclical policy adjustments to roll out in stages into mid-next year.

    David Brodnick: The National Party Congress isn't traditionally thought of as a policy setting event, but perhaps a way to telegraph some of the likely policy changes that'll get netted out over the coming months and years. It seems like one of the takeaways from President Xi's three and a half hour opening remarks was a willingness to sacrifice the pace of economic growth in China for higher quality growth. Obviously, the second order effects of China's economic trajectory are increasingly massive. Could a deceleration or a mixed shift in the drivers of China's economic growth play out in differently in some of the markets that are shackled to its economic growth trajectory?

    Wei Li: It's really a fine balance between well, quality and quantity of growth and reform. Specifically, if you think about China's growth model, up until 2008, China's very impressive growth rate was largely dependent on a combination of rising exports and rapid investment.  Then came the global financial crisis, which very much undermined the country's previous growth strategy.  So external demand then subsequently slowed and competitiveness deteriorated. Now, things are balancing out a little bit better, and we're moving towards a consumption-driven economy. So as drivers of growth in this enormous machine change, the investment implications differ as well, and potentially warrants a more differentiated, single-country approach for those looking to play this theme. Also, more broadly, emerging market economies are at different points in their cycles. They are still behind where developed markets are, and have more room to run. This has contributed to a lower correlation amongst assets and further raises the importance of country selection. Now tying all of that back to China, we see real GDP growth around the 6% to 6.5% mark really quite achievable and a reasonably desirable outcome for economic growth for next year. 

    David Brodnick: So there's an old investment adage that the further you are from China, the risker investing in China looks. And sitting in New York, I quite literally couldn't be farther from Shanghai or Tianjin or Beijing. But nonetheless, it's really impossible to deny the incredible dynamism we see across many areas within the Chinese economy. What has you most enthused and optimistic about China?

    Wei Li: There are quite a few, but if I have to pick one, it's going to have to be innovation. Innovation is a cornerstone of President Xi's agenda. Reforming the old economy SOE in sectors such as energy and telecommunications will not be just about reducing capacity and removing redundant workers. It is also about automation and it's also about artificial intelligence. These are going to play increasingly important roles in really making changes to traditional industries, and at the same time, the world’s race for digitalization and AI across a range of problems is really open to anyone, and China's very broad and very deep manufacturing provides a very solid testing ground. Speaking to investors all over the world, it's clear that even though it is slow in starting, the Chinese market is really going from niche to necessity. The last two decades, if you think about the transformation of China, it's been very much about the integration of China into global trade. But in the next decade, or maybe even shorter, it will be all about the integration of China and Chinese assets into global financial markets. So think about index providers including Chinese assets into their compositions, MSCI for example, all of that is happening and it is massively exciting. One thing for sure is that China is definitely getting too big to ignore.

    David Brodnick: Thanks so much for joining us, Wei. To our listeners, we’ll see you next time on The Bid.

Episode 3: A taxing path to reform

It seems like the provisions of Washington’s latest tax package are intentionally aimed to confuse. With debate occurring on all sides, we set out to separate signal from noise with Chief Equity Strategist Kate Moore.

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    David Brodnick: Sometimes it seems like tax policy is intentionally aimed to confuse. But we wanted to ask around to see if some of the big buzzwords surrounding the current Republican tax proposal were making sense to people.

    Have you ever heard of the term “Pass thorough entities”?

    Male 1: No.

    David Brodnick: No, okay, what about reconciliation in the context of Congress?

    Male 1: No.

    David Brodnick:  Does the term “unified framework for fixing our broken tax system” mean anything to you?

    Female 2: I understand the individual words, like unified and framework, but no, I have no idea what you’re talking about.

    David Brodnick:  Is dynamic scoring a basketball term or something pertaining to tax policy?

    Female 2: Sounds complicated, but not basketball or tax. Maybe something finance.

    David Brodnick: It seems like the answer is a resounding no. For this episode of The Bid, we decided to consult Kate Moore, BlackRock’s Chief Equity Market Strategist. I’m your host David Brodnick, we hope you enjoy.

    Kate, we appreciate your joining us here today. So just a couple weeks back, we got a first indication of what the Republican led tax package is going to look like. Can you just paint a broad strokes picture for us at what we’re looking at?

    Kate Moore: Sure. Let’s just be very clear, I think the proposal that we received thus far beat market expectations in terms of having more detail than many people expected. There were lots of expectations before the announcement that it was going to be very, very short on structure, but we did get some good meat about what the plan would like in an ideal scenario, both on the corporate side as well as the individual side. Effectively, some people will see their taxes cut, others will not. There’s going to be some reduction and removal of exceptions and deductions. It's really hard to say at this point what the final package will look like, or what the timing of that package will actually be.

    David Brodnick: When we talk about tax reform, there is this penchant in the news media to latch onto specific headlines like four tax brackets, or 20 percent corporate tax rates. But some of the provisions in there are extremely nuanced and complicated. At a corporate level, obviously some of these reforms are going to be very impactful for large publicly traded multinational companies, the sorts of securities that are held within the portfolios of many of our clients. Can you just spec out for us what some of the current reforms that are being mooted are?

    Kate Moore: This is really a comprehensive proposal that involves both corporate and individual, and so while from an equity investment perspective, I often think about the corporate side, the truth of the matter is, it may be hard to get through some of the corporate changes if we don’t concurrently have the individual changes. So we have to think about this as being really comprehensive; where can we borrow from one place, or where could we fund change in another? I will say the framework released would cost between $4 and $6 trillion dollars over ten years. That’s the standard proposal, or what consultants are suggesting might be the cost. And there is a way to offset what might be a significant change in the deficit as a result of some of these tax cuts, using something we call dynamic scoring, or the governments calls Dynamic Scoring, using GDP growth as a result of the tax cut to offset and change the overall magnitude of the debt increase. And I think a lot of this is going to depend on how growth generative each of these tax packages or tax cuts will be for both the corporate side and the individual side. And trying to understand what the implications might be for companies will depend a lot on if there is a change in consumer behavior as a result of this; if the growth juice that the Republicans are hoping will come from this really manifests, and over what time period. So just want to say that at the beginning, there’s a lot of moving parts here. When we think about the corporates, the main components are a massive cut from 35 percent to 20 percent for the headline corporate tax rate. There’s a change in some expensing provisions, allowing 100 percent of capital expenditure to be expensed in the first year for the first five years. There are some changes in interest deductions, changes in dividend treatment, and then I’d say the next big bucket about this is really around foreign earnings and repatriation. And thinking about how companies who generate large amounts of cash overseas but may not be taking that back into the U.S. should pay the U.S. government if they are U.S. domiciled companies. So those are the main things we’re watching for. I would just note again, on the individual side, that it’s really important to think about the simplification here, and if we end up reducing the individual tax rates across a number of different brackets, then we’re going to have to offset that someplace else. It can’t just be offset by segment of wealthy individuals, it also will have to be offset, I think, with some of the concessions on the corporate tax side.

    David Brodnick: So do we see this impact, acknowledging it’s very early days, impacting specific sectors more heavily than others? How does this manifest itself looking at the totality of the equity market?

    Kate Moore: Without going too far into the weeds, but also acknowledging the different components, here is what we’ve thought about so far. First, on the headline corporate tax cut and the implications that that could have, let’s be very clear: a lot of domestically oriented large cap and mid cap companies don’t pay 35 percent in their taxes. The truth of the matter is, it’s a much more living and breathing activity than this straight 15 percent reduction. Just looking at this, though, you would say there are a couple of things that should do well. Financial services in particular really stand out. It’s a sector you might know that we’ve been really constructive on for a number of regulatory and growth reasons. Consumer sectors, staples, and discretionary should also benefit.

    David Brodnick: In terms of investment implications, would you say, netting all factors here, this continues to support our longstanding preference for risk assets for equities in particular?

    Kate Moore: Absolutely. It should be largely positive for earnings, and if we were to get – even if it’s not the same magnitude as the proposal that’s been put on the table – movement in the tax code, I think we will see earnings estimates move up for all sizes in the U.S. equity space. That will be an interesting tailwind, I think, and help sentiment even further. But one of the things we’re also watching is what is the feedback loop going to be of getting some movement in Washington, finally, after a series of failures in 2017? Business confidence is already quite buoyant, consumer confidence is high, small business confidence and intentions to hire and invest are all at post-GFC highs, and so if we get this positive feedback loop, we’re just feeling like there’s progress in DC and also perhaps some regulatory easing on the side. Maybe this leads to a sustained period in 2018 where we grow significantly above what we think potential growth is in the U.S. Some people are talking about GDP with a three handle, which we used to think about as being normal, but is now more of an exception. So I think the sentiment impact that has on corporate behavior as well as consumer spending and on willingness to take risk in the equity market is something we can’t discount either.

    David Brodnick: Kate, thank you so much for joining us this morning.

    Kate Moore: It was great to be here. I think it’s going to be a pretty exciting next few months as we watch this play out in DC.

Episode 2: Is Amazon eating inflation?

Consumers love a good deal, but bargain hunting is more than a fad. According to Rick Rieder, it’s reshaping the economic landscape in a big way. We explore how Amazon and its peers are eating inflation and what this means for bond investors.

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    David Brodnick: So my wireless mouse is out of batteries and I need a single AAA battery, which is a pain because you can’t buy a single AAA battery. So I’m at a Midtown Manhattan pharmacy, looking at batteries, and it looks like for 16 batteries it’s 20 bucks, so a $1.25 a battery, but there is no way I need 16 batteries. Let’s go look somewhere else.

    Okay. On Amazon, AAA batteries, Amazon Basics. This is 20 batteries for 24 cents a battery. 16,000 reviews, 4.5 stars. I have no choice. I’m going to buy these.

    So this isn’t just a battery thing; we actually looked at the data, and prices for books, and consumer electronics, apparel and accessories, they’ve actually been falling for years, and these are the sectors of the economy that have seen the biggest uptick in terms of online consumption. We know all Americans like cheap things. But according to Rick Rieder, our Global Chief Investment Officer for fixed income, this sort of bargain shopping is fundamentally reshaping the economic landscape. I’m your host David Brodnick, we hope you enjoy.

    Rick, thank you so much for joining us in the studio today. So let’s get right to it. Set the stage for us. Inflation rates globally are incredibly depressed across the developed market world, can you just give context around how low and how sustained this period of low inflation is looking?

    Rick Rieder: So I think there are a couple of things to factor in. First of all, the economy can grow without as much inflation globally as it has before. It’s one thing when people talk about inflation, and historically, people thought inflation, my god, if it’s not staying at the level at a two percent or so level, that there’s no growth and there is no inflationary expectations, no investment. It’s not what is happening today. We’re going through a cost revolution of epic proportion. I think it’s the greatest cost revolution we’ve ever had. Inflation is not happening while growth is extremely strong. In fact, when you look at the quantity of goods, quantity of services that are taking place through the system globally—you see this in global trade, you see this in exports, you see it literally in things like apparel, why is the quantity going up? It’s going up dramatically. People are consuming more apparel, they’re consuming more goods, just at a lower cost. It’s because technology is changing the distribution mechanism, changing commerce today and this concept. And you’re now seeing central banks that are saying, okay, we can actually move rates moderately higher, even though we’re not hitting this two percent target. It’s because we’re never going to hit the two percent target in this type of framework.

    I should say that we are starting to see inflation trend higher. You’re seeing it in places because you’re seeing wages now moving higher. When you measure wages right, you’re seeing a dynamic. We showed this in our last monthly that the median wage as opposed to the mix shift, because you’ve hired so many lower income jobs, that have depressed the hourly average earnings. The median wage is up somewhere between 3.5 and 4.2 percent. That is strong. So you’ve hired a tremendous amount of people, by the way, not just in the U.S. You’re seeing this in Europe and other parts of the world. Now you’re getting some wage acceleration. We do think you’re getting inflation that is trending higher, and we will approach that two percent number, but boy, the headwinds to get there are difficult.

    David Brodnick: So the demographics and wage growth, we’re seeing that starting to flow through into the inflation rates. But the countervailing force in your opinion is obviously technology: how is technology, for lack of a better term, eating inflation, and how is that suppressing inflation rates so dramatically?

    Rick Rieder: So it is incredible, and people talk more and more about the Amazon effect, which is clear in terms of what to do, and you see that in the prices of goods. And I think it took people a long time to figure out that gosh, we see it in things we consume and it’s cheaper, it’s easier to get them; logistically, you’re taking out the middle man in a lot of these places. But now it’s been flowing through the inflation data. So obviously you have that. What people don’t focus on is the second and third order effects that are so profound. For example, in New York City, you can use one of the car services to get around, and I think it’s $5 dollars to get from one point in the city to the next. What does that do? The other services all of a sudden now have to lower their prices. By the way, then the rental car companies have to lower their prices, and then all of a sudden, now they’ve got to reduce the size of their fleet. So what happens? Used car prices come down. Then what happens to new car prices? They start to come down. It’s the second and third order effects that are so powerful in terms of what is creating this pressing down of inflation.

    David Brodnick: So presumably you can’t squeeze your supply chain to a zero cost basis.

    Rick Rieder: Right.

    David Brodnick: Is there a peak point of disinflation that we’re going to see? Is this compression going to occur over five, ten years?

    Rick Rieder:  Yeah. I think that’s a fair point, you’ve hit this Moore’s Law curve that’s really been accelerating. I think we’ve got probably another year or two where costs continue to come down, and you shift cash flow in the world to different places.

    And by the way, you create pricing power in some areas, such as the big introduction of the Apple iPhone. Boy, people are impressed with how high that price is. You’re shifting cash flow around and you’re shifting pricing power around in the world. If you can’t lower the cost anymore, then I think investment starts to get cut off. And I don’t think we’re there yet, but I would argue in some places, transportation services, it seems pretty low right now. And I think you’ll probably see it start to level off and then start to improve again. But I think we’ve got a period of time before it takes place. But I don’t think it’s a five to ten year range; I think most of this will play through in the next year or so.

    David Brodnick: So this is a bit of a provocative question here, but I just remember a couple weeks back, post the Amazon acquisition of Whole Foods, everybody was talking about a 15 percent reduction of price of avocados and bananas. It seemed that embedded in this conversation was this feeling that maybe price reduction, this deflationary pressure, has costs. Do you think in aggregate, this reduced ability for corporations to generate cash flows is ultimately going to have a negative cost in terms of unemployment rates or compensation for individuals, or is the deflationary benefit outweighing the inability to drive wage growth or the possible layoffs that might accompany this kind of pressure?

    Rick Rieder: So, that is a really hard question because you can go a bunch of different ways on that. I do think automation robotics will continue and there will be a cost in terms of jobs; part of why I’m such a devout believer in education is as you move to a more service economy, as you move towards this automated economy, you have to make sure people are educated. And I think you’re going to see that shift. So yes, I think there is a cost there. I do think there is a cost of investment dollars where they go. You’re seeing it with companies today, what are they doing, their cap-ex expenditure is not that high, the heavy infrastructure plan to build, do I need another building? What are they spending on? Research and development, software, make my business more efficient. That has costs as well that we’ve seen play out. When you don’t build those plants or you don’t build out infrastructure, it certainly creates a dynamic where those businesses don’t grow, which we’re seeing in some of the retailors. There is a lot of real estate that is available as a result of this. So absolutely there are costs as the system shifts. I’ve seen quotes that I believe in that ultimately I think people are going to work fewer hours and I think it’s going to be more about experiences, and automation and people working fewer hours. How we get from here to there is tricky.

    David Brodnick: Maybe the Tim Ferriss or Maynard Keynes four hour work week. I wouldn’t object to that.

    Rick Rieder: No, I’m looking forward to that. What was it, if you go back 100 years, the average work week in the agricultural period was about 100 hours on average, now we’re down to about 35, and the view is, by 2050, we’re probably down to 15. I’m still at 100, so I don’t know, hoping to get it down sooner.

    David Brodnick:  So a last question here, just to render this investible, you alluded to the fact that this disruption is not happening—it’s not equally unfolding across different sectors. For bond investors, what are the implications of this? Obviously retail being more exposed to the risks than say, a technology firm. How do you think about that when constructing bond portfolios?

    Rick Rieder: So a bunch of different ways. First thing you think about is interest rates are probably going to stay lower for a long period of time. What drove volatility in the system certainly in the last decade—if you go back 20, 30 years, it was housing prices that during the baby boom created this tremendous volatility of inflation, but then energy, in the last 20 years, you had oil go from 40 to 150 to 80. Because of technology, because of horizontal fracking, we’re not going to have another shock in energy again unless there is some geopolitical event, because of where it’s produced around the world. It means interest rates stay lower for longer, it means that discount rates on assets is lower. It means valuations, whether it’s real estate, the equity market, any asset, your valuations can stay higher for longer. And I don’t think people can take that into account when the volatility of inflation is lower. When the discount rates stay down, you can be more confident in a long duration asset, meaning you hold arguably more risk. But if the discount rate stays down, your net present value of those flows is more powerful. So anyway, I think that is a really big deal.

    In terms of from a granular asset class point of view, energy was what created stress in the markets last year. Retailing then took over. So we’re thinking about how cash flow is shifting in the world: where do I go and get my cash flow? The demand for income is not going away. It won’t go away for ten years because of the demographic. Emerging markets, the places where they’re growing, they are the beneficiary of trade growing in the world, growth being good. So we like emerging markets quite a bit. It’s a place where we think cash flow will be durable.

    David Brodnick: Wonderful. Well, Rick thank you so much for doing this.

    Rick Rieder: That was fun. Thank you very much.

Episode 1: When reflation becomes expansion

Is the market’s current calm a positive sign or signaling something ominous? Will global central banks stick the landing as they shift to a tighter policy stance? Richard Turnill and Jeff Rosenberg answer these questions and more.

  • View transcript

    David Brodnick: At BlackRock, July starts as it always does with the launch of our Investment Institutes media outlook. In fact, just weeks ago, 90 of our investors and strategists gathered in London to debate the state of the markets, the economic cycle and what the future holds for our clients. There’s a lot of debate. Is the market’s incredible calm a positive sign or does it signal something ominous? With the U.S. steel low globally, are stock valuations really as lofty as they seem? Can central banks stick the landing as they shift to a tighter policy stance? In this episode of The Bid, we’ll turn to some of our senior most thinkers to unpack BlackRock’s views for the back half of 2017. I’m your host, David Brodnick. We hope you enjoy. Our Chief Investment Strategist, Richard Turnill joins us straight from London and from what I believe is a fairly aggressive charity bike ride you completed last week?

    Richard Turnill: That’s right, David. That’s 500 kilometers across Europe, so glad to be back.

    David Brodnick: I imagine so. Richard, in the U.S. we’re about a decade into the current market cycle, but the sentiment amongst our investors at our investment forum was pretty constructive this quarter. Can you explain to our listeners why you think this cycle continues to have legs?

    Richard Turnill: I think cycles die of old age and we’re eight years into this expansion and the typical length of expansion has been eight years, so many investors think that we’re due a recession and, therefore, one must be around the corner, but when we at BlackRock look at the cycle, we think you’ve got to take into account the fact it’s been an incredibly slow growth cycle so far. The pace of growth has been far, far below what we’ve seen in previous expansions and as a result of that, we haven’t created the unbalances, which typically lead to the end of the cycle. We take into account the fact that growth has been so slow.

    Actually, we’ve come to the conclusion that rather than being at the end of the cycle, we’re somewhere in the middle. What that means is that the time to the next recession could potentially be measured in years rather than quarters. Some of the evidence I look at to support that would be some of the inflation data. We saw core inflation in the U.S. fall back to a two-year low. The wage data we’re getting, which is rising gradually, but at 2.5%. Average out of the earnings growth is, again, consistent with an economy, which is somewhere in the middle of its cycle rather than late cycle, so we think we’ve got potentially years to go in this expansion and I think for interest rates that means gradually rising interest rates, gradually rising bond yields over time, but it sets a pretty, I’d say, constructive backdrop for investing in equities.

    David Brodnick: We’re in the midst of a kind of slow motion recovery compared to predecessors. Seems fairly average with some significant room to run, but with valuations where they current stand, it doesn’t look like anybody’s getting rich quick in the markets today. Are there ways you suggest investors should be positioning to take advantage of this recovery and perhaps make the coming years a bit more fruitful?

    Richard Turnill: You’re certainly not going to get rich quick by keeping your money in cash. Actually, what’s going to happen is you’re going to get poor slowly. You’re losing purchasing power every single day that you keep your money in cash over the next five years. We estimate you’ll lose around 3% of the value of your assets in real terms by hoarding money in cash whereas in fixed income your real returns are likely to be close to zero. For those looking to build wealth, I think it’s time to start looking at areas other than cash and fixed income and where to generate returns. Actually, the area we think they should be looking is in equity markets and specifically in international equity markets.

    We like the U.S. market, but we think we’re going to get even higher returns if we look at markets like Europe, Japan and actually like emerging markets.

    If we look at the European markets today, they trade at around a 20% discount still to the U.S. market. They’ve done well this year, but we think there’s still further scope for the valuation gap to close. We’ve seen strong fundamentals in the European economy. PMI data now at a six-year high in Europe. We’re seeing a decline in populism. One of the reasons investors have been very nervous about investing in Europe and actually the potential for stable pro-EU governments in both France and Germany going forward, so we think Europe offers a very attractive opportunity for U.S. investors and emerging markets on close to a 30% discount to the U.S. and where we’re seeing increasing signs of broadening growth across many emerging markets, particularly in Asia where we see China in a self-sustained expansion.

    David Brodnick: I thought the investment outlook this quarter really exposed a very interesting myth about volatility and for those who are listening who haven’t read the full report, essentially the BlackRock Investment Institute is proposing that the low volatility that we’ve seen in markets of late is really just reflective of a very benign economic backdrop and the sort of mean reversion that so many market prognosticators have called for may not come to pass the way that we’ve predicted. Can you flesh this out a little bit for us, Richard?

    Richard Turnill: Yeah, there’s an irony here, which is that many investors look at the current low levels of volatility, low levels of the VIX, the so-called fear index and they see that as a warning sign. They see low volatility, low VIX as a sign of complacency in the market and, therefore, a reason not to invest. Our analysis doesn’t support that at all, so first of all, low levels of the VIX give no forward-looking indication as to the direction of the market either way, but perhaps more importantly, what we see is that periods of low volatility are actually normal. Many of us have had an experience of markets heavily influenced by the last decade and particularly the global financial crisis. When we see the VIX down close to ten, that feels extreme, feels abnormal because it’s low in the context of what we’ve seen the last decade, but actually we look at longer periods of time. What you see is volatility is better characterized by prolonged periods of low volatility often associated with periods of stable economic growth followed by short periods of much higher volatility. It was often characterized as fear and greed.

    Today, we’re in this low volatility environment. That’s important because if you’re in a low volatility environment today, one in which the economic environment is constructive, then actually the likelihood is that you stay in that volatility environment until one of two things happen, so the first is you go into a recession. Sustained spikes in volatility are always associated with either a recession or a significant financial crisis.

    We see pockets of risk, but no systemic risk, partly because we’ve seen authorities take a much stricter regulatory approach since the global financial crisis, which has really helped cap leverage across the system.

    This is an environment where investors should look to take advantage of opportunities of short-term volatility to add to their risk positions over time and rather than fearing a market volatility, actually I think it should be embraced. Most investors today still don’t own enough risk in their portfolios to meet their financial goals.

    David Brodnick: Richard, thank you very much for spending the time with us here today.

    Richard Turnill: Thank you.

    David Brodnick: Let’s turn to the world of bonds now with Jeff Rosenberg, BlackRock’s esteemed Chief Income Strategist. Jeff, we’re thrilled to have you.

    Jeff Rosenberg: Esteemed? That’s a very nice compliment, thank you.

    David Brodnick: It’s been an odd year in bonds and I’ll just be blunt. What the heck is going on? Monetary policy is turning tighter. Growth is stabilizing, yet the yield curve just keeps flattening. Has the term premium vanished or is it just dormant?

    Jeff Rosenberg: There’s a lot of stuff in that question, David. Let’s just unpack it just a bit. What’s really confusing in the big picture sense is the Feds raising interest rates, the economy’s doing well. That’s why the Fed’s raising interest rates, yet long-term interest rates up until this last week or so have been trending lower. That’s what you meant when the term premium, the difference between long-term interest rates, say the ten-year and short-term interest rates, say the two-year, what the Fed is moving up are moving in opposite directions. Now there are a lot of reasons for that, but basically the story is that the post-election environment saw a big surge upward in growth expectations that fueled expectations for a faster pace of policy accommodation normalization by the Fed that now we’re getting, but it’s not as fast as what market participants expected. There’s more in there as well around inflation expectations. Near term inflation data has actually been quite disappointing and as I think we’ll get into, the global picture has really been a big factor in pushing long-term, interest rates in the U.S. lower as up until most recently, long-term interest rates around the world have been declining and term premiums have been flattening as well.

    David Brodnick: Just looking at the Fed a little bit further, we’re getting increasing clarity in terms of the pace and timeline against which they’re going to be pairing their balance sheet. Do we think they can really stick the landing here?

    Jeff Rosenberg: There was a lot of angst a number of years ago around the taper tantrum 2013. It was a different environment. There was a lot more reliance on an ever-increasing balance sheet and we just evolved away from. More importantly or as importantly, the Fed’s communications strategy is learned from the mistakes around taper tantrum. There’s been a much greater degree of priming the market for the communication that we got last meeting, which is here’s the path that we’ve laid out. Now the focus and we got the minutes recently. When exactly are they going to execute the plan, but we know what the plan is and expectations are pretty much centered around sometime in September. There’s a possibility in the July meeting, but generally people expect they’re going to start the plan and we know what the plan is and, importantly, the plan is to just run it off in the background. Not make it an active communication strategy, not try to confuse the market about tinkering with the pace or the level. They’re going to set it on autopilot. We’re going to have a very, very gradual normalization process.

    By 2023 or so, the balance sheet will be normalized. That’s under everything else unchanged. Of course, everything else won’t be unchanged. That’s kind of your best case scenario. The balance sheet will normalize and the market will focus on what they’re doing on short-term interest rates. The short answer to your question is, yes, we don’t expect the market to have a taper tantrum type of event because the Fed is paring to back its balance sheet through this very gradual runoff.

    David Brodnick: Just to take it into the more investible realm here, we’re dealing with an environment in which we’re expecting the term premium to come back to life, yield curves to steepen, rates to gradually rise. We have kind of complex views on the bond market today. We like investment grade over high yield, inflation length over nominal exposure. There’s a lot to balance. How do you suggest investors go about positioning in fixed income?

    Jeff Rosenberg: The first thing really is to just understand what role fixed income is playing in your portfolio. I can’t make a recommendation without knowing what role you are looking for fixed income to play. The general role, the kind of generic perspective is that we’re talking about a balanced portfolio where fixed income is balancing risk against an equity portfolio and there’s some kind of mix of assets. Within that kind of context, what we’re talking about is an outlook for Fed normalization, rising interest rates, normalization of the term premium, everything that we just talked about and how that manifests itself into portfolio structure. Well, you want to take a bit less duration risk in an environment of rising rates and increasing term premium because those things are going to ultimately be good for your fixed income portfolio, but along the way, if you have too much interest rate exposure, too much long maturity exposure, it’s going to be damaging to your price return performance. What we’re talking about is just paring that back a little bit.

    Now how that manifests in a specific portfolio, again, it depends on the degree of risks that are going on on the other side, but generally it means bringing down durations, generally means managing some interest rate risk. When it comes to term premium, there’s some tactical views around where on the yield curve we like to take duration exposure. Right now, that tactically means we actually like the longest end of the curve, but that means offsetting that overall duration by having some either short positions, which you can implement through flexible strategies or through having a bigger position in the very frontend of the curve. Those are going to be tactical. We’re going to move around on those. Now on credit, what we’re talking about is an environment where valuations are relatively full. The prospective return outlook is less than what we’ve recently experienced because valuations have already seen a compression in the relative value, the credit spread, the difference in yields versus treasuries.

    Going forward, we think there’s really little of that to be had and so it argues for a bit more defensive positioning, hence the focus on higher quality positions in investment grade. Finally, when it comes to inflation protection, that’s a way to add a bit of diversification, a way to mitigate some of the impact of rising interest and valuations have cheapened up recently on this inflation scare, making the inflation protected market a bit more attractive over the medium term where we expect inflation to eventually start to tick back up. Now that’s a medium-term view because of the near term. Over the next one, two, three months, inflation and headline inflation is going to continue to tick downward, but over a 12 month horizon we’re going to get back to in our forecast closer to that 2% objective and that kind of environment, substituting nominal treasury exposure for some inflation-protected exposure if going to be a successful strategy for maintaining the role of fixed income in a balanced portfolio i.e. ballast, but mitigating some of the cost of that rising interest rate environment.

    David Brodnick: Last question here. I know your travel schedule is relentless, but I’m hoping to get some time out of the office this August. If we were to find you on the beach, what cocktail would be in your hand?

    Jeff Rosenberg: Well, it’s hard to make a good cocktail on the beach because you lack the proper equipment, so if I’m in my backyard or I’m in a place where I can make the cocktail, I make what I would call the bond guy’s version of a mojito. Now what that is is this is not your bartender 7-Up, Bacardi, a lime and some mint leaves. This is the dark and brooding version of a mojito, so it’s really the key that the ingredients are dark rum. It’s brown sugar and then some club soda. The club soda, brown sugar allows me to modulate the sweetness because I don’t like my mojitos too sweet. It’s got to be a nice balance and I like it dark and brooding, the way a bond guy would drink his mojito.

    David Brodnick: Garnish with a prospectus run to taste.

    Jeff Rosenberg: Exactly.

    David Brodnick: Wonderful. Well, Jeff, thank you so much for joining us today and for our listeners, thank you as well. Here’s wishing you all a restful and profitable summer. We hope to hear from you next month.